UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

For the transition period from                     to                     

Commission File No. 1-9328

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes     ý     No     o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes     ý     No     o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of June 30, 2004.

257,440,930 shares of common stock, par value $1.00 per share.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

ECOLAB INC.

CONSOLIDATED STATEMENT OF INCOME

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

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ECOLAB INC.

CONSOLIDATED STATEMENT OF INCOME

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

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ECOLAB INC.

CONSOLIDATED BALANCE SHEET

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

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ECOLAB INC.

CONSOLIDATED BALANCE SHEET (Continued)

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

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ECOLAB INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

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

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ECOLAB INC.

CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)

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

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.     Consolidated Financial Information

The unaudited consolidated financial information as of June 30, 2004 and for the three and six-month periods ended June 30, 2004 and 2003, reflect, in the opinion of management, all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows of Ecolab Inc. (“the company”) for the interim periods presented. The financial results for any interim period are not necessarily indicative of results for the full year. The consolidated balance sheet data as of December 31, 2003 were derived from the audited consolidated financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States of America.  The unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto incorporated in the company’s Annual Report on Form 10-K for the year ended December 31, 2003.

With respect to the unaudited financial information of the company as of June 30, 2004 and for the three and six-month periods ended June 30, 2004 and 2003, included in this Form 10-Q, PricewaterhouseCoopers LLP reported that they have applied limited procedures in accordance with professional standards, which do not require an audit, for a review of such information. Therefore, their separate report dated July 22, 2004 appearing herein, states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied.  PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 (the “Act”) for their report on the unaudited financial information because that report is not a report or a part of a registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.

2.     Stock-Based Compensation

The company measures compensation cost for its stock incentive and option plans using the intrinsic value-based method of accounting.

Had the company used the fair value-based method of accounting to measure compensation expense for its stock incentive and option plans and charged compensation cost against income over the vesting periods, based on the fair value of options at the date of grant, net income and the related basic and diluted per common share amounts for the three and six-month periods ended June 30, 2004 and 2003 would have been reduced to the pro forma amounts in the following table.

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2.     Stock-Based Compensation (continued)

3.     Selected Balance Sheet Information

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3.     Selected Balance Sheet Information (continued)

Accumulated other comprehensive income as of June 30, 2004 consists of $11.4 million of net unrealized losses primarily on financial instruments and additional minimum pension liabilities and $22.0 million of cumulative translation income.  Accumulated other comprehensive income as of December 31, 2003 consists of $12.0 million of net unrealized losses primarily on financial instruments and additional minimum pension liabilities and $16.1 million of cumulative translation income.

4.     Financial Instruments

In February 2002, the company issued euro 300 million of 5.375 percent Euronotes, due February 2007. The company designated a portion (euro 300 million as of the end of the second quarter 2004) of this Euronote debt as a hedge of existing foreign currency exposures related to net investments the company has in certain European subsidiaries.  Accordingly, the transaction gains and losses on the portion of the Euronotes that are designated and are effective as hedges of the company’s net investments have been included as a component of the cumulative translation account.  Total transaction gains and losses related to the Euronotes charged or credited to shareholders’ equity were gains of $8.7 million and losses of $26.9 million for the second quarter of 2004 and 2003, respectively, and losses of $5.9 million and $44.0 million for the first six months of 2004 and 2003, respectively.

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

5.     Comprehensive Income

Comprehensive income was as follows:

6.  Special Charges

In the first quarter of 2002, management approved plans to undertake restructuring and cost saving actions during 2002, including costs related to the integration of the company’s European operations.  These actions included global workforce reductions, facility closings, and product line discontinuations.  These actions were substantially completed by December 31, 2003.  Remaining amounts accrued primarily represent contractual periodic payments to be made over time.

