1st Quarter, 2020

As we write, we are enjoying the first lifting of some of the restrictions imposed by Governor Cuomo to curtail the spread of the Coronavirus (COVID-19). New York State continues to have by far the largest number of reported cases of the virus with 377,316 as of June 7 with New Jersey number two with 163,503. The marching of protesters for the past two weeks through parts of the city has now lessened and the looting seems to have ceased while political rancor has captured the attention of many news commentators. The Federal Reserve’s response to the 34% drop in the stock market value, as measured by the S&P, from February 19th until March 23rd along with a drop in the yield on our ten-year Treasury Bond to 90 basis points is conclusive evidence that the Federal Reserve will inject whatever amount of liquidity is needed to ensure that our financial markets are functioning and not impeding the recovery. The Fed’s actions already have aided the recoupment of almost all of the stock market decline from mid-February until the last week of March. This unprecedented injection of liquidity has worked. It has helped lift the prices of eight of our stocks while only three are below their prices at the beginning of the year.


The net impact of COVID-19 on Microsoft’s fiscal third quarter revenue and earnings per share, which rose 15% to $35.0 billion and 23% to $1.40, respectively, was minimal. The surge in remote work and learning necessitated by global stay-at-home orders increased revenue from Microsoft’s cloud services including Azure, Teams and Windows Virtual Desktop, Microsoft’s service that enables IT departments to let employees use personal devices to securely access business applications. Usage of Virtual Desktop tripled during the quarter. This growth was offset by a 20% decline in on-premise Office software installations, primarily with small and medium-sized businesses, and lower advertising spending on Bing search and LinkedIn towards the end of the quarter as economic activity contracted rapidly. Revenue from search advertising rose just 1%, down from 6% growth a quarter ago. Supply chain constraints in China that began in January reversed more quickly than management expected. Sales of machines installed with Windows Pro operating systems grew 5% rather than falling as the company forecast in February. Sales and marketing expenses rose half as much as revenue which helped operating margin rise three percentage points to 37%.

Commercial Cloud revenue grew 39% to $13.3 billion, reflecting both the swell in usage caused by lockdowns and the continued structural shift to cloud computing. Azure revenue grew 59% because businesses are using more of Microsoft’s computing power. Office 365 Commercial revenue rose 25% from subscriber growth of 20% to 258 million and from existing customers paying for more software tools such as enhanced security and Teams, Microsoft’s integrated chat and video collaboration service. Teams now has 75 million corporate users, up from 20 million in January, including 20 organizations with more than 100,000 employees each. Northwell Health, New York State’s largest healthcare provider and private employer with 68,000 staff, and the U.K.’s National Health Service each use Teams to deliver telehealth services to patients and to communicate internally. A small but growing service within Commercial Cloud is Dynamics 365, Microsoft’s cloud-based enterprise resource planning and customer relationship software, which increased revenue by 47%. It helps customers manage complex supply chains and provide new services such as curbside pickup, remote sales calls and remote customer assistance. The total return on Microsoft’s stock is 20% since January 1.

IDEXX Laboratories

IDEXX Laboratories’ first quarter 2020 earnings of $1.29 per share were 10% higher than last year’s results despite weakening growth towards the end of the quarter during March when U.S. State government’s stay-at-home policies directed toward containing the COVID-19 pandemic persuaded many pet owners to cancel or not make regularly scheduled veterinary appointments. Social distancing protocols along with sick patient priorities for emergency procedures at IDEXX-supplied vet clinics resulted in a 15% to 30% decline in patient visits at practices from March 27th through the first two weeks of April. More recent data from the closing weeks of April shows U.S. clinical visits were running 15% below last year. To adjust to the decline in the use of IDEXX’s services, management has cut the salary of its able CEO Jonathan Mazelsky by 30% along with a 20% cut for its other officers and senior executives. The majority of IDEXX’s other salaried employees are taking a 10% cut. IDEXX also has taken actions to strengthen its finances by expanding its credit facility to $1 billion under a new three-year agreement while also issuing $200 million of 10-year 2.5% fixed rate notes. Salary cuts and debt issuance together often are dire measures taken by failing managers hoping for a miracle. IDEXX’s management are capable realists who see the change wrought in the vet business by COVID-19 as an opportunity, so they have strengthened the company’s finances while giving their senior managers a shared goal of recouping their salary reduction, and increasing the compensation of the sales force on increased sales to existing customers. IDEXX’s stock price is up 19% since the beginning of the year.


