<PAGE>
 
                                                                    EXHIBIT (13)


                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
and Shareholders of
Nalco Chemical Company

In our opinion, the accompanying statements of consolidated financial condition
and the related consolidated statements of earnings, of cash flows and of common
shareholders' equity present fairly, in all material respects, the financial
position of Nalco Chemical Company and its subsidiaries at December 31, 1998 and
1997, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.



PricewaterhouseCoopers LLP                              R. R. Ross
Chicago, Illinois                                       Engagement Partner
February 6, 1999
<PAGE>
 
-------------------------------------------------------------------------
Statements of Consolidated Earnings
<TABLE>
<CAPTION>

                                                       Years Ended December 31
                                                   ------------------------------
(in millions, except per share figures)              1998       1997       1996
---------------------------------------------------------------------------------
<S>                                                <C>        <C>        <C>
Net Sales                                          $1,573.5   $1,433.7   $1,303.5
Operating costs and expenses
   Cost of products sold                              714.1      629.6      568.6
   Selling, administrative and research expenses      618.0      561.4      518.2
   Cost reduction program                             180.0          -          -
                                                   --------   --------   --------
                                                    1,512.1    1,191.0    1,086.8
                                                   --------   --------   --------
Operating Earnings                                     61.4      242.7      216.7
Interest and other income                               2.4        0.7        2.6
Interest expense                                      (26.5)     (15.3)     (14.4)
Equity in earnings of partnership                      22.6       28.2       24.5
                                                   --------   --------   --------
Earnings from Continuing Operations
   Before Income Taxes                                 59.9      256.3      229.4
Income taxes                                           22.0       92.9       83.5
                                                   --------   --------   --------
Earnings from Continuing Operations                    37.9      163.4      145.9
Earnings from discontinued operations,
   net of taxes                                           -          -        8.6
                                                   --------   --------   --------
Earnings Before Effect of Accounting Change            37.9      163.4      154.5
Cumulative effect of change in accounting for
   business process reengineering costs,
   net of taxes                                           -       (4.5)         -
                                                   --------   --------   --------
Net Earnings                                       $   37.9   $  158.9   $  154.5
                                                   ========   ========   ========

Earnings Per Common Share--Basic
   Earnings from continuing operations             $    .40   $   2.28   $   2.00
   Discontinued operations, net of taxes                  -          -        .13
   Cumulative effect of change in accounting for
      business process reengineering costs,
      net of taxes                                        -       (.07)         -
                                                   --------   --------   --------
   Net earnings                                    $    .40   $   2.21   $   2.13
                                                   ========   ========   ========
Earnings Per Common Share--Diluted
   Earnings from continuing operations             $    .40   $   2.10   $   1.86
   Discontinued operations, net of taxes                  -          -        .11
   Cumulative effect of change in accounting for
      business process reengineering costs,
      net of taxes                                        -       (.06)         -
                                                   --------   --------   --------
   Net earnings                                    $    .40   $   2.04   $   1.97
                                                   ========   ========   ========

Average Shares Outstanding (in thousands)
   Basic                                             65,847     66,700     67,280
                                                   ========   ========   ========

   Diluted                                           66,268     75,265     75,529
                                                   ========   ========   ========
</TABLE>

The notes to consolidated financial statements on pages 27 through 39 are an
integral part of these statements.
<PAGE>

-------------------------------------------------------------------------------
Statements of Consolidated Financial Condition
<TABLE>
<CAPTION>
                                                                December 31
                                                            -------------------
(in millions, except per share figures)                       1998       1997
-------------------------------------------------------------------------------
<S>                                                         <C>        <C>
Assets
Current Assets
Cash and cash equivalents                                   $   31.2   $   49.7
Receivables, less allowances
   of $6.1 in 1998 and $4.2 in 1997                            276.7      241.6
Inventories
   Finished products                                            97.4       68.2
   Materials and work in process                                24.4       26.3
                                                            --------   --------
                                                               121.8       94.5
Prepaid expenses, taxes and other current assets                47.9       23.2
                                                            --------   --------
Total Current Assets                                           477.6      409.0
Other Assets
Investment in and advances to partnership                      124.5      122.9
Goodwill, less accumulated amortization
   of $40.5 in 1998 and $29.5 in 1997                          376.3      249.4
Miscellaneous                                                  155.0      167.1
                                                            --------   --------
Total Other Assets                                             655.8      539.4
Net Property, Plant and Equipment                              517.3      492.5
                                                            --------   --------
Total Assets                                                $1,650.7   $1,440.9
                                                            ========   ========


Liabilities and Shareholders' Equity
Current Liabilities
Short-term debt                                             $   75.8   $   22.1
Accounts payable                                               124.9      108.1
Accrued compensation                                            34.0       33.9
Other accrued expenses                                          90.2       57.5
Income taxes                                                    26.4       34.0
                                                            --------   --------
Total Current Liabilities                                      351.3      255.6
Long-Term Debt                                                 496.2      335.3
Deferred Income Taxes                                           15.6       37.2
Accrued Pension Benefits                                        63.2       40.8
Accrued Postretirement Benefits                                123.0      100.7
Other Liabilities                                               15.5       18.6
Commitments and Contingent Liabilities                             -          -

Shareholders' Equity
Preferred stock--par value $1.00 per share                       0.4        0.4
   Capital in excess of par value of shares                    179.1      184.1
   Unearned ESOP compensation                                 (140.5)    (151.1)
                                                            --------   --------
                                                                39.0       33.4
Common stock--par value $.1875 per share;
   80.3 shares issued                                           15.1       15.1
   Capital in excess of par value of shares                     48.0       40.8
Common stock reacquired--at cost                              (449.7)    (420.4)
Retained earnings                                            1,033.2    1,072.7
Accumulated other comprehensive income                         (99.7)     (88.9)
                                                            --------   --------
Total Shareholders' Equity                                     585.9      652.7
                                                            --------   --------
Total Liabilities and Shareholders' Equity                  $1,650.7   $1,440.9
                                                            ========   ========
</TABLE>

The notes to consolidated financial statements on pages 27 through 39 are an
integral part of these statements.
<PAGE>
 
----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Statements of Consolidated Cash Flows
                                                        Years Ended December 31
                                                   ---------------------------------
(in millions)                                             1998      1997      1996
------------------------------------------------------------------------------------
<S>                                                     <C>        <C>       <C>
Cash Provided by (Used for) Operating Activities
Net earnings                                            $  37.9    $ 158.9   $ 154.5
Adjustments to reconcile net earnings to
   cash provided by operating activities
      Cost reduction program, net of cash payments         75.9          -         -
      Cumulative effect of change in accounting for
         business process reengineering costs                 -        4.5         -
      Depreciation and amortization                       100.6      103.2      98.3
      Equity in earnings of partnership,
         net of distributions                             (12.4)     (17.4)    (14.0)
      Noncurrent deferred income taxes                    (21.3)      (5.0)     (9.0)
      Other--net                                           12.9       11.2       9.1
      Changes in current assets and liabilities
         Receivables                                      (14.7)     (25.2)      6.4
         Inventories                                      (15.5)     (12.1)     (0.1)
         Accounts payable                                  (0.1)       0.7     (15.9)
         Other                                            (34.1)      (5.1)     (0.4)
                                                        -------    -------   -------
Net Cash Provided by Operating Activities                 129.2      213.7     228.9
                                                        -------    -------   -------
Cash Provided by (Used for) Investing Activities
Additions to property, plant and equipment               (115.3)    (101.4)    (92.5)
Business purchases                                       (148.8)     (79.6)    (83.4)
(Investments in) advances from partnership                  7.9       19.1      18.0
Proceeds from sale of business                              1.1          -      41.2
Other investing activities                                  5.1       (4.9)      7.2
                                                        -------    -------   -------
Net Cash (Used for)
   Investing Activities                                  (250.0)    (166.8)   (109.5)
                                                        -------    -------   -------
Cash Provided by (Used for) Financing Activities
Cash dividends, net of taxes                              (77.4)     (78.2)    (78.7)
Proceeds from long-term debt                              166.1      102.8      59.2
Payments of long-term debt                                 (1.2)      (4.2)    (12.1)
Increase (decrease) in short-term debt                     48.8       (3.8)    (69.5)
Common stock reacquired                                   (43.4)     (75.7)    (26.3)
Other financing transactions                                8.7       27.3       9.9
                                                        -------    -------   -------
Net Cash Provided by (Used for) Financing Activities      101.6      (31.8)   (117.5)
Effect of foreign exchange rate changes
   on cash and cash equivalents                             0.7       (4.2)     (1.2)
                                                        -------    -------   -------
Increase (decrease) in cash
   and cash equivalents                                   (18.5)      10.9       0.7
Cash and cash equivalents at the
   beginning of the year                                   49.7       38.8      38.1
                                                        -------    -------   -------
Cash and Cash Equivalents
   at the End of the Year                               $  31.2    $  49.7   $  38.8
                                                        =======    =======   =======
</TABLE>