The second quarter and six months ended June 30, 2004 includes the reversal of $270,000 and $495,000, respectively, of previously accrued estimated severance and lease termination costs.  Of the $270,000 reversed in the second quarter of 2004, $16,000 is included as a component of cost of sales. Of the $495,000 reversed in the first six months, $66,000 is included as a component of cost of sales.

Also included in “Special Charges” for the first six months of 2004 is a loss related to the disposal of a grease management product line of the Institutional division of the U.S. Cleaning & Sanitizing segment of $4.0 million ($2.4 million after tax).

Restructuring liabilities are classified as a component of other current liabilities.

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6.     Special Charges (continued)

For segment reporting purposes, each of these items have been included in the company’s corporate segment, which is consistent with the company’s internal management reporting.

Changes to the restructuring liability accounts include the following:

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7.     Business Acquisitions and Investments

In January 2004, the company acquired Nigiko, a Paris-based provider of commercial pest elimination services throughout France.  Nigiko pest elimination has annual sales of approximately $55 million.  These operations became part of our International Cleaning & Sanitizing operations.

In February 2004, the company acquired Daydots International, a Texas-based provider of food safety products.  Daydots has annual sales of approximately $22 million.  These operations became part of our U.S. Cleaning & Sanitizing operations.

In May 2004, the company acquired Elimco, a Cape Town, South Africa-based provider of commercial pest elimination services.  Elimco has annual sales of approximately $4 million.  These operations became part of our International Cleaning & Sanitizing operations.

In June 2004, the company acquired the Restoration and Maintenance business unit of VIC International located in Knoxville, Tennessee.  This business unit has sales of approximately $5 million and will become part of our U.S. Cleaning & Sanitizing operations and our International Cleaning & Sanitizing operations.

The total cash paid for acquisitions and investments in affiliates was $10.7 million and $2.3 million during the second quarter of 2004 and 2003, respectively.  Total cash paid for acquisitions and investments in affiliates was $128.9 million and $27.9 million during the first six months of 2004 and 2003, respectively.  This included payments of restructuring costs related to Henkel-Ecolab that were accrued in 2002.  The aggregate purchase price has been reduced for any cash or cash equivalents acquired with the acquisitions.

Based upon purchase price allocations, which may have components representing preliminary allocations with respect to recent acquisitions, the components of the aggregate purchase prices of the acquisitions made, and the allocation of the purchase prices, were as follows:

The allocation of the purchase price contains adjustments to preliminary allocations from prior periods, if any.

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7.     Business Acquisitions and Investments (continued)

The changes in the carrying amount of goodwill for each of the company’s reportable segments for the quarter and six months ended June 30, 2004 were as follows:

Goodwill acquired in 2004 also includes adjustments to prior year acquisitions.

Operations of the acquired companies have been included in the operations of the company since the date of the respective acquisition.  The purchase prices have been allocated to assets acquired and liabilities assumed based on their estimated fair values at the dates of acquisition.  These acquisitions individually and in the aggregate are not material to the company’s operations.

In April 2004, the company sold its grease management product line to National Fire Services of Gurnee, Illinois effective March 31, 2004.  Sales of the grease management product line totaled approximately $20 million in 2003 and were included in U.S. Cleaning & Sanitizing operations.

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8.     Income Per Common Share

The computations of the basic and diluted net income per share amounts were as follows:

Stock options to purchase approximately 200,000 shares for the six months ended June 30, 2004 were not dilutive and, therefore, were not included in the computations of diluted common shares outstanding.

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9.     Pension and Postretirement Plans

The components of net periodic pension and postretirement healthcare benefit costs for the second quarter are as follows:

The components of net periodic pension and postretirement healthcare benefit costs for the six months ended June 30 are as follows:

The company previously disclosed in its financial statements for the year ended December 31, 2003, that it was not required to make any contributions to the U.S. pension plan and postretirement healthcare benefit plans in 2004.  As of June 30, 2004, no contributions have been made to those plans. The company is not required to make any contributions to the U.S. pension plan and postretirement healthcare benefit plans for the remainder of 2004.

