ECL

Business Context and Reporting Period

Company: Ecolab Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2007
Business Overview: Ecolab provides water, hygiene, and energy technologies and services to customers in the food, beverage, hospitality, and industrial sectors. The company operates through U.S. Cleaning & Sanitizing, U.S. Other Services, and International segments.

Key Financial Metrics

Note: Total debt as of Sept 30, 2007, consists of $265.3 million short-term and $569.9 million long-term. Cash decreased significantly from $484.0 million at year-end 2006 due to debt repayment and share repurchases.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated net sales increased 11% in Q3 2007 and 11% for the nine-month period. Growth was driven by volume (5%), price changes (2%), and foreign currency exchange (4%).
• Profitability: Net income rose 3% in Q3 and 12% for the nine months. Diluted EPS increased 7% in Q3 and 15% year-to-date.
• Special Charges: Operating income was impacted by $27.8 million in special charges for the quarter and nine months ended Sept 30, 2007. This primarily includes a $27.4 million arbitration settlement related to California wage/hour class action lawsuits involving Pest Elimination employees.
• Tax Rate: The effective income tax rate decreased to 28.2% in Q3 2007 from 35.1% in Q3 2006, largely due to discrete tax benefits of $8.6 million from corporate tax rate reductions in the UK and Germany.
• Balance Sheet: Total assets decreased to $4.3 billion from $4.4 billion at year-end 2006, primarily due to the reduction in cash used to repay $397 million in euronotes.

Guidance, Outlook, and Risks

• Outlook: Management expects the effective income tax rate, excluding discrete benefits, to approximate 34% to 35% for the full year 2007.
• Acquisitions:
  • Microtek Medical: Announced a definitive agreement to acquire Microtek Medical Holdings, Inc. for $6.30 per share in cash. The deal is subject to shareholder approval and expected to close in Q4 2007.
  • Other Acquisitions: Completed several smaller acquisitions in 2007 (e.g., Apprise Technologies, Green Harbour, Fuma Pest, Eagle Environmental Systems) totaling $52.0 million in purchase price for the nine months.
• Divestitures: Completed the sale of Peter Cox Limited (UK) in September 2007, expecting a gain of $5 million to $6 million after tax in Q4 2007.
• Liquidity: Increased borrowing capacity under the Multicurrency Credit Agreement from $450 million to $600 million in October 2007. Management believes cash from operations and reserves are sufficient to meet foreseeable needs.
• Risks:
  • Legal: The company is challenging the $27.4 million arbitration award regarding wage/hour claims.
  • Tax: Gross liability for unrecognized tax benefits was $94 million as of Sept 30, 2007. It is reasonably possible this liability could decrease by up to $45 million in the next 12 months due to audit settlements.

Investor Verification Checklist

• Arbitration Settlement: Verify the status of the $27.4 million wage/hour arbitration settlement and the likelihood of the company's challenge succeeding.
• Microtek Acquisition: Confirm the closing of the Microtek Medical merger and the integration timeline for Q4 2007.
• Tax Liability: Monitor the resolution of open tax audits (specifically IRS 2002-2004) which could impact the $94 million unrecognized tax benefit liability.
• Cash Position: Assess the impact of the significant cash drawdown (from $484M to $107M) on liquidity given the upcoming debt repayments and acquisition funding needs.
• Share Repurchases: Review the remaining authorization under the share repurchase program (4.7 million shares remaining as of Sept 30, 2007).