EX-13 3 a09-36096_1ex13.htm EX-13

Exhibit 13

 

FINANCIAL DISCUSSION

 

Executive Summary

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

 

The global recession had a significant impact on our hospitality and foodservice markets and made 2009 one of the most challenging years in recent memory. Our customers’ need for our products and services were as critical as ever to keep their environments clean, safe, and healthy, but they also faced increased pressures due to softer demand and a turbulent economy. We responded with aggressive actions to serve our customers and to control our costs. We delivered innovative new products that provide outstanding results and enable customers to save labor, water and energy. We continued to add new accounts. We maintained appropriate pricing and took necessary actions to significantly reduce our operating costs. We continued to invest in systems to improve our operating efficiency. And through these actions, we delivered for our shareholders while building opportunity for the future. Our performance during these challenging times underscored the strength of our business, our people and our strategies.

 

Both 2009 and 2008 results of operations included significant special gains and charges, as well as discrete tax items which impact the year over year comparisons.

 

Financial Performance

Sales: Reported consolidated net sales decreased 4% in 2009 to $5.9 billion from $6.1 billion in 2008. Net sales were negatively impacted by unfavorable foreign currency exchange compared to the prior year. When measured in fixed rates of foreign currency exchange, net sales were flat to the prior year as we were able to offset a 3% decrease in volume with a 3% increase due to pricing.

 

Gross Margin: We experienced continued increases in our delivered product costs during the first half of 2009 but saw our delivered product costs decline on a year over year basis during the second half of 2009. For the full year, our delivered product costs increased moderately compared to the prior year. We were able to successfully offset the increase with pricing and cost-saving initiatives, which helped improve our gross margin in 2009 to 49.5% compared to 48.8% in 2008.

 

Operating Income: Operating income declined 4% in 2009 to $681 million compared to $713 million in 2008. Adjusted operating income, excluding the impact of special gains and charges, increased 3% in 2009. See Non-GAAP Financial Measures at the end of this Financial Discussion for further information.

 

Diluted Net Income Per Share: Reported diluted net income per share decreased 3% to $1.74 for 2009 compared to $1.80 per share in 2008. Special gains and charges and discrete tax items negatively impacted 2009 by $0.25 per share and 2008 by $0.06 per share. Adjusted diluted net income per share, excluding the impact of special gains and charges, and discrete tax items, increased 7% to $1.99 in 2009 compared to $1.86 in 2008. See Non-GAAP Financial Measures at the end of this Financial Discussion for further information.

 

Cash Flow: Cash flow from operating activities was $695 million in 2009, despite making voluntary contributions of $225 million to our U.S. pension plan of which $100 million was made in the fourth quarter. We continue to generate strong cash flow from operations, allowing us to make key investments in our business, pay down debt and provide returns to our shareholders through cash dividends and share repurchases.

 

Balance Sheet: Our balance sheet remained within the “A” categories of the major rating agencies during 2009 and exceeded our stated objective of having an investment grade balance sheet. Our strong balance sheet has allowed us to continue to have access to capital at attractive rates despite increased volatility in capital markets.

 

Return on Equity: In 2009 our return on beginning shareholders’ equity was 26.6%. This was the 18th consecutive year in which we achieved our long-term financial objective of at least 20% return on beginning shareholders’ equity.

 

Dividends: We increased our quarterly cash dividend 11% in December 2009 to an indicated annual rate of $0.62 per share for 2010. The increase represents our 18th consecutive annual dividend rate increase and the 73rd consecutive year we have paid cash dividends. We continued our record of consecutive annual cash dividend increases, reflecting our earnings performance, good cash flows and a solid balance sheet. Ecolab remains a strong company with a very strong future and our dividend increase reflects our equally strong commitment to improving shareholder returns.

 

 

 

Restructuring: In 2009 we made the difficult but necessary decision to complete a restructuring plan to streamline our operations and improve efficiency and effectiveness. The restructuring included a global workforce reduction and optimization of our supply chain including the reduction of plant and distribution center locations. As a result of these actions, we recorded restructuring charges of $73 million ($52 million after tax) or $0.22 per diluted share in 2009. These actions are expected to provide annualized pretax savings of approximately $75 million ($50 million after tax), with pretax savings of $50 million realized in 2009.

 

EBS Update: We continued the rollout of Ecolab Business Solutions (EBS), an extensive multi-year project to implement a common set of business processes and systems across all of Europe.

 

21



 

Outlook

            We enter 2010 a stronger company, and we will continue to improve our operating efficiency and effectiveness, leveraging actions and investments made in 2009.

 

            We expect a limited economic recovery and continued challenges in our markets in 2010. Our customers, particularly in the U.S. and Europe, will face ongoing pressure as economic uncertainties persist.

 

            We will remain focused on sustainable long-term growth and returns for our shareholders.

 

            We will continue to focus on new account growth, better customer penetration and new innovative product sales.

 

            We will continue to make key investments in our business that will support our future growth opportunities.

 

            We intend to continue to make targeted acquisitions.

 

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 $52 million and $44 million, as of December 31, 2009 and 2008, respectively. These amounts include our allowance for sales returns and credits of $10 million as of December 31, 2009 and $9 million as of December 31, 2008. Our bad debt expense as a percent of net sales was 0.4% in 2009 and 2008 and 0.3% in 2007. We believe that it is reasonably likely that future results will be consistent with historical trends and experience. However, 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 thirty years. Bond issues in the population are rated no less than Aa by Moody’s Investor Services or AA by Standard & Poors. The discount rate is calculated by matching 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. Significant differences in actual experience or significant changes in assumptions may materially affect pension and other post-

 

22



 

retirement obligations. The unrecognized actuarial loss on our U.S. qualified and nonqualified pension plans decreased from $546 million to $533 million (before tax) as of December 31, 2008 and 2009, respectively, primarily due to higher than expected return on plan assets and amortization of existing unrecognized losses, partially offset by a decrease in our discount rate. In determining our U.S. pension and postretirement obligations for 2009, our discount rate decreased to 5.84% from 6.26% at year-end 2008 and our projected salary increase was unchanged at 4.32%. Our expected return on plan assets, used for determining 2009 and 2010 expense, was decreased to 8.50% from 8.75% in prior years to reflect lower expected long-term returns on plan assets.