Certain international pension benefit plans are required to be funded in accordance with local government requirements.  The company contributed $10.7 million and $13.1 million to its international pension benefit plans during the second quarter and six months ended June 30, 2004, respectively. Currently, the company expects that it will contribute $4.7 million to the international pension benefit plans during the remainder of 2004.

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

10.  Operating Segments

Financial information for each of the company’s reportable segments is as follows:

The International Cleaning & Sanitizing amounts included above are based on translation into U.S. dollars at the fixed currency exchange rates used by management for 2004.

Consistent with the company’s internal management reporting, corporate operating income includes income from reductions in restructuring accruals of approximately $0.3 million and $0.1 million for second quarter 2004 and 2003, respectively and approximately $0.5 million and $0.3 million for the six months ended June 30, 2004 and 2003, respectively. Corporate expense for the first six months ended June 30, 2004 also includes a charge of $4.0 million related to the disposal of a grease management product

line.

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11.   Goodwill and Other Intangible Assets

Under Statement of Financial Accounting Standards (SFAS) No. 142, goodwill must be tested annually for impairment.  As of June 30, 2004, the company has completed its annual test for goodwill impairment, including businesses reporting losses such as GCS Service.  Based on this testing, no adjustment to the carrying value of goodwill is necessary.

Goodwill and other intangible assets arise principally from business acquisitions.  Goodwill represents the excess of the purchase price over the fair value of net assets acquired.  Other intangible assets include primarily customer relationships, trademarks, patents and other technology. Other intangible assets are amortized on a straight-line basis over their estimated economic lives that results in a weighted average useful life of 14 and 12 years as of June 30, 2004 and 2003, respectively.

The straight-line method of amortization reflects an appropriate allocation of the cost of the intangible assets to earnings in proportion to the amount of economic benefits obtained by the company in each reporting period.  Total amortization expense related to other intangible assets during the second quarter ended June 30, 2004 and 2003 was approximately $5.8 million and $4.4 million, respectively.  Total amortization expense related to other intangible assets during the six months ended June 30, 2004 and 2003 was approximately $11.2 million and $9.4 million, respectively.  As of June 30, 2004, future estimated amortization expense related to amortizable other identifiable intangible assets will be (amounts in thousands):

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ECOLAB INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

12.   New Accounting Pronouncements

On December 17, 2003, the SEC staff released Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition.  The staff updated and revised the existing revenue recognition in Topic 13, Revenue Recognition, to make its interpretive guidance consistent with current accounting guidance, principally EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.”  Also, SAB 104 incorporates portions of the Revenue Recognition in Financial Statements – Frequently Asked Questions and Answers document that the SEC staff considered relevant and rescinds the remainder. The company’s revenue recognition policies are consistent with this guidance; therefore, this guidance did not have an immediate impact on the company’s consolidated financial statements.

The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retiree health care benefit plans.  The company’s U.S. Postretirement Health Care Benefits plan offers prescription drug benefits and the company expects to benefit from this legislation.  The company does not anticipate that its plan will need to be amended to obtain the benefits provided under the Act.  In accordance with the FASB’s original guidance on the accounting for the Act, the company elected to defer recognition of the effects of the Act and any measures of benefit cost or benefit obligation in the financial statements or accompanying notes.  In April 2004, the FASB issued FASB Staff Position No. FAS 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 which provided additional accounting guidance.  The company expects to begin recording the favorable benefits provided by the Act in the third quarter of 2004 consistent with this guidance and is currently considering whether to adopt the Act prospectively or retroactively to the date of this Act’s enactment.  The company has estimated an annual after-tax benefit in the range of $1.5 to $2.0 million related to the Act in 2004.

