3rd Quarter, 2019

Your companies’ average third quarter sales and earnings growth of 12.1% and 12.4%, which excludes Wabtec’s results, are significantly better than the results of the S&P companies which reported a collective earnings decline of 2.2% on a 3.1% increase in sales. We exclude Wabtec from this comparison because its transformative acquisition of GE Transportation resulted in an 86% increase in its sales and an 8% increase in earnings after merger expenses.

Automatic Data Processing

ADP’s fiscal first quarter revenue rose 6% to $3.5 billion and adjusted earnings of $1.34 rose 12% from a year ago as the company’s operating margin increased 60 basis points to 21.3%. Share repurchases reduced the number of shares outstanding by 1%. ADP’s Employer Services segment generated 5% organic constant currency growth to $2.4 billion as the number of employees on existing client payrolls increased 2.4%, down from the 2.8% rate of growth in the previous quarter, but flat with the rate of growth during the same quarter last year. New business bookings, an indicator of future growth, rose 6%. ADP’s PEO Services segment revenue rose 8% to $1.1 billion as average worksite employees increased 7% to 563,000. Interest earned on client funds and client funds balances rose 13% and 7%, respectively, to $134 million and $23.7 billion as the average interest yield improved 10 basis points from a year ago to 2.3%. ADP decided to liquidate its Dutch and French client funds’ portfolio as a result of the negative interest rate environment.

ADP’s Next Gen HCM (Human Capital Management) platform continues to gain recognition in the marketplace after several years of investment. It is an open cloud-native platform that scales and adapts to its customers’ needs in a secure environment. The average HR organization uses 11 systems of record. To simplify and still meet customers’ varying needs, ADP’s platform enables the rapid integration of any of its 140 “mini apps”. Once development is opened to third parties, its offerings will be supplemented by the 400 apps that currently exist in the ADP Marketplace which receive more than 780 million hits annually. ADP’s mobile HR app is the third most highly rated business app in the Apple App store with a 4.7 rating and 1.1 million reviews. ADP also leverages it’s unmatched HCM data through an artificial intelligence application, ADP DataCloud. It provides recommendations on hundreds of talent issues by analyzing data from ADP’s more than 740,000 U.S. customers who have contributed more than 30 million job descriptions. ADP continues to enhance its leadership in multinational payroll. Microsoft recently adopted its multinational solutions to reduce the number of payroll administrators from 400 to a handful of payroll experts across the world. The total return on ADP stock is 31% since the beginning of the year.


CME’s strong third quarter results were driven by a 30% increase in ADV (average daily volume) to 20.2 million futures and options contracts from a year ago. ADV outside the US rose 40% to 5.3 million with Europe up 34%, and Asia up 61%. Volume growth was boosted by increased volatility, geopolitical uncertainty and new contracts, including SOFR (Secured Overnight Financing Rate) which is replacing LIBOR and Micro E-Mini Equity futures. Volume growth was strongest in Equity index and interest rate contracts which rose 47% to 3.9 million and 39% to 10.9 million, respectively. Energy and metals rose 12% and 32% to 2.5 million and 0.8 million, respectively, while agricultural commodities and foreign exchange fell 2% to 1.3 million and 10% to 0.9 million. CME’s revenue of $1.3 billion during the quarter rose 41% overall with clearing and transaction fees exceeding $1.0 billion, up 38%, and market data and information services up 17%. Adjusted earnings of $1.90 per share rose 31% from a year ago. The acquired NEX business generated $194 million in revenue during the quarter. An influx of new participants utilize CME’s SOFR futures which were launched in May 2018. Open interest in SOFR futures grew to 508,000 contracts representing $1.9 trillion of notional value in October. More than 6 million contracts have traded since their introduction. CME announced it would launch SOFR Options on January 6, 2020.