 

The effect on 2010 expense of a decrease in the discount rate or expected return on assets assumption as of December 31, 2009 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

 

2010

 

  ASSUMPTION

 

CHANGE

 

OBLIGATION

 

EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Discount rate

 

-0.25pts

 

$37.9

 

$5.0

 

 

 

 

 

 

 

 

 

  Expected return on assets

 

-0.25pts

 

N/A

 

$2.7

 

 

 

 

 

 

 

 

 

 

 

 

EFFECT ON U.S. POSTRETIREMENT

 

  MILLIONS

 

HEALTH CARE BENEFITS PLAN

 

 

 

 

 

INCREASE IN

 

HIGHER

 

 

 

ASSUMPTION

 

RECORDED

 

2010

 

  ASSUMPTION

 

CHANGE

 

OBLIGATION

 

EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Discount rate

 

-0.25pts

 

$4.6

 

$0.9

 

 

 

 

 

 

 

 

 

  Expected return on assets

 

-0.25pts

 

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 vest or be forfeited. Estimating vesting includes assessing the probability of meeting service and performance conditions. If actual vesting or 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. Our annual effective income tax rate includes the impact of reserve provisions. We recognize the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with a taxing authority. 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 entire 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. federal income tax returns through 2006. The U.S. income tax returns for the years 2007 and 2008 are currently under audit and the anticipated settlement is early 2011. It is reasonably possible for specific open positions within the 1999 through 2004 examinations, which are still open with the IRS, to be settled in the next twelve months. 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 twelve months. Settlement of any particular issue could result in offsets to other balance sheet accounts, cash payments or receipts and/or adjustments to tax expense. 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.

 

23



 

Long-Lived and Intangible Assets

We periodically review our long-lived and intangible assets for impairment and assess whether significant events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. This could occur when the carrying amount of an asset exceeds the anticipated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded, if any, is calculated as the excess of the asset’s carrying value over its estimated fair value. We also periodically reassess the estimated remaining useful lives of our long-lived assets.

 

Changes to estimated useful lives would impact the amount of depreciation and amortization expense recorded in earnings. We have experienced no significant changes in the carrying value or estimated remaining useful lives of our long-lived assets.

 

We test our goodwill for impairment on an annual basis during the second quarter for all reporting units. Our reporting units are our operating segments. If circumstances change significantly, we would test for impairment during interim periods between our annual tests. Goodwill is 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. Based on our testing, there has been no impairment of goodwill during the three years ending December 31, 2009.

 

RESULTS OF OPERATIONS

 

Net Sales

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

 

 

 

 

 

 

 

 

 

 

MILLIONS

 

   2009

 

2008

 

2007

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

$5,901  

 

$6,138

 

$5,470

 

(4)

%

 

12

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Volume

(3)%

 

3%

 

Price changes

3  

 

3   

 

Foreign currency exchange

(4)  

 

3   

 

Acquisitions and divestitures

-  

 

3   

 

 

 

 

 

 

Total net sales change

(4)%

 

12%

 

 

 

 

 

 

 

 

 

Gross Margin

 

 

 2009

 

2008

 

 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit as a percent of net sales

 

49.5%

 

48.8%

 

50.8%

 

 

 

 

 

 

 

 

 

 

Our gross profit margin (“gross margin”) (defined as the difference between net sales less cost of sales divided by net sales) increase in 2009 over 2008 was driven by pricing and cost-saving initiatives, which more than offset lower sales volume and higher raw material costs. Our 2009 gross margin was negatively impacted by restructuring charges included in cost of sales of $12.6 million, which decreased our gross margin by 0.2 percentage points.

 

Our gross margin decreased in 2008 compared to 2007. The 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 margin was also negatively impacted by our Microtek and Ecovation acquisitions which, based on their business models, operate at lower gross margins than our historical business. In 2008 we experienced significant increases in our raw material costs compared to 2007.

 

Selling, General and Administrative Expenses

 

 

 

 2009

 

2008

 

 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

36.8%

 

36.8%

 

38.2%

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses as a percentage of consolidated net sales was 36.8% for both 2009 and 2008. The savings from our recent restructuring, pricing leverage and well-managed spending were offset by investments and other cost increases. We continue to make key business investments that drive innovation and efficiency, through R&D and information technology.

 

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.

 

Special Gains and Charges

Special gains and charges reported on the Consolidated Statement of Income included the following items:

 

 

 

 

 

 

 

 

 

MILLIONS

 

  2009

 

   2008

 

   2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

 

 

 

 

 

 

 

 

Restructuring charges

 

 

$   12.6

 

 

$     -   

 

$     -   

 

Special gains and charges

 

 

 

 

 

 

 

 

 

Restructuring charges

 

 

59.9

 

 

-   

 

-   

 

Business structure and optimization

 

 

2.8

 

 

25.6

 

2.0

 

Legal settlement

 

 

-   

 

 

-   

 

27.4

 

Business write-downs and closures

 

 

2.4

 

 

19.1

 

-   

 

Gain on sale of plant

 

 

-   

 

 

(24.0

)

-   

 

Gain on sale of businesses

 

 

-   

 

 

(1.7

)

(11.0

)

Other items

 

 

2.0

 

 

6.9

 

1.3

 

Subtotal

 

 

67.1

 

 

25.9

 

19.7

 

Total

 

 

$79.7

 

 

$   25.9

 

$   19.7

 

 

 

 

 

 

 

 

 

 

 

 

In the first quarter of 2009, we announced plans to undertake restructuring and other cost-saving actions during 2009 in order to streamline operations and improve efficiency and effectiveness. The restructuring plan included a reduction of the company’s global workforce by 950 positions or 4% and

 

24



 

the reduction of plant and distribution center locations. As a result of these actions, we recorded restructuring charges of $72.5 million ($52.0 million after tax) or $0.22 per diluted share during 2009.

