Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended July 1, 2006
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 1-11625
Pentair, Inc.
(Exact name of Registrant as specified in its charter)
Minnesota | 41-0907434 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification number) | |
5500 Wayzata Blvd, Suite 800, Golden Valley, Minnesota | 55416 | |
(Address of principal executive offices) | (Zip code) |
Registrant’s telephone number, including area code: (763) 545-1730
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. Yesþ Noo
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).
12b-2 of the Act).
Large accelerated filerþ Accelerated filero Non-accelerated filero
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ
On July 28, 2006, 101,123,144 shares of the Registrant’s common stock were outstanding.
Pentair, Inc. and Subsidiaries
2
Table of Contents
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Pentair, Inc. and Subsidiaries
Condensed Consolidated Statements of Income (Unaudited)
Three months ended | Six months ended | |||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||
In thousands, except per-share data | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Net sales | $ | 862,022 | $ | 788,523 | $ | 1,633,411 | $ | 1,498,158 | ||||||||
Cost of goods sold | 599,333 | 553,290 | 1,148,214 | 1,058,787 | ||||||||||||
Gross profit | 262,689 | 235,233 | 485,197 | 439,371 | ||||||||||||
Selling, general and administrative | 139,831 | 117,467 | 268,920 | 238,092 | ||||||||||||
Research and development | 14,883 | 10,532 | 29,746 | 21,959 | ||||||||||||
Operating income | 107,975 | 107,234 | 186,531 | 179,320 | ||||||||||||
Gain on sale of investment | — | 5,199 | — | 5,199 | ||||||||||||
Net interest expense | 12,553 | 11,696 | 25,837 | 22,972 | ||||||||||||
Income from continuing operations before income taxes | 95,422 | 100,737 | 160,694 | 161,547 | ||||||||||||
Provision for income taxes | 26,789 | 39,358 | 48,990 | 59,987 | ||||||||||||
Income from continuing operations | 68,633 | 61,379 | 111,704 | 101,560 | ||||||||||||
Loss on disposal of discontinued operations, net of tax | — | — | (1,451 | ) | — | |||||||||||
Net income | $ | 68,633 | $ | 61,379 | $ | 110,253 | $ | 101,560 | ||||||||
Earnings (loss) per common share | ||||||||||||||||
Basic | ||||||||||||||||
Continuing operations | $ | 0.68 | $ | 0.61 | $ | 1.11 | $ | 1.01 | ||||||||
Discontinued operations | — | — | (0.01 | ) | — | |||||||||||
Basic earnings per common share | $ | 0.68 | $ | 0.61 | $ | 1.10 | $ | 1.01 | ||||||||
Diluted | ||||||||||||||||
Continuing operations | $ | 0.67 | $ | 0.60 | $ | 1.09 | $ | 0.99 | ||||||||
Discontinued operations | — | — | (0.01 | ) | — | |||||||||||
Diluted earnings per common share | $ | 0.67 | $ | 0.60 | $ | 1.08 | $ | 0.99 | ||||||||
Weighted average common shares outstanding | ||||||||||||||||
Basic | 100,509 | 100,769 | 100,498 | 100,566 | ||||||||||||
Diluted | 102,429 | 102,827 | 102,457 | 102,715 | ||||||||||||
Cash dividends declared per common share | $ | 0.14 | $ | 0.13 | $ | 0.28 | $ | 0.26 |
See accompanying notes to condensed consolidated financial statements.
3
Table of Contents
Pentair, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
July 1 | December 31 | July 2 | ||||||||||
In thousands, except share and per-share data | 2006 | 2005 | 2005 | |||||||||
Assets | ||||||||||||
Current assets | ||||||||||||
Cash and cash equivalents | $ | 48,331 | $ | 48,500 | $ | 41,853 | ||||||
Accounts and notes receivable, net | 502,982 | 423,847 | 457,878 | |||||||||
Inventories | 380,219 | 349,312 | 339,460 | |||||||||
Deferred tax assets | 45,922 | 48,971 | 49,077 | |||||||||
Prepaid expenses and other current assets | 27,659 | 24,394 | 27,734 | |||||||||
Total current assets | 1,005,113 | 895,024 | 916,002 | |||||||||
Property, plant and equipment, net | 312,146 | 311,839 | 324,477 | |||||||||
Other assets | ||||||||||||
Goodwill | 1,729,179 | 1,718,207 | 1,614,248 | |||||||||
Intangibles, net | 263,600 | 266,533 | 254,233 | |||||||||
Other | 80,167 | 62,152 | 60,538 | |||||||||
Total other assets | 2,072,946 | 2,046,892 | 1,929,019 | |||||||||
Total assets | $ | 3,390,205 | $ | 3,253,755 | $ | 3,169,498 | ||||||
Liabilities and Shareholders’ Equity | ||||||||||||
Current liabilities | ||||||||||||
Short-term borrowings | $ | 4,869 | $ | — | $ | — | ||||||
Current maturities of long-term debt | 6,970 | 4,137 | 6,469 | |||||||||
Accounts payable | 224,237 | 207,320 | 195,702 | |||||||||
Employee compensation and benefits | 83,071 | 95,552 | 80,584 | |||||||||
Accrued product claims and warranties | 41,346 | 43,551 | 43,940 | |||||||||
Current liabilities of discontinued operations | — | 192 | 192 | |||||||||
Income taxes | 22,533 | 17,518 | 45,123 | |||||||||
Accrued rebates and sales incentives | 35,723 | 45,374 | 38,177 | |||||||||
Other current liabilities | 83,937 | 111,026 | 97,367 | |||||||||
Total current liabilities | 502,686 | 524,670 | 507,554 | |||||||||
Long-term debt | 801,898 | 748,477 | 727,631 | |||||||||
Pension and other retirement compensation | 164,480 | 152,780 | 138,830 | |||||||||
Post-retirement medical and other benefits | 73,723 | 73,949 | 70,309 | |||||||||
Deferred tax liabilities | 125,418 | 125,785 | 143,377 | |||||||||
Other non-current liabilities | 79,838 | 70,455 | 67,576 | |||||||||
Non-current liabilities of discontinued operations | — | 2,029 | 2,031 | |||||||||
Total liabilities | 1,748,043 | 1,698,145 | 1,657,308 | |||||||||
Commitments and contingencies | ||||||||||||
Shareholders’ equity | ||||||||||||
Common shares par value $0.162/3; 101,122,243, 101,202,237 and 101,845,021 shares issued and outstanding, respectively | 16,854 | 16,867 | 16,974 | |||||||||
Additional paid-in capital | 512,356 | 518,751 | 520,968 | |||||||||
Retained earnings | 1,102,773 | 1,020,978 | 963,975 | |||||||||
Accumulated other comprehensive income (loss) | 10,179 | (986 | ) | 10,273 | ||||||||
Total shareholders’ equity | 1,642,162 | 1,555,610 | 1,512,190 | |||||||||
Total liabilities and shareholders’ equity | $ | 3,390,205 | $ | 3,253,755 | $ | 3,169,498 | ||||||
See accompanying notes to condensed consolidated financial statements.
4
Table of Contents
Pentair, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
Six months ended | ||||||||
July 1 | July 2 | |||||||
In thousands | 2006 | 2005 | ||||||
Operating activities | ||||||||
Net income | $ | 110,253 | $ | 101,560 | ||||
Adjustments to reconcile net income to net cash used for operating activities | ||||||||
Loss on disposal of discontinued operations | 1,451 | — | ||||||
Depreciation | 30,386 | 28,962 | ||||||
Amortization | 9,476 | 8,074 | ||||||
Deferred income taxes | 181 | 2,572 | ||||||
Stock compensation | 12,484 | 13,306 | ||||||
Excess tax benefits from stock-based compensation | (2,605 | ) | (7,809 | ) | ||||
Gain on sale of investment | — | (5,199 | ) | |||||
Changes in assets and liabilities, net of effects of business acquisitions and dispositions | ||||||||
Accounts and notes receivable | (74,193 | ) | (72,729 | ) | ||||
Inventories | (28,032 | ) | (22,340 | ) | ||||
Prepaid expenses and other current assets | (2,809 | ) | (4,036 | ) | ||||
Accounts payable | 12,382 | 4,590 | ||||||
Employee compensation and benefits | (16,832 | ) | (29,912 | ) | ||||
Accrued product claims and warranties | (1,793 | ) | 1,228 | |||||
Income taxes | 6,443 | 18,285 | ||||||
Other current liabilities | (19,933 | ) | 787 | |||||
Pension and post-retirement benefits | 8,722 | 7,370 | ||||||
Other assets and liabilities | 1,565 | (5,144 | ) | |||||
Net cash provided by continuing operations | 47,146 | 39,565 | ||||||
Net cash provided by (used for) operating activities of discontinued operations | 48 | (630 | ) | |||||
Net cash provided by operating activities | 47,194 | 38,935 | ||||||
Investing activities | ||||||||
Capital expenditures | (20,217 | ) | (39,077 | ) | ||||
Proceeds from sale of property and equipment | 221 | 11,553 | ||||||
Acquisitions, net of cash acquired | (19,694 | ) | (10,513 | ) | ||||
Divestitures | (24,007 | ) | (190 | ) | ||||
Other | (4,273 | ) | 23,596 | |||||
Net cash used for investing activities | (67,970 | ) | (14,631 | ) | ||||
Financing activities | ||||||||
Net short-term borrowings | 4,763 | — | ||||||
Proceeds from long-term debt | 414,233 | 186,610 | ||||||
Repayment of long-term debt | (358,141 | ) | (186,993 | ) | ||||
Proceeds from exercise of stock options | 2,939 | 6,355 | ||||||
Excess tax benefits from stock-based compensation | 2,605 | 7,809 | ||||||
Repurchases of common stock | (18,330 | ) | — | |||||
Dividends paid | (28,458 | ) | (26,648 | ) | ||||
Net cash provided by (used for) financing activities | 19,611 | (12,867 | ) | |||||
Effect of exchange rate changes on cash and cash equivalents | 996 | (1,079 | ) | |||||
Change in cash and cash equivalents | (169 | ) | 10,358 | |||||
Cash and cash equivalents, beginning of period | 48,500 | 31,495 | ||||||
Cash and cash equivalents, end of period | $ | 48,331 | $ | 41,853 | ||||
See accompanying notes to condensed consolidated financial statements.
5
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
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 (“EITF 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 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 Changesand 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 05-5”). EITF 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
6
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
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 05-5 did not have a material impact on our consolidated results of operations or financial condition.
In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”)Accounting for Uncertainty in Income Taxes–an interpretation of FASB Statement 109. FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file a tax return in a particular jurisdiction. FIN 48 is effective for fiscal years beginning after December 15, 2006. If there are changes in net assets as a result of application of FIN 48, these will be accounted for as an adjustment to retained earnings. The Company is currently assessing the impact of FIN 48 on its 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 half of 2006 and 2005 was $12.5 million and $13.3 million, respectively.
Non-vested shares of our common stock were granted during the first half 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 half of 2006 and 2005 was $4.8 million and $4.0 million, respectively.
