Pentair - 10-Q quarterly report FY

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-11625

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 x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act).
Large accelerated filer xAccelerated filer o Non-accelerated filer o

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

On April 28, 2006, 101,670,992 shares of the Registrant’s common stock were outstanding.

1.     Basis of Presentation and Responsibility for Interim Financial Statements
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 2005 Annual Report on Form 10-K for the year ended December 31, 2005.

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.

Certain reclassifications have been made to prior years’ consolidated financial statements to conform to the current year’s presentation.

2.     New Accounting Standards
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 153, Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions(“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005 and we adopted it on January 1, 2006. The adoption of SFAS 153 did not have a material impact on our consolidated results of operations, financial condition, or cash flow.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs—An Amendment of ARB No. 43, Chapter 4 (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005 and we adopted it on January 1, 2006. The adoption of SFAS 151 did not have on material impact on our consolidated results of operations or financial condition.

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-1 provides guidance on other-than-temporary impairment models for marketable debt and equity securities accounted for under SFAS 115 and non-marketable equity securities accounted for under the cost method. The EITF developed a basic three-step model to evaluate whether an investment is other-than-temporarily impaired. In November 2005, the FASB approved the issuance of FASB Staff Position FAS No. 115-1 and FAS No. 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The FASB Staff Position (“FSP”) addresses when an investment is considered impaired, whether the impairment is other-than-temporary and the measurement of an impairment loss. The FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary. The FSP is effective for reporting periods beginning after December 15, 2005 and we adopted it on January 1, 2006. The adoption of EITF No. 03-1 did not have a material impact on our consolidated results of operations or financial condition.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS 154”) which replaces Accounting Principles Board Opinion No. 20, Accounting Changes and SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements—An Amendment of APB Opinion No. 28. SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 on January 1, 2006 has not had a material impact on our consolidated results of operations or financial condition.

In June 2005, the EITF reached a consensus on Issue No. 05-5, Accounting for Early Retirement or Postemployment Programs with Specific Features (such as Terms Specified in Altersteilzeit Early Retirement Arrangements). EITF No. 05-5 addresses the accounting for the bonus feature in the German Altersteilzeit (“ATZ”) early retirement programs and requires recognition of the program expenses at the time the ATZ contracts are signed. The EITF offers two transition alternatives, either cumulative effect or retrospective application. The EITF is effective for fiscal years beginning after December 15, 2005 and we adopted it on January 1, 2006. The adoption of EITF No. 05-5 did not have a material impact on our consolidated results of operations or financial condition.

3.     Stock-based Compensation
In the fourth quarter 2005, we adopted SFAS No. 123 (Revised 2004), Share-Based Payment (“SFAS 123R”), using the modified retrospective transition method as permitted by SFAS 123R. Under this transition method, we restated our 2005 interim financial statements. Total stock-based compensation expense for the first quarter of 2006 and 2005 was $6.6 million and $6.2 million, respectively.

Non-vested shares of our common stock were granted during the first quarter of 2006 to eligible employees with a vesting period of two to five years after issuance. The non-vested shares were granted at the market price on the date of grant and are expensed over the vesting period. Total compensation expense for non-vested share awards during the first quarter of 2006 and 2005 was $2.3 million and $1.9 million, respectively.

During the first quarter of 2006, option awards were granted under the Omnibus Stock Incentive Plan and the Outside Directors Nonqualified Stock Option plan with an exercise price equal to the market price of our common stock on the date of grant. Option awards granted in the first quarter of 2006 under the Omnibus Stock Incentive Plan did not have a reload feature attached to the option. The options vest one-third each year over a three-year period and have a ten-year contractual term. Compensation expense equal to the grant date fair value is recognized for these awards over the vesting period. Certain option grants were reloaded during the quarter for individuals retiring shares to pay the exercise price of options granted prior to 2006. Reload options are vested and expensed immediately. Total compensation expense for stock option awards was $4.3 million for the first quarter of both 2006 and 2005.

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 first quarter of 2006 and 2005 was $11.49 and 10.93 per share, respectively.

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 SFAS No. 123R, 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. The increase in the expected life in 2006 compared to 2005 was the result of a decrease in exercise activity and the stock price in the preceding year. 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.

4.     Earnings Per Common Share
Basic and diluted earnings per share were calculated using the following:

5.     Acquisitions
On December 1, 2005, we acquired McLean Thermal Management, Aspen Motion Technologies, and Electronic Solutions businesses from APW, Ltd. (collectively, “Thermal”) for $140.0 million, including a cash payment of $138.9 million and transaction costs of $1.1 million. During 2006, we paid an additional $2.2 million in transaction costs. These businesses provide thermal management solutions and integration services to the telecommunications, data communications, medical, industrial, and security markets as part of our Technical Products Group. Goodwill recorded as part of the initial purchase price allocation was $93.7 million, all of which is tax deductible. We continue to evaluate the purchase price allocation for the Thermal acquisition, including intangible assets, contingent liabilities, plant rationalization costs, and property, plant and equipment. We expect to revise the purchase price allocation as better information becomes available in 2006.

