Pentair - 10-Q quarterly report FY2010 Q3

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§223.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yesþ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

On October 2, 2010, 98,690,604 shares of Registrant’s common stock were outstanding.

We prepared the unaudited condensed consolidated financial statements following the requirements of the Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States can be condensed or omitted.

We are responsible for the unaudited financial statements included in this document. The financial statements include all normal recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. As these are condensed financial statements, one should also read our consolidated financial statements and notes thereto, which are included in our 2009 Annual Report on Form 10-K for the year ended December 31, 2009.

Revenues, expenses, cash flows, assets and liabilities can and do vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be indicative of those for a full year.

Our fiscal year ends on December 31. We report our interim quarterly periods on a 13-week basis ending on a Saturday.

In connection with preparing the unaudited condensed consolidated financial statements for the nine months ended October 2, 2010, we have evaluated subsequent events for potential recognition and disclosure through the date of this filing.

In June 2009, the Financial Accounting Standards Board issued an amendment to the accounting and disclosure requirements for the consolidation of variable interest entities. The guidance affects the overall consolidation analysis and requires enhanced disclosures on involvement with variable interest entities. The guidance is effective for fiscal years beginning after November 15, 2009. We adopted the new guidance as of January 1, 2010, which did not have a material effect on our condensed consolidated financial statements.

No other new accounting pronouncements issued or effective during the first nine months of 2010 have had or are expected to have a material impact on the Condensed Consolidated Financial Statements.

Total stock-based compensation expense was $4.2 million and $4.0 million for the three months ended October 2, 2010 and September 26, 2009, respectively, and was $16.6 million and $13.1 million for the nine months ended October 2, 2010 and September 26, 2009, respectively.

During the first nine months of 2010, restricted shares and restricted stock units of our common stock were granted under the 2008 Omnibus Stock Incentive Plan to eligible employees with a vesting period of three to four years after issuance. Restricted share awards and restricted stock units are valued at market value on the date of grant and are typically expensed over the vesting period. Total compensation expense for restricted share awards and restricted stock units was $1.8 million and $2.4 million for the three months ended October 2, 2010 and September 26, 2009, respectively, and was $8.3 million and $7.7 million for the nine months ended October 2, 2010 and September 26, 2009, respectively.

During the first nine months of 2010, option awards were granted under the 2008 Omnibus Stock Incentive Plan with an exercise price equal to the market price of our common stock on the date of grant. Option awards are typically expensed over the vesting period. Total compensation expense for stock option awards was $2.4 million and $1.6 million for the three months ended October 2, 2010 and September 26, 2009, respectively, and $8.3 million and $5.4 million for the nine months ended October 2, 2010 and September 26, 2009, respectively.

We estimated the fair value of each stock option award on the date of grant using a Black-Scholes option pricing model, modified for dividends and using the following assumptions:

The weighted-average fair value of options granted during the third quarter of 2010 was $8.74. There were no options granted during third quarter of 2009.

These estimates require us to make assumptions based on historical results, observance of trends in our stock price, changes in option exercise behavior, future expectations and other relevant factors. If other assumptions had been used, stock-based compensation expense, as calculated and recorded under the accounting guidance could have been affected.

We based the expected life assumption on historical experience as well as the terms and vesting periods of the options granted. For purposes of determining expected volatility, we considered a rolling average of historical volatility measured over a period approximately equal to the expected option term. The risk-free rate for periods that coincide with the expected life of the options is based on the U.S. Treasury Department yield curve in effect at the time of grant.

Basic and diluted earnings per share were calculated using the following:

During 2009 and 2008, we announced and initiated certain business restructuring initiatives aimed at reducing our fixed cost structure and rationalizing our manufacturing footprint. These initiatives included the closure of certain manufacturing facilities as well as the reduction in hourly and salaried headcount. These actions were generally completed by the end of 2009.

Restructuring-related costs included in Selling, general and administrative expenses on the Condensed Consolidated Statements of Income include costs for severance and related benefits of $10.4 million and $2.7 million for asset impairment charges in the nine months ended September 26, 2009 and $13.2 million of costs for severance and related benefits for the period ending December 31, 2009.

