Operating Results

Consolidated

*Unusual items included the gain on the sale of the Jackson MSC, Inc. business of $25.9 million, special charges of $7.1 million and the cumulative effect of a change in accounting for revenue recognition of $2.4 million.

Consolidated net sales reached nearly $2.4 billion for 2001, an increase of 4 percent over net sales of nearly $2.3 billion in 2000. Sales growth was experienced in nearly all of the company’s divisions. Business acquisitions also contributed to the overall sales growth for 2001. Businesses acquired in 2001 and the annualized effect of businesses acquired and disposed of in 2000 accounted for approximately 2 percentage points of the growth in consolidated sales for 2001. Changes in currency translation negatively impacted the consolidated sales growth rate by approximately 2 percentage points for 2001. Sales results reflected benefits from aggressive sales efforts, new account growth, new products, and additional programs to solve customer cleaning needs. These benefits were partially offset by a poor economic environment and a slowdown in the travel and hospitality markets following the September 11 terrorist attacks.

The company’s consolidated gross profit margin was 53.7 percent of net sales for 2001, which decreased from a gross profit margin of 54.7 percent in 2000. The lower margin reflected increased raw material costs, unfavorable sales mix, fixed costs growing faster than unit volume, foreign currency effects and general cost increases. The comparison benefited from lower restructuring costs in 2001. Net selling price increases during 2001 were not significant.

Selling, general and administrative expenses for 2001 were 40.2 percent of net sales, a decrease from total selling, general and administrative expenses of 40.5 percent of net sales in 2000. Selling, general and administrative expenses in 2000 included $4.4 million of income for reductions in probable losses related to certain environmental matters partially offset by $4 million of expenses related to a large distributor. Selling, general and administrative expense improvements for 2001 primarily reflected the benefits of a tighter focus on discretionary costs, lower incentive-based compensation and synergies from acquisitions, which were partially offset by investments in the sales-and-service force, investments in acquisitions and increased retirement plan and medical costs.

Operating income for 2001 was $318 million and decreased 7 percent from $343 million in 2000. This is a decrease of 2 percent from 2000 when excluding the unusual items that occurred during 2000. Business acquisitions had a minimal effect on operating income for 2001. As a percentage of net sales, operating income was 13.5 percent compared with 2000 operating income of 14.3 percent, excluding unusual items. This decrease in operating income reflects the poor economic environment and a slowdown in the travel and hospitality markets.

The company’s net income for 2001 was $188 million, a decrease of 9 percent compared with net income of $206 million for 2000. Excluding the unusual items from 2000, net income for 2001 decreased 5 percent from $198 million. The decrease in net income reflected the effects of a difficult economic environment, lower gross margins, higher net interest expense, lower equity in the earnings of Henkel-Ecolab and the negative impact of foreign currency translation. As a percentage of net sales, after-tax income for 2001 was 8.0 percent, down from 8.7 percent in 2000, excluding the unusual items previously mentioned.

2000 compared with 1999

Consolidated net sales reached nearly $2.3 billion for 2000, an increase of 9 percent over net sales of nearly $2.1 billion in 1999. This sales growth reflected double-digit increases in Kay’s and Pest Elimination’s operations and in sales in the Latin America region, as well as another year of solid growth in the company’s core Institutional business. Business acquisitions also contributed to the overall sales growth for 2000. Businesses acquired in 2000 and the annualized effect of businesses acquired in 1999 accounted for approximately 3 percentage points of the growth in consolidated sales for 2000. Changes in currency translation had a very modest negative effect on the consolidated sales growth rate for 2000. The growth in sales also reflected new product introductions, a larger and better trained sales-and-service force, new customers and a continuation of generally good conditions in the hospitality and lodging industries, particularly in the United States.

The consolidated gross profit margin was 54.7 percent of net sales for 2000, down slightly from a gross profit margin of 54.9 percent in 1999. This modest decrease reflected the negative effects of the lower gross margin and more service-related businesses the company has acquired, higher costs of fuel and special charges. The gross profit margin for 2000 benefited from strong Institutional and International performances and sales of new products. Selling price increases for 2000 were not significant.

Selling, general and administrative expenses for 2000 were 40.5 percent of net sales, a decrease from total selling, general and administrative expenses of 41.0 percent of net sales in 1999. Selling, general and administrative expenses included approximately $4 million of expenses related to a large distributor in both 2000 and 1999. Prior to issuing the company’s 1999 annual financial statements, the company received notice of a January 31, 2000 bankruptcy filing by a large distributor. This resulted in a $4 million charge in 1999 for outstanding accounts receivable related to 1999 sales. In 2000, the company expensed another $4 million related to this distributor, $2 million of which was for additional receivables from sales in 2000 and $2 million of which was for a preference claim the bankruptcy estate filed against the company in 2001. Selling, general and administrative expenses in both years also included a significant favorable item: expenses for 2000 were reduced by $4.4 million for reductions in probable losses related to ceýtain environmental matters, and 1999 included a non-taxable gain of $1.5 million related to the demutualization of an insurance company. The $4.4 million reduction in probable losses in 2000 relates to an environmental claim made against the company by the Netherlands government. In 1996 the company recorded a liability of $5 million related to its best estimate of the probable losses associated with these claims. In 2000, the Netherlands government settled the claim for $600,000. Selling, general and administrative expense improvements for 2000 also reflected lower costs related to retirement plans, and the benefits of synergies from the effects of business acquisitions and cost controls. These benefits were partially offset by higher investments in the sales-and-service force and in new businesses.

During the fourth quarter of 2000, management approved various actions to improve the long-term efficiency and competitiveness of the company and to reduce costs. These actions included personnel reductions, discontinuance of certain product lines, changes to certain manufacturing and distribution operations and the closing of selected sales and administrative offices. As a result of these actions, the company recorded special charges totaling $7.1 million ($4.3 million after tax, or $0.03 per diluted share). Further details related to these special charges are included in Note 3 of the notes to consolidated financial statements.

Also, during the fourth quarter of 2000, the company sold its Jackson dishmachine manufacturing business for cash proceeds of approximately $36 million. The company realized a gain on the sale of $25.9 million ($15.0 million after tax, or $0.11 per diluted share).

Operating income for 2000, excluding the unusual items, totaled $324 million and increased 12 percent over consolidated operating income of $290 million in 1999. Business acquisitions accounted for approximately 2 percentage points of the growth in operating income for 2000. As a percentage of net sales, operating income excluding the unusual items represented 14.3 percent compared with the 1999 operating income of 13.9 percent. These improvements in operating income reflected the strong performance of the company’s International and U.S. Institutional operations.

The company’s net income for 2000 was $206 million. Net income included $2.4 million of net expense to reflect the cumulative effect of a change in accounting for revenue recognition. This change resulted from adopting the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements.” This amount was recorded to reflect changes in the company’s policies from recording revenue when products are shipped to the time title transfers to the customer. Excluding this charge and the other unusual items, after-tax income for 2000 would have been $198 million, an increase of 13 percent over net income of $176 million in 1999. This improvement reflected strong operating income growth, a lower effective income tax rate and improved equity in earnings of Henkel-Ecolab, partially offset by higher net interest expense. As a percentage of net sales, this after-tax income was 8.7 percent, up slightly from net income of 8.5 percent in 1999.