Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis provides information that we believe is useful in understanding our operating results, cash flows and financial condition. The discussion should be read in conjunction with both the unaudited consolidated financial information and related notes included in this Form 10-Q, and the Management's Discussion and Analysis of Financial Condition and Result of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2008. The discussion contains various "Forward-Looking Statements" within the meaning of the Private Securities Litigation Reform Act of 1995. We refer readers to the statement entitled "Forward-Looking Statements" located at the end of Part I of this report.

Overview of the third quarter ended September 30, 2009

Our third quarter results were once again led by new account gains, pricing and cost savings actions which offset the negative effects of the global recession and unfavorable foreign currency exchange.

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.

Sales Performance

† Consolidated net sales decreased 5% to $1.5 billion. Net sales were negatively impacted by unfavorable foreign currency exchange during the quarter. When measured in fixed rates of currency exchange, sales were about even with the prior year.

† U.S. Cleaning & Sanitizing sales were $693 million for the third quarter compared to $696 million in the prior year. Results were led by 11% Healthcare sales growth. Kay sales grew 4%, Food & Beverage reported 2% growth, while Institutional reported a 4% sales decline.

† U.S. Other Services sales declined 6% to $118 million. Pest Elimination reported a 4% decline and GCS reported an 11% decrease in sales.

† International sales, when measured in fixed rates of currency exchange, increased 1% to $692 million in the third quarter. Latin America and Canada enjoyed strong sales growth of 8% and 6%, respectively, while Asia Pacific reported 2% sales growth. Europe/Middle East/Africa ("EMEA") sales declined 1% in the quarter. When measured at public currency rates, International sales declined 9%.

Financial Performance

† Operating income increased 11% to $223 million. Excluding the impact of special gains and charges from both years, operating income increased 8% compared to the third quarter of 2008.

† Net income attributable to Ecolab increased 15% to $145 million. Excluding the impact of special gains and charges, and discrete tax items, net income attributable to Ecolab increased 6%.

† Diluted net income attributable to Ecolab per share increased 20% to $0.60 for the third quarter of 2009 compared to $0.50 in the third quarter of 2008. Third quarter 2009 results were reduced by $0.01 per share of special gains and charges and discrete tax items. Third quarter 2008 results were reduced by $0.05 per share of special gains and charges and discrete tax items.

† Our reported effective income tax rate was 30.2% for the third quarter of 2009 compared to 32.1% for the third quarter of 2008. Excluding the tax rate impact of special gains and charges, and discrete tax items, our adjusted effective income tax rate was 32.0% and 30.4% for the third quarter of 2009 and 2008, respectively.

Results of Operations - Third Quarter and Nine Months Ended September 30, 2009

Net Sales

Consolidated net sales for the third quarter ended September 30, 2009 were $1.5 billion, a decrease of 5% compared to last year. For the first nine months of 2009, net sales decreased 7% to $4.3 billion. When measured in fixed rates of currency exchange, sales for both the third quarter and first nine months of 2009 were about even with the comparable prior year periods. The components of the quarter and year-to-date sales decline are shown below.

                              Third Quarter Ended   Nine Months Ended
(percent)                     September 30, 2009    September 30, 2009

Volume                                (3)%                  (4)%
Price changes                          3                    4
Foreign currency exchange             (5)                  (7)
Acquisitions & divestitures            -                    -
Total sales decrease                  (5)%                  (7)%

Gross Profit Margin

The gross profit margin ("gross margin")(defined as the difference between net sales less cost of sales divided by net sales) was 50.6% and 48.7% for the third quarter of 2009 and 2008, respectively. Our gross margin increase for the third quarter was driven by pricing and favorable delivered product costs. For the nine-month year to date period, the gross margin was 49.3% in 2009 and 49.0% in 2008. The 2009 year to date gross margin was negatively impacted by restructuring special charges included in cost of sales of $9.4 million which reduced our reported gross margin by 0.3 percentage points. Our year to date gross margin increase was driven by pricing and cost savings initiatives, which more than offset higher delivered product costs, especially in Europe, and lower sales volume.

Selling, General and Administrative Expense

Selling, general and administrative expenses as a percentage of consolidated net sales were 35.8% for the third quarter of 2009 compared to 35.6% in 2008. The increase in ratio for the third quarter was due to continued investments in our business and other cost increases which more than offset savings from our recent restructuring, pricing leverage and well-managed spending. For the nine-month period, selling, general, and administrative expenses were 36.8% of sales in 2009 and 36.9% of sales in 2008. Year to date, the savings from our recent restructuring, pricing leverage and well-managed spending more than offset investments and cost increases to reduce the ratio. We continue to make key business investments that drive innovation and efficiency, through R&D and information technology systems.

Special Gains and Charges



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



                                        Third Quarter Ended        Nine Months Ended
                                            September 30             September 30
(millions)                              2009          2008          2009        2008

Cost of sales
Restructuring charges                 $     1.3    $         -   $      9.4    $     -

Special gains and charges
Restructuring charges                       4.0              -         52.6          -
Business structure and optimization         0.7            8.6          2.3       14.3
Gain on sale of plant                         -              -            -      (24.0 )
Gain on sale of business                      -              -            -       (1.7 )
Other non-recurring items                   0.7            3.2          2.0        5.8
Total                                       5.4           11.8         56.9       (5.6 )

Total special gains and charges       $     6.7    $      11.8   $     66.3    $  (5.6 )

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. As a result of these actions, we recorded restructuring expense of $5 million ($4 million after tax) or $0.02 per diluted share and $62 million ($44 million after tax) or $0.18 per diluted share, during the third quarter and nine months ended September 30, 2009, respectively. Restructuring expense on the Consolidated Statement of Income has been included both as a component of cost of sales and as a component of special gains and charges, as shown in the table above.

We anticipate additional restructuring expenses during the remainder of 2009, which are expected to result in total pretax charges of approximately $70 million ($50 million after tax) for the full year 2009. These actions are expected to provide annualized pretax savings of approximately $75 million ($50 million after tax), with pretax savings of $50 million to be realized in 2009. We anticipate that approximately $65 million of the total restructuring charges represent cash expenditures, of which $33 million has been paid as of September 30, 2009 and the majority of the remainder is expected to be paid within the next twelve months. Further details related to these restructuring expenses are included in Note 2.

Operating Income

Reported operating income increased 11% for the third quarter of 2009. The operating income increase was impacted by the year over year comparison of special gains and charges. Excluding the impact of special gains and charges, operating income increased 8% in the third quarter. Excluding the impact of special gains and charges, and unfavorable currency exchange, fixed currency operating income increased 14% in the third quarter as pricing, favorable delivered product costs, cost savings from our recent restructuring and well-managed spending more than offset continued investment in the business and other costs in the quarter. Reported operating income for the first nine months of 2009 declined 15% compared to 2008. The operating income decline was driven by special gains and charges. Excluding the impact of special gains and charges, operating income for the first nine months of 2009 fell 3%. Excluding the impact of special gains and charges, and unfavorable currency exchange, fixed currency operating income for the first nine months of 2009 increased 4% as pricing and cost savings efforts more than offset the increased delivered product and other costs during the period.

Interest Expense, Net

Net interest expense totaled $15.1 million in the third quarter of 2009, compared with $16.0 million in the third quarter of 2008. The decrease in our third quarter net interest expense was primarily due to lower average interest rates and lower borrowing on our U.S. commercial paper program during the period. Net interest expense was $46.1 million for both the first nine months of 2009 and 2008.