Restructuring accrual activity recorded on the Condensed Consolidated Balance Sheets is summarized as follows for the periods ended October 2, 2010, December 31, 2009 and September 26, 2009.

Inventories were comprised of:

The changes in the carrying amount of goodwill for the nine months ended October 2, 2010 and September 26, 2009 by segment were as follows:

The detail of acquired intangible assets consisted of the following:

Intangible asset amortization expense was approximately $6.3 million and $7.7 million for the three months ended October 2, 2010 and September 26, 2009, respectively, and was approximately $18.1 million and $21.1 million for the nine months ended October 2, 2010 and September 26, 2009, respectively.

The estimated future amortization expense for identifiable intangible assets during the remainder of 2010 and the next five years is as follows:

Debt and the average interest rates on debt outstanding are summarized as follows:

We have a multi-currency revolving Credit Facility (“Credit Facility”). The Credit Facility creates an unsecured, committed revolving credit facility of up to $800 million, with multi-currency sub facilities to support investments outside the U.S. The Credit Facility expires on June 4, 2012. Borrowings under the Credit Facility bear interest at the rate of LIBOR plus 0.625%. Interest rates and fees on the Credit Facility vary based on our credit ratings.

We are authorized to sell short-term commercial paper notes to the extent availability exists under the Credit Facility. We use the Credit Facility as back-up liquidity to support 100% of commercial paper outstanding. Our use of commercial paper as a funding vehicle depends upon the relative interest rates for our paper compared to the cost of borrowing under our Credit Facility. As of October 2, 2010, we had no commercial paper outstanding.

Total availability under our existing Credit Facility was $731.8 million as of October 2, 2010, which was not limited by the credit agreement’s leverage ratio covenant as of that date.

In addition to the Credit Facility, we have $40.0 million of uncommitted credit facilities, under which we had $4.2 million of borrowings as of October 2, 2010.

Our debt agreements contain certain financial covenants, the most restrictive of which is a leverage ratio (total consolidated indebtedness, as defined, over consolidated EBITDA, as defined) that may not exceed 3.5 to 1.0. We were in compliance with all financial covenants in our debt agreements as of October 2, 2010.

On March 16, 2009, we announced the redemption of all of our remaining outstanding $133.9 million aggregate principal 7.85% Senior Notes due 2009 (the “Notes”). The Notes were redeemed on April 15, 2009 at a redemption price of $1,035.88 per $1,000 of principal outstanding plus accrued interest thereon. As a result of this transaction, we recognized a loss of $4.8 million on early extinguishment of debt in 2009. The loss included the write off of $0.1 million in unamortized deferred financing fees in addition to recognition of $0.3 million in previously unrecognized swap gains, and cash paid of $5.0 million related to the redemption and other costs associated with the purchase.

Debt outstanding at October 2, 2010 matures on a calendar year basis as follows:

The accounting guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities measured at fair value are classified using the following hierarchy, which is based upon the transparency of inputs to the valuation as of the measurement date:

In making fair value measurements, observable market data must be used when available. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.

In August 2007, we entered into a $105 million interest rate swap agreement with a major financial institution to exchange variable rate interest payment obligations for a fixed rate obligation without the exchange of the underlying principal amounts in order to manage interest rate exposures. The effective date of the swap was August 30, 2007. The swap agreement has a fixed interest rate of 4.89% and expires in May 2012. The fixed interest rate of 4.89% plus the .50% interest rate spread over LIBOR results in an effective fixed interest rate of 5.39%. The fair value of the swap was a liability of $7.6 million, $8.1 million and $9.0 million at October 2, 2010, December 31, 2009 and September 26, 2009, respectively, and was recorded in Other non-current liabilities on the Condensed Consolidated Balance Sheets.

In September 2005, we entered into a $100 million interest rate swap agreement with several major financial institutions to exchange variable rate interest payment obligations for fixed rate obligations without the exchange of the underlying principal amounts in order to manage interest rate exposures. The effective date of the fixed rate swap was April 25, 2006. The swap agreement has a fixed interest rate of 4.68% and expires in July 2013. The fixed interest rate of 4.68% plus the .60% interest rate spread over LIBOR results in an effective fixed interest rate of 5.28%. The fair value of the swap was a liability of $11.0 million, $8.3 million and $9.3 million at October 2, 2010, December 31, 2009 and September 26, 2009, respectively, and was recorded in Other non-current liabilities on the Condensed Consolidated Balance Sheets.

