EX-13 16 a09-1718_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 enjoyed another year of record sales and earnings in 2008. We achieved strong financial performance despite increasingly challenging economic conditions and rapidly increasing delivered product costs. We overcame these challenges and continued to invest in our business to build for the future while delivering in the present.

 

FINANCIAL PERFORMANCE

Consolidated net sales increased 12% reaching a record $6.1 billion in 2008.

 

 

Operating income increased 7% in 2008 to a record $713 million compared to $667 million in 2007.

 

 

Diluted earnings per share increased 6% to $1.80 per share for 2008, compared to $1.70 per share in 2007. Special gains and charges and discrete tax items negatively impacted 2008 by $0.06 per share and favorably impacted 2007 by $0.04 per share.

 

 

Cash flow from operating activities was $753 million in 2008, despite making a $75 million voluntary contribution to our U.S. pension plan. We continue to generate strong cash flow from operations, allowing us to continue to invest in our business while providing returns to our shareholders through cash dividends and share repurchases.

 

 

We repurchased 12.1 million shares of our common stock in 2008, reducing our shares outstanding by 4%. In November 2008, Henkel AG & Co. KGaA (“Henkel”) completed the sale of all 72.7 million Ecolab shares it held. We repurchased 11.3 million shares directly from Henkel for $300 million.

 

 

Our balance sheet remained within the “A” categories of the major rating agencies during 2008 and exceeded our investment grade objective.

 

 

 

Our return on beginning shareholders’ equity was 23.1% in 2008, the 17th consecutive year we achieved our long-term financial objective of a 20% return on beginning shareholders’ equity.

 

 

 

In December 2008, we increased our quarterly cash dividend 8% to an indicated annual rate of $0.56 per share for 2009. The increase represents our 17th consecutive annual dividend rate increase and the 72nd consecutive year we have paid cash dividends. The increase reflects our solid performance in 2008, our strong financial position and cash flow, and our commitment to delivering superior returns for our shareholders through both our business progress and dividend growth.

 

We expanded our U.S. Food & Beverage offerings by acquiring Ecovation Inc., a provider of renewable energy solutions and effluent management systems primarily in the food and beverage manufacturing industry in the U.S.

 

We made significant investments in Europe, including the establishment of our European headquarters in Zurich, Switzerland, and began the rollout of Ecolab Business Solution (EBS), an extensive project to implement a common set of business processes and systems across all of Europe.

 

 

We experienced significant increases and volatility in our delivered product costs during 2008. We were able to offset these increases with pricing and cost-saving initiatives, but were not able to fully offset the negative impact on our gross margin.

 

OUTLOOK

Despite the challenging economic outlook, we expect continued annual earnings growth in 2009, excluding the impacts of any special gains and charges and discrete tax events. We expect modest revenue growth in 2009 at fixed currency exchange rates. We expect raw material costs to be above 2008 levels for at least the first half of 2009, and expect unfavorable foreign currency exchange. We will work hard to offset these headwinds with new products, new account growth, better customer penetration and a more aggressive drive to reduce costs and improve operational efficiency.

 

 

In January 2009, we announced a restructuring plan to streamline operations and improve efficiency and effectiveness. The restructuring includes a global workforce reduction and optimization of our supply chain, including the reduction of plant and distribution center locations.

 

 

We will remain focused on achieving sustainable growth and returns for our shareholders.

 

 

We will continue our successful Circle the Customer - Circle the Globe growth strategy.

 

 

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

 

 

We intend to continue to invest in the rollout of EBS in Europe.

 

21



 

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 financial condition, changes in financial condition or 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. 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 specific customer balances when it is deemed probable that the balance is uncollectible. Actual results could differ from these estimates under different assumptions. Our allowance for doubtful accounts balance was $44 million and $43 million, as of December 31, 2008 and 2007, respectively. These amounts include our allowance for sales returns and credits of $9 million as of December 31, 2008 and 2007. Our bad debt expense as a percent of net sales was 0.4% in 2008 and 0.3% in 2007 and 2006. If the financial condition of our customers were to deteriorate, resulting in an inability to make payments, or if unexpected events or significant changes in future trends were to occur, additional allowances may be required.

 

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 amount 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 population of high-quality, non-callable, corporate bond issues with maturity dates of six months to 30 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 the plans’ projected 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 increased to $546 million (before tax) as of December 31, 2008, primarily due to 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 2008, our discount rate increased to 6.26% from 5.99% at year-end 2007, and our projected salary increase was unchanged at 4.32%. The mortality table used was updated from the RP-2000 table used in prior years to the RP-2000 Combined Healthy projected to December 31, 2008, with Scale AA table. Our expected return on plan assets, used for determining 2009 expense, was decreased to 8.50% from 8.75% in prior years to reflect lower expected long-term returns on plan assets.

 

22



 

The effect on 2009 expense of a decrease in the discount rate or expected return on assets assumption as of December 31, 2008 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

 

2009

 

  ASSUMPTION

 

CHANGE

 

OBLIGATION

 

EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Discount rate

 

-0.25 pts

 

$32.3

 

$4.1

 

  Expected return on assets

 

-0.25 pts

 

N/A

 

$2.1

 

 

 

 

 

 

 

 

 

 

 

 

EFFECT ON U.S. POSTRETIREMENT

 

  MILLIONS

 

HEALTH CARE BENEFITS PLAN

 

 

 

 

 

INCREASE IN

 

HIGHER

 

 

 

ASSUMPTION

 

RECORDED

 

2009

 

  ASSUMPTION

 

CHANGE

 

OBLIGATION

 

EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Discount rate

 

-0.25 pts

 

$4.3

 

$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 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 and 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 insurance deductibles.

 

SHARE-BASED COMPENSATION

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. The Internal Revenue Service (IRS) has completed its examinations of our U.S. income tax returns for the years 1999 through 2006. It is reasonably possible for specific open positions within the 1999 through 2006 tax years to be settled in the next 12 months. We anticipate a final settlement of the audit of tax years 2005 and 2006 in early 2009. In addition, it is reasonably possible that we will settle an income tax audit for Germany covering the years 2003 through 2006 in the next 12 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. For additional information on income taxes, see Note 11.