Provision for Income Taxes



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



                                   Third Quarter Ended        Nine Months Ended
                                      September 30               September 30
(percent)                          2009          2008         2009         2008

Reported tax rate                     30.2 %        32.1 %       31.2 %       30.1 %
Tax rate impact of special
gains and charges and
discrete tax items                     1.8          (1.7 )        0.4          1.8
Non-GAAP nominal tax rate*            32.0 %        30.4 %       31.6 %       31.9 %

The decrease in the non-GAAP nominal tax rate for first nine months of 2009 over the respective 2008 rate, which excludes the tax rate impact of special gains and charges and discrete tax items, is due primarily to increased tax benefits from international operations, including global rate reductions. The 2009 third quarter non-GAAP nominal tax rate is higher than 2008 primarily due to lower tax benefits derived from our international operations which increased the third quarter 2009 rate above the expected full year rate, and tax benefits in the prior year which reduced the third quarter 2008 rate.

Provision for Income Taxes (Continued)

Our reported tax rate for the third quarter and first nine months of 2009 was lower than our non-GAAP nominal tax rate primarily due to the tax rate impact of discrete tax benefits of $4.8 million and $4.1 million, respectively. The 2009 discrete tax benefits are primarily due to a $4.4 million third quarter benefit related to prior year reserve adjustments.

Our reported tax rate for the nine months ended 2008 was lower than our non-GAAP nominal tax rate due to the tax rate impact of the $4.8 million discrete tax benefits recorded in the first quarter of 2008, as well as the tax rate impact of a $24 million tax free gain on the sale of a European plant, included in special gains and charges, recorded in the second quarter of 2008. Our reported tax rate for the third quarter of 2008 is higher than our non-GAAP nominal tax rate primarily due to a discrete tax charge of $2.1 million recorded in the third quarter of 2008.

Net Income Attributable to Ecolab

Net income attributable to Ecolab increased 15% to $145 million in the third quarter of 2009. On a per share basis, reported diluted net income attributable to Ecolab per share increased 20% to $0.60 per share compared to $0.50 per share in 2008. The third quarter of 2009 includes $5.5 million, net of tax, of special gains and charges, and discrete tax benefits of $4.8 million, which together reduced the reported per share amount by $0.01. Currency translation had an unfavorable impact of approximately $7 million, net of tax, or $0.03 per share for the third quarter of 2009 compared to 2008. The third quarter of 2008 included $9.2 million, net of tax, of net charges reported in special gains and charges, and $2.1 million of discrete tax charges, which together decreased the reported per share amount by $0.05.

Net income attributable to Ecolab for the first nine months of 2009 decreased 18% to $302 million. On a per share basis, diluted net income attributable to Ecolab per share decreased 14% to $1.26, compared to $1.46 per share in 2008. Amounts for the first nine months of 2009 include $47.6 million, net of tax, of special gains and charges and net discrete tax benefits of $4.1 million. These items together reduced the reported per share amount by $0.18. Currency translation had an unfavorable impact of approximately $27 million, net of tax, or $0.11 per share for the first nine months of 2009 compared to 2008. The first nine months of 2008 included $10.5 million, net of tax, of net gains reported in special gains and charges and $2.7 million of discrete tax benefits. These items increased reported diluted net income attributable to Ecolab per share by $0.05.

Segment Results



Sales for each of our reportable segments are as follows:



                                           Third Quarter Ended       Nine Months Ended
                                              September 30             September 30
(millions)                                  2009         2008        2009        2008

Net Sales
United States
Cleaning & Sanitizing                    $     693.2   $   695.5   $ 1,987.2   $ 2,012.6
Other Services                                 117.6       124.7       340.0       356.0
Total                                          810.8       820.2     2,327.2     2,368.6
International                                  692.0       684.1     1,973.4     1,953.3
Effect of foreign currency translation          43.6       122.0        35.5       332.3
Consolidated                             $   1,546.4   $ 1,626.3   $ 4,336.1   $ 4,654.2

U.S. Cleaning & Sanitizing sales were similar to the prior year in the third quarter and decreased 1% for the first nine months of 2009 compared to the prior year. Sales for our large U.S. Cleaning & Sanitizing businesses were as follows:

† Institutional - Sales declined 4% and 5% for the third quarter and first nine months of 2009, respectively. New account gains, success with new products and pricing enabled us to outperform continued lower demand from our lodging and foodservice customers. We continue to see strong results for our Apex solids warewashing line due to customer demand for energy and cost savings solutions. We have not yet seen improvement in Institutional's major end markets and do not expect a significant pick-up this year.

† Food & Beverage - Sales increased 2% in the third quarter as strong results for our core Food & Beverage business were partially offset by lower Ecovation sales. 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. Sales for the year to date period declined 1% compared to the prior year. The year to date sales comparison was negatively impacted by the timing of a large Ecovation project sale in the first quarter of 2008. Excluding the impact of Ecovation, Food & Beverage continues to perform well as sales grew 4% and 5% for the third quarter and first nine months of 2009, respectively.

† Kay - Sales grew 4% in the third quarter of 2009 compared to a very strong third quarter last year when sales grew 21%. For the first nine months of 2009, sales grew 8%. Kay QSR sales grew moderately in the quarter benefiting from existing customer growth. The food retail business showed strong results due to growth at new accounts.

† Healthcare - Sales increased 11% for both the third quarter and first nine months of 2009. Business acquisitions contributed 3% and 2% to the third quarter and year-to-date sales growth, respectively. Continued solid growth from our infection barrier business and skin care products led the results. Sales growth has also benefited from H1N1 related sales of hand sanitizers.

Segment Results (Continued)

U.S. Other Services sales decreased 6% in the third quarter and 4% for the first nine months of 2009 compared to the prior year periods. Sales for our U.S. Other Services businesses were as follows:

† Pest Elimination - Sales declined 4% for the third quarter and were down 1% for the first nine months of 2009. Gains in the quick service restaurant and food & beverage plant market were offset by soft conditions in restaurants and lodging. Both contract services and non-contract sales were lower. New account gains are being offset by customer cancellations as our customers are focusing on reducing their spending due to the continued soft economy.

† GCS Service - Sales declined 11% and 13% for the third quarter and first nine months of 2009, respectively, compared to the prior year periods. Both service and direct parts sales continued to be soft. New account wins were more than offset by slower foodservice business conditions which has resulted in prospective customers delaying their decision to buy contract services.

We evaluate the performance of our International operations based on fixed management rates of currency exchange. Fixed currency rate sales for our International operations increased 1% for both the third quarter and first nine months of 2009. When measured at public currency rates, International sales decreased 9% and 12% for the third quarter and first nine months of 2009, respectively. Fixed currency sales changes for our International regions were as follows:

† EMEA - Sales declined 1% for both the third quarter and first nine months of 2009. Third quarter sales growth in the U.K., France and Italy was offset by lower sales in Germany. The EMEA region continues to be negatively impacted by the current economic recession in Europe. From a divisional perspective, our Healthcare business continued to show solid growth in the region while Institutional and Food & Beverage reported modest sales declines. Textile Care and Pest Elimination also reported sales declines for the quarter.

† Asia Pacific - Sales increased 2% in the third quarter and are up 3% for the first nine months of 2009, compared to the prior year. Sales growth in the region continued to be led by growth in Food & Beverage due to increased product penetration and new account gains. From a country perspective, sales growth has been driven by growth in China, Australia and New Zealand. Sales growth reflected the impact of economic uncertainty and low levels of business travel and tourism in the region.

† Latin America - We continue to experience strong sales growth in Latin America as sales in the region increased 8% for both the third quarter and first nine months of 2009. Our Institutional, Food & Beverage and Pest Elimination businesses all showed strong gains in the region against weak economic conditions. Sales growth was led by continued strong growth in Brazil and Venezuela.

† Canada - Sales increased 6% and 8% for the third quarter and first nine months of 2009, respectively, compared to the prior year periods. Sales growth was led by strong results from Food & Beverage, driven by new account gains and product price increases. Institutional also reported sales growth for both the quarter and year to date periods led by pricing and success with distributor partners.

Segment Results (Continued)



Operating income for each of our reportable segments is as follows:



                                           Third Quarter Ended       Nine Months Ended
                                              September 30             September 30
(millions)                                  2009          2008        2009        2008

Operating Income
United States
Cleaning & Sanitizing                    $     141.1    $  120.4   $    370.0    $ 332.8
Other Services                                  18.4        17.9         49.9       37.9
Total                                          159.5       138.3        419.9      370.7
International                                   71.0        66.7        144.5      174.7
Effect of foreign currency translation           5.7        15.8          5.1       43.5
Corporate                                      (13.2 )     (19.4 )      (84.0 )    (16.3 )
Consolidated                             $     223.0    $  201.4   $    485.5    $ 572.6

U.S. Cleaning & Sanitizing operating income increased 17% and 11% for the third quarter and first nine months of 2009, respectively. Pricing gains, favorable delivered product costs and well-managed spending drove significant operating income growth.

U.S. Other Services operating income increased 3% and 32% for the third quarter and first nine months of 2009, respectively. Operating income growth was driven by pricing, productivity and efficiency gains and cost reductions.

International segment operating income at fixed currency rates increased 6% for the third quarter and declined 17% for the first nine months of 2009. The lag of higher delivered product cost increases internationally, especially in Europe, continued to impact our third quarter and year to date International operating income. For the quarter, pricing gains and cost savings actions more than offset slowing delivered product cost increases and continued investment in the business. Year to date, pricing gains and cost savings efforts were unable to fully offset lower sales volume, delivered product and other cost increases, and continued investment in the business. When measured at public currency rates, International operating income decreased 7% and 31% for the third quarter and first nine months of 2009, respectively, compared to prior year periods.

Consistent with our internal management reporting, the Corporate segment includes special gains and charges reported on the Consolidated Statement of Income. The Corporate segment also includes investments in the development of business systems and other corporate investments we are making as part of our ongoing efforts to improve efficiency and returns.

Financial Position and Liquidity

Total assets were $5.0 billion as of September 30, 2009, compared to total assets of $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. When measured in fixed rates of currency exchange, our accounts receivable and inventory balances declined from year end 2008.

Total debt was $1.0 billion as of September 30, 2009 and $1.1 billion as of December 31, 2008. The ratio of total debt to capitalization (shareholders' equity plus total debt) decreased to 33% at September 30, 2009 compared to 42% at December 31, 2008 due to the increase in equity and the decrease in short-term debt on our balance sheet. We are in compliance with all of our debt covenants and believe we have sufficient borrowing capacity to meet our foreseeable operating needs.

Cash provided by operating activities totaled $532 million for the first nine months of 2009 compared to $496 million in 2008. Operating cash flow in 2009 was negatively impacted by $125 million of voluntary contributions to our U.S. pension plan compared to $75 million in 2008. We continue to generate strong cash flow from operations, which has allowed us to continue to fund our ongoing operations, pay down short-term borrowings, and return cash to shareholders through dividend payments.

Cash used for investing activities decreased in 2009 primarily due to significantly lower acquisition activity as the first nine months of 2008 included our Ecovation acquisition. Capital and software investments also decreased in 2009 compared to 2008.

Cash used for financing activities in 2009 included $220 million of repayments of our short-term borrowing. Due to our $300 million repurchase of 11.3 million shares from Henkel in the fourth quarter of 2008, we did not repurchase shares during the first nine months of 2009 under our share repurchase program. 2008 financing cash flow activities included the proceeds from the issuance of our $250 million 4.875% senior unsecured notes.

The schedule of contractual obligations included in the Financial Position and Liquidity section of our Form 10-K for the year ended December 31, 2008 disclosed total notes payable and long-term debt due within one year of $339 million. As of September 30, 2009, the total notes payable and long-term debt due within one year has declined to $121 million. The decrease from year-end is primarily due to the pay down of commercial paper during 2009. Our gross liability for uncertain tax positions under FIN 48 was $109 million as of September 30, 2009 and $111 million as of December 31, 2008. We are not able to reasonably estimate the amount by which the liability will increase or decrease . . .