 

The restructuring was completed as of the end of 2009. These actions will provide annualized pretax savings of approximately $75 million ($50 million after tax), with pretax savings of approximately $50 million realized in 2009. Further details related to the restructuring are included in Note 3.

 

2009 special gains and charges also included the write-down of our carrying value in a non-strategic business as well as costs to optimize our business structure.

 

Special gains and charges in 2008 included 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 healthcare 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 in 2007 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 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.

 

Operating Income

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

 

 

 

 

 

 

 

 

 

 

 

MILLIONS

 

   2009

 

    2008

 

  2007

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported GAAP operating income

 

 

$  681.3

 

 

$  712.8

 

$  669.0

 

(4)

%

 

7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Special gains and charges

 

 

79.7

 

 

25.9

 

19.7

 

 

 

 

 

 

 

Non-GAAP adjusted operating income

 

 

$  761.0

 

 

$  738.7

 

$  688.7

 

3%

 

7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported operating income declined in 2009 compared to 2008. The operating income decrease was impacted by the year over year comparison of special gains and charges and the unfavorable impact of foreign currency exchange. Excluding the impact of special gains and charges, adjusted operating income increased 3% in 2009. Excluding unfavorable currency exchange, adjusted operating income increased 8% in 2009 as increased pricing and cost savings efforts more than offset increased raw material and other costs during the year.

 

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 would have grown 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.

 

Interest Expense, Net

Net interest expense totaled $61 million, $62 million and $51 million in 2009, 2008 and 2007, respectively. The increase in our 2008 net interest expense compared to 2007 is due to higher debt levels, primarily to fund share repurchases and acquisitions.

 

Provision for Income Taxes

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

 

 

 

 

 

 

 

 

 

PERCENT

 

2009

 

 2008

 

 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported tax rate

 

 

32.5%

 

 

31.1%

 

30.6%

 

Tax rate impact of:

 

 

 

 

 

 

 

 

 

Special gains and charges

 

 

(0.6)

 

 

0.2

 

0.7

 

Discrete tax items

 

 

(0.2)

 

 

0.3

 

3.1

 

Non-GAAP adjusted effective tax rate

 

 

31.7%

 

 

31.6%

 

34.4%

 

 

 

 

 

 

 

 

 

 

 

 

Our reported tax rate includes discrete impacts from special gains and charges and discrete tax events. Our adjusted effective income tax rate in 2009 was comparable to 2008. The reduction in our adjusted effective income tax rate in 2008 from 2007 was primarily due to increased tax benefits from international operations, including global rate reductions.

 

The 2009 reported tax rate was impacted by $20.4 million of tax items including $21.5 million of net tax benefits on special gains and charges as well as $1.1 million of discrete tax net charges. Discrete tax items in 2009 included tax benefits of $3.4 million related to prior year reserve adjustments which were more than offset by $4.5 million of tax charges related to optimizing our business structure.

 

The 2008 reported tax rate was impacted by $11.0 million of 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 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.

 

25



 

Net Income Attributable to Ecolab

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

 

 

 

 

 

 

 

 

 

 

 

 

 

MILLIONS

 

2009

 

2008

 

2007

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported GAAP net income

 

$

417.3

 

 

 

$

448.1

 

 

$

427.2

 

 

(7

)%

 

 

5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Special gains and charges

 

58.2

 

 

 

16.8

 

 

9.5

 

 

 

 

 

 

 

 

 

Discrete tax expense (benefit)

 

1.1

 

 

 

(1.9

)

 

(19.3

)

 

 

 

 

 

 

 

 

Non-GAAP adjusted net income

 

$

476.6

 

 

 

$

463.0

 

 

$

417.4

 

 

3

%

 

 

11

%

 

 

Diluted Net Income Per Common Share (EPS)

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

 

 

 

 

 

 

 

 

 

 

 

 

 

DOLLARS

 

2009

 

2008

 

2007

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported GAAP EPS

 

$

1.74

 

 

 

$

1.80

 

 

$

1.70

 

 

(3

)%

 

 

6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Special gains and charges

 

0.24

 

 

 

0.07

 

 

0.04

 

 

 

 

 

 

 

 

 

Discrete tax expense (benefit)

 

0.00

 

 

 

(0.01

)

 

(0.08

)

 

 

 

 

 

 

 

 

Non-GAAP adjusted EPS

 

$

1.99

 

 

 

$

1.86

 

 

$

1.66

 

 

7

%

 

 

12

%

 

 

Note: Per share amounts do not necessarily sum due to rounding.

 

Net income attributable to Ecolab for 2009 decreased 7% to $417 million. On a per share basis, diluted net income per share decreased 3% to $1.74. Amounts for both 2009 and 2008 included special gains and charges and discrete tax items. Excluding these items from both years adjusted net income attributable to Ecolab increased 3% and adjusted diluted net income per share increased 7%. Currency translation had an unfavorable impact of approximately $25 million, net of tax, or $0.10 per share for 2009 compared to 2008.

 

Net income attributable to Ecolab increased 5% to $448 million in 2008 compared to $427 million in 2007. Diluted net income per share increased 6% to $1.80 per share in 2008, compared to $1.70 per share in 2007. Both years included special gains and charges and discrete tax items. Excluding these items from both years, adjusted net income attributable to Ecolab increased 11% and adjusted diluted net income per share increased 12%. Our 2008 adjusted net income attributable to Ecolab growth was also favorably impacted by currency translation of approximately $13 million, net of tax, and a lower adjusted effective income tax rate compared to 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 rates of foreign 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 foreign currency exchange rates used by management for 2009. 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.