CME is investing in its Globex electronic trading platform to accommodate the migration of BrokerTec and EBS from their legacy NEX technology infrastructure. The migration results in duplicative costs as the new environment is built and tested but will ultimately reduce operating costs and provide revenue synergies as cash and futures markets are available on a single platform. Moving these trading platforms to Globex draws more business from customers who also benefit from portfolio margin savings which reached a record $5.7 billion in October. The technology platform migrations remain on track and are scheduled for 2020 and 2021. Expected cost savings from the NEX business integration will total $200 million annually by the end of 2021. Of this, 45% comes from SG&A, 20% from operational functions and 35% from IT consolidation. The total return on CME stock since the beginning of the year is 11%.


Visa reported a strong fiscal fourth quarter and year ending September 30, 2019 with revenue rising 13% and 11%, respectively, to $6.1 billion and $23.0 billion. Earnings per share, excluding one-time items, rose 21% in the fourth quarter to $1.47 and 18% in the full year to $5.44. During the fourth quarter, global payments volume of $2.3 trillion grew 8.9% in constant currencies, up from growth of 8.7% in the previous quarter. U.S. payments volume rose 8% as lower gas prices and travel spending were more than offset by e-commerce spending growth. International payments volume, which accounts for 55% of Visa’s total volume, rose 10% in constant currencies and 12% excluding China. Visa card acceptance in China is limited to hotels, airports and other areas where foreign visitors go. European payments volume of $441 billion grew 8.8% in constant currencies and 13% excluding the U.K. which remains weak in anticipation of Brexit. For the full year, Visa payments volume of $8.8 trillion rose 9.1% in constant currencies as the number of payments transactions rose 12.0% to 180 billion. Visa announced an increase of 20% in its dividend to an annual rate of $1.20 per share. The total return on Visa’s stock since January 1 is 40%.

Visa continues to expand its global network and invest in tools and technology to improve authorization speed and accuracy and to reduce fraud. Visa cards are now accepted at 61 million merchant locations around the world, up 14% from a year ago. Visa acquired U.K.-based Earthport, one of the world’s largest independent cross-border automated clearing house (ACH) money transfer services, for $320 million in July 2019 to extend the reach of its network. An ACH processes high volumes of electronic transactions between financial institutions in batches and are typically initiated by the payee. Before Earthport, Visa could reach about half of the world’s bank accounts through Visa Direct, Visa’s near real-time service that transfers money between bank accounts linked to Visa debit cards. Visa will integrate Earthport with Visa Direct to provide Visa clients a way to send payments to most of the world’s banked population, reaching more than 99% of bank accounts in 88 countries. Visa Direct transactions rose over 100% to more than 2 billion in fiscal 2019, still just over 1% of Visa’s total volume. Customers use Visa Direct for person-to-person transfers, business-to-customer distributions such as payroll and business-to-business bill payments. Visa Advanced Authorization analyzes every transaction in one millisecond, 379 million times per day. In the last year, Visa’s artificial intelligence-based risk scoring system helped its 16,000 card-issuing financial institution clients prevent $25 billion in fraud, more than Visa’s annual revenue. For in-person transactions, chip technology on cards has reduced counterfeit fraud at chip-enabled merchants by 87% since 2015 when the payment industry began to deploy chip technology in the U.S.


Record membership renewal rates helped Costco’s fiscal fourth quarter earnings per share of $2.69 increase 14% over the year ago period, excluding a one-time $123 million product tax assessment which Costco plans to dispute. Costco members in the U.S. and Canada renewed at a rate of 90.9%, up from 90.7% in the third quarter, and global renewals were 88.4%. Membership fee income in the quarter ending September 1, 2019 rose 5.3% to $1.05 billion, or 72% of operating income. Ten net new warehouse openings, 3.7% more shopper visits at existing locations and 1.4% higher spending per visit drove total revenue, including retail sales of $46.5 billion and membership fees, 7.0% higher to $47.5 billion. Gross margin percentage on Costco’s merchandise rose 14 basis points to 11.06% as lower fuel prices of $2.94 per gallon versus $3.05 a year ago resulted in higher margin to Costco. Costco benefits when gas prices decline because it reduces prices less than its wholesale costs fall. It also raises prices less when costs rise resulting in a lower margin at higher fuel prices. Costco sold over $16 billion of gas in fiscal 2019, or 11% of its total sales. Recently Costco added real-time gas prices to its mobile app which has increased traffic. About half of the customers who refuel at Costco also make purchases in the warehouse. In the fiscal year ending September 1, 2019, revenue of $152.7 billion rose 7.9% and earnings of $8.19 per share increased 17.0%.