During the first half 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 half 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 first half of 2006 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 $7.7 million and $9.3 million for the first half of 2006 and 2005, respectively.
We estimated the fair value of each stock option award during the second quarter of 2006 and 2005 on the date of grant using a Black-Scholes option pricing model, modified for dividends and using the following assumptions:
July 1 | July 2 | |||||||
2006 | 2005 | |||||||
Expected stock price volatility | 31.5 | % | 34.5 | % | ||||
Expected life | 4.5 yrs. | 3.6 yrs. | ||||||
Risk-free interest rate | 4.99 | % | 3.75 | % | ||||
Dividend yield | 1.54 | % | 1.20 | % |
The weighted-average fair value of options granted during the first half of 2006 and 2005 was $10.94 and $11.44 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.
7
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
4. Earnings Per Common Share
Basic and diluted earnings per share were calculated using the following:
Three months ended | Six months ended | |||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||
In thousands, except per-share data | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Earnings (loss) per common share — basic | ||||||||||||||||
Continuing operations | $ | 68,633 | $ | 61,379 | $ | 111,704 | $ | 101,560 | ||||||||
Discontinued operations | — | — | (1,451 | ) | — | |||||||||||
Net income | $ | 68,633 | $ | 61,379 | $ | 110,253 | $ | 101,560 | ||||||||
Continuing operations | $ | 0.68 | $ | 0.61 | $ | 1.11 | $ | 1.01 | ||||||||
Discontinued operations | — | — | (0.01 | ) | — | |||||||||||
Basic earnings per common share | $ | 0.68 | $ | 0.61 | $ | 1.10 | $ | 1.01 | ||||||||
Earnings (loss) per common share — diluted | ||||||||||||||||
Continuing operations | $ | 68,633 | $ | 61,379 | $ | 111,704 | $ | 101,560 | ||||||||
Discontinued operations | — | — | (1,451 | ) | — | |||||||||||
Net income | $ | 68,633 | $ | 61,379 | $ | 110,253 | $ | 101,560 | ||||||||
Continuing operations | $ | 0.67 | $ | 0.60 | $ | 1.09 | $ | 0.99 | ||||||||
Discontinued operations | — | — | (0.01 | ) | — | |||||||||||
Diluted earnings per common share | $ | 0.67 | $ | 0.60 | $ | 1.08 | $ | 0.99 | ||||||||
Weighted average common shares outstanding — basic | 100,509 | 100,769 | 100,498 | 100,566 | ||||||||||||
Dilutive impact of stock options and restricted stock | 1,920 | 2,058 | 1,959 | 2,149 | ||||||||||||
Weighted average common shares outstanding — diluted | 102,429 | 102,827 | 102,457 | 102,715 | ||||||||||||
Stock options excluded from the calculation of diluted earnings per share because the exercise price was greater than the average market price of the common shares | 2,410 | 561 | 2,382 | 549 |
5. Acquisitions
On June 23, 2006, we acquired as part of our Water Group the assets of Cozad & O’Hara of Cathedral City, Inc. (“Cozad & O’Hara”) for $0.5 million in cash plus a note payable and debt assumed of $0.6 million. Goodwill recorded as part of the initial purchase price allocation was $0.7 million, all of which is tax deductible. We continue to evaluate the purchase price allocation for the Cozad & O’Hara acquisition and expect to revise the purchase price allocation as better information becomes available.
On April 12, 2006, we acquired as part of our Water Group the assets of Geyer’s Manufacturing & Design Inc. and FTA Filtration, Inc. (together “Krystil Klear”), two privately-held companies, for $15.0 million in cash plus debt assumed of $0.4 million. Krystil Klear expands our industrial filtration product offering to include a full range of steel and stainless steel housing filtration solutions. Goodwill recorded as part of the initial purchase price allocation was $8.9 million, all of which is tax deductible. We continue to evaluate the purchase price allocation for the Krystil Klear 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.
On December 1, 2005, we acquired the 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 and paid a final purchase price adjustment of $1.6 million. 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.
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.
8
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
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.
Three months ended | Six months ended | |||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||
In thousands, except per-share data | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Pro forma net sales from continuing operations | $ | 862,553 | $ | 824,405 | $ | 1,635,534 | $ | 1,566,921 | ||||||||
Pro forma net income from continuing operations | 68,538 | 62,472 | 111,581 | 102,596 | ||||||||||||
Pro forma earnings per common share — continuing operations | ||||||||||||||||
Basic | $ | 0.68 | $ | 0.62 | $ | 1.11 | $ | 1.02 | ||||||||
Diluted | $ | 0.67 | $ | 0.61 | $ | 1.09 | $ | 1.00 | ||||||||
Weighted average common shares outstanding | ||||||||||||||||
Basic | 100,509 | 100,769 | 100,498 | 100,566 | ||||||||||||
Diluted | 102,429 | 102,827 | 102,457 | 102,715 |
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 second quarter and first half of 2006 and 2005 are summarized below:
Three months ended | Six months ended | |||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||
In thousands | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Loss on disposal of discontinued operations | $ | (683 | ) | $ | — | $ | (3,937 | ) | $ | — | ||||||
Income tax benefit | 683 | — | 2,486 | — | ||||||||||||
Loss on disposal of discontinued operations, net of tax | $ | — | $ | — | $ | (1,451 | ) | $ | — | |||||||
9
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
7. Inventories
Inventories were comprised of:
July 1 | December 31 | July 2 | ||||||||||
In thousands | 2006 | 2005 | 2005 | |||||||||
Raw materials and supplies | $ | 173,432 | $ | 146,389 | $ | 136,410 | ||||||
Work-in-process | 50,761 | 49,418 | 44,527 | |||||||||
Finished goods | 156,026 | 153,505 | 158,523 | |||||||||
Total inventories | $ | 380,219 | $ | 349,312 | $ | 339,460 | ||||||
8. Comprehensive Income
Comprehensive income and its components, net of tax, were as follows:
Three months ended | Six months ended | |||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||
In thousands | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Net income | $ | 68,633 | $ | 61,379 | $ | 110,253 | $ | 101,560 | ||||||||
Changes in cumulative foreign currency translation adjustment | 4,594 | (12,377 | ) | 8,491 | (22,347 | ) | ||||||||||
Changes in market value of derivative financial instruments classified as cash flow hedges | 1,111 | 104 | 2,674 | 214 | ||||||||||||
Comprehensive income | $ | 74,338 | $ | 49,106 | $ | 121,418 | $ | 79,427 | ||||||||
9. Goodwill and Other Intangible Assets
Changes in the carrying amount of goodwill for the six months ended July 1, 2006 by segment were as follows:
Technical | ||||||||||||
In thousands | Water | Products | Consolidated | |||||||||
Balance at December 31, 2005 | $ | 1,433,280 | $ | 284,927 | $ | 1,718,207 | ||||||
Acquired | 9,584 | — | 9,584 | |||||||||
Purchase accounting adjustments | (9,695 | ) | 4,138 | (5,557 | ) | |||||||
Foreign currency translation | 3,898 | 3,047 | 6,945 | |||||||||
Balance at July 1, 2006 | $ | 1,437,067 | $ | 292,112 | $ | 1,729,179 | ||||||
The acquired goodwill in the Water segment is related to our acquisitions of Krystil Klear and Cozad & O’Hara during the second quarter of 2006.
Purchase accounting adjustments recorded during the first half of 2006 relate to the WICOR, Inc. , DEP, Thermal, and Krystil Klear acquisitions. The purchase price adjustments during the first half of 2006 included adjustments for additional transaction and restructuring costs incurred, and reclassifications related to the WICOR, Inc. purchase accounting.
Intangible assets, other than goodwill, were comprised of:
July 1, 2006 | December 31, 2005 | July 2, 2005 | ||||||||||||||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||||||||||||||
carrying | Accum. | carrying | Accum. | carrying | Accum. | |||||||||||||||||||||||||||||||
In thousands | amount | amort | Net | amount | amort | Net | amount | amort | Net | |||||||||||||||||||||||||||
Finite-life intangibles | ||||||||||||||||||||||||||||||||||||
Patents | $ | 18,711 | $ | (5,123 | ) | $ | 13,588 | $ | 15,685 | $ | (4,135 | ) | $ | 11,550 | $ | 15,690 | $ | (3,179 | ) | $ | 12,511 | |||||||||||||||
Non-compete agreements | 4,129 | (2,520 | ) | 1,609 | 3,937 | (2,021 | ) | 1,916 | 7,463 | (4,919 | ) | 2,544 | ||||||||||||||||||||||||
Proprietary technology | 51,493 | (7,302 | ) | 44,191 | 51,386 | (5,107 | ) | 46,279 | 45,093 | (3,457 | ) | 41,636 | ||||||||||||||||||||||||
Customer relationships | 87,741 | (11,539 | ) | 76,202 | 87,707 | (8,647 | ) | 79,060 | 84,526 | (6,005 | ) | 78,521 | ||||||||||||||||||||||||
Total finite-life intangibles | $ | 162,074 | $ | (26,484 | ) | $ | 135,590 | $ | 158,715 | $ | (19,910 | ) | $ | 138,805 | $ | 152,772 | $ | (17,560 | ) | $ | 135,212 | |||||||||||||||
Indefinite-life intangibles | ||||||||||||||||||||||||||||||||||||
Brand names | $ | 128,010 | $ | — | $ | 128,010 | $ | 127,728 | $ | — | $ | 127,728 | $ | 119,021 | $ | — | $ | 119,021 | ||||||||||||||||||
Total intangibles, net | $ | 263,600 | $ | 266,533 | $ | 254,233 | ||||||||||||||||||||||||||||||
10
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
Intangible asset amortization expense for the six months ended July 1, 2006 and July 2, 2005 was approximately $6.6 million and $5.7 million, respectively. The estimated future amortization expense for identifiable intangible assets during the remainder of 2006 and the next five years is as follows:
In thousands | 2006 Q3 - Q4 | 2007 | 2008 | 2009 | 2010 | 2011 | ||||||||||||||||||
Estimated amortization expense | $ | 6,811 | $ | 12,314 | $ | 11,399 | $ | 11,219 | $ | 10,715 | $ | 10,515 |
10. Debt
Debt and the average interest rate on debt outstanding is summarized as follows:
Average | ||||||||||||||||||||
interest rate | Maturity | July 1 | December 31 | July 2 | ||||||||||||||||
In thousands | July 1, 2006 | (Year) | 2006 | 2005 | 2005 | |||||||||||||||
Commercial paper, maturing within 48 days | 5.62 | % | $ | 217,287 | $ | 144,656 | $ | 172,544 | ||||||||||||
Revolving credit facilities | 5.94 | % | 2010 | 95,900 | 112,300 | 63,100 | ||||||||||||||
Private placement — fixed rate | 5.50 | % | 2007-2013 | 135,000 | 135,000 | 135,000 | ||||||||||||||
Private placement — floating rate | 5.70 | % | 2013 | 100,000 | 100,000 | 100,000 | ||||||||||||||
Senior notes | 7.85 | % | 2009 | 250,000 | 250,000 | 250,000 | ||||||||||||||
Other | 2.35 | % | 2006-2016 | 11,760 | 6,285 | 8,499 | ||||||||||||||
Total contractual debt obligations | 809,947 | 748,241 | 729,143 | |||||||||||||||||
Interest rate swap monetization deferred income | 3,790 | 4,373 | 4,957 | |||||||||||||||||
Total long-term debt, including current portion per balance sheet | 813,737 | 752,614 | 734,100 | |||||||||||||||||
Less: Current maturities of long-term debt | (6,970 | ) | (4,137 | ) | (6,469 | ) | ||||||||||||||
Short-term borrowings | (4,869 | ) | — | — | ||||||||||||||||
Total long-term debt | $801,898 | $748,477 | $727,631 | |||||||||||||||||
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 July 1, 2006, we had $217.3 million of commercial paper outstanding that matures within 48 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 have $35 million of outstanding private placement debt maturing in May 2007. We classified this debt as long-term as of July 1, 2006 as we have the intent and ability to refinance such obligation on a long-term basis under the Credit Facility.