The uncertainty of the unprecedented challenges created by the COVID-19 pandemic resulted in increased volatility in the futures and options traded at the CME leading to significantly higher hedging and risk management across CME’s products and geographies. During the first quarter, revenues of $1.5 billion and adjusted earnings of $2.33 per share rose 29% and 44%, respectively, from the same period a year ago. First quarter average daily volume (ADV) of 27 million contracts surged 45% compared to a year ago with growth of 56% outside the U.S. to a record 7.3 million contracts. CME’s continued technology investment in its Globex trading platform handled the increased volume without interruption and enabled remaining trading floor activity, primarily Eurodollar options, to shift to electronic trading. The ADV of each product line increased at double-digit rates with equity indexes, metals, energy and interest rates leading the way with increases of 105%, 58%, 38% and 34% respectively. The micro E-mini S&P 500 contract, launched in Q2 2019, reached a record ADV of 1.4 million contracts. CME’s Globex electronic trading platform remained the most liquid and active venue for clients.

CME’s clearing house operated flawlessly during this very active period which required it to raise margins on many products across asset classes as a result of heightened volatility in the underlying markets. The higher margin requirements along with the surge in trading activity led customers to pledge $100.4 billion of performance bonds and guarantee fund contributions on March 31, up from $37.1 billion three months earlier on December 31. These funds are placed on deposit with the Federal Reserve and receive 10 basis points of interest on excess reserves. CME passes along 80% of this to its clients, retaining 2 basis points. This interest income contributed significantly to non-operating income of $32.6 million during the quarter, up 51% from the prior year. During April and May, CME’s ADV eased from the torrid pace of the first quarter to 17.8 million and 17.9 million, up 13% and down 25% respectively from the prior year periods. The total return on CME’s stock is -4% since the beginning of the year.


Costco adapted well to a complex retail environment and produced strong financial results in its twelve-week third quarter ending May 10, 2020. Despite operating hour constraints, lower gas prices and demand, limits on high demand items such as beef, chicken, sanitizers and paper goods, and temporary closure of some of Costco’s popular ancillary services, revenue increased 7.3% to $37.3 billion. This growth was driven by demand for essential goods at low prices. Membership fee income of $815 million rose 5.0% with renewal rates achieving a peak of 91.0% in the U.S. and Canada and 88.4% internationally. In April, U.S. retail sales plummeted 16.4%, the worst such figure since 1992 when this data was first published, while Costco’s U.S. sales were flat compared to a year ago, excluding changes in currencies and fuel prices. Online orders spiked 85.7% in April, 106.2% in May and 64.5% during the quarter. Costco’s website handled the increased volume and its shipping logistics improved throughout the quarter.

Costco members visited warehouses 4.1% less frequently during the quarter due to social distancing but spent 9.3% more per trip to stock up on fresh foods, office supplies, electronics and other items useful for people spending more time at home. Earnings per share of $1.89 were even with the same quarter a year ago, excluding that quarter’s one-time tax benefit. Related to the health crisis, Costco management chose to pay its associates $251 million more during the quarter and spent $32 million to provide them with masks, gloves, plexiglass partitions and more cleaning supplies. These operating expenses reduced earnings per share by 47 cents. Gross margin widened by 0.54 percentage points to 11.53% as gas prices declined and sales shifted to relatively higher margin items. Costco’s average price for gas in April was 38% lower than a year ago at $1.94 per gallon which reduced sales by 1.9%, or about $700 million. Costco had to close or limit its ancillary services, its optical, hearing aids, photo and food courts, which reduced sales by one or two percentage points but increased gross margin. Costco still sells a jumbo hot dog with a 20-ounce beverage for $1.50, a price unchanged since 1984. Higher sales of fresh foods reduced spoilage costs which also added to gross margin. The total return on Costco’s stock is 6% since January 1.