On February 23, 2005, we acquired certain assets of Delta Environmental Products, Inc. and affiliates (collectively, “DEP”), a privately-held company, for $10.3 million, including a cash payment of $10.0 million, transaction costs of $0.2 million, and debt assumed of $0.1 million. The DEP product line addresses the water and wastewater markets and is part of our Water Group. Goodwill recorded as part of the initial purchase price allocation was $9.3 million, all of which is tax deductible. We finalized the purchase price allocation for the DEP acquisition during the first quarter of 2006.

The following pro forma condensed consolidated financial results of operations are presented as if the acquisitions described above had been completed at the beginning of each period presented.

These pro forma condensed consolidated financial results have been prepared for comparative purposes only and include certain adjustments, such as increased interest expense on acquisition debt. They do not reflect the effect of synergies that would have been expected to result from the integration of these acquisitions. The pro forma information does not purport to be indicative of the results of operations that actually would have resulted had the combination occurred at the beginning of each period presented, or of future results of the consolidated entities.

6.     Discontinued Operations
Effective after the close of business on October 2, 2004, we completed the sale of our former Tools Group to The Black & Decker Corporation (“BDK”). Pursuant to the purchase agreement for the sale of our former Tools Group, we completed the repurchase of a manufacturing facility in Suzhou, China from BDK for approximately $5.7 million in January 2006. We recorded no gain or loss on the repurchase. On March 8, 2006, we received notice regarding the settlement of an outstanding net asset value dispute with BDK relating to the purchase price for the sale of our former Tools Group. The decision by the arbitrator constituted a final resolution of all disputes between BDK and us regarding the net asset value. We paid the final purchase price adjustment of $16.1 million plus interest of $1.1 million in March 2006, resulting in an incremental pre-tax loss on disposal of discontinued operations of $3.4 million or $1.6 million net of tax.

In 2001, we completed the sale of our former Service Equipment businesses (Century Mfg. Co./Lincoln Automotive Company) to Clore Automotive, LLC. In the fourth quarter of 2003, we reported an additional loss from discontinued operations of $2.9 million related to exiting the remaining two facilities. In March 2006, we exited a leased facility from our former Service Equipment business resulting in a net cash outflow of $2.2 million and an immaterial gain from disposition.

Operating results of the discontinued operations for the first quarter of 2006 and 2005 are summarized below:

7.     Inventories
Inventories were comprised of:

8.     Comprehensive Income
Comprehensive income and its components, net of tax, were as follows:

9.     Goodwill and Other Intangible Assets
Changes in the carrying amount of goodwill for the three months ended April 1, 2006 by segment were as follows:

Purchase accounting adjustments recorded during the first quarter of 2006 relate to the DEP and Thermal acquisitions. We finalized our evaluation of the purchase price allocation for the DEP acquisition during the first quarter of 2006. The purchase price adjustments during the first quarter of 2006 included adjustments for additional transaction costs incurred.

Intangible assets, other than goodwill, were comprised of:

Intangible asset amortization expense for the three months ended April 1, 2006 and April 2, 2005 was approximately $3.2 million and $2.9 million, respectively. The estimated future amortization expense for identifiable intangible assets during the remainder of 2006 and the next five years is as follows:

10.     Debt
Debt and the average interest rate on debt outstanding is summarized as follows:

We have a multi-currency revolving Credit Facility (the “Credit Facility”) of $800 million expiring on March 4, 2010. The interest rate on the loans under the $800 million Credit Facility is 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. As of April 1, 2006, we had $166.3 million of commercial paper outstanding that matures within 51 days. All of the commercial paper was classified as long-term as we have the intent and the ability to refinance such obligations on a long-term basis under the Credit Facility.

We were in compliance with all debt covenants as of April 1, 2006.

In addition to the Credit Facility, we have $25 million of uncommitted credit facilities, under which we had no borrowings as of April 1, 2006.

Long-term debt outstanding at April 1, 2006 matures on a calendar year basis as follows:

11.     Derivatives and Financial Instruments
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 principle amounts in order to manage interest rate exposures. The effective date of the fixed rate swap is 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 at April 1, 2006 was $3.4 million and was recorded in other assets at April 1, 2006.