The variable to fixed interest rate swaps are designated as cash-flow hedges. The fair value of these swaps are recorded as assets or liabilities on the Condensed Consolidated Balance Sheets. Unrealized income/expense is included in Accumulated other comprehensive income (“OCI”) and realized income/expense and amounts due to/from swap counterparties, are included in earnings. We realized incremental expense resulting from the swaps of $6.9 million and $5.5 million for the nine months ended October 2, 2010 and September 26, 2009, respectively.

The variable to fixed interest rate swaps are designated as and are effective as cash-flow hedges. The fair value of these swaps are recorded as assets or liabilities on the Condensed Consolidated Balance Sheets, with changes in their fair value included in OCI. Derivative gains and losses included in OCI are reclassified into earnings at the time the related interest expense is recognized or the settlement of the related commitment occurs.

Failure of one or more of our swap counterparties would result in the loss of any benefit to us of the swap agreement. In this case, we would continue to be obligated to pay the variable interest payments per the underlying debt agreements which are at variable interest rates of 3 month LIBOR plus .50% for $105 million of debt and 3 month LIBOR plus .60% for $100 million of debt. Additionally, failure of one or all of our swap counterparties would not eliminate our obligation to continue to make payments under our existing swap agreements if we continue to be in a net pay position.

At October 2, 2010, our interest rate swaps are carried at fair value measured on a recurring basis. Fair values are determined through the use of models that consider various assumptions, including time value, yield curves, as well as other relevant economic measures, which are inputs that are classified as Level 2 in the valuation hierarchy defined by the accounting guidance.

The provision for income taxes consists of provisions for federal, state and foreign income taxes. We operate in an international environment with operations in various locations outside the U.S. Accordingly, the consolidated income tax rate is a composite rate reflecting the earnings in the various locations and the applicable rates.

The effective income tax rate for the nine months ended October 2, 2010 was 33.1% compared to 32.0% for the nine months ended September 26, 2009. We expect the effective tax rate for the remainder of 2010 to be between 32% and 33%, resulting in a full year effective income tax rate of between 32.5% and 33.5%. We continue to actively pursue initiatives to reduce our effective tax rate. The tax rate in any quarter can be affected positively or negatively by adjustments that are required to be reported in the specific quarter of resolution.

The total gross liability for uncertain tax positions was $24.6 million, $30.0 million and $29.1 million at October 2, 2010, December 31, 2009 and September 26, 2009, respectively. We record penalties and interest related to unrecognized tax benefits in Provision for income taxes and Net interest expense, respectively, on the Condensed Consolidated Statements of Income, which is consistent with our past practices.

Components of net periodic benefit cost for the three and nine months ended October 2, 2010 and September 26, 2009 were as follows:

Financial information by reportable segment for the three and nine months ended October 2, 2010 and September 26, 2009 is shown below:

The changes in the carrying amount of service and product warranties as of October 2, 2010, December 31, 2009 and September 26, 2009 were as follows:

There have been no further material developments from the disclosures contained in our 2009 Annual Report on Form 10-K.

This report contains statements that we believe to be “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements give our current expectations or forecasts of future events. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project,” or “continue,” or similar words or the negative thereof. From time to time, we also may provide oral or written forward-looking statements in other materials we release to the public. Any or all of our forward-looking statements in this report and in any public statements we make could be materially different from actual results. They can be affected by assumptions we might make or by known or unknown risks or uncertainties. Consequently, we cannot guarantee any forward-looking statements. Investors are cautioned not to place undue reliance on any forward-looking statements. Investors should also understand that it is not possible to predict or identify all such factors and should not consider the following list to be a complete statement of all potential risks and uncertainties.

The following factors and those discussed in ITEM 1A, Risk Factors, included in our 2009 Annual Report on Form 10-K, may impact the achievement of forward-looking statements:

The foregoing factors are not exhaustive, and new factors may emerge or changes to the foregoing factors may occur that would impact our business. We assume no obligation, and disclaim any duty, to update the forward-looking statements in this report.

