EX-13 5 a08-6080_1ex13.htm EX-13

Exhibit (13)

 

 

FINANCIAL DISCUSSION

EXECUTIVE SUMMARY

This Financial Discussion should be read in conjunction with the information on Forward-Looking Statements and Risk Factors found at the end of this Financial Discussion.

 

Ecolab continued its trend of exceptionally strong financial performance in 2007.  It was an outstanding year of growth, development and investment for the future.  Results for 2007 marked another year of record sales and earnings and we did this while continuing to invest in our people and business to drive our future long-term growth. We demonstrated our commitment to building for the future while delivering today. Below are the highlights of another successful year.

 

We once again exceeded all three of our long-term financial objectives:

 

 

 

2007 RESULTS

 

LONG-TERM OBJECTIVE

 

 

 

 

 

 

 

EPS Growth

 

19%

 

15%

 

ROBE

 

25%

 

20%

 

Balance Sheet

 

A

 

Investment Grade

 

 

FINANCIAL PERFORMANCE

   Consolidated net sales increased 12% reaching a record $5.5 billion for 2007.

 

Operating income increased 9% in 2007 to a record $667 million, including $20 million of special gains and charges which decreased operating income growth by 3%.

 

Diluted net income per share increased 19% to $1.70 per share for 2007, compared to $1.43 per share in 2006. The 2007 per share amount was favorably impacted by $0.04 per share of special gains and charges and discrete tax benefits.

 

Cash flow from operating activities reached a record $798 million in 2007.

 

We repurchased $371 million of our common stock during 2007.

 

Our return on beginning shareholders’ equity was 25.4% in 2007, the 16th consecutive year in which we achieved our long-term financial objective of a 20% return on beginning shareholders’ equlty.

 

We increased our cash dividend 13% to an indicated annual rate of $0.52 per share.  This is our 71st consecutive year of paying a cash dividend and 16th consecutive year of cash dividend increases. The increase reflects the continued growth we achieved in 2007, our solid financial position and cash flows, and our confidence in the ongoing strength of the business for the years ahead.

 

OPERATING HIGHLIGHTS

We significantly expanded our healthcare offerings by acquiring Microtek Medical Holdings, Inc., a manufacturer and marketer of infection control products for healthcare and acute care facilities with annual sales of approximately $150 million in 2007.

 

In 2007 we launched more than 40 new innovative products and services including Apex™, a revolutionary warewashing system, a new Hand Hygiene Monitoring Compliance Program for hospitals and healthcare facilities and the Inspexx® sanitization system which helps poultry producers save water, energy and labor.

 

Our legendary service is what sets Ecolab apart. We continued to invest in our sales-and-service team adding more than 650 associates to our global field organization.

 

We completed the management transition in Europe and made significant progress toward transforming the region by committing to establishing a European headquarters in Zurich, Switzerland and beginning the development of Ecolab Business Solution (EBS), an extensive project to implement a common set of business processes and systems across all of Europe.

 

We launched a new business platform for GCS Service that will allow us to more effectively and efficiently grow the GCS business and realize its significant market potential.

 

We continued to execute our aggressive stock keeping unit (SKU) reduction initiative, designed to standardize product offerings, improve operating efficiencies and provide consistent performance for our customers across businesses and around the world. To date, we have eliminated nearly 3,000 SKUs.

 

We continue to utilize Lean Six Sigma to improve operational performance and efficiency. By applying these tools, we have achieved a 35% reduction in order entry cycle time, 10% reduction in backorders, 17% improvement in shipment quality and 10% increase in shipment size.

 

 

OUTLOOK

We will remain focused on achieving strong and steady growth and superior returns for our shareholders.

 

We plan to leverage our Circle the Customer - Circle the Globe growth strategy in new and improved ways.

 

We intend to continue to invest in the necessary people, systems, R&D, new products and infrastructure that will equity support our drive for superior long-term growth.

 

We will drive our initiatives in Europe, establishing our new European headquarters in Switzerland and achieving pan-European integration as we begin implementation of EBS. 2008 will be a year of significant investment in Europe and these investments will be reflected in Ecolab’s results; however, we believe the investments will be critical to generating higher growth and profitability in Europe in subsequent years.

 

We will continue to leverage our investments in GCS, using them to help us enhance our service offering and take advantage of the huge opportunity we see in commercial kitchen equipment repair.

 

We will work to build our opportunities in the high-potential healthcare market, utilizing both internal development and acquisitions.

 

We intend to continue to make targeted acquisitions, following our disciplined approach to ensure strong strategic business fit and solid financial performance.

 

19



 

CRITICAL ACCOUNTING ESTIMATES

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). We have adopted various accounting policies to prepare the consolidated financial statements in accordance with U.S. GAAP. Our most significant accounting policies are disclosed in Note 2 of the notes to the consolidated financial statements.

 

Preparation of our consolidated financial statements, in conformity with U.S. GAAP, requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions to be made about matters that are highly uncertain at the time the accounting estimate is made, and (2) different estimates that the company reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, have a material impact on the presentation of the company’s results of operations.

 

Besides estimates that meet the “critical” estimate criteria, we make many other accounting estimates in preparing our financial statements and related disclosures. All estimates, whether or not deemed critical, affect reported amounts of assets, liabilities, revenues and expenses as well as disclosures of contingent assets and liabilities. Estimates are based on experience and other information available prior to the issuance of the financial statements. Materially different results can occur as circumstances change and additional information becomes known, even from estimates not deemed critical. Our critical accounting estimates include the following:

 

REVENUE RECOGNITION

We recognize revenue on product sales at the time title to the product and risk of loss transfers to the customer. We recognize revenue on services as they are performed. Our sales policies do not provide for general rights of return and do not contain customer acceptance clauses. We record estimated reductions to revenue for customer programs and incentive offerings including pricing arrangements, promotions and other volume-based incentives at the time the sale is recorded. Depending on market conditions, we may increase customer incentive offerings, which could reduce gross profit margins at the time the incentive is offered.

 

VALUATION ALLOWANCES AND ACCRUED LIABILITIES

We estimate sales returns and allowances by analyzing historical returns and credits, and apply these trend rates to the most recent 12 months’ sales data to calculate estimated reserves for future credits. We estimate the allowance for doubtful accounts by analyzing accounts receivable balances by age and applying historical write-off trend rates. In addition, our estimates also include separately providing for 100% of specific customer balances when it is deemed probable that the balance is uncollectible. Actual results could differ from these estimates under different assumptions.

 

Estimates used to record liabilities related to pending litigation and environmental claims are based on our best estimate of probable future costs. We record the amounts that represent the points in the range of estimates that we believe are most probable or the minimum amounts when no amount within the range is a better estimate than any other amount. Potential insurance reimbursements are not anticipated in our accruals for environmental liabilities or other insured losses. Expected insurance proceeds are recorded as receivables when recovery is probable. While the final resolution of litigation and environmental contingencies could result in amounts different than current accruals, and therefore have an impact on our consolidated financial results in a future reporting period, we believe the ultimate outcome will not have a significant effect on our financial position.

 

ACTUARIALLY DETERMINED LIABILITIES

The measurement of our pension and postretirement benefit obligations are dependent on a variety of assumptions determined by management and used by our actuaries. These assumptions affect the amount and timing of future contributions and expenses.

 

The assumptions used in developing the required estimates include, among others, discount rate, projected salary and health care cost increases and expected return or earnings on assets. The discount rate assumption for the U.S. Plans is calculated using a bond yield curve constructed from a large population of high-quality, non-callable, corporate bond issues with maturity dates of six months to thirty years. Bond issues in the population are rated no less than Aa by Moody’s Investor Services or AA by Standard & Poors. The discount rate is calculated by matching of the plan liability cash flows to the yield curve.  Projected salary and health care cost increases are based on our long-term actual experience, the near-term outlook and assumed inflation. The expected return on plan assets reflects asset allocations, investment strategies and the views of investment advisors. The effects of actual results differing from our assumptions, as well as changes in assumptions, are reflected in the unrecognized actuarial loss and amortized over future periods and, therefore, generally affect our recognized expense in future periods. The unrecognized actuarial loss on our U.S. qualified and nonqualified pension plans decreased to $183 million (before tax) as of December 31, 2007, due primarily to an increase in the discount rate at the end of 2007 and amortization of existing unrecognized actuarial losses, partially offset by lower than expected return on plan assets. Significant differences in actual experience or significant changes in assumptions may materially affect pension and other post-retirement obligations. In determining our U.S. pension and postretirement obligations for 2007, our discount rate increased to 5.99% from 5.79% at year-end 2006. Our projected salary increase was unchanged at 4.32% and our expected return on plan assets used for determining 2007 expense was unchanged at 8.75%.

 

The effect on 2008 expense of a decrease in the discount rate or expected return on assets assumption as of December 31, 2007 is shown below assuming no changes in benefit levels and no amortization of gains or losses for our major plans:

 

MILLIONS

 

EFFECT ON U.S. PENSION PLAN

 

 

 

 

 

INCREASE IN

 

HIGHER

 

 

 

ASSUMPTION

 

RECORDED

 

2008

 

ASSUMPTION

 

CHANGE

 

OBLIGATION

 

EXPENSE

 

 

 

 

 

 

 

 

 

 Discount rate

 

-0.25 pts

 

$32.1

 

$4.3

 

 Expected return on assets

 

-0.25 pts

 

N/A

 

$2.0

 

 

 

 

EFFECT ON U.S. POSTRETIREMENT

 

MILLIONS

 

HEALTH CARE BENEFITS PLAN

 

 

 

 

 

INCREASE IN

 

HIGHER

 

 

 

ASSUMPTION

 

RECORDED

 

2008

 

ASSUMPTION

 

CHANGE

 

OBLIGATION

 

EXPENSE

 

 

 

 

 

 

 

 

 

 Discount rate

 

-0.25 pts

 

$4.5

 

$0.7

 

 Expected return on assets

 

-0.25 pts

 

N/A

 

$0.1

 

 

We use similar assumptions to measure our international pension obligations. However, the assumptions used vary by country based on specific local country requirements. See Note 15 for further

 

20



 

discussion concerning our accounting policies, estimates, funded status, planned contributions and overall financial positions of our pension and post-retirement plan obligations.

