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(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 Boulevard,
Suite 800,
Golden Valley, Minnesota (Address of principal
executive offices)
55416-1259 (Zip
code)
Registrant’s telephone number, including area code:
(763) 545-1730
Securities registered pursuant to Section 12(b) of the
Act:
Title of each class
Name of each exchange on which
registered
Common Shares,
$0.162/3
par value
New York Stock Exchange
Preferred Share Purchase Rights
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the
Act: None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes þ
No o
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o
No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant
was required to file such reports) and (2) has been subject
to such filing requirements for the past
90 days. Yes þ
No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
PART III of this
Form 10-K
or any amendment to this
Form 10-K. þ
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).
þ Large
accelerated
filer o Accelerated
filer o Non-accelerated
filer
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the
Act). Yes o No þ
Aggregate market value of voting and non-voting common equity
held by non-affiliates of the Registrant, based on the closing
price of $42.62 per share as reported on the New York Stock
Exchange on July 2, 2005 (the last day of Registrant’s
most recently completed second quarter): $4,077,996,205
The number of shares outstanding of Registrant’s only class
of common stock on February 17, 2006 was 101,456,370.
Parts of the company’s definitive proxy statement for its
annual meeting to be held on May 4, 2006, are incorporated
by reference in this
Form 10-K
in response to Part III, ITEM 10, 11, 12 and 14.
Pentair, Inc. is 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, formerly referred to as our Enclosures Group, is
a leader in the global enclosures market, designing and
manufacturing standard, modified and custom enclosures that
house and protect sensitive electronics and electrical
components; thermal management products; and accessories.
Pentair
Strategy
Our basic operating strategies include:
•
The Pentair Integrated Management System (PIMS) consisting of
strategy deployment, lean enterprise, and IGNITE, which is our
process to drive organic growth;
•
long-term growth in sales, income and cash flows, driven by
internal growth initiatives and acquisitions;
•
new product development and ongoing product enhancement;
•
focus on attractive growth markets, particularly international;
•
multi-channel distribution; and
•
proactive portfolio management of our businesses, including
consideration of new business platforms.
Pentair
Financial Objectives
Our long-term financial objectives are to:
• Achieve 5-8% organic
sales growth, plus acquisitions
• Achieve benchmark
financial performance:
•
EBIT Margin
14%
•
Return on Invested Capital
(ROIC)(pre-tax)
20%
•
Free Cash Flow (FCF)
100% conversion of net income
•
EPS Growth
10+% (sales growth plus margin
expansion)
•
Debt/Total Capital
£40%
• Achieve 5% annual
productivity improvement on core business cost
Unless the context otherwise indicates, references herein to
“Pentair”, the “Company,” and such words as
“we,”“us,” and “our” include
Pentair, Inc. and its subsidiaries. Pentair is a Minnesota
corporation incorporated in 1966.
BUSINESS
AND PRODUCTS
WATER
GROUP
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 Water Group offers a broad
array of products and systems to multiple markets and customers.
We have identified a target water industry totaling
$50 billion,
with our current primary focus on three markets: Pump
(approximately 40% of segment sales), Pool & Spa
(approximately 30% of segment sales), and Filtration
(approximately 30% of segment sales).
Pump
Market
We address the Pump market with products ranging from light duty
diaphragm pumps to high-flow turbine pumps and solid handling
pumps designed for water and wastewater applications, and
agricultural spraying, as well as pressure tanks for residential
applications. Applications for our broad range of products
include pumps for residential and municipal wells, water
treatment, wastewater solids handling, pressure boosting, engine
cooling, fluid delivery, circulation, and transfer.
Brand names for the Pump market include
STA-RITE®,
Myers®,
Flotec®,
Aurora®,
Hypro®,
Hydromatic®,
Fairbanks
Morse®,
Berkeley®,
Aermotortm,
Water
Ace®,
Layne &
Bowler®,
Simer®,
Verti-line®,
Sherwood®,
SherTech®,
Diamond®,
FoamPro®,
Ongatm,
Nocchitm,
Shur-Dri®,
SHURflo®,
and
Edwards®.
Pool &
Spa Market
We address the Pool & Spa market with a complete line
of commercial and residential pool/spa equipment and accessories
including pumps, filters, heaters, lights, automatic controls,
automatic pool cleaners, commercial deck equipment, barbeque
deck equipment, aquatic pond products and accessories, pool tile
and interior finishing surfaces, maintenance equipment,
spa/jetted tub hydrotherapy fittings, and pool/spa accessories.
Applications for our pool products include commercial and
residential pool and spa construction, maintenance, repair,
service, and retail.
Brand names for the Pool & Spa market include Pentair
Pool
Products®,
Pentair Water Pool and
Spatm,
National Pool Tile
Group®,
Pentair
Aquatics®,
STA-RITE®,
Paragon
Aquatics®,
Pentair Spa &
Bathtm,
Kreepy
Krauly®,
Compool®,
WhisperFlo®,
PoolShark®,
Legendtm,
Rainbowtm,
Ultra
Jet®,
Vico®,
FIBERworks®,
and
IntelliTouchtm.
Filtration
Market
We address the Filtration market with control valves, filtration
components, tanks, pressure vessels, and specialty dispensing
pumps providing flow solutions for specific end-user market
applications including residential, commercial, foodservice,
recreation vehicles, marine, and aviation. Filtration products
are used in the manufacture of water softeners; filtration,
deionization, and desalination systems; and industrial and
residential water filtration applications.
Brand names for the Filtration market include
Fleck®,
SIATAtm,
CodeLine®,
Structuraltm,
WellMatetm,
American
Plumber®,
Armor®,
Everpure®,
Pentek®,
OMNIFILTER®,
Park
Internationaltm,
SHURflo®,
and
Fibredynetm.
Customers
Our Water Group distributes its products through wholesale
distributors, retail distributors, original equipment
manufacturers, and home centers. Information regarding
significant customers in our Water Group is contained in
ITEM 8, Note 14 of the Notes to Consolidated Financial
Statements, included in this
Form 10-K.
Seasonality
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 impacted by weather patterns particularly
related to heavy flooding and droughts.
Our Water Group faces numerous domestic and international
competitors, some of which have substantially greater resources.
Consolidation, globalization, and outsourcing are continuing
trends in the water industry. Competition in commercial and
residential pump markets focuses on brand names, product
performance, quality, and price. While home center and national
retailers are important for residential lines of water and
wastewater pumps, they are much less important for commercial
pumps. For municipal pumps, competition focuses on performance
to meet required specifications, service, and price. Competition
in water treatment and filtration components focuses on product
performance and design, quality, delivery, and price. For pool
and spa equipment, there are a significant number of
competitors. We compete by offering a wide variety of innovative
and high-quality products, which are competitively priced. We
believe our distribution channels and reputation for quality
also contribute to our continuing industry penetration.
TECHNICAL
PRODUCTS GROUP
Our Technical Products Group, formerly referred to as our
Enclosures 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. We have identified a target market in excess of
$30 billion. Our Technical Products Group focuses its
business portfolio on four primary industries:
Commercial & Industrial (55% of segment sales), Telecom
and Datacom (25% of segment sales), Electronics (15% of segment
sales), and Networking (5% of segment sales). The primary brand
names for the Technical Products Group are:
Hoffman®,
Schroff®,
Pentair Electronic
Packagingtm,
and
Taunustm.
The thermal businesses we acquired in December 2005 go to market
under four brand names:
McLean®,
Electronic
Solutionstm,
Birtchertm,
and Aspen
Motiontm.
Products and related accessories of the Technical Products Group
include metallic and composite enclosures, cabinets, cases,
subracks, backplanes, heat exchangers, and blowers. Applications
served include industrial machinery, data communications,
networking, telecommunications, test and measurement,
automotive, medical, security, defense, and general electronics.
Customers
Our Technical Products Group distributes its products through
original equipment manufacturers, electrical and data
contractors, and electrical and electronic components
distributors. Information regarding significant customers in our
Technical Products Group is contained in ITEM 8,
Note 14 of the Notes to Consolidated Financial Statements,
included in this
Form 10-K.
Seasonality
Our Technical Products Group is not significantly impacted by
seasonal demand fluctuations.
Competition
Competition in the technical products markets can be intense,
particularly in telecom and datacom markets, where product
design, prototyping, global supply, price competition, and
customer service are significant factors. Our Technical Products
Group has continued to focus on cost control and improving
profitability on a sequential quarter to quarter basis. Recent
growth in the Technical Products Group is a result of continued
channel penetration, growth in targeted market segments, new
product development, geographic expansion, acquisitions, and
overall market growth. Consolidation, globalization, and
outsourcing are visible trends in the technical products
marketplace and typically play to the strengths of a large and
globally positioned supplier. We believe our Technical Products
Group has the broadest array of enclosures products available
for commercial and industrial uses.
Business segment and geographical financial information is
contained in ITEM 8, Note 14 of the Notes to
Consolidated Financial Statements, included in this
Form 10-K.
We continually look at each of our businesses to determine
whether they fit with our evolving strategic vision. Our primary
focus is on businesses with strong fundamentals and growth
opportunities, especially in international markets. We seek
growth through product and service innovation, market expansion,
and acquisitions. Acquisitions have played an important part in
the growth of our business, and we expect acquisitions will
continue to be an important part of our growth in the future.
Acquisitions
On December 1, 2005, we acquired McLean Thermal Management,
Aspen Motion Technologies, and Electronic Solutions businesses
from APW, Ltd. (collectively, “Thermal”) for
$140.0 million, including a cash payment of
$138.9 million and transaction costs of $1.1 million.
These businesses provide thermal management solutions and
integration services to the telecommunications, data
communications, medical, 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. Preliminary estimates of identifiable
intangible assets acquired as part of the acquisition were
$18.9 million, including definite-lived intangibles, such
as proprietary technology and customer relationships, of
$9.8 million with a weighted average amortization period of
10.0 years. We continue to evaluate the purchase price
allocation for the Thermal acquisition, including intangible
assets, contingent liabilities, plant rationalization costs, and
property, plant and equipment. We expect to revise the purchase
price allocation as better information becomes available in 2006.
On February 23, 2005, we acquired certain assets of Delta
Environmental Products, Inc. and affiliates (collectively,
“DEP”), a privately-held company, for
$10.3 million, including a cash payment of
$10.0 million, transaction costs of $0.2 million, and
debt assumed of $0.1 million. The DEP product line
addresses the water and wastewater markets and is part of our
Water Group. Goodwill recorded as part of the initial purchase
price allocation was $9.3 million, all of which is tax
deductible.
Effective July 31, 2004, we completed the acquisition of
all of the shares of capital stock of WICOR, Inc.
(“WICOR”) from Wisconsin Energy Corporation
(“WEC”) for $874.7 million, including a cash
payment of $871.1 million, transaction costs of
$11.2 million, and debt assumed of $21.6 million, less
a favorable final purchase price adjustment of
$14.0 million and less cash acquired of $15.2 million.
This includes an additional $0.4 million in transaction
costs recorded in the first three quarters of 2005. WICOR
manufactures water system, filtration, and pool equipment
products primarily under the
STA-RITE®,
SHURflo®
and
Hypro®
brands.
On December 31, 2003, we acquired all of the common stock
of Everpure, Inc. (“Everpure”), from United States
Filter Corporation, a unit of Veolia Environnement, for
$218.9 million in cash, less cash acquired of
$5.5 million and transaction costs of $2.2 million.
Everpure is a leading global provider of water filtration
products for the commercial and consumer sectors.
During 2003, we also completed four product line acquisitions in
our Water Group for total consideration of $21.4 million in
cash including transaction costs: Hydrotemp Manufacturing Co.,
Inc., Letro Products, Inc. and certain assets of TwinPumps,
Inc., and K&M Plastics, Inc.
Also refer to ITEM 7, Management’s Discussion and
Analysis, and ITEM 8, Note 2 of the Notes to
Consolidated Financial Statements, included in this
Form 10-K.
Discontinued
Operations/Divestitures
Effective after the close of business October 2, 2004, we
completed the sale of our former Tools Group to The
Black & Decker Corporation (“BDK”) for
approximately $796.8 million in cash, including a
$21.8 million interim net asset value increase, subject to
post-closing adjustments. The Tools Group was comprised of the
Porter-Cable®,
Delta®,
DeVilbiss Air Power, Oldham Saw, and
FLEX®
brands, among others. We used the proceeds from the Tools Group
sale and borrowings under our credit facility to repay, on
October 4, 2004, an
$850 million bridge facility used to acquire WICOR. In the
fourth quarter of 2004, we recorded a loss on the disposal of
the Tools Group of $6.0 million, net of a tax provision of
$9.0 million. In July 2005, we paid $10.4 million to
BDK in purchase price adjustments related to the sale of our
former Tools Group. We currently have an outstanding dispute
with BDK over the net asset value of the Tools Group and may be
required to repay additional proceeds. We believe our accrual at
December 31, 2005 is an adequate reserve amount for any
potential liability. We expect resolution of this matter in the
first quarter of 2006.
In 2001, we completed the sale of the Service Equipment
businesses (Century Mfg. Co./Lincoln Automotive Company) to
Clore Automotive, LLC for total consideration of
$18.2 million and we completed the sale of Lincoln
Industrial to affiliates of The Jordan Company LLC (Jordan),
other investors, and members of management of Lincoln Industrial
for total consideration of $78.4 million, including the
retention of a preferred stock interest. In January 2003, we
paid $2.4 million for a final adjustment to the selling
price related to the disposition of Lincoln Industrial, which
was offset by a previously established reserve. In the fourth
quarter of 2003, we reported an additional loss from
discontinued operations of $2.9 million primarily due to a
reduction in estimated proceeds related to exiting two remaining
facilities.
Also refer to ITEM 7, Management’s Discussion and
Analysis, and ITEM 8, Note 3 of the Notes to
Consolidated Financial Statements, included in this
Form 10-K.
INFORMATION
REGARDING ALL BUSINESS SEGMENTS
Backlog
Our backlog of orders from continuing operations as of
December 31 by segment was:
The $6.9 million decrease in Water Group backlog was
primarily due to the timing of filtration and pool product
orders. The $31.4 million increase in Technical Products
Group backlog reflects the acquisition of the thermal management
businesses from APW, as well as order growth in the Group’s
Asian businesses, particularly China. Due to the relatively
short manufacturing cycle and general industry practice,
backlog, which typically represents approximately 30 days
of shipments, is not deemed to be a significant item for our
business. A substantial portion of our revenues result from
orders received and product sold in the same month. We expect
that most of our backlog at December 31, 2005 will be
filled in 2006.
Research
and Development
We conduct research and development activities in our own
facilities, which consist primarily of the development of new
products, product applications, and manufacturing processes.
Research and development expenditures during 2005, 2004, and
2003 were $46.0 million, $31.5 million, and
$22.9 million, respectively.
Environmental
Environmental matters are discussed in ITEM 3, ITEM 7,
and in ITEM 8, Note 15 of the Notes to Consolidated
Financial Statements, included in this
Form 10-K.
Raw
Materials
The principal materials used in the manufacturing of our
products are electric motors, mild steel, stainless steel,
electronic components, plastics (resins, fiberglass, epoxies),
and paint (powder and liquid). In addition to the purchase of
raw materials, we purchase some finished goods for distribution
through our sales channels.
The materials used in the various manufacturing processes are
purchased on the open market, and the majority are available
through multiple sources and are in adequate supply. We have not
experienced any significant work stoppages to-date due to
shortages of materials. We have certain long-term commitments,
principally price commitments, for the purchase of various
component parts and raw materials and believe that it is
unlikely that any of these agreements would be terminated
prematurely. Alternate sources of supply at competitive prices
are available for most materials for which long-term commitments
exist, and we believe that the termination of any of these
commitments would not have a material adverse effect on
operations.
Certain commodities, such as steel and resin, are subject to
market and duty-driven price fluctuations. We manage these
fluctuations through several mechanisms, including long-term
agreements with
escalator/de-escalator
clauses. Prices for raw materials, such as steel, carbon, and
resins, may continue to trend higher in the future.
Intellectual
Property
Patents, non-compete agreements, proprietary technologies,
customer relationships, trade marks, trade names, and brand
names are important to our business. However, we do not regard
our business as being materially dependent upon any single
patent, non-compete agreement, proprietary technology, customer
relationship, trade mark, trade name, or brand name.
Patents, patent applications, and license agreements will expire
or terminate over time by operation of law, in accordance with
their terms or otherwise. We do not expect the termination of
patents, patent applications, and license agreements to have a
material adverse effect on our financial position, results of
operations or cash flows.
Employees
As of December 31, 2005, Pentair, Inc. and its subsidiaries
employed an aggregate of approximately 14,700 people worldwide.
Total employees in the United States were approximately 10,700,
of whom approximately 900 are represented by six different trade
unions having collective bargaining agreements. Generally, labor
relations have been satisfactory.
Captive
Insurance Subsidiary
We insure general and product liability, property, workers’
compensation, and automobile liability risks through our
regulated wholly-owned captive insurance subsidiary, Penwald
Insurance Company (Penwald). Reserves for policy claims are
established based on actuarial projections of ultimate losses.
Accruals with respect to liabilities insured by third parties,
such as liabilities retained from acquired businesses,
pre-1992
liabilities and those of certain foreign operations, are
established without regard to the availability of insurance.
Matters pertaining to Penwald are discussed in ITEM 3 and
ITEM 8, Note 1 of the Notes to Consolidated Financial
Statements, included in this
Form 10-K.
Available
Information
We make available free of charge (other than an investor’s
own Internet access charges) through our Internet website
(http://www.pentair.com) our Annual Report on
Form 10-K,
Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K,
and if applicable, amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 as soon as reasonably
practicable after we electronically file such material with, or
furnish it to, the Securities and Exchange Commission. Reports
of beneficial ownership filed by our directors and executive
officers pursuant to Section 16(a) of the Securities
Exchange Act of 1934 are also available on our website. We are
not including the information contained on our website as part
of, or incorporating it by reference into, this Annual Report on
Form 10-K.
You should carefully consider the following risk factors and
warnings before making an investment decision. If any of the
risks described below actually occur, our business, financial
condition, results of operations or prospects could be
materially adversely affected. In that case, the price of our
securities could decline and you could lose all or part of your
investment. You should also refer to the other information set
forth in this document.
