Market Risk

The company enters into contractual arrangements (derivatives) in the ordinary course of business to manage foreign currency exposure and interest rate risks. The company does not enter into derivatives for trading purposes. The company’s 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 the company’s income statement.

The company enters into forward contracts, swaps, and foreign currency options to hedge certain intercompany financial arrangements, and to hedge against the effect of exchange rate fluctuations on transactions related to cash flows and net investments denominated in currencies other than U.S. dollars. At December 31, 2001, the company had approximately $320 million of foreign currency forward exchange contracts with face amounts denominated primarily in euros. The majority of these contracts related to short-term financing of the acquisition of Henkel-Ecolab and matured in February 2002. The remaining contracts generally expire within one year.

The company manages interest expense using a mix of fixed and floating rate debt. To help manage borrowing costs, the company may enter into interest rate swaps. Under these arrangements, the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional principal amount. At year-end 2001, the company had an interest rate swap agreement on the first 50 million Australian dollars (approximately $26 million U.S. dollars) of anticipated Australian floating rate debt. This agreement is effective through November 2004 and has a fixed annual pay rate of approximately 6%.

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

Subsequent Events

In January 2002, the company announced that it plans to undertake restructuring and other cost-saving actions during 2002 in order to streamline and improve its global operations. These anticipated actions will result in pretax charges of $50 to $60 million in 2002. These charges will be partially offset by gains attributable to certain benefit plan changes. Approximately $6 million of those gains will be reported in the first quarter of 2002 and an estimated $16 million of net unrealized gains are expected to be amortized over 8 years and will reduce future benefit costs. The restructuring includes a reduction of the company’s global workforce by approximately 2 percent (350-450 positions) during 2002, the closing of several facilities, the discontinuance of selected product lines and other potential actions. The expected cost savings related to the restructuring and benefit plan changes are expected to begin in 2002, have a full impact in 2003, and continue to grow in future years. Upon completion of the plan in 2003, the company expects annual pretax savings of $25 million to $30 million ($15 million to $18 million after tax).

Effective March 2002, the company will change its postretirement benefits plan. The company will discontinue its employer subsidy of postretirement health care benefits for most of its active employees. The subsidized benefits will continue to be provided to certain defined active employees and all existing retirees. As a result of these actions, the company will record a curtailment gain of approximately $6 million in the first quarter of 2002, as mentioned in the preceding paragraph. In addition, the company will make changes in March 2002 to its 401(k) savings plan. Employee before-tax contributions of up to 3 percent of eligible compensation will be matched 100 percent by the company and employee before-tax contributions between 3 percent and 5 percent will be matched 50 percent by the company and will be 100 percent vested immediately.

In February 2002, the company issued euro 300 million ($265.9 million) of Eurobonds, due February 2007. The proceeds from this debt issuance were used to repay a portion of outstanding commercial paper as of December 31, 2001. The commercial paper had been issued to finance the acquisition of the remaining 50 percent of Henkel-Ecolab that the company purchased on November 30, 2001.