On September 10, 2019, Costco opened its $300 million state-of-the-art chicken processing plant in Fremont, Nebraska. At capacity, the plant will produce 2 million air-chilled chickens per week, enough to meet 40% of Costco’s annual demand and ensure a $4.99 price for the 60 million rotisserie chickens it sells each year. About 95% of U.S. poultry plants are still water chilled. Costco’s decision to invest in a massive air-chilled facility reflects its commitment to high quality product and significantly reduces its water consumption. The total return on Costco’s stock is 47% since January 1.


Wabtec’s third quarter sales of $2.0 billion were 86% higher than the sales of $1.08 billion realized during the comparable quarter a year ago. The increase is wholly attributable to the acquisition of GE Transportation consummated on February 25th of this year. Wabtec now is the world’s leading manufacturer of locomotives. Its preeminent position is bolstered by having 16,000 locomotives under long-term lease to railroads in North America. These contracts contain a provision for reductions in the day rate if a locomotive is taken out of service. This provision is adhered to scrupulously because a locomotive improperly stored must be thoroughly overhauled before it can safely be returned to service. GE Transportation’s principal manufacturing plant is a new facility built by GE in Fort Worth Texas before GE’s financial difficulties compelled it to sell the locomotive business to raise cash.

Wabtec’s third quarter fully diluted earnings were $1.03 per share, starting with GAAP earnings of 48¢ to which 28¢ is added for restructuring and litigation costs along with harmonization costs of 25¢ and 6¢ for property and plant appreciation from which 4¢ is subtracted for non-deductible transaction costs. Depreciation was $43 million during the quarter. Amortization is $80 million. For the full year depreciation and amortization will amount to $400 million. Wabtec has bought a profitable, well-managed business that complements and strengthens its other rail businesses. Its locomotive backlog contains orders for 1,850 new locomotives and modernizations of 775 locomotives, which generate half the revenue of a new $4 million locomotive but are more profitable. Older direct current locomotives constitute 65% of the North American fleet. Conversion of these older locomotives to alternating current will increase their horsepower by over 35%. These opportunities along with focused experienced managers has encouraged Wabtec’s new able CEO, Rafael Santana, to set a goal of realizing cash flow from operations of $900 million for this year and earnings per share of $4.10-$4.15. The total return on Wabtec’s stock is 10% since the beginning of the year.

Varian Medical Systems

The successful September launch of the Ethos therapy system, which allows clinicians to adapt treatment each day based on the position of a patient’s tumor and surrounding organs in the standard 15 to 20 minute treatment period and strong fourth fiscal quarter order growth of 10% in Oncology Systems’ North American market lifted the Varian Medical Systems’ stock price 32% from a 52-week low of $105 on September 4, 2019. Investors saw that the company’s integrated radiation systems and software were designed to provide the quality and efficiency needed to meet value-based reimbursement requirements of CMS’ Alternative Payment Model. Varian Medical Systems’ stock price is up 22% since the beginning of the year. The Ethos therapy system, which contains elements of the new Halcyon system, takes a CT scan at the beginning of each treatment session and uses artificial intelligence to adjust a patient’s diagnostic MRI, PET and CT scans to create new diagnostic images. The software creates a new treatment plan that clinicians can then modify and deliver. Varian took orders for 17 Ethos systems during the last five weeks of the quarter.