We are a focused diversified industrial manufacturing company comprised of two operating segments: Water and Technical Products. Our Water Group is a global leader in providing innovative products and systems used worldwide in the movement, storage, treatment and enjoyment of water. Our Technical Products Group is a leader in the global enclosures and thermal management markets, designing and manufacturing standard, modified and custom enclosures that house and protect sensitive electronics and electrical components and protect the people that use them. In 2010, we expect our Water Group and Technical Products Group to generate approximately 2/3 and 1/3 of our total revenues, respectively.

Our Water Group has progressively become a more important part of our business portfolio with sales increasing from approximately $125 million in 1995 to approximately $1.8 billion in 2009. We believe the water industry is structurally attractive as a result of a growing demand for clean water and the large global market size (of which we have identified a target market totaling $60 billion). Our vision is to be a leading global provider of innovative products and systems used in the movement, storage, treatment and enjoyment of water. In the later part of 2008 and in 2009, sales revenues in water significantly declined due to the impact of the global recession. We have seen some improvement in the Water Group markets in 2010.

Our Technical Products Group operates in a large global market with significant potential for growth in industry segments such as energy, medical and security and defense. We believe we have the largest industrial and commercial distribution network in North America for enclosures and the highest brand recognition in the industry in North America. From mid-2001 through 2003, the Technical Products Group experienced significantly lower sales volumes as a result of severely reduced capital spending in the industrial and commercial markets and over-capacity and weak demand in the data communication and telecommunication markets. From 2004 through 2008, sales volumes increased due to the addition of new distributors, new products, price increases and higher demand in targeted markets. In 2009, sales revenues in our Technical Products Group declined significantly due to the impact of the global recession. We have seen some improvement in the Technical Products Group markets in 2010.

The following trends and uncertainties affected our financial performance in 2009 and the first nine months of 2010 and will likely impact our results in the future:

In 2010, our operating objectives include the following:

On October 26, 2010, we announced our earnings for the third quarter of 2010 of $0.55 per share from continuing operations on a diluted basis. As further noted below, our revenue increased 17% in the quarter from the year-earlier period, with higher growth in our Technical Products segment.

At the same time, we provided earnings guidance for the fourth quarter and full year 2010. We anticipate that fourth quarter sales growth will be in the mid-single digits, compared to the prior year quarter and reported earnings per share on a diluted basis will range from $0.42 to $0.47 in the fourth quarter.

On February 2, 2010, we initiated earnings guidance for the full year 2010 of a range of $1.75 to $1.90 per share from continuing operations on a diluted basis, which we adjusted on July 29, 2010 to $1.86 to $1.96 per share from continuing operations on a diluted basis and further adjusted on October 26, 2010 to $1.93 to $1.98 per share from continuing operations on a diluted basis.

Our full year 2010 outlook is based on several variables. First, our guidance anticipates revenue growth of approximately 12 percent as a result of improvements in overall market conditions, as well as the benefit from our growth initiatives, which we expect to bring our total revenue to approximately $3 billion for the full year. Second, based upon that revenue expectation, we project net earnings of $1.93 to $1.98 per share as a result of higher operating margins due to carryover of productivity gains from our restructuring projects in 2009 and ongoing productivity, offset partly by higher costs for certain raw materials, reinstatement of certain employee benefits and wage increases and increased investments on research and development and sales and marketing resources. Third, we expect a reduction in interest expense as a result of lower borrowing levels and lower interest rates. As noted previously, however, deterioration in general economic conditions in our primary markets and geographies would adversely impact our anticipated annual revenues and financial performance.

Our guidance assumes an absence of significant acquisitions or divestitures in 2010. We continue to look for acquisitions to expand our geographic reach internationally, expand our presence in our various channels to market and acquire technologies and products to broaden our businesses’ capabilities to serve additional markets. We may also consider the divestiture or closure of discrete business units to further focus our businesses on their most attractive markets.

The ability to achieve our operating objectives will depend, to a certain extent, on factors outside our control. See “Forward-Looking Statements” in this report and “Risk Factors” under ITEM 1A in our 2009 Annual Report on Form 10-K.