 

We are self-insured in North America for most workers compensation, general liability and automotive liability losses, subject to per occurrence and aggregate annual liability limitations. We are insured for losses in excess of these limitations. We have recorded both a liability and an offsetting receivable for amounts in excess of these limitations. We are also self-insured for health care claims for eligible participating employees, subject to certain deductibles and limitations. We determine our liabilities for claims incurred but not reported on an actuarial basis. A change in these assumptions would cause reported results to differ. Outside of North America, we are fully insured for losses, subject to annual deductibles.

 

SHARE-BASED COMPENSATION

As required by Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment (“SFAS 123R”), we measure compensation expense for share-based awards at fair value at the date of grant and recognize compensation expense over the service period for awards expected to vest. Determining the fair value of share-based awards at the grant date requires judgment, including estimating expected volatility, exercise and post-vesting termination behavior, expected dividends and risk-free rates of return. Additionally, the expense that is recorded is dependent on the amount of share-based awards expected to be forfeited. If actual forfeiture results differ significantly from these estimates, share-based compensation expense and our results of operations could be impacted. For additional information on our stock incentive and option plans, including significant assumptions used in determining fair value, see Note 10.

 

INCOME TAXES

Judgment is required to determine the annual effective income tax rate, deferred tax assets and liabilities and any valuation allowances recorded against net deferred tax assets. Our effective income tax rate is based on annual income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which we operate.Effective January 1, 2007 we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statements No. 109 (“FIN 48”).  FIN 48 requires us to recognize the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with a taxing authority. Our annual effective income tax rate includes the impact of reserve provisions. We adjust these reserves in light of changing facts and circumstances. During interim periods, this annual rate is then applied to our year-to-date operating results.  In the event that there is a significant one-time item recognized in our interim operating results, the tax attributable to that item would be separately calculated and recorded in the same period as the one-time item.

 

Tax regulations require items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, the effective income tax rate reflected in our financial statements differs from that reported in our tax returns. Some of these differences are permanent, such as expenses that are not deductible on our tax return, and some are temporary differences, such as depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax return in future years for which we have already recorded the tax benefit in our income statement. We establish valuation allowances for our deferred tax assets when the amount of expected future taxable income is not likely to support the utilization of the deduction or credit. Deferred tax liabilities generally represent items for which we have already taken a deduction in our tax return, but have not yet recognized that tax benefit in our financial statements. Undistributed earnings of foreign subsidiaries are considered to have been reinvested indefinitely or available for distribution with foreign tax credits available to offset the amount of applicable income tax and foreign withholding taxes that might be payable on earnings.  It is impractical to determine the amount of incremental taxes that might arise if all undistributed earnings were distributed.

 

A number of years may elapse before a particular tax matter, for which we have established a reserve, is audited and finally resolved. The number of tax years with open tax audits varies depending on the tax jurisdiction. During 2004, the Internal Revenue Service (IRS) completed its field examination of our U.S. income tax returns for 1999 through 2001.  During 2007, the IRS completed its field examination of our U.S. income tax returns for 2002 through 2004. It is reasonably possible for specific open positions related to these examinations as of year end to be settled in the next twelve months.  Unfavorable settlement of any particular issue could result in offsets to other balance sheet accounts, cash payments and/or additional tax expense. Favorable resolution could result in reduced income tax expense reported in the financial statements in the future. The majority of our tax reserves are presented in the balance sheet within other non-current liabilities.

 

LONG-LIVED AND INTANGIBLE ASSETS

We periodically review our long-lived and intangible assets for impairment and assess whether significant events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. This could occur when the carrying amount of an asset exceeds the anticipated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded, if any, is calculated as the excess of the asset’s carrying value over its estimated fair value. We also periodically reassess the estimated remaining useful lives of our long-lived assets. Changes to estimated useful lives would impact the amount of depreciation and amortization expense recorded in earnings. We have experienced no significant changes in the carrying value or estimated remaining useful lives of our long-lived assets.

 

We review our goodwill for impairment on an annual basis for all reporting units. If circumstances change significantly within a reporting unit, we would test for impairment during interim periods prior to the annual test. Goodwill and certain intangible assets are assessed for impairment using fair value measurement techniques. Specifically, goodwill impairment is determined using a two-step process. Both the first step of determining the fair value of a reporting unit and the second step of determining the fair value of individual assets and liabilities of a reporting unit (including unrecognized intangible assets) are judgmental in nature and often involve the use of significant estimates and assumptions. Estimates of fair value are primarily determined using discounted cash flows, market comparisons and recent transactions. These valuation methodologies use significant estimates and assumptions, which include projected future cash flows (including timing), discount rate reflecting the risk inherent in future cash flows, perpetual growth rate, and determination of appropriate market comparables. No impairments were recorded in 2007, 2006 or 2005 as a result of the tests performed. Of the total goodwill included in our consolidated balance sheet, 25% is recorded in our U.S. Cleaning & Sanitizing reportable segment, 4% in our U.S. Other Services segment and 71% in our International segment.

 

21



 

FUNCTIONAL CURRENCIES

In preparing the consolidated financial statements, we are required to translate the financial statements of our foreign subsidiaries from the currency in which they keep their accounting records, the local currency, into United States dollars. Assets and liabilities of these operations are translated at the exchange rates in effect at each fiscal year end. The translation adjustments related to assets and liabilities that arise from the use of differing exchange rates from period to period are included in accumulated other comprehensive income in shareholders’ equity. Income statement accounts are translated at average rates of exchange prevailing during the year. We evaluate our International operations based on fixed rates of exchange; however, the different exchange rates from period to period impact the amount of reported income from our consolidated operations.

 

RESULTS OF OPERATIONS

CONSOLIDATED

 

 

 

 

 

 

 

 

 

PRIOR YEAR

 

MILLIONS,

 

 

 

 

 

 

 

PERCENT CHANGE

 

EXCEPT PER SHARE

 

2007

 

2006

 

2005

 

2007

 

2006

 

Net sales

 

 

$5,470

 

$4,896

 

$4,535

 

12

%

 

8

%

 

Operating income

 

 

667

 

612

 

542

 

9

 

 

13

 

 

Net income

 

 

427

 

369

 

319

 

16

 

 

15

 

 

Diluted net income per common share

 

 

$  1.70

 

$

1.43

 

$

1.23

 

19

%

 

16

%

 

 

Our consolidated net sales increased 12% in 2007. The components include 5% volume growth, 2% favorable effect from price changes, 1% due to acquisitions and divestitures and 4% due to favorable changes in currency translation.

 

 

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

Gross profit as a percent of net sales

 

50.8%

 

50.7%

 

50.4%

 

Selling, general & administrative expenses as a percent of net sales

 

38.2%

 

38.2%

 

38.4%

 

 

Our consolidated gross profit margin (defined as gross profit divided by net sales) increased in 2007, primarily driven by pricing and cost savings initiatives, more than offsetting higher delivered product costs, acquisition dilution and business mix in our international operations.

 

Selling, general and administrative expenses as a percentage of sales remained at 38.2% for 2007. Leverage from our sales growth was fully offset by investments we are making in business systems, new product solutions and business efficiency initiatives.

 

Special gains and charges were $19.7 million in 2007 and include a $27.4 million charge for an arbitration settlement related to two California class action lawsuits involving wage/hour claims affecting former and current Pest Elimination employees recorded in the third quarter of 2007. Special gains and charges also include one-time costs related to establishing the company’s European headquarters in Zurich, Switzerland and other non-recurring charges. These charges were partially offset by a $6.3 million gain on the sale of a minority investment located in the U.S. and a $4.7 million gain on the sale of Peter Cox Ltd. in the U.K. which were recorded in the fourth quarter of 2007. For segment reporting purposes, these items have been included in our corporate segment, which is consistent with our internal management reporting.

 

 

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

Operating income as a percent of net sales

 

12.2%

 

12.5%

 

12.0%

 

 

Operating income increased 9% in 2007 over 2006. The increase in operating income in 2007 is due to sales volume, pricing and cost savings initiatives, partially offset by special gains and charges, higher delivered product costs and investments in the business. Operating income as a percent of sales decreased from 2006 due to special gains and charges of $19.7 million. Excluding special gains and charges, our 2007 operating income margin increased to 12.6%.

 

Net income increased 16% in 2007 to $427 million compared to $369 million in 2006. Net income in both years included items of a non-recurring nature that are not necessarily indicative of future operating results. Net income in 2007 includes $9.5 million, net of tax benefit, of special gains and charges and $19.3 million of discrete tax benefits.  Net income in 2006 included a discrete tax benefit of $1.8 million which was offset by a $1.8 million charge, net of tax benefit, in selling, general and administrative expense to recognize minimum royalties under a licensing agreement with no future benefit. These items increased net income growth in 2007 by 3%. Our 2007 net income was positively impacted by favorable currency translation of approximately $15 million and also benefited when compared to 2006 due to a lower overall effective income tax rate.

 

2006 COMPARED WITH 2005

Our consolidated net sales for 2006 increased 8% over 2005. The components include 6% volume growth and 2% favorable effect from price changes.  Acquisitions and divestitures and changes in currency translation did not have a significant impact on the consolidated sales growth rate for 2006.

 

Our consolidated gross profit margin for 2006 increased from 2005, primarily driven by pricing and cost savings initiatives which more than offset higher delivered product costs during the year.

 

Selling, general and administrative expenses as a percentage of sales improved in 2006 compared to 2005. The improvement in the 2006 expense ratio was primarily due to increased sales leverage and cost saving programs which more than offset investments in the business.

 

Operating income increased 13% in 2006 over 2005. As a percent of sales, operating income also increased from 2005. The increase in operating income was due to pricing, sales volume and cost reduction initiatives partially offset by higher delivered product costs as well as investments in the business.

 

Our net income increased 15% in 2006 compared to 2005. Net income in both years included items of a non-recurring nature that are not necessarily indicative of future operating results. Net income in 2006 included a discrete tax benefit of $1.8 million which was offset by a $1.8 million charge, net of tax benefit, in selling, general and administrative expense to recognize minimum royalties under a licensing agreement with no future benefit. Net income in 2005 included a tax charge of $3.1 million related to the repatriation of foreign earnings under the American Jobs Creation Act (AJCA).  These items increased net income growth by 1% for 2006. The increase in net income reflects improved sales, gross margin and operating income growth. Currency translation positively impacted net income in 2006 by approximately $2 million. Our 2006 net income also benefited when compared to 2005 due to a lower overall effective income tax rate.

 

22



 

SEGMENT PERFORMANCE

Our operating segments have been aggregated into three reportable segments: U.S. Cleaning & Sanitizing, U.S. Other Services and International. We evaluate the performance of our International operations based on fixed management rates of currency exchange. Therefore, International sales and operating income totals, as well as the International financial information included in this financial discussion, are based on translation into U.S. dollars at the fixed currency exchange rates used by management for 2007. The difference between actual currency exchange rates and the fixed currency exchange rates used by management is included in “Effect of foreign currency translation” within our operating segment results. All other accounting policies of the reportable segments are consistent with U.S. GAAP and the accounting policies of the company described in Note 2 of the notes to consolidated financial statements. Additional information about our reportable segments is included in Note 16 of the notes to consolidated financial statements.

 

SALES BY REPORTABLE SEGMENT

 

 

 

 

 

 

 

 

 

PRIOR YEAR

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

 

 

 

 

 

 

 

 

 

 

 

MILLIONS

 

  2007

 

2006

 

2005

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

 

 

 

 

 

Cleaning & Sanitizing

 

$2,351

 

 

$2,152

 

$1,952

 

9

%

 

10

%

 

Other Services

 

450

 

 

411

 

375

 

10

 

 

9

 

 

Total United States

 

2,801

 

 

2,563

 

2,327

 

9

 

 

10

 

 

International

 

2,522

 

 

2,372

 

2,245

 

6

 

 

6

 

 

Total

 

5,323

 

 

4,935

 

4,572

 

8

 

 

8

 

 

Effect of foreign currency translation

 

147

 

 

(39

)

(37

)

 

 

 

 

 

 

Consolidated

 

$5,470

 

 

$4,896

 

$4,535

 

12

%

 

8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Cleaning & Sanitizing sales increased 9% in 2007, led by Institutional, Food & Beverage, and Kay gains.  Acquisitions added 1% to the year over year sales growth.  Institutional sales increased 8% in 2007 resulting from new account gains and good sales growth into its various end-market segments including travel, restaurant and healthcare.  Food & Beverage sales increased 9% for 2007. An acquisition in 2006 added 2% and the remaining increase was due to sales growth in the meat & poultry, food and beverage markets. Kay sales grew 9% in 2007 led by solid ongoing food retail and quickservice restaurant demand from major existing customers, strong new account gains and success with new products and programs.

 

 

U.S. Other Services sales increased 10% in 2007. Pest Elimination continued to show strong growth as its sales increased 10%, driven by strong contract sales with significant new corporate account gains, supplemented by strong non-contract sales. GCS Service sales increased a strong 8% in 2007 showing improved sales momentum driven by corporate account gains.

 

 

Management rate sales of our International operations grew 6% in 2007. Acquisitions and divestitures did not have a significant impact on the year over year sales growth in 2007. Sales in Europe/ Middle East/Africa (EMEA) increased 5% in 2007 as good sales gains in the United Kingdom, South Africa and Turkey were partially offset by weak results in Germany and France. EMEA also achieved geographic growth in 2007 through further expansion in eastern Europe.  Asia Pacific sales grew 9% primarily driven by significant growth in China and Hong Kong as well as good growth in Japan and Australia. Asia Pacific sales benefited from new corporate accounts and good results in the beverage and brewery market. Latin America sales continued to be strong, rising 14% in 2007. The growth over last year was led by double-digit growth in Brazil, Mexico and the Caribbean. Sales benefited from new account gains, growth of existing accounts and success with new programs. Sales in Canada increased 7% in 2007, led by institutional growth due to corporate account gains, new products and excellent account retention.

 

23



 

OPERATING INCOME BY REPORTABLE SEGMENT

 

MILLIONS

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

Cleaning & Sanitizing

 

$

394

 

$

329

 

$

280

 

Other Services

 

41

 

39

 

36

 

Total United States

 

435

 

368

 

316

 

International

 

253

 

247

 

231

 

Total

 

688

 

615

 

547

 

Corporate

 

(40

)

 

 

Effect of foreign currency translation

 

19

 

(3

)

(5

)

Consolidated

 

$

667

 

$

612

 

$

542

 

 

 

 

 

 

 

 

 

Operating income as a percent of net sales

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

Cleaning & Sanitizing

 

16.8

%

15.3

%

14.3

%

Other Services

 

9.0

 

9.5

 

9.6

 

Total United States

 

15.5

 

14.4

 

13.6

 

International

 

10.0

 

10.3

 

10.3

 

Consolidated

 

12.2

%

12.5

%

12.0

%

 

 

 

 

 

 

 

 

 

U.S. Cleaning & Sanitizing operating income increased 20% in 2007. As a percentage of net sales, operating income increased to 16.8% in 2007 from 15.3% in 2006. Operating income increased due to pricing, higher sales volume and cost efficiencies which more than offset rising delivered product costs and investments in the business. Acquisitions and divestitures had minimal effect on the overall percentage increase in operating income.

 

U.S. Other Services operating income increased 4% in 2007. Operating income increased due to pricing and higher sales volume which were partially offset by investments in the business and costs associated with the implementation of a new business platform for GCS. As a percentage of net sales, operating income decreased to 9.0% in 2007 from 9.5% in 2006. The decrease in the ratio was primarily due to legal charges at Pest Elimination as well as system implementation costs at GCS.

 

International management-rate based operating income rose 2% in 2007. The International operating income margin was 10.0% in 2007 compared to 10.3% in 2006. Operating income increased due to higher sales volume and pricing. However, operating income margin decreased due to higher delivered product costs and significant investment in our international business in 2007. When measured at public currency rates, operating income increased 12% in 2007. Acquisitions and divestitures did not have a significant impact on operating income growth.

 

Operating income margins of our International operations are generally less than those realized for our U.S. operations. The lower International margins are due to (i) the additional costs caused by the difference in scale of International operations where many operating locations are smaller in size, (ii) the additional cost of operating in numerous and diverse foreign jurisdictions and (iii) higher costs of importing raw materials and finished goods. Proportionately larger investments in sales, technical support and administrative personnel are also necessary in order to facilitate the growth of our International operations.

 

CORPORATE

Consistent with our internal management reporting, the corporate segment includes $19.7 million of special gains and charges reported on the Consolidated Statement of Income. It also includes investments we are making in business systems and to optimize our business structure as part of our ongoing efforts to improve our efficiency and returns. We did not report any items in our corporate segment in 2006 or 2005.

 

2006 COMPARED WITH 2005

Sales of our U.S. Cleaning & Sanitizing operations increased 10% in 2006 from 2005. Sales were driven by double-digit sales growth from Institutional and Kay, along with good growth from Food & Beverage. Institutional sales increased 11%, benefiting from significant new account gains during the year. Institutional results reflect sales growth into all end market segments, including double-digit growth in travel, casual dining and health care markets. Food & Beverage sales increased 8% for 2006. An acquisition added 1% and the remaining increase was due to double-digit gains in the meat & poultry market as well as good gains in the dairy, food and soft drink markets. Kay recorded an 11% sales increase in 2006 led by gains in its core quickservice and food retail markets. Kay benefited from good ongoing demand from existing customers as well as new account gains.

 

Sales of our U.S. Other Services operations increased 9% in 2006. Pest Elimination continued its double-digit sales growth as sales rose 13%. Sales were driven by growth in both core pest elimination contract and non-contract services. Sales also benefited from new accounts and strong customer retention. GCS Service sales grew modestly as service and installed parts sales increased over last year. GCS Service continued to focus on infrastructure and process development in 2006 that helped improve competitive advantage and business scalability in the future.

 

Management rate sales of our International operations increased 6% in 2006 over 2005. Acquisitions and divestitures added 1% to the year over year sales growth. Sales in Europe increased 4% from 2005. Good sales growth in the United Kingdom was partially offset by slower sales growth in Germany, France and Italy. Europe also achieved geographic growth in 2006 through further expansion in eastern Europe. Asia Pacific sales grew 6% primarily driven by growth in China, Australia, Thailand and Hong Kong partially offset by weakness in Japan. Asia Pacific sales benefited from new corporate accounts and good results in the beverage and brewery market. Latin America recorded strong 14% sales growth in 2006. The growth was driven by results in Mexico, the Caribbean and Venezuela. Results were due to new account gains, growth of existing accounts and success with new programs. Sales in Canada increased 8% in 2006, reflecting good results from all divisions. Sales benefited from pricing, account retention and new business.

 

Operating income of our U.S. Cleaning & Sanitizing operations increased 18% in 2006. As a percentage of net sales, operating income increased to 15.3% in 2006 from 14.3% in 2005. Acquisitions and divestitures had no effect on the overall percentage increase in operating income. Operating income increased due to pricing, higher sales volume and improved cost efficiencies, which more than offset higher delivered product costs and investments in the business.

 

Operating income of our U.S. Other Services operations increased 8% in 2006. As a percentage of net sales, operating income decreased slightly to 9.5% in 2006 from 9.6% in 2005. Double-digit operating income growth at Pest Elimination was offset by slow

 

24



 

sales growth as well as investments in the GCS business. Operating income growth and operating income margin comparisons were also impacted by a $0.5 million regulatory expense in the second quarter of 2006 and a $0.5 million patent settlement benefit in the first quarter of 2005.

 

Management-rate based operating income of International operations rose 7% in 2006. The International operating income margin was 10.3% in both 2006 and 2005. Acquisitions and divestitures occurring in 2006 and 2005 increased operating income growth by 1% over 2005. Operating income growth benefited from pricing, sales volume growth and cost efficiencies which more than offset higher delivered product costs and investments in the business.

 

INTEREST

Net interest expense totaled $51 million in 2007 compared to $44 million in 2006. The increase in our net interest expense in 2007 is due to higher debt, primarily to fund acquisitions and share repurchases. Net interest expense was $44 million for both 2006 and 2005.

 

INCOME TAXES

The following table provides a summary of our reported tax rate:

 

 

 

 2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

Reported tax rate

 

30.7%

 

35.0%

 

35.9%

 

 

 

 

 

 

 

 

 

Impact of discrete items – increase (decrease)

 

(3.7)%

 

(0.4)%

 

0.3%

 

 

Reductions in our effective income tax rates over the last three years have primarily been due to U.S. tax legislation, international rate reductions and tax planning efforts. The 2007 reported tax rate was impacted by $29.5 million of discrete items including $10.2 million of net tax benefits on special gains and charges as well as $19.3 million of discrete tax benefits. Discrete tax benefits in 2007 included $8.4 million of tax benefit due to legislated corporate tax rate reductions in the U.K. and Germany which reduced our net deferred tax liability and $10.9 million for various audit settlements as well as other discrete items during 2007.  2006 included the benefit of a $1.8 million tax settlement and a $0.5 million benefit related to prior years. 2005 included a $3.1 million tax charge related to the repatriation of foreign earnings under the AJCA and other one-time benefits.

 

FINANCIAL POSITION & LIQUIDITY

FINANCIAL POSITION

Our debt continued to be rated within the “A” categories by the major rating agencies during 2007. Significant changes in our financial position during 2007 included the following:

 

Total assets increased to $4.7 billion as of December 31, 2007 from $4.4 billion at year-end 2006. The increase is primarily due to acquisitions which added $0.4 billion and foreign currency translation which added approximately $0.2 billion to the value of non-U.S. assets on the balance sheet as the U.S. dollar weakened against foreign currencies, primarily the euro. These increases were partially offset by a decrease in cash and cash equivalents used for the scheduled repayment of our 5.375% euronotes in February 2007.

 

Total liabilities increased to $2.8 billion at December 31, 2007 from $2.7 billion at December 31, 2006 primarily due to an increase in short-term borrowings and the effects of currency translation, offset by the scheduled repayment of our 5.375% euronotes.

 

 

Total debt was $1.0 billion at December 31, 2007 and decreased from total debt of $1.1 billion at December 31, 2006. The decrease in total debt was primarily due to the scheduled repayment of our 5.375% euronotes in February 2007, offset partially by an increase in short-term borrowings primarily to fund acquisitions and share repurchases. The ratio of total debt to capitalization (total debt divided by the sum of shareholder's equity plus total debt) was 34% at year-end 2007 and 39% at year-end 2006. The debt to capitalization ratio was higher in 2006, due to the new senior notes issued in December 2006, the proceeds of which were used to repay our 5.375% euronotes in February 2007. Excluding the 5.375% euronotes, the total debt to capitalization would have been 29% for 2006 compared to 34% for 2007. 2007 increased due to additional short-term borrowing discussed above. We view our debt to capitalization ratio as an important indicator of our creditworthiness.

 

CASH FLOWS

Cash provided by operating activities increased $170 million in 2007. The increase in operating cash flow for 2007 over 2006 is due to increased earnings, reduction of pension contributions and lower income tax payments due in 2007 compared to 2006. The increase in operating cash flow for 2006 over 2005 reflects our higher earnings offset partially by an increase in income tax payments and accounts receivable in 2006. Historically, we have had strong operating cash flows and we anticipate this will continue. We expect to continue to use this cash flow to acquire new businesses, repurchase our common stock, pay down debt and meet our ongoing obligations and commitments.

 

Cash used for investing activities increased in 2007 primarily due to increased acquisition activity, higher capital and software investments, and timing of short-term investment sales in 2006.  We continue to acquire strategic businesses which compliment our growth strategy. We also continue to invest in merchandising equipment consisting primarily of systems used by our customers to dispense our cleaning and sanitizing products.  Capital software expenditures increased due to investments in new business systems. We expect to continue to make significant capital investments and acquisitions to support our long-term growth.

 

Our cash flows from financing activities reflect issuances and repayment of debt, common stock repurchases, dividend payments and proceeds from common stock issuances related to our equity incentive programs. Cash used for financing activities increased in 2007 due to long-term debt repayment and a significant increase in share repurchases, offset partially by short-term borrowings.

 

 

25



 

Share repurchases were funded with operating cash flows, short-term borrowing and cash from the exercise of employee stock options.  In October 2006, we announced an authorization to repurchase up to 10 million shares of Ecolab common stock. As of December 31, 2007, approximately 4.7 million shares remained to be purchased under this authorization. Shares are repurchased for the purpose of offsetting the dilutive effect of stock options and incentives and for general corporate purposes. During 2008, we expect to repurchase at least enough shares to offset the dilutive effect of stock options. Cash proceeds from the exercises as well as the tax benefits will provide a portion of the funding for this repurchase activity.

 

In 2007, we increased our indicated annual dividend rate for the 16th consecutive year. We have paid dividends on our common stock for 71 consecutive years. Cash dividends declared per share of common stock, by quarter, for each of the last three years were as follows:

 

 

 

FIRST

 

SECOND

 

THIRD

 

FOURTH

 

 

 

 

 

QUARTER

 

QUARTER

 

QUARTER

 

QUARTER

 

YEAR

 

 

 

 

 

 

 

 

 

 

 

 

 

 2007

 

$0.1150

 

$0.1150

 

$0.1150

 

$0.1300

 

$0.4750

 

 2006

 

0.1000

 

0.1000

 

0.1000

 

0.1150

 

0.4150

 

 2005

 

0.0875

 

0.0875

 

0.0875

 

0.1000

 

0.3625

 

 

LIQUIDITY AND CAPITAL RESOURCES

We currently expect to fund all of the requirements which are reasonably foreseeable for 2008, including scheduled debt repayments, new investments in the business, share repurchases, dividend payments, possible business acquisitions and pension contributions from operating cash flow, cash reserves and short-term and/or long-term borrowings. In the event of a significant acquisition or other significant funding need, funding may occur through additional short and/or long-term borrowings or through the issuance of the company’s common stock.

 

In December 2006, we issued and sold in a private placement euro 300 million ($439 million as of December 31, 2007) aggregate principal amount of senior notes in two series: 4.355% Series A Senior Notes due 2013 in the aggregate principal amount of euro 125 million and 4.585% Series B Senior Notes due 2016 in the aggregate principal amount of euro 175 million (the “Notes),” pursuant to a Note Purchase Agreement dated July 26, 2006, between the company and the purchasers. The Notes are not subject to prepayment except where, in certain specified instances, we consolidate or merge all or substantially all of our assets with any other Person (as defined in the Note Purchase Agreement) and there is also a resulting ratings downgrade to below investment grade. Upon such consolidation or merger, we will offer to prepay all of the Notes at 100% of the principal amount outstanding plus accrued interest. In the event of a default by the company under the Note Purchase Agreement, the Notes may become immediately due and payable for the unpaid principal amount, accrued interest and a make-whole amount determined as of the time of the default. The proceeds were used to repay our euro 300 million 5.375% euronotes which became due in February 2007.

 

While cash flows could be negatively affected by a decrease in revenues, we do not believe that our revenues are highly susceptible, in the short term, to rapid changes in technology within our industry. We have a $600 million U.S. commercial paper program and a $200 million European commercial paper program. Both programs are rated A-1 by Standard & Poor’s and P-1 by Moody’s. To support our commercial paper programs and other general business funding needs, we maintain a $600 million multi-year committed credit agreement which expires in June 2012. We can draw directly on the credit facility on a revolving credit basis.

 

As of December 31, 2007, $345 million of this credit facility was committed to support outstanding U.S. commercial paper, leaving $255 million available for other uses. In addition, we have other committed and uncommitted credit lines of approximately $241 million with major international banks and financial institutions to support our general global funding needs. Additional details on our credit facilities are included in Note 6 of the notes to consolidated financial statements.

 

A schedule of our obligations under various notes payable, long-term debt agreements, operating leases with noncancelable terms in excess of one year, interest obligations and benefit payments are summarized in the following table:

 

 MILLIONS

 

 

 

PAYMENTS DUE BY PERIOD

 

 

 

 

 

LESS

 

 

 

 

 

MORE

 

 Contractual

 

 

 

THAN

 

1–3

 

3–5

 

THAN

 

 obligations

 

TOTAL

 

1 YEAR

 

YEARS

 

YEARS

 

5 YEARS

 

 Notes payable

 

$

400

 

$

400

 

$

 

$

 

$

 

 Long-term debt

 

603

 

3

 

5

 

152

 

443

 

 Operating leases

 

176

 

53

 

70

 

31

 

22

 

 Interest*

 

198

 

35

 

64

 

44

 

55

 

 Benefit payments**

 

848

 

64

 

134

 

156

 

494

 

 Total contractual cash obligations

 

$

2,225

 

$

555

 

$

273

 

$

383

 

$

1,014

 

 

*

Interest on variable rate debt was calculated using the interest rate at year-end 2007.

**

Benefit payments are paid out of the company’s pension and postretirement health care benefit plans.

 

As of December 31, 2007, our gross liability for uncertain tax positions under FIN 48 was $99 million. We are not able to reasonably estimate the amount by which the liability will increase or decrease over time. Therefore, these amounts have been excluded from the schedule of contractual obligations.

 

We are not required to make any contributions to our U.S. pension and postretirement health care benefit plans in 2008, based on plan asset values as of December 31, 2007 and have not yet determined if we will do so. Certain international pension benefit plans are required to be funded in accordance with local government requirements. We estimate contributions to be made to our international plans will approximate $20 million to $30 million in 2008. These amounts have been excluded from the schedule of contractual obligations.

 

We lease sales and administrative office facilities, distribution center facilities and other equipment under longer-term operating leases. Vehicle leases are generally shorter in duration. Vehicle leases have guaranteed residual value requirements that have historically been satisfied by the proceeds on the sale of the vehicles. No amounts have been recorded for these guarantees in the table preceding as we believe that the potential recovery of value from the vehicles when sold will be greater than the residual value guarantee.

 

Except for approximately $56 million of letters of credit supporting domestic and international commercial relationships and transactions, primarily our North America self-insurance program, we do not have significant unconditional purchase obligations, or significant other commercial commitments, such as commitments under lines of credit, standby letters of credit, guarantees, standby repurchase obligations or other commercial commitments.

 

As of year-end 2007, we are in compliance with all covenants and other requirements of our credit agreements and indentures. Our $600 million multicurrency credit agreement, as amended and restated, no longer includes a covenant regarding the ratio of total debt to capitalization. Our euro 300 million senior notes include

 

26



 

covenants regarding the amount of indebtedness secured by liens and subsidiary indebtedness allowed.

 

A downgrade in our credit rating could limit or preclude our ability to issue commercial paper under our current programs. A credit rating downgrade could also adversely affect our ability to renew existing, or negotiate new credit facilities in the future and could increase the cost of these facilities. Should this occur, we could seek additional sources of funding, including issuing term notes or bonds. In addition, we have the ability at our option to draw upon our $600 million committed credit facilities prior to their termination.

 

OFF-BALANCE SHEET ARRANGEMENTS

Other than operating leases, we do not have any off-balance sheet financing arrangements. See Note 12 for information on our operating leases. We do not have relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “structured finance” or “special purposes entities”, which are sometimes established for the purpose of facilitating off-balance sheet financial arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

 

NEW ACCOUNTING PRONOUNCEMENTS

Effective January 1, 2007 we adopted the provisions of FIN 48 with the cumulative effect of initially applying FIN 48 recorded as an increase to opening retained earnings of $5.1 million.

 

See Note 2 of the notes to consolidated financial statements for additional information on this adoption and other new accounting pronouncements.

 

MARKET RISK

We enter into contractual arrangements (derivatives) in the ordinary course of business to manage foreign currency exposure and interest rate risks. We do not enter into derivatives for trading purposes. Our use of derivatives is subject to internal policies that provide guidelines for control, counterparty risk and ongoing monitoring and reporting and is designed to reduce the volatility associated with movements in foreign exchange and interest rates on our income statement and cash flows.

 

We enter into forward contracts, swaps and foreign currency options to hedge certain intercompany financial arrangements, and to hedge against the effect of exchange rate fluctuations on transactions related to cash flows and net investments denominated in currencies other than U.S. dollars. At December 31, 2007, we had approximately $366 million notional amount of foreign currency forward exchange contracts with face amounts denominated primarily in euros.

 

We manage interest expense using a mix of fixed and floating rate debt. To help manage borrowing costs, we may enter into interest rate swap agreements. Under these arrangements, we agree to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional principal amount.

 

Based on a sensitivity analysis (assuming a 10% adverse change in market rates) of our foreign exchange and interest rate derivatives and other financial instruments, changes in exchange rates or interest rates would not materially affect our financial position and liquidity. The effect on our results of operations would be substantially offset by the impact of the hedged items.

 

SUBSEQUENT EVENTS

In February 2008, we acquired Ecovation, Inc., a Rochester, N.Y. area-based provider of renewable energy solutions and effluent management systems primarily for the food and beverage manufacturing industry in the U.S., including dairy, beverage, and meat and poultry producers. Ecovation is growing rapidly: 2007 sales were approximately $50 million, having grown tenfold since 2005; 2008 sales are expected to exceed $100 million. We paid $210 million for Ecovation but intend to sell approximately $40 million of acquired long-term lease receivables. Ecovation will become part of our U.S. Cleaning & Sanitizing operations during the first quarter of 2008.

 

Also in February 2008, we issued and sold $250 million aggregate principal amount of senior unsecured notes that mature in 2015 at a rate of 4.875%. The proceeds were used to refinance outstanding commercial paper and for general corporate purposes. The notes are not subject to prepayment except where there is a Change of Control as defined in the Supplemental Indenture dated February 8, 2008 and there is a resulting ratings downgrade to below investment grade. Upon consolidation or merger, we will offer to prepay all of the notes at 101% for the principal outstanding plus accrued interest. In the event of a default by the company under the Supplemental Indenture, the notes may immediately become due and payable for the unpaid principal amount and accrued interest. The notes are subject to covenants regarding the amount of indebtedness secured by liens and certain sale and leaseback transactions.

 

FORWARD-LOOKING STATEMENTS AND RISK FACTORS

This financial discussion and other portions of this Annual Report to Shareholders contain various “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include expectations concerning:

 

business progress and expansion

 

business acquisitions

 

currency translation

 

cash flows

 

debt repayments

 

share repurchases

 

global economic conditions

 

pension expenses and potential contributions

 

income taxes

 

and liquidity requirements.

 

Without limiting the foregoing, words or phrases such as “will likely result,” “are expected to,” “will continue,” “is anticipated,” “we believe,” “we expect,” “estimate,” “project” (including the negative or variations thereof) or similar terminology, generally identify forward-looking statements. Forward-looking statements may also represent challenging goals for us. We caution that undue reliance should not be placed on such forward-looking statements, which speak only as of the date made. Some of the factors which could cause results to differ from those expressed in any forward-looking statements are set forth under Item 1A of our Form 10-K for the year ended December 31, 2007, entitled Risk Factors.

 

In addition, we note that our stock price can be affected by fluctuations in quarterly earnings. There can be no assurances that our earnings levels will meet investors’ expectations.  Except as may be required under applicable law, we undertake no duty to update our Forward-Looking Statements.

 

27



 

CONSOLIDATED STATEMENT OF INCOME

 

YEAR ENDED DECEMBER 31 (MILLIONS, EXCEPT PER SHARE)

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

Net sales

 

 

$

5,469.6

 

 

$

4,895.8

 

$

4,534.8

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of sales

 

 

2,691.7

 

 

2,416.1

 

2,248.8

 

Selling, general and administrative expenses

 

 

2,090.9

 

 

1,868.1

 

1,743.6

 

Special gains and charges

 

 

19.7

 

 

 

 

 

 

Operating income

 

 

667.3

 

 

611.6

 

542.4

 

Interest expense, net

 

 

51.0

 

 

44.4

 

44.2

 

Income before income taxes

 

 

616.3

 

 

567.2

 

498.2

 

Provision for income taxes

 

 

189.1

 

 

198.6

 

178.7

 

Net income

 

 

$

427.2

 

 

$

368.6

 

$

319.5

 

Net income per common share

 

 

 

 

 

 

 

 

 

Basic

 

 

$

1.73

 

 

$

1.46

 

$

1.25

 

Diluted

 

 

$

1.70

 

 

$

1.43

 

$

1.23

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

 

$

0.4750

 

 

$

0.4150

 

$

0.3625

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

 

246.8

 

 

252.1

 

255.7

 

Diluted

 

 

251.8

 

 

257.1

 

260.1

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

28



 

CONSOLIDATED BALANCE SHEET

 

DECEMBER 31 (MILLIONS)

 

2007

 

 2006

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

 

$  137.4  

 

$  484.0  

Accounts receivable, net

 

 

974.0  

 

867.6  

Inventories

 

 

450.8  

 

364.9  

Deferred income taxes

 

 

89.4  

 

86.9  

Other current assets

 

 

65.7  

 

50.2  

Total current assets

 

 

1,717.3  

 

1,853.6  

Property, plant and equipment, net

 

 

1,083.4  

 

951.6  

Goodwill

 

 

1,279.2  

 

1,035.9  

Other intangible assets, net

 

 

328.9  

 

223.8  

Other assets

 

 

314.0  

 

354.5  

Total assets

 

 

$4,722.8  

 

$4,419.4  

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities

 

 

 

 

 

Short-term debt

 

 

$  403.5  

 

$   509.0  

Accounts payable

 

 

343.7  

 

330.9  

Compensation and benefits

 

 

280.2  

 

252.7  

Income taxes

 

 

27.7  

 

17.7  

Other current liabilities

 

 

463.2  

 

392.5  

Total current liabilities

 

 

1,518.3  

 

1,502.8  

Long-term debt

 

 

599.9  

 

557.1  

Postretirement health care and pension benefits

 

 

418.5  

 

420.2  

Other liabilities

 

 

250.4  

 

259.1  

Shareholders’ equity (a)

 

 

 

 

 

Common stock

 

 

326.5  

 

322.6  

Additional paid-in capital

 

 

1,015.2  

 

868.2  

Retained earnings

 

 

2,298.4  

 

1,983.2  

Accumulated other comprehensive income (loss)

 

 

63.1  

 

(96.5) 

Treasury stock

 

 

(1,767.5) 

 

(1,397.3) 

Total shareholders’ equity

 

 

1,935.7  

 

1,680.2  

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

 

$4,722.8  

 

$4,419.4  

 

 

 

 

 

 

 

 

 

 

 

 

 

(a)  Common stock, 400.0 million shares authorized, $1.00 par value, 246.8 million shares outstanding at December 31, 2007, 251.3 million shares outstanding at December 31, 2006.

 

The accompanying notes are an integral part of the consolidated financial statements.

 

29

 



 

CONSOLIDATED STATEMENT OF CASH FLOwS

 

YEAR ENDED DECEMBER 31 (MILLIONS)

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

OPERATINg ACTIVITIES

 

 

 

 

 

 

 

 

Net income

 

 

$427.2

 

 

$368.6

 

$319.5

 

Adjustments to reconcile net income to

 

 

 

 

 

 

 

 

 

cash provided by operating activities:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

291.9

 

 

268.6

 

256.9

 

Deferred income taxes

 

 

2.5

 

 

(18.8

)

(13.0

)

Share-based compensation expense

 

 

37.9

 

 

36.3

 

39.1

 

Excess tax benefits from share-based payment arrangements

 

 

(20.6

)

 

(19.8

)

(11.7

)

Disposal losses (gains), net

 

 

(11.0

)

 

0.4

 

 

 

Other, net

 

 

6.9

 

 

1.3

 

(0.9

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(34.4

)

 

(66.8

)

(44.8

)

Inventories

 

 

(19.3

)

 

(18.0

)

2.6

 

Other assets

 

 

20.7

 

 

(27.1

)

(21.9

)

Accounts payable

 

 

(10.0

)

 

44.5

 

19.0

 

Other liabilities

 

 

105.8

 

 

58.4

 

45.3

 

Cash provided by operating activities

 

 

797.6

 

 

627.6

 

590.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(306.5

)

 

(287.9

)

(268.8

)

Property disposals

 

 

7.4

 

 

25.6

 

21.2

 

Capitalized software expenditures

 

 

(55.0

)

 

(33.1

)

(10.9

)

Businesses acquired and investments in affiliates, net of cash acquired

 

 

(329.4

)

 

(65.5

)

(26.9

)

Sale of businesses and assets

 

 

19.8

 

 

1.8

 

1.4

 

Proceeds from sales and maturities of short-term investments

 

 

 

 

 

125.1

 

60.6

 

Purchases of short-term investments

 

 

 

 

 

 

 

(185.7

)

Cash used for investing activities

 

 

(663.7

)

 

(234.0

)

(409.1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

 

Net borrowings (repayments) of notes payable

 

 

279.9

 

 

(47.7

)

96.7

 

Long-term debt borrowings

 

 

 

 

 

396.2

 

4.7

 

Long-term debt repayments

 

 

(394.2

)

 

(86.3

)

(5.7

)

Reacquired shares

 

 

(371.4

)

 

(282.8

)

(213.3

)

Cash dividends on common stock

 

 

(114.0

)

 

(101.2

)

(89.8

)

Exercise of employee stock options

 

 

96.7

 

 

87.9

 

49.7

 

Excess tax benefits from share-based payment arrangements

 

 

20.6

 

 

19.8

 

11.7

 

Other, net

 

 

 

 

 

(2.3

)

 

 

Cash used for financing activities

 

 

(482.4

)

 

(16.4

)

(146.0

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

 

1.9

 

 

2.4

 

(1.8

)

 

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

 

(346.6

)

 

379.6

 

33.2

 

Cash and cash equivalents, beginning of year

 

 

484.0

 

 

104.4

 

71.2

 

Cash and cash equivalents, end of year

 

 

$137.4

 

 

$484.0

 

$104.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

30



 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME AND SHAREHOLDER’S EQUITY

 

 

 

 

 

 

 

 

 

ACCUMULATED

 

 

 

 

 

 

 

 

 

ADDITIONAL

 

 

 

OTHER

 

 

 

 

 

 

 

COMMON

 

PAID-IN

 

RETAINED

 

COMPREHENSIVE

 

TREASURY

 

 

 

MILLIONS

 

STOCK

 

CAPITAL

 

EARNINGS

 

INCOME (LOSS)

 

STOCK

 

TOTAL

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance December 31, 2004

 

$315.7    

 

$  630.5       

 

$1,492.4    

 

$   72.2              

 

$  (912.7)   

 

$1,598.1  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

319.5    

 

 

 

 

 

319.5  

 

Cumulative translation adjustment

 

 

 

 

 

 

 

(50.5)             

 

 

 

(50.5) 

 

Derivative instruments

 

 

 

 

 

 

 

4.4              

 

 

 

4.4  

 

Minimum pension liability

 

 

 

 

 

 

 

(16.3)              

 

 

 

(16.3) 

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

257.1  

 

Cash dividends declared

 

 

 

 

 

(92.7)   

 

 

 

 

 

(92.7) 

 

Stock options and awards

 

2.9    

 

96.9       

 

 

 

 

 

0.2    

 

100.0  

 

Reacquired shares

 

 

 

 

 

 

 

 

 

(213.3)   

 

(213.3) 

 

Balance December 31, 2005

 

318.6    

 

727.4       

 

1,719.2    

 

9.8              

 

(1,125.8)   

 

1,649.2  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

368.6    

 

 

 

 

 

368.6  

 

Cumulative translation adjustment

 

 

 

 

 

 

 

65.8              

 

 

 

65.8  

 

Derivative instruments

 

 

 

 

 

 

 

(3.4)             

 

 

 

(3.4) 

 

Minimum pension liability

 

 

 

 

 

 

 

(0.6)             

 

 

 

(0.6) 

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

430.4  

 

Cumulative effect adjustment for adoption of SFAS 158

 

 

 

 

 

 

 

(168.1)             

 

 

 

(168.1) 

 

Cash dividends declared

 

 

 

 

 

(104.6)   

 

 

 

 

 

(104.6) 

 

Stock options and awards

 

4.0    

 

140.8       

 

 

 

 

 

1.0    

 

145.8  

 

Reacquired shares

 

 

 

 

 

 

 

 

 

(272.5)   

 

(272.5) 

 

Balance December 31, 2006

 

322.6    

 

868.2       

 

1,983.2    

 

(96.5)             

 

(1,397.3)   

 

1,680.2  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

427.2    

 

 

 

 

 

427.2  

 

Cumulative translation adjustment

 

 

 

 

 

 

 

128.8              

 

 

 

128.8  

 

Derivative instruments

 

 

 

 

 

 

 

(2.3)              

 

 

 

(2.3) 

 

Pension and postretirement benefits

 

 

 

 

 

 

 

33.1              

 

 

 

33.1  

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

586.8  

 

Cumulative effect adjustment for adoption of FIN 48

 

 

 

 

 

5.1    

 

 

 

 

 

5.1  

 

Cash dividends declared

 

 

 

 

 

(117.1)   

 

 

 

 

 

(117.1) 

 

Stock options and awards

 

3.9    

 

147.0       

 

 

 

 

 

0.5    

 

151.4  

 

Reacquired shares

 

 

 

 

 

 

 

 

 

(370.7)   

 

(370.7) 

 

Balance December 31, 2007

 

$326.5    

 

$1,015.2       

 

$2,298.4    

 

$   63.1              

 

$(1,767.5)   

 

$1,935.7  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

COMMON STOCK ACTIVITY

 

 

 

2007

 

2006

 

2005

 

YEAR ENDED DECEMBER 31

 

COMMON

 

TREASURY 

COMMON

 

TREASURY 

COMMON

 

TREASURY 

(SHARES)

 

STOCK

 

STOCK 

STOCK

 

STOCK 

STOCK

 

STOCK 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares, beginning of year

 

322,578,427

 

(71,241,560

)

318,602,705

 

(64,459,800

)

315,742,759

 

(58,200,908

)

Stock options

 

3,952,429

 

49,197

 

3,975,722

 

172,665

 

2,859,946

 

18,666

 

Stock awards, net issuances

 

 

 

50,702

 

 

 

49,519

 

 

 

34,689

 

Reacquired shares

 

 

 

(8,564,099

)

 

 

(7,003,944

)

 

 

(6,312,247

)

Shares, end of year

 

326,530,856

 

(79,705,760

)

322,578,427

 

(71,241,560

)

318,602,705

 

(64,459,800

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

31



 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. NATURE OF BUSINESS

Ecolab Inc. (the “company”) develops and markets premium products and services for the hospitality, foodservice, healthcare and light industrial markets.  The company provides cleaning and sanitizing products and programs, as well as pest elimination, maintenance and repair services primarily to hotels and restaurants, healthcare and educational facilities, quickservice (fast-food and convenience stores) units, grocery stores, commercial and institutional laundries, light industry, dairy plants and farms, food and beverage processors and the vehicle wash industry.

 

2. SUMMARY OF SIgNIFICANT ACCOUNTINg POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the company and all majority-owned subsidiaries. International subsidiaries are included in the financial statements on the basis of their November 30 fiscal year-ends to facilitate the timely inclusion of such entities in the company’s consolidated financial reporting. All intercompany transactions and profits are eliminated in consolidation.

 

USE OF ESTIMATES

The preparation of the company’s financial statements requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates.

 

FOREIgN CURRENCY TRANSLATION

Financial position and results of operations of the company’s international subsidiaries are measured using local currencies as the functional currency. Assets and liabilities of these operations are translated at the exchange rates in effect at each fiscal year end. The translation adjustments related to assets and liabilities that arise from the use of differing exchange rates from period to period are included in accumulated other comprehensive income (loss) in shareholders’ equity. The cumulative translation gain as of year-end 2007 and 2006 was $171.0 million and $57.0 million, respectively. Income statement accounts are translated at the average rates of exchange prevailing during the year. The different exchange rates from period to period impact the amount of reported income from the company’s international operations. Foreign currency translation positively impacted net income by approximately $15 million, $2 million and $5 million for the years ended December 31, 2007, 2006 and 2005, respectively.

 

CASH AND CASH EQUIVALENTS

Cash equivalents include highly-liquid investments with a maturity of three months or less when purchased.

 

ALLOwANCE FOR DOUBTFUL ACCOUNTS

The company estimates the balance of allowance for doubtful accounts by analyzing accounts receivable balances by age and applying historical write-off trend rates. The company’s estimates include separately providing for specific customer balances when it is deemed probable that the balance is uncollectible. Account balances are charged off against the allowance when it is probable the receivable will not be recovered.

 

The company’s allowance for doubtful accounts balance includes an allowance for the expected return of products shipped and credits related to pricing or quantities shipped of approximately $9 million, $7 million and $5 million as of December 31, 2007, 2006 and 2005, respectively. This returns and credit activity is recorded directly  to sales.

 

The following table summarizes the activity in the allowance for doubtful accounts:

 

MILLIONS

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

 

$38  

 

$39  

 

$44  

 

Bad debt expense

 

 

15  

 

13  

 

12  

 

Write-offs

 

 

(16) 

 

(17) 

 

(15) 

 

Other*

 

 

6  

 

3  

 

(2) 

 

Ending balance

 

 

$43  

 

$38  

 

$39  

 

 

 

 

 

 

 

 

 

 

 

* Other amounts are primarily the effects of changes in currency and acquisitions.

 

INVENTORY VALUATIONS

Inventories are valued at the lower of cost or market. Domestic chemical inventory costs are determined on a last-in, first-out (LIFO) basis. LIFO inventories represented 23% and 28% of consolidated inventories at year-end 2007 and 2006, respectively. All other inventory costs are determined on a first-in, first-out (FIFO) basis.

 

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated at cost. Merchandising equipment consists principally of various systems that dispense the company’s machines. The dispensing systems are accounted for on a mass asset basis, whereby equipment is capitalized and depreciated as a group and written off when fully depreciated. The company capitalizes both internal and external costs of development or purchase of computer software for internal use. Costs incurred for data conversion, training and maintenance associated with capitalized software are expensed as incurred.

 

Depreciation is charged to operations using the straight-line method over the assets’ estimated useful lives ranging from 5 to 40 years for buildings and leaseholds, 3 to 11 years for machinery and equipment and 3 to 7 years for merchandising equipment and capital software. Total depreciation expense was $260.9 million, $235.8 million and $222.7 million for 2007, 2006 and 2005, respectively.  Expenditures for repairs and maintenance are charged to expense as incurred. Expenditures for major renewals and betterments, which significantly extend the useful lives of existing plant and equipment, are capitalized and depreciated.

 

Upon retirement or disposition of plant and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in income.

 

gOODwILL AND OTHER INTANgIBLE ASSETS

Goodwill and other intangible assets arise principally from business acquisitions. Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired. Other intangible assets primarily include customer relationships, trademarks, patents and other technology. The fair value of identifiable intangible assets is estimated based upon discounted future cash flow projections and other acceptable valuation methods. Other intangible assets are amortized on a straight-line basis over their estimated economic lives. The weighted-average useful life of other intangible assets was 14 years as of December 31, 2007 and 2006.

 

32



 

The weighted-average useful life by type of asset at December 31, 2007 is as follows:

 

NUMBER OF YEARS

Customer relationships

 

12

 

Intellectual property

 

14

 

Trademarks

 

19

 

Other

 

10

 

 

The straight-line method of amortization reflects an appropriate allocation of the cost of the intangible assets to earnings in proportion to the amount of economic benefits obtained by the company in each reporting period. Total amortization expense related to other intangible assets during the years ended December 31, 2007, 2006 and 2005 was $30.2 million, $25.0 million and $23.5 million, respectively. Future amortization expense is expected to increase significantly primarily due to the Microtek acquisition. As of December 31, 2007, future estimated amortization expense related to amortizable other identifiable intangible assets will be:

 

MILLIONS

 

 

 

2008

 

$40

 

2009

 

37

 

2010

 

36

 

2011

 

35

 

2012

 

34

 

 

The company tests goodwill for impairment on an annual basis for all reporting units. An impairment charge is recognized for the amount, if any, by which the carrying amount of goodwill exceeds its implied fair value. Fair values of reporting units are established using a discounted cash flow method. Where available and as appropriate, comparative market multiples are used to corroborate the results of the discounted cash flow method. Based on the testing, there has been no impairment of goodwill during the three years ended December 31, 2007. The company performs its annual goodwill impairment test during the second quarter. If circumstances change significantly within a reporting unit, the company would also test a reporting unit for impairment prior to the annual test.

 

LONg-LIVED ASSETS

The company periodically reviews its long-lived assets for impairment and assesses whether significant events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. An impairment loss may be recognized when the carrying amount of an asset exceeds the anticipated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded, if any, is calculated by the excess of the asset’s carrying value over its fair value.

 

REVENUE RECOgNITION

The company recognizes revenue as services are performed or on product sales at the time title to the product and risk of loss transfers to the customer. The provide for general rights of return and do not contain customer acceptance clauses. Trade accounts receivable are recorded at the invoiced amount and generally do not bear interest. The company records estimated reductions to revenue for customer programs and incentive offerings, including pricing arrangements, promotions and other volume-based incentives at the time the sale is recorded. The company also records estimated reserves for anticipated uncollectible accounts and for product returns and credits at the time of sale.

 

INCOME PER COMMON SHARE

The computations of the basic and diluted net income per share amounts were as follows:

 

MILLIONS

 

 

 

 

 

 

 

EXCEPT PER SHARE

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 $

427.2

 

 

$

368.6

 

$

319.5

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common

 

 

 

 

 

 

 

 

 

shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

 

246.8

 

 

252.1

 

255.7

 

Effect of dilutive stock

 

 

 

 

 

 

 

 

 

options and awards

 

 

5.0

 

 

5.0

 

4.4

 

Diluted

 

 

251.8

 

 

257.1

 

260.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

 

 

 

 

 

 

 

 

Basic

 

 

 $

1.73

 

 

$

1.46

 

$

1.25

 

Diluted

 

 

 $

1.70

 

 

$

1.43

 

$

1.23

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted stock awards of 68,180 shares for 2007, 24,670 shares for 2006 and 22,175 shares for 2005 were excluded from the computation of basic weighted-average shares outstanding because such shares were not yet vested at those dates.

 

Stock options to purchase 5.3 million shares for 2007, 2.6 million shares for 2006 and 7.1 million shares for 2005 were not dilutive and, therefore, were not included in the computations of diluted common shares outstanding.

 

SHARE-BASED COMPENSATION

Effective October 1, 2005, the company adopted Statement of Financial Accounting Standard No. 123 (Revised 2004), Share-Based Payment (“SFAS 123R”) under the modified retrospective application method. SFAS 123R requires the company to measure compensation expense for share-based awards at fair value at the date of grant and recognize compensation expense over the service period for awards expected to vest. As part of the transition to the new standard, all prior period financial statements were restated to recognize share-based compensation expense historically reported in the notes to the consolidated financial statements.

 

Effective with the company’s adoption of SFAS 123R, new stock option grants to retirement eligible recipients are attributed to expense using the non-substantive vesting method and are fully expensed by the time recipients attain age 55 with at least 5 years of service. If the company had used the non-substantive vesting method during all periods, net income for 2007, 2006 and 2005 would have increased by $1.4 million, $2.7 million and $2.5 million, respectively. In addition, the company previously accounted for forfeitures when they occurred. Commencing at the date of adoption, the company includes a forfeiture estimate in the amount of compensation expense being recognized. This change from the company’s historical practice of recognizing forfeitures as they occur did not result in the recognition of any cumulative adjustments to income. The company has used the actual tax effects of stock options and the transition guidance prescribed within SFAS 123R for establishing the pool of excess tax  benefits (APIC Pool).

 

COMPREHENSIVE INCOME

Comprehensive income includes net income, foreign currency translation adjustments, unrecognized actuarial gains and losses on pension and postretirement liabilities, gains and losses on derivative instruments designated and effective as cash flow hedges and nonderivative instruments designated and effective as foreign currency net investment hedges that are charged or credited to the accumulated other comprehensive income (loss) account in shareholders’ equity.