Fourth quarter revenue of $879 million rose 11% over the same period a year ago. Unfavorable foreign exchange rates reduced revenue by one percentage point during the quarter. Oncology Systems’ revenue of $820 million rose 9% with software revenue up 12%. Orders of $559 million rose 11% with strong growth in China and India, Varian’s second and fourth largest markets. The company won its first big software tender in China at Tianjin Medical University Cancer Hospital that includes the ARIA China clinical information platform which is in Chinese and is designed for the workflow in a Chinese hospital. Varian also received ten orders for Halcyon systems during the quarter. Varian’s revenue in India has grown 25% annually for the past five years and the installed base of radiation systems has grown from 109 to 273 during that time. In March 2019, Varian and the Tata Trusts signed a three-year agreement to provide up to 200 radiation systems with integrated software. Tata ordered 13 TrueBeam systems during the fourth quarter. Full year revenue of $3.2 billion grew 12% over fiscal year 2018 with revenue from the company’s four recent acquisitions contributing one percentage point to revenue growth. Earnings per share of $1.21 for the quarter and $4.63 for the year rose 4% and 6%, respectively. Varian received a tariff exclusion for the export of its radiation systems from China on September 5, 2019. The 19¢ per share benefit to earnings for both periods was offset by an 8¢ per share increase in tax expense related to the 2017 tax reform law and a 5¢ per share gift to the company’s foundation to support clinical trials.


Mettler-Toledo’s third quarter sales rose 4% in local currencies over the third quarter of 2018. Unfavorable foreign currency rates reduced sales reported in U.S. dollars by one percentage point. Sales in the Americas grew a strong 7%, while sales in Europe and Asia rose 2% and 4%, respectively. Food Retail sales declined 15% over the same period a year ago and reduced sales in the Americas and Europe by 2 percentage points and sales in Asia by one percentage point. The company’s third quarter sales rose 6% excluding Food Retail. Excellent execution in the Laboratory and Industrial businesses and a 7% increase in Service and Consumables’ sales more than offset the impact of lower revenue in Food Retail on operating profit and margin for the quarter. Operating profit of $196 million grew 8% and the operating margin of 26% was 1.2 percentage points higher than the 24.8% operating margin achieved a year ago. Earnings per share of $5.77 rose 13%.

Mettler’s execution of its targeted selling programs and its improving supply chain and inventory management contribute to higher operating margins, but product innovation is critical to the company’s success. While no single new product has a material impact on sales, the constant flow of new products gives the sales force the opportunity to demonstrate the value of the newest instrument when a customer considers replacing one and allows the company to consistently realize price increases. Mettler’s market-leading instruments account for 40% of the instruments used on a lab bench. The company continues to introduce new products to increase sales of its pipettes. In 2016, Mettler launched Rainin SmartStand, which holds four of its newest pipettes. It reads an RFID chip in each pipette to determine whether the pipette needs to be calibrated and checks its service record. This quarter, Mettler launched software that links all SmartStands at a company and tracks the location and calibration status for all pipette brands and models in a lab. A pipette is a personal instrument and individuals have strong brand preferences. A large biopharma company may track as many as 10,000 pipettes. Mettler-Toledo’s stock price has risen 34% since the beginning of the year.

IDEXX Laboratories

IDEXX Laboratories’ third quarter revenue of $605 million rose 12% in constant currencies over the same period a year ago with an extra day of sales adding one percentage point of growth during the quarter. Unfavorable foreign exchange rates reduced revenue growth in U.S. dollars to 11%. Strong gains in consumables and reference lab sales contributed to 14% growth in global Companion Animal Group (CAG) Diagnostic recurring revenue with U.S. and international revenue up 13% and 16%, respectively. The extra day of sales added 2% to the revenue growth rate in the U.S. and 1.5% internationally. Strong instrument consumable revenue growth, lab productivity gains, price increases of 2% to 3% and operating leverage from strong revenue growth raised operating profit by 19% to $140 million. The quarter’s operating margin rose 1.3 percentage points to 23%. Earnings per share of $1.24 rose 21% over the same period a year ago.