We were in compliance with all debt covenants as of July 1, 2006.
In addition to the Credit Facility, we have $25 million of uncommitted credit facilities, under which we had borrowings of $4.9 million as of July 1, 2006.
Long-term debt outstanding at July 1, 2006 matures on a calendar year basis as follows:
In thousands | 2006 Q3-Q4 | 2007 | 2008 | 2009 | 2010 | 2011 | Thereafter | Total | ||||||||||||||||||||||||
Contractual long-term debt obligation maturities | $ | 1,664 | $ | 4,426 | $ | 260 | $ | 250,251 | $ | 348,366 | $ | 76 | $ | 200,035 | $ | 805,078 | ||||||||||||||||
Other maturities | 583 | 1,166 | 1,166 | 875 | — | — | — | 3,790 | ||||||||||||||||||||||||
Total maturities | $ | 2,247 | $ | 5,592 | $ | 1,426 | $ | 251,126 | $ | 348,366 | $ | 76 | $ | 200,035 | $ | 808,868 | ||||||||||||||||
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 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 at July 1, 2006 was $5.2 million and was recorded in other assets at July 1, 2006.
11
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
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 six months ended July 1, 2006 was 30.5% compared to 37.1% for the six months ended July 2, 2005. The tax rate for the first half of 2006 includes a favorable adjustment in the second quarter primarily related to the resolution of an IRS exam for the periods of 2002-2003 and a favorable adjustment in the first quarter related to a prior year tax return. The 2005 effective tax rate included an unfavorable settlement related to a routine German tax examination for prior years which was partially offset by a favorable settlement for an IRS exam for the periods of 1998-2001. 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 and six months ended July 1, 2006 and July 2, 2005 were as follows:
Three months ended | ||||||||||||||||
Pension benefits | Post-retirement | |||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||
In thousands | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Service cost | $ | 4,512 | $ | 4,118 | $ | 184 | $ | 213 | ||||||||
Interest cost | 7,343 | 7,456 | 799 | 947 | ||||||||||||
Expected return on plan assets | (6,974 | ) | (7,373 | ) | — | — | ||||||||||
Amortization of transition obligation | 31 | 30 | — | — | ||||||||||||
Amortization of prior year service cost (benefit) | 77 | 74 | (59 | ) | (50 | ) | ||||||||||
Recognized net actuarial loss | 1,009 | 698 | (212 | ) | — | |||||||||||
Net periodic benefit cost | $ | 5,998 | $ | 5,003 | $ | 712 | $ | 1,110 | ||||||||
Six months ended | ||||||||||||||||
Pension benefits | Post-retirement | |||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||
In thousands | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Service cost | $ | 9,024 | $ | 8,236 | $ | 368 | $ | 425 | ||||||||
Interest cost | 14,686 | 14,911 | 1,598 | 1,894 | ||||||||||||
Expected return on plan assets | (13,948 | ) | (14,746 | ) | — | — | ||||||||||
Amortization of transition obligation | 62 | 59 | — | — | ||||||||||||
Amortization of prior year service cost (benefit) | 154 | 149 | (118 | ) | (100 | ) | ||||||||||
Recognized net actuarial loss | 2,018 | 1,396 | (424 | ) | — | |||||||||||
Net periodic benefit cost | $ | 11,996 | $ | 10,005 | $ | 1,424 | $ | 2,219 | ||||||||
14. Business Segments
Financial information by reportable segment for the three and six months ended July 1, 2006 and July 2, 2005 is shown below:
12
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
Three months ended | Six months ended | |||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||
In thousands | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Net sales to external customers | ||||||||||||||||
Water | $ | 605,516 | $ | 585,657 | $ | 1,122,685 | $ | 1,097,745 | ||||||||
Technical Products | 256,506 | 202,866 | 510,726 | 400,413 | ||||||||||||
Consolidated | $ | 862,022 | $ | 788,523 | $ | 1,633,411 | $ | 1,498,158 | ||||||||
Intersegment sales | ||||||||||||||||
Water | $ | 55 | $ | 187 | $ | 105 | $ | 209 | ||||||||
Technical Products | 1,312 | 630 | 2,201 | 1,032 | ||||||||||||
Other | (1,367 | ) | (817 | ) | (2,306 | ) | (1,241 | ) | ||||||||
Consolidated | $ | — | $ | — | $ | — | $ | — | ||||||||
Operating income (loss) | ||||||||||||||||
Water | $ | 84,191 | $ | 92,167 | $ | 139,778 | $ | 152,656 | ||||||||
Technical Products | 39,678 | 26,325 | 77,382 | 51,497 | ||||||||||||
Other | (15,894 | ) | (11,258 | ) | (30,629 | ) | (24,833 | ) | ||||||||
Consolidated | $ | 107,975 | $ | 107,234 | $ | 186,531 | $ | 179,320 | ||||||||
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.
15. Warranty
The changes in the carrying amount of service and product warranty accruals for the six months ended July 1, 2006 and July 2, 2005 were as follows:
July 1 | July 2 | |||||||
In thousands | 2006 | 2005 | ||||||
Balance at beginning of the year | $ | 33,551 | $ | 32,524 | ||||
Service and product warranty provision | 20,576 | 20,898 | ||||||
Payments | (22,910 | ) | (19,596 | ) | ||||
Acquired | — | 446 | ||||||
Translation | 129 | (332 | ) | |||||
Balance at end of the period | $ | 31,346 | $ | 33,940 | ||||
16. Commitments and Contingencies
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. 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 cruise ship, and allegations that the spa and filters contained Legionnaire’s disease bacteria that infected certain passengers on cruises from April 1994 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. All of the personal injury cases have now been resolved through either settlement or trial.
The only remaining unresolved claims in this case were 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. On June 28, 2006, the jury returned a verdict against the Essef defendants in the total amount of $193 million for its claims for out-of-pocket expenses ($10.4 million), lost profits ($47.6 million) and loss of business enterprise value ($135 million). The verdict is exclusive of pre-judgment interest and attorneys’ fees. We believe that the jury verdict is not consistent with the law nor the evidence offered
13
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
at trial. We intend to argue all appropriate post-trial motions, or if unsuccessful to appeal any subsequent judgment, to reverse or substantially reduce this verdict, in particular the claims relating to lost profits and lost enterprise value.
We have assessed the impact of the verdict on our previously established reserves for this matter and based on information available at this time, have deemed it unnecessary to adjust our reserves. First, several issues have not been addressed by the court, including whether Celebrity is entitled to recovery of its attorneys’ fees and related costs in the passenger claims phase of the case ($4.1 million), and, with respect to pre-judgment interest, the length of the interest period and the rate of interest on any eventual judgment. In addition, the court has not decided Essef’s contribution claim to reduce Celebrity’s recovery by 30% to account for its contributory negligence. Second we believe that we will ultimately be successful in obtaining substantial relief from this misguided verdict. While we are not able to determine the amount of the eventual liability at this time, we believe that an appropriate result would be substantially less than the verdict the jury rendered. As a result, we are maintaining our accruals at the same level as before, which we believe are within the range of reasonable outcomes for this case.
If judgment were subsequently entered on this verdict and upheld on appeal as it currently stands, which we believe is unlikely to occur for the reasons noted above, the interest incurred through June 2006 would range from approximately $75 to $171 million, depending on interest rate and interest period used. In this worst case situation, the gross amount that we would have pay in this matter would then total from $268 to $364 million. While we believe the majority of the amount would be tax-deductible in the year paid or in subsequent years, we are still analyzing the tax impact of a loss of that magnitude. In addition to the impact of a loss on this matter on our earnings per share when recognized, we would also need eventually to borrow funds from our banks or other sources to pay any judgment finally determined after exhaustion of all appeals. We expect that we would have available adequate funds to allow us to do so, based on discussions with our lending sources and our estimates of the results of our business operations over the next two years.
During the period prior to final determination and payment of any ultimate recovery to Celebrity, we believe that we will be able to operate in the normal course of business, although interim acquisition plans and other discretionary spending may be reduced. Any final judgment paid would also increase our indebtedness or reduce cash available for other uses. Any such payment could impact our ability to execute our long-term strategic plans to their full extent, but we do not believe our ongoing financial and operational condition will be compromised.
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.
14
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
17. Financial Statements of Subsidiary Guarantors
The $250 million Senior Notes due 2009 are jointly and severally guaranteed by our 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 July 1, 2006 and December 31, 2005, the related condensed consolidated statements of income for the three months and six months ended July 1, 2006 and July 2, 2005, and statements of cash flows for the six months ended July 1, 2006 and July 2, 2005, for the Parent Company, the Guarantor Subsidiaries, the non-guarantor subsidiaries and total consolidated Pentair and subsidiaries.
Pentair, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
For the three months ended July 1, 2006
Parent | Guarantor | Non-Guarantor | ||||||||||||||||||
In thousands | Company | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net sales | $ | — | $ | 722,090 | $ | 179,670 | $ | (39,738 | ) | $ | 862,022 | |||||||||
Cost of goods sold | 222 | 509,036 | 130,599 | (40,524 | ) | 599,333 | ||||||||||||||
Gross profit | (222 | ) | 213,054 | 49,071 | 786 | 262,689 | ||||||||||||||
Selling, general and administrative | 9,264 | 98,082 | 31,699 | 786 | 139,831 | |||||||||||||||
Research and development | — | 11,549 | 3,334 | — | 14,883 | |||||||||||||||
Operating (loss) income | (9,486 | ) | 103,423 | 14,038 | — | 107,975 | ||||||||||||||
Net interest (income) expense | (16,369 | ) | 29,800 | (878 | ) | — | 12,553 | |||||||||||||
Income from continuing operations before income taxes | 6,883 | 73,623 | 14,916 | — | 95,422 | |||||||||||||||
Provision for income taxes | 2,388 | 19,035 | 5,366 | — | 26,789 | |||||||||||||||
Net income | $ | 4,495 | $ | 54,588 | $ | 9,550 | $ | — | $ | 68,633 | ||||||||||
Pentair, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
For the six months ended July 1, 2006
Parent | Guarantor | Non-Guarantor | ||||||||||||||||||
In thousands | Company | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net sales | $ | — | $ | 1,355,150 | $ | 360,955 | $ | (82,694 | ) | $ | 1,633,411 | |||||||||
Cost of goods sold | 347 | 968,259 | 262,672 | (83,064 | ) | 1,148,214 | ||||||||||||||
Gross profit | (347 | ) | 386,891 | 98,283 | 370 | 485,197 | ||||||||||||||
Selling, general and administrative | 15,485 | 191,623 | 61,442 | 370 | 268,920 | |||||||||||||||
Research and development | — | 23,333 | 6,413 | — | 29,746 | |||||||||||||||
Operating (loss) income | (15,832 | ) | 171,935 | 30,428 | — | 186,531 | ||||||||||||||
Net interest (income) expense | (31,901 | ) | 59,586 | (1,848 | ) | — | 25,837 | |||||||||||||
Income from continuing operations before income taxes | 16,069 | 112,349 | 32,276 | — | 160,694 | |||||||||||||||
Provision for income taxes | 5,580 | 32,071 | 11,339 | — | 48,990 | |||||||||||||||
Income from continuing operations | 10,489 | 80,278 | 20,937 | — | 111,704 | |||||||||||||||
Loss on disposal of discontinued operations, net of tax | (1,451 | ) | — | — | — | (1,451 | ) | |||||||||||||
Net income | $ | 9,038 | $ | 80,278 | $ | 20,937 | $ | — | $ | 110,253 | ||||||||||
15
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
Pentair, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
July 1, 2006
July 1, 2006
Parent | Guarantor | Non-Guarantor | ||||||||||||||||||
In thousands | Company | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Assets | ||||||||||||||||||||
Current assets | ||||||||||||||||||||
Cash and cash equivalents | $ | 9,832 | $ | 7,634 | $ | 30,865 | $ | — | $ | 48,331 | ||||||||||
Accounts and notes receivable, net | 642 | 403,759 | 149,483 | (50,902 | ) | 502,982 | ||||||||||||||
Inventories | — | 285,489 | 94,730 | — | 380,219 | |||||||||||||||
Deferred tax assets | 19,532 | 33,946 | 5,591 | (13,147 | ) | 45,922 | ||||||||||||||
Prepaid expenses and other current assets | 3,349 | 10,727 | 16,375 | (2,792 | ) | 27,659 | ||||||||||||||
Total current assets | 33,355 | 741,555 | 297,044 | (66,841 | ) | 1,005,113 | ||||||||||||||
Property, plant and equipment, net | 5,059 | 219,631 | 87,456 | — | 312,146 | |||||||||||||||
Other assets | ||||||||||||||||||||
Investments in subsidiaries | 1,983,413 | 43,942 | 94,715 | (2,122,070 | ) | — | ||||||||||||||
Goodwill | — | 1,492,452 | 236,727 | — | 1,729,179 | |||||||||||||||
Intangibles, net | — | 240,433 | 23,167 | — | 263,600 | |||||||||||||||
Other | 54,596 | 19,703 | 5,868 | — | 80,167 | |||||||||||||||
Total other assets | 2,038,009 | 1,796,530 | 360,477 | (2,122,070 | ) | 2,072,946 | ||||||||||||||
Total assets | $ | 2,076,423 | $ | 2,757,716 | $ | 744,977 | $ | (2,188,911 | ) | $ | 3,390,205 | |||||||||
Liabilities and Shareholders’ Equity | ||||||||||||||||||||
Current liabilities | ||||||||||||||||||||
Short-term borrowings | $ | — | $ | — | $ | 4,869 | $ | — | $ | 4,869 | ||||||||||
Current maturities of long-term debt | 1,166 | 291 | 28,157 | (22,644 | ) | 6,970 | ||||||||||||||
Accounts payable | 1,925 | 185,237 | 87,249 | (50,174 | ) | 224,237 | ||||||||||||||
Employee compensation and benefits | 10,869 | 45,541 | 26,661 | — | 83,071 | |||||||||||||||
Accrued product claims and warranties | — | 26,458 | 14,888 | — | 41,346 | |||||||||||||||
Income taxes | (2,141 | ) | 16,473 | 8,201 | — | 22,533 | ||||||||||||||
Accrued rebates and sales incentives | — | 33,871 | 1,852 | — | 35,723 | |||||||||||||||
Other current liabilities | 13,428 | 48,960 | 24,336 | (2,787 | ) | 83,937 | ||||||||||||||
Total current liabilities | 25,247 | 356,831 | 196,213 | (75,605 | ) | 502,686 | ||||||||||||||
Long-term debt | 800,811 | 1,787,051 | 11,763 | (1,797,727 | ) | 801,898 | ||||||||||||||
Pension and other retirement compensation | 81,385 | 29,614 | 53,481 | — | 164,480 | |||||||||||||||
Post-retirement medical and other benefits | 23,634 | 50,089 | — | — | 73,723 | |||||||||||||||
Deferred tax liabilities | (51,407 | ) | 162,806 | 27,166 | (13,147 | ) | 125,418 | |||||||||||||
Due to / (from) affiliates | (475,844 | ) | 100,682 | 241,804 | 133,358 | — | ||||||||||||||
Other non-current liabilities | 30,436 | 7,323 | 42,079 | — | 79,838 | |||||||||||||||
Total liabilities | 434,262 | 2,494,396 | 572,506 | (1,753,121 | ) | 1,748,043 | ||||||||||||||
Shareholders’ equity | 1,642,161 | 263,320 | 172,471 | (435,790 | ) | 1,642,162 | ||||||||||||||
Total liabilities and shareholders’ equity | $ | 2,076,423 | $ | 2,757,716 | $ | 744,977 | $ | (2,188,911 | ) | $ | 3,390,205 | |||||||||
16
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
Pentair, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
For the six months ended July 1, 2006
Parent | Guarantor | Non-Guarantor | ||||||||||||||||||
In thousands | Company | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Operating activities | ||||||||||||||||||||
Net income | $ | 9,038 | $ | 80,278 | $ | 20,937 | $ | — | $ | 110,253 | ||||||||||
Adjustments to reconcile net income to net cash provided by (used for) operating activities: | ||||||||||||||||||||
Loss on disposal of discontinued operations | 1,451 | — | — | — | 1,451 | |||||||||||||||
Depreciation | 801 | 22,756 | 6,829 | — | 30,386 | |||||||||||||||
Amortization | 2,924 | 6,069 | 483 | — | 9,476 | |||||||||||||||
Deferred income taxes | 1,973 | (4,646 | ) | 2,854 | — | 181 | ||||||||||||||
Stock compensation | 5,868 | 5,617 | 999 | — | 12,484 | |||||||||||||||
Excess tax benefit from stock-based compensation | (1,225 | ) | (1,172 | ) | (208 | ) | — | (2,605 | ) | |||||||||||
Changes in assets and liabilities, net of effects of business acquisitions and dispositions | ||||||||||||||||||||
Accounts and notes receivable | (1,055 | ) | (64,438 | ) | (25,571 | ) | 16,871 | (74,193 | ) | |||||||||||
Inventories | — | (17,761 | ) | (10,271 | ) | — | (28,032 | ) | ||||||||||||
Prepaid expenses and other current assets | 14,798 | (1,887 | ) | (13,450 | ) | (2,270 | ) | (2,809 | ) | |||||||||||
Accounts payable | 1,223 | 16,485 | 11,545 | (16,871 | ) | 12,382 | ||||||||||||||
Employee compensation and benefits | (6,050 | ) | (11,702 | ) | 920 | — | (16,832 | ) | ||||||||||||
Accrued product claims and warranties | — | (1,664 | ) | (129 | ) | — | (1,793 | ) | ||||||||||||
Income taxes | (531 | ) | 11,170 | (4,196 | ) | — | 6,443 | |||||||||||||
Other current liabilities | (16,530 | ) | (15,414 | ) | 9,741 | 2,270 | (19,933 | ) | ||||||||||||
Pension and post-retirement benefits | 5,047 | 1,731 | 1,944 | — | 8,722 | |||||||||||||||
Other assets and liabilities | (3,656 | ) | (3,015 | ) | 8,236 | — | 1,565 | |||||||||||||
Net cash provided by continuing operations | 14,076 | 22,407 | 10,663 | — | 47,146 | |||||||||||||||
Net cash provided by (used for) operating activities of discontinued operations | 1,451 | — | (1,403 | ) | — | 48 | ||||||||||||||
Net cash provided by operating activities | 15,527 | 22,407 | 9,260 | — | 47,194 | |||||||||||||||
Investing activities | ||||||||||||||||||||
Capital expenditures | (178 | ) | (11,891 | ) | (8,148 | ) | — | (20,217 | ) | |||||||||||
Proceeds from sale of property and equipment | — | 120 | 101 | — | 221 | |||||||||||||||
Acquisitions, net of cash acquired | (19,477 | ) | (217 | ) | — | — | (19,694 | ) | ||||||||||||
Investment in subsidiaries | 9,603 | (2,680 | ) | (6,923 | ) | — | — | |||||||||||||
Divestitures | (18,246 | ) | — | (5,761 | ) | — | (24,007 | ) | ||||||||||||
Other | (1,750 | ) | (2,523 | ) | — | — | (4,273 | ) | ||||||||||||
Net cash used for investing activities | (30,048 | ) | (17,191 | ) | (20,731 | ) | — | (67,970 | ) | |||||||||||
Financing activities | ||||||||||||||||||||
Net short-term borrowings (repayments) | 4,763 | — | — | — | 4,763 | |||||||||||||||
Proceeds from long-term debt | 414,233 | — | — | — | 414,233 | |||||||||||||||
Repayment of long-term debt | (358,141 | ) | — | — | — | (358,141 | ) | |||||||||||||
Proceeds from exercise of stock options | 2,939 | — | — | — | 2,939 | |||||||||||||||
Excess tax benefits from stock-based compensation | 1,225 | 1,172 | 208 | — | 2,605 | |||||||||||||||
Dividends paid | (28,458 | ) | — | — | — | (28,458 | ) | |||||||||||||
Repurchases of common stock | (18,330 | ) | — | — | — | (18,330 | ) | |||||||||||||
Net cash provided by financing activities | 18,231 | 1,172 | 208 | — | 19,611 | |||||||||||||||
Effect of exchange rate changes on cash | 3,118 | (3,116 | ) | 994 | — | 996 | ||||||||||||||
Change in cash and cash equivalents | 6,828 | 3,272 | (10,269 | ) | — | (169 | ) | |||||||||||||
Cash and cash equivalents, beginning of period | 3,004 | 4,362 | 41,134 | — | 48,500 | |||||||||||||||
Cash and cash equivalents, end of period | $ | 9,832 | $ | 7,634 | $ | 30,865 | $ | — | $ | 48,331 | ||||||||||
17
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
Pentair, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
For the three months ended July 2, 2005
Parent | Guarantor | Non-Guarantor | ||||||||||||||||||
In thousands | Company | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net sales | $ | — | $ | 654,825 | $ | 164,384 | $ | (30,686 | ) | $ | 788,523 | |||||||||
Cost of goods sold | 103 | 467,212 | 116,682 | (30,707 | ) | 553,290 | ||||||||||||||
Gross profit | (103 | ) | 187,613 | 47,702 | 21 | 235,233 | ||||||||||||||
Selling, general and administrative | 7,127 | 84,486 | 25,833 | 21 | 117,467 | |||||||||||||||
Research and development | — | 8,072 | 2,460 | — | 10,532 | |||||||||||||||
Operating (loss) income | (7,230 | ) | 95,055 | 19,409 | — | 107,234 | ||||||||||||||
Gain on sale of investment | 5,199 | — | — | — | 5,199 | |||||||||||||||
Net interest (income) expense | (11,737 | ) | 22,959 | 474 | — | 11,696 | ||||||||||||||
Income before income taxes | 9,706 | 72,096 | 18,935 | — | 100,737 | |||||||||||||||
Provision for income taxes | 3,409 | 26,123 | 9,826 | — | 39,358 | |||||||||||||||
Net income | $ | 6,297 | $ | 45,973 | $ | 9,109 | $ | — | $ | 61,379 | ||||||||||
Pentair, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
For the six months ended July 2, 2005
Parent | Guarantor | Non-Guarantor | ||||||||||||||||||
In thousands | Company | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net sales | $ | — | $ | 1,232,704 | $ | 328,692 | $ | (63,238 | ) | $ | 1,498,158 | |||||||||
Cost of goods sold | 163 | 887,141 | 234,619 | (63,136 | ) | 1,058,787 | ||||||||||||||
Gross profit | (163 | ) | 345,563 | 94,073 | (102 | ) | 439,371 | |||||||||||||
Selling, general and administrative | 16,505 | 169,584 | 52,105 | (102 | ) | 238,092 | ||||||||||||||
Research and development | — | 16,948 | 5,011 | — | 21,959 | |||||||||||||||
Operating (loss) income | (16,668 | ) | 159,031 | 36,957 | — | 179,320 | ||||||||||||||
Gain on sale of investment | 5,199 | — | — | — | 5,199 | |||||||||||||||
Net interest (income) expense | (39,614 | ) | 63,374 | (788 | ) | — | 22,972 | |||||||||||||
Income before income taxes | 28,145 | 95,657 | 37,745 | — | 161,547 | |||||||||||||||
Provision for income taxes | 8,922 | 34,532 | 16,533 | — | 59,987 | |||||||||||||||
Net income | $ | 19,223 | $ | 61,125 | $ | 21,212 | $ | — | $ | 101,560 | ||||||||||
18
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
Pentair, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
December 31, 2005
Parent | Guarantor | Non-Guarantor | ||||||||||||||||||
In thousands | Company | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Assets | ||||||||||||||||||||
Current assets | ||||||||||||||||||||
Cash and cash equivalents | $ | 3,004 | $ | 4,362 | $ | 41,134 | $ | — | $ | 48,500 | ||||||||||
Accounts and notes receivable, net | 543 | 338,439 | 118,896 | (34,031 | ) | 423,847 | ||||||||||||||
Inventories | — | 267,007 | 82,305 | — | 349,312 | |||||||||||||||
Deferred tax assets | 74,116 | 34,039 | 8,154 | (67,338 | ) | 48,971 | ||||||||||||||
Prepaid expenses and other current assets | 7,658 | 8,798 | 12,999 | (5,061 | ) | 24,394 | ||||||||||||||
Total current assets | 85,321 | 652,645 | 263,488 | (106,430 | ) | 895,024 | ||||||||||||||
Property, plant and equipment, net | 5,681 | 228,858 | 77,300 | — | 311,839 | |||||||||||||||
Other assets | ||||||||||||||||||||
Investments in subsidiaries | 1,983,857 | 42,174 | 84,804 | (2,110,835 | ) | — | ||||||||||||||
Goodwill | — | 1,488,425 | 229,782 | — | 1,718,207 | |||||||||||||||
Intangibles, net | — | 240,084 | 26,449 | — | 266,533 | |||||||||||||||
Other | 49,100 | 7,157 | 5,895 | — | 62,152 | |||||||||||||||
Total other assets | 2,032,957 | 1,777,840 | 346,930 | (2,110,835 | ) | 2,046,892 | ||||||||||||||
Total assets | $ | 2,123,959 | $ | 2,659,343 | $ | 687,718 | $ | (2,217,265 | ) | $ | 3,253,755 | |||||||||
Liabilities and Shareholders’ Equity | ||||||||||||||||||||
Current liabilities | ||||||||||||||||||||
Current maturities of long-term debt | $ | 1,166 | $ | 76,269 | $ | 19,862 | $ | (93,160 | ) | $ | 4,137 | |||||||||
Accounts payable | 836 | 167,256 | 72,531 | (33,303 | ) | 207,320 | ||||||||||||||
Employee compensation and benefits | 13,869 | 57,006 | 24,677 | — | 95,552 | |||||||||||||||
Accrued product claims and warranties | — | 28,664 | 14,887 | — | 43,551 | |||||||||||||||
Current liabilities of discontinued operations | — | — | 192 | — | 192 | |||||||||||||||
Income taxes | 886 | 7,195 | 9,437 | — | 17,518 | |||||||||||||||
Accrued rebates and sales incentives | — | 42,262 | 3,112 | — | 45,374 | |||||||||||||||
Other current liabilities | 31,547 | 61,318 | 23,223 | (5,062 | ) | 111,026 | ||||||||||||||
Total current liabilities | 48,304 | 439,970 | 167,921 | (131,525 | ) | 524,670 | ||||||||||||||
Long-term debt | 745,162 | 1,710,648 | 12,344 | (1,719,677 | ) | 748,477 | ||||||||||||||
Pension and other retirement compensation | 75,743 | 28,386 | 48,651 | — | 152,780 | |||||||||||||||
Post-retirement medical and other benefits | 24,155 | 49,794 | — | — | 73,949 | |||||||||||||||
Deferred tax liabilities | — | 167,544 | 25,579 | (67,338 | ) | 125,785 | ||||||||||||||
Due to / (from) affiliates | (356,365 | ) | 64,324 | 246,212 | 45,829 | — | ||||||||||||||
Other non-current liabilities | 31,350 | 881 | 38,224 | — | 70,455 | |||||||||||||||
Non-current liabilities of discontinued operations | — | — | 2,029 | — | 2,029 | |||||||||||||||
Total liabilities | 568,349 | 2,461,547 | 540,960 | (1,872,711 | ) | 1,698,145 | ||||||||||||||
Shareholders’ equity | 1,555,610 | 197,796 | 146,758 | (344,554 | ) | 1,555,610 | ||||||||||||||
Total liabilities and shareholders’ equity | $ | 2,123,959 | $ | 2,659,343 | $ | 687,718 | $ | (2,217,265 | ) | $ | 3,253,755 | |||||||||
19
Table of Contents
Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)
Notes to condensed consolidated financial statements (unaudited)
Pentair, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
For the six months ended July 2, 2005
Parent | Guarantor | Non-Guarantor | ||||||||||||||||||
In thousands | Company | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Operating activities | ||||||||||||||||||||
Net income | $ | 19,223 | $ | 61,125 | $ | 21,212 | $ | — | $ | 101,560 | ||||||||||
Adjustments to reconcile net income to net cash provided by (used for) operating activities: | ||||||||||||||||||||
Depreciation | 750 | 22,183 | 6,029 | — | 28,962 | |||||||||||||||
Amortization | 2,162 | 5,249 | 663 | — | 8,074 | |||||||||||||||
Deferred income taxes | 137 | (3,467 | ) | 5,902 | — | 2,572 | ||||||||||||||
Stock compensation | 6,254 | 5,988 | 1,064 | — | 13,306 | |||||||||||||||
Excess tax benefit from stock-based compensation | (3,670 | ) | (3,514 | ) | (625 | ) | — | (7,809 | ) | |||||||||||
Gain on sale of investment | (5,199 | ) | — | — | — | (5,199 | ) | |||||||||||||
Changes in assets and liabilities, net of effects of business acquisitions and dispositions | ||||||||||||||||||||
Accounts and notes receivable | 2,736 | (63,937 | ) | (24,113 | ) | 12,585 | (72,729 | ) | ||||||||||||
Inventories | — | (19,210 | ) | (3,130 | ) | — | (22,340 | ) | ||||||||||||
Prepaid expenses and other current assets | 15,597 | (2,100 | ) | (16,106 | ) | (1,427 | ) | (4,036 | ) | |||||||||||
Accounts payable | (5,195 | ) | 4,219 | 18,173 | (12,607 | ) | 4,590 | |||||||||||||
Employee compensation and benefits | (12,249 | ) | (16,097 | ) | (1,566 | ) | — | (29,912 | ) | |||||||||||
Accrued product claims and warranties | — | 1,281 | (53 | ) | — | 1,228 | ||||||||||||||
Income taxes | 5,000 | 16,520 | (3,235 | ) | — | 18,285 | ||||||||||||||
Other current liabilities | (6,601 | ) | (6,352 | ) | 12,291 | 1,449 | 787 | |||||||||||||
Pension and post-retirement benefits | 3,029 | 2,247 | 2,094 | — | 7,370 | |||||||||||||||
Other assets and liabilities | (9,749 | ) | (61 | ) | 4,666 | — | (5,144 | ) | ||||||||||||
Net cash provided by continuing operations | 12,225 | 4,074 | 23,266 | — | 39,565 | |||||||||||||||
Net cash used for operating activities of discontinued operations | — | — | (630 | ) | — | (630 | ) | |||||||||||||
Net cash provided by operating activities | 12,225 | 4,074 | 22,636 | — | 38,935 | |||||||||||||||
Investing activities | ||||||||||||||||||||
Capital expenditures | (2,095 | ) | (30,137 | ) | (6,845 | ) | — | (39,077 | ) | |||||||||||
Proceeds from sale of property and equipment | — | 11,553 | — | — | 11,553 | |||||||||||||||
Acquisitions, net of cash acquired | (10,513 | ) | — | — | — | (10,513 | ) | |||||||||||||
Investment in subsidiaries | (10,628 | ) | 11,047 | (419 | ) | — | — | |||||||||||||
Divestitures | 2 | 289 | (481 | ) | — | (190 | ) | |||||||||||||
Other | 23,599 | 226 | (229 | ) | — | 23,596 | ||||||||||||||
Net cash provided by (used for) investing activities | 365 | (7,022 | ) | (7,974 | ) | — | (14,631 | ) | ||||||||||||
Financing activities | ||||||||||||||||||||
Proceeds from long-term debt | 186,610 | — | — | — | 186,610 | |||||||||||||||
Repayment of long-term debt | (186,993 | ) | — | — | — | (186,993 | ) | |||||||||||||
Proceeds from exercise of stock options | 6,355 | — | — | — | 6,355 | |||||||||||||||
Excess tax benefit from stock-based compensation | 3,670 | 3,514 | 625 | — | 7,809 | |||||||||||||||
Dividends paid | (26,648 | ) | — | — | — | (26,648 | ) | |||||||||||||
Net cash (used for) provided by financing activities | (17,006 | ) | 3,514 | 625 | — | (12,867 | ) | |||||||||||||
Effect of exchange rate changes on cash | 5,941 | 4,280 | (11,300 | ) | — | (1,079 | ) | |||||||||||||
Change in cash and cash equivalents | 1,525 | 4,846 | 3,987 | — | 10,358 | |||||||||||||||
Cash and cash equivalents, beginning of period | 2,295 | 5,570 | 23,630 | — | 31,495 | |||||||||||||||
Cash and cash equivalents, end of period | $ | 3,820 | $ | 10,416 | $ | 27,617 | $ | — | $ | 41,853 | ||||||||||
20
Table of Contents
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
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 the negative thereof or similar words. 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 may impact the achievement of forward-looking statements:
• | changes in general economic and industry conditions, such as: |
• | the strength of product demand; | ||
• | the intensity of competition, including that from foreign competitors; | ||
• | pricing pressures; | ||
• | market acceptance of new product introductions and enhancements; | ||
• | the introduction of new products and enhancements by competitors; | ||
• | our ability to maintain and expand relationships with large customers; | ||
• | our ability to source raw material commodities from our suppliers without interruption and at reasonable prices; | ||
• | our ability to source components from third parties, in particular from foreign manufacturers, without interruption and at reasonable prices; and | ||
• | the financial condition of our customers; |
• | our ability to successfully appeal and limit damages arising out of the Horizon litigation; |
• | our ability to identify, complete, and integrate acquisitions successfully and to realize expected synergies on our anticipated timetable; |
• | changes in our business strategies, including acquisition, divestiture, and restructuring activities; |
• | domestic and foreign governmental and regulatory policies; |
• | general economic and political conditions, such as political instability, the rate of economic growth in our principal geographic or product markets, or fluctuations in exchange rates; |
• | changes in operating factors, such as continued improvement in manufacturing activities and the achievement of related efficiencies, cost reductions, and inventory risks due to shifts in market demand and costs associated with moving production overseas; |
• | our ability to continue to successfully generate savings from our excellence in operations initiatives consisting of lean enterprise, supply management and cash flow practices; |
• | unanticipated developments that could occur with respect to contingencies such as litigation, intellectual property matters, product liability exposures and environmental matters; |
• | our ability to accurately evaluate the effects of contingent liabilities such as taxes, product liability, environmental, and other claims; and |
• | our ability to access capital markets and obtain anticipated financing under favorable terms. |
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.
Overview
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, treatment, storage, and enjoyment of water. Our Technical Products Group is a global leader in the global enclosures market that designs, manufactures, and markets standard, modified, and custom enclosures that house and protect sensitive controls, components; thermal management products; and accessories. In 2006, we expect our Water Group and Technical Products Group to generate approximately 70 percent and 30 percent of total revenues, respectively.
Our Water Group has progressively become a more important part of our business portfolio with sales increasing from $100 million in 1995 to approximately $2.1 billion in 2005. 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 industry segment totaling $50 billion). Our vision is to become a leading global provider of innovative products and systems used in the movement, treatment, storage, and enjoyment of water.
Our Technical Products Group operates in a large global market with significant potential for growth in industry segments such as defense, security, medical, and networking. We believe we have the largest enclosures industrial and commercial distribution network in North America and the highest enclosures brand recognition in the industry. 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 datacom and telecom markets. In 2004, 2005, and the first half of 2006, sales volumes increased due to the addition of new distributors, new products, and higher demand in all targeted markets. In addition, through the success of our Pentair Integrated Management Systems (“PIMS”) initiatives, we have increased Technical Products segment margins for 18 consecutive quarters.
21
Table of Contents
Key Trends and Uncertainties
The following trends and uncertainties affected our financial performance in the first six months of 2006 and will likely impact our results in the future:
• | We experience seasonal demand in a number of markets within our Water Group. End-user demand for pool/spa equipment follows warm weather trends and is at seasonal highs from March to July. The magnitude of the sales spike is partially mitigated by effective use of the distribution channel by employing some advance sales programs (generally including extended payment terms and/or additional discounts). Demand for residential and agricultural water systems is also affected by weather patterns particularly related to heavy flooding and droughts. |
• | We expect our operations to continue to benefit from our PIMS initiatives which include: strategy deployment; lean enterprise with special focus on sourcing and supply management, cash flow management, and lean operations; and IGNITE, our process to drive organic growth. |
• | We are experiencing material cost inflation in a number of our businesses. We are striving for greater productivity improvements and implementing selective increases in selling prices to help mitigate cost increases in base materials such as steel and resins, freight, fuel, as well as rising costs of health care and insurance. |
• | Free cash flow, which we define as cash flow from operating activities less capital expenditures, including both continuing and discontinued operations, plus proceeds from sale of property and equipment, exceeded $200 million for the fourth consecutive year in 2005 and is expected to be approximately $200 million in 2006. See our discussion ofOther financial measuresunder the caption “Liquidity and Capital Resources” of this report. |
• | In the first six months of 2006, the U.S. dollar was stronger against the Euro when compared to the same period in 2005. This resulted in year-over-year unfavorable foreign currency effects, which may or may not continue to trend unfavorably in the future. |
• | The effective tax rate for the first six months of 2006 was 30.5% due in part to a favorable adjustment in the second quarter primarily related to the resolution of an IRS exam for the periods of 2002 – 2003. 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. |
Outlook
In 2006 and beyond, our operating objectives include the following:
• | Continue to drive for operating excellence through PIMS: lean enterprise initiatives, supply management practices, and cash flow management; |
• | Continue the integration of acquisitions and realize identified synergistic opportunities; |
• | Continue proactive talent management process building competencies in international management and other key functional areas; |
• | Achieve organic sales growth (in excess of market growth), particularly in international markets; and |
• | Continue to make strategic acquisitions to grow and expand our existing platforms in our Water and Technical Products Groups. |
22
Table of Contents
RESULTS OF OPERATIONS
Net sales
Consolidated net sales and the change from the prior year period were as follows:
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||||||||||||||||||
In thousands | 2006 | 2005 | $ change | % change | 2006 | 2005 | $ change | % change | ||||||||||||||||||||||||
Net sales | $ | 862,022 | $ | 788,523 | $ | 73,499 | 9.3 | % | $ | 1,633,411 | $ | 1,498,158 | $ | 135,253 | 9.0 | % | ||||||||||||||||
The components of the net sales change in 2006 from 2005 were as follows:
% Change from 2005 | ||||||||
Percentages | Second quarter | Six months | ||||||
Volume | 7.6 | 7.5 | ||||||
Price | 1.6 | 2.0 | ||||||
Currency | 0.1 | (0.5 | ) | |||||
Total | 9.3 | 9.0 | ||||||
Consolidated net sales
The 9.3 percent and the 9.0 percent increases in consolidated net sales in the second quarter and the first half, respectively, of 2006 from 2005 were primarily the result of:
• | an increase in sales volume due to our acquisitions, primarily the December 1, 2005 acquisition of the McLean Thermal Management, Aspen Motion Technologies, and Electronic Solutions businesses from APW, Ltd. (collectively, “Thermal”); and |
• | organic sales growth of approximately 4.5 percent (excluding the effects of acquisitions and foreign currency exchange), which includes selective increases in selling prices to mitigate inflationary cost increases. |
These increases were partially offset by:
• | unfavorable foreign currency effects in the first three months of 2006 as the stronger U.S. dollar decreased the U.S. dollar value of sales denominated in foreign currencies. |
Net sales by segment and the change from the prior year period were as follows:
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||||||||||||||||||
In thousands | 2006 | 2005 | $ change | % change | 2006 | 2005 | $ change | % change | ||||||||||||||||||||||||
Water | $ | 605,516 | $ | 585,657 | $ | 19,859 | 3.4 | % | $ | 1,122,685 | $ | 1,097,745 | $ | 24,940 | 2.3 | % | ||||||||||||||||
Technical Products | 256,506 | 202,866 | 53,640 | 26.4 | % | 510,726 | 400,413 | 110,313 | 27.5 | % | ||||||||||||||||||||||
Total | $ | 862,022 | $ | 788,523 | $ | 73,499 | 9.3 | % | $ | 1,633,411 | $ | 1,498,158 | $ | 135,253 | 9.0 | % | ||||||||||||||||
Water
The 3.4 percent and the 2.3 percent increases in Water segment net sales in the second quarter and first half, respectively, of 2006 from 2005 were primarily result of:
• | organic sales growth of approximately 3 percent (excluding foreign currency exchange) which includes selective increases in selling prices to mitigate inflationary cost increases: |
• | strong pump sales in our commercial, municipal, and residential markets; | ||
• | increased sales of pool products driven by new products along with sales increases in filtration reflecting strong industrial sales; and | ||
• | a strong sales performance in Asia. |
23
Table of Contents
These increases were partially offset by:
• | lower sales of spa and bath products as well as in the residential and original equipment manufacturer (OEM) filtration markets; and |
• | unfavorable foreign currency effects in the first three months of 2006. |
Technical Products
The 26.4 percent and 27.5 percent increases in Technical Product segment net sales in the second quarter and first half, respectively, of 2006 from 2005 were primarily the result of:
• | an increase in sales volume primarily due to our December 1, 2005 acquisition of the Thermal businesses; |
• | organic sales growth of approximately 7 percent and 10 percent for the second quarter and first half of 2006, respectively, (excluding acquisitions and foreign currency exchange) which includes selective increases in selling prices to mitigate inflationary cost increases: |
• | market share gain in our targeted markets for petrochemical, food & beverage, and commercial construction driven by new products and focused vertical market efforts; and | ||
• | higher sales in Asia driven by continued market penetration in China and continued market recovery in Japan. |
These increases were partially offset by:
• | unfavorable foreign currency effects for the first three months of 2006. |
Gross profit
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
July 1 | % of | July 2 | % of | July 1 | % of | July 2 | % of | |||||||||||||||||||||||||
In thousands | 2006 | sales | 2005 | sales | 2006 | sales | 2005 | sales | ||||||||||||||||||||||||
Gross profit | $ | 262,689 | 30.5 | % | $ | 235,233 | 29.8 | % | $ | 485,197 | 29.7 | % | $ | 439,371 | 29.3 | % | ||||||||||||||||
Percentage point change | 0.7pts | 0.4 pts |
The 0.7 and 0.4 percentage point increases in gross profit as a percentage of sales in the second quarter and first half, respectively, of 2006 from 2005 were primarily the result of:
• | selective increases in selling prices in our Water and Technical Products Groups to mitigate inflationary cost increases; |
• | savings generated from our PIMS initiatives including lean and supply management practices; and |
• | cost leverage from our increase in sales volume. |
These increases were offset by:
• | inflationary increases related to material, labor and freight costs; |
• | anticipated inefficiencies resulting from plant and product line moves in the Water Group; and |
• | lower margins due to unfavorable product mix (primarily in the Water Group). |
Selling, general and administrative (SG&A)
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
July 1 | % of | July 2 | % of | July 1 | % of | July 2 | % of | |||||||||||||||||||||||||
In thousands | 2006 | sales | 2005 | sales | 2006 | sales | 2005 | sales | ||||||||||||||||||||||||
SG&A | $ | 139,831 | 16.2 | % | $ | 117,467 | 14.9 | % | $ | 268,920 | 16.5 | % | $ | 238,092 | 15.9 | % | ||||||||||||||||
Percentage point change | 1.3pts | 0.6 pts |
24
Table of Contents
The 1.3 and 0.6 percentage point increases in SG&A expense as a percent of sales in the second quarter and first half, respectively, of 2006 from 2005 were primarily the result of:
• | higher selling, general and administrative expense to fund investments in future growth in all markets in our Water Group, with emphasis on growth in the international markets, including personnel and business infrastructure investments; |
• | reorganization costs in our Water Group; |
• | an increase in amortization expense related to the intangible assets from the Thermal acquisition; and |
• | a write-down of a tax-related investment. |
These increases were partially offset by:
• | cost leverage from our increase in sales volume in the Technical Products Group. |
Research and development (R&D)
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
July 1 | % of | July 2 | % of | July 1 | % of | July 2 | % of | |||||||||||||||||||||||||