The notes to consolidated financial statements on pages 27 through 39 are an
integral part of these statements.
<PAGE>
 
-------------------------------------------------------------------------------
Statements of Consolidated Common Shareholders' Equity
<TABLE>
<CAPTION>
(in millions, except per share figures)
--------------------------------------------------------------------------------------------------------------------
                                                                                     Common Stock
                                                                Capital in            Reacquired
                                                     Common     Excess of       -----------------------
                                                     Stock      Par Value       Number                     Retained
                                                     Issued     of Shares       of Shares       Cost       Earnings
--------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>         <C>             <C>            <C>         <C>
Balance at January 1, 1996                           $ 15.1       $ 27.8         13.2          $(350.3)    $  916.2

   Net earnings                                                                                               154.5
   Other comprehensive income:
    Minimum pension liability adjustment
    Currency translation adjustments
      --net of tax of $0.5

   Comprehensive income

   Dividends on preferred stock                                                                               (11.4)
    --net of tax benefit of $3.9
   Dividends on common stock
    ($1.00 per share)                                                                                         (67.3)
   Treasury stock transactions                                                    0.7            (26.3)
   Stock issued under option,
    benefit and other plans                                          3.4         (0.6)            12.4
                                                     ------       ------     --------          -------     --------
Balance at December 31, 1996                           15.1         31.2         13.3           (364.2)       992.0

   Net earnings
   Other comprehensive income:                                                                                158.9
    Minimum pension liability adjustment
      --net of tax benefit of $0.8
    Currency translation adjustments
      --net of tax benefit of $0.1

   Comprehensive income
   Dividends on preferred stock
    --net of tax benefit of $3.5                                                                              (11.5)
   Dividends on common stock
    ($1.00 per share)                                                                                         (66.7)
   Treasury stock transactions                                                    2.0            (75.7)
   Stock issued under option,
    benefit and other plans                                          9.6         (1.0)            19.5
                                                     ------       ------     --------          -------     --------
Balance at December 31, 1997                           15.1         40.8         14.3           (420.4)     1,072.7

   Net earnings
   Other comprehensive income:                                                                                 37.9
    Minimum pension liability adjustment
      --net of tax benefit of $3.2
    Currency translation adjustments

   Comprehensive income

   Dividends on preferred stock
    --net of tax benefit of $3.2                                                                              (11.5)
   Dividends on common stock
    ($1.00 per share)                                                                                         (65.9)
   Treasury stock transactions                                                    1.2            (43.4)
   Stock issued under option,
    benefit and other plans                                          7.2         (0.7)            14.1
                                                     ------       ------     --------          -------     --------
Balance at December 31, 1998                         $ 15.1       $ 48.0         14.8          $(449.7)    $1,033.2
                                                     ======       ======     ========          =======     ========
</TABLE>


<TABLE>
<CAPTION>
(in millions, except per share figures)
-------------------------------------------------------------------------------------------------------------
                                                                 Accumulated Other
                                                               Comprehensive Income
                                                  ---------------------------------------------
                                                    Minimum Pension        Foreign Currency     Comprehensive
                                                  Liability Adjustment  Translation Adjustments    Income
-------------------------------------------------------------------------------------------------------------
<S>                                               <C>                   <C>                     <C>
Balance at January 1, 1996                               $ (6.0)              $(48.0)

   Net earnings                                                                                   $  154.5
   Other comprehensive income:
    Minimum pension liability adjustment                   (0.1)                                      (0.1)
    Currency translation adjustments
      --net of tax of $0.5                                                       8.1                   8.1
                                                                                                    ------
   Comprehensive income                                                                             $162.5
                                                                                                    ======
   Dividends on preferred stock
    --net of tax benefit of $3.9
   Dividends on common stock
    ($1.00 per share)
   Treasury stock transactions
   Stock issued under option,
    benefit and other plans

                                                         ------               ------
Balance at December 31, 1996                               (6.1)               (39.9)

   Net earnings                                                                                     $158.9
   Other comprehensive income:
    Minimum pension liability adjustment
      --net of tax benefit of $0.8                         (1.2)                                      (1.2)
    Currency translation adjustments
      --net of tax benefit of $0.1                                             (41.7)                (41.7)
                                                                                                    ------
   Comprehensive income                                                                             $116.0
                                                                                                    ======
   Dividends on preferred stock
    --net of tax benefit of $3.5
   Dividends on common stock
    ($1.00 per share)
   Treasury stock transactions
   Stock issued under option,
    benefit and other plans

                                                         ------               ------
Balance at December 31, 1997                               (7.3)               (81.6)

   Net earnings                                                                                     $ 37.9
   Other comprehensive income:
    Minimum pension liability adjustment
      --net of tax benefit of $3.2                         (5.3)                                      (5.3)
    Currency translation adjustments                                            (5.5)                 (5.5)
                                                                                                    ------
   Comprehensive income                                                                             $ 27.1
                                                                                                    ======
   Dividends on preferred stock
    --net of tax benefit of $3.2
   Dividends on common stock
    ($1.00 per share)
   Treasury stock transactions
   Stock issued under option,
    benefit and other plans

                                                         ------               ------
Balance at December 31, 1998                             $(12.6)              $(87.1)
                                                         ======               ======
</TABLE>

The notes to consolidated financial statements on pages 27 through 39 are an
integral part of these statements.
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CONSOLIDATION POLICY--Nalco's consolidated financial statements include the
accounts of the parent company, its majority-owned subsidiaries and Nalco-
Chemserve, in which Nalco has a controlling interest. All intercompany balances
and transactions are eliminated. Investments in partnerships are reported on the
equity method.

Certain amounts in the prior years' financial statements and notes thereto have
been reclassified to conform to the current year presentation.

USE OF ESTIMATES--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

CONCENTRATION OF CREDIT RISK--Credit risk represents the accounting loss that
would be recognized at the reporting date if counterparties failed completely to
perform as contracted. Management believes the likelihood of incurring material
losses due to concentration of credit risk is remote. The principal financial
instruments subject to credit risk are as follows:

  Cash and cash equivalents, short-term marketable securities - Nalco has a
  formal policy of placing these instruments in investment grade companies or
  financial institutions and limiting the size of an investment with any single
  entity.

  Receivables - A large number of customers in diverse industries and
  geographies, as well as the practice of establishing reasonable credit lines,
  limits credit risk. The allowances for doubtful accounts are adequate to cover
  potential credit risk losses.

  Foreign exchange contracts and derivatives - The Company has formal policies
  which establish credit limits and investment grade credit criteria of "A" or
  better for all counterparties.

CASH AND CASH EQUIVALENTS--Cash and cash equivalents include all cash balances
and highly liquid investments with original maturities of three months or less.

DERIVATIVES--Gains and losses on hedges of existing assets or liabilities are
included in the carrying amounts of those assets or liabilities and are
ultimately recognized in income as part of those carrying amounts. Gains and
losses related to qualifying hedges of firm commitments also are deferred and
are recognized in income or as adjustments of carrying amounts when the hedged
transaction occurs.

FOREIGN CURRENCY TRANSLATION--The local currency has been designated as the
functional currency in financial statements of companies which account for
approximately 98 percent of total foreign subsidiary net assets at the end of
1998. These financial statements are translated at current and average exchange
rates, with any resulting translation adjustments included in the currency
translation adjustment account in shareholders' equity. The remaining
subsidiaries operate in countries with highly inflationary environments and
their statements are translated using a combination of current, average, and
historical exchange rates, with the resulting translation impact included in
results of operations. Transactions executed in different currencies resulting
in exchange adjustments are included in results of operations. Foreign currency
exchange losses, included in interest and other income in 1998, 1997 and 1996,
were $1 million, $4 million and $2 million, respectively.

INVENTORY VALUATION--Inventories are valued at the lower of cost or market.
Approximately 73 percent of the inventories at the end of 1998 are valued using
the average cost or first-in, first-out (FIFO) method. The remaining inventories
are valued using the last-in, first-out (LIFO) method. If the FIFO method of
accounting had been used for all inventories, reported

<PAGE>
 
inventory amounts would have been approximately $23 million and $24 million
higher at December 31, 1998 and 1997, respectively.

GOODWILL--Goodwill consists of costs in excess of the fair value of net tangible
and identified intangible assets of acquired companies and is amortized over
periods ranging from 15 years to 40 years using the straight-line method. When
appropriate, the Company evaluates whether the projected earnings and
undiscounted cash flows of each of the acquired companies is sufficient to
recover the carrying value of the net investment, including goodwill, in order
to determine if an impairment has occurred. Management is currently of the
opinion that no such impairment exists.

STOCK-BASED COMPENSATION--The Company recognizes stock-based compensation costs
under the intrinsic value based method of accounting as prescribed by Accounting
Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to
Employees."

INCOME TAXES--Income taxes are recognized during the year in which transactions
enter into the determination of financial statement income, with deferred income
taxes being provided for the tax effect of temporary differences between the
carrying amount of assets and liabilities and their tax bases.

Deferred income taxes are provided on the undistributed earnings of foreign
subsidiaries and affiliated companies except to the extent such earnings are
considered to be permanently reinvested in the subsidiary or affiliate. Where it
is contemplated that earnings will be remitted, credit for foreign taxes already
paid generally will offset applicable U.S. income taxes. In cases where foreign
tax credits will not offset U.S. income taxes, appropriate provisions are
included in the consolidated statements of earnings. Repatriation of permanently
reinvested earnings would not materially increase the Company's tax liabilities.

RETIREMENT PLANS--The cost of retirement plans is computed on the basis of
accepted actuarial methods (using the projected unit credit method for the
principal plan) and includes current service costs, amortization of increases in
prior service costs over the expected future service of active participants as
of the date such costs are first recognized, and amortization of the initial
unrecognized net pension asset or liability on a straight-line basis over 18
years.

The costs of health and life insurance postretirement benefits are accrued as
earned. Annual expense represents a combination of interest and service cost
provisions. Most postretirement benefits are not funded.

EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)--ESOP contribution expense is based upon
non-level debt payments made by the ESOP to meet the plan funding requirements.

RESEARCH AND DEVELOPMENT--Research and development costs ($43.7 million in 1998,
$43.0 million in 1997, and $41.9 million in 1996) are charged to expense as
incurred.

<PAGE>
 
NOTE 2--BUSINESS SEGMENT DATA

Nalco is engaged in the worldwide manufacture and sale of highly specialized
Service Chemical programs. This includes production and service related to the
sale and application of chemicals and technology used in water treatment,
pollution control, energy conservation, oil production and refining,
steelmaking, papermaking, mining, and other industrial processes.

The Company has determined that its reportable segments are those that are based
on the Company's method of internal reporting. Effective January 1, 1998, the
Company established a new sales and marketing organization based on the nature
of the customer served, the product application, or the geographic location of
the customer. This organization is comprised of the following reportable
segments:

INDUSTRIAL DIVISION--Serves the water and waste treatment needs of basic
industry customers in North America, Europe, the Middle East and South Africa.

SPECIALTY DIVISION--Serves the water and waste treatment needs of middle market
customers in North America and Europe.

PULP AND PAPER DIVISION--Serves the process chemical needs of pulp and paper
customers in North America and Europe.

PROCESS DIVISION--Serves the process chemical needs of all industries, except
pulp and paper, worldwide.

LATIN AMERICA DIVISION--Serves the water and waste treatment needs of all
industries and the process chemical needs of the pulp and paper industries in
South and Central America, the Caribbean and Mexico.

PACIFIC DIVISION--Serves the water and waste treatment needs of all industries
and the process chemical needs of the pulp and paper industries in the Pacific
Rim.

The accounting policies of the segments are the same as those described in "Note
1--Summary of Significant Accounting Policies." The Company evaluates the
performance of its segments based on "direct contribution" (net sales, less cost
of products sold, selling and research expenses directly attributable to each
segment). There are no intersegment revenues.

With the exception of net sales for the year ended December 31, 1997, the
Company has not disclosed prior years' segment data on a comparative basis,
because management found it impracticable to obtain the comparative data for
prior years. Prior to 1998, the Company was comprised of one reportable segment.

The following table presents net sales by reportable segment for the years ended
December 31, 1998 and 1997:

<TABLE>
<CAPTION>
(in millions)                  1998            1997
---------------------------------------------------
<S>                        <C>             <C>
Industrial                 $  462.5        $  408.8
Specialty                     351.7           301.6
Pulp and Paper                358.4           333.8
Process                       196.6           189.7
Latin America                  85.8            82.7
Pacific                       118.5           117.1
---------------------------------------------------
Total                      $1,573.5        $1,433.7
---------------------------========================
</TABLE>

The following table presents direct contribution by reportable segment and
reconciles the total segment direct contribution to earnings from continuing
operations before income taxes for the year ended December 31, 1998:

<TABLE>
<CAPTION>
(in millions)                                  1998
---------------------------------------------------
<S>                                         <C>
Segment direct contribution:
  Industrial                                $ 115.5
  Specialty                                    82.4
  Pulp and Paper                               85.7
  Process                                      41.7
</TABLE> 

<PAGE>
 
<TABLE>
<S>                                                        <C>
  Latin America                                               16.9
  Pacific                                                     22.8
------------------------------------------------------------------
Total segment direct contribution                            365.0
Income (expenses) not allocated to segments:
  Unallocated operating costs and expenses                  (123.6)
  Cost reduction program                                    (180.0)
------------------------------------------------------------------
Operating Earnings                                            61.4
Interest and other income                                      2.4
Interest expense                                             (26.5)
Equity in earnings of partnership                             22.6
------------------------------------------------------------------
Earnings from Continuing Operations Before Income Taxes    $  59.9
-----------------------------------------------------------=======
</TABLE>

Asset information by reportable segment has not been reported, since the Company
does not produce such information internally. In addition, although depreciation
expense is a component of each reportable segment's direct contribution, it is
not discretely identifiable.

The following table presents net sales for the United States and all other
countries based on the location of the use of product:

<TABLE>
<CAPTION>
(in millions)                          1998        1997        1996
-------------------------------------------------------------------
<S>                                <C>         <C>         <C>
United States                      $  900.1    $  792.2    $  705.6
Other                                 673.4       641.5       597.9
-------------------------------------------------------------------
Total                              $1,573.5    $1,433.7    $1,303.5
-----------------------------------================================
</TABLE>

The following table presents net property, plant and equipment located in the
United States and all other countries:

<TABLE>
<CAPTION>
(in millions)                          1998        1997        1996
-------------------------------------------------------------------
<S>                                <C>         <C>         <C>
United States                      $  335.8    $  320.9    $  327.5
Other                                 181.5       171.6       194.5
-------------------------------------------------------------------
Total                              $  517.3    $  492.5    $  522.0
-----------------------------------================================
</TABLE>

Net sales and property, plant and equipment were not material in any individual
country other than the United States.

<PAGE>
 
NOTE 3--COST REDUCTION PROGRAM

In the fourth quarter 1998, management approved and began implementing a cost
reduction program to cut its overall cost structure by $30 million annually.
Virtually all of the Company's global operations were affected by this plan,
including sales, marketing, manufacturing and support services. The program
included redesigning, combining and streamlining operations to improve
efficiency and customer focus. Approximately 500 positions were eliminated
during the fourth quarter 1998, mainly as a result of a voluntary enhanced early
retirement program, and an additional 100 positions are scheduled for
elimination in early 1999.

As a result of the cost reduction program, the Company recorded a pretax
provision of $180 million, which included $127 million for pension costs and $19
million for other postretirement benefit costs associated with the early
retirement program. The pension costs resulted in the Company making cash
payments in the fourth quarter 1998 and early 1999 to the Company's principal
U.S. retirement plan and directly to employees for obligations under a
supplementary, non-qualified pension plan. The cost of other postretirement
benefits represents a non-cash charge, which will be paid out in future years.
(See Note 5). Also included in the provision for the cost reduction program were
$21 million for severance and other termination payments; $7 million for legal
and consulting fees, contract termination charges (principally leases), and
other costs related to program; and $6 million for non-cash asset write-offs of
abandoned property and equipment.

Most cost reduction plan activities were completed by the end of 1998 and all
are expected to be concluded by mid-1999. As of December 31, 1998, $127 million
had been charged against the provision for the cost reduction program. The
following talk sets forth the details of activity for 1998:

<TABLE>
<CAPTION>
                                                                     Balance at
                                   1998        Cash      Noncash    December 31,
(in millions)                    Provision   Payments    Charges        1998
--------------------------------------------------------------------------------
<S>                              <C>         <C>         <C>        <C>
Pension benefits                    $127.6    $ (94.4)    $    -           $33.2
Other postretirement benefits         18.8                 (18.8)              -
Termination benefits                  20.7       (7.4)         -            13.3
Legal, consulting and other            7.4       (2.3)         -             5.1
Asset write-offs                       5.5          -       (4.1)            1.4
--------------------------------------------------------------------------------
Total                               $180.0    $(104.1)    $(22.9)          $53.0
------------------------------------============================================
</TABLE>

Of the remaining balance of $53 million at December 31, 1998, $34 million was
included in the statement of consolidated financial condition in other accrued
expenses and $19 million in accrued pension benefits.

<PAGE>
 
NOTE 4--DISCONTINUED OPERATIONS

In October 1996, the Company completed the sale of its discontinued
superabsorbent chemicals business. The gain on the sale was $3 million, net of
income taxes of $1 million.

The results of the superabsorbent chemicals business have been classified as
discontinued operations in the accompanying financial statements. Sales from the
discontinued operation, which are excluded from consolidated sales, amounted to
$63 million in 1996. Excluding the aforementioned gain on the sale, net earnings
from discontinued operations totaled $6 million in 1996 which included the
pretax operating earnings of the discontinued operations, less applicable income
taxes of $4 million. The effective income tax rate for discontinued operations
differs from the federal statutory rate primarily because of state income taxes,
net of federal tax benefit.

<PAGE>
 
NOTE 5--PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

The Company has several noncontributory defined benefit pension plans covering
most employees in the United States and those with six foreign subsidiaries. The
principal U.S. plan represents approximately 63 percent of the benefit
obligation and 70 percent of the total market value of plan assets. The Company
also provides a supplementary, non-qualified, unfunded plan for U.S. employees
whose pension benefits exceed ERISA limitations. In addition, the Company has
defined benefit postretirement plans that provide medical, dental and life
insurance benefits for substantially all U.S. retirees and eligible dependents.
The Company retains the right to change or terminate these benefits.

As part of the Company's plan to reduce future operating expenses, a voluntary
enhanced early retirement program was offered in the fourth quarter 1998. (See
Note 3). This program resulted in charges totaling $146 million for special
termination benefits, settlements and curtailments, all of which have been
included in the Company's $180 million charge for the cost reduction program. No
contributions had been made by the Company to its principal U.S. plan during the
period from 1985 to 1997. However, as a result of the early retirement program,
the Company contributed $72 million to the plan in 1998, and expects to
contribute an additional $30 million in 1999. The Company also made payments
totaling $36 million for the settlement of obligations under the supplementary,
non-qualified plan.

The following table details the changes in the funded status of defined benefit
pension and other postretirement benefit plans, and sets forth amounts
recognized and not recognized in the statements of consolidated financial
condition:
<TABLE>
<CAPTION>
 
                                                                                         Pension Benefits     Other Benefits
                                                                                        ------------------  ------------------
(in millions)                                                                             1998      1997      1998      1997
------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                     <C>       <C>       <C>       <C>
Change in benefit obligation
Benefit obligation at beginning of year                                                 $ 370.4    $338.3   $  77.8   $  64.9
Service cost                                                                               16.7      15.0       2.3       2.1
Interest cost                                                                              28.2      26.8       5.8       5.5
Participant contributions                                                                   0.7       0.9       0.4       0.3
Plan amendments                                                                             1.2       1.9         -         -
Actuarial loss                                                                            135.9      25.4       5.3       9.0
Benefits paid                                                                             (50.9)    (28.9)     (3.7)     (4.0)
Special termination benefits                                                               59.2         -      22.9         -
Settlements                                                                              (174.7)        -         -         -
Curtailments                                                                              (14.0)        -      (4.1)        -
Foreign currency exchange rate changes                                                      2.2      (9.0)        -         -
------------------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year                                                         374.9     370.4     106.7      77.8
------------------------------------------------------------------------------------------------------------------------------
Change in plan assets
Fair value of plan assets at beginning of year                                            340.2     322.8         -         -
Actual return on plan assets                                                               31.8      41.7         -         -
Employer contributions                                                                    119.7       5.7       3.3       3.7
Participant contributions                                                                   0.7       0.9       0.4       0.3
Benefits paid                                                                            (225.6)    (28.9)     (3.7)     (4.0)
Foreign currency exchange rate changes                                                      0.1      (2.0)        -         -
------------------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of year                                                  266.9     340.2         -         -
------------------------------------------------------------------------------------------------------------------------------
Funded status                                                                            (108.0)    (30.2)   (106.7)    (77.8)
Unrecognized net actuarial (gains) losses                                                  69.6      18.0     (20.2)    (26.8)
Unrecognized prior service costs                                                            9.7      16.1         -         -
Unrecognized net transition asset                                                          (8.9)    (16.6)        -         -
------------------------------------------------------------------------------------------------------------------------------
Net amount recognized                                                                   $ (37.6)   $(12.7)  $(126.9)  $(104.6)
--------------------------------------------------------------------------------------========================================
 
Amounts recognized in the statements of consolidated financial condition consist of:
 
                                                                                        Pension Benefits    Other Benefits
                                                                                        ----------------    --------------
(in millions)                                                                              1998      1997      1998      1997
------------------------------------------------------------------------------------------------------------------------------
Prepaid benefit cost                                                                    $   2.5    $  8.9   $     -   $     -
Other accrued expenses                                                                        -         -      (3.9)     (3.9)
Accrued benefit liability                                                                 (63.2)    (40.8)   (123.0)   (100.7)
Intangible asset                                                                            2.7       7.3         -         -
Accumulated other comprehensive income                                                     20.4      11.9         -         -
                                                                                        --------------------------------------
Net amount recognized                                                                   $ (37.6)   $(12.7)  $(126.9)  $(104.6)
                                                                                        ======================================
</TABLE>

The projected benefit obligation (PBO), accumulated benefit obligation (ABO) and
fair value of plan assets for defined benefit pension plans with ABOs in excess
of plan assets were $62 million, $52 million and $14 million, respectively, at
December 31, 1998. At December 31, 1997, the PBO and ABO for such plans were $44
million and $35 million, respectively, and none of the plans held assets.

<PAGE>
 
Net pension and other postretirement benefit expense for all defined benefit
plans was comprised of:
<TABLE>
<CAPTION>
 
                                            Pension Benefits           Other Benefits    
                                        -------------------------  -----------------------
(in millions)                            1998     1997     1996     1998     1997     1996
------------------------------------------------------------------------------------------
<S>                                     <C>      <C>      <C>      <C>      <C>      <C>
Service cost                            $ 16.7   $ 15.0   $ 16.1    $ 2.3    $ 2.1   $ 2.2
Interest cost                             28.2     26.8     25.6      5.8      5.5     5.1
Expected return on plan assets           (30.1)   (28.6)   (27.7)       -        -       -
Amortization of prior service cost         1.6      2.1      2.1        -        -       -
Amortization of net transition asset      (2.9)    (2.9)    (2.9)       -        -       -
Recognized net actuarial (gain) loss       1.5      1.2      1.7     (1.3)    (1.7)   (1.5)
Special termination benefits              64.2      0.2        -     22.9        -       -
Settlement charge                         61.9        -        -        -        -       -
Curtailment charge (credit)                1.5        -        -     (4.1)       -       -
------------------------------------------------------------------------------------------
Net benefit expense                     $142.6   $ 13.8   $ 14.9    $25.6    $ 5.9   $ 5.8
--------------------------------------====================================================
</TABLE>

As previously noted, the 1998 amounts in the table above include $146 million
for special termination benefits, settlements and curtailments resulting from
the early retirement program offered to employees in the fourth quarter 1998. Of
that amount, $127 million was attributable to pension benefits and $19 million
was attributable to other postretirement benefits. The $146 million charge was
reported as a component of the $180 million cost reduction program expense.

The assumptions used for the U.S. defined benefit plans as of the end of the
last three years were as follows:
<TABLE>
<CAPTION>
 
                                                                      Pension Benefits                       Other Benefits
                                                               -----------------------------        -----------------------------
                                                               1998        1997         1996        1998         1997        1996
                                                               ------------------------------------------------------------------ 
<S>                                                            <C>          <C>          <C>        <C>           <C>         <C>
Discount rates                                                 6.75%        7.5%         8.0%       6.75%         7.5%        8.0%
Rates of increase in compensation levels                        4.0         4.0          4.0         4.0          4.0         4.0
Rates of return on plan assets                                  9.5         9.5          9.5           -            -           -
---------------------------------------------------------------------------------------------------------------------------------
 
The assumptions used for the foreign defined benefit
 pension plans as of the end of the last three years
 were as follows:
 
                                                             1998                     1997                     1996
---------------------------------------------------------------------------------------------------------------------------------
Discount rates                                            5.0 -  6.5%              6.0 - 7.25%              6.5 -  9.0%      
Rates of increase in compensation levels                  3.0 -  5.0               3.0 -  6.0               4.0 - 6.25
Rates of return on plan assets                            5.5 - 7.25               6.0 - 8.75               6.5 - 9.75
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The Company has assumed a health care cost trend rate of 6.5% for 1999,
decreasing ratably to 5.0% in 2002 and thereafter. A one-percentage-point change
in assumed health care cost trend rates would have the following effects on 1998
service and interest costs and the accumulated postretirement benefit obligation
at December 31, 1998:
<TABLE>
<CAPTION>
 
                                              One-Percentage-Point
(in millions)                                  Increase  Decrease
-----------------------------------------------------------------
<S>                                              <C>       <C>
Effect on total of service and interest
  cost components                                $  1.2    $ (1.0)
Effect on postretirement benefit obligation        12.5     (11.2)
-----------------------------------------------------------------
</TABLE>
<PAGE>
 
NOTE 6--EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)

Nalco's ESOP gives most United States employees an additional opportunity to
share in the ownership of the Company's stock. Preferred shares are allocated to
eligible employees based on a percentage of pretax earnings.

Selected information about the ESOP is as follows:
<TABLE>
<CAPTION>
 
(dollars in millions, shares in thousands)     1998    1997    1996
--------------------------------------------  ------  ------  ------
<S>                                           <C>     <C>     <C>
Preferred stock dividends                     $ 14.7  $ 15.0  $ 15.3
Interest expense on ESOP debt                 $  7.8  $  8.7  $  9.4
ESOP benefit expense                          $    -  $  4.1  $  3.2
ESOP contribution payments                    $  4.2  $  5.5  $  5.1
Preferred shares at year end:
  Allocated                                    152.4   140.0   124.2
  Committed-to-be-released                      12.2    22.9    24.9
  Suspense                                     208.7   220.9   243.8
--------------------------------------------  ------  ------  ------
</TABLE>
No provision was recorded for ESOP benefit expense in 1998 because the expected
debt service requirements of the ESOP will not require any contributions by the
Company.
<PAGE>
 
NOTE 7--STOCK OPTION AND PERFORMANCE PLANS

Nalco's Employee Stock Compensation Plan and its 1990 Stock Option Plan for key
management employees authorized the granting of stock options for the purchase
of up to 8,000,000 shares and 6,000,000 shares, respectively, of Nalco common
stock. The Company's 1982 Stock Option Plan authorized the granting of either
incentive stock options or non-qualified options for the purchase of up to
6,000,000 shares of Nalco's common stock. The option price under these plans
cannot be less than the fair market value on the date of grant. Options granted
since 1989 generally become exercisable ratably over the three years following
the grant date, and will expire ten years after the date granted. Options
granted prior to 1989 had a term of ten years, and were exercisable upon grant.
Options may be exercised in whole or in part for cash, shares of common stock,
or a combination thereof.

The 1990 Stock Option Plan for Non-Employee Directors authorizes the granting of
stock options to outside directors for the purchase of up to 500,000 common
shares. The option price under the plan cannot be less than the fair market
value on the date of the grant. These options become exercisable upon grant, and
expire ten years from the grant date.

Information regarding these stock option plans for 1998, 1997 and 1996 is as
follows:

<TABLE>
<CAPTION>
                                            1998                            1997                            1996
                               -----------------------------   -----------------------------   -----------------------------
                                            Weighted-Average                Weighted-Average                Weighted-Average
                                 Shares      Exercise Price      Shares      Exercise Price      Shares      Exercise Price
                               -----------------------------   -----------------------------   -----------------------------
<S>                            <C>          <C>                <C>          <C>                <C>          <C>
At the beginning of
    the year                   7,577,371         $33.69        7,473,363        $32.77         6,657,723         $32.17
Granted                        3,513,900         $37.97        1,002,700        $36.48         1,595,200         $31.64
Exercised                       (494,300)        $29.23         (754,492)       $28.17          (500,460)        $20.54
Expired or cancelled            (687,900)        $38.13         (144,200)       $34.04          (279,100)        $34.04
At the end of the year         9,909,071         $35.13        7,577,371        $33.69         7,473,363         $32.77
Options exercisable at
    end of year                6,637,813         $33.67        5,231,142        $33.34         4,574,896         $32.33
Weighted-average fair
    value of options
    granted during
    the year                       $7.94                         $9.02                             $6.53
</TABLE>
 
The following table summarizes information about fixed stock options outstanding
at December 31, 1998:
 
<TABLE>
<CAPTION>
                                      Options Outstanding                          Options Exercisable
                      ---------------------------------------------------    -------------------------------
                                     Weighted-Average
    Range of             Number          Remaining       Weighted-Average       Number      Weighted-Average
 Exercise Prices      Outstanding          Life           Exercise Price     Exercisable     Exercise Price
 ---------------      -----------    ----------------    ----------------    -----------    ----------------
<S>                     <C>          <C>                 <C>                 <C>            <C>
$20.16 to $24.25          298,500        0.4 yrs.             $20.92            298,500          $20.92
$29.56 to $31.97        1,794,050        7.8                  $31.32          1,520,428          $31.25
$32.69 to $35.75        2,705,200        6.0                  $34.46          2,705,200          $34.46
$36.00 to $39.94        5,111,321        7.0                  $37.65          2,113,685          $36.20
                       ----------                                             ---------
$20.16 to $39.94        9,909,071        6.7                  $35.13          6,637,813          $33.67
                       ==========                                             =========
</TABLE>

The Company applies APB 25 and related Interpretations in accounting for the
aforementioned stock plans. Accordingly, no compensation cost has been
recognized for its fixed stock option plans while compensation expense has been
recognized for its compensatory plans. Had compensation cost for the Company's
fixed stock option plans been determined based on the fair value based method,
as defined in Statement of Financial Accounting Standards No. 123 (SFAS 123),
"Accounting for Stock-Based Compensation," the Company's net earnings and
earnings per share would have been reduced to the pro forma amounts indicated
below:

<TABLE>
<CAPTION>
(in millions, except per share data)           1998       1997       1996
-------------------------------------------------------------------------
<S>                      <C>                  <C>       <C>        <C>
Net earnings             As reported          $37.9     $158.9     $154.5
                         Pro forma             28.9      151.4      146.1
-------------------------------------------------------------------------
Earnings per share
  Basic                  As reported          $0.40     $ 2.21     $ 2.13
                         Pro forma             0.26       2.10       2.00
  Diluted                As reported           0.40       2.04       1.97
                         Pro forma             0.26       1.94       1.86
-------------------------------------------------------------------------
</TABLE>

The fair value of each option grant was estimated on the date of the grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996, respectively: dividend yield of 2.5
percent, 2.8 percent and 3.2 percent; expected volatility of 16.2 percent, 20.0
percent and 20.7 percent; risk-free interest rate of 5.4 percent, 6.3 percent
and 6.5 percent; and expected lives of 6.3, 6.3 and 6.6 years.

<PAGE>
 
The effects of applying SFAS 123 in the above pro forma disclosures are not
indicative of future amounts as they do not include the effects of awards
granted prior to 1995, some of which would have had income statement effects in
1996 and 1997 due to the three-year vesting period associated with the fixed
stock option awards. Additionally, future amounts are likely to be affected by
the number of grants awarded since additional awards are generally expected to
be made at varying amounts.

In 1996, the Performance Share Plan for designated officers and other key
executives was amended and reapproved by the shareholders. It provides for the
annual assignment of performance shares which are contingent upon future
earnings growth of the Company. Performance awards shall be paid half in cash
and half in the Company's common stock, except that any payments made after
1,000,000 shares have been issued shall be made only in cash and only with
respect to contingent performance shares already assigned. The cash portion of
an award shall be paid after determination of the award; however, the right to
receive common shares shall not vest to a participant until three years after
the end of a performance period.

Charges to earnings for compensatory stock related plans were not significant in
1998 and totaled $3 million in 1997 and $2 million in 1996.

<PAGE>
 
NOTE 8--INCOME TAXES

The sources of earnings from continuing operations before income taxes were as
follows:

<TABLE>
<CAPTION>
(in millions)              1998       1997       1996
-----------------------------------------------------
<S>                       <C>       <C>        <C>
Domestic                  $14.3     $185.7     $168.6
Foreign                    45.6       70.6       60.8
                          -----     ------     ------
Total                     $59.9     $256.3     $229.4
                          =====     ======     ======
</TABLE>

The components of income tax provisions (benefits) attributable to earnings from
continuing operations are summarized as follows:

<TABLE>
<CAPTION>
(in millions)              1998      1997      1996
----------------------------------------------------
<S>                      <C>        <C>       <C>
Current
  Federal                $ 18.1     $58.2     $50.9
  State                     5.3      11.1      10.4
  Foreign                  21.9      25.6      20.6
                         ------     -----     -----
                           45.3      94.9      81.9
                         ------     -----     -----
Deferred
  Federal                 (18.6)     (3.8)     (3.0)
  State                    (3.1)     (0.6)     (0.1)
  Foreign                  (1.6)      2.4       4.7
                         ------     -----     -----
                          (23.3)     (2.0)      1.6
                         ------     -----     -----
Total                    $ 22.0     $92.9     $83.5
                         ======     =====     =====
</TABLE>

Current foreign taxes listed above include taxes withheld by foreign governments
on distributions from subsidiaries and affiliates (principally dividends and
service fees).

Nalco made income tax payments of $74 million, $103 million and $84 million
during 1998, 1997 and 1996, respectively.

The effective income tax rate varies from the federal statutory rate because of
the factors indicated below:

<TABLE>
<CAPTION>
                                        1998      1997      1996
-----------------------------------------------------------------
<S>                                     <C>       <C>       <C>
Statutory U.S. federal tax rate         35.0%     35.0%     35.0%
State income taxes, net
  of federal tax benefit                 2.7       2.6       2.9
Other                                   (1.0)     (1.4)     (1.5)
                                        ----      ----      ----
Effective tax rate                      36.7%     36.2%     36.4%
                                        ====      ====      ====
</TABLE>

Details of the 1998 and 1997 deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
(in millions)                                   1998          1997
------------------------------------------------------------------
<S>                                          <C>           <C>
Deferred tax assets:
  Postretirement benefits                    $ (51.5)       $(42.5)
  Pension benefits                             (20.4)         (3.6)
  Other                                        (48.8)        (42.5)
                                             -------       -------
  Total                                       (120.7)        (88.6)
                                             -------       -------
Deferred tax liabilities:
  Depreciation                                  60.6          57.9
  Leveraged lease investments                   28.6          29.2
  Other                                         29.5          26.5
                                             -------       -------
  Total                                        118.7         113.6
                                             -------       -------
Net deferred tax (asset) liability           $  (2.0)       $ 25.0
                                             =======       =======
Included in:
  Prepaid expenses, taxes
     and other current assets                $  (7.8)       $ (6.2)
  Miscellaneous other assets                    (7.9)         (5.8)
  Income taxes                                  (1.9)         (0.2)
  Deferred income taxes                         15.6          37.2
                                             -------       -------
Net deferred tax (asset) liability           $  (2.0)       $ 25.0
                                             =======       =======
</TABLE>

<PAGE>
 
NOTE 9--EARNINGS PER SHARE

Basic earnings per share (EPS) is computed by dividing net earnings (after
deducting preferred stock dividends, net of income taxes) by the weighted-
average number of common shares outstanding during the year. Diluted EPS is
based upon the weighted-average number of common shares and dilutive potential
common shares outstanding, plus the weighted average number of common shares
resulting from the assumed conversion of the Series B ESOP Convertible Preferred
Stock (preferred stock). Earnings for purposes of computing diluted EPS are
reduced for additional ESOP debt service expense resulting from the assumed
replacement of preferred stock dividends with common stock dividends, net of
related tax benefits. At December 31, 1998, there were 373,195 shares of
preferred stock outstanding which were convertible to approximately 7.5 million
common shares. The preferred stock was not included in the computation of
diluted EPS for 1998 since it would have resulted in an antidilutive effect.

The following table reconciles the numerators and denominators of the basic and
diluted EPS computations for earnings from continuing operations:

<TABLE>
<CAPTION>
(dollars in millions, shares in thousands)                1998         1997         1996
----------------------------------------------------------------------------------------
<S>                                                    <C>          <C>          <C>
Earnings from continuing operations                    $  37.9      $ 163.4      $ 145.9
Dividends on preferred stock, net of taxes               (11.5)       (11.5)       (11.3)
----------------------------------------------------------------------------------------
Earnings from continuing operations available
  to common shareholders used in basic EPS                26.4        151.9        134.6
Assumed conversion of preferred stock                        -         11.5         11.3
Additional ESOP expense resulting from assumed
  conversion of preferred stock, net of taxes                -         (4.5)        (4.5)
Income tax adjustment on assumed common dividends            -         (1.0)        (0.9)
----------------------------------------------------------------------------------------
Earnings from continuing operations available to
  common shareholders used in diluted EPS              $  26.4      $ 157.9      $ 140.5
-------------------------------------------------------=================================

Average shares outstanding used in basic EPS            65,847       66,700       67,280
Effect of dilutive securities:
  Assumed conversion of preferred stock                      -        7,760        7,930
  Stock options and contingently
     issuable shares                                       421          805          319
----------------------------------------------------------------------------------------

Average shares outstanding used in diluted EPS          66,268       75,265       75,529
-------------------------------------------------------=================================
</TABLE>

The following options to purchase shares of common stock were outstanding during
each year, but were not included in the computation of diluted EPS because the
exercise price was greater than the average market price:

<TABLE>
<CAPTION>
                                                     1998      1997        1996
-------------------------------------------------------------------------------
<S>                                                <C>         <C>       <C>
Number of options (thousands)                       5,357         -       3,139
Weighted-average exercise price                    $37.56      $  -      $35.52
-------------------------------------------------------------------------------
</TABLE>

<PAGE>
 
NOTE 10 -- ACCOUNTING CHANGE

In November 1997, the Emerging Issues Task Force of the Financial Accounting
Standards Board reached a consensus on Issue 97-13 (EITF 97-13), "Accounting for
Costs Incurred in Connection with a Consulting Contract or an Internal Project
That Combines Business Process Reengineering and Information Technology
Transformation." The consensus clarified the accounting for third-party and
internally generated costs associated with projects that combine business
process reengineering activities and information technology transformation,
requiring that such costs be expensed as incurred. Additionally, the transition
provisions of EITF 97-13 required any unamortized previously capitalized costs
for business process reengineering activities to be written off in the quarter
that contained November 20, 1997 and to be reported as a cumulative effect of a
change in accounting principle.

As a result of EITF 97-13, the Company recorded a noncash pretax charge of $7
million ($4.5 million after tax, or 6 cents per share on a diluted basis) in
1997, which was comprised of unamortized capitalized business process
reengineering costs.

<PAGE>
 
NOTE 11--ACQUISITIONS

The Company acquired seventeen businesses in 1998, eight businesses in 1997 and
two businesses in 1996 that operate in Nalco's core markets of water treatment
and process chemicals. Each of the acquisitions was accounted for as a purchase
and, accordingly, the operating results of each acquired business was included
in the consolidated financial results of the Company from its respective
acquisition date. In addition, during 1998 the Company increased its investments
in Taiwan Nalco Chemical Co. Ltd. from 79 percent to 82 percent and Nalco
Chemical India, Ltd. from 65 percent to 80 percent. During 1997 the Company
increased its investment in Taiwan Nalco Chemical Co. from 55 percent to 79
percent. The combined purchase price of these acquisitions, net of cash
acquired, was approximately $149 million in 1998, $80 million in 1997 and $83
million in 1996. On a preliminary basis, the purchase price exceeded the fair
value of the net tangible assets of those businesses which were acquired during
1998 by about $132 million which was allocated to goodwill and other intangible
assets. The Company does not anticipate that the final purchase allocations will
differ significantly from the preliminary purchase price allocations recorded.
The purchase price exceeded the fair value of the net tangible assets which were
acquired during 1997 and 1996 by $70 million and $75 million, respectively.

Effective January 1998, the Company merged its South African affiliate company
with the water treatment interests of Chemical Services Limited, South Africa's
largest specialty chemicals company, to form Nalco-Chemserve. In connection with
the merger, Nalco obtained a controlling interest in Nalco-Chemserve and,
accordingly, has consolidated the results of Nalco-Chemserve from January 1,
1998.

The pro forma impact as if these acquisitions had occurred at the beginning of
the respective years is not significant.

<PAGE>
 
NOTE 12--INVESTMENT IN AND ADVANCES TO PARTNERSHIP

The Company's investment in partnership consists of its 60 percent interest in
Nalco/Exxon, a joint venture partnership which was formed in 1994.

The Company's investment in Nalco/Exxon of $125 million at December 31, 1998
included $45 million in demand notes payable to Nalco/Exxon. There were $35
million of demand notes payable to Nalco/Exxon at December 31, 1997.

All significant management decisions of the joint venture require agreement by
both the Company and Exxon. In addition, certain provisions of the joint venture
agreement provide Exxon with an option to cause Nalco/Exxon to redeem a portion
of the Company's interest in Nalco/Exxon such that subsequent to such
redemption, the Company and Exxon shall share equally in the results of the
joint venture. As a result of the Company not exercising control over
Nalco/Exxon, its investment in the joint venture is accounted for by the equity
method.

The following table summarizes the Company's equity in earnings of Nalco/Exxon
and distributions from the partnership for the years 1998, 1997 and 1996:

<TABLE>
<CAPTION>
(in millions)                                   1998       1997       1996
--------------------------------------------------------------------------
<S>                                           <C>        <C>        <C>
Nalco/Exxon:
  Net sales                                   $487.8     $455.6     $436.6
  Earnings before income taxes                  42.7       51.1       42.4
  Net income                                    34.6       42.6       35.7
Nalco's equity interest                           60%        60%        60%
                                              ------     ------     ------
Nalco's equity in net income                    20.8       25.6       21.4
Amortization and income preference, net          1.8        2.6        3.1
                                              ------     ------     ------
Equity in earnings of partnership             $ 22.6     $ 28.2     $ 24.5
                                              ======     ======     ======
Distributions received from partnership       $ 10.2     $  9.2     $  8.4
                                              ======     ======     ======
</TABLE>

In the fourth quarter 1998, Nalco/Exxon began implementing a cost reduction
program which included provisions for employee terminations and impaired assets.
The Company's equity portion of Nalco/Exxon's cost reduction program was over $2
million.

The Company's investment in Nalco/Exxon at December 31, 1998 included $7 million
for the net excess of the Company's investment over its equity in the joint
venture's net assets which is being amortized to equity earnings over the life
of the related assets. In addition, the Company received a 2 percent, 4 percent
and 6 percent earnings preference in 1998, 1997 and 1996, respectively, which
has been included in equity earnings.

Condensed balance sheet information for the Nalco/Exxon joint venture at
December 31, 1998 and 1997 was as follows:

<TABLE>
<CAPTION>
(in millions)                                 1998        1997
--------------------------------------------------------------
<S>                                         <C>         <C>
Current assets                              $154.9      $164.7
Noncurrent assets                            223.3       203.8
Current liabilities                           83.2        89.9
Noncurrent liabilities                        31.5        33.7
--------------------------------------------------------------
</TABLE>

The Company has an agreement with Nalco/Exxon to provide certain administrative
services to the partnership. Fees earned by the Company in 1998, 1997 and 1996
were $14 million, $14 million and $15 million, respectively.

In the normal course of business, the Company supplies Nalco/Exxon with certain
products, and purchases certain products from Nalco/Exxon. These transactions
are generally at cost and were not significant in 1998, 1997 or 1996.

<PAGE>
 
NOTE 13--PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment (including major improvements) are recorded at
cost. Depreciation of buildings and equipment is calculated over their estimated
useful lives generally using the straight-line method. The estimated useful
lives of the major classes of depreciable assets are as follows: buildings 15 to
40 years; equipment 3 to 15 years.

Property, plant and equipment consists of the following:

<TABLE>
<CAPTION>
(in millions)                                     1998          1997
---------------------------------------------------------------------
<S>                                           <C>           <C>
Land                                          $   35.5      $   34.8
Buildings                                        208.7         199.4
Equipment                                        980.9         901.0
                                              --------      --------
                                               1,225.1       1,135.2
Allowances for depreciation                     (707.8)       (642.7)
                                              --------      --------
Net property, plant and equipment             $  517.3      $  492.5
                                              ========      ========
</TABLE>

<PAGE>
 
NOTE 14--SHORT-TERM DEBT

Short-term debt consists of the following:

<TABLE>
<CAPTION>
(in millions)                                    1998       1997
----------------------------------------------------------------
<S>                                             <C>        <C>
Notes payable                                   $10.8      $18.9
Current maturities of long-term debt              5.0        3.2
Commercial paper borrowings                      60.0          -
                                                -----      -----
Total                                           $75.8      $22.1
                                                =====      =====
</TABLE>

The weighted-average interest rate on short-term debt was 5.8 percent and 9.1
percent at December 31, 1998 and 1997, respectively.

For general purposes and to support the ESOP loans and the issuance of
commercial paper, Nalco has a $350 million Revolving Credit Agreement with
eleven banks. This agreement is structured as a four-year revolving credit.
Borrowings under the agreement are at rates which, at Nalco's option, vary with
the prime rate, CD rate, LIBOR or money market rates. The credit line carries a
facility fee of .08 percent. The credit arrangements were unused at December 31,
1998.

<PAGE>
 
NOTE 15--LONG-TERM DEBT

Long-term debt consists of the following:

<TABLE>
<CAPTION>
(in millions)                           1998        1997
--------------------------------------------------------
<S>                                   <C>         <C>
ESOP loans                            $140.5      $151.1
Commercial paper borrowings            148.0       143.0
Unsecured notes, due 2008              149.5           -
Other                                   63.2        44.4
                                      ------      ------
                                       501.2       338.5
Less current portion                    (5.0)       (3.2)
                                      ------      ------
Total                                 $496.2      $335.3
                                      ======      ======
</TABLE>

In 1989, the ESOP borrowed $200 million to purchase preferred stock from the
Company. Nalco borrowed $66 million which was subsequently loaned to the ESOP,
and guaranteed the balance of $134 million. Borrowings related to the ESOP are
reflected as long-term debt with a corresponding reduction of shareholders'
equity (unearned ESOP compensation). The ESOP is repaying the loans and interest
over a projected 20-year period ending December 31, 2008 using Company
contributions and dividends from preferred stock. As the principal amount of the
borrowings is repaid, the debt and the unearned ESOP compensation are being
reduced. At December 31, 1998, $88 million of the ESOP borrowings are variable
rate notes which are presently remarketed on a monthly basis with a final
maturity on December 31, 2008. Any notes which cannot be successfully remarketed
will be purchased by the Company or one of its subsidiaries. The Company entered
into an interest rate swap agreement which effectively converted the $88 million
of variable rate notes into fixed-rate debt of 7.3 percent. The notional value
of the swap agreement decreased to $43 million in 1998 with final maturity in
1999. The remaining borrowings are comprised of a $38 million variable rate loan
which matures in 2008 and a $15 million loan with a fixed rate of 8.1 percent
and a final maturity in the year 2000. The weighted-average interest rate of all
ESOP loans was 6.1 percent at December 31, 1998.

Commercial paper borrowings of $148 million and $143 million at December 31,
1998 and 1997, respectively, were classified as long-term based on the Company's
intent to refinance these borrowings on a long-term basis. Interest rates on the
commercial paper outstanding at December 31, 1998 ranged from 4.8 percent to 5.2
percent with a weighted-average rate of 5.0 percent.

In May 1998, the Company issued $150 million of 6.25% unsecured notes under a
shelf registration statement filed with the Securities and Exchange Commission
in April 1998. The notes mature in May 2008. Notes up to $250 million remain
available under the shelf registration statement.

The $63 million in other long-term debt includes $36 million owed by a foreign
subsidiary at a variable interest rate (an effective rate of 5.1% at December
31, 1998). The remaining $27 million was borrowed by various foreign
subsidiaries at interest rates ranging from 3.6 percent to 21.2 percent with a
weighted-average rate of 8.5 percent.

Interest paid by Nalco was $25 million, $14 million and $14 million in 1998,
1997 and 1996, respectively.

The following table presents the projected annual maturities of long-term debt
for the next five years after 1998:

(in millions)
-----------------------
1999              $ 5.0
2000               10.4
2001                 -
2002                 -
2003                 -
-----------------------

The amounts above include approximately $15 million in maturities related to the
ESOP loans.

<PAGE>
 
NOTE 16--SHAREHOLDERS' EQUITY

Information on preferred and common shares is summarized in the following table:

<TABLE>
<CAPTION>
(dollars in millions, except per share amounts)        1998      1997
---------------------------------------------------------------------
<S>                                                   <C>       <C>
Preferred stock, par value $1.00 per share;
  authorized 2,000,000 shares;
     Series B ESOP Convertible
       Preferred Stock--outstanding;
       373,195 shares-1998 and 383,774
       shares-1997                                    $ 0.4     $ 0.4
     Series C Junior Participating
       Preferred Stock--none issued
Common stock, par value $.1875 per share;
  authorized 200,000,000 shares;
     issued 80,287,568 shares                          15.1      15.1
---------------------------------------------------------------------
</TABLE>

There were 14,758,440 shares and 14,251,003 shares held in treasury at December
31, 1998 and 1997, respectively.

In 1996, Nalco's Board of Directors authorized the repurchase of up to 3 million
shares of the Company's common stock. During 1998, the repurchase of those
shares was completed and the Board of Directors authorized the repurchase of an
additional 3 million shares.

The Company issued 415,800 shares of preferred stock to the ESOP in 1989 for
$481.00 per share, the preference price upon liquidation. This preferred stock
ranks senior to Series C Junior Participating Preferred Stock and common stock
as to the payment of dividends and the distribution of assets on liquidation,
dissolution and winding up of Nalco. Dividends on each share of preferred stock
are cumulative and will be paid quarterly at the rate of 8 percent or $38.48 per
annum. Full conversion of preferred shares occurs upon a holder's retirement or
separation of service from the Company, and effective in 1999 participants in
the ESOP may partially convert their stock upon reaching age 55. The conversion
ratio and number of votes per share of preferred stock are subject to adjustment
under certain conditions. The preferred stock entitles a participant to 20 votes
per share, voting together with the holders of common stock, and initially was
convertible into 20 shares of common stock. The shares of preferred stock are
redeemable by Nalco at $481.00 per share, and may be required to be redeemed by
Nalco under certain circumstances. During 1998, 10,579 preferred shares were
converted to 213,484 common shares of Nalco stock. During 1997 and 1996, 9,077
and 6,572 preferred shares were converted to 182,417 and 132,179 common shares,
respectively. Approximately 8,000,000 common shares have been reserved for the
conversion of preferred stock.