 

Sales by Reportable Segment

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

 

 

 

 

 

 

 

 

 

 

 

 

 

MILLIONS

 

2009

 

2008

 

2007

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

 

 

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cleaning & Sanitizing

 

$

2,663

 

 

 

$

2,661

 

 

$

2,351

 

 

0

%

 

 

13

%

 

Other Services

 

450

 

 

 

469

 

 

450

 

 

(4

)

 

 

4

 

 

Total United States

 

3,113

 

 

 

3,130

 

 

2,801

 

 

(1

)

 

 

12

 

 

International

 

2,675

 

 

 

2,651

 

 

2,492

 

 

1

 

 

 

6

 

 

Total

 

5,788

 

 

 

5,781

 

 

5,293

 

 

0

 

 

 

9

 

 

Effect of foreign currency translation

 

113

 

 

 

357

 

 

177

 

 

 

 

 

 

 

 

 

Consolidated

 

$

5,901

 

 

 

$

6,138

 

 

$

5,470

 

 

(4

)%

 

 

12

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales for our largest U.S. Cleaning & Sanitizing businesses were as follows:

 

Institutional - Sales declined 3% in 2009 compared to 2008. New account gains, success with new products and appropriate pricing enabled us to outperform our markets in an unusually soft restaurant and lodging market environment. We continue to see strong results for our ApexTM solids warewashing line due to customer demand for energy and cost savings solutions. While our markets are expected to remain soft over the near term, we remain confident in their long-term potential, and that our investments in business development, innovation and productivity improvements will continue to deliver steady long-term growth.

 

Food & Beverage - Sales decreased 1% as good results for our core Food & Beverage business were offset by lower Ecovation sales. Excluding the impact of Ecovation, our core Food & Beverage business continued to perform well as sales rose 5%. Food & Beverage enjoyed good gains in the dairy, beverage and food markets as pricing, corporate account wins and new products offset soft results in agri and meat & poultry markets. Water care sales in 2009 were similar to results in 2008. Ecovation experienced a sales decline in 2009 as the sales comparison was negatively impacted by the timing of a large Ecovation project sale in the first quarter of 2008, with the remainder of the unfavorability driven by delays in design/build projects due to the overall economic climate which is causing customers to be reluctant to make capital investments.

 

Kay - Sales were strong in 2009 growing 9% compared to the prior year. Quick service restaurant sales experienced solid growth benefiting from new accounts, new product introductions and growth at existing customers. The food retail business showed strong results due to new account growth.

 

26



 

Healthcare - Sales increased 11% for 2009. Business acquisitions contributed 2% to the year over year sales growth. Continued solid growth from our infection barrier business and hand hygiene products led the results. Sales growth has also benefited from H1N1 related sales of hand sanitizers during 2009.

 

GRAPHIC

 

U.S. Other Services sales decreased 4% in 2009. Sales for our U.S. Other Services businesses were as follows:

 

Pest Elimination - Pest Elimination experienced a 1% sales decline in 2009 as weakness in full service restaurants and hospitality more than offset gains in the quick service restaurant and food & beverage plant markets. Both contract and non-contract services were lower. New account gains are being offset by customer cancellations as our customers focused on reducing their spending due to the soft economy.

 

GCS Service - Sales declined 11% in 2009 compared to the prior year. The difficult economic conditions and uncertainty in the foodservice market caused existing customers to delay repairs and maintenance, and prospective customers to delay the start of new programs. We also chose to exit some low-margin business during the year. Despite the challenging environment, our corporate account prospect pipeline remains healthy.

 

 

We evaluate the performance of our International operations based on fixed rates of foreign currency exchange. When measured in fixed currency rates, sales for our International operations increased 1% in 2009. When measured at public foreign currency rates, International sales decreased 7%. Fixed currency sales changes for our International regions were as follows:

 

Europe, Middle East and Africa (EMEA) - Sales declined 2% in 2009 compared to 2008 as the significant slowdown in foodservice and hospitality markets in Europe more than offset sales growth in the Middle East and Africa. In Europe, sales growth in the U.K. was offset by lower sales in Germany, France and Italy as the region continues to be negatively impacted by the global economic recession. From a divisional perspective, our Healthcare business continued to show solid growth in the region while Institutional, Food & Beverage, Textile Care and Pest Elimination businesses all reported modest sales declines. In 2009 we continued the implementation of our new business information system, EBS, which will provide the platform to effectively manage our pan-European business to drive growth and more efficiently operate our supply chain.

 

Asia Pacific - Sales increased 4% in 2009 compared to the prior year. New customer account gains and increased product penetration in key markets helped overcome the impact of economic uncertainty and low levels of business travel and tourism in the region. Sales growth in the region continued to be led by growth in Food & Beverage. From a country perspective, sales growth has been driven by China, Australia and New Zealand.

 

Latin America - We continue to experience strong sales growth in Latin America as sales in the region increased 8% in 2009. Our Institutional, Food & Beverage and Pest Elimination businesses all showed strong gains in the region against weak economic conditions. Growth was driven by new corporate account wins and increased product penetration within existing accounts. This helped to offset the economic slowdown brought about by the global recession and the initial H1N1 virus outbreak in Mexico that negatively impacted the tourism and lodging industry throughout the region. From a country perspective, sales were led by continued strong gains in Venezuela and Brazil.

 

Canada - Sales increased 8% in 2009. Sales growth was led by strong results from Food & Beverage, driven by new account gains and product price increases. Institutional also reported sales growth in 2009 led by pricing, success with distributor partners and new account wins during the year.

 

Operating Income by Reportable Segment

 

MILLIONS

 

2009

 

2008

 

2007

 

 

 

 

 

 

 

 

 

Operating income

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

 

 

 

Cleaning & Sanitizing

 

$

495

 

 

$

430

 

 

$

394

 

 

Other Services

 

66

 

 

52

 

 

41

 

 

Total United States

 

561

 

 

482

 

 

435

 

 

International

 

209

 

 

236

 

 

247

 

 

Total

 

770

 

 

718

 

 

682

 

 

Corporate

 

(104

)

 

(55

)

 

(40

)

 

Effect of foreign currency translation

 

15

 

 

50

 

 

27

 

 

Consolidated

 

$

681

 

 

$

713

 

 

$

669

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income as a percent of net sales

 

 

 

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

 

 

 

Cleaning & Sanitizing

 

18.6

%

 

16.2

%

 

16.8

%

 

Other Services

 

14.6

 

 

11.1

 

 

9.1

 

 

Total United States

 

18.0

 

 

15.4

 

 

15.5

 

 

International

 

7.8

 

 

8.9

 

 

9.9

 

 

Consolidated

 

11.5

%

 

11.6

%

 

12.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

27



 

U.S. Cleaning & Sanitizing operating income increased 15% in 2009 compared to 2008. As a percentage of net sales, operating income increased to 18.6% in 2009 from 16.2% in 2008. Increased pricing, favorable raw material costs and cost savings actions drove the significant operating income growth in 2009.