13.   Subsequent Event

On July 30, 2004, the company closed on the purchase of Alcide Corporation (NASDQ: ALCD).  Alcide is a Redmond, Washington-based producer of biocidal and sanitation products that are primarily used in the dairy, meat and poultry industries.  Pursuant to the merger agreement, a wholly-owned acquisition subsidiary of the company was merged with and into Alcide. Based on an exchange ratio of 0.6744, we will issue approximately 1,830,000 shares of Ecolab common stock plus additional cash-in-lieu of fractional shares to the former shareholders of Alcide, in exchange for 2,721,683 shares of Alcide Corporation common stock outstanding as of July 30, 2004.  In addition, Ecolab assumed certain outstanding options granted by Alcide; after adjustment for the merger, the Alcide stock options entitle 16 holders to purchase an aggregate of approximately 20,100 shares of Ecolab common stock, at adjusted prices ranging from $17.79 to $93.42.  The options expire at various times through April 30, 2011.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Directors

Ecolab Inc.

We have reviewed the accompanying consolidated balance sheet of Ecolab Inc. as of June 30, 2004, and the related consolidated statements of income for each of the three and six-month periods ended June 30, 2004 and 2003, and of cash flows for the six-month periods ended June 30, 2004 and 2003.  These financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2003, and the related consolidated statements of income, of comprehensive income and shareholders’ equity, and of cash flows for the year then ended (not presented herein); and in our report dated February 26, 2004, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2003, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

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ECOLAB INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Item 2.  Mangement’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis provides information that management believes is useful in understanding the company’s operating results, cash flows and financial condition.  The discussion should be read in conjunction with the consolidated financial statements and related notes included in this Form 10-Q.

The following discussion contains various “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995. We refer readers to the company’s statement entitled “Forward-Looking Statements and Risk Factors” located at the end of Part I of this report.  Additional risk factors may be described from time to time in Ecolab’s filings with the Securities and Exchange Commission.

Overview for the Quarter Ended June 30, 2004

The second quarter showed another quarter of earnings gains, improved sales growth and operational improvement as diluted net income per share rose 20% to 30 cents per share.  The strong earnings performance leveraged our improving market conditions during the second quarter.  These better trends and continued margin strength from our U.S. and international businesses were bolstered by favorable currency and lower tax rate, and enabled us to outperform the industry and to gain market share.

Operating Performance

•      Second quarter sales for our United States Cleaning & Sanitizing operations rose 5% to $451 million, showing improving sales trends for every division.  Kay sales were up 16%, led by strong gains in quick-service restaurants and food retail.  Institutional sales trends are improving as economic indicators in the hospitality and foodservice industries are showing a recovery is underway.  Food & Beverage sales growth accelerated in the second quarter, increasing 6%.

•      Our United States Other Services sales increased 4% to $86 million in the second quarter.  Pest Elimination sales growth of 8% was offset by a sales decrease at GCS Service.

•      Sales of our International Cleaning & Sanitizing operations rose 8% in the second quarter when measured at fixed currency rates to $486 million.  Strong sales in Latin America and Canada were offset by slower growth in Europe and Asia Pacific.  At public currency rates, International Cleaning and Sanitizing sales increased 17%.

•      We continued to invest in future growth during the second quarter of 2004. This included investing in our sales-and-service force, research and development, information technology, as well as acquiring Elimco (pest elimination business in South Africa) and the Restoration and Maintenance business unit of VIC International.

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ECOLAB INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Financial Performance

•      Cash provided by operating activities for the second quarter continued to be strong and helped us to make acquisitions and finance other cash requirements.

•      Currency translation had a positive impact on our financial results during the second quarter, adding approximately $2.5 million to net income.  For the first six months of 2004, currency translation added $5.1 million to net income.

•      An improvement in our annual effective income tax rate from 38.9 percent for the first six months of 2003 to 37.2 in 2004 added approximately $2.1 million to net income for the second quarter and $4.0 for the first six months of 2004.

•      Diluted net income per share was $0.30 for the second quarter of 2004, up 20 percent from $0.25 in the comparable period of 2003.  For the first six months, net income per share was $0.55 in 2004 compared to $0.46 in 2003. Earnings for the first six months of 2004 include an after-tax charge of $2.4 million related to the disposal of a grease management product line in the first quarter of 2004.