Excellent execution by the U.S. sales force achieved the strong revenue gains in sales of in-clinic instruments and consumables, reference lab services and rapid assay tests as well as high customer retention rates. The sales force continues to advance IDEXX’s preventive care initiative, adding 330 practices during the quarter for a total of 3,500 practices in the U.S. About two-thirds of the sales representatives added at least one clinic to the program. The company uses blood work as a proxy for diagnostics utilization and found that only 8% of clinical wellness visits included it. For clinics enrolled in the preventive care program, wellness visits with blood work have increased about 1% per year since 2017, a year after the program was first introduced. This early success supports the program’s 1% to 2% contribution to annual CAG Diagnostics recurring revenue growth. IDEXX is adding 40 new sales representatives and 23 new territories in the U.S. so that its sales representatives have more time to spend at each clinic. Jay Mazelsky became President and CEO of IDEXX on November 1, 2019. Jon Ayers, who continues to recover from a spinal cord injury that resulted from a cycling accident in late June, will remain on the Board. Mr. Ayers made the decisions to reorganize the sales force in 2014 and to move to direct distribution in 2015. These changes and the current team who implemented them account for the accelerating growth in IDEXX’s revenue and profits. IDEXX Laboratories’ stock price has risen 34% since January 1.

Ecolab, Inc.

Ecolab’s third quarter revenue of $3.81 billion rose 2% over the same period last year. With the sales force focused on getting customers to accept higher prices, all the revenue growth came from price increases. A one percentage point increase in sales from acquisitions offset the impact of unfavorable foreign exchange rates. The sales force began to focus on winning new business a few months ago which led to net new business growing 40% in the third quarter. It takes 3 or 4 months for new business wins to generate sales. Revenue for the Global Industrial business of $1.41 billion rose 3%. Revenue growth in Food & Beverage, chemical plants, commercial buildings and life sciences more than offset slower growth in the automotive and steel industries to deliver 5% revenue growth for the Water business. Global Industrial revenue of $1.36 billion also grew 3% with 9% revenue growth from the Specialty business. Revenue from both the quick service restaurant and food retail businesses benefitted from Ecolab’s newest digital initiatives in food safety. Global Energy revenue fell 3% to $836 million as a significant decline in the Upstream business more than offset good growth in the Downstream business. The Downstream business will become part of the Global Industrial business once the Upstream business is spun off and becomes a publicly traded company in mid-2020. Revenue for the Pest Elimination business rose 6% over the same period a year ago. Ecolab’s operating income rose 11% to $636 million with growth of 13% and 17% to $240 million and $102 million, respectively, in the Global Industrial and Global Energy businesses. Operating income for the Global Institutional business rose 9% to $313 million. Earnings per share of $1.71 rose 12% over the same period a year ago and exclude special gains and charges and one-time tax items. The total return on Ecolab’s stock is 27% year-to-date.


Innovation and growth in online advertising drove strong results at Alphabet. Third quarter revenue increased 20% and 22% in constant currency to $40.5 billion. Operating income of $10.9 billion in the Google segment, which produces 99.6% of Alphabet’s revenue and includes advertising, cloud, Play and hardware, rose 14.5%. Earnings per share of $11.59 declined 2% from the year ago period, excluding the impact of losses on Google’s equity investments which reduced earnings per share by $1.47. Earnings this quarter were also negatively impacted by a 9.3 percentage point increase in the effective tax rate to 18% from an increase in unrecognized tax benefits and a $554 million legal settlement with French authorities related to a tax dispute. Alphabet’s stock price has risen 30% since January 1.

Revenue from Google’s digital advertising business increased 17.1% to $33.9 billion, or 84% of total Alphabet revenue, as print and TV ads continue to move online. Online ad spending in the U.S. rose 16.9% to $57.9 billion in the first half of 2019, driven by mobile advertising growth of 29.1% to 69% of total online ad spending, a substantial increase from 30% just four years ago. Ads delivered on video platforms are growing fastest, rising 35.7% in the U.S. in the first half of 2019. Video ads now account for 16.4% of total internet ad spending and two thirds of video ads are viewed on mobile devices. Google’s YouTube is the dominant online video platform with over one billion hours of videos viewed daily. Its new video ad tool allows marketers to upload multiple videos for each ad campaign and uses machine learning to deliver the most efficient combination of videos to users. Online ads employ two primary pricing models: performance-based (62% of ads) and impression-based (36% of ads). Performance advertising is priced per click and provides more information to advertisers than impression ads which are priced on an estimate of how many people view the ad. Impression-based ads build brand awareness while performance ads can more easily be traced to an action such as a purchase. Google Analytics provides tools to help customers see which formats and ad campaigns produce the best results. Clicks on Google ads rose 18% from the year ago quarter while impressions of Google banner ads on third-party sites increased 12%.

Johnson & Johnson

Johnson & Johnson delivered good third quarter results. Sales of $20.7 billion rose 1.9% in U.S, dollars over the third quarter of 2018. Foreign currency headwinds and the impact of acquisitions and divestitures reduced organic revenue growth of 5.2% by 1.3 percentage points and 2.0 percentage points, respectively. Earnings per share of $2.12 rose 5.9%, excluding amortization and transaction costs associated with the company’s recent acquisitions. J&J’s Pharmaceutical sales rose 6.4% to $10.9 billion. Generic competition for prostate cancer drug Zytiga reduced the quarter’s sales by 3.5 percentage points. Immunology sales rose 10.3% to $3.71 billion with revenue growth of $508 million for Stelara, primarily in Crohn’s Disease, and for Tremfya, J&J’s newest drug for psoriasis, more than offsetting the $243 million decline in sales of Remicade. Oncology revenue grew 8.8% to $2.76 billion with 42% growth in sales of Darzalex (multiple myeloma) and 33% revenue growth of Imbruvica (leukemia and lymphoma). Revenue for the long-acting anti-psychotic drugs rose 15% to $850 million.

Medical Device revenue of $6.4 billion grew 5.3% over the same period a year ago, excluding the loss of revenue from the sale of two businesses. Revenue for the Vision and Interventional businesses rose 6.1% and 14.3%, respectively, to $1.19 billion and $741 million. Strong sales growth from new products in Orthopaedics’ Hip, Trauma and international Knee businesses offset a decline in the Spine business to deliver revenue growth of 2.3% for the quarter. Tylenol in OTC and Neutrogena and Aveeno in Beauty raised their market share and were the largest contributors to Consumer’s revenue growth of 3.3% to $3.5 billion. Recent acquisitions and divestitures reduced organic revenue growth by two percentage points to 1.3%.

The total return on Johnson & Johnson’s stock is 12% since January 1. The stock price has moved with good and bad news about the opioid and the talc litigation. On October 21, 2019 several state Attorneys General announced a framework for settling all claims of the opioid litigation with J&J paying $4 billion of a $48 billion settlement. The talc litigation remains in the news. J&J’s stock price fell 6% on October 18, 2019 when the company announced that it had recalled one lot of baby powder because the FDA found a trace amount of asbestos (0.00002% or 200 parts per billion) in a bottle of baby powder. The stock price rose almost 3% eleven days later when the company announced that two independent laboratories tested additional samples from that bottle and from other bottles in the lot and found no evidence of asbestos.

Air Lease Corporation

Air Lease’s revenue during the quarter of $531 million rose 18% from the prior year as the company took delivery of 15 aircraft from its order book and sold 15 older aircraft for a gain. Adjusted earnings of $1.80 per share rose 4% and the company raised its annual dividend 15% to 60¢ per share. At quarter end, the Air Lease fleet was comprised of 307 owned aircraft, up 15% from a year ago, leased to 108 airlines around the world. The weighted average age and lease term was 3.6 years and 7.2 years, respectively, compared to 3.8 years and 6.8 years a year ago. Air Lease also manages 64 aircraft, four more than a year ago. On October 31, Air Lease agreed to sell 19 aircraft for $575 million to Thunderbolt III, a newly formed investment entity in which the company will retain a 5% equity interest and continue to manage the aircraft. The planes being sold by Air Lease have a weighted average age of 9.7 years. The prices of the aircraft being sold are 40% above the appraised value according to a widely referenced provider of used aircraft valuations and are meaningfully above book value. Environmental considerations and sustainability have become increasingly important in airlines fleet decisions which makes Air Lease’s young fleet and order book of the most fuel efficient, environmentally friendly aircraft available in the world highly valuable. The total return on Air Lease stock is 56% 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.