 

U.S. Other Services operating income increased 27% in 2009. As a percentage of net sales, operating income increased to 14.6% in 2009 from 11.1% in 2008. Operating income growth was driven by good operating income growth at Pest Elimination and significant improvement in GCS Service operating results compared to 2008. Operating income benefited from pricing, cost savings actions and well-managed spending.

 

International fixed currency operating income decreased 12% in 2009 compared to 2008. The International operating income margin was 7.8% in 2009 compared to 8.9% in 2008. Pricing gains and cost savings efforts were unable to fully offset raw material and other cost increases, and continued investment in the business. When measured at public currency rates, operating income declined 21% in 2009.

 

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 smaller 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 certain raw materials and finished goods in some regions. Proportionately larger investments in sales, technical support and administrative personnel are also necessary in order to facilitate the growth of our International operations.

 

Corporate

The corporate segment includes special gains and charges reported on the Consolidated Statement of Income of $80 million, $26 million and $20 million for 2009, 2008 and 2007, respectively. It also included investments in the development of business systems and other corporate investments we made during the last three years as part of our ongoing efforts to improve our efficiency and returns.

 

2008 Compared With 2007

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 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 were 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 control 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 rates of foreign currency exchange. Fixed rate sales of our International operations grew 6% in 2008. The net impact of acquisitions and divestitures did not have a significant impact on total International year-over-year sales growth in 2008. Sales in 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 2007, 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 2007 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.

 

U.S. Cleaning & Sanitizing operating income increased 9% 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 compared to 2007. 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.

 

28



 

International fixed rate operating income decreased 4% in 2008 compared to 2007. The International operating income margin was 8.9% in 2008 compared to 9.9% 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.

 

FINANCIAL POSITION & LIQUIDITY

Financial Position

Significant changes in our financial position during 2009 included the following:

 

Total assets increased to $5.0 billion as of December 31, 2009 from $4.8 billion at December 31, 2008. The increase was primarily due to the impact of foreign currency exchange rates, which increased the value of international assets on our balance sheet when translated into U.S. dollars. The increase due to currency translation more than offset reductions in accounts receivables, inventory and other assets on our balance sheet when measured using local currencies before translation into U.S. dollars.

 

Total liabilities decreased to $3.0 billion at December 31, 2009 from $3.2 billion at December 31, 2008 primarily due to a decrease in our short-term debt and a reduction of our U.S. pension liability, which more than offset an increase in liabilities due to currency translation.

 

GRAPHIC

 

Total debt was $1.0 billion at December 31, 2009 and decreased from total debt of $1.1 billion at December 31, 2008. Our debt continued to be rated within the “A” categories by the major rating agencies during 2009. The decrease in total debt was primarily due to the paydown of our outstanding commercial paper during 2009. 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 total equity and total debt) was 32% at year-end 2009 and 42% at year-end 2008. The debt to capitalization ratio was lower at year-end 2009 due to the decrease in debt as well as an increase in equity due to cumulative translation adjustments and an increase in retained earnings. We view our debt to capitalization ratio as an important indicator of our creditworthiness.

 

Cash Flows

 

Cash provided by operating activities decreased to $695 million in 2009 compared to $753 million in 2008. The decrease in operating cash flow was primarily due to an increase in pension plan contributions. In 2009 we made voluntary contributions of $225 million to our U.S. pension plan compared to $75 million in 2008. Operating cash flow in 2009 was also negatively impacted by the payment of a $35 million legal settlement, higher tax payments and restructuring payments of $50 million in 2009, compared to 2008. 2009 operating cash flow benefited from lower working capital, including improved accounts receivable collection and lower inventory. 2008 operating cash flow included $30 million of proceeds from the sale of Ecovation lease receivables. Our bad debt expense increased to $27 million or 0.4% of net sales in 2009 from $23 million or 0.4% of net sales in 2008. We continue to monitor our receivable portfolio and 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 significantly in 2009 compared to 2008 and 2007, primarily due to decreased acquisition activity and capital expenditures. We reduced our capital spending in 2009 due to the slower economic environment, efforts to more efficiently allocate and utilize equipment and as we focused on restructuring and streamlining our business operations. Cash used for investing activities in 2008 included a $21 million deposit into an indemnification escrow for a portion of the purchase price for the Ecovation acquisition. We continue to target strategic business acquisitions 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. 2009 financing activities included a $242 million paydown of our U.S. commercial paper and $69 million of share repurchases. 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 were funded with operating cash flows, short-term borrowing and cash from the exercise of employee stock options. 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

 

29



 

corporate purposes. Cash proceeds and tax benefits from option exercises provide a portion of the funding for repurchase activity.

 

In December 2009, we increased our indicated annual dividend rate for the 18th consecutive year. We have paid dividends on our common stock for 73 consecutive years. Cash dividends declared per share of common stock, by quarter, for each of the last three years were as follows:

 

 

 

FIRST
QUARTER

 

SECOND
QUARTER

 

THIRD
QUARTER

 

FOURTH
QUARTER

 

YEAR

 

2009

 

$0.1400

 

 

$0.1400

 

 

$0.1400

 

 

$0.1550

 

 

$0.5750

 

 

2008

 

0.1300

 

 

0.1300

 

 

0.1300

 

 

0.1400

 

 

0.5300

 

 

2007

 

0.1150

 

 

0.1150

 

 

0.1150

 

 

0.1300

 

 

0.4750

 

 

 

Liquidity and Capital Resources

We currently expect to fund all of our cash requirements which are reasonably foreseeable for 2010, 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 additional short-term and/or long-term borrowings. In the event of a significant acquisition or other significant funding need, funding may occur through additional short and/or long-term borrowings or through the issuance of the company’s common stock.