In 1996, the Board of Directors approved a Shareholder Rights Plan and declared
a dividend distribution of one Preferred Share Purchase Right (Right) for each
outstanding share of common stock. The Rights are not exercisable or
transferable apart from the common stock until a person or group has acquired,
or makes a tender offer for 15 percent or more of the common stock. If Nalco is
acquired in a merger or other business combination transaction or 50 percent or
more of Nalco's assets or earning power are sold, each Right other than that
held by the acquiring party will entitle the holder to receive, upon exercise at
a price of $125, subject to adjustment, common stock of either Nalco or the
acquiring company having a value equal to two times that price. The Rights are
redeemable at $.01 each at any time before a 15 percent or greater position has
been acquired, and expire on August 31, 2006. In connection with the
distribution of the 1996 Rights, the Company's Series A Junior Participating
Preferred Stock was cancelled and its Series C Junior Participating Preferred
Stock was authorized.

<PAGE>
 
NOTE 17--FINANCIAL INSTRUMENTS AND RISK MANAGEMENT

Nalco has limited involvement with derivative financial instruments and does not
trade them. The Company does use derivatives to fix the cost of issuing debt and
to manage well-defined interest rate and foreign exchange exposures.

Notional Amounts and Credit Exposures of Derivatives

  The notional amounts of derivatives summarized below do not represent amounts
  exchanged by the parties and, thus, are not a measure of the exposure of the
  Company through its use of derivatives. The amounts exchanged are calculated
  on the basis of the notional amounts and the other terms of the derivatives,
  which relate primarily to interest rates and foreign exchange rates.

  The Company is exposed to credit-related losses in the event of nonperformance
  by counterparties to financial instruments, but it does not expect any
  counterparties to fail to meet their obligations given their high credit
  ratings.

Interest Rate Risk Management

  Interest rate swap agreements are used to reduce the potential impact of
  increases in interest rates on floating rate long-term debt. The Company was a
  counterparty to one interest rate swap with a notional value of $43 million at
  December 31, 1998, and $51 million at December 31, 1997. This swap fixes
  interest payments on a corresponding amount of floating rate ESOP notes at 7.3
  percent until February 1999. The average interest rate received on this
  interest rate swap was 4.6 percent in both 1998 and 1997.

Foreign Exchange Risk Management

  The Company enters into various types of foreign exchange contracts in
  managing its intercompany foreign exchange risk, including currency swaps,
  forward exchange contracts and option contracts.

  The Company's currency swap agreements were designed to hedge foreign currency
  intercompany loans that have maturities up to seven years. Gains and losses
  related to these swaps are offset with gains and losses on the underlying
  foreign currency loans. Forward exchange and option contracts are used to
  hedge various intercompany transactions with foreign subsidiaries and selected
  net asset exposures. These contracts usually have maturities of six months,
  but occasionally may have maturities of up to eighteen months.

  The Company had foreign exchange contracts with notional values of $51 million
  and $64 million at December 31, 1998 and 1997, respectively.

  Deferred realized and unrealized gains and losses from firm foreign currency
  commitments, based on dealer-quoted prices, are included in the statements of
  consolidated financial condition as either miscellaneous other assets or
  accounts payable. They are recognized in earnings as part of the underlying
  transaction when it is recognized. There was no net deferred realized and
  unrealized gain or loss at December 31, 1998 or December 31, 1997.

<PAGE>
 
NOTE 18--FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents the carrying amounts and fair values of the
Company's financial instruments at December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                          1998                  1997
                                   ----------------------------------------
                                   Carrying      Fair    Carrying      Fair
(in millions)                       Amount      Value     Amount      Value
---------------------------------------------------------------------------
<S>                                <C>         <C>       <C>         <C>
Nonderivatives:
  Cash and cash equivalents          $ 31.2    $ 31.2      $ 49.7    $ 49.7
  Short-term debt                      75.8      75.8        22.1      22.1
  Long-term debt                      496.2     502.8       335.3     336.0
Derivatives:
  Miscellaneous other assets            3.8       1.6         7.0       4.6
---------------------------------------------------------------------------
</TABLE>

The following methods and assumptions were used to estimate the fair values of
financial instruments:
 
  Cash and cash equivalents - The carrying amount approximates fair value
  because of the short-term maturities of such instruments.

  Short-term debt - The carrying amount approximates fair value because of the
  short-term maturities of such instruments.

  Long-term debt - The carrying amount of term borrowings at variable interest
  rates approximates fair value. The fair value of the Company's fixed-rate ESOP
  borrowings was estimated using discounted cash flow analyses, based on the
  Company's current borrowing rates for similar types of borrowing arrangements.
  The fair value of the Company's 6.25% fixed-rate notes was based on the quoted
  market price.

  Derivatives - The fair value of derivatives, including currency swaps, foreign
  currency forward exchange and option contracts, and interest rate swaps was
  estimated based on current settlement prices, quoted market prices of
  comparable contracts, and pricing models or formulas using current
  assumptions.

<PAGE>
 
NOTE 19--CONTINGENCIES AND LITIGATION

Nalco has been named as a potentially responsible party (PRP) by the
Environmental Protection Agency (EPA) or state enforcement agencies at 14 waste
sites where some financial contribution is or may be required.

These agencies have also identified many other parties who may be responsible
for clean-up costs at the waste disposal sites. Nalco's financial contribution
to remediate these sites is expected to be minor. There has been no significant
financial impact on Nalco up to the present, nor is it anticipated that there
will be in the future, as a result of these matters. Nalco has made and will
continue to make provisions for these costs if the Company's liability becomes
probable and when costs can be reasonably estimated. As of December 31, 1998,
the Company had undiscounted reserves of approximately $1 million for the
maximum amount of known environmental clean-up costs. The Company's 1998
expenditures relating to environmental compliance and clean-up activities were
not significant. These environmental reserves represent management's current
estimate of its proportional clean-up costs and are based upon negotiation and
agreement with enforcement agencies, its previous experience with respect to
clean-up activities, a detailed review by the Company of known conditions, and
information about other PRPs. They are not reduced by any possible recoveries
from insurance companies or other PRPs not specifically identified. Although
management cannot determine whether or not a material effect on future
operations is reasonably likely to occur, given the evolving nature of
environmental regulations, it believes that the recorded reserve levels are
appropriate estimates of the potential liability. Although settlement will
require future cash outlays, it is not expected that such outlays will
materially impact the Company's liquidity position.

It is the Company's policy to accrue for estimated post-closure and site
remediation costs when the decision has been made by management to close a
facility.

In the ordinary course of its business, Nalco is also a party to a number of
lawsuits and is subject to various claims, the outcome of which, in the opinion
of management, should not have a material effect on the consolidated financial
position of Nalco.

<PAGE>
 
Quarterly Summary (Unaudited)

<TABLE>
<CAPTION>

                                                       1998                                               1997
                                  ----------------------------------------------      -------------------------------------------
(dollar amounts in millions,          First       Second      Third       Fourth        First     Second        Third      Fourth
except per share figures)           Quarter      Quarter    Quarter      Quarter      Quarter    Quarter      Quarter     Quarter
---------------------------------------------------------------------------------------------------------------------------------
<S>                               <C>          <C>          <C>        <C>            <C>        <C>        <C>          <C>
Sales                             $   367.1    $   403.0    $ 408.4    $   395.0      $ 334.6    $ 354.4    $   371.0    $  373.7

Gross earnings                        202.2        221.8      221.7        213.7        189.8      201.8        206.0       206.5

Earnings (loss) before
  accounting change                    38.0         42.0       40.7        (82.8)*       35.8       40.1         44.2        43.3

Cumulative effect of
  accounting change                       -            -          -            -            -          -            -        (4.5)

Net earnings (loss)                    38.0         42.0       40.7        (82.8)*       35.8       40.1         44.2        38.8

Per common share

   Earnings (loss) - basic
      Before accounting change          .53          .59        .58        (1.31)         .49        .56          .62         .61
      Accounting change                   -            -          -            -            -          -            -        (.07)
      Net earnings (loss)               .53          .59        .58        (1.31)         .49        .56          .62         .54

   Earnings (loss) - diluted
      Before accounting change          .49          .55        .54        (1.31)         .46        .51          .57         .56
      Accounting change                   -            -          -            -            -          -            -        (.06)
      Net earnings (loss)               .49          .55        .54        (1.31)         .46        .51          .57         .50

   Dividends                            .25          .25        .25          .25          .25        .25          .25         .25

   Market price
      High                         40 15/16     40 15/16     36 3/8       34 3/8       38 7/8         40     41 13/16     42 7/16
      Low                            36 3/4       34 1/8     27 3/8     27 11/16       35 1/8     34 1/4      38 5/16      37 1/2
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

* Includes after tax charges of $117.0 million for cost reduction program
  expenses recognized by the Company and Nalco/Exxon.