Results of Operations - Second Quarter and Six Months Ended June 30, 2004

Consolidated net sales for the second quarter ended June 30, 2004 were $1.043 billion, an increase of 10 percent over net sales of $0.947 billion in the second quarter of last year.  For the first six months of 2004, net sales increased 11 percent to $2.022 billion from $1.823 billion in the comparable period of 2003.  Excluding acquisitions and divestitures, consolidated net sales increased 8 percent in the second quarter and 9 percent for the first six months of 2004.  Changes in currency translation positively impacted sales growth by approximately 4 percentage points for the second quarter and approximately 5 percentage points for the six months ended June 30, 2004.

The gross profit margin (defined as the difference between net sales less cost of sales divided by net sales) was 51.6 percent and 50.7 percent of net sales for the quarter ended June 30, 2004 and 2003, respectively.  For the six-month periods, the gross profit margins were 51.6 percent in 2004 and 50.8 percent in 2003.  The increase in the gross margins for the second quarter and year-to-date periods compared with the 2003 gross margins is due to the benefits of improved business and product mix as well as cost savings initiatives.

Selling, general and administrative expenses were 38.6 percent of consolidated net sales for the second quarter of 2004, an increase from 37.9 percent of net sales in the comparable quarter of last year.  For the six-month period, selling, general and administrative expenses also increased as a percentage of net sales to 39.0 percent in 2004 from 38.6 percent in 2003. This increase for the quarter and year-to-date periods is due to an increase in sales force investments, as well as higher sales commissions and incentives.

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ECOLAB INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations - Second Quarter and Six Months Ended June 30, 2004 (continued)

Net income totaled $78 million for the second quarter of 2004 and $67 million for the comparable period of 2003.  On a per share basis, diluted net income per common share was $0.30 for the second quarter of 2004 and increased 20 percent over diluted net income per share of $0.25 in the second quarter of last year.  For the first six months of 2004, net income was $144 million as compared to net income of $122 million in the comparable period of last year.  Diluted net income per share increased 20 percent to $0.55 for the six months ended June 30, 2004 from $0.46 for the first six months of last year.  Net income for the first six months of 2004 includes a charge of $2.4 million related to the disposal of a grease management product line in the first quarter of 2004.  Currency translation benefited net income by approximately $2.5 million for the second quarter and $5.1 million for the first six months of 2004.  The comparison of net income also benefited from a lower effective tax rate in 2004.

Sales for each of our reportable segments is as follows:

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ECOLAB INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations - Second Quarter and Six Months Ended June 30, 2004 (continued)

The following table shows the increase or growth in sales by operating segment for the second quarter ended June 30, 2004 over the second quarter of 2003 and for the six months ended June 30, 2004 over the first six months of 2003:

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ECOLAB INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations - Second Quarter and Six Months Ended June 30, 2004 (continued)