The variable to fixed interest rate swap is designated as and is effective as a cash-flow hedge. The fair value of the swap is recorded on the balance sheet, with changes in fair values included in Other Comprehensive Income (“OCI”). Derivative gains and losses included in OCI are recorded in earnings at the time the related interest rate expense is recognized or the settlement of the related commitment occurs.

12.     Income Taxes
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 three months ended April 1, 2006 was 34.0% compared to 33.9% for the three months ended April 2, 2005. The tax rate for the first quarter of 2006 includes a $0.9 million favorable adjustment related to a prior year tax return. The 2005 effective tax rate included a favorable settlement for an IRS exam for the periods of 1998-2001, resulting in the release of tax contingency reserves of $1.3 million. We expect the effective tax rate for the remainder of 2006 to be approximately 35.5%, resulting in a full year effective income tax rate of 35.2 %. However, 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.

13.     Benefit Plans
Components of net periodic benefit cost for the three months ended April 1, 2006 and April 2, 2005 were as follows:

14.     Business Segments
Financial information by reportable segment for the three months ended April 1, 2006 and April 2, 2005 is shown below:

Other operating loss is primarily composed of unallocated corporate expenses, costs related to our captive insurance subsidiary and our intermediate finance companies, and intercompany eliminations.

Environmental and Litigation
There have been no further material developments from the disclosures contained in our 2005 Annual Report on Form 10-K, other than those matters identified below.

Horizon Litigation
Twenty-eight separate lawsuits involving 29 primary plaintiffs, a class action, and claims for indemnity by Celebrity Cruise Lines, Inc. (Celebrity) were brought against Essef Corporation (Essef) and certain of its subsidiaries prior to our acquisition of Essef in August 1999. Celebrity has alleged that it had sustained economic damages due to loss of use of the M/V Horizon while it was dry-docked.

The claims against Essef and its involved subsidiaries were based upon the allegation that Essef designed, manufactured, and marketed two sand swimming pool filters that were installed as a part of the spa system on the Horizon, and allegations that the spa and filters contained Legionnaire’s disease bacteria that infected certain passengers on cruises from December 1993 through July 1994.

The individual and class claims by passengers were tried and resulted in an adverse jury verdict finding liability on the part of the Essef defendants (70%) and Celebrity and its sister company, Fantasia (together 30%).

After expiration of post-trial appeals, we paid all outstanding punitive damage awards of $7.0 million in the Horizon cases, plus interest of approximately $1.6 million, in January 2004. We had reserved for the amount of punitive damages awarded at the time of the Essef acquisition. A reserve for the $1.6 million interest cost was recorded in 2003. All of the personal injury cases have now been resolved through either settlement or trial.

The only remaining unresolved claims in this case are those brought by Celebrity for damages resulting from the outbreak. Celebrity filed an amended complaint seeking attorney fees and costs for prior litigation as well as out-of-pocket losses, lost profits, and loss of business enterprise value. Discovery commenced late in 2004, and was completed in August 2005. Celebrity’s claims for damages exceed $185 million. Assuming matters of causation, standing, contribution and proof are decided against it, Essef’s experts believe that damages should amount to no more than approximately $16 to $25 million. Dispositive motions in this matter were filed in August 2005, which were decided in December 2005. Celebrity’s motion for indemnity from Essef for payments made by Celebrity for passenger claims of approximately $2.3 million was denied. Essef’s motion for dismissal of certain damage claims was denied without prejudice to renewal in conjunction with both parties’ motions to exclude certain expert testimony. Those hearings were held in April 2006 and Essef expects to review its motion to dismiss certain claims. Trial is currently scheduled for June 2006. We believe our reserves for any liability to Celebrity are adequate and intend to vigorously defend against these claims.

Other
We are occasionally a party to other litigation arising in the normal course of business. We regularly analyze current information and, as necessary, provide accruals for probable liabilities based on the expected eventual disposition of these matters. While it is possible that the Company’s cash flows and results of operations in a particular quarter or year could be materially affected by the one-time impacts of the resolution of such contingencies, it is the opinion of management that the ultimate disposition of these matters will not have a material impact on the Company’s financial position, or ongoing results of operations and cash flows.

17.     Financial Statements of Subsidiary Guarantors
The $250 million Senior Notes due 2009 are jointly and severally guaranteed by domestic subsidiaries (the “Guarantor Subsidiaries”), each of which is directly or indirectly wholly-owned by Pentair (the “Parent Company”). The following supplemental financial information sets forth the condensed consolidated balance sheets as of April 1, 2006 and December 31, 2005, the related condensed consolidated statements of income for the three-months ended April 1, 2006 and April 2, 2005, and statements of cash flows for the three-months ended April 1, 2006 and April 2, 2005, for the Parent Company, the Guarantor Subsidiaries, the non-guarantor subsidiaries and total consolidated Pentair and subsidiaries.