 

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

 

23



 

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 test our goodwill for impairment on an annual basis for all reporting units. If circumstances change significantly, we would test for impairment during interim periods between our annual tests. 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. Fair values of reporting units are established using a discounted cash flow method. Where available and as appropriate, comparable market multiples are used to corroborate the results of the discounted cash flow method. These valuation methodologies use 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 2008, 2007 or 2006 as a result of the tests performed. Due to a sales decline at GCS Service in the second half of 2008, we updated our impairment analysis of GCS Service as of December 31, 2008. The updated analysis indicated there has been no impairment. Of the total goodwill included in our consolidated balance sheet, 35% is recorded in our U.S. Cleaning & Sanitizing reportable segment, 4% in our U.S. Other Services segment and 61% in our International segment.

 

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

MILLIONS,

 

 

 

 

 

 

 

PERCENT CHANGE

 

 

 

 

 

 

 

 

 

 

EXCEPT PER SHARE

 

 2008

 

2007

 

2006

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

$6,138  

 

$5,470

 

$4,896

 

12

%

 

12

%

 

Operating income

 

 

713  

 

667

 

612

 

7

 

 

9

 

 

Net income

 

 

448  

 

427

 

369

 

5

 

 

16

 

 

Diluted net income per common share

 

 

$  1.80  

 

$

1.70

 

$

1.43

 

6

%

 

19

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2008

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit as a percent of net sales

 

48.8%

 

50.8%

 

50.7%

 

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

 

36.8%

 

38.2%

 

38.2%

 

 

 

 

 

 

 

 

 

 

NET SALES

The components of the year-over-year net sales increases are as follows:

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Volume growth

3

%

 

5

%

 

Price changes

3

 

 

2

 

 

Foreign currency exchange

3

 

 

4

 

 

Acquisitions and divestitures

3

 

 

1

 

 

 

 

 

 

 

 

 

Total net sales growth

12

%

 

12

%

 

 

 

 

 

 

 

 

 

GROSS MARGIN

Our consolidated gross profit margin (defined as net sales less cost of sales, divided by net sales) decreased in 2008 compared to 2007. Our gross profit margin decline was driven by higher delivered product costs, which more than offset the margin impact of sales leverage, pricing and cost savings initiatives. Our gross profit margin was also negatively impacted by our Microtek and Ecovation acquisitions which, by their business models, both operate at lower gross profit margins than our historical business. In 2008, we experienced significant increases in our raw material costs, and we expect high raw material costs to continue in 2009.

 

The gross profit margin increase in 2007 compared to 2006 was primarily driven by pricing and cost savings initiatives, more than offsetting the margin impact of higher delivered product costs and acquisition dilution.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses as a percentage of sales decreased to 36.8% in 2008 from 38.2% in 2007. The decrease in the ratio reflected leverage from our sales volume and pricing growth, cost controls, reductions of variable compensation and the impact of acquisitions. This leverage more than offset investments in business systems and efficiency, R&D and information technology.

 

Selling, general and administrative expenses as a percentage of sales was 38.2% for both 2007 and 2006. Leverage from sales growth was fully offset by investments made in business systems, new product solutions and business efficiency initiatives.

 

SPECIAL GAINS AND CHARGES

Special gains and charges were $25.9 million in 2008 and include a charge of $19.1 million, recorded in the fourth quarter, for the write-down of investments in an energy management business and closure of two small non-strategic health care businesses, as well as costs to optimize our business structure, including costs related to establishing our new European headquarters in Zurich, Switzerland. These charges were partially offset by a gain of $24.0 million from the sale of a plant in Denmark recorded in the second quarter and a $1.7 million gain related to the sale of a business in the United Kingdom (U.K.) recorded in the first quarter.

 

Special gains and charges were $19.7 million in 2007 and included a $27.4 million charge for an arbitration settlement recorded in the third quarter of 2007, as well as costs related to establishing our European headquarters 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 a business in the U.K., which were both recorded in the fourth quarter of 2007.

 

For segment reporting purposes, special gains and charges have been included in our corporate segment, which is consistent with our internal management reporting.

 

24



 

OPERATING INCOME

 

 

 

2008

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income as a percent of net sales

 

11.6%

 

12.2%

 

12.5%

 

 

 

 

 

 

 

 

 

 

Operating income increased 7% in 2008 compared to 2007. Special gains and charges did not have a significant impact on operating income growth. Excluding the negative impact from acquisitions and divestitures and favorable impact of foreign currency exchange, operating income grew 5% in 2008. The increase in operating income was due to sales volume and pricing gains, improved cost efficiencies and reductions of variable compensation, which more than offset higher delivered product costs and investments in the business. Special gains and charges reduced reported operating income margins for both 2008 and 2007. Excluding special gains and charges, our 2008 operating income margin decreased to 12.0% compared to 12.6% in 2007 as the negative margin impact of acquisitions and higher delivered product costs were not fully offset by pricing and cost savings initiatives.

 

Operating income increased 9% in 2007 over 2006. Excluding special gains and charges, operating income increased 12%. The increase in operating income in 2007 was 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%.

 

INTEREST

Net interest expense totaled $62 million, $51 million and $44 million in 2008, 2007 and 2006, respectively. The increase in our net interest expense is due to higher debt levels, primarily to fund share repurchases and acquisitions.

 

INCOME TAXES

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

 

 

 

2008

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported tax rate

 

31.2%

 

30.7%

 

35.0%

 

Decrease due to discrete items

 

(0.4)%

 

(3.7)%

 

(0.4)%

 

 

 

 

 

 

 

 

 

 

Our reported tax rate includes discrete impacts from special gains and charges and discrete tax events. Reductions in our effective income tax rates (excluding discrete impacts) over the last three years have primarily been due to tax planning efforts and international rate reductions.

 

The 2008 reported tax rate was impacted by $11.0 million of non-recurring tax items including $9.1 million of net tax benefits on special gains and charges as well as $1.9 million of discrete tax benefits. Discrete tax items in 2008 included $4.8 million of discrete tax benefits recorded in the first quarter due to enacted tax legislation and an international rate change. 2008 also included $2.1 million of discrete tax expense recorded in the third quarter related to recognizing adjustments from filing our 2007 U.S. federal income tax return and $0.8 million of discrete tax expense recorded in the fourth quarter.

 

The 2007 reported tax rate was impacted by $29.5 million of non-recurring tax 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 $5.4 million of discrete tax benefits recorded in the second quarter for tax audit settlements, $8.6 million of discrete tax benefits recorded in the third quarter for reductions in net deferred tax liabilities related to international tax rate changes and $5.3 million of tax benefits recorded in the fourth quarter primarily due to tax audit settlements.

 

The 2006 reported tax rate included the benefit of a $1.8 million tax settlement and a $0.5 million benefit related to prior years.

 

NET INCOME AND EARNINGS PER SHARE

Net income increased 5% to $448 million in 2008 compared to $427 million in 2007. Net income in both years included items of a non-recurring nature that are not necessarily indicative of future operating results. Net income in 2008 was negatively impacted by $16.8 million, net of tax benefit, of special gains and charges, partially offset by $1.9 million of discrete tax benefits. Net income in 2007 was negatively impacted by $9.5 million, net of tax benefit, of special gains and charges, which was more than offset by $19.3 million of discrete tax benefits. These items decreased net income growth in 2008 by 6%. Our 2008 net income growth was also favorably impacted by currency translation of approximately $13 million and a lower overall effective income tax rate compared to 2007 (excluding the impact of discrete tax items). Diluted earnings per share increased 6% to $1.80 per share in 2008, compared to $1.70 per share in 2007. Special gains and charges and discrete tax items negatively impacted 2008 by $0.06 per share and favorably impacted 2007 by $0.04 per share.

 

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. Diluted earnings per share increased 19% to $1.70 per share in 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 recorded in 2007.

 

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 2008. 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. Additional information about our reportable segments is included in Note 16.

 

25



 

SALES BY REPORTABLE SEGMENT

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

 

 

 

 

 

 

 

 

 

 

 

MILLIONS

 

2008

 

  2007

 

 2006

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cleaning & Sanitizing

 

 

$ 2,661

 

 

$ 2,351

 

$ 2,152

 

13

%

 

9

%

 

Other Services

 

 

469

 

 

450

 

411

 

4

 

 

10

 

 

Total United States

 

 

3,130

 

 

2,801

 

2,563

 

12

 

 

9

 

 

International

 

 

2,975

 

 

2,794

 

2,630

 

6

 

 

6

 

 

Total

 

 

6,105

 

 

5,595

 

5,193

 

9

 

 

8

 

 

Effect of foreign currency translation

 

 

33

 

 

(125

)

(297

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

$ 6,138

 

 

$ 5,470

 

$ 4,896

 

12

%

 

12

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Cleaning & Sanitizing sales increased 13% in 2008. Acquisitions added 7% of the 13% year-over-year sales growth. Sales growth was led by Kay, Healthcare and Food & Beverage gains. Institutional sales increased 5% in 2008 as we saw very strong sales of our new ApexTM warewashing system due to customer demand for energy and cost saving solutions. New business gains also continued, but were partially offset by lower consumption among our foodservice and lodging customers as they experienced a softening of their traffic trends due to the current economic environment. Beginning in the first quarter of 2008, following the Ecovation acquisition, we combined our Water Care Services and Ecovation businesses into our Food & Beverage division. Food & Beverage customers are the primary targets for our Water Care sales and there are potential synergies and efficiencies available between Water Care and Ecovation. Combined Food & Beverage sales, including Water Care and Ecovation, increased 17% in 2008 compared to 2007. The acquisition of Ecovation added 8% to the sales growth. Sales were led by strong growth in the agri, meat & poultry and dairy market segments. New business gains, growth at existing accounts and customer retention continue to fuel organic growth in spite of more difficult market conditions in 2008. Kay sales grew 15% in 2008. Kay’s strong sales growth reflected new account gains and success with new products and programs. Business trends remain strong with very good ongoing demand from new and existing quick service restaurant customers. Sales for our Healthcare business increased significantly in 2008, reflecting the impact of the Microtek acquisition in the fourth quarter of 2007. Excluding the impact of the Microtek acquisition, Healthcare sales rose 11% for the year reflecting continued end-market demand for our infection prevention and skin care products. The Microtek business reported strong sales growth for the year led by sales of their infection control barriers.

 

 

U.S. Other Services sales increased 4% in 2008. Pest Elimination reported 7% sales growth for the year led by continued growth in contract services due to the addition of new customer locations and new programs. Sales growth slowed beginning in the fourth quarter of 2008 as we saw reduced discretionary spending by our Pest Elimination customers due to the current recession. GCS Service sales declined 1% in 2008 compared to 2007. Moderate service sales growth was offset by a decline in direct parts sales during the year. GCS Service sales declined beginning in the fourth quarter due to softness in the foodservice market and reduced discretionary spending on equipment maintenance.

 

 

We evaluate the performance of our International operations based on fixed management rates of currency exchange. Fixed management rate sales of our International operations grew 6% in 2008. The net impact of acquisitions and divestitures did not have a significant impact on International year-over-year sales growth in 2008. Sales in Europe/Middle East/Africa (EMEA) increased 3% in 2008 led by sales growth in Germany, U.K., Turkey and South Africa. The net impact of acquisitions and divestitures reduced EMEA sales growth by 2% compared to last year, primarily due to the divestiture of a business in the U.K. Asia Pacific sales grew 8% in 2008 led by double-digit growth in China and Hong Kong, as well as good growth in Australia and New Zealand. 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 15% in 2008 as sales were strong throughout the region. The increase over last year was led by double-digit growth in Brazil, Chile and the Caribbean. Sales benefited from new account gains, growth of existing accounts and success with new programs. In the fourth quarter of 2008 we began to experience some softening in the Latin America region, primarily Mexico and the Caribbean, due to the current economic environment. Sales in Canada increased 6% in 2008. Sales growth in Canada continued to be led by Institutional growth due to new products and good account retention.

 

26



 

OPERATING INCOME BY REPORTABLE SEGMENT

 

MILLIONS

 

2008 

 

2007 

 

2006 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

Cleaning & Sanitizing

 

 $

432

 

 $

394

 

$

329

 

Other Services

 

52

 

41

 

39

 

Total United States

 

484

 

435

 

368

 

International

 

280

 

290

 

283

 

Total

 

764

 

725

 

651

 

Corporate

 

(55

)

(40

)

 

Effect of foreign currency translation

 

4

 

(18

)

(39

)

Consolidated

 

 $

713

 

 $

667

 

$

612

 

 

 

 

 

 

 

 

 

Operating income as a percent of net sales

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

Cleaning & Sanitizing

 

16.2

%

16.8

%

15.3

%

Other Services

 

11.1

 

9.1

 

9.5

 

Total United States

 

15.5

 

15.5

 

14.4

 

International

 

9.4

 

10.4

 

10.8

 

Consolidated

 

11.6

%

12.2

%

12.5

%

 

 

 

 

 

 

 

 

 

U.S. Cleaning & Sanitizing operating income increased 10% in 2008. As a percentage of net sales, operating income decreased to 16.2% in 2008 from 16.8% in 2007. Acquisitions reduced operating income growth by 2%. Operating income increased as sales volume, pricing, improved cost efficiencies and variable compensation reductions more than offset higher delivered product costs.

 

U.S. Other Services operating income increased 27% in 2008. Operating income growth was driven by continued operating income growth at Pest Elimination. GCS operating results improved in the fourth quarter of 2008, but were flat for the full year. As a percentage of net sales, operating income increased to 11.1% in 2008 from 9.1% in 2007. The increase in the ratio was primarily due to continued profit growth at Pest Elimination, as well as a favorable comparison to 2007, which included legal charges at Pest Elimination and system implementation costs at GCS.

 

International management-rate based operating income decreased 3% in 2008. The International operating income margin was 9.4% in 2008 compared to 10.4% in 2007. Higher delivered product costs and investments in our international business more than offset sales gains, driving the decline in operating income in 2008. When measured at public currency rates, operating income increased 3% in 2008. Acquisitions and divestitures did not have a significant impact on International operating income.

 

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 in 2008 included $25.9 million of special gains and charges reported on the Consolidated Statement of Income. It also included investments in the development of business systems and other corporate investments we made as part of our ongoing efforts to improve our efficiency and returns.

 

In 2007, the corporate segment included $19.7 million of special gains and charges reported on the Consolidated Statement of Income. It also included investments we made in business systems and to optimize our business structure.

 

We did not report any items in our corporate segment in 2006.

 

2007 COMPARED WITH 2006

U.S. Cleaning & Sanitizing sales increased 9% in 2007 compared to 2006, 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% in 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 quick service 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 compared to 2006. Pest Elimination reported 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 compared to 2006. Acquisitions and divestitures did not have a significant impact on the year-over-year sales growth in 2007. Sales in EMEA increased 5% in 2007 as good sales gains in the U.K., 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 rose 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.

 

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.

 

27



 

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 10.4% in 2007 compared to 10.8% 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. 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.

 

FINANCIAL POSITION & LIQUIDITY

FINANCIAL POSITION

Significant changes in our financial position during 2008 included the following:

 

Total assets increased to $4.8 billion as of December 31, 2008 from $4.7 billion at December 31, 2007. Increases due to acquisitions, investment in the business and working capital growth were partially offset by foreign currency exchange impacts which reduced total assets by approximately $0.4 billion as the U.S. dollar strengthened against foreign currencies.

 

Total liabilities increased to $3.2 billion at December 31, 2008 from $2.8 billion at December 31, 2007, primarily due to an increase in our long-term debt and our U.S. pension liability due to significant losses on plan assets during 2008.

 

 

Total debt was $1.1 billion at December 31, 2008, and increased from total debt of $1.0 billion at December 31, 2007. Our debt continued to be rated within the “A” categories by the major rating agencies during 2008. The increase in total debt was primarily due to an increase in borrowings to fund the $300 million share repurchase from Henkel in November 2008. In February 2008, we issued and sold $250 million of 4.875% senior unsecured notes that mature in 2015. The proceeds were used to refinance outstanding commercial paper related to acquisitions and for general corporate purposes. The ratio of total debt to capitalization (total debt divided by the sum of shareholders’ equity and total debt) was 42% at year-end 2008 and 34% at year-end 2007. The debt to capitalization ratio was higher at year-end 2008 due to a $135 million increase in debt, as well as a $364 million decrease in shareholders’ equity due to share repurchases, cumulative translation and losses on our U.S. pension plan. We view our debt to capitalization ratio as an important indicator of our creditworthiness.

 

CASH FLOWS

Cash provided by operating activities declined $45 million or 6% to $753 million in 2008 compared to 2007. The decrease in operating cash flow for 2008 reflects a $75 million voluntary contribution to our U.S. pension plan and an increase in accounts receivable, excluding the effects of currency exchange, which more than offset our increased earnings, lower tax payments and $30 million of proceeds from the sale of Ecovation lease receivables. Our bad debt expense increased to $23 million or 0.4% of net sales in 2008 from $16 million or 0.3% of net sales in 2007. The increase in bad debt occurred primarily during the second half of 2008 due to the current economic environment. We continue to monitor the creditworthiness of our customers closely and do not expect our future cash flow to be materially impacted. Historically, we have had strong operating cash flow, and we anticipate this will continue. We expect to continue to use this cash flow to pay dividends, acquire new businesses, repurchase our common stock, pay down debt and meet our ongoing obligations and commitments.

 

 

 

Cash used for investing activities decreased in 2008 primarily due to decreased acquisition activity, partially offset by increased capital and software investments as we continue to invest in our business to support our long-term growth. Cash used for investing activities in 2008 also includes a $21 million deposit into an indemnification escrow for a portion of the purchase price for the Ecovation acquisition. We continue to acquire strategic businesses which complement 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. We expect to continue to make significant capital investments and acquisitions in the future 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. 2008 financing activities included the issuance of $250 million 4.875% senior notes and $337 million of share repurchases. 2007 financing activities included the repayment of our euro 300 million ($390 million) 5.375% euronotes in February 2007 and $371 million of share repurchases, offset partially by short-term borrowings. Share repurchases in both years were funded with operating cash flows, short-term borrowing and cash from the exercise of employee stock options. In November 2008, our Board authorized the purchase of $300 million of our common stock from Henkel. The authorized repurchase was completed with the purchase of 11.3 million shares from Henkel in November 2008. In October 2006, we announced an authorization to repurchase up to 10 million shares of Ecolab common stock. As of December 31, 2008, approximately 3.9 million shares remain to be purchased under this authorization. Shares are repurchased for the purpose of offsetting the dilutive effect of stock options and incentives, to efficiently return capital to shareholders and for general corporate purposes. We do not expect to repurchase a significant amount of shares in 2009. Cash proceeds and tax benefits from option exercises provide a portion of the funding for repurchase activity.

 

28



 

In 2008, we increased our indicated annual dividend rate for the 17th consecutive year. We have paid dividends on our common stock for 72 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

 

 2008

 

$0.1300

 

$0.1300

 

$0.1300

 

$0.1400

 

$0.5300

 

 2007

 

  0.1150

 

  0.1150

 

  0.1150

 

  0.1300

 

  0.4750

 

 2006

 

  0.1000

 

  0.1000

 

  0.1000

 

  0.1150

 

  0.4150

 

 

LIQUIDITY AND CAPITAL RESOURCES

We currently expect to fund all of our cash requirements which are reasonably foreseeable for 2009, 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 borrowing. In the event of a significant acquisition or other significant funding need, funding may occur through additional short and/or long-term borrowing or through the issuance of the company’s common stock.

 

In the third quarter of 2008, global credit markets, including the commercial paper markets, began experiencing adverse conditions, and volatility within these markets temporarily increased the costs associated with issuing debt due to increased spreads over relevant interest rate benchmarks. Despite this volatility and disruption, we continued to have access to the commercial paper market and we are well positioned to weather the current volatility in the credit markets. 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 with a diverse portfolio of banks which expires in June 2012. We can draw directly on the credit facility on a revolving credit basis. As of December 31, 2008, $316 million of this credit facility was committed to support outstanding U.S. commercial paper, leaving $284 million available for other uses. In addition, we have other committed and uncommitted credit lines of $140 million with major international banks and financial institutions to support our general global funding needs. Approximately $120 million of these credit lines were undrawn and available for use as of our 2008 year end. Additional details on our credit facilities are included in Note 6.

 

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

 

  $

334    

 

  $

334    

 

  $

–    

 

  $

–    

 

  $

–    

 

 

Long-term debt

 

804    

 

5    

 

159    

 

164    

 

476    

 

 

Operating leases

 

174    

 

56    

 

68    

 

27    

 

23    

 

 

Interest*

 

221    

 

42    

 

73    

 

61    

 

45    

 

 

Benefit payments**

 

929    

 

70    

 

139    

 

184    

 

536    

 

 

Total contractual cash obligations

 

  $

2,462    

 

  $

507    

 

  $

439    

 

  $

436    

 

  $

1,080    

 

 

*

Interest on variable rate debt was calculated using the interest rate at year-end 2008.

**

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

 

As of December 31, 2008, our gross liability for uncertain tax positions under FIN 48 was $111 million. We are not able to reasonably estimate the amount by which the liability will increase or decrease over an extended period of 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 2009, based on plan asset values as of December 31, 2008. We expect to make a voluntary contribution of approximately $50 million to our U.S. pension plan in the beginning of April 2009. We are in compliance with all funding requirements of our pension and postretirement health care plans. We are required to fund certain international pension benefit plans in accordance with local legal requirements. We estimate contributions to be made to our international plans will approximate $25 million in 2009. 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 primarily by the proceeds on the sale of the vehicles.

 

Except for approximately $57 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 December 31, 2008, 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 covenants regarding the amount of indebtedness secured by liens and subsidiary indebtedness allowed.

 

29



 

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

See Note 2 for information on 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, 2008, we had approximately $486 million notional amount of foreign currency forward exchange contracts with face amounts denominated primarily in euros. These contracts are recorded on our balance sheet at fair-value of $14 million. Under SFAS 157, fair value is determined using foreign currency exchange rates (level 2 - significant other observable inputs) as of 2008 year end.

 

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. As of December 31, 2008, we do not have any interest rate swaps outstanding.

 

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 EVENT

In January 2009, we announced plans to undertake restructuring and other cost-saving actions during 2009 in order to streamline our operations and improve our efficiency and effectiveness. The restructuring includes a reduction of our global workforce by approximately 1,000 positions or 4%, and the reduction of plant and distribution center locations. We estimate these anticipated actions will result in pretax restructuring special charges of approximately $65 million to $75 million ($42 million to $49 million after tax) in 2009. These actions are expected to provide annualized pretax savings of approximately $70 million to $80 million ($45 million to $50 million after tax), with pretax savings of approximately $50 million to be realized in 2009. We anticipate that approximately $55 million to $65 million of the restructuring special charges represent cash expenditures.

 

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 items such as:

 

revenue and earnings growth

 

 

raw material and delivered product costs

 

 

currency translation

 

 

business acquisitions

 

 

system implementations

 

 

restructuring charges and cost savings

 

 

cash flows

 

 

loss of customers and bad debt

 

 

debt repayments

 

 

disputes and claims

 

 

environmental and regulatory considerations

 

 

share repurchases

 

 

global economic conditions and credit risk

 

 

pension expenses and potential contributions

 

 

new accounting pronouncements

 

 

income taxes, including unrecognized tax benefits or uncertain tax positions

 

 

borrowing capacity

 

 

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, 2008, 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.

 

30



 

CONSOLIDATED STATEMENT OF INCOME

 

YEAR ENDED DECEMBER 31 (MILLIONS, EXCEPT PER SHARE)

 

 

2008

 

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

$

6,137.5

 

 

$

5,469.6

 

$

4,895.8

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of sales

 

 

3,141.6

 

 

2,691.7

 

2,416.1

 

Selling, general and administrative expenses

 

 

2,257.5

 

 

2,090.9

 

1,868.1

 

Special gains and charges

 

 

25.9

 

 

19.7

 

 

 

Operating income

 

 

712.5

 

 

667.3

 

611.6

 

Interest expense, net

 

 

61.6

 

 

51.0

 

44.4

 

Income before income taxes

 

 

650.9

 

 

616.3

 

567.2

 

Provision for income taxes

 

 

202.8

 

 

189.1

 

198.6

 

Net income

 

 

$

448.1

 

 

$

427.2

 

$

368.6

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

 

 

 

 

 

 

 

 

Basic

 

 

$

1.83

 

 

$

1.73

 

$

1.46

 

Diluted

 

 

$

1.80

 

 

$

1.70

 

$

1.43

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

 

$

0.5300

 

 

$

0.4750

 

$

0.4150

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

 

245.4

 

 

246.8

 

252.1

 

Diluted

 

 

249.3

 

 

251.8

 

257.1

 

 

 

 

 

 

 

 

 

 

 

 

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

 

31



 

CONSOLIDATED BALANCE SHEET

 

DECEMBER 31 (MILLIONS)

 

2008

 

 

2007

 

ASSETS

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

66.7

 

 

$

137.4

 

Accounts receivable, net

 

971.0

 

 

974.0

 

Inventories

 

467.2

 

 

450.8

 

Deferred income taxes

 

94.7

 

 

89.4

 

Other current assets

 

91.5

 

 

65.7

 

Total current assets

 

1,691.1

 

 

1,717.3

 

Property, plant and equipment, net

 

1,135.2

 

 

1,083.4

 

Goodwill

 

1,267.7

 

 

1,279.2

 

Other intangible assets, net

 

326.7

 

 

328.9

 

Other assets

 

336.2

 

 

314.0

 

Total assets

 

$

4,756.9

 

 

$

4,722.8

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

Short-term debt

 

$

338.9

 

 

$

403.5

 

Accounts payable

 

359.6

 

 

343.7

 

Compensation and benefits

 

261.1

 

 

280.2

 

Income taxes

 

46.3

 

 

27.7

 

Other current liabilities

 

436.0

 

 

463.2

 

Total current liabilities

 

1,441.9

 

 

1,518.3

 

Long-term debt

 

799.3

 

 

599.9

 

Postretirement health care and pension benefits

 

680.2

 

 

418.5

 

Other liabilities

 

263.9

 

 

250.4

 

Shareholders’ equity (a)

 

 

 

 

 

 

Common stock

 

328.0

 

 

326.5

 

Additional paid-in capital

 

1,090.5

 

 

1,015.2

 

Retained earnings

 

2,617.0

 

 

2,298.4

 

Accumulated other comprehensive income (loss)

 

(359.1

)

 

63.1

 

Treasury stock

 

(2,104.8

)

 

(1,767.5

)

Total shareholders’ equity

 

1,571.6

 

 

1,935.7

 

Total liabilities and shareholders’ equity

 

$

4,756.9

 

 

$

4,722.8

 

 

 

 

 

 

 

 

 

(a)    Common stock, 400 million shares authorized, $1.00 par value, 236.2 million shares outstanding at December 31, 2008, 246.8 million shares outstanding at December 31, 2007.

 

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

 

32



 

CONSOLIDATED STATEMENT OF CASH FLOWS

 

YEAR ENDED DECEMBER 31 (MILLIONS)

 

2008

 

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income

 

$

448.1

 

 

$

427.2

 

$

368.6

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

334.7

 

 

291.9

 

268.6

 

Deferred income taxes

 

80.6

 

 

2.5

 

(18.8

)

Share-based compensation expense

 

33.6

 

 

37.9

 

36.3

 

Excess tax benefits from share-based payment arrangements

 

(8.2

)

 

(20.6

)

(19.8

)

Gain on sale of plant

 

(24.5

)

 

 

 

 

 

Disposal (gains) losses, net

 

(1.7

)

 

(11.0

)

0.4

 

Write-down of business investments

 

19.1

 

 

 

 

 

 

Other, net

 

7.0

 

 

6.9

 

1.3

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

(89.9

)

 

(34.4

)

(66.8

)

Inventories

 

(57.5

)

 

(19.3

)

(18.0

)

Other assets

 

6.8

 

 

20.7

 

(27.1

)

Accounts payable

 

30.0

 

 

(10.0

)

44.5

 

Other liabilities

 

(24.9

)

 

105.8

 

58.4

 

Cash provided by operating activities

 

753.2

 

 

797.6

 

627.6

 

 

 

 

 

 

 

 

 

 

INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Capital expenditures

 

(326.7

)

 

(306.5

)

(287.9

)

Capitalized software expenditures

 

(67.8

)

 

(55.0

)

(33.1

)

Property sold

 

36.4

 

 

7.4

 

25.6

 

Businesses acquired and investments in affiliates, net of cash acquired

 

(203.8

)

 

(329.4

)

(65.5

)

Sale of businesses

 

2.2

 

 

19.8

 

1.8

 

Deposit into indemnification escrow

 

(21.0

)

 

 

 

 

 

Proceeds from sales and maturities of short-term investments

 

 

 

 

 

 

125.1

 

Cash used for investing activities

 

(580.7

)

 

(663.7

)

(234.0

)

 

 

 

 

 

 

 

 

 

FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Net (repayments) issuances of notes payable

 

(67.8

)

 

279.9

 

(47.7

)

Long-term debt borrowings

 

257.7

 

 

 

 

396.2

 

Long-term debt repayments

 

(3.9

)

 

(394.2

)

(86.3

)

Reacquired shares

 

(337.2

)

 

(371.4

)

(282.8

)

Cash dividends on common stock

 

(128.5

)

 

(114.0

)

(101.2

)

Exercise of employee stock options

 

36.4

 

 

96.7

 

87.9

 

Excess tax benefits from share-based payment arrangements

 

8.2

 

 

20.6

 

19.8

 

Other, net

 

(0.5

)

 

 

 

(2.3

)

Cash used for financing activities

 

(235.6

)

 

(482.4

)

(16.4

)

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

(7.6

)

 

1.9

 

2.4

 

 

 

 

 

 

 

 

 

 

(Decrease) increase in cash and cash equivalents

 

(70.7

)

 

(346.6

)

379.6

 

Cash and cash equivalents, beginning of year

 

137.4

 

 

484.0

 

104.4

 

Cash and cash equivalents, end of year

 

$

66.7

 

 

$

137.4

 

$

484.0

 

 

 

 

 

 

 

 

 

 

 

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

 

33



 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME AND SHAREHOLDERS’ EQUITY

 

MILLIONS

 

COMMON
STOCK

 

ADDITIONAL
PAID-IN
CAPITAL

 

RETAINED
EARNINGS

 

ACCUMULATED
OTHER
COMPREHENSIVE
INCOME (LOSS)

 

TREASURY
STOCK

 

TOTAL

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

448.1

 

 

 

 

 

 

 

 

448.1

 

Cumulative translation adjustment

 

 

 

 

 

 

 

 

 

(233.6

)

 

 

 

 

(233.6

)

Derivative instruments

 

 

 

 

 

 

 

 

 

13.4

 

 

 

 

 

13.4

 

Pension and postretirement benefits

 

 

 

 

 

 

 

 

 

(202.0

)

 

 

 

 

(202.0

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

25.9

 

Cash dividends declared

 

 

 

 

 

 

(129.5

)

 

 

 

 

 

 

 

(129.5

)

Stock options and awards

 

1.5

 

 

75.3

 

 

 

 

 

 

 

(0.1

)

 

76.7

 

Reacquired shares

 

 

 

 

 

 

 

 

 

 

 

 

(337.2

)

 

(337.2

)

Balance December 31, 2008

 

$   328.0

 

 

$  1,090.5

 

$   2,617.0

 

 

$     (359.1

)

 

$  (2,104.8

)

 

$  1,571.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

COMMON STOCK ACTIVITY

 

 

 

2008

 

 

2007

 

2006

 

YEAR ENDED DECEMBER 31
(SHARES)

 

COMMON
STOCK

 

TREASURY
STOCK

 

 

COMMON
STOCK

 

TREASURY
STOCK

 

COMMON
STOCK

 

TREASURY
STOCK

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares, beginning of year

 

326,530,856

 

(79,705,760

)

 

322,578,427

 

(71,241,560

)

318,602,705

 

(64,459,800

)

Stock options

 

1,422,526

 

60,932

 

 

3,952,429

 

49,197

 

3,975,722

 

172,665

 

Stock awards, net issuances

 

 

 

45,336

 

 

 

 

50,702

 

 

 

49,519

 

Reacquired shares

 

 

 

(12,174,341

)

 

 

 

(8,564,099

)

 

 

(7,003,944

)

Shares, end of year

 

327,953,382

 

(91,773,833

)

 

326,530,856

 

(79,705,760

)

322,578,427

 

(71,241,560

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

34



 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. NATURE OF BUSINESS

Ecolab Inc. (the “company”) develops and markets premium products and services for the hospitality, foodservice, health care and 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, health care and educational facilities, quick service (fast-food and convenience store) 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. Cumulative translation included cumulative losses of $39 million and gains of $171 million as of December 31, 2008 and 2007, 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 $13 million, $15 million and $2 million for the years ended December 31, 2008, 2007 and 2006, 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 as of December 31, 2008 and 2007, and $7 million as of December 31, 2006. Returns and credit activity is recorded directly to sales.

 

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

 

MILLIONS

 

2008

 

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$43

 

 

 

$38

 

 

$39

 

 

Bad debt expense

 

23

 

 

 

16

 

 

13

 

 

Write-offs

 

(20

)

 

 

(17

)

 

(17

)

 

Other*

 

(2

)

 

 

6

 

 

3

 

 

Ending balance

 

$44

 

 

 

$43

 

 

$38

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

* 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 24% and 23% of consolidated inventories at year-end 2008 and 2007, 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 cleaning and sanitizing products and dishwashing 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 $286 million, $261 million and $236 million for 2008, 2007 and 2006, respectively. Expenditures for repairs and maintenance are charged to expense as incurred. Expenditures for major renewals and improvements, 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, intellectual property, trademarks 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 13 years as of December 31, 2008, and 14 years as of December 31, 2007.

 

35



 

The weighted-average useful life by type of asset at December 31, 2008 is as follows:

 

NUMBER OF YEARS

 

 

 

Customer relationships

 

12

 

Intellectual property

 

12

 

Trademarks

 

19

 

Other

 

7

 

 

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, 2008, 2007 and 2006, was $48 million, $30 million and $25 million, respectively. Amortization expense has increased significantly primarily due to the Microtek and Ecovation acquisitions. As of December 31, 2008, future estimated amortization expense related to amortizable other identifiable intangible assets will be:

 

MILLIONS

2009

 

$42

 

2010

 

39

 

2011

 

38

 

2012

 

36

 

2013

 

35

 

 

The company tests goodwill for impairment on an annual basis during the second quarter for all reporting units. If circumstances change significantly, the company would also test a reporting unit for impairment during interim periods between our annual tests. The company’s reporting units are its operating segments. 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 company’s testing, there has been no impairment of goodwill during the three years ended December 31, 2008. Due to a sales decline at GCS Service in the second half of 2008, the company updated the impairment analysis of GCS Service as of December 31, 2008. The updated analysis indicated there has been no impairment.

 

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 company’s sales policies do not provide for general rights of return. 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

 

2008

 

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

448.1

 

 

$

427.2

 

$

368.6

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

 

Basic

 

245.4

 

 

246.8

 

252.1

 

Effect of dilutive stock options and awards

 

3.9

 

 

5.0

 

5.0

 

Diluted

 

249.3

 

 

251.8

 

257.1

 

Net income per common share

 

 

 

 

 

 

 

 

Basic

 

$

1.83

 

 

$

1.73

 

$

1.46

 

Diluted

 

$

1.80

 

 

$

1.70

 

$

1.43

 

 

 

 

 

 

 

 

 

 

 

Restricted stock awards of 88,250 shares for 2008, 68,180 shares for 2007 and 24,670 shares for 2006 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 5.5 million shares for 2008, 5.3 million shares for 2007, and 2.6 million shares for 2006, 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. 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.

 

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. 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 five years of service. In addition, the company includes a forfeiture estimate in the amount of compensation expense being recognized based on an estimate of the number of outstanding awards expected to vest. 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.

 

36



 

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 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 amended 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, for financial assets and liabilities measured on a recurring basis. The adoption did not have a material impact on the company’s consolidated results of operations and financial condition. The company’s financial assets measured on a recurring basis as of December 31, 2008, include foreign exchange contracts with fair market value of approximately $14 million, which are valued using foreign currency exchange rates as of the balance sheet date (level 2 - significant other observable inputs). In addition, the company has concluded that it does not have any amounts of financial assets and liabilities measured using the company’s own assumptions of fair market value (level 3 - unobservable inputs). The company does not expect the future adoption for non-financial assets and liabilities to have a material impact on the company’s consolidated results of operations and financial position.