Alphabet’s first quarter revenue of $41.2 billion increased 13%, or 15% in constant currencies, driven by Search, YouTube and Cloud. Operating earnings per share of $10.79, which exclude an $814 million loss on equity securities, were two cents lower than a year ago. Alphabet’s shares jumped 9% on April 29 after CFO Ruth Porat reported that March’s abrupt decline in ad spending caused by governments’ stay-at-home orders did not worsen in April. Though internet search activity increased in March, queries were more focused on the virus than on commercial interests causing advertisers to curb Google Search spending by 13% to 17% by the end of March. This decline was offset by strong growth in January and February which contributed to 9% growth in Search revenue for the full quarter to $24.5 billion, or 60% of Alphabet’s total revenue. Unlike print and TV advertising, Google’s ad platform provides marketers with tools that help them see the return on their advertising investment in near real-time, enabling customers to adjust spending quickly. Advertisers view this as valuable and cost-effective, which will continue to drive the shift from traditional to digital advertising.

Outside of Search, ad revenue from YouTube rose 33% to $4.0 billion as consumers spend more time on their internet-connected devices with video streaming and live broadcasts continuing to rise significantly. Performance of direct-response ads, in which viewers click a sponsored link in a video to download an app or game or connect to an advertiser’s website, was strong throughout the quarter. Revenue from Google Cloud grew 52% in the quarter to $2.8 billion. Google Cloud Platform (GCP), which hosts and runs applications and analyzes data for businesses, continues to win new customers across sectors, including retail, governments, healthcare and communications, who want to use Google’s data analytics capabilities. HCA Healthcare, with 185 hospitals and 2,000 sites of care in 21 states and the United Kingdom, partnered with Google Cloud in April to analyze ICU bed availability, ventilator supplies and COVID-19 test results in an open platform shared with other hospitals and communities. Vodafone, the world’s second largest mobile network operator after China Mobile, also chose Google as its strategic cloud platform for infrastructure, data analytics and machine learning. GCP is helping Vodafone use data and machine learning to optimize use of its mobile network by its 625 million subscribers. Alphabet’s stock price has risen 8% since January 1.


In Visa’s fiscal second quarter, revenue of $5.9 billion and earnings per share of $1.39, excluding investment gains and losses and non-recurring acquisition-related costs, rose 7% and 9%, respectively. Payments volume of $2.1 trillion rose 4.6% in constant currency with regional spending trends tracking the coronavirus’ spread across the globe. Early in the quarter, the economic slowdown hit Visa’s Asia Pacific region where payments declined 4% in the quarter. By March the virus exacted its toll on U.S. payments volume. Though U.S. volume of $984 billion rose 5.7% in the quarter, it declined 28% during the last week of March. The decline in spending continued in April and May but improved from its late March nadir with May volume just 5% lower than a year earlier. The composition of payments volume changed drastically, however. Despite the economic contraction, debit card spending began to rise in the second half of April and increased 12% in May, aided by the U.S. government’s distribution of Economic Impact Payments, four million of which were issued as Visa prepaid debit cards instead of paper checks. Debit card use typically rises relative to credit during times of economic uncertainty because consumers prefer to spend the money they have. Credit card spending declined 30% in April and 21% in May.

Spending at Walmart, Costco, Target and other food and drugstores, which accounts for one-fifth of Visa’s U.S. payments volume, rose over 20% in April and May. Online spending excluding travel grew at about 30% in April and May, faster than before the pandemic. Costco’s spike in e-commerce benefitted Visa which is Costco’s exclusive credit card network. Less discretionary spending categories, such as utilities, medical equipment and home improvement held up well versus other retail categories, such as apparel, which plunged 89% in April. Spending on travel, fuel, restaurants and entertainment, which accounts for 25% of Visa’s U.S. payments volume, dropped more than 40%. Typically, low fuel prices drive higher demand, but with travel halted, demand collapsed. Travel spending alone plummeted an astonishing 80% in April with only slight improvement in May. With April and May U.S. payments volume down 18% and 5%, respectively, Visa management has curtailed expenses, particularly travel, marketing and professional services, and expects expense growth to be flat in the second half of its fiscal year. Operating expenses rose 4% to $1.9 billion in the second quarter contributing to an expansion in operating margin from 66.3% to 67.0%. The total return on Visa’s stock is 6% year-to-date.


Mettler-Toledo’s first quarter sales of $649 million were 3% lower in local currencies than a year ago. Although the company’s manufacturing plant in Changzhou was one of the first to reopen in China in early February, strengthening customer demand in China in March was not enough to offset the sales decline in January and February. Sales in China fell 13% during the quarter which contributed to the 8% decline in sales in Asia. Sales in the Americas rose 3%, while sales in Europe fell 9% as rising COVID-19 infections in the West forced laboratories and factories that did not produce essential goods to close in mid-March. Laboratory sales rose 1% during the quarter with strong demand from the pharmaceutical industry for pipettes and automated chemistry instruments to speed the research and development of manufacturing processes to produce large quantities of vaccines and therapies to attack the coronavirus. This gain was offset by revenue declines from lab closures in other industries. The company maintained last year’s operating margin of 21.8% despite the decline in revenue by implementing pricing and productivity initiatives as well as senior level salary cuts, employee furloughs, reduced travel and lower variable compensation. Earnings per share of $4.00 were 2% lower than earnings of $4.10 reported a year ago.

Revenues of Mettler’s service and consumables business rose 7% during the quarter as the company’s global field service accommodated customer safety concerns by offering late night and weekend service as well as expanding pick-up and drop off centers to repair and calibrate instruments. Both the sales and service organizations quickly adapted to using the company’s remote capabilities. In a matter of weeks, the sales organization shifted to telesales and could share screens with customers to show product information and demos by video. The company launched a new product during the quarter with e-launches and live video streaming of the product demo. They also used these videos to train the sales force.

In early January, the company added a new set of metrics to its data analytics platform to monitor each country’s business by end user. They include key metrics like lease renewals, the number of customer visits, phone calls and sales opportunities. Management used these metrics to redirect the sales force to business segments with the best growth opportunities and to improve their forecasts for the company. Mettler’s ability to quickly move resources to the most promising sales opportunities results from the company’s successful development and implementation of its Spinnaker marketing and sales program. CEO Olivier Filliol began developing this program in 2005. Mettler-Toledo’s stock price has increased 7% since January 1.

Varian Medical Systems

Varian Medical Systems’ fiscal second quarter revenue of $795 million rose 3% in constant currencies over the same period a year ago. Revenue from acquisitions contributed four percentage points of growth resulting in a 1% decline in organic revenue growth for the quarter. Oncology Systems’ revenue of $761 million rose 3% with 6% growth in Software sales and 11% growth in Service revenues more than offsetting a 7% decline in sales of radiation therapy equipment.  Revenue growth for January and February was up 8% and declined 4% in March as rising COVID-19 infections in North America and Europe delayed installation and acceptance of new radiation systems. Sales in these highly profitable regions fell 7% and were partially offset by increased revenues in China and South Korea. The sharp revenue decline in March contributed to the 19% fall in earnings per share to 85¢ for the quarter.

Radiation treatments are not considered elective and are well-suited to the current environment because they are planned and delivered with little patient contact. Radiation oncologists and dosimetrists can access information system and treatment planning software remotely. Clinics are deploying Varian’s remote tools across training, installation and field service to maintain high uptime levels. Increased use of CTSI’s remote treatment planning, quality assurance and other services contributed to Service revenue growth during the quarter. CTSI’s ability to combine their medical physics expertise with Varian’s technology has been well-received by the radiation oncology community. They won a five-year $15 million contract to provide these services on-site and remotely to Memorial Hermann Health System, the largest not-for-profit health system in Southeast Texas.

Oncology Systems’ orders rose 2% to $773 million, which included two large orders from a company in Russia and the National Health Service in the U.K. Ethos, Varian’s new adaptive treatment system, received FDA approval in February. The company received 15 orders during the quarter – 11 in North America, three in Europe and one in Asia. Five clinics are treating patients with Ethos. The Herlev Hospital in Denmark, the first center to treat patients with Ethos, found that adjusting the daily treatment for 100 bladder cancer patients reduced the radiation dose to critical organs by 50%. A free-standing clinic chose an Ethos system over a competitive system because it uses artificial intelligence for adaptive treatments, uses CT, MRI and PET images and can provide conventional as well as adaptive treatments on a daily basis. Varian Medical Systems’ stock price is down 6% since the beginning of the year.

Johnson & Johnson

Johnson & Johnson’s first quarter sales of $20.7 billion rose 5.6% in constant currencies, excluding the impact of acquisitions and divestitures, over the first quarter of 2019. Sales of the company’s over-the-counter medicines in Consumer Health and Pharmaceuticals businesses grew 25.8% and 10%, respectively, to $1.3 billion and $11.1 billion. Pre-pandemic stocking accounted for seven percentage points of revenue growth for the OTC business and one percentage point for the Pharmaceuticals business. Although one-third of the Medical Devices business supports urgent surgeries for trauma, stroke and critical cancer surgeries, sales declined seven to eight percentage points because procedures for joint replacements, contact lens sales, cataract surgery and other general surgeries were delayed. Sales for this business fell 4.8%, excluding the impact of a large divestiture, to $5.9 billion. Earnings per share of $2.30 rose 10% from $2.10 a year ago.

Paul Stoffels, J&J’s Chief Scientific Officer, discussed the company’s vaccine program for the coronavirus during the earnings call on April 14, 2020. In January, a team of scientists at the Harvard Medical School and Janssen scientists began injecting different parts of the genome of the coronavirus’ spike protein into a non-infective common cold virus, the company’s vaccine platform that induces the immune system to make antibodies to a virus. J&J’s successful Ebola vaccine was developed using this platform. Over 50,000 people have been treated with J&J’s vaccines. They induce a strong immune response, have low risk of causing respiratory disease, can be made in high yields and distributed through the existing delivery infrastructure for vaccines. The company’s vaccines facility in Leiden, Netherlands can produce 300 million doses per year. J&J plans to build a plant in the U.S. and work with partners to build plants in Europe and in Asia.

On March 30, 2020, the company announced the identification of a lead candidate and two backups. They plan to begin clinical trials to test the safety and efficacy of the vaccine in the U.S. and Europe in September. With clinical data available in December, J&J will file for emergency use authorization with the FDA in January 2021. Manufacturing the vaccine will begin soon with the goal of producing 1 billion doses by the end of next year. J&J is following all the clinical and good manufacturing processes required for FDA approval. They are doing several processes in parallel rather than in sequence to reduce the time to develop the vaccine from five to seven years to five to seven months. The total return on Johnson & Johnson’s stock is 2% since the beginning of the year.


ADP provides payroll services to 26 million workers in the U.S. and 15 million outside the U.S. Its fiscal third quarter revenues increased 6% to $4.0 billion while adjusted earnings of $1.92 per share rose 8% from the prior year. In response to COVID-19, ADP shifted over 50,000 employees to work from home with 98% of its workforce now working remotely. The shift impacted its salesforce productivity immediately with new business bookings declining 9% during the quarter. Clients and potential clients are time and resource constrained as they manage the complexity of the pandemic. To respond to customers’ needs, ADP quickly retrained and redeployed hundreds of employees. They digested and translated new legislation from hundreds of jurisdictions into payroll and other human capital management systems critical to their customers’ businesses. ADP provided relevant information to assist employers with payroll cost and headcount reports necessary to apply for forgivable loans under the Payroll Protection Program of the CARES Act. As employers prepare to get back to work, ADP is providing webinars and information on best practices to return to work safely.

During the quarter, the number of employees on existing client payrolls increased 1.9%. In April, this important metric dropped to a double-digit decline with small businesses impacted more severely than large businesses. This decline was more severe than the decline experienced during the financial crisis in ‘08/’09. The need for businesses of all sizes to rely on ADP in an extremely complex environment is greater than ever; however, the need to reduce headcount to cut costs will hurt ADP’s revenues, margins and profits until employment recovers. The total return on ADP’s stock is -5% since the beginning of the year.


Ecolab’s first quarter revenue of $3.6 billion rose 3% in constant currency over the first quarter of 2019. Price and volume increases contributed two percentage points to revenue growth during the quarter. Acquisitions added another percentage point to the quarter’s revenue growth. The demand for increased hygiene and cleaning programs in food and beverage and pharmaceutical manufacturing plants, hospitals, quick serve restaurants and grocery stores lifted sales of Food & Beverage, Life Science and Specialty by 6%, 14% and 16%, respectively. Strong sales of sanitizing and cleaning products, which includes a 5-fold increase in demand for hand sanitizers, to restaurants, hotels and other Institutional businesses were offset by weak demand for other programs as leisure and hospitality businesses closed in mid-March because of the pandemic. The strong sales in Specialty helped Global Institutional achieve sales of $1.07 billion, an increase of 4%.

In preparation for the merger of Ecolab’s Upstream energy business ChampionX with Apergy, which took place on June 3, 2020, Ecolab moved the Healthcare business out of Global Institutional and the Life Science business out of Global Industrial to create Global Healthcare and Life Sciences which posted sales of $246 million, up 4% over the same period a year ago. Global Industrial’s revenue of $1.44 billion rose 3% and now includes the company’s Food & Beverage, Water, Downstream energy and Paper businesses. The slow-growing Textile business was moved to Ecolab’s Other business, which along with Pest Elimination and another small business delivered sales growth of 1% to $278 million. While the impact of COVID-19 reduced sales somewhat during the quarter, it reduced travel and entertainment expenses, benefits and other costs more. These lower costs along with good pricing and volume growth led to operating income growth of 12% to $462 million. Earnings per share of $1.13 were 10% higher than earnings of $1.03 reported a year ago. Operating income and earnings per share exclude costs associated with the separation of ChampionX, other special charges and gains and one-time tax items. The total return on Ecolab’s stock since the beginning of the year is 19%.


We sold Wabtec stock at the end of April because we were concerned about lower freight volumes from transporting less agricultural produce for export, less oil and fewer new autos to U.S. car dealers. Overall, North American carload volumes were down 5% during the first quarter while intermodal freight declined 8%. Significantly for us, Wabtec drew down at the end of the first quarter, the last $600 million available on its loan agreement, which helped finance its profitable GE Transportation acquisition.

Air Lease Corporation

We sold Air Lease in April after its stock price recovered from a dramatic decline in March. The impact of the COVID-19 pandemic on airlines around the world is severe and unprecedented. Though well-managed, Air Lease is no longer a suitable investment for client portfolios because too much remains unknown about the long-term impact of the pandemic on global air travel and the response of governments and consumers to the evolving health crisis.

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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.