 

Beginning 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. We continued to have access to the commercial paper market during this volatile and disruptive period. While the credit markets have improved and stabilized in 2009, we believe we are well-positioned to manage any renewed volatility in the credit markets as a result of our A-1/P-1 short term debt ratings and strong operating cash flow.

 

As of December 31, 2009, we had $74 million of cash and cash equivalents on hand and expect our operating cash flow to remain strong. Additionally, we have a $600 million multi-year credit facility with a diverse group of banks which expires in June 2012. The credit facility supports our $600 million U.S. commercial paper program and our $200 million European commercial paper program. Combined borrowing under these two commercial paper programs may not exceed $600 million. As of December 31, 2009, we had $74 million outstanding in our U.S. commercial paper program and no amounts outstanding under our European commercial paper program. Both programs are rated A-1 by Standard & Poor’s and P-1 by Moody’s.

 

In addition, we have other committed and uncommitted credit lines of $150 million with major international banks and financial institutions to support our general global funding needs. Approximately $134 million of these credit lines were undrawn and available for use as of our 2009 year end.

 

We are in compliance with all covenants and other requirements of our credit agreements and indentures.

 

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 facility prior to their termination.

 

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

Contractual
obligations

TOTAL

LESS
THAN
1YEAR

2-3
YEARS

4-5
YEARS

MORE
THAN
5 YEARS

Notes payable

$

91

 

$

91

 

$

 

$

 

$

 

Long-term debt

859

 

2

 

153

 

190

 

514

 

Capital lease obligations

18

 

6

 

7

 

4

 

1

 

Operating leases

203

 

61

 

81

 

36

 

25

 

Interest*

197

 

45

 

69

 

58

 

25

 

Benefit payments**

1,007

 

72

 

160

 

180

 

595

 

Total contractual cash obligations

$

2,375

 

$

277

 

$

470

 

$

468

 

$

1,160

 

 

*                   Interest on variable rate debt was calculated using the interest rate at year-end 2009.

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

 

As of December 31, 2009, our gross liability for uncertain tax positions was $117 million. We are not able to reasonably estimate the amount by which the liability will increase or decrease over an extended period of time or whether a cash settlement of the liability will be required. 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 healthcare benefit plans in 2010, based on plan asset values as of December 31, 2009 and have not determined whether or not we will do so. 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 $28 million in 2010. 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 $53 million of letters of credit supporting domestic and international commercial relationships and transactions, primarily for 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.

 

30



 

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 “special purposes entities”, which are sometimes established for the purpose of facilitating off-balance sheet financial arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

 

New Accounting Pronouncements

Effective January 1, 2009, we adopted the provisions of new FASB guidance on noncontrolling interests and revised our current and prior year financial statement presentation in accordance with this guidance. See Note 2 for further information on this adoption and other new accounting pronouncements.

 

Market Risk

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

 

We enter into foreign currency forward contracts to hedge certain intercompany financial arrangements, and to hedge against the effect of exchange rate fluctuations on transactions related to cash flows denominated in currencies other than U.S. dollars. See Note 8 for further information on our hedging activity.

 

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, 2009 and 2008, we did 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 Events

Beginning in 2010, Venezuela has been designated hyper-inflationary and as such all foreign currency fluctuations are recorded in income. On January 8, 2010 the Venezuelan government devalued its currency (Bolivar Fuerte). As a result of the devaluation, we recorded a charge of approximately $4 million, net of tax, in the first quarter of 2010 due to the remeasurement of the local balance sheet. We expect that future ongoing currency gains and losses related to the translation of the Venezuela local financial statements will not have a material impact on our future consolidated results of operations or financial position.

 

In February 2010, our Board of Directors authorized the repurchase of up to 10 million shares of our common stock. As of December 31, 2009, 2,720,784 shares remained to be repurchased under previous authorization. We intend to repurchase all shares under both authorizations, for which no expiration dates have been established, in open market or privately negotiated transactions, subject to market conditions.

 

We have evaluated and determined that there were no other material subsequent events required to be recognized or disclosed as of February 26, 2010, the date these financial statements were issued.

 

Non-GAAP Financial Measures

This Financial Discussion includes financial measures that have not been calculated in accordance with accounting principles generally accepted in the U.S. (GAAP). These Non-GAAP measures include fixed currency sales and fixed currency operating income, adjusted operating income, adjusted effective tax rate, adjusted net income attributable to Ecolab and adjusted diluted net income per share amounts. We provide these measures as additional information regarding our operating results. We use these Non-GAAP measures internally to evaluate our performance and in making financial and operational decisions, including with respect to incentive compensation. We believe that our presentation of these measures provides investors with greater transparency with respect to our results of operations and that these measures are useful for period-to-period comparison of results.

 

We include in special gains and charges items that are unusual in nature, significant in amount and important to an understanding of underlying business performance. In order to better allow investors to compare underlying business performance period-to-period, we provide adjusted operating income, adjusted net income and adjusted diluted net income per share, which exclude special gains and charges and discrete tax items.

 

The adjusted effective tax rate measure promotes period-to-period comparability of the underlying effective tax rate because the amounts excluded do not necessarily reflect costs associated with historical trends or expected future costs.

 

We evaluate the performance of our international operations based on fixed currency rates of foreign exchange. Fixed currency sales and fixed currency operating income measures eliminate the impact of exchange rate fluctuations on our international sales and operating income, respectively, and promote a better understanding of our underlying sales and operating income trends. Fixed currency amounts are based on translation into U.S. dollars at fixed foreign currency exchange rates established by management at the beginning of 2009.