 

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. The adoption did not have an impact on the company’s consolidated results of operations and financial position because the company did not elect the fair value option for any of its financial assets or liabilities.

 

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. In preparation for the adoption, the company has chosen to expense acquisition costs as incurred. The company’s 2008 results include immaterial amounts of acquisition costs. The company adopted SFAS 141R effective January 1, 2009. The adoption did not have a material impact on the company’s consolidated results of operations and financial position.

 

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. The company adopted SFAS 160 effective January 1, 2009. The adoption did not have a material impact on the company’s consolidated results of operations and financial position.

 

In March 2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment to FASB Statement 133 (“SFAS 161”). SFAS 161 requires companies to provide greater transparency through disclosures about how and why the company uses derivative instruments. This includes how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, the level of derivative activity entered into by the company and how derivative instruments and related hedged items affect the company’s financial position, results of operations, and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The company will include the required disclosures upon adoption of SFAS 161 in the first quarter of 2009.

 

In December 2008, the FASB issued FSP FAS 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets (“FSP FAS 132(R)-1”) which amends SFAS 132(R) to require more detailed disclosures regarding employers’ plan assets, including their investment strategies, major categories of plan assets, concentration of risk, and valuation methods used to measure the fair value of plan assets. FSP FAS 132(R)-1 is effective for fiscal years ending after December 15, 2009. The company is currently evaluating the impact of adoption.

 

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.

 

37



 

3.  SPECIAL GAINS AND CHARGES

 

Special gains and charges were $25.9 million in 2008 and include a charge of $19.1 million recorded in the fourth quarter, for the write-down of investments in an energy management business and the closure of two small non-strategic health care businesses, as well as costs to optimize the company’s business structure, including costs related to establishing the new European headquarters in Zurich, Switzerland. These charges were partially offset by a gain of $24.0 million from the sale of a plant in Denmark recorded in the second quarter and a $1.7 million gain related to the sale of a business in the U.K. recorded in the first quarter.

 

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 costs related to establishing the company’s European headquarters 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 a business 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.

 

In January 2009, the company announced plans to undertake restructuring and other cost-saving actions during 2009 in order to streamline operations and improve efficiency and effectiveness. The restructuring includes a reduction of the company’s global workforce by approximately 1,000 positions or 4%, and the reduction of plant and distribution center locations. The company estimates these anticipated actions will result in pretax restructuring special charges of approximately $65 million to $75 million ($42 million to $49 million after tax) in 2009. These actions are expected to provide annualized pretax savings of approximately $70 million to $80 million ($45 million to $50 million after tax), with pretax savings of approximately $50 million to be realized in 2009. The company anticipates that approximately $55 million to $65 million of the restructuring special charges represent cash expenditures.

 

4.  RELATED PARTY TRANSACTIONS

 

Henkel AG & Co. KGaA (“Henkel”) beneficially owned 72.7 million Ecolab common shares, or approximately 29.4%, of the company’s outstanding common shares on December 31, 2007. In February 2008, Henkel announced its intention to sell some or all of its Ecolab shares. In November 2008, Henkel completed the sale of all 72.7 million shares. As part of the sale transaction, the company repurchased 11.3 million shares directly from Henkel for $300 million.

 

The company and its affiliates sold products and services in the aggregate amounts of $8 million, $5 million and $6 million in 2008, 2007 and 2006, respectively, to Henkel or its affiliates. The company purchased products and services in the amounts of $73 million, $65 million and $66 million in 2008, 2007 and 2006, 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 2008, 2007 and 2006 were as follows:

 

 

 

 

 

 

 

ESTIMATED

 

 

 

 

 

 

 

ANNUAL SALES

 

  BUSINESS

 

DATE OF

 

 

 

PRE-ACQUISITION

 

  ACQUIRED

 

ACQUISITION

 

SEGMENT

 

(MILLIONS)

 

 

 

 

 

 

 

(UNAUDITED)

 

  2008

 

 

 

 

 

 

 

  Ecovation, Inc.

 

February

 

U.S. C&S

 

$    50

 

 

 

 

 

 

(Food & Beverage)

 

 

 

 

 

 

 

 

 

 

 

 

 

  Novartis-Ireland dairy hygiene business

 

January

 

International
(EMEA)

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  2007

 

 

 

 

 

 

 

 

  Microtek

 

November

 

U.S. C&S

 

150

 

 

Medical Holdings,
Inc.

 

 

 

International
(Healthcare)

 

 

 

 

 

 

 

 

 

 

 

 

 

  Eagle

 

June

 

International

 

4

 

 

Environmental

 

 

 

(Asia Pacific)

 

 

 

 

Systems

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  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
(Food & 

 

10

 

 

 

 

 

 

Beverage)

 

 

 

 

 

 

 

 

 

 

 

 

 

  Powles Hunt & Sons International Ltd.

 

September

 

International
(EMEA)

 

5

 

 

 

 

 

 

 

 

 

 

 

  Shield

 

June

 

International

 

19

 

 

Medicare Ltd.

 

 

 

(EMEA)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In February 2008, the company 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. The total purchase price was approximately $210 million, of which $21 million remains payable and was placed in escrow for indemnification purposes.

 

In November 2007, the company acquired Microtek Medical Holdings Inc., a manufacturer and marketer of infection prevention products for health care 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.

 

38



 

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. Acquisitions in 2008, 2007 and 2006 were not material to the company’s consolidated financial statements; therefore pro forma financial information is not presented. The aggregate purchase price of acquisitions and investments in affiliates has been reduced for any cash or cash equivalents acquired with the acquisitions.

 

Based upon preliminary purchase price allocations and subsequent adjustments thereto, the components of the aggregate purchase prices of the acquisitions and investment in affiliates made were as follows:

 

 MILLIONS

 

  2008

 

2007

 

2006

 

 Net tangible assets acquired (liabilities assumed)

 

$

36

 

$

61

 

$

(6

)

 Identifiable intangible assets

 

 

 

 

 

 

 

Customer relationships

 

11

 

55

 

20

 

Intellectual property

 

26

 

5

 

1

 

Trademarks

 

16

 

27

 

5

 

Other intangibles

 

10