Sales of our United States Cleaning & Sanitizing operations were $451 million, an increase of 5 percent compared with sales of $431 million in the second quarter of last year.  United States Cleaning & Sanitizing sales were $881 million for the first six months of 2004, up 4 percent over net sales of $848 million in the comparable period of last year.  Excluding acquisitions and dispositions, sales increased 4 percent and 3 percent for the quarter and six months ended June 30, 2004, respectively.  Sales benefited from double-digit growth in Kay and Water Care Services and good growth in Institutional and Food & Beverage, which were partially offset by lower sales in Professional Products due to the exit of a non-strategic business line.  The increase in sales in our Institutional division reflects an increase in new accounts, the successful introduction of new products and the benefits of our improved service initiatives.  Institutional’s results include sales increases in most market segments, particularly travel and casual dining.  Improving trends in the hospitality, foodservice and healthcare markets are also expected to help sales growth in the remainder of 2004.  Excluding the acquisition of Daydots and the disposition of a grease management product line, sales growth for Institutional was 4 percent for both the quarter and six months ended June 30, 2004.  Kay’s sales growth reflects strong growth in its food retail services business and to its core quickservice customers.  New products and programs, such as those sold to our specialty retail customers, are also showing good results.  Textile Care sales increased during the second quarter due to new corporate accounts and improved customer retention.  For the first six months of 2004, Textile Care sales growth is slightly negative as the division begins to recover from account losses in the second half of 2003.  Sales growth in corporate accounts in our Professional Products operations was offset by the planned phase down of the janitorial equipment distribution business.  The sales growth in our Healthcare division was flat for the second quarter and slightly negative for the first six months of 2004 due to the exit of a private label product line.  Adjusting for this, our Healthcare division achieved good growth in both skin care and surgical instrument care revenues.  Our Food & Beverage operations reported an increase in sales due to improved sales to the agri, dairy, soft drink, meat and poultry and food markets.  Water Care Services had strong sales growth in our major markets, especially the food and beverage market.  Our “Circle the Customer” strategy has produced new account gains as our Water Care division works with our Food & Beverage, Healthcare and Textile Care divisions to drive its sales growth.  Vehicle Care sales declined for both the quarter and year-to-date periods.  The second quarter sales were hurt by the very wet weather in May and June and the year-to-date sales were also impacted by the severe U.S. winter weather in January.

Sales of our United States Other Services operations totaled $86 million for the second quarter of 2004, an increase of 4 percent over net sales of $83 million in the second quarter of last year.  United States Other Services sales were $164 million for the first six months of 2004, an increase of 5 percent over net sales of $156 million in the comparable period of last year.  Pest Elimination sales increased with good growth in core pest elimination contract services and continuing growth in non-contract services such as one-shot services, the Stealth fly program and its food safety audit

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ECOLAB INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations - Second Quarter and Six Months Ended June 30, 2004 (continued)

business.  GCS Service sales decreased for both the second quarter and six months of 2004 as an increase in direct part sales was more than offset by a decrease in service sales.

Management rate sales for our International Cleaning & Sanitizing operations were $486 million for the second quarter of 2004, an increase of 8 percent over sales of $449 million in the comparable quarter of last year. For the first six months of 2004, sales increased 7 percent to $925 million from $864 million during the comparable period last year.  Excluding the effects of acquisitions and divestitures, sales increased 4 percent for both the second quarter and for the six-month periods ended June 30, 2004.  Sales in Europe, excluding acquisitions and divestitures, increased 3 percent for both the second quarter and first six months of 2004, primarily due to successful new product launches being partially offset by the effects of a weak European economy.  Sales growth for Asia Pacific was positive, led by strong sales growth in East Asia being offset by flat sales growth in Japan and Australia.  Latin America had double-digit sales increases in almost all countries and benefited from increased tourism as well as continued success with food retail programs.  Sales in Canada increased as trends in the hospitality industry improve and the market recovers from the impact of last year’s SARS outbreak.

Operating income for each of our reportable segments is:

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ECOLAB INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations - Second Quarter and Six Months Ended June 30, 2004 (continued)

Operating income of our United States Cleaning & Sanitizing operations increased 5 percent and 8 percent over operating income in the second quarter and first six months of 2003, respectively.  Excluding acquisitions and divestitures, operating income increased 3 percent and 6 percent over operating income in the second quarter and first six months of 2003, respectively.  The operating income margin for the U.S. Cleaning & Sanitizing segment was 16.7 percent of net sales in both the second quarter of 2004 and 2003 and increased to 17.3 percent of sales from 16.7 percent of net sales for the six-month period.  Operating income margin comparisons reflect a favorable business mix and cost efficiency improvements in several divisions partially offset by sales force and other investments.