 

These measures are not in accordance with, or an alternative to GAAP, and may be different from Non-GAAP measures used by other companies. Investors should not rely on any single financial measure when evaluating our business. We recommend that investors view these measures in conjunction with the GAAP measures included in this Financial Discussion and have provided reconciliations of reported GAAP amounts to the Non-GAAP amounts.

 

31



 

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:

 

              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, credit risk and currency gains and losses

 

              pension expenses and potential contributions

 

              new accounting pronouncements

 

              income taxes, including unrecognized tax benefits or uncertain tax positions

 

              borrowing capacity

 

              liquidity requirements

 

              sales and earnings growth

 

              end market trends and demand for our products and services

 

              new product and program introductions

 

              progress on sustainability

 

              investments

 

              and operating efficiencies and SKU reduction

 

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, 2009, 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.

 

32



 

CONSOLIDATED STATEMENT OF INCOME

 

YEAR ENDED DECEMBER 31 (MILLIONS, EXCEPT PER SHARE)

 

 

2009

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

$

5,900.6

 

 

$

6,137.5

 

$

5,469.6

 

Operating expenses

 

 

 

 

 

 

 

 

 

Cost of sales (including special charges of $12.6 in 2009)

 

 

2,978.0

 

 

3,141.6

 

2,691.7

 

Selling, general and administrative expenses

 

 

2,174.2

 

 

2,257.2

 

2,089.2

 

Special gains and charges

 

 

67.1

 

 

25.9

 

19.7

 

Operating income

 

 

681.3

 

 

712.8

 

669.0

 

Interest expense, net

 

 

61.2

 

 

61.6

 

51.0

 

Income before income taxes

 

 

620.1

 

 

651.2

 

618.0

 

Provision for income taxes

 

 

201.4

 

 

202.8

 

189.1

 

Net income including noncontrolling interest

 

 

418.7

 

 

448.4

 

428.9

 

Less: Net income attributable to noncontrolling interest

 

 

1.4

 

 

0.3

 

1.7

 

Net income attributable to Ecolab

 

 

$

417.3

 

 

$

448.1

 

$

427.2

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to Ecolab per common share

 

 

 

 

 

 

 

 

 

Basic

 

 

$

1.76

 

 

$

1.83

 

$

1.73

 

Diluted

 

 

$

1.74

 

 

$

1.80

 

$

1.70

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

 

$

0.5750

 

 

$

0.5300

 

$

0.4750

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

 

236.7

 

 

245.4

 

246.8

 

Diluted

 

 

239.9

 

 

249.3

 

251.8

 

 

 

 

 

 

 

 

 

 

 

 

33



 

CONSOLIDATED BALANCE SHEET

 

DECEMBER 31 (MILLIONS)

 

2009

 

 

2008

 

ASSETS

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

73.6

 

 

$

66.7

 

Accounts receivable, net

 

1,016.1

 

 

971.0

 

Inventories

 

493.4

 

 

467.2

 

Deferred income taxes

 

83.9

 

 

94.7

 

Other current assets

 

147.2

 

 

91.5

 

Total current assets

 

1,814.2

 

 

1,691.1

 

Property, plant and equipment, net

 

1,176.2

 

 

1,135.2

 

Goodwill

 

1,414.1

 

 

1,267.7

 

Other intangible assets, net

 

312.5

 

 

326.7

 

Other assets

 

303.9

 

 

336.2

 

Total assets

 

$

5,020.9

 

 

$

4,756.9

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

Short-term debt

 

$

98.5

 

 

$

338.9

 

Accounts payable

 

360.9

 

 

359.6

 

Compensation and benefits

 

302.1

 

 

261.1

 

Income taxes

 

21.8

 

 

46.3

 

Other current liabilities

 

466.9

 

 

436.0

 

Total current liabilities

 

1,250.2

 

 

1,441.9

 

Long-term debt

 

868.8

 

 

799.3

 

Postretirement health care and pension benefits

 

603.7

 

 

680.2

 

Other liabilities

 

288.6

 

 

256.5

 

Shareholders’ equity (a)

 

 

 

 

 

 

Common stock

 

329.8

 

 

328.0

 

Additional paid-in capital

 

1,179.3

 

 

1,090.5

 

Retained earnings

 

2,898.1

 

 

2,617.0

 

Accumulated other comprehensive loss

 

(232.9

)

 

(359.1

)

Treasury stock

 

(2,173.4

)

 

(2,104.8

)

Total Ecolab shareholders’ equity

 

2,000.9

 

 

1,571.6

 

Noncontrolling interest

 

8.7

 

 

7.4

 

Total equity

 

2,009.6

 

 

1,579.0

 

Total liabilities and equity

 

$

5,020.9

 

 

$

4,756.9

 

 

 

 

 

 

 

 

 

(a)         Common stock, 400.0 million shares authorized, $1.00 par value, 236.6 million shares outstanding at December 31, 2009, 236.2 million shares outstanding at December 31, 2008.

 

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

 

34



 

CONSOLIDATED STATEMENT OF CASH FLOWS

 

YEAR ENDED DECEMBER 31 (MILLIONS)

 

2009

 

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income including noncontrolling interest

 

$

418.7

 

 

$

448.4

 

$

428.9

 

Adjustments to reconcile net income including noncontrolling interest to cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

334.3

 

 

334.7

 

291.9

 

Deferred income taxes

 

88.1

 

 

80.6

 

2.5

 

Share-based compensation expense

 

37.3

 

 

33.6

 

37.9

 

Excess tax benefits from share-based payment arrangements

 

(7.7

)

 

(8.2

)

(20.6

)

Pension and postretirement plan contributions

 

(263.7

)

 

(112.4

)

(40.7

)

Pension and postretirement plan expense

 

82.0

 

 

73.6

 

80.9

 

Restructuring, net of cash paid

 

22.4

 

 

 

 

 

 

Gain on sale of plant

 

 

 

 

(24.5

)

 

 

Gain on sale of businesses

 

 

 

 

(1.7

)

(11.0

)

Business write-downs and closures

 

2.4

 

 

19.1

 

 

 

Other, net

 