Demand
for our products will be affected by general economic
conditions.
Demand for our residential and commercial products is influenced
by many economic conditions, including but not limited to new
construction activity and the level of repair and remodeling
activity. The level of new construction and repair and
remodeling activity is affected by a number of factors beyond
our control, such as the overall strength of the economy
(including confidence in the economy by our customers), the
strength of the residential and commercial real estate markets,
institutional building activity, the age of existing housing
stock, unemployment rates, availability of consumer financing
and interest rates. Any declines in new housing or commercial
construction starts or demand for replacement building and home
improvement products may adversely impact us, and there can be
no assurance that any such adverse effects would not be material
and would not continue for an indeterminate period of time.
Further, while we attempt to minimize our exposure to economic
or market fluctuations by serving a balanced mix of end markets
and geographic regions, we cannot assure you that a significant
or sustained downturn in a specific end market or geographic
region would not have a material adverse effect on us.
Our
businesses operate in highly competitive markets, so we may be
forced to cut prices or to incur additional costs.
Our businesses generally face substantial competition in each of
their respective markets. Competition may force us to cut prices
or to incur additional costs to remain competitive. We compete
on the basis of product design, quality, availability,
performance, customer service and price. Present or future
competitors may have greater financial, technical or other
resources which could put us at a disadvantage in the affected
business or businesses. We cannot assure you that these and
other factors will not have a material adverse effect on our
results of operations.
Our
inability to sustain consistent organic growth could adversely
affect our financial performance.
In 2005, our organic growth was generated in part from expanding
international sales, entering new distribution channels, and
introducing new products. To grow more rapidly than our end
markets, we will have to continue to expand our geographic
reach, further diversify our distribution channels, continue to
introduce new products, and increase sales of existing products
to our customer base. We may not be able to successfully meet
those challenges, which could adversely affect our ability to
sustain consistent organic growth. If we are unable to sustain
consistent organic growth, we will be less likely to meet our
stated revenue growth targets, which could adversely affect our
net income growth, and, in turn, the market price of our stock.
Our
inability to complete or successfully complete and integrate
acquisitions could adversely affect our financial
performance.
A significant percentage of our net sales growth in 2005 and
2004 was generated as a result of acquisitions completed during
those periods, including our acquisition of WICOR and Everpure.
We may not be able to sustain this level of growth from
acquisition activity in the future. We intend to continue to
evaluate strategic acquisitions primarily in our current
business segments, and we may consider acquisitions outside of
these segments as well. Our ability to expand through
acquisitions is subject to various risks, including the
following:
•
increased competition for acquisitions, especially in the water
industry;
lack of suitable acquisition candidates in targeted product or
market areas;
•
diversion of management time and attention to acquisitions and
acquired businesses;
•
inability to integrate acquired businesses effectively or
profitably; and
•
inability to achieve anticipated synergies or other benefits
from acquisitions.
Acquisitions could have a material adverse effect on our
operating results, particularly in the fiscal quarters
immediately following the acquisitions, while we attempt to
integrate operations of the acquired businesses into our
operations. Once integrated, acquired operations may not achieve
the levels of profitability originally anticipated.
Material
cost inflation could adversely affect our results of
operations.
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, resins, ocean freight and fuel, health care and
insurance. We also are continuing to implement our excellence in
operations initiatives in order to continuously reduce our
costs. We cannot assure you, however, that these actions will be
successful to manage our costs or increase our productivity.
Continued cost inflation or failure of our initiatives to
generate cost savings or improve productivity may negatively
impact our results of operations.
Seasonality
of sales and weather conditions may adversely affect our
financial results.
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 advance sales
programs (generally including extended payment terms
and/or
additional discounts). Demand for residential and agricultural
water systems is also impacted by water patterns particularly
related to heavy flooding and droughts. We cannot assure you
that seasonality and weather conditions will not have a material
adverse effect on our results of operations.
Intellectual
property challenges may hinder product development and
marketing.
Patents, non-compete agreements, proprietary technologies,
customer relationships, trade marks, trade names, and brand
names are important to our business. Intellectual property
protection, however, may not preclude competitors from
developing products similar to ours or from challenging our
names or products. Over the past few years, we have noticed an
increasing tendency for participants in our markets to use
conflicts over and challenges to intellectual property as a
means to compete. Patent and trademark challenges increase our
costs to develop, engineer and market our products.
Our
results of operations may be negatively impacted by
litigation.
Our business exposes us to potential litigation, especially
product liability suits that are inherent in the design,
manufacture, and sale of our products. While we currently
maintain what we believe to be suitable product liability
insurance, we cannot be assured that we will be able to maintain
this insurance on acceptable terms or that this insurance will
provide adequate protection against potential liabilities. In
addition, we self-insure a portion of product liability claims.
A series of successful claims against us could materially and
adversely affect our product reputation and our financial
condition, results of operations, and cash flows.
We may
be required to make payments in respect of businesses that we
have sold.
We have sold a number of businesses over the last ten years,
including the sale of our former Tools Group to BDK in October
2004. In this and other dispositions, we typically agree to
indemnify the buyers with respect to certain matters relating to
the businesses that we have sold, and we may from time to time
be required to make payments to the buyers under those
indemnities. To the extent we are required to make any
such payments in the future, those payments could be
substantial, which could require us to borrow additional amounts
at unfavorable borrowing terms and cause a significant decrease
in our liquidity, both of which could severely harm our business.
The
availability and cost of capital could have a negative impact on
our continued growth.
Our plans to continue our growth in our chosen markets will
require additional capital for future acquisitions, capital
expenditures for existing businesses, growth of working capital,
and continued international and regional expansion. In the past,
we have financed our growth primarily through debt financings.
Any significant future acquisitions will require us to expand
our debt financing resources or to issue equity securities. Our
financial results may be adversely affected if interest costs
under our debt financings are higher than the income generated
by acquisitions or other internal growth. In addition, future
acquisitions could be dilutive to your equity investment if we
issue additional stock to fund acquisitions. We cannot be
assured that we will be able to issue equity securities or to
obtain future debt financing at favorable terms. Without
sufficient financing, we will not be able to pursue our growth
strategy, which will limit our growth and revenues in the future.
Our
international operations are subject to foreign market and
currency fluctuation risks.
We expect the percentage of sales outside of North America to
increase in the future. Over the past few years, the economies
of many of the foreign countries in which we do business have
had slower growth than the U.S. economy. The European Union
currently accounts for the majority of our foreign sales and
income. Our most significant European market is Germany, where
the capital goods market has been very slow. We cannot predict
how changing European market conditions will impact our
financial results.
We are also exposed to the risk of fluctuation of foreign
currency exchange rates which may affect our financial results.
As of December 31, 2005, we held immaterial positions in
foreign exchange-forward contracts.
We are
exposed to political, economic and other risks that arise from
operating a multinational business.
Sales outside of North America, including export sales from
North American businesses, accounted for approximately 22% of
our net sales in 2005. Further, certain of our businesses obtain
raw materials and finished goods from foreign suppliers.
Accordingly, our business is subject to the political, economic
and other risks that are inherent in operating in numerous
countries. These risks include:
•
the difficulty of enforcing agreements and collecting
receivables through foreign legal systems;
•
trade protection measures and import or export licensing
requirements;
•
tax rates in certain foreign countries that exceed those in the
U.S. and the imposition of withholding requirements on foreign
earnings;
•
the imposition of tariffs, exchange controls or other
restrictions;
•
difficulty in staffing and managing widespread operations and
the application of foreign labor regulations;
•
the protection of intellectual property in foreign countries may
be more difficult;
•
required compliance with a variety of foreign laws and
regulations; and
•
changes in general economic and political conditions in
countries where we operate, particularly in emerging markets.
Our business success depends in part on our ability to
anticipate and effectively manage these and other risks. We
cannot assure you that these and other factors will not have a
material adverse effect on our international operations or on
our business as a whole.
We are
exposed to potential environmental liabilities and
litigation.
Compliance with environmental regulations could require us to
discharge environmental liabilities, increase the cost of
manufacturing our products or otherwise adversely affect our
business, financial condition and results of operations. We are
subject to federal, state, local and foreign laws and
regulations governing public and worker health and safety and
the indoor and outdoor environment. Any violations of these laws
by us could cause us to incur unanticipated liabilities that
could harm our operating results and cause our business to
suffer. We are also required to comply with various
environmental laws and maintain permits, some of which are
subject to discretionary renewal from time to time, for many of
our businesses, and we could suffer if we are unable to renew
existing permits or to obtain any additional permits that we may
require.
We have been named as defendants, targets, or potentially
responsible parties (PRPs) in a number of environmental
clean-ups relating to our current or former business units. We
have disposed of a number of businesses over the last ten years
and, in certain cases, we have retained responsibility and
potential liability for certain environmental obligations. We
have received claims for indemnification from certain
purchasers. We may be named as a PRP at other sites in the
future for existing business units, as well as both divested and
acquired businesses.
We cannot ensure that environmental requirements will not change
or become more stringent over time or that our eventual
environmental
clean-up
costs and liabilities will not exceed the amount of our current
reserves.
Anti-takeover provisions in our charter documents, under
Minnesota law and in our shareholder rights plan could prevent
or delay transactions that our shareholders may favor.
Our Restated Articles of Incorporation and Bylaws include
provisions relating to the election, appointment and removal of
directors, as well as shareholder notice and shareholder voting
requirements which could delay, prevent or make more difficult a
merger, tender offer, proxy contest or other change of control.
In addition, our common share purchase rights could cause
substantial dilution to a person or group that attempts to
acquire us, which could deter some acquirers from making
takeover proposals or tender offers. Also, the Minnesota
Business Corporations Act contains control share acquisition and
business combination provisions which could delay, prevent or
make more difficult a merger, tender offer, proxy contest or
other change of control. Our shareholders might view any such a
transaction as being in their best interests since the
transaction could result in a higher stock price than the
current market price for our common stock.
Item 1B.
Unresolved
Staff Comments
None.
Item 2.
Properties
Our principal executive office is in leased premises located in
Golden Valley, Minnesota. Our Water Group manufacturing
operations are carried out at approximately 25 plants located
throughout the United States and at 22 plants located in 11
other countries. In addition, our Water Group has 54
distribution facilities and 17 sales offices located in numerous
countries throughout the world. Our Technical Products Group
operations are carried out at approximately 8 plants located
throughout the United States and 8 plants located in 6 other
countries. In addition, our Technical Products Group has 9
distribution facilities and 28 sales offices located in numerous
countries throughout the world.
We believe that our production facilities are suitable for their
purpose and are adequate to support our businesses.
We have been made parties to a number of actions filed or have
been given notice of potential claims relating to the conduct of
our business, including those pertaining to commercial disputes,
product liability, environmental, safety and health, patent
infringement, and employment matters.
We comply with the requirements of Statement of Financial
Accounting Standards (“SFAS”) No. 5,
Accounting for Contingencies, and related guidance, and
record liabilities for an estimated loss from a loss contingency
where the outcome of the matter is probable and can be
reasonably estimated. Factors that are considered when
determining whether the conditions for accrual have been met
include the (a) nature of the litigation, claim, or
assessment, (b) progress of the case, including progress
after the date of the financial statements but before the
issuance date of the financial statements, (c) opinions of
legal counsel, and (d) management’s intended response
to the litigation, claim, or assessment. Where the reasonable
estimate of the probable loss is a range, we record the most
likely estimate of the loss. When no amount within the range is
a better estimate than any other amount, however, the minimum
amount in the range is accrued. Gain contingencies are not
recorded until realized.
While we believe that a material adverse impact on our
consolidated financial position, results of operations, or cash
flows from any such future charges is unlikely, given the
inherent uncertainty of litigation, a remote possibility exists
that a future adverse ruling or unfavorable development could
result in future charges that could have a material adverse
impact. We do and will continue to periodically reexamine our
estimates of probable liabilities and any associated expenses
and receivables and make appropriate adjustments to such
estimates based on experience and developments in litigation. As
a result, the current estimates of the potential impact on our
consolidated financial position, results of operations, and cash
flows for the proceedings and claims described in “Legal
Proceedings” could change in the future.
Environmental
We have been named as defendants, targets, or potentially
responsible parties (PRPs) in a small number of environmental
clean-ups, in which our current or former business units have
generally been given de minimis status. To date, none of
these claims have resulted in
clean-up
costs, fines, penalties, or damages in an amount material to our
financial position or results of operations. We have disposed of
a number of businesses over the last ten years and in certain
cases, such as the disposition of the Cross Pointe Paper
Corporation uncoated paper business in 1995, the disposition of
the Federal Cartridge Company ammunition business in 1997, the
disposition of Lincoln Industrial in 2001, and the disposition
of the Tools Group in 2004, we have retained responsibility and
potential liability for certain environmental obligations. We
have received claims for indemnification from purchasers both of
the paper business and the ammunition business and have
established what we believe to be adequate accruals for
potential liabilities arising out of retained responsibilities.
We settled some of the claims in 2005 and 2003 and our recorded
accrual was adequate.
In addition, there are pending environmental issues at a limited
number of sites, including one site acquired in the acquisition
of Essef Corporation in 1999, which relates to operations no
longer carried out at that site. We have established what we
believe to be adequate accruals for remediation costs at this
and other sites. We do not believe that projected response costs
will result in a material liability.
We may be named as a PRP at other sites in the future, for both
divested and acquired businesses. When it is probable and it is
possible to provide reasonable estimates of our liability, with
respect to environmental sites, provisions have been made in
accordance with generally accepted accounting principles in the
United States. As of December 31, 2005 and 2004, our
reserves for such environmental liabilities were approximately
$6.4 million and $9.4 million, respectively, measured
on an undiscounted basis. We cannot ensure that environmental
requirements will not change or become more stringent over time
or that our eventual environmental
clean-up
costs and liabilities will not exceed the amount of our current
reserves.
We are subject to various product liability lawsuits and
personal injury claims. A substantial number of these lawsuits
and claims are insured and accrued for by Penwald, our captive
insurance subsidiary. See discussion in ITEM 1 and
ITEM 8, Note 1 of the Notes to Consolidated Financial
Statements — Insurance subsidiary. Penwald
records a liability for these claims based on actuarial
projections of ultimate losses. For all other claims, accruals
covering the claims are recorded, on an undiscounted basis, when
it is probable that a liability has been incurred and the amount
of the liability can be reasonably estimated based on existing
information. The accruals are adjusted periodically as
additional information becomes available. We have not
experienced significant unfavorable trends in either the
severity or frequency of product liability lawsuits or personal
injury claims.
Horizon
Litigation
Twenty-eight separate lawsuits involving 29 primary plaintiffs,
a class action, and claims for indemnity by Celebrity Cruise
Lines, Inc. (Celebrity) were brought against Essef Corporation
(Essef) and certain of its subsidiaries prior to our acquisition
of Essef in August 1999. Celebrity has alleged that it had
sustained economic damages due to loss of use of the M/V Horizon
while it was dry-docked.
The claims against Essef and its involved subsidiaries were
based upon the allegation that Essef designed, manufactured, and
marketed two sand swimming pool filters that were installed as a
part of the spa system on the Horizon, and allegations that the
spa and filters contained Legionnaire’s disease bacteria
that infected certain passengers on cruises from December 1993
through July 1994.
The individual and class claims by passengers were tried and
resulted in an adverse jury verdict finding liability on the
part of the Essef defendants (70%) and Celebrity and its sister
company, Fantasia (together 30%).
After expiration of post-trial appeals, we paid all outstanding
punitive damage awards of $7.0 million in the Horizon
cases, plus interest of approximately $1.6 million in
January 2004. We had reserved for the amount of punitive damages
awarded at the time of the Essef acquisition. A reserve for the
$1.6 million interest cost was recorded in 2003. All of the
personal injury cases have now been resolved through either
settlement or trial.
The only remaining unresolved claims in this case are those
brought by Celebrity for damages resulting from the outbreak.
Celebrity filed an amended complaint seeking attorney fees and
costs for prior litigation as well as
out-of-pocket
losses, lost profits, and loss of business enterprise value.
Discovery commenced late in 2004, and was completed in August
2005. Celebrity’s claims for damages exceed
$185 million. Assuming matters of causation, standing,
contribution and proof are decided against it, Essef’s
experts believe that damages should amount to no more than
approximately $16 to $25 million. Dispositive motions in
this matter were filed in August 2005, which were decided in
December 2005. Celebrity’s motion for indemnity from Essef
for payments made by Celebrity for passenger claims of
approximately $2.3 million was denied. Essef’s motion
for dismissal of certain damage claims was denied without
prejudice to renewal in conjunction with both parties’
motions to exclude certain expert testimony. We expect these
motions to be adjudicated in March 2006. Trial has been
scheduled for April 24, 2006. We believe our reserves for
any liability to Celebrity are adequate and intend to vigorously
defend against these claims.
Item 4.
Submission
of Matters to a Vote of Security Holders
Chief Executive Officer since
January 2001 and Chairman of the Board effective May 1,2002; President and Chief Operating Officer, December
1999 — December 2000; Executive Vice President
and President of Pentair’s Electrical and Electronic
Enclosures Group, March 1998 — December 1999;
United Technologies’ 1994 — 1997: Carrier
Transicold President 1995 — 1997;
Pratt & Whitney Industrial Turbines Vice President and
General Manager 1994 — 1995; General Electric
various executive positions 1988 — 1994;
McKinsey & Company consultant
1981 — 1987.
Richard J. Cathcart
61
Vice Chairman of Pentair since
February 2005; President and Chief Operating Officer of Water
Technologies segment January 2001 — January 2005;
Executive Vice President and President of Pentair’s Water
Technologies Group, February 1996 — December
2000; Executive Vice President, Corporate Development, March
1995 — January 1996.
Executive Vice President and Chief
Financial Officer since February 2000; Executive Vice President
and Chief Financial Officer of The Scotts Company, August
1999 — February 2000; Executive Vice President
and Chief Financial Officer of Coltec Industries, August
1996 — August 1999; Executive Vice President and
Chief Financial Officer of Pentair, Inc., March
1994 — July 1996; Senior Executive with General
Electric Technical Services organization, January
1990 — March 1994. Various executive positions
with General Electric Plastics/Borg-Warner Chemicals
1972-1990.
Michael V. Schrock
53
President and Chief Operating
Officer of Filtration and Technical Products since October 2005;
President and Chief Operating Officer of Enclosures October
2001 — September 2005; President, Pentair Water
Technologies — Americas, January
2001 — October 2001; President, Pentair Pump and
Pool Group, August 2000 — January 2001;
President, Pentair Pump Group, January
1999 — August 2000; Vice President and
General Manager, Aurora, Fairbanks Morse and Pentair Pump Group
International, March 1998 — December 1998;
Divisional Vice President and General Manager, Honeywell Inc.,
1994 — 1998.
Charles M. Brown
47
President and Chief Operating
Officer of Pump and Pool Operations since April 2005; President
Pentair Tools Group Integration with The Black and Decker
Corporation August 2004 — March 2005; President
and Chief Operating Officer of Pentair Tools Group August
2003 — August 2004; President of Aqua
Glass Corporation March 1996 — August 2003;
Vice President of Marketing for Delta Faucet May
1993 — March 1996.
Louis L. Ainsworth
58
Senior Vice President and General
Counsel since July 1997 and Secretary since January 2002;
Shareholder and Officer of the law firm of Henson &
Efron, P.A., November 1985 — June 1997.
Jack J. Dempsey
44
Senior Vice President of
Operations and Technology effective April 2005; Director,
McKinsey and Company July 1999 — March 2005;
Prior McKinsey and Company experience: Principal, July
1993 — June 1999, Consultant, August
1987 — June 1993; Chase Manhattan Bank, various
retail banking roles September 1983 — August 1985.
Frederick S. Koury
45
Senior Vice President, Human
Resources, since August 2003; Vice President of Human Resources
of the Victoria’s Secret Stores unit of Limited Brands,
September 2000 — August 2003; PepsiCo, Inc.,
various executive positions, June
1985 — September 2000.
Senior Vice President of Finance
and Analysis since January 2006; Vice President of Finance and
Controller April 2002 — December 2005; Vice
President, Controller, September 1997 — March
2002; Controller, January 1996 — August 1997;
Assistant Controller, September 1994 — December
1995; Director of Financial Planning and Control of Hoffman
Enclosures Inc. (subsidiary of Pentair), October
1989 — August 1994; various finance and
accounting positions with Honeywell Inc.,
1981-1989.
Michael G. Meyer
47
Vice President of Treasury and Tax
since April 2004; Treasurer, January 2002 — March
2004; Assistant Treasurer, September
1994 — December 2001. Various executive positions
with Federal-Hoffman, Inc. (former subsidiary of Pentair),
August 1985 — August 1994.
Market
for Registrant’s Common Stock, Related Security Holder
Matters and Issuer Purchases of Equity Securities
Pentair’s common stock is listed for trading on the New
York Stock Exchange and trades under the symbol “PNR.”
As of December 31, 2005, there were 3,922 shareholders
of record.
The high, low, and closing sales price for our common stock and
the dividends declared for each of the quarterly periods for
2005 and 2004 were as follows:
2005
2004
First
Second
Third
Fourth
First
Second
Third
Fourth
High
$
44.32
$
46.03
$
45.17
$
38.41
$
29.60
$
33.64
$
35.03
$
44.03
Low
$
38.39
$
37.45
$
36.11
$
30.80
$
22.52
$
28.48
$
30.90
$
34.27
Close
$
39.14
$
42.62
$
36.50
$
34.52
$
29.60
$
32.95
$
35.03
$
43.56
Dividends declared
$
0.130
$
0.130
$
0.130
$
0.130
$
0.105
$
0.105
$
0.110
$
0.110
Pentair has paid 120 consecutive quarterly dividends.
On May 17, 2004, our Board of Directors approved a
2-for-1
stock split in the form of a 100 percent stock dividend
payable on June 8, 2004, to shareholders of record as of
June 1, 2004. All share and per share information presented
in this
Form 10-K
has been retroactively restated to reflect the effect of this
stock split.
Purchases
of Equity Securities
The following table provides information with respect to
purchases made by Pentair of common stock during the fourth
quarter of 2005:
The purchases in this column include only those shares deemed
surrendered to us by plan participants to satisfy the exercise
price or withholding of tax obligations related to the exercise
price of employee stock options.
(b)
The average price paid in this column includes only those shares
deemed surrendered to us by plan participants to satisfy the
exercise price or withholding of tax obligations related to the
exercise price of employee stock options.
(c)
The number of shares in this column represents the number of
shares repurchased as part of our publicly announced plan to
repurchase up to $25 million of our common stock annually.
(d)
In December 2004, our Board of Directors authorized the
development of a program and process to annually repurchase
shares of our common stock up to a maximum dollar limit of
$25 million. There is no expiration associated with the
authorization granted. As of December 31, 2005 we had
repurchased 755,663 shares for $25 million pursuant to
this program, the average price paid per share was $33.08.
From January 1, 2006 to February 17, 2006, no shares
have been repurchased pursuant to this program and accordingly,
we have the authority to repurchase shares up to a maximum
dollar limit of $25 million during the remainder of 2006.
In 2005 we early adopted SFAS 123R retroactively to
January 1, 2005 and the results of operations for 2005
include after tax expense of $12.0 million, or ($0.12)
diluted EPS.
*
All share and per share information presented in this
Form 10-K
have been retroactively restated to reflect the effect of a 100%
stock dividend in 2004.
Capital
expenditures — continuing and discontinued
operations
62,471
48,867
43,622
56,696
53,668
68,041
53,671
43,335
Employees of continuing operations
14,700
12,900
9,000
8,600
8,700
9,900
8,700
6,500
Days sales outstanding in
receivables(2)
54
52
54
58
65
65
58
59
Days inventory on hand(2)
70
62
59
64
72
64
67
73
(1)
Effective January 1, 2002 we adopted
SFAS No. 142, Goodwill and Other Intangible
Assets. This standard requires goodwill and intangible
assets deemed to have an indefinite life no longer be amortized.
This standard did not require restatement of prior period
amounts to be consistent with the current year presentation and
therefore, we have not made any adjustments to the historical
financial information presented. However, we have provided
supplemental tax and diluted EPS information as we believe it is
necessary to the understanding of our financial performance
trend.
(2)
Calculated using a
13-month
average.
In 2005, we adopted SFAS 123R, Share Based Payment,
which requires the fair value of stock options to be expensed.
We did not restate prior period amounts to be consistent with
the current year presentation and therefore we have not made any
adjustments to prior year information presented. The after tax
expense impact of adoption was $12.0 million or ($0.12)
diluted EPS.
In 2004, we divested our Tools Group. Our financial statements
have been restated to reflect the Tools Group as a discontinued
operation for all periods presented. The 2004 results reflect a
pre-tax gain on the sale of the Tools Group of $3.0 million
($6.0 million loss after tax).
In 2002, capital expenditures from discontinued operations
included $23.0 million for the acquisition of a previously
leased facility.
In 2000, we discontinued our Equipment segment (Century Mfg.
Co./Lincoln Automotive and Lincoln Industrial businesses). Our
financial statements have been restated to reflect the Equipment
segment as a discontinued operation for all periods presented.
The 2001 results reflected a pre-tax loss on the sale of these
businesses of $36.3 million ($24.6 million loss after
tax).
In 2001, we adopted SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, resulting in
an increase to other assets and other noncurrent liabilities of
$7.5 million and $0.8 million, respectively, and a
cumulative transition adjustment of $6.7 million in OCI.
The transition adjustment relates to our hedging activities
through December 31, 2000. Prior to the adoption of
SFAS No. 133, financial instruments designated as
hedges were not recorded in the financial statements, but cash
flows from such contracts were recorded as adjustments to
earnings as the hedged items affected earnings.
In 2001, cost of goods sold included $1.0 million related
to the 2001 restructuring charge for our Technical Products
segment.
In 2000, operations reflected a non-cash pre-tax cumulative
effect of accounting change related to revenue recognition that
reduced income by $0.03 million, net of tax.
Our accounting policy prior to the adoption of
SFAS No. 142 was to amortize goodwill on a
straight-line basis over the estimated future periods to be
benefited, principally between 25 and 40 years.
Reference should be made to the Notes to Consolidated Financial
Statements and Management’s Discussion and Analysis of
Financial Condition and Results of Operations.
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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 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 foreign manufacturers, without interruption and at
reasonable prices; and
•
the financial condition of our customers;
•
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;
•
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;
•
unanticipated developments that could occur with respect to
contingencies such as litigation, intellectual property matters,
product liability exposures and environmental matters;
•
our ability to continue to successfully generate savings from
our excellence in operations initiatives consisting of lean
enterprise, supply management and cash flow practices;
•
our ability to accurately evaluate the effects of contingent
liabilities such as taxes, product liability, environmental, and
other claims;
•
our ability to access capital markets and obtain anticipated
financing under favorable terms; and
other risks specifically discussed under the heading “Risk
Factors” under Part I of this report.
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, our Water Group and Technical Products
Group are forecasted 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.
As of July 31, 2004, we continued the expansion of our
global footprint in the water equipment industry through the
acquisition of WICOR, a manufacturer of pumps, filtration, and
pool equipment marketed primarily under the
STA-RITE®,
SHURflo®,
and
Hypro®
brands. We initially funded the payment of the purchase price
and related fees and expenses of the WICOR acquisition with an
$850 million committed line of credit (the “Bridge
Facility”) and through additional borrowings available
under our existing credit facility. We used the proceeds from
the Tools Group sale to repay, on October 4, 2004, the
$850 million Bridge Facility.
We realized $36 million in synergies net of integration
costs in the first full year of ownership with respect to the
WICOR acquisition via key initiatives including facility
rationalizations, lean enterprise, material cost savings, and
administrative cost savings. We also expect to achieve
significant working capital reductions, net fixed asset
reductions, and revenue synergies from cross-selling
opportunities during the first two years of ownership as a
result of the acquisition. Integration of the former WICOR
businesses proceeded as expected during 2005 with 17 facilities
closed or consolidated to date.
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 highest enclosures
brand recognition in the industry. From mid-2001 through
mid-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 and 2005, 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
PIMS initiatives, we have increased Technical Products segment
margins for sixteen consecutive quarters.
Key
Trends and Uncertainties
The following trends and uncertainties affected our financial
performance in 2005 and may impact our results in the future:
•
In 2005, we achieved approximately six percent sales growth on a
proforma basis, assuming we had acquired WICOR at the beginning
of 2004, excluding the recent Thermal acquisition, and excluding
the effects of foreign currency translation.
We plan to drive strategic growth initiatives in both our Water
and Technical Products platforms, with particular emphasis on
international growth.
•
We expect our operations to continue to benefit from our PIMS
initiative: including strategy deployment; lean enterprise with
special focus on sourcing and supply management, cash
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, resins, ocean freight and fuel, 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 and is expected to be approximately
$200 million in 2006. See our discussion of Other
financial measures under the caption “Liquidity and
Capital Resources” of this report.
•
In 2005, we experienced favorable foreign currency effects in
the first half of the year and unfavorable in the second half of
the year. Overall, we experienced a slightly favorable foreign
currency effect in 2005. Our currency effect is primarily for
the U.S. dollar against the Euro, which may not trend
favorably in the future.
•
We expect our overall effective tax rate to be 36 percent
in 2006. As a part of our acquisition and international
strategies, we are pursuing rate reduction opportunities, which
could improve our effective tax rate.
•
As anticipated, our Water Group operating income margins in each
of the first two quarters of 2005 were lower compared to the
prior year comparable periods due to the lower former WICOR
operating margins versus Pentair Water operating margins. In the
third quarter of 2005, the Water Group’s operating margins
crossed over and both the third and fourth quarter operating
margins were higher than the same quarters in 2004. In the
future, we intend to drive margins in the expanded Water Group
toward a goal of 15 percent, while capturing growth
opportunities.
•
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 impacted by weather patterns particularly
related to heavy flooding and droughts.
Outlook
In 2006, our operating objectives include the following:
•
Continue to use PIMS to drive the three key elements of our
strategy: operating excellence, international expansion, and
growth, both organic and acquired;
•
Continue the integration of the WICOR and Thermal acquisitions
and realize identified synergistic opportunities;
•
Continue proactive talent management process building
competencies in international management and other key
functional areas;
•
Achieve significant 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 segments.
Our ability to achieve our operating objectives will depend, to
a certain extent, on factors outside our control. See “Risk
Factors” under Part I of this report.
RESULTS
OF OPERATIONS
Net
Sales
The components of the net sales change were:
2005 vs. 2004
2004 vs. 2003
(Percentages)
Volume
25.8
34.8
Price
3.1
1.9
Currency
0.4
2.0
Total
29.3
38.7
The 29.3 percent increase in consolidated net sales in
2005 from 2004 was primarily the result of:
•
an increase in sales volume driven by our July 31, 2004
acquisition of WICOR, February 23, 2005 acquisition of DEP
and December 1, 2005 acquisition of thermal management
businesses from APW;
•
proforma sales growth from continuing operations of
approximately six percent, assuming we had acquired WICOR at the
beginning of 2004, excluding the recent Thermal acquisition, and
excluding the effects of foreign currency translation;
•
selective increases in selling prices in our Water and Technical
Products segments to mitigate inflationary cost
increases; and
•
favorable foreign currency effects as the weaker
U.S. dollar increased the U.S. dollar value of foreign
sales.
The 38.7 percent increase in consolidated net sales in
2004 from 2003 was primarily the result of:
•
an increase in sales volume driven by our July 31, 2004
acquisition of WICOR and our December 31, 2003 acquisition
of Everpure;
•
organic sales growth from continuing operations of approximately
14 percent, removing the effects of acquisitions and
excluding foreign currency exchange;
•
selective increases in selling prices in our Water and Technical
Products segments to mitigate inflationary cost
increases; and
•
favorable foreign currency effects as the weaker
U.S. dollar increased the U.S. dollar value of foreign
sales.
Sales by segment and the
year-over-year
changes were as follows:
2005 vs. 2004
2004 vs. 2003
2005
2004
2003
$ Change
% Change
$ Change
% Change
(In thousands)
Water
$
2,131,505
$
1,563,394
$
1,060,303
$
568,111
36.3%
$
503,091
47.4%
Technical Products
815,074
714,735
582,684
100,339
14.0%
132,051
22.7%
Total
$
2,946,579
$
2,278,129
$
1,642,987
$
668,450
29.3%
$
635,142
38.7%
Water
The 36.3 percent increase in Water segment sales in 2005
from 2004 was primarily the result of:
•
an increase in sales volume driven by our July 31, 2004
acquisition of WICOR and our February 23, 2005 acquisition
of DEP;
selective increases in selling prices to mitigate inflationary
cost increases;
•
sales growth on a proforma basis (assuming we had acquired WICOR
at the beginning of 2004 and excluding the recent Thermal
acquisition and favorable foreign currency exchange) of
approximately four percent for the year;
•
an increase in sales of pool and spa equipment due to market
share gains, favorable weather conditions, and successful early
buy programs;
•
growth in international markets; and
•
favorable foreign currency effects.
The 47.4 percent increase in Water segment sales in 2004
from 2003 was primarily the result of:
•
an increase in sales volume driven by our July 31, 2004
acquisition of WICOR and our December 31, 2003 acquisition
of Everpure;
•
higher organic growth for pool and spa equipment by capturing a
larger share of the increasing spend on the home environment,
primarily through the expansion of our product offerings,
including the introduction of several new innovative products
and product systems;
•
strong sales of pumps for residential water systems and sump
pumps, somewhat driven by North American weather patterns,
combined with strong demand for commercial and engineered
pumping systems;
•
significant growth in international markets;
•
an increase in the sales of water filtration products including
residential and industrial tanks and valves in the U.S. and
European markets, which was driven particularly in the first
half of 2004 by rebounding economic conditions consistent with
increased housing starts and the low interest rate environment;
•
favorable foreign currency effects; and
•
selective increases in selling prices to mitigate inflationary
cost increases.
Technical
Products
The 14.0 percent increase in Technical Products segment
sales in 2005 from 2004 was primarily the result of:
•
Growth in new products including Advanced Telecommunications
Computing Architecture (ATCA), slide rails for datacom
applications and a new cabinet line targeted toward the telecom
and electronic markets;
•
improved service and delivery resulting in increased sales
volume in North America with strong sales in commercial and
medical industry segments;
•
selective increases in selling prices to mitigate inflationary
cost increases;
•
an increase in sales volume driven by our December 1, 2005
acquisition of thermal management businesses from APW, Ltd;
•
higher sales in China; and
•
favorable foreign currency effects.
The 22.7 percent increase in Technical Products segment
sales in 2004 from 2003 was primarily the result of:
•
higher sales due to the addition of new distributors, new
products, and higher demand from established industrial markets,
as well as security, medical, networking, and commercial markets;
•
some recovery in North American telecom and datacom demand;
an increase in European sales volume due to new customers and
improved business activity at large OEMs, particularly in the
test and measurement, automation and control, and telecom
markets, offset by a slowing European economy;
•
selective increases in selling prices to mitigate inflationary
cost increases, principally for steel; and
•
favorable foreign currency effects.
Gross
Profit
% of
2005
% of Sales
2004
% of Sales
2003
Sales
(In thousands)
Gross profit
$
848,021
28.8%
$
654,710
28.7%
$
446,230
27.2%
Percentage point change
0.1 pts
1.5 pts
The 0.1 percentage point increase in gross profit as a
percent of sales in 2005 from 2004 was primarily the result
of:
•
selective increases in selling prices in our Water and Technical
Products segments to mitigate inflationary cost increases;
•
savings generated from our PIMS initiatives including lean
enterprise and supply management practices;
•
cost leverage from our increase in sales volume; and
•
synergy benefits, net of integration costs, related to the
acquisition of the former WICOR businesses.
These increases were partially offset by:
•
inflationary cost increases in our Water and Technical Products
segments;
•
lower margins associated with our July 31, 2004 acquisition
of WICOR; and
•
operating inefficiencies related to WICOR product moves, plant
consolidations, and
start-up
costs in new water facilities.
The 1.5 percentage point increase in gross profit as a
percent of sales in 2004 from 2003 was primarily the result
of:
•
cost leverage from our increase in sales volume;
•
savings generated from our key initiatives, supply management
and PIMS;
•
selective increases in selling prices in our Water and Technical
Products segments to mitigate inflationary cost increases;
•
lower costs as a result of engineered cost reductions throughout
Pentair; and
•
higher gross margins associated with our December 31, 2003
acquisition of Everpure.
These increases were partially offset by:
•
lower initial gross margins associated with our July 31,2004 acquisition of WICOR; and
•
the expensing of fair market value inventory adjustments related
to inventory acquired in the Everpure and WICOR transactions.
The 1.1 percentage point increase in Technical Products
segment operating income as a percent of net sales in 2005 from
2004 was primarily the result of:
•
selective increases in selling prices to mitigate inflationary
cost increases;
•
leverage gained on volume expansion through new product sales
and market share growth; and
•
savings from the continued success of PIMS, including lean
enterprise and supply management activities.
These increases were partially offset by:
•
material cost inflation, primarily aluminum and steel; and
•
adoption of SFAS 123R which requires us to record expense
for the fair value of stock-based compensation.
The 3.5 percentage point increase in Technical Products
segment operating income as a percent of net sales in 2004 from
2003 was primarily the result of:
•
leverage gained on volume expansion;
•
savings from the continued success of PIMS, including lean
enterprise and supply management activities;
•
selective increases in selling prices to mitigate inflationary
cost increases; and
•
the absence of expenses associated with downsizing included in
the comparable prior period.
These increases were partially offset by:
•
material cost inflation, primarily steel.
Net
Interest Expense
2005
2004
Difference
% Change
2004
2003
Difference
% Change
(In thousands)
Net interest expense
$
44,989
$
37,210
$
7,779
20.9%
$
37,210
$
26,395
$
10,815
41.0%
The 20.9 percent increase in interest expense from
continuing operations in 2005 from 2004 was primarily the result
of:
•
a portion of interest expense in 2004 was allocated to
discontinued operations for our former Tools Group versus all
the interest expense in 2005 being attributed to continuing
operations; and
•
higher interest rates in 2005.
The 41.0 percent increase in interest expense from
continuing operations in 2004 from 2003 was primarily the result
of:
•
higher debt levels resulting from the Everpure and WICOR
acquisitions, including the Bridge Facility financing, partially
offset by operating cash flows.
Income from continuing operations
before income taxes
$
283,518
$
210,032
$
143,815
Provision for income taxes
98,469
73,008
45,665
Effective tax rate
34.7
%
34.8
%
31.8
%
The 0.1 percentage point decrease in the tax rate in
2005 from 2004 was primarily the result of:
•
a favorable benefit of $1.4 million related to R&D tax
credits;
•
a favorable settlement of an IRS audit for the periods
1998-2001
resulting in a release of tax contingency reserves in the amount
of $1.3 million;
•
a favorable adjustment of $1.0 million related to the
filing of the 2004 Federal tax return; and
•
a benefit related to the deduction for qualified production
activities.
These decreases were partially offset by:
•
an anticipated unfavorable settlement of $3.2 million
recorded for a routine tax examination of prior years in
Germany; and
•
higher effective tax rate due to the non-deductibility of
certain SFAS 123R expenses related to stock options.
The 3.0 percentage point increase in the tax rate in
2004 from 2003 was primarily the result of:
•
increased operating income coupled with the relatively fixed
nature of many of our tax savings programs;
•
the mix of our 2004 U.S. and foreign earnings; and
•
our July 31, 2004 acquisition of WICOR which results in a
higher effective tax rate.
We expect our full year effective tax rate in 2006 to be
36 percent. We will continue to pursue tax rate reduction
opportunities.
LIQUIDITY
AND CAPITAL RESOURCES
Cash requirements for working capital, capital expenditures,
equity investments, acquisitions, debt repayments, 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. In 2005, we invested
$151 million in acquisitions, paid $53 million in
dividends and repurchased $25 million of our stock; and
increased our debt by only $17 million.
We experience seasonal cash flows primarily due to seasonal
demand in a number of markets within our Water segment. 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 impacted 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:
December 31
December 31
December 31
2005
2004
2003
(Days)
Days of sales in accounts
receivable
54
52
54
Days inventory on hand
70
62
59
Days in accounts payable
56
57
54
Operating
Activities
Cash provided by operating activities was $247.9 million in
2005, or $16.2 million lower compared with the same period
in 2004. The decrease in cash provided by operating activities
is due to working capital increases related to increased sales
volume, the rationalization of Water segment operations, and
increases in various customer rebates. The increased days of
sales in accounts receivable as of December 31, 2005
compared to December 31, 2004 is the result of the
differences in sales terms offered by the former WICOR business
compared to the terms offered by our former Tools Group and the
sale of approximately a $22.0 million interest in a pool of
accounts receivable to a third-party financial institution in
2004. The increased days inventory on hand as of
December 31, 2005 compared to December 31, 2004 was
driven by the increased inventory levels attributable to
increased sourcing out of Asia, higher value of inventories due
to rising raw material input costs, and inventory redundancies
associated with the
ramp-up of
new facilities and the wind-down of old facilities. The working
capital ratios as of December 31, 2005 versus
December 31, 2004 have increased, primarily for the same
reasons. In the future, we expect our working capital ratios to
improve as we are able to capitalize on the anticipated success
of our post-acquisition integration activities and PIMS
initiatives.
Cash provided by operating activities was $264.1 million in
2004, or $1.2 million higher compared with the same period
in 2003. The increase in net cash provided by operating
activities was primarily attributable to an increase in net
income offset by higher levels of inventory due to inventory
builds to support customers during product transfers and plant
consolidation activities in Water. The WICOR acquisition has
increased our working capital ratios, primarily inventory days,
which will continue until our post-acquisition integration
activities are farther along and our PIMS initiatives are better
established.
In December 2004, we sold an approximate $22.0 million
interest in a pool of accounts receivable to a third-party
financial institution to mitigate the credit risk associated
with the receivable balance of a large customer. In compliance
with Statement of Financial Accounting Standards No. 140,
Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, sales of accounts
receivable are reflected as a reduction of accounts receivable
in the consolidated balance sheets and the proceeds are included
in the cash flows from operating activities in the consolidated
statement of cash flows. As the estimated present value of the
receivables sold approximated the carrying amount, no gain or
loss was recorded in 2004. The Accounts Receivable Purchase
Agreement was not renewed in 2005.
Investing
Activities
Capital expenditures in 2005, 2004, and 2003 were
$62.5 million, $48.9 million (including
$43.1 million for continuing operations) and
$43.6 million (including $29.0 million for continuing
operations), respectively. We anticipate capital expenditures
for fiscal 2006 to be approximately $80 to $85 million,
primarily for 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.
Cash proceeds from the sale of property and equipment of
$17.1 million in 2005 was primarily related to the sale of
three facilities.
On December 1, 2005, we acquired McLean Thermal Management,
Aspen Motion Technologies and Electronic Solutions businesses
from APW for approximately $140.0 million, including a cash
payment of
$138.9 million and transaction costs of $1.1 million.
These businesses provide thermal management solutions and
integration services to the telecommunications, data
communications, medical and security markets as part of our
Technical Products Group.
In the third quarter 2005, we paid $10.4 million in
post-closing purchase price adjustments related to the October
2004 sale of our former Tools Group to The Black &
Decker Corporation.
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. The terms of the sale agreement
establish two escrow accounts totaling $14 million to be
used for payment of any potential adjustments to the purchase
price, transaction expenses, and indemnification for certain
losses such as environmental claims. In December 2005, we
received $0.2M from the escrow accounts which increased our gain
from the sale. Any remaining escrow balances are to be
distributed by April 2008 to the former shareholders in
accordance with their ownership percentages. Any funds received
from settlement of escrows in future periods will be accounted
for as additional gain on the sale of this interest.
On February 23, 2005, we acquired certain assets of 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.
Effective after the close of business October 2, 2004, we
completed the sale of our Tools Group to BDK for approximately
$796.8 million in cash, including a $21.8 million
interim net asset value increase, subject to post-closing
adjustments.
Effective July 31, 2004, we completed the acquisition of
all of the shares of capital stock of WICOR from Wisconsin
Energy Corporation for $874.7 million, including a cash
payment of $871.1 million, transaction costs of
$11.2 million, and debt assumed of $21.6 million, less
a favorable final purchase price adjustment of
$14.0 million; and less cash acquired of
$15.2 million. This includes an additional
$0.4 million in transaction costs recorded in the first
three quarters of 2005.
On April 5, 2004, we acquired all of the remaining stock of
the Tools Group’s Asian joint venture for
$21.8 million in cash, $6.4 million of which was paid
following the sale of the Tools Group. The level of return on
sales targets achieved in the second quarter of 2004 required a
payment of $0.9 million, which was recorded as an increase
to goodwill. The acquisition included cash acquired of
$6.2 million and debt assumed of $9.0 million. The
investment in the Tools Group’s Asian joint venture
business was sold as part of the Tools Group to BDK.
In the second quarter of 2004, we paid $3.9 million in
purchase price adjustments related to the December 31, 2003
acquisition of Everpure. The adjustment primarily related to the
final determination of closing date net assets.
In the first quarter of 2004, we paid $2.3 million for
acquisition fees primarily related to the December 31, 2003
acquisition of Everpure.
Financing
Activities
Net cash used for financing activities was $43.8 million in
2005 compared to $137.8 million in 2004. Financing
activities included draw downs and repayments on our revolving
credit facilities to fund our operations in the normal course of
business, dividend payments, share repurchases, and cash
received from stock option exercises.
In March 2005, we amended and restated our multi-currency
revolving Credit Facility, increasing the size of the facility
from $500 million to $800 million with a term of five
years. 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 December 31, 2005, we had
$144.7 million of commercial paper outstanding that matured
within 54 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.
Availability under our Credit Facility at December 31,2005, including outstanding commercial paper, was approximately
$543.0 million.
Effective following the close of business on July 31, 2004,
we completed the acquisition of WICOR. We funded the payment of
the purchase price and related fees and expenses of the WICOR
acquisition with the Bridge Facility and through additional
borrowings available under our existing Credit Facility. The
interest rate on the Bridge Facility and loans under the Credit
Facility during the period of the Bridge Facility was LIBOR plus
1.375%.
On October 4, 2004, we received approximately
$796.8 million of proceeds from the sale of our Tools Group
to BDK. As required under the terms of the Bridge Facility, we
used the proceeds from the Tools Group sale and additional
borrowings under the Credit Facility to pay off the Bridge
Facility. Following payment of the Bridge Facility and based on
our existing credit ratings, the interest rate on loans under
the Credit Facility decreased to LIBOR plus 1.125%.
In addition to the Credit Facility, we have $25 million of
uncommitted credit facilities, under which we had no borrowings
as of December 31, 2005.
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
We believe the potential impact of a downgrade in our financial
outlook is currently not significant to our liquidity exposure
or cost of debt. A credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific
financial obligation, a specific class of financial obligations,
or a specific financial program. The credit rating takes into
consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation and takes
into account the currency in which the obligation is
denominated. On the other hand, the ratings outlook highlights
the potential direction of a short or long-term rating. It
focuses on identifiable events and short-term trends that cause
ratings to be placed under observation by the respective Rating
Agencies. A change in rating outlook does not mean a rating
change is inevitable. Prior changes in our ratings outlook have
had no immediate impact on our liquidity exposure or on our cost
of debt.
We issue short-term commercial paper notes that are currently
not rated by Standard & Poor’s or Moody’s.
Even though our short-term commercial paper is unrated, we
believe a downgrade in our long-term debt rating could have a
negative impact on our ability to continue to issue unrated
commercial paper.
We do not expect that a one rating downgrade of our long-term
debt by either Standard & Poor’s or Moody’s
would substantially affect our ability to access the long term
debt capital markets. However, depending upon market conditions,
the amount, timing and pricing of new borrowings could be
adversely affected. If both of our long-term debt ratings were
downgraded to below BBB-/Baa3, our flexibility to access the
term debt capital markets would be reduced. In the event of a
downgrade of our long-term debt rating, the cost of borrowing
and fees payable under our Credit Facility and $35 million
private placement fixed rate note could increase. While the
Credit Facility has a pricing grid based in part on credit
ratings, we do not have any agreements under which the
obligations are accelerated in the event of a ratings downgrade.
As of December 31, 2005, our capital structure consisted of
$752.6 million in total indebtedness and
$1,555.6 million in shareholders’ equity. The ratio of
debt-to-total
capital at December 31, 2005 was 32.6 percent,
compared with 33.7 percent at December 31, 2004. Our
targeted
debt-to-total
capital ratio is 40 percent or less.
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.
We paid dividends in 2005 of $53.1 million, compared with
$43.1 million in 2004 and $40.5 million in 2003. We
anticipate continuing the practice of paying dividends on a
quarterly basis.
In December 2004, the Board of Directors authorized the
development of a program and process to repurchase shares of our
common stock up to a maximum dollar limit of $25.0 million
of our common stock annually. There is no expiration associated
with the authorization granted. In 2005, we repurchased
755,663 shares at $25 million under this plan. As of
February 17, 2006, we had not repurchased any additional
shares under this plan and, accordingly, we have the authority
in 2006 to repurchase shares up to a maximum dollar limit of
$25 million. In 2004 and 2003, respectively, we repurchased
105,500 shares and 80,000 shares of our common stock
under similar plans.
The following summarizes our significant contractual
obligations that impact our liquidity:
Payments Due by Period
More than
2006
2007
2008
2009
2010
5 Years
Total
(In thousands)
Long-term debt obligations
$
2,971
$
37,910
$
156
$
250,129
$
257,034
$
200,041
$
748,241
Interest obligations on fixed-rate
debt
27
26
25
15
5
13
111
Capital lease obligations
214
132
135
80
—
—
561
Operating lease obligations, net
of sublease rentals
25,830
20,571
16,812
13,812
11,633
22,555
111,213
Purchase obligations
—
—
—
—
—
—
—
Other long-term liabilities
4,802
4,034
2,392
1,594
317
—
13,139
Total contractual cash
obligations, net
$
33,844
$
62,673
$
19,520
$
265,630
$
268,989
$
222,609
$
873,265
In addition to the summary of significant contractual
obligations, we will incur annual interest expense on
outstanding variable rate debt. As of December 31, 2005,
variable interest rate debt was $357.0 million at a
weighted average interest rate of 4.8%.
A purchase obligation is defined as an agreement to purchase
goods or services that is enforceable and legally binding on us
that specifies all significant terms. The purchase obligation
amounts do not represent our total anticipated future purchases,
but represent those purchases for which we are contractually
obligated. As of December 31, 2005, we did not have any
purchase obligations requiring cash outflows of $1 million
or greater per year.
We expect to make contributions in the range of $5 million
to $10 million to our pension plans in 2006.
Other
Financial Measures
In addition to measuring our cash flow generation or usage based
upon operating, investing, and financing classifications
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 have a long-term goal to consistently generate
free cash flow that equals or exceeds 100 percent
conversion of net income. We believe free cash flow and
conversion of net income are important measures of operating
performance because they provide us and our investors 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:
Twelve Months Ended
December 31
2005
2004
2003
(In thousands)
Cash flow provided by operating
activities
$
247,858
$
264,091
$
262,939
Capital expenditures
(62,471
)
(48,867
)
(43,622
)
Proceeds from sale of property and
equipment
17,111
—
—
Free cash flow
202,498
215,224
219,317
Net income
185,049
171,225
141,352
Conversion of net income
109
%
126
%
155
%
In 2006, we expect free cash flow to approximate
$200 million.
Off-Balance
Sheet Arrangements
At December 31, 2005, we had no off-balance sheet financing
arrangements.
COMMITMENTS
AND CONTINGENCIES
Environmental
We have been named as defendants, targets, or potentially
responsible parties (PRPs) in a small number of environmental
clean-ups, in which our current or former business units have
generally been given de minimis status. To date, none of
these claims have resulted in
clean-up
costs, fines, penalties, or damages in an amount material to our
financial position or results of operations. We have disposed of
a number of businesses over the last ten years and in certain
cases, such as the disposition of the Cross Pointe Paper
Corporation uncoated paper business in 1995, the disposition of
the Federal Cartridge Company ammunition business in 1997, the
disposition of Lincoln Industrial in 2001, and the disposition
of the Tools Group in 2004, we have retained responsibility and
potential liability for certain environmental obligations. We
have received claims for indemnification from purchasers both of
the paper business and the ammunition business and have
established what we believe to be adequate accruals for
potential liabilities arising out of retained responsibilities.
We settled some of the claims in 2005 and 2003 and our recorded
accruals were adequate.
In addition, there are pending environmental issues at a limited
number of sites, including one site acquired in the acquisition
of Essef Corporation in 1999, that relates to operations no
longer carried out at that site. We have established what we
believe to be adequate accruals for remediation costs at this
and other sites. We do not believe that projected response costs
will result in a material liability.
We may be named as a PRP at other sites in the future, for both
divested and acquired businesses. When it is probable and it is
possible to provide reasonable estimates of our liability with
respect to environmental sites, provisions have been made in
accordance with generally accepted accounting principles in the
United States. As of December 31, 2005 and 2004, our
reserves for such environmental liabilities were approximately
$6.4 million and $9.4 million, respectively, measured
on an undiscounted basis. We cannot ensure that environmental
requirements will not change or become more stringent over time
or that our eventual environmental
clean-up
costs and liabilities will not exceed the amount of our current
reserves.
Stand-By
Letters of Credit
In the ordinary course of business, predominantly for contracts
and bids involving municipal pump products, we are required to
commit to bonds that require payments to our customers for any
non-performance. The outstanding face value of the bonds
fluctuates with the value of our projects in process and in our
backlog. In addition, we issue financial stand-by letters of
credit to secure our performance to third parties under
self-insurance programs and certain legal matters. As of
December 31, 2005, the outstanding value of these
instruments totaled $38.8 million. As of December 31,2004, the outstanding value of these instruments
totaled $64.9 million, which included a $38.9 million
stand-by letter of credit pertaining to an indemnified legal
matter that was resolved in our favor during 2005, eliminating
the bond requirement.
NEW
ACCOUNTING STANDARDS
See ITEM 8, Note 1 of the Notes to Consolidated
Financial Statements for information pertaining to recently
adopted accounting standards or accounting standards to be
adopted in the future.
CRITICAL
ACCOUNTING POLICIES
We have adopted various accounting policies to prepare the
consolidated financial statements in accordance with accounting
principles generally accepted in the United States. Our
significant accounting policies are more fully described in
ITEM 8, Note 1 to our consolidated financial
statements. Certain of our accounting policies require the
application of significant judgment by management in selecting
the appropriate assumptions for calculating financial estimates.
By their nature, these judgments are subject to an inherent
degree of uncertainty. These judgments are based on our
historical experience, terms of existing contracts, our
observance of trends in the industry, and information available
from other outside sources, as appropriate. We consider an
accounting estimate to be critical if:
•
it requires us to make assumptions about matters that were
uncertain at the time we were making the estimate; and
•
changes in the estimate or different estimates that we could
have selected would have had a material impact on our financial
condition or results of operations.
Our critical accounting estimates include the following:
Impairment
of Goodwill
The fair value of each of our reporting units was estimated
using a discounted cash flow approach. The test for impairment
requires us to make several estimates about projected future
cash flows and appropriate discount rates. If these estimates
change, we may incur charges for impairment of goodwill. During
the fourth quarter of 2005, we completed our annual impairment
test of goodwill and determined there was no impairment.
Impairment
of Long-lived Assets
We review the recoverability of long-lived assets to be held and
used, such as property, plant and equipment, when events or
changes in circumstances occur that indicate the carrying value
of the asset or asset group may not be recoverable. The
assessment of possible impairment is based on our ability to
recover the carrying value of the asset or asset group from the
expected future pre-tax cash flows (undiscounted and without
interest charges) of the related operations. If these cash flows
are less than the carrying value of such asset, an impairment
loss is recognized for the difference between estimated fair
value and carrying value. Impairment losses on long-lived assets
held for sale are determined in a similar manner, except that
fair values are reduced for the cost to dispose of the assets.
The measurement of impairment requires us to estimate future
cash flows and the fair value of long-lived assets.
Pension
We sponsor domestic and foreign defined-benefit pension and
other post-retirement plans. The amounts recognized in our
consolidated financial statements related to our defined-benefit
pension and other post-retirement plans are determined from
actuarial valuations. Inherent in these valuations are
assumptions including expected return on plan assets, discount
rates, rate of increase in future compensation levels, and
health care cost trend rates. These assumptions are updated
annually and are disclosed in ITEM 8, Note 11 to the
Consolidated Financial Statements. Changes to these assumptions
will affect pension expense.
The discount rate reflects the current rate at which the pension
liabilities could be effectively settled at the end of the year
based on our December 31 measurement date. The discount
rate was determined by matching our expected benefit payments to
payments from a stream of AA or higher bonds available in the
marketplace, adjusted to eliminate the effects of call
provisions. This produced a discount rate for our
U.S. plans of 5.75 percent in 2005 and 2004 and
6.25 percent in 2003. The discount rates on our foreign
plans ranged from 2.00% to 4.90% in 2005 versus a range of 2.00%
to 5.25% in 2004. There are no known or anticipated changes in
our discount rate assumption that will impact our pension
expense in 2006.
Expected
Rate of Return
The expected rate of return on plan assets is designed to be a
long-term assumption that may be subject to considerable
year-to-year
variance from actual returns. In developing the expected
long-term rate of return, we considered our historical ten-year
compounded annual return of 9.0 percent, with consideration
given to forecasted economic conditions, our asset allocations,
input from external consultants and broader longer-term market
indices. In 2005, the pension plan assets yielded a positive
return of 4.2 percent, compared to positive returns of
17.6 percent in 2004 and 24.8 percent in 2003. Our
expected rate of return in 2005 equaled 8.5 percent, which
remained unchanged from 2004 and 2003. In 2005 our expected
return on plan assets was higher than our actual return on plan
assets while in 2004 our expected return on plan assets was
lower than our actual return on plans assets, the significant
difference between our expected return on plan assets compared
to our actual return on plan assets in 2005 and 2004 is
primarily attributable to the fluctuations of the Pentair common
stock during the respective years. There are no known or
anticipated changes in our return assumption that will impact
our pension expense in 2006.
We base our determination of pension expense or income on a
market-related valuation of assets which reduces
year-to-year
volatility. This market-related valuation recognizes investment
gains or losses over a five-year period from the year in which
they occur. Investment gains or losses for this purpose are the
difference between the expected return calculated using the
market-related value of assets and the actual return based on
the market-related value of assets. Since the market-related
value of assets recognizes gains or losses over a
five-year-period,
the future value of assets will be impacted as previously
deferred gains or losses are recorded.
Pension-Related
Adjustments to Equity
In 2003, the financial markets recovered and resulted in a
positive return on plan assets of 24.8 percent which
eliminated $20.9 million of the 2002 $29.2 million
charge to shareholders’ equity. The charge did not impact
earnings. In 2004, our discount rate was lowered from
6.25 percent to 5.75 percent. However, the change in
the discount rate assumption was offset by higher than
anticipated returns on assets and thus, did not significantly
affect our shareholders’ equity. In 2005, the lower
discount rate for our foreign plans and the lower return on plan
assets resulted in an after-tax charge to equity of
$5.7 million.
Net
Periodic Benefit Cost
Total net periodic pension benefit cost was $20.0 million
in 2005, $19.2 million in 2004, and $15.7 million in
2003. Total net periodic pension benefit cost is expected to be
approximately $24.5 million in 2006. The increasing trend
in net periodic pension cost from 2003 forward is largely driven
by the decrease in the discount rates and by actual returns on
plan assets. The net periodic pension benefit cost for 2006 has
been estimated assuming a discount rate of 5.75 percent and
an expected return on plan assets of 8.5 percent.
Unrecognized
Pension Losses
As of our December 31, 2005 measurement date, our pension
plans have $93.4 million of cumulative unrecognized losses.
To the extent the unrecognized loss exceeds 10% of the projected
benefit obligation, it will be amortized into expense each year
on a straight-line basis over the remaining expected
future-working
lifetime of active participants (currently approximating
12 years). The amount included in pension expense for loss
amortization in 2005 was $2.8 million.
See ITEM 8, Note 11 of the Notes to Consolidated
Financial Statements for further information regarding pension
plans.
Market risk is the potential economic loss that may result from
adverse changes in the fair value of financial instruments. We
are exposed to various market risks, including changes in
interest rates and foreign currency rates. We use derivative
financial instruments to manage or reduce the impact of some of
these risks. Counterparties to all derivative contracts are
major financial institutions, thereby minimizing the risk of
credit loss. All instruments are entered into for other than
trading purposes. The major accounting policies and utilization
of these instruments is described more fully in ITEM 8,
Note 1 of the Notes to Consolidated Financial Statements.
Our derivatives and other financial instruments consist of
long-term debt (including current portion), interest rate swaps,
and foreign exchange-forward contracts. The net market value of
these financial instruments combined is referred to below as the
net financial instrument position. As of December 31, 2005
and December 31, 2004, the net financial instrument
position was a liability of $769.0 million and
$766.5 million, respectively.
Interest
Rate Risk
Our debt portfolio, including swap agreements, as of
December 31, 2005, was primarily comprised of debt
predominantly denominated in U.S. dollars (99%). This debt
portfolio is composed of 52% fixed-rate debt and 48%
variable-rate debt, considering the effects of our interest rate
swaps. Taking into account the variable to fixed rate swap
agreement we entered with an effective date of April 2006, our
debt portfolio would be comprised of 66% fixed-rate debt and 34%
variable-rate debt. Changes in interest rates have different
impacts on the fixed and variable-rate portions of our debt
portfolio. A change in interest rates on the fixed portion of
the debt portfolio impacts the net financial instrument position
but has no impact on interest incurred or cash flows. A change
in interest rates on the variable portion of the debt portfolio
impacts the interest incurred and cash flows but does not impact
the net financial instrument position.
Based on the variable-rate debt included in our debt portfolio,
including the interest rate swap agreements, as of
December 31, 2005, a 100 basis point increase or
decrease in interest rates would result in a $3.5 million
increase or decrease in interest incurred.
Foreign
Currency Risk
We are exposed to market risks related to fluctuations in
foreign exchange rates because some sales transactions, and the
assets and liabilities of our foreign subsidiaries, are
denominated in foreign currencies, primarily the euro. We held
immaterial positions in foreign exchange-forward contracts as of
December 31, 2005. We do not expect the effect of foreign
exchange rates to have a material impact on our operations.
MANAGEMENT’S
REPORT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING
Management of Pentair, Inc. and its subsidiaries (“the
Company”) is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term
is defined in
Rules 13a-15(f)
and
15d-15(f) of
the Securities Exchange Act of 1934. The Company’s internal
control over financial reporting is designed to provide
reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for
external purposes in accordance with generally accepted
accounting principles. The Company’s internal control over
financial reporting includes those policies and procedures that
(1) pertain to maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and
dispositions of the assets of the Company; (2) provide
reasonable assurance that transactions are recorded as necessary
to permit preparation of the financial statements in accordance
with generally accepted accounting principles, and that receipts
and expenditures of the Company are being made only in
accordance with authorizations of management and directors of
the Company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use
or disposition of the Company’s assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of the effectiveness of
internal control over financial reporting to future periods are
subject to the risk that the controls may become inadequate
because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s
internal control over financial reporting as of
December 31, 2005. In making this assessment, management
used the criteria for effective internal control over financial
reporting described in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this assessment, management
believes that, as of December 31, 2005, the Company’s
internal control over financial reporting was effective based on
those criteria. Management has excluded from its assessment the
internal control over financial reporting at the thermal
management businesses acquired from APW, Ltd. on
December 1, 2005 and whose financial statements reflect
total assets and total revenues constituting five percent and
one percent, respectively, of the related consolidated financial
statement amounts of the Company as of and for the year ended
December 31, 2005.
Our independent registered public accounting firm,
Deloitte & Touche LLP, has issued an attestation report
on management’s assessment of the Company’s internal
control over financial reporting for December 31, 2005.
That attestation report is set forth immediately following the
report of Deloitte & Touche LLP on the financial
statements included herein.
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors and Shareholders of Pentair, Inc.
We have audited management’s assessment, included in the
accompanying Management’s Report on Internal Control Over
Financial Reporting, that Pentair, Inc. and subsidiaries (the
“Company”) maintained effective internal control over
financial reporting as of December 31, 2005, based on
criteria established in Internal
Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(the “COSO Framework”). As described in
Management’s Report on Internal Control Over Financial
Reporting, management excluded from their assessment the
internal control over financial reporting at the thermal
management businesses acquired from APW, Ltd. on
December 1, 2005, and whose financial statements reflect
total assets and revenues constituting 5 percent and
1 percent, respectively, of the related consolidated
financial statement amounts as of and for the year ended
December 31, 2005. Accordingly, our audit did not include
the internal control over financial reporting at the thermal
management business. The Company’s management is
responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an
opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinions.
A company’s internal control over financial reporting is a
process designed by, or under the supervision of, the
company’s principal executive and principal financial
officers, or persons performing similar functions, and effected
by the company’s Board of Directors, management, and other
personnel to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
accounting principles generally accepted in the United States of
America (“generally accepted accounting principles”).
A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions
of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance
with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a
material effect on the financial statements.
Because of the inherent limitations of internal control over
financial reporting, including the possibility of collusion or
improper management override of controls, material misstatements
due to error or fraud may not be prevented or detected on a
timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting
to future periods are subject to the risk that the controls may
become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may
deteriorate.
In our opinion, management’s assessment that the Company
maintained effective internal control over financial reporting
as of December 31, 2005, is fairly stated, in all material
respects, based on the criteria established in the COSO
Framework. Also in our opinion, the Company maintained, in all
material respects, effective internal control over financial
reporting as of December 31, 2005, based on the criteria
established in the COSO Framework.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated financial statements and financial statement
schedule listed in the Index at ITEM 15 as of and for the
year ended December 31, 2005, of the Company, and our
report dated February 27, 2006, expressed an unqualified
opinion on those financial statements and financial statement
schedule and included an explanatory paragraph relating to the
Company’s change in 2005 in its method of accounting for
stock-based compensation.
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors and Shareholders of Pentair, Inc.
We have audited the accompanying consolidated balance sheets of
Pentair, Inc. and subsidiaries (the “Company”) as of
December 31, 2005 and 2004, and the related consolidated
statements of income, cash flows, and changes in
shareholders’ equity for each of the three years in the
period ended December 31, 2005. Our audits also included
the financial statement schedule listed in the Index at
ITEM 15. These financial statements and financial statement
schedule are the responsibility of the Company’s
management. Our responsibility is to express an opinion on the
financial statements and financial statement schedule based on
our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present
fairly, in all material respects, the financial position of the
Company at December 31, 2005 and 2004, and the results of
their operations and their cash flows for each of the three
years in the period ended December 31, 2005, in conformity
with accounting principles generally accepted in the United
States of America. Also, in our opinion, such financial
statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth
therein.
As discussed in Notes 1 and 13 to the consolidated
financial statements, in 2005 the Company changed its method of
accounting for stock-based compensation to conform to Statement
of Financial Accounting Standards No. 123(R),
Share-Based Payment.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of the Company’s internal control over
financial reporting as of December 31, 2005, based on the
criteria established in Internal
Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway
Commission, and our report dated February 27, 2006
expressed an unqualified opinion on management’s assessment
of the effectiveness of the Company’s internal control over
financial reporting and an unqualified opinion on the
effectiveness of the Company’s internal control over
financial reporting.
Our fiscal year ends on December 31. We report our interim
quarterly periods on a
13-week
basis ending on a Saturday.
Principles
of Consolidation
The accompanying consolidated financial statements include the
accounts of Pentair and all subsidiaries, both U.S. and
non-U.S.,
that we control. Intercompany accounts and transactions have
been eliminated. Investments in companies of which we own
20 percent to 50 percent of the voting stock or have
the ability to exercise significant influence over operating and
financial policies of the investee are accounted for using the
equity method of accounting and, as a result, our share of the
earnings or losses of such equity affiliates is included in the
statement of income. The cost method of accounting is used for
investments in which Pentair has less than a 20 percent
ownership interest and we do not have the ability to exercise
significant influence. These investments are carried at cost and
are adjusted only for
other-than-temporary
declines in fair value.
On May 17, 2004, our Board of Directors approved a
2-for-1
stock split in the form of a 100 percent stock dividend
payable on June 8, 2004, to shareholders of record as of
June 1, 2004. All share and per share information presented
in this
Form 10-K
has been retroactively restated to reflect the effect of this
stock split.
Effective after the close of business October 2, 2004, we
completed the sale of our former Tools Group to The
Black & Decker Corporation. Our consolidated financial
statements have been restated to reflect the Tools Group as a
discontinued operation for all periods presented.
Certain reclassifications have been made to the prior
years’ consolidated financial statements to conform to the
current year’s presentation.
Use of
Estimates
The preparation of our consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America (GAAP) requires us to make estimates
and assumptions that affect the amounts reported in these
consolidated financial statements and accompanying notes. Due to
the inherent uncertainty involved in making estimates, actual
results reported in future periods may be based upon amounts
that could differ from those estimates. The critical accounting
policies that require our most significant estimates and
judgments include:
•
the assessment of recoverability of long-lived assets, including
goodwill; and
•
accounting for pension benefits, because of the importance in
making the estimates necessary to apply these policies.
Revenue
Recognition
We recognize revenue when it is realized or realizable and has
been earned. Revenue is recognized when persuasive evidence of
an arrangement exists; shipment or delivery has occurred
(depending on the terms of the sale); the seller’s price to
the buyer is fixed or determinable; and collectibility is
reasonably assured.
Generally, there is no post-shipment obligation on product sold
other than warranty obligations in the normal, ordinary course
of business. In the event significant post-shipment obligations
were to exist, revenue recognition would be deferred until
substantially all obligations were satisfied.
Notes to
Consolidated Financial
Statements — (continued)
Sales
Returns
The right of return may exist explicitly or implicitly with our
customers. Revenue from a transaction is recognized only if our
price is fixed and determinable at the date of sale; the
customer has paid or is obligated to pay; the customer’s
obligation would not be changed in the event of theft, physical
destruction, or damage of the product; the customer has economic
substance apart from our Company; we do not have significant
obligations for future performance to directly bring about
resale of the product by the customer; and the amount of returns
can reasonably be estimated.
In general, our return policy allows for customer returns only
upon our authorization. Goods returned must be product we
continue to market and must be in salable condition. Returns of
custom or modified goods are normally not allowed.
At the time of sale, we reduce revenue for the estimated effect
of returns. Estimated sales returns include consideration of
historical sales levels, the timing and magnitude of historical
sales return levels as a percent of sales, type of product, type
of customer, and a projection of this experience into the future.
Pricing
and Sales Incentives
We record estimated reductions to revenue for customer programs
and incentive offerings including pricing arrangements,
promotions, and other volume-based incentives at the later of
the date revenue is recognized or the incentive is offered.
Sales incentives given to our customers are recorded as a
reduction of revenue unless we (1) receive an identifiable
benefit for the goods or services in exchange for the
consideration and (2) we can reasonably estimate the fair
value of the benefit received. The following represents a
description of our pricing arrangements, promotions, and other
volume-based incentives:
Pricing
Arrangements
Pricing is established up front with our customers, and we
record sales at the agreed upon net selling price. However, one
of our businesses allows customers to apply for a refund of a
percentage of the original purchase price if they can
demonstrate sales to a qualifying OEM customer. At the time of
sale, we estimate the anticipated refund to be paid based on
historical experience and reduce sales for the probable cost of
the discount. The cost of these refunds is recorded as a
reduction in gross sales.
Promotions
Our primary promotional activity is what we refer to as
cooperative advertising. Under this cooperative advertising
program, we agree to pay the customer a fixed percentage of
sales as an allowance to be used to advertise and promote our
products. The customer is not required to provide evidence of
the advertisement or promotion. We recognize the cost of this
cooperative advertising at the time of sale. The cost of this
program is recorded as a reduction in gross sales.
Volume-Based
Incentives
These incentives involve rebates that are negotiated up front
with the customer and are redeemable only if the customer
achieves a specified cumulative level of sales. Under these
incentive programs, at the time of sale, we reforecast the
anticipated rebate to be paid based on forecasted sales levels.
These forecasts are updated at least monthly, for each customer
and sales are reduced for the anticipated cost of the rebate. If
the forecasted sales for a customer changes, the accrual for
rebates is adjusted to reflect the new amount of rebates
expected to be earned by the customer.
There have been no material accounting revisions for
revenue-recognition related estimates.
Notes to
Consolidated Financial
Statements — (continued)
Shipping
and Handling Costs
Amounts billed to customers for shipping and handling are
recorded in net sales in the accompanying consolidated
statements of income. Shipping and handling costs incurred by
Pentair for the delivery of goods to customers are included in
cost of goods sold in the accompanying consolidated
statements of income.
Cash
Equivalents
We consider highly liquid investments with original maturities
of three months or less to be cash equivalents.
Trade
Receivables and Concentration of Credit Risk
We record an allowance for doubtful accounts, reducing our
receivables balance to an amount we estimate is collectible from
our customers. Estimates used in determining the allowance for
doubtful accounts are based on historical collection experience,
current trends, aging of accounts receivable, and periodic
credit evaluations of our customers’ financial condition.
We generally do not require collateral. No customer receivable
balances exceeded 10 percent of total net receivable
balances as of December 31, 2005 and 2004, respectively.
In December 2004, we entered into a one-year Accounts Receivable
Purchase Agreement whereby designated customer accounts
receivable may be sold without recourse to a third-party
financial institution on a revolving basis. These receivables
consisted of specific invoices that were assigned and subject to
a filed security interest. We acted as the agent for the
third-party, providing collections and claims services.
Following the initial settlement period, we were required to
transfer payments, make adjustment to invoice amounts and pay
interest (at LIBOR plus 1.05%) on the assigned receivables to
the third-party on a monthly basis. We were also required to
maintain trade credit insurance on the sold receivables.
Receivable sales could have occurred on the settlement date or
as the third-party permitted, up to a maximum total outstanding
amount of $30 million, with the ability to make additional
sales as sold receivables are repaid. The Accounts Receivable
Purchase Agreement was not renewed in 2005.
As of December 31, 2004, we had sold an approximate
$22.0 million interest in our pool of accounts receivable
to a third-party financial institution to mitigate the credit
risk associated with the receivable balance of a large customer.
In compliance with Statement of Financial Accounting Standards
No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, sales
of accounts receivable are reflected as a reduction of accounts
receivable in the consolidated balance sheets and the proceeds
are included in the cash flows from operating activities in the
consolidated statement of cash flows. As the estimated present
value of the receivables sold approximated the carrying amount,
no gain or loss was recorded in 2004.
Inventories
Inventories are stated at the lower of cost or market.
Inventories of United States subsidiaries are generally
determined by the
last-in,
first-out (LIFO) method. Inventories of foreign-based
subsidiaries are determined by the
first-in,
first-out (FIFO) and moving average methods.
Property,
Plant, And Equipment
Property, plant, and equipment is stated at historical cost. We
compute depreciation by the straight-line method based on the
following estimated useful lives:
Notes to
Consolidated Financial
Statements — (continued)
Significant improvements that add to productive capacity or
extend the lives of properties are capitalized. Costs for
repairs and maintenance are charged to expense as incurred. When
property is retired or otherwise disposed of, the cost and
related accumulated depreciation are removed from the accounts
and any related gains or losses are included in income.
We review the recoverability of long-lived assets to be held and
used, such as property, plant and equipment, when events or
changes in circumstances occur that indicate the carrying value
of the asset or asset group may not be recoverable. The
assessment of possible impairment is based on our ability to
recover the carrying value of the asset or asset group from the
expected future pre-tax cash flows (undiscounted and without
interest charges) of the related operations. If these cash flows
are less than the carrying value of such asset, an impairment
loss is recognized for the difference between estimated fair
value and carrying value. Impairment losses on long-lived assets
held for sale are determined in a similar manner, except that
fair values are reduced for the cost to dispose of the assets.
The measurement of impairment requires us to estimate future
cash flows and the fair value of long-lived assets.
Goodwill
and Identifiable Intangible Assets
Goodwill represents the excess of the cost of acquired
businesses over the fair value of identifiable tangible net
assets and identifiable intangible assets purchased.
Goodwill is tested for impairment on an annual basis. During the
fourth quarter of 2005, we completed our annual impairment test
of goodwill and determined there was no impairment.
The primary identifiable intangible assets of Pentair include
trade marks and trade names, brand names, patents, non-compete
agreements, proprietary technology, and customer relationships.
Under the provisions of SFAS No. 142, identifiable
intangibles with finite lives are amortized and those
identifiable intangibles with indefinite lives are not
amortized. Identifiable intangible assets that are subject to
amortization are evaluated for impairment whenever events or
changes in circumstances indicate that the carrying amount may
not be recoverable. Identifiable intangible assets not subject
to amortization are tested for impairment annually, or more
frequently if events warrant. The impairment test consists of a
comparison of the fair value of the intangible asset with its
carrying amount. During the fourth quarter of 2005, we completed
our annual impairment test for those identifiable assets not
subject to amortization and determined there was no impairment.
Cost
and Equity Method Investments
We have investments that are accounted for at historical cost
or, if we have significant influence over the investee, using
the equity method. Pentair’s proportionate share of income
or losses from investments accounted for under the equity method
is recorded in the consolidated statements of income. We write
down or write off an investment and recognize a loss when events
or circumstances indicate there is impairment in the investment
that is
other-than-temporary.
This requires significant judgment, including assessment of the
investees’ financial condition, and in certain cases the
possibility of subsequent rounds of financing, as well as the
investees’ historical results of operations and projected
results and cash flows. If the actual outcomes for the investees
are significantly different from projections, we may incur
future charges for the impairment of these investments.
Income
Taxes
Pentair uses the asset and liability approach to account for
income taxes. Under this method, deferred tax assets and
liabilities are recognized for the expected future tax
consequences of differences between the carrying amounts of
assets and liabilities and their respective tax basis using
enacted tax rates in effect for the year in which the
differences are expected to reverse. The effect on deferred tax
assets and liabilities of a
Notes to
Consolidated Financial
Statements — (continued)
change in tax rates is recognized in income in the period when
the change is enacted. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is
more likely than not that some portion or all of the deferred
tax assets will not be realized. Changes in valuation allowances
from period to period are included in our tax provision in the
period of change.
Environmental
In accordance with
SOP 96-1,
Environmental Remediation Liabilities, we recognize
environmental
clean-up
liabilities on an undiscounted basis when a loss is probable and
can be reasonably estimated. Such liabilities generally are not
subject to insurance coverage. The cost of each environmental
clean-up is
estimated by engineering, financial, and legal specialists based
on current law. Such estimates are based primarily upon the
estimated cost of investigation and remediation required and the
likelihood that, where applicable, other potentially responsible
parties (PRPs) will be able to fulfill their commitments at the
sites where Pentair may be jointly and severally liable. The
process of estimating environmental
clean-up
liabilities is complex and dependent primarily on the nature and
extent of historical information and physical data relating to a
contaminated site, the complexity of the site, the uncertainty
as to what remedy and technology will be required, and the
outcome of discussions with regulatory agencies and other PRPs
at multi-party sites. In future periods, new laws or
regulations, advances in
clean-up
technologies, and additional information about the ultimate
clean-up
remedy that is used could significantly change our estimates.
Accruals for environmental liabilities are included in other
liabilities in the Consolidated Balance Sheets.
Insurance
Subsidiary
We insure general and product liability, property, workers’
compensation, and automobile liability risks through our wholly-
owned captive insurance subsidiary. Reserves for policy claims
are established based on actuarial projections of ultimate
losses. As of December 31, 2005 and 2004, reserves for
policy claims were $45.8 million ($10.0 million
included in accrued product claims and warranties and
$35.8 million included in other noncurrent
liabilities) and $38.8 million ($10.0 million
included in accrued product claims and warranties and
$28.8 million included in other noncurrent
liabilities), respectively.
Stock-Based
Compensation
In the fourth quarter of 2005, we adopted the fair value
recognition provisions of Statement of Financial Accounting
Standards No. (SFAS) 123R (revised 2004), Share Based
Payment, which revised SFAS 123, Accounting for
Stock-Based Compensation (SFAS 123) and supersedes
Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees (APB 25) requiring
us to recognize expense related to the fair value of our
stock-based compensation awards. We adopted SFAS 123R
effective January 1, 2005 using the modified retrospective
transition method permitted by SFAS 123R. Under this
transition method, restatement of only the interim financial
statements in the year of adoption is permitted. We did not
restate the financial information for 2004 and 2003 as a result
of the adoption. In connection with the adoption, the expense in
the proforma disclosures related to stock-based compensation was
corrected for immaterial errors, resulting in no change to
previously reported quarterly proforma earnings per share. The
adoption of SFAS 123R in 2005 resulted in the recognition
of incremental pre-tax stock-based compensation expense of
$16.4 million, a reduction in net income of
$12.0 million, a reduction in basic and diluted earnings
per share of $.12, a reduction in cash flows from operating
activities of $8.7 million and an increase in cash flows
from financing activities of $8.7 million. We additionally
reclassified our unearned compensation on non-vested share
awards of $7.9 million to additional paid in capital. The
cumulative effect adjustment for forfeitures related to
non-vested share awards was immaterial.
In accordance with SFAS 123R the estimated grant date fair
value of each stock-based award is recognized in income on an
accelerated basis over the requisite service period (generally
the vesting period).
Notes to
Consolidated Financial
Statements — (continued)
The estimated fair value of each Pentair option is calculated
using the Black-Scholes option-pricing model. From time to time,
we have elected to modify the terms of the original grant. These
modified grants in 2005 have been accounted for as a new award
and measured using the fair value method under SFAS 123R,
resulting in the inclusion of additional compensation expense in
our consolidated statement of income. Non-vested share awards
are recorded as compensation cost over the requisite service
periods based on the market value on the date of grant.
Prior to January 1, 2005 we applied the recognition and
measurement principles of APB 25 to our stock options and
other stock-based compensation plans as permitted pursuant to
SFAS 123.
In accordance with APB 25, cost for stock-based
compensation is recognized in income based on the excess, if
any, of the quoted market price of the stock at the grant date
of the award or other measurement date over the amount an
employee must pay to acquire the stock. The exercise price for
stock options granted to employees equals the fair market value
of Pentair’s common stock at the date of grant, thereby
resulting in no recognition of compensation expense by Pentair.
However, from time to time, we have elected to modify the terms
of the original grant. Those modified grants have been accounted
for as a new award and
measured using the intrinsic value method under APB 25,
resulting in the inclusion of compensation expense in our
consolidated statement of income. Non-vested share awards are
recorded as compensation cost over the requisite service periods
based on the market value on the date of grant. Unearned
compensation cost on non-vested share awards was shown as a
reduction to shareholders’ equity.
Earnings
Per Common Share
Basic earnings per share are computed by dividing net income by
the weighted-average number of common shares outstanding.
Diluted earnings per share are computed by dividing net income
by the weighted average number of common shares outstanding,
including the dilutive effects of stock options and non-vested
shares. Unless otherwise noted, references are to diluted
earnings per share.
Notes to
Consolidated Financial
Statements — (continued)
Basic and diluted earnings per share were calculated using
the following:
2005
2004
2003
(In thousands, except per-share
data)
Earnings per common
share — basic
Continuing operations
$
185,049
$
137,024
$
98,150
Discontinued operations
—
34,201
43,202
Net income
$
185,049
$
171,225
$
141,352
Continuing operations
$
1.84
$
1.38
$
1.00
Discontinued operations
—
0.34
0.44
Basic earnings per common share
$
1.84
$
1.72
$
1.44
Earnings per common
share — diluted
Continuing operations
$
185,049
$
137,024
$
98,150
Discontinued operations
—
34,201
43,202
Net income
$
185,049
$
171,225
$
141,352
Continuing operations
$
1.80
$
1.35
$
0.99
Discontinued operations
—
0.33
0.43
Diluted earnings per common share
$
1.80
$
1.68
$
1.42
Weighted average common shares
outstanding — basic
100,665
99,316
97,876
Dilutive impact of stock-based
compensation
1,953
2,390
1,744
Weighted average common shares
outstanding — diluted
102,618
101,706
99,620
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
1,040
42
1,246
Derivative
Financial Instruments
We recognize all derivatives, including those embedded in other
contracts, as either assets or liabilities at fair value in our
balance sheet. If the derivative is designated as a fair-value
hedge, the changes in the fair value of the derivative and the
hedged item are recognized in earnings. If the derivative is
designated and is effective as a cash-flow hedge, changes in the
fair value of the derivative are recorded in other comprehensive
income (OCI) and are recognized in the consolidated statements
of income when the hedged item affects earnings. If the
underlying hedged transaction ceases to exist or if the hedge
becomes ineffective, all changes in fair value of the related
derivatives that have not been settled are recognized in current
earnings. For a derivative that is not designated as or does not
qualify as a hedge, changes in fair value are reported in
earnings immediately.
We use derivative instruments for the purpose of hedging
interest rate and currency exposures, which exist as part of
ongoing business operations. All hedging instruments are
designated and effective as hedges, in accordance with the
provisions of SFAS 133, as amended. We do not hold or issue
derivative financial instruments for trading or speculative
purposes. All other contracts that contain provisions meeting
the definition of a derivative also meet the requirements of,
and have been designated as, normal purchases or sales. Our
policy is not to enter into contracts with terms that cannot be
designated as normal purchases or sales.
Notes to
Consolidated Financial
Statements — (continued)
Foreign
Currency Translation
The financial statements of subsidiaries located outside of the
United States are measured using the local currency as the
functional currency. Assets and liabilities of these
subsidiaries are translated at the rates of exchange at the
balance sheet date. The resultant translation adjustments are
included in accumulated other comprehensive income, a separate
component of shareholders’ equity. Income and expense items
are translated at average monthly rates of exchange.
New
Accounting Standards to be Adopted in the Future
In December 2004, the Financial Accounting Standards Board
(FASB) issued SFAS 153, Exchanges of Nonmonetary
Assets — An Amendment of APB Opinion No. 29,
Accounting for Nonmonetary
Transactions. 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 is required to be adopted by us on January 1,2006. The adoption of SFAS 153 is not expected to have a
material impact on our consolidated financial position, results
of operations or cash flow.
In November 2004, the FASB issued SFAS No. 151,
Inventory Costs — An Amendment of ARB
No. 43, Chapter 4. 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 is required to be adopted
by us on January 1, 2006. We are currently evaluating the
effect that the adoption of SFAS 151 will have on our
consolidated results of operations and financial condition but
do not expect SFAS 151 to have a material impact.
In March 2004, the Emerging Issues Task Force (EITF) reached a
consensus on Issue
No. 03-1,
“The Meaning of
Other-Than-Temporary
Impairment and Its Application to Certain Investments.”
EITF 03-1
provides guidance on
other-than-temporary
impairment models for marketable debt and equity securities
accounted for under SFAS 115 and non-marketable equity
securities accounted for under the cost method. The EITF
developed a basic three-step model to evaluate whether an
investment is
other-than-temporarily
impaired. In November 2005, the FASB approved the issuance of
FASB Staff Position
FAS No. 115-1
and
FAS 124-1,
“The Meaning of
Other-Than-Temporary
Impairment and Its Application to Certain Investments.” The
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 is required to be adopted by us on
January 1, 2006. The adoption of this accounting principle
is not expected to have a significant impact on our financial
position or results of operations.
2.
Acquisitions
On December 1, 2005, we acquired McLean Thermal Management,
Aspen Motion Technologies, and Electronic Solutions businesses
from APW, Ltd. (collectively, “Thermal”) for
$140.0 million, including a cash payment of
$138.9 million and transaction costs of $1.1 million.
These businesses provide thermal management solutions and
integration services to the telecommunications, data
communications, medical, and security
Notes to
Consolidated Financial
Statements — (continued)
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. Preliminary
estimates of identifiable intangible assets acquired as part of
the acquisition were $18.9 million, including
definite-lived intangibles of $9.8 million with a weighted
average amortization period of 10.0 years. We continue to
evaluate the purchase price allocation for the Thermal
acquisition, including intangible assets, contingent
liabilities, plant rationalization costs, and property, plant
and equipment. We expect to revise the purchase price allocation
as better information becomes available in 2006.
On February 23, 2005, we acquired certain assets of Delta
Environmental Products, Inc. and affiliates (collectively,
“DEP”), a privately-held company, for
$10.3 million, including a cash payment of
$10.0 million, transaction costs of $0.2 million, and
debt assumed of $0.1 million. The DEP product line
addressees the water and wastewater markets as 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.
Effective July 31, 2004, we completed the acquisition of
all of the shares of capital stock of WICOR, Inc.
(“WICOR”) from Wisconsin Energy Corporation
(“WEC”) for $874.7 million, including a cash
payment of $871.1 million, transaction costs of
$11.2 million, and debt assumed of $21.6 million, less
a favorable final purchase price adjustment of
$14.0 million, and cash acquired of $15.2 million.
This includes an additional $0.4 million of transaction
costs recorded in the first three quarters of 2005. WICOR
manufactures water system, filtration, and pool equipment
products primarily under the
STA-RITE®,
SHURflo®,
and
Hypro®
brands. We funded the payment of the purchase price and related
fees and expenses of the WICOR acquisition with an $850 million
committed line of credit (the “Bridge Facility”) and
through additional borrowings available under our existing
credit facility.
Identifiable intangible assets acquired as part of the
acquisition were $181.5 million, including
$102.0 million of definite-lived intangible assets,
including patented and proprietary technology of
$39.6 million with a weighted average amortization period
of 11.6 years and customer relationships of
$62.4 million with a weighted average amortization period
of 18.0 years. We ascribed useful lives to patented and
proprietary technology based on an analysis of the legal and
contractual provisions. In addition, we ascribed a useful life
of 18.0 years to customer relationships based on an
analysis of customer attrition rates, the stability of product
technology, and the value of proven customer service in
retaining long standing customers. Due to a relatively flat
forecasted attrition pattern, we will amortize the customer
relationship balance on a straight-line basis over its estimated
useful life.
Goodwill recorded as part of the final purchase price allocation
was adjusted to $612.4 million, of which $70.6 million
is tax deductible.
Notes to
Consolidated Financial
Statements — (continued)
The following pro forma consolidated condensed financial results
of operations for the years ended December 31, 2005, and
2004 are presented as if the acquisitions had been completed at
the beginning of each period presented.
Years Ended
December 31
2005
2004
(In thousands, except
per-share data)
Pro forma net sales from
continuing operations
$
3,068,371
$
2,091,238
Pro forma net income from
continuing operations
186,215
152,156
Pro forma net income
186,215
186,357
Pro forma earnings per common
share — continuing operations
Basic
$
1.85
$
1.53
Diluted
$
1.81
$
1.50
Weighted average common shares
outstanding
Basic
100,665
99,316
Diluted
102,618
101,706
These pro forma consolidated condensed financial results have
been prepared for comparative purposes only and include certain
adjustments, such as increased interest expense on acquisition
debt. The adjustments 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 on January 1 of
each year presented, or of future results of the consolidated
entities.
3.
Discontinued
Operations/Divestitures
Effective after the close of business October 2, 2004, we
completed the sale of our former Tools Group to The
Black & Decker Corporation (“BDK”) for
approximately $796.8 million in cash, including a
$21.8 million interim net asset value increase, subject to
post-closing adjustments. We used the proceeds from the Tools
Group sale and borrowings under our credit facility to repay, on
October 4, 2004, the $850 million Bridge Facility used
to acquire WICOR. We retained certain insurance liabilities,
employee compensation and benefit liabilities, environmental
liabilities, pension obligations, and post-retirement
obligations of the Tools Group. In the fourth quarter of 2004,
we recorded a loss on the disposal of the Tools Group of
$6.0 million, net of a tax provision of $9.0 million.
In July of 2005, we paid $10.4 million to BDK related to
purchase price adjustments. We currently have an outstanding
dispute over the net asset value of the Tools Group and may be
required to repay some portion of the proceeds to BDK. We
believe our accrual at December 31, 2005 is an adequate
reserve amount for any potential liability. We expect resolution
of this matter in the first quarter of 2006.
In 2001, we completed the sale of our Service Equipment
businesses (Century Mfg. Co./Lincoln Automotive Company) to
Clore Automotive, LLC for total consideration of
$18.2 million and we completed the sale of Lincoln
Industrial to affiliates of The Jordan Company LLC (Jordan),
other investors, and members of management of Lincoln Industrial
for total consideration of $78.4 million, including the
retention of a preferred stock interest. In January 2003, we
paid $2.4 million for a final adjustment to the selling
price related to the disposition of Lincoln Industrial, which
was offset by a previously established reserve. In the fourth
quarter of 2003, we reported an additional loss from
discontinued operations of $2.9 million primarily due to a
reduction in estimated proceeds related to exiting two remaining
facilities.
Notes to
Consolidated Financial
Statements — (continued)
Operating results of the discontinued operations are summarized
below. The amounts exclude general corporate overhead previously
allocated to the Tools Group. The amounts include an allocation
of interest based on a ratio of the net assets of the
discontinued operations to the total net assets of Pentair.
2005
2004*
2003
(In thousands)
Net sales
$
—
$
842,110
$
1,081,378
Income (loss) from discontinued
operations before income taxes
Income from discontinued
operations, net of income taxes
—
40,248
46,138
Gain (loss) on disposal of
discontinued operations
(4,197
)
2,990
(4,517
)
Income tax (benefit) expense
(4,197
)
9,037
(1,581
)
Loss on disposal of discontinued
operations, net of tax
$
—
$
(6,047
)
$
(2,936
)
*
Includes discontinued operations through the date of
divestiture, October 2, 2004.
During 2005 we recorded an additional loss on the disposal of
discontinued operations of $4.2 million. The additional
loss relates to increased reserve requirements for product
recalls and contingent purchase price adjustments associated
with the sale of our former Tools Group. We recorded a
$4.2 million benefit in our income tax provision related to
discontinued operations. The effective tax rate in 2005 for
discontinued operations differs from the statutory rate due
primarily to research and development tax credits and permanent
book/tax differences.
During 2004 and 2003 our income tax provision related to
discontinued operations was $34.0 million and
$27.1 million, respectively. The effective tax rate of the
discontinued operations for 2004 and 2003 differs from the
statutory rate due primarily to state and foreign taxes. The tax
provision resulting from the Tools Group sale transaction was
$9.0 million. This amount, reflected in the
$34.0 million amount above, differs from the statutory rate
due primarily to state and foreign taxes which were impacted by
the form of the transaction and the geographic locations of the
assets that were sold.
Net (liabilities) assets of discontinued operations consist
of the following:
2005
2004
(In thousands)
Property, plant, and equipment, net
$
—
$
393
Current liabilities
192
192
Other noncurrent liabilities
2,029
3,054
Total liabilities
2,221
3,246
Net (liabilities) assets of
discontinued operations
$
(2,221
)
$
(2,853
)
At December 31, 2005 and 2004, the liabilities totaling
$2.2 million and $3.2 million, respectively, represent
the estimated future cash outflows associated with the exit from
a leased facility.
Purchase accounting adjustments recorded in 2005 relate to the
WICOR, DEP, and ESSEF acquisitions. During 2005 we finalized our
evaluation of the purchase price allocation for the WICOR
acquisition, the adjustments primarily related to contingent
liabilities, reserves for plant rationalizations, and deferred
income taxes. During the fourth quarter of 2005 we made an
adjustment to reverse a pre-acquisition tax contingency reserve
related to the ESSEF acquisition.
The detail of acquired intangible assets consisted of the
following:
2005
2004
Gross
Gross
Carrying
Accumulated
Carrying
Accumulated
Amount
Amortization
Net
Amount
Amortization
Net
(In thousands)
Finite-life intangible
assets
Patents
$
15,685
$
(4,135
)
$
11,550
$
14,659
$
(2,239
)
$
12,420
Non-compete agreements
3,937
(2,021
)
1,916
7,464
(4,237
)
3,227
Proprietary technology
51,386
(5,107
)
46,279
45,145
(1,896
)
43,249
Customer relationships
87,707
(8,647
)
79,060
84,044
(3,451
)
80,593
Total finite-life intangible assets
$
158,715
$
(19,910
)
$
138,805
$
151,312
$
(11,823
)
$
139,489
Indefinite-life intangible
assets
Brand names
$
127,728
$
—
$
127,728
$
118,637
$
—
$
118,637
Total intangibles, net
$
266,533
$
258,126
Intangible asset amortization expense in 2005, 2004, and 2003
was $11.7 million, $7.5 million, and
$1.5 million, respectively. The increase in amortization
expense between 2005 and 2004 was primarily the result of the
WICOR acquisition. In the third quarter of 2004, we recorded
$102.0 million of finite-lived intangible assets, including
patented and proprietary technology of $39.6 million with a
weighted average amortization period of 11.6 years and
customer relationships of $62.4 million with a weighted
average amortization period of 18.0 years.
The estimated future amortization expense for identifiable
intangible assets during the next five years is as follows:
Certain inventories are valued at LIFO. If all inventories were
valued at FIFO as of the end of 2005 and 2004, inventories would
have been $351.1 million and $324.1 million,
respectively.
Cost
Method Investments
As part of the sale of Lincoln Industrial in 2001, we received
37,500 shares of 5% Series C Junior Convertible
Redeemable Preferred Stock convertible into a 15 percent
equity interest in the new organization — LN
Holdings Corporation. During the second quarter of 2005 we sold
our interest in the stock LN Holdings Corporation for cash
consideration of $23.6 million, resulting in a pre-tax gain
of $5.2 million or an after-tax gain of $3.5 million.
The terms of the sale agreement establish two escrow accounts
totaling $14 million. We received payments from an escrow
of $0.2 million during the fourth quarter of 2005,
increasing our gain. Any remaining escrow balances are to be
distributed by April 2008 to former shareholders in accordance
with their ownership percentages. Any funds received from
settlement of escrows in future periods will be accounted for as
additional gain on sale of this interest. The preferred stock
was recorded at $18.4 million in other assets as
December 31, 2004, which represented the estimated fair
value of that investment at the time of the Lincoln Industrial
sale.
Equity
Method Investments
We have a 50 percent investment in FARADYNE Motors LLC at
December 31, 2005, a joint venture with ITT Water
Technologies, Inc. that began design, development, and
manufacturing of submersible pump motors in 2005. We do not
consolidate the investment in our financial statements as we do
not have a controlling interest over the investment. The
investment at December 31, 2005 was $1.2 million,
which is net of our proportionate share of losses during 2005 of
$1.2 million. Our proportionate share of earnings or losses
is recorded on a one-month lag.
Notes to
Consolidated Financial
Statements — (continued)
6. Supplemental
Cash Flow Information
The following table summarizes supplemental cash flow
information:
2005
2004
2003
(In thousands)
Interest payments
$
44,403
$
49,339
$
41,962
Income tax payments
79,414
63,488
46,598
7. Accumulated
Other Comprehensive Income (Loss)
Components of accumulated other comprehensive income (loss)
consist of the following:
2005
2004
2003
(In thousands)
Minimum pension liability
adjustments, net of tax
$
(17,534
)
$
(11,832
)
$
(11,395
)
Foreign currency translation
adjustments
16,045
44,451
19,092
Market value of derivative
financial instruments, net of tax
503
(213
)
(1,865
)
Accumulated other comprehensive
income (loss)
$
(986
)
$
32,406
$
5,832
In 2005, the minimum pension liability adjustment increased
compared to the prior year despite no change in the discount
rate for the U.S. plans. The increase is attributable to
lower than expected pension plan performance as well as a
reduction in the discount rates associated with our foreign
defined benefit plans. In 2004, the minimum pension liability
remained relatively consistent compared to prior year despite
the 50 basis point decrease in the discount rate to 5.75%
as of December 31, 2004, as it was offset by our pension
plan asset performance. The net foreign currency translation
loss in 2005 of $28.4 million was the result of the
weakening of the U.S. dollar against the Euro. The net
foreign currency gain in 2004 of $25.4 million, was
primarily the result of a stronger U.S. dollar against the
Euro and Canadian dollar currencies. Changes in the market value
of derivative financial instruments was impacted primarily by
the maturities of derivatives and changing interest rates.
Fluctuations in the value of hedging instruments are generally
offset by changes in the cash flows of the underlying exposures
being hedged.
Notes to
Consolidated Financial
Statements — (continued)
8. Debt
Long-term debt and the average interest rate on debt
outstanding as of December 31 is summarized as follows:
Average
Interest Rate
December 31,
Maturity
December 31
December 31
2005
(Year)
2005
2004
(In thousands)
Commercial paper, maturing within
54 days
4.74
%
$
144,656
$
178,008
Revolving credit facilities
4.93
%
2010
112,300
53,700
Private
placement — fixed rate
5.50
%
2007-2013
135,000
135,000
Private
placement — floating rate
4.80
%
2013
100,000
100,000
Senior notes
7.85
%
2009
250,000
250,000
Other
2.55
%
2006-2009
6,285
14,394
Total contractual debt obligations
748,241
731,102
Interest rate swap monetization
deferred income
4,373
5,539
Fair value adjustment of hedged
debt
—
(536
)
Total long-term debt, including
current portion per balance sheet
752,614
736,105
Less current maturities
(4,137
)
(11,957
)
Long-term debt
$
748,477
$
724,148
As of December 31, 2005, we had a $800 million
multi-currency revolving credit facility (the “Credit
Facility”) with various banks expiring on March 4,2010. The interest rate on the loans under the Credit Facility
is LIBOR plus 0.625%. Interest rates and fees on the Credit
Facility vary based on our credit ratings.
In July 2005, we amended our floating rate private placement
note purchase agreement, decreasing the interest rate on the
notes by .550% to LIBOR plus .600%. Additionally, the amendment
extended the prepayment provisions of the note purchase
agreement permitting prepayment on or after July 25, 2006.
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
December 31, 2005, we had $144.7 million of commercial
paper outstanding that matured within 54 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. Availability under
our Credit Facility at December 31, 2005, including
outstanding commercial paper, was approximately
$543.0 million.
Effective following the close of business on July 31, 2004,
we completed the acquisition of WICOR. We funded the payment of
the purchase price and related fees and expenses of the WICOR
acquisition with an $850 million Bridge Facility and
through additional borrowings available under our existing
Credit Facility. The interest rate on the Bridge Facility and
loans under the Credit Facility during the period of the Bridge
Facility was LIBOR plus 1.375%.
On October 4, 2004, we received approximately
$796.8 million of proceeds from the sale of our Tools Group
to BDK. As required under the terms of the Bridge Facility, we
used the proceeds from the Tools Group sale and additional
borrowings under the Credit Facility to pay off the Bridge
Facility. Following payment of the Bridge Facility and based on
our existing credit ratings, the interest rate on loans under
the Credit Facility decreased to LIBOR plus 1.125%.
We were in compliance with all debt covenants as of
December 31, 2005.
Notes to
Consolidated Financial
Statements — (continued)
In addition to the Credit Facility, we have $25 million of
uncommitted credit facilities, under which we had no borrowings
as of December 31, 2005.
Long-term debt outstanding at December 31, 2005, matures on
a calendar year basis by contractual debt maturity as follows:
2006
2007
2008
2009
2010
Thereafter
Total
(In thousands)
Contractual debt obligation
maturities
$
2,971
$
37,910
$
156
$
250,129
$
257,034
$
200,041
$
748,241
Other maturities
1,166
1,166
1,166
875
—
—
4,373
Total maturities
$
4,137
$
39,076
$
1,322
$
251,004
$
257,034
$
200,041
$
752,614
9. Derivative
and Financial Instruments
Cash-Flow
Hedges
We have a $100 million interest rate swap agreement with
several major financial institutions, expiring July 2013, to
exchange variable rate interest payment obligations for fixed
rate obligations without the exchange of the underlying
principal amounts in order to manage interest rate exposures.
The swap becomes effective in April 2006, at the fixed interest
rate of 4.68% plus .60% interest rate spread over LIBOR,
resulting in a fixed interest rate of 5.28%. The fair value of
the swap was an asset of $0.8 million at December 31,2005. At December 31, 2004 we had a variable to fixed
interest rate swap agreement outstanding with an aggregate
notional amount of $20.0 million, with a fixed interest
rate of 6.31 percent, this agreement expired in June 2005.
The fair value of this swap was a liability of $0.4 million
at December 31, 2004.
The variable to fixed interest rate swap is designated as and is
effective as a cash-flow hedge. The fair value of this 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 reclassified into earnings at the
time the related interest expense is recognized or the
settlement of the related commitment occurs. We estimate the net
derivative gains or losses that will be reclassified into
earnings during 2006 will not be material. No hedging
relationships were de-designated during 2005.
Fair
Value Hedge
During 2002, we entered into a interest rate swap agreement to
effectively convert $100 million of senior notes for the
term of the notes (maturing October 2009) from a
7.85 percent fixed annual rate to a floating annual rate
equal to the six-month LIBOR rate plus 3.69 percent. The
fair value of the swap was a liability of $0.5 million at
December 31, 2004. This swap agreement was designated and
accounted for as a fair value hedge. Since this swap qualified
for the short-cut method under SFAS No. 133, changes
in the fair value of the swap (included in other long-term
liabilities in the consolidated balance sheets) are offset
by changes in the fair value of the designated debt being
hedged. Consequently, there was no impact on net income or
shareholders’ equity. During 2005, we terminated this swap
agreement resulting in a nominal amount of proceeds.
Notes to
Consolidated Financial
Statements — (continued)
Fair
Value of Financial Instruments
The recorded amounts and estimated fair values of long-term
debt, excluding the effects of derivative financial instruments,
and the recorded amounts and estimated fair value of those
derivative financial instruments were as follows:
2005
2004
Recorded
Fair
Recorded
Fair
Amount
Value
Amount
Value
(In thousands)
Long-term debt, including
current portion
Variable rate
$
356,956
$
356,956
$
338,582
$
338,582
Fixed rate
391,285
411,253
392,520
428,766
Total
$
748,241
$
768,209
$
731,102
$
767,348
Derivative financial
instruments
Variable to fixed interest rate
swap asset (liability)
$
773
$
773
$
(350
)
$
(350
)
Fixed to variable interest rate
swap liability
—
—
(536
)
(536
)
Market value of derivative
financial instruments
$
773
$
773
$
(886
)
$
(886
)
The following methods were used to estimate the fair values of
each class of financial instrument:
•
short-term financial instruments (cash and cash equivalents,
accounts and notes receivable, accounts and notes payable, and
short-term borrowings) — recorded amount
approximates fair value because of the short maturity period;
•
long-term debt, including current
maturities — fair value is based on market quotes
available for issuance of debt with similar terms; and
•
interest rate swap agreements — fair value is
based on market or dealer quotes.
10. Income
Taxes
Income from continuing operations before income taxes
consisted of the following:
Reconciliation of the U.S. statutory income tax rate to
our effective tax rate for continuing operations follows:
2005
2004
2003
(Percentages)
U.S. statutory income tax rate
35.0
35.0
35.0
State income taxes, net of federal
tax benefit
2.3
2.6
1.9
Tax effect of stock-based
compensation
0.6
—
—
Tax effect of international
operations
(1.2
)
(1.4
)
(2.6
)
Tax credits
(1.5
)
(1.4
)
(2.1
)
Domestic manufacturing deduction
(0.5
)
—
—
ESOP dividend benefit
(0.3
)
(0.3
)
(0.5
)
All other, net
0.3
0.3
0.1
Effective tax rate on continuing
operations
34.7
34.8
31.8
Deferred taxes arise because of different treatment between
financial statement accounting and tax accounting, known as
“temporary differences.” We record the tax effect of
these temporary differences as “deferred tax assets”
(generally items that can be used as a tax deduction or credit
in future periods) and “deferred tax liabilities”
(generally items for which we received a tax deduction but the
tax impact has not yet been recorded in the consolidated
statements of income).
During 2005, our effective tax rate was impacted by a benefit of
$1.4 million related to R&D tax credits, a settlement
of an IRS audit resulting in a release of tax contingency
reserves of $1.3 million, a favorable adjustment related to
the filing of our 2004 Federal tax return of $1.0 million.
Our effective tax rate was also impacted favorably by tax
deductions for profits associated with qualified domestic
production activities. These favorable items are offset by a
$3.2 million anticipated unfavorable settlement for a
routine German tax examination related to prior years as well as
the tax impact of the adoption of SFAS 123R.
During the fourth quarter of 2004, we repatriated approximately
$75.0 million in extraordinary dividends, as defined in the
American Jobs Creation Act of 2004 (the “Jobs Act”),
consisting primarily of foreign proceeds resulting from the sale
of the Tools Group. We elected to apply the provisions of
Section 965 of the Internal Revenue Code, enacted as part
of the Jobs Act, to the repatriated extraordinary dividends and
therefore, were eligible to claim an eighty-five percent
dividends received deduction for income tax purposes on the
eligible amounts. The net tax cost of the repatriation of the
extraordinary dividends, recorded in discontinued operations,
was approximately $4.0 million.
Notes to
Consolidated Financial
Statements — (continued)
United States income taxes have not been provided on
undistributed earnings of international subsidiaries. It is our
intention to reinvest these earnings permanently or to
repatriate the earnings only when it is tax effective to do so.
As of December 31, 2005, approximately $97.0 million
of unremitted earnings attributable to international
subsidiaries were considered to be indefinitely invested. We
believe that any U.S. tax on repatriated earnings would be
substantially offset by U.S. foreign tax credits.
The tax effects of the major items recorded as deferred tax
assets and liabilities are as follows:
2005 Deferred Tax
2004 Deferred Tax
Assets
Liabilities
Assets
Liabilities
(In thousands)
Accounts receivable allowances
$
5,336
$
—
$
5,606
$
—
Inventory valuation
—
3,055
354
—
Accelerated
depreciation/amortization
—
28,047
—
37,349
Accrued product claims and
warranties
38,781
—
33,778
—
Employee benefit accruals
92,487
—
72,810
—
Goodwill and other intangibles
—
150,793
—
140,126
Other, net
—
31,524
—
28,872
Total deferred taxes
$
136,604
$
213,419
$
112,548
$
206,347
Net deferred tax liability
$
(76,815
)
$
(93,799
)
The determination of annual income tax expense takes into
consideration amounts which may be needed to cover exposures for
open tax years. The Internal Revenue Service (IRS) has examined
our U.S. federal income tax returns through 2001 with no
material adjustments and is currently auditing 2002 and 2003. In
connection with the completion of the 1998 to 2001 Federal
income tax audit, we adjusted certain income tax reserves
established related to the periods under examination and
recorded a benefit of $1.3 million to our first quarter
2005 income statement. We do not expect any material impact on
earnings to result from the resolution of matters related to
open tax years; however, actual settlements may differ from
amounts accrued.
Non-U.S. tax
losses of $5.7 million and $5.3 million were available
for carryforward at December 31, 2005 and 2004,
respectively. A valuation allowance of $1.5 million and
$1.6 million exists for deferred income tax benefits
related to the loss carryforwards available that may not be
realized as of December 31, 2005 and 2004, respectively. We
believe that sufficient taxable income will be generated in the
respective countries to allow us to fully recover the remainder
of the tax losses. A majority of our
non-U.S. tax
losses can be carried forward indefinitely. The remaining
non-U.S. tax
losses will begin to expire in 2007.
11.
Benefit
Plans
Pension
and Post-Retirement Benefits
We sponsor domestic and foreign defined-benefit pension and
other post-retirement plans. Pension benefits are based
principally on an employee’s years of service
and/or
compensation levels near retirement. In addition, we also
provide certain post-retirement health care and life insurance
benefits. Generally, the post-retirement health care and life
insurance plans require contributions from retirees. We use a
December 31 measurement date each year.
The acquisition of WICOR in 2004 increased unfunded pension
liabilities by approximately $23.7 million and increased
post-retirement liabilities by approximately $32.1 million
at December 31, 2004. Corresponding liabilities equal to
the unfunded liabilities were recorded on WICOR’s opening
balance sheet.
Notes to
Consolidated Financial
Statements — (continued)
The sale of our Tools Group in 2004 decreased post-retirement
liabilities at December 31, 2004 by approximately
$4.8 million. In 2005 we completed the transfer of pension
plan assets and related plan liabilities, resulting in a
reduction in plan liabilities that was $3.8 million greater
than the amount of plan assets transferred.
In 2004, under the requirements of SFAS No. 88,
Employers’ Accounting for Settlements and Curtailments
of Defined Benefit Pension Plans and for Termination
Benefits, we recognized a curtailment expense and special
termination benefits totaling approximately $1.8 million
due to the divestiture of the Tools Group.
On December 8, 2003, the Medicare Prescription Drug
Improvement and Modernization Act of 2003 (the Medicare Act) was
signed into law. The Act expands Medicare to include coverage
for prescription drugs. On May 19, 2004, the FASB issued
FSP
No. 106-2,
“Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug Improvement and Modernization Act of
2003”, which requires current recognition of the federal
subsidy that employers may receive for providing drug coverage
to retirees. FSP
No. 106-2
was effective for the CompanyJuly 4, 2004. The amount of
subsidies we expect to receive is not material relative to our
accumulated post-retirement benefit obligation.
Notes to
Consolidated Financial
Statements — (continued)
Obligations
and Funded Status
The following tables present reconciliations of the benefit
obligation of the plans, the plan assets of the pension plans,
and the funded status of the plans:
Pension Benefits
Post-Retirement
2005
2004
2005
2004
(In thousands)
Change in benefit
obligation
Benefit obligation beginning of
year
$
545,118
$
419,616
$
68,085
$
36,903
Service cost
16,809
15,998
850
696
Interest cost
29,515
27,514
3,787
3,012
Amendments
158
—
—
—
Liability transfer
(22,432
)
—
—
—
Special termination benefits
—
1,589
—
—
Actuarial (gain) loss
8,610
30,799
(11,669
)
2,992
Acquisitions
—
91,433
—
32,136
Divestiture
—
(14,479
)
—
(4,765
)
Translation (gain) loss
(7,876
)
3,906
—
—
Benefits paid
(27,798
)
(31,258
)
(3,487
)
(2,889
)
Benefit obligation end of year
$
542,104
$
545,118
$
57,566
$
68,085
Change in plan assets
Fair value of plan assets
beginning of year
$
381,281
$
295,399
$
—
$
—
Actual return on plan assets
13,518
53,696
—
—
Asset
transfer — acquisitions
—
67,709
—
—
Asset
transfer — divestiture
(18,600
)
(11,954
)
—
—
Company contributions
4,133
7,193
3,487
2,889
Translation (loss) gain
(878
)
496
—
—
Benefits paid
(27,798
)
(31,258
)
(3,487
)
(2,889
)
Fair value of plan assets end of
year
$
351,656
$
381,281
$
—
$
—
Funded status
Plan assets less than benefit
obligation
$
(190,448
)
$
(163,837
)
$
(57,566
)
$
(68,085
)
Unrecognized cost:
Net transition obligation
87
122
—
—
Net actuarial (gain) loss
93,398
76,694
(16,123
)
(612
)
Prior service cost (benefit)
774
915
(260
)
(970
)
Net amount recognized
$
(96,189
)
$
(86,106
)
$
(73,949
)
$
(69,667
)
Of the $190.4 million underfunding at December 31,2005, $104.8 million relates to foreign pension plans and
our supplemental executive retirement plans which are not
commonly funded.
Notes to
Consolidated Financial
Statements — (continued)
Additional
Information
Pension Benefits
2005
2004
(In thousands)
Increase in minimum liability
included in other comprehensive income, net of tax
$
(5,702
)
$
(437
)
Assumptions
Weighted-average assumptions used to determine domestic
benefit obligations at December 31 are as follows:
Pension Benefits
Post-Retirement
2005
2004
2003
2005
2004
2003
(Percentages)
Discount rate
5.75
5.75
6.25
5.75
5.75
6.25
Rate of compensation increase
5.00
5.00
5.00
Weighted-average assumptions used to determine the domestic
net periodic benefit cost for years ending December 31 are
as follows:
Pension Benefits
Post-Retirement
2005
2004
2003
2005
2004
2003
(Percentages)
Discount rate
5.75
6.25
6.25
5.75
6.25
6.25
Expected long-term return on plan
assets
8.50
8.50
8.50
Rate of compensation increase
5.00
5.00
5.00
Discount
Rate
The discount rate reflects the current rate at which the pension
liabilities could be effectively settled at the end of the year
based on our December 31 measurement date. The discount
rate was determined by matching our expected benefit payments to
payments from a stream of AA or higher bonds available in the
marketplace, adjusted to eliminate the effects of call
provisions. This produced a discount rate of 5.75 percent
in 2005 and 2004 and 6.25 percent in 2003. The discount
rates on our foreign plans ranged from 2.00% to 4.90% in 2005
versus a range of 2.00% to 5.25% in 2004. There are no known or
anticipated changes in our discount rate assumptions that will
impact our pension expense in 2006.
Expected
Rate of Return
The expected rate of return on plan assets is designed to be a
long-term assumption that may be subject to considerable
year-to-year
variance from actual returns. In developing the expected
long-term rate of return, we considered our historical ten-year
compounded annual return of 9.0 percent, with consideration
given to forecasted economic conditions, our asset allocations,
input from external consultants and broader longer-term market
indices. In 2005, the pension plan assets yielded a positive
return of 4.2 percent, compared to a positive return of
17.6 percent in 2004. Our expected rate of return in 2005
equaled 8.5 percent, which remained unchanged from 2004. In
2005 our expected return on plan assets was higher than our
actual return on plan assets while in 2004 our expected return
on plan assets was lower than our actual return on plans assets,
the significant difference between our expected return on plan
assets compared to our actual return on plan assets in 2005 and
2004 is primarily attributable to the fluctuations of the
Pentair common stock price during the respective years. There
are no known or anticipated changes in our return assumption
that will impact our pension expense in 2006.
Notes to
Consolidated Financial
Statements — (continued)
We base our determination of pension expense or income on a
market-related valuation of assets which reduces
year-to-year
volatility. This market-related valuation recognizes investment
gains or losses over a five-year period from the year in which
they occur. Investment gains or losses for this purpose are the
difference between the expected return calculated using the
market-related value of assets and the actual return based on
the market-related value of assets. Since the market-related
value of assets recognizes gains or losses over a
five-year-period,
the future value of assets will be impacted as previously
deferred gains or losses are recorded.
Pension-Related
Adjustments to Equity
In 2003, the financial markets recovered and resulted in a
positive return on plan assets of 24.8 percent which
eliminated $20.9 million of the 2002 $29.2 million
charge to shareholders’ equity. The charge did not impact
earnings. In 2004, our discount rate was lowered from
6.25 percent to 5.75 percent. However, the change in
the discount rate assumption was offset by higher than
anticipated returns on assets and thus, did not significantly
affect our shareholders’ equity. In 2005, our discount rate
remained consistent with 2004; however, a lower return on plan
assets as well as a decrease in the discount rates for our
foreign plans resulted in an after-tax charge to equity of
$5.7 million.
Net
Periodic Benefit Cost
Total net periodic pension benefit cost was $20.0 million
in 2005, $19.2 million in 2004, and $15.7 million in
2003. Total net periodic pension benefit cost is expected to be
approximately $24.5 million in 2006. The increasing trend
in net periodic pension cost from 2003 forward is largely driven
by the decrease in the discount rate in 2005 and by actual
returns on plan assets. The net periodic pension benefit cost
for 2006 has been estimated assuming a discount rate of
5.75 percent and an expected return on plan assets of
8.5 percent.
Unrecognized
Pension Losses
As of our December 31, 2005 measurement date, our pension
plans have $93.4 million of cumulative unrecognized losses.
To the extent the unrecognized loss exceeds 10% of the projected
benefit obligation, it will be amortized into expense each year
on a straight-line basis over the remaining expected
future-working lifetime of active participants (currently
approximating 12 years). The amount included in pension
expense for loss amortization in 2005 was $2.8 million.
The assumed health care cost trend rates at December 31
are as follows:
2005
2004
Health care cost trend rate
assumed for next year
11.00
%
11.50
%
Rate to which the cost trend rate
is assumed to decline (the ultimate trend rate)
5.00
%
5.00
%
Year that the rate reaches the
ultimate trend rate
2018
2018
The assumed health care cost trend rates can have a significant
effect on the amounts reported for health care plans. A
one-percentage-point change in the assumed health care cost
trend rates would have the following effects:
Notes to
Consolidated Financial
Statements — (continued)
Plan
Assets
Objective
The primary objective of our pension plans is to meet
commitments to our employees at a reasonable cost to the
company. This is primarily accomplished through growth of
capital and safety of the funds invested. The plans will
therefore be actively invested to achieve real growth of capital
over inflation through appreciation of securities held and
through the accumulation and reinvestment of dividend and
interest income.
Asset
Allocation
Our actual overall asset allocation for the plans as compared to
our investment policy goals is as follows:
We regularly review our asset allocation and periodically
rebalance our investments to our targeted allocation when
considered appropriate. From time to time, we may be outside our
targeted ranges by amounts we deem acceptable.
At December 31, 2004, our cash balance was higher than
normal due to the liquidation of the WICOR pension assets held
in a separate trust. Those funds were transferred to our pension
master trust and subsequent to December 31, 2004, a portion
was reinvested in accordance with our targeted asset
allocations. We transferred most of the remaining cash balance
to BDK in conjunction with our transfer of certain pension
benefit obligations related to the divested Tools Group. We do
require a cash balance to be available to fund monthly benefit
payments and administrative fees.
Equity securities include Pentair common stock in the amount of
$32.6 million and $41.1 million at December 31,2005 and 2004, respectively.
Cash
Flows
Contributions
In 2005, pension contributions totaled $4.1 million,
including $0.3 million of contributions to domestic defined
benefit pension plans. In 2004, pension contributions totaled
$7.2 million, including $2.7 million of contributions
to domestic defined benefit pension plans. The contributions in
2005 and 2004 equaled or exceeded the minimum funding
requirement. Our 2006 pension contributions are expected to be
in the range of $5 million to $10 million.
Notes to
Consolidated Financial
Statements — (continued)
Estimated
Future Benefit Payments
The following benefit payments, which reflect expected future
service, as appropriate, are expected to be paid by the plans as
follows:
Pension Benefits
Post-Retirement
(In millions)
2006
$
25.7
$
4.0
2007
24.7
4.0
2008
25.9
4.0
2009
27.0
4.0
2010
28.1
4.0
2011-2015
166.9
21.7
Savings
Plan
We have a 401(k) plan (the plan) with an employee stock
ownership (ESOP) bonus component, which covers certain union and
nearly all non-union U.S. employees who meet certain age
requirements. Under the plan, eligible U.S. employees may
voluntarily contribute a percentage of their eligible
compensation. Matching contributions are made in cash to
employees who meet certain eligibility and service requirements.
Our matching contribution is fixed at 50 percent of
eligible employee contributions, and is limited to
5 percent of employee compensation contributed by employees.
In addition to the matching contribution, all employees who meet
certain service requirements receive a discretionary ESOP
contribution equal to 1.5 percent of annual eligible
compensation.
Our combined expense for the plan and ESOP were approximately
$8.8 million, $10.7 million, and $7.3 million, in
2005, 2004, and 2003, respectively.
12.
Shareholders’
Equity
Authorized
Shares
We may issue up to 250 million shares of common stock. Our
Board of Directors may designate up to 15 million of those
shares as preferred stock. On December 10, 2004, the Board
of Directors designated a new series of preferred stock of up to
2.5 million shares, Series A Junior Participating
Preferred Stock, par value $0.10 per share. No shares of
preferred stock were issued or outstanding as of
December 31, 2005 or December 31, 2004.
Purchase
Rights
On December 10, 2004, our Board of Directors declared a
dividend of one preferred share purchase right (a
“Right”) for each outstanding share of common stock.
The dividend was payable upon the close of business on
January 28, 2005 to the shareholders of record upon the
close of business on January 28, 2005. Each Right entitles
the registered holder to purchase one one-hundredth of a share
of Series A Junior Participating Preferred Stock, at a
price of $240.00 per one one-hundredth of a share, subject to
adjustment. However, the Rights are not exercisable unless
certain change in control events occur, such as a person
acquiring or obtaining the right to acquire beneficial ownership
of 15 percent or more of our outstanding common stock. The
description and terms of the Rights are set forth in a Rights
Agreement, dated December 10, 2004. The Rights will expire
on January 28, 2015, unless the Rights are earlier redeemed
or exchanged in accordance with the terms of the Rights
Agreement. On January 28, 2005, the common share purchase
rights issued pursuant to the Rights Agreement dated
July 31, 1995 were redeemed in their entirety for an amount
equal to $0.0025 per right.
Notes to
Consolidated Financial
Statements — (continued)
Share
Repurchases
In December 2004, the Board of Directors authorized the
development of a program and process to repurchase shares of our
common stock up to a maximum dollar limit of $25.0 million
annually. There is no expiration associated with the
authorization granted. In 2005, we repurchased
755,663 shares for $25.0 million under this plan. We
have the authority in 2006 to repurchase shares up to a maximum
dollar limit of $25.0 million. As of February 17, 2006
we had not repurchased any shares under this plan. In 2004 and
2003, respectively, we repurchased 105,500 shares and
80,000 shares of our common stock under similar plans.
13.
Stock
Plans
Total stock-based compensation expense from continuing
operations in 2005, 2004, and 2003 was $24.2 million,
$6.3 million, and $4.0 million, respectively. The
increase in 2005 is attributable to the adoption of
SFAS 123R in the fourth quarter of 2005 using the modified
retrospective transition method and restating interim periods in
2005. The adoption of SFAS 123R in 2005 resulted in the
recognition of incremental pre-tax stock-based compensation of
$16.4 million, a reduction in net income of
$12.0 million, a reduction in basic and diluted earnings
per share of $.12, a reduction in cash flows from operating
activities of $8.7 million and an increase in cash flows
from financing activities of $8.7 million. We additionally
reclassified our unearned compensation on non-vested share
awards of $7.9 million to additional paid in capital. The
cumulative effect adjustment for forfeitures related to
non-vested share awards was immaterial.
The following table shows the 2005 quarterly impact of the
adoption