 

33



 

DERIVATIVE INSTRUMENTS AND  HEDgINg ACTIVITIES

The company uses foreign currency forward contracts, interest rate swaps and foreign currency debt to manage risks generally associated with foreign exchange rates, interest rates and net investments in foreign operations. The company does not hold derivative financial instruments of a speculative nature. On the date that the company enters into a derivative contract, it designates the derivative as (1) a hedge of (a) the fair value of a recognized asset or liability or (b) an unrecognized firm commitment (a “fair value” hedge), (2) a hedge of (a) a forecasted transaction or (b) the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a “cash flow” hedge) or (3) a foreign-currency fair-value or cash flow hedge (a “foreign currency” hedge). The company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. The company also formally assesses (both at the hedge’s inception and on an ongoing basis) whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative is not (or has ceased to be) highly effective as a hedge, the company will discontinue hedge accounting prospectively. The company believes that on an ongoing basis its portfolio of derivative instruments will generally be highly effective as hedges.

 

All of the company’s derivatives are recognized on the balance sheet at their fair value. The earnings impact resulting from the change in fair value of the derivative instruments is recorded in the same line item in the consolidated statement of income as the underlying exposure being hedged.

 

NEw ACCOUNTINg PRONOUNCEMENTS

In July 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertain tax positions in accordance with FASB Statement No. 109, Accounting for Income Taxes. For each tax position the company will be required to recognize, in its financial statements, the largest tax benefit that is “more-likely-than-not” to be sustained on audit based solely on the technical merits of the position as of the reporting date. FIN 48 also provides guidance on new disclosure requirements, reporting and accrual of interest and penalties, accounting in interim periods, and transition. The company adopted FIN 48 effective January 1, 2007 with the cumulative effect of initially applying FIN 48 recorded as an increase to opening retained earnings of $5.1 million. See Note 11 for additional information on this adoption.

 

In September 2006, the FASB issued SFAS 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and expanded disclosures about fair value measurement. Additionally, in February 2008, the FASB announced it will defer for one year the effective date of SFAS 157 for nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The FASB also decided to amend SFAS 157 to add a scope exception for leasing transactions subject to SFAS 13 Accounting for Leases from its application. The company adopted SFAS 157 effective January 1, 2008 and does not expect it will have a material impact on its consolidated financial statements.

 

In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment of FASB Statement No. 115 (“SFAS 159”).  SFAS 159 provides companies with an option to report selected financial assets and financial liabilities at fair value, which can be elected on an instrument-by-instrument basis. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. The company adopted SFAS 159 effective January 1, 2008 and does not expect it will have a material impact on its consolidated financial statements.

 

In December 2007, the FASB issued SFAS 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141R is effective for fiscal years beginning after December 15, 2008, and will be adopted by the company in the first quarter of 2009. The company is currently evaluating the potential impact of the adoption of  SFAS 141R on its consolidated results of operations and  financial condition.

 

In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements–an amendment of Accounting Research Bulletin No. 51 (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008, and will be adopted by the company in the first quarter of 2009.  The company is currently evaluating the potential impact of the adoption of SFAS 160 on its consolidated results of operations and financial condition.

 

No other new accounting pronouncement issued or effective has had or is expected to have a material impact on the company’s consolidated financial statements.

 

3. SPECIAL gAINS AND CHARgES

Special gains and charges were $19.7 million in 2007 and include a $27.4 million charge for an arbitration settlement related to two California class action lawsuits involving wage/hour claims affecting former and current Pest Elimination employees recorded in the third quarter of 2007. Special gains and charges also include one-time costs related to establishing the company’s European headquarters in Zurich, Switzerland and other non-recurring charges.  These charges were partially offset by a $6.3 million gain on the sale of a minority investment located in the U.S. and a $4.7 million gain on the sale of Peter Cox Ltd. in the U.K. which were recorded in the fourth quarter of 2007.  For segment reporting purposes, these items have been included in the company’s corporate segment, which is consistent with the company’s internal management reporting.

 

4. RELATED PARTY TRANSACTIONS

Henkel KGaA (“Henkel”) beneficially owned 72.7 million shares, or approximately 29.4%, of the company’s outstanding common stock on December 31, 2007. Under a stockholders’ agreement between the company and Henkel, Henkel is permitted ownership in the company of up to 35% of the company’s outstanding common stock. Henkel is also entitled to proportionate representation on the company’s board of directors.

 

34



 

In 2007, 2006 and 2005, the company and its affiliates sold products and services in the aggregate amounts of $4.6 million, $5.7 million and $3.6 million, respectively, to Henkel or its affiliates, and purchased products and services in the amounts of $64.6 million, $66.0 million and $65.3 million, respectively, from Henkel or its affiliates. The transactions with Henkel and its affiliates were made in the ordinary course of business and were negotiated at arm’s length.

 

5. BUSINESS ACQUISITIONS AND DISPOSITIONS

BUSINESS ACQUISITIONS

 

Business acquisitions made by the company during 2007, 2006 and 2005 were as follows: 

 

 

 

 

 

 

 

ESTIMATED

 

 

 

 

 

 

 

ANNUAL SALES

 

BUSINESS

 

  DATE OF

 

 

 

PRE-ACQUISITION

 

ACQUIRED

 

ACQUISITION

 

SEGMENT 

 

(MILLIONS)

 

 

 

 

 

 

 

(UNAUDITED)

 

2007

 

 

 

 

 

 

 

Microtek

 

November

 

U.S. C&S

 

$  150         

 

Medical Holdings, Inc.

 

 

 

International

 

 

 

 

 

 

 

(Healthcare)

 

 

 

 

 

 

 

 

 

 

 

Eagle Environmental

 

June

 

International

 

4         

 

Systems

 

 

 

(Asia Pacific)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fuma Pest

 

May

 

International

 

2         

 

 

 

 

 

(Asia Pacific)

 

 

 

 

 

 

 

 

 

 

 

Green Harbour

 

March

 

International

 

4         

 

 

 

 

 

(Asia Pacific)

 

 

 

 

 

 

 

 

 

 

 

Apprise

 

February

 

U.S. C&S

 

1         

 

Technologies, Inc.

 

 

 

(Institutional)

 

 

 

 

 

 

 

 

 

 

 

Wotek

 

January

 

International

 

3         

 

 

 

 

 

(EMEA)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DuChem Industries, Inc.

 

September

 

U.S. C&S

 

10         

 

 

 

 

 

(Food &

 

 

 

 

 

 

 

Beverage)

 

 

 

 

 

 

 

 

 

 

 

Powles Hunt & Sons

 

September

 

International

 

5         

 

International Ltd.

 

 

 

(EMEA)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shield

 

June

 

International

 

19         

 

Medicare Ltd.

 

 

 

(EMEA)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Kilco Chemicals Ltd.

 

April

 

International

 

5         

 

 

 

 

 

(EMEA)

 

 

 

 

 

 

 

 

 

 

 

YSC Chemical Company

 

February

 

International

 

3         

 

 

 

 

 

(Asia Pacific)

 

 

 

 

 

 

 

 

 

 

 

Associated

 

January

 

U.S. C&S

 

16         

 

Chemicals &

 

 

 

(Water Care)

 

 

 

Services, Inc.

 

 

 

 

 

 

 

(Aka Midland

 

 

 

 

 

 

 

Research)

 

 

 

 

 

 

 

 

In November 2007, the company acquired Microtek Medical Holdings, Inc., a manufacturer and marketer of infection control products for healthcare and acute care facilities. Microtek’s specialized product lines include infection barrier equipment drapes, patient drapes, fluid control products and operating room cleanup systems. The total purchase price was approximately $277 million, net of cash acquired.

 

In September 2007, the company made a minority investment in Site Controls, LLC, a leading provider of energy management and business intelligence solutions.

 

The business acquisitions have been accounted for as purchases and, accordingly, the results of their operations have been included in the financial statements of the company from the dates of acquisition. Net sales and operating income of these businesses were not significant to the company’s consolidated financial statements; therefore pro forma financial information is not presented.

 

The total cash consideration paid by the company for acquisitions and investments has been reduced for any cash or cash equivalents acquired with the acquisitions. Based upon purchase price allocations, the components of the aggregate purchase prices of the acquisitions made were as follows:

 

MILLIONS

 

 

2007

 

2006

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net tangible assets acquired (liabilities assumed)

 

 

$   61

 

 

$  (6

)

$    –

 

Identifiable intangible assets

 

 

118

 

 

28

 

8

 

Goodwill

 

 

150

 

 

44

 

19

 

Purchase price

 

 

$ 329

 

 

$ 66

 

$  27

 

 

 

 

 

 

 

 

 

 

 

 

The allocation of purchase price includes preliminary allocations and adjustments to prior period allocations, if any.

 

35



 

The changes in the carrying amount of goodwill for each of the company’s reportable segments for the years ended December 31, 2007 and 2006 are as follows:

 

 

 

U.S.

 

U.S.

 

 

 

 

 

 

 

 

 

CLEANING &

 

OTHER

 

 TOTAL

 

 

 

 

 

MILLIONS

 

SANITIZING

 

SERVICES

 

 U.S.

 

INTERNATIONAL

 

CONSOLIDATED

 

Balance

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 

 

 

 

 

 

 

 

 

2005

 

$  189.7     

 

$  49.5   

 

$  239.2  

 

$  697.8        

 

$  937.0       

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

 

 

 

 

 

 

 

 

 

 

acquired

 

 

 

 

 

 

 

 

 

 

 

during year*

 

7.3     

 

1.0   

 

8.3  

 

35.7        

 

44.0       

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

 

 

 

 

 

 

 

 

 

 

allocated

 

 

 

 

 

 

 

 

 

 

 

to business