12.9

 

 

7.0

 

6.9

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

45.1

 

 

(89.9

)

(34.4

)

Inventories

 

13.0

 

 

(57.5

)

(19.3

)

Other assets

 

(30.7

)

 

6.8

 

20.7

 

Accounts payable

 

(25.1

)

 

30.0

 

(10.0

)

Other liabilities

 

(34.0

)

 

13.6

 

63.9

 

Cash provided by operating activities

 

695.0

 

 

753.2

 

797.6

 

 

 

 

 

 

 

 

 

 

INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Capital expenditures

 

(252.5

)

 

(326.7

)

(306.5

)

Capitalized software expenditures

 

(44.8

)

 

(67.8

)

(55.0

)

Property sold

 

11.7

 

 

36.4

 

7.4

 

Businesses acquired and investments in affiliates, net of cash acquired

 

(14.4

)

 

(203.8

)

(329.4

)

Sale of businesses

 

0.7

 

 

2.2

 

19.8

 

Deposit into indemnification escrow

 

 

 

 

(21.0

)

 

 

Cash used for investing activities

 

(299.3

)

 

(580.7

)

(663.7

)

 

 

 

 

 

 

 

 

 

FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Net (repayments) issuances of notes payable

 

(244.0

)

 

(67.8

)

279.9

 

Long-term debt borrowings

 

 

 

 

257.7

 

 

 

Long-term debt repayments

 

(6.4

)

 

(3.9

)

(394.2

)

Reacquired shares

 

(68.8

)

 

(337.2

)

(371.4

)

Cash dividends on common stock

 

(132.7

)

 

(128.5

)

(114.0

)

Exercise of employee stock options

 

46.4

 

 

36.4

 

96.7

 

Excess tax benefits from share-based payment arrangements

 

7.7

 

 

8.2

 

20.6

 

Other, net

 

 

 

 

(0.5

)

 

 

Cash used for financing activities

 

(397.8

)

 

(235.6

)

(482.4

)

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

9.0

 

 

(7.6

)

1.9

 

 

 

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

6.9

 

 

(70.7

)

(346.6

)

Cash and cash equivalents, beginning of year

 

66.7

 

 

137.4

 

484.0

 

Cash and cash equivalents, end of year

 

$

73.6

 

 

$

66.7

 

$

137.4

 

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION

 

 

 

 

 

 

 

 

Income taxes paid

 

$

143.5

 

 

$

100.4

 

$

161.0

 

Interest paid

 

66.4

 

 

64.3

 

75.5

 

 

 

 

 

 

 

 

 

 

 

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

 

35


 

 


 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME AND EQUITY

 

 

 

 

ECOLAB SHAREHOLDERS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ACCUMULATED

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ADDITIONAL

 

 

 

OTHER

 

 

 

TOTAL ECOLAB

 

NON-

 

 

 

 

 

 

 

COMMON

 

PAID-IN

 

RETAINED

 

COMPREHENSIVE

 

TREASURY

 

SHAREHOLDERS’

 

CONTROLLING

 

 

 

 

MILLIONS

 

 

STOCK

 

CAPITAL

 

EARNINGS

 

INCOME (LOSS)

 

STOCK

 

EQUITY

 

INTEREST

 

TOTAL

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance December 31, 2006

 

 

$   322.6

 

$   868.2

 

$   1,983.2

 

$    (96.5

)

$  (1,397.3

)

$  1,680.2

 

$       6.4

 

$ 1,686.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

427.2

 

 

 

 

 

427.2

 

1.7

 

428.9

 

 

Cumulative translation adjustment

 

 

 

 

 

 

 

 

128.8

 

 

 

128.8

 

0.5

 

129.3

 

 

Derivative instruments

 

 

 

 

 

 

 

 

(2.3

)

 

 

(2.3

)

 

 

(2.3

)

 

Pension and postretirement benefits

 

 

 

 

 

 

 

 

33.1

 

 

 

33.1

 

 

 

33.1

 

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

586.8

 

2.2

 

589.0

 

 

Distributions to noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1.4

)

(1.4

)

 

Cumulative effect accounting adoption

 

 

 

 

 

 

5.1

 

 

 

 

 

5.1

 

 

 

5.1

 

 

Cash dividends declared

 

 

 

 

 

 

(117.1

)

 

 

 

 

(117.1

)

 

 

(117.1

)

 

Stock options and awards

 

 

3.9

 

147.0

 

 

 

 

 

0.5

 

151.4

 

 

 

151.4

 

 

Reacquired shares

 

 

 

 

 

 

 

 

 

 

(370.7

)

(370.7

)

 

 

(370.7

)

 

Balance December 31, 2007

 

 

326.5

 

1,015.2

 

2,298.4

 

63.1

 

(1,767.5

)

1,935.7

 

7.2

 

1,942.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

448.1

 

 

 

 

 

448.1

 

0.3

 

448.4

 

 

Cumulative translation adjustment

 

 

 

 

 

 

 

 

(233.6

)

 

 

(233.6

)

(0.1

)

(233.7

)

 

Derivative instruments

 

 

 

 

 

 

 

 

13.8

 

 

 

13.8

 

 

 

13.8

 

 

Unrealized gains (losses) on securities

 

 

 

 

 

 

 

 

(0.4

)

 

 

(0.4

)

(0.2

)

(0.6

)

 

Pension and postretirement benefits

 

 

 

 

 

 

 

 

(202.0

)

 

 

(202.0

)

 

 

(202.0

)

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

25.9

 

-

 

25.9

 

 

Distributions to noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1.1

)

(1.1

)

 

Initial investment by

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1.3

 

1.3

 

 

Cash dividends declared

 

 

 

 

 

 

(129.5

)

 

 

 

 

(129.5

)

 

 

(129.5

)

 

Stock options and awards

 

 

1.5

 

75.3

 

 

 

 

 

(0.1

)

76.7

 

 

 

76.7

 

 

Reacquired shares

 

 

 

 

 

 

 

 

 

 

(337.2

)

(337.2

)