In thousands | 2006 | sales | 2005 | sales | 2006 | sales | 2005 | sales | ||||||||||||||||||||||||
R&D | $ | 14,883 | 1.7 | % | $ | 10,532 | 1.3 | % | $ | 29,746 | 1.8 | % | $ | 21,959 | 1.5 | % | ||||||||||||||||
Percentage point change | 0.4pts | 0.3pts |
The 0.4 and 0.3 percentage point increases in R&D expense as a percent of sales in the second quarter and first half, respectively, of 2006 from 2005 were primarily the result of:
• | additional investments related to new product development initiatives in our Water and Technical Products Groups; and |
• | proportionately higher spending in the newly acquired Thermal businesses. |
Operating income
Water
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
July 1 | % of | July 2 | % of | July 1 | % of | July 2 | % of | |||||||||||||||||||||||||
In thousands | 2006 | sales | 2005 | sales | 2006 | sales | 2005 | sales | ||||||||||||||||||||||||
Operating income | $ | 84,191 | 13.9 | % | $ | 92,167 | 15.7 | % | $ | 139,778 | 12.5 | % | $ | 152,656 | 13.9 | % | ||||||||||||||||
Percentage point change | (1.8) pts | (1.4 | )pts |
The 1.8 and 1.4 percentage point decreases in Water segment operating income as a percent of sales in the second quarter and first half, respectively, of 2006 from 2005 were primarily the result of:
• | inflationary increases related to material, labor, and freight costs; |
• | planned investments in new products and new customers, reinforcing international talent, and implementing a unified business infrastructure in Europe; |
• | expected inefficiencies resulting from plant and product line moves; and |
• | unfavorable product mix. |
These decreases were partially offset by:
• | selective increases in selling prices to mitigate inflationary cost increases; and |
• | savings realized from continued success of PIMS, including lean and supply management activities. |
25
Table of Contents
Technical Products
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
July 1 | % of | July 2 | % of | July 1 | % of | July 2 | % of | |||||||||||||||||||||||||
In thousands | 2006 | sales | 2005 | sales | 2006 | sales | 2005 | sales | ||||||||||||||||||||||||
Operating income | $ | 39,678 | 15.5 | % | $ | 26,325 | 13.0 | % | $ | 77,382 | 15.2 | % | $ | 51,497 | 12.9 | % | ||||||||||||||||
Percentage point change | 2.5pts | 2.3 pts |
The 2.5 and 2.3 percentage point increases in Technical Products segment operating income as a percent of sales in the second quarter and first half, respectively, of 2006 from 2005 were primarily the result of:
• | leverage gained on volume expansion through market share growth; |
• | savings realized from the continued success of PIMS, including lean and supply management activities; and |
• | selective increases in selling prices to mitigate inflationary cost increases. |
These increases were partially offset by:
• | inflationary increases related to labor and freight costs. |
Gain on sale of investment
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||||||||||||||||||
In thousands | 2006 | 2005 | Difference | % change | 2006 | 2005 | Difference | % change | ||||||||||||||||||||||||
Gain on sale of investment | $ | — | $ | 5,199 | $ | (5,199 | ) | (100.0 | %) | $ | — | $ | 5,199 | $ | (5,199 | ) | (100.0 | %) | ||||||||||||||
The gain on sale of investment of $5.2 million for the three and six month periods ended July 2, 2005 represents the gain from the sale of our interest in the stock of LN Holdings Corporation.
Net interest expense
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||||||||||||||||||
In thousands | 2006 | 2005 | Difference | % change | 2006 | 2005 | Difference | % change | ||||||||||||||||||||||||
Net interest expense | $ | 12,553 | $ | 11,696 | $ | 857 | 7.3 | % | $ | 25,837 | $ | 22,972 | $ | 2,865 | 12.5 | % | ||||||||||||||||
The 7.3 and 12.5 percentage point increases in interest expense in the second quarter and first half, respectively, of 2006 from 2005 were primarily the result of:
• | increases in interest rates and outstanding debt in 2006; and |
• | incremental interest expense related to the payments made in connection with the final resolution on the net asset value dispute with BDK in the first quarter of 2006. |
These increases were partially offset by:
• | a favorable adjustment to interest expense related to the IRS settlement in the second quarter of 2006. |
Provision for income taxes from continuing operations
Three months ended | Six months ended | |||||||||||||||
July 1 | July 2 | July 1 | July 2 | |||||||||||||
In thousands | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Income before income taxes | $ | 95,422 | $ | 100,737 | $ | 160,694 | $ | 161,547 | ||||||||
Provision for income taxes | 26,789 | 39,358 | 48,990 | 59,987 | ||||||||||||
Effective tax rate | 28.1 | % | 39.1 | % | 30.5 | % | 37.1 | % |
26
Table of Contents
The 11.0 and 6.6 percentage point decreases in the tax rate in the second quarter and first half, respectively, of 2006 from 2005 were primarily the result of:
• | a favorable settlement in the second quarter of 2006 of a routine IRS exam for the periods 2002-2003; |
• | an unfavorable settlement in the second quarter of 2005 for a routine tax exam for prior years in Germany; and |
• | a favorable adjustment in the first quarter of 2006 related to a prior year tax return. |
These decreases were partially offset by:
• | a favorable settlement in the first quarter of 2005 of a routine IRS exam for the periods 1998-2001. |
LIQUIDITY AND CAPITAL RESOURCES
Cash requirements for working capital, capital expenditures, equity investments, acquisitions, debt repayments, share repurchases, and dividend payments are generally funded from cash generated from operations, availability under existing committed revolving credit facilities, and in certain instances, public and private debt and equity offerings.
We experience seasonal changes in cash flows primarily due to seasonal demand in a number of our markets. We generally make payments on annual programs during the first quarter each year. Also, end-user demand for pool/spa equipment follows warm weather trends and is at seasonal highs from March to July. We somewhat mitigate the magnitude of the sales spike through effective use of the distribution channel by employing some advance sales programs (generally including extended payment terms and/or additional discounts). Demand for residential and agricultural water systems is also affected by weather patterns particularly related to heavy flooding and droughts.
The following table presents selected working capital measurements calculated from our monthly operating results based on a 13-month moving average:
July 1 | December 31 | July 2 | ||||||||||
Days | 2006 | 2005 | 2005 | |||||||||
Days of sales in accounts receivable | 54 | 54 | 53 | |||||||||
Days inventory on hand | 71 | 70 | 68 | |||||||||
Days in accounts payable | 56 | 56 | 56 |
Operating activities
Cash provided by operating activities was $47.2 million in the first six months of 2006 compared with cash provided by operating activities of $38.9 million in the prior year comparable period. The increase in cash provided by operating activities was primarily related to the increase in net income. The increase in days inventory on hand as of July 1, 2006 compared to December 31, 2005 was attributable to increased inventory levels to support the product moves from plant rationalizations and to meet seasonal needs. In the future, we expect our working capital ratios to improve as we are able to complete our facility rationalization activities and capitalize on our PIMS initiatives.
Investing activities
Capital expenditures in the first six months of 2006 were $20.2 million compared with $39.1 million in the prior year period. We currently anticipate that capital expenditures for fiscal 2006 will be approximately $70 to $75 million, primarily related to expansion of low cost country manufacturing facilities, implementation of a unified business systems infrastructure in Europe, selective increases in equipment capacity, new product development, and general maintenance capital.
On April 12, 2006, we acquired the assets of Geyer’s Manufacturing & Design Inc. and FTA Filtration, Inc. (together “Krystil Klear”), two privately held companies, for $15.4 million, including a cash payment of $15.0 million plus debt assumed of $0.4 million. Krystil Klear expands our industrial filtration product offering to include a full range of steel and stainless steel housing filtration solutions. In 2006, we also paid approximately $4.9 million of additional costs related to the acquisition of the Thermal businesses and other acquisitions.
Divestiture activities during 2006 relate to the following: In January 2006, 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. On March 8, 2006, we received notice regarding the settlement of an outstanding dispute with BDK regarding the net asset value 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 in March 2006. Also in March 2006, we exited a leased facility formerly used by our discontinued Service Equipment business. The net cash outflow from this transaction was $2.2 million.
Cash proceeds from the sale of property and equipment in our Water Group of $11.6 million were received during the first half of 2005, primarily related to the sale of two California facilities.
27
Table of Contents
On February 23, 2005, we acquired the 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, plus debt assumed of $0.1 million. The DEP product line addresses the water and wastewater markets and is part of our Water Group.
In April 2005, we sold our interest in the stock of LN Holdings Corporation for cash consideration of $23.6 million, resulting in a pre-tax gain of $5.2 million and an after tax gain of $3.3 million.
Financing activities
Net cash provided by financing activities was $19.6 million in the first six months of 2006 compared with $12.9 million used for financing activities in the prior year period. Financing activities included draw downs and repayments on our revolving credit facilities to fund our operations in the normal course of business, payments of dividends, repurchase of Company stock, cash received from stock option exercises, and tax benefits related to stock-based compensation.
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 July 1, 2006, we had $217.3 million of commercial paper outstanding that matures within 48 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 have $35 million of outstanding private placement debt maturing in May 2007. We classified this debt as long-term as of July 1, 2006 as we have the intent and ability to refinance such obligation on a long-term basis under the Credit Facility.
We were in compliance with all debt covenants as of July 1, 2006.
In addition to the Credit Facility, we have $25 million of uncommitted credit facilities, under which we had borrowings of $4.9 million as of July 1, 2006.
Our current credit ratings are as follows:
Rating Agency | Long-Term Debt Rating | Current Rating Outlook | ||
Standard & Poor’s | BBB | Stable | ||
Moody’s | Baa3 | Stable |
As of July 1, 2006, our capital structure consisted of $813.7 million in total indebtedness and $1,642.2 million in shareholders’ equity. The ratio of debt-to-total capital at July 1, 2006 was 33.1 percent, compared with 32.6 percent at December 31, 2005 and 32.7 percent at July 2, 2005. Our targeted debt-to-total capital ratio is approximately 40 percent. We will exceed this target ratio from time to time as needed for operational purposes and/or acquisitions.
We expect to continue to have cash requirements to support working capital needs and capital expenditures, to pay interest and service debt, and to pay dividends to shareholders. In order to meet these cash requirements, we intend to use available cash and internally generated funds, and to borrow under our committed and uncommitted credit facilities.
Any adverse judgment in the Horizon litigation discussed in Part II, Item 1 of this Form 10-Q could increase our indebtedness or reduce cash available for other uses. Any such payment could impact our ability to execute our long-term strategic plans to their full extent, but we do not believe our ongoing financial and operational condition will be compromised.
Dividends paid in the first six months of 2006 were $28.5 million, or $0.28 per common share, compared with $26.6 million, or $0.26 per common share, in the prior year period. We have increased dividends every year for the last 30 years and expect to continue paying dividends on a quarterly basis.
There have been no material changes with respect to the contractual obligations or off-balance sheet arrangements described in our Annual Report on Form 10-K for the year ended December 31, 2005.
Other financial measures
In addition to measuring our cash flow generation or usage based upon operating, investing, and financing activities included in the consolidated statements of cash flows, we also measure our free cash flow and our conversion of net income. Free cash flow and conversion of net income are non-GAAP financial measures that we use to assess our cash flow performance, and we have a long-term goal to consistently generate free cash flow that equals or exceeds 100 percent of our net income. We believe free cash flow and conversion of net income are important measures of operating performance, because they provide our investors and us with a measurement of cash generated from operations that is available to pay dividends and repay debt. In addition, free cash flow and conversion of net income are used as a criterion to measure and pay compensation-based incentives. Our measure of free cash flow and conversion of net income may not be comparable to similarly titled measures reported by other companies. The following table is a reconciliation of free cash flow and a calculation of the conversion of net income with cash flows from continuing and discontinued operating activities:
28
Table of Contents
Six months ended | ||||||||
July 1 | July 2 | |||||||
In thousands | 2006 | 2005 | ||||||
Net cash provided by operating activities | $ | 47,194 | $ | 38,935 | ||||
Capital expenditures | (20,217 | ) | (39,077 | ) | ||||
Proceeds from sale of property and equipment | 221 | 11,553 | ||||||
Free cash flow | 27,198 | 11,411 | ||||||
Net income | 110,253 | 101,560 | ||||||
Conversion of net income | 24.7 | % | 11.2 | % | ||||
In 2006, we are targeting free cash flow of approximately $200 million .
NEW ACCOUNTING STANDARDS
See Note 2 (New Accounting Standards) of ITEM 1.
CRITICAL ACCOUNTING POLICIES
In our Annual Report on Form 10-K for the year ended December 31, 2005, we identified the critical accounting policies which affect our more significant estimates and assumptions used in preparing our consolidated financial statements. We have not changed these policies from those previously disclosed in our Annual Report.
29
Table of Contents
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in our market risk during the six months ended July 1, 2006. For additional information, refer to Item 7A of our 2005 Annual Report on Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES
(a) | Evaluation of Disclosure Controls and Procedures | |
We maintain a system of disclosure controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements and other disclosures included in this report. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter ended July 1, 2006 pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon their evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the quarter ended July 1, 2006 to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms, and to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosures. | ||
(b) | Changes in Internal Controls | |
There was no change in our internal control over financial reporting that occurred during the quarter ended July 1, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. |
30
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
Pentair, Inc.
We have reviewed the accompanying condensed consolidated balance sheets of Pentair, Inc. and Subsidiaries (the “Company”) as of July 1, 2006 and July 2, 2005, the related condensed consolidated statements of income for the three and six-month periods ended July 1, 2006 and July 2, 2005 and cash flows for the six-month periods ended July 1, 2006 and July 2, 2005. These interim financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2005, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated February 27, 2006, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2005 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
August 4, 2006
August 4, 2006
31
Table of Contents
PART II OTHER INFORMATION
Item 1. Legal Proceedings
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. 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 cruise ship, and allegations that the spa and filters contained Legionnaire’s disease bacteria that infected certain passengers on cruises from April 1994 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. All of the personal injury cases have now been resolved through either settlement or trial.
The only remaining unresolved claims in this case were 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. On June 28, 2006, the jury returned a verdict against the Essef defendants in the total amount of $193 million for its claims for out-of-pocket expenses ($10.4 million), lost profits ($47.6 million) and loss of business enterprise value ($135 million). The verdict is exclusive of pre-judgment interest and attorneys’ fees. We believe that the jury verdict is not consistent with the law nor the evidence offered at trial. We intend to argue all appropriate post-trial motions, or if unsuccessful to appeal any subsequent judgment, to reverse or substantially reduce this verdict, in particular the claims relating to lost profits and lost enterprise value.
We have assessed the impact of the verdict on our previously established reserves for this matter and based on the information available at this time, have deemed it unnecessary to adjust our reserves. First, several issues have not been addressed by the court, including whether Celebrity is entitled to recovery of its attorneys’ fees and related costs in the passenger claims phase of the case ($4.1 million), and, with respect to pre-judgment interest, the length of the interest period and the rate of interest on any eventual judgment. In addition, the court has not decided Essef’s contribution claim to reduce Celebrity’s recovery by 30% to account for its contributory negligence. Second we believe that we will ultimately be successful in obtaining substantial relief from this misguided verdict. While we are not able to determine the amount of the eventual liability at this time, we believe that an appropriate result would be substantially less than the verdict the jury rendered. As a result, we are maintaining our accruals at the same level as before, which we believe are within the range of reasonable outcomes for this case.
If judgment were subsequently entered on this verdict and upheld on appeal as it currently stands, which we believe is unlikely to occur for the reasons noted above, the interest incurred through June 2006 would range from approximately $75 to $171 million, depending on interest rate and interest period used. In this worst case situation, the gross amount that we would have pay in this matter would then total from $268 to $364 million. While we believe the majority of the amount would be tax-deductible in the year paid or in subsequent years, we are still analyzing the tax impact of a loss of that magnitude. In addition to the impact of a loss on this matter on our earnings per share when recognized, we would also need eventually to borrow funds from our banks or other sources to pay any judgment finally determined after exhaustion of all appeals. We expect that we would have available adequate funds to allow us to do so, based on discussions with our lending sources and our estimates of the results of our business operations over the next two years.
During the period prior to final determination and payment of any ultimate recovery to Celebrity, we believe that we will be able to operate in the normal course of business, although interim acquisition plans and other discretionary spending may be reduced. Any final judgment paid would also increase our indebtedness or reduce cash available for other uses. Any such payment could impact our ability to execute our long-term strategic plans to their full extent, but we do not believe our ongoing financial and operational condition will be compromised.
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.
Item 1A. Risk Factors
The risks relating to the Horizon Litigation and jury verdict are set forth in Part II, Item 1 of this Quarterly Report on Form 10-Q. There have been no other material changes from the risk factors previously disclosed in Item 1A. of our 2005 Annual Report on Form 10-K.
32
Table of Contents
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information with respect to purchases we made of our common stock during the second quarter of 2006:
(c) Total Number of | (d) | |||||||||||||||
(a) Total | (b) | Shares Purchased as | Dollar value of Shares | |||||||||||||
Number of | Average | Part of Publicly | that May Yet Be | |||||||||||||
Shares | Price Paid | Announced Plans or | Purchased Under the | |||||||||||||
Period | Purchased | per Share | Programs | Plans or Programs | ||||||||||||
April 2 – April 29, 2006 | 305 | 40.56 | — | $ | 25,000,000 | |||||||||||
April 30 – May 27, 2006 | 5,338 | 35.66 | — | $ | 25,000,000 | |||||||||||
May 28 – July 1, 2006 | 730 | 34.38 | 573,100 | $ | 6,218,158 | |||||||||||
Total | 6,373 | 573,100 | ||||||||||||||
(a) | The purchases in this column include only those shares deemed surrendered to us by participants in our Omnibus Stock Incentive Plan and the outside Directors Nonqualified Stock Option Plan (the “Plans”) to satisfy the exercise price or withholding tax obligations related to the exercise of stock options and non-vested shares. | |
(b) | The average price paid in this column includes only those shares deemed surrendered to us by participants in the Plans to satisfy the exercise price or withholding of tax obligations related to the exercise price of stock options and non-vested shares. | |
(c) | The number of shares in this column represents the number of shares repurchased as part of our publicly announced program to repurchase up to $25 million of our common stock annually. | |
(d) | In December 2004, our Board of Directors authorized a program to annually repurchase shares of our common stock up to a maximum dollar limit of $25 million per year. There is no expiration associated with the authorization granted. As of July 1, 2006, we had repurchased 573,100 shares for $18.8 million pursuant to this program and accordingly we had the authority to repurchase up to a maximum dollar limit of $6.2 million for the remainder of 2006. On July 28, 2006, our Board of Directors authorized the repurchase of up to an additional $25 million of shares of our common stock. In July 2006, we repurchased an additional 200,000 shares for $5.7 million, leaving us authorization to repurchase up to an additional $25.5 million of our common stock for the remainder of 2006. |
ITEM 4. Submission of Matters to a Vote of Security Holders
The Company’s annual meeting of shareholders was held on May 4, 2006. There were 101,620,166 shares of Common Stock entitled to vote at the meeting and a total of 88,482,540 shares (87.07%) were represented at the meeting.
Proposal 1. – Election of Directors
To elect three directors of the Company to terms expiring in 2009. Each nominee for director was elected by a vote of the shareholders as follows:
Nominees | Votes For | Votes Withheld | ||
Charles A. Haggerty | 81,757,230 | 6,725,310 | ||
Randall J. Hogan | 84,792,156 | 3,690,384 | ||
David A. Jones | 53,193,432 | 35,289,109 |
The Company’s other directors that were in office prior to the Annual Meeting of Stockholders and with terms of office that continue after the Annual Meeting of Stockholders are Glynis A. Bryan, Richard J. Cathcart, Barbara B.Grogan, Augusto Meozzi, Ronald L. Merriman, William T. Monahan and Karen E. Welke.
Proposal 2. – Ratification of Appointment of Deloitte & Touche LLP as independent registered public accounting firm of the company for 2006
To ratify the appointment of Deloitte & Touche LLP as the Company’s independent registered public accounting firm for the year ending December 31, 2006. The proposal was approved by a vote of the shareholders as follows:
Votes For | Votes Against | Abstain | Broker Non-Vote | |||
86,054,462 | 2,127,729 | 300,049 | — |
33
Table of Contents
ITEM 6. Exhibits
(a) Exhibits
15 | Letter Regarding Unaudited Interim Financial Information. | ||||
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||||
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||||
32.1 | Certification of Chief Executive Officer, Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||||
32.2 | Certification of Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
34
Table of Contents
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on August 4, 2006.
PENTAIR, INC. | ||||
Registrant | ||||
By /s/ David D. Harrison | ||||
Executive Vice President and Chief Financial Officer | ||||
(Chief Accounting Officer) |
35
Table of Contents
Exhibit Index to Form 10-Q for the Period Ended July 1, 2006
15 | Letter Regarding Unaudited Interim Financial Information | |||||
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||||
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||||
32.1 | Certification of Chief Executive Officer, Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||||
32.2 | Certification of Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
36