Second quarter 2004 operating income of our United States Other Services operations increased 20 percent from the second quarter of last year. For the six-month period, operating income increased 28 percent from the comparable period last year.  The operating income margin for United States Other Services increased to 9.5 percent from 8.2 percent in the second quarter of last year.  For the six-month period, the operating income margin was 8.1 percent, an increase from 6.7 percent for the same period last year. Other Services benefited from a $0.6 million patent settlement in the second quarter of 2004 and $2.1 million in the first six months of 2004.  In addition, Pest Elimination showed profit gains while GCS Service showed comparatively larger operating losses for the quarter and year-to-date periods.

Operating income of our International Cleaning & Sanitizing operations increased 12 percent from the second quarter of last year.  For the first six months of 2004, operating income increased 13 percent from the comparable period of last year.  Excluding acquisitions and divestitures, operating income increased 9 percent over the comparable quarter of last year and 8 percent for the six-month period.  The operating income margin increased to 10.3 percent of net sales in the second quarter of 2004 from 9.9 percent in the comparable period of last year.  For the six-month period ended June 30, 2004, the operating income margin increased to 9.2 percent of net sales from 8.7 percent in the comparable period of last year.  Excluding acquisitions and divestitures, the operating income margin for International increased to 10.2 percent of net sales from 9.7 percent in the second quarter of last year and increased to 9.1 percent of net sales from 8.7 percent for the six-month period.  Profits were up across all regions and were achieved through higher sales and careful cost management.

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ECOLAB INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations - Second Quarter and Six Months Ended June 30, 2004 (continued)

Corporate operating income was $0.3 million for the second quarter of 2004 as compared to $0.1 million for the comparable quarter last year.  For the six-month period, corporate operating income (expense) was ($3.5) million as compared to $0.3 million for the comparable period last year.  Corporate operating expense for the first six months of 2004 includes a charge of $4.0 million related to the disposal of a grease management product line in the first quarter offset by a reduction in restructuring accruals of $0.5 million.  Corporate operating income in the first six months of 2003 is income from the reduction in restructuring accruals.

Net interest expense totaled $11.2 million in the second quarter of 2004, a decrease of 5 percent from net interest expense of $11.8 million in the second quarter of 2003.  For the six-month period, net interest expense was $22.4 million and $22.5 million in 2004 and 2003, respectively.

The provision for income taxes for the first six months of 2004 reflected an effective income tax rate of 37.2 percent as compared to an effective income tax rate of 38.9 percent for the first six months of 2003.  The reduction in the 2004 effective tax rate is primarily due to a lower international rates and tax savings efforts.

Financial Position and Liquidity

Total assets were $3.413 billion at June 30, 2004, an increase of $184 million, or 6 percent, over total assets at year-end 2003.  Approximately $15 million of the increase in assets was related to the strengthening of foreign currencies.  In addition, the net increase in assets (excluding cash and cash equivalents) acquired and disposed of was approximately $170 million for the first six months of 2004.

Total debt was $712 million at June 30, 2004, up from total debt of $675 million at year-end 2003.  The ratio of total debt to capitalization was 34 percent at June 30, 2004, unchanged from December 31, 2003 due to an increase in debt being offset by an increase in shareholders’ equity.  We are in compliance with all of our debt covenants and we believe we have ample borrowing capacity to meet foreseeable business needs.

Cash provided by operating activities totaled $233 million and $220 million, for the first six months of 2004 and 2003, respectively.  Operating cash flows for 2004 increased over 2003 primarily due to higher sales in the first six months compared to the prior year which were partially offset by increased federal tax payments in 2004 compared to 2003.

We currently expect to fund all of the cash requirements which are reasonably foreseeable for the remainder of 2004, including new program investments, scheduled debt repayments, dividend payments, possible acquisitions and planned share repurchases from operating activities, cash reserves and short-term borrowings.  In the event of a significant acquisition or other significant funding need, funding may occur through additional long-term borrowing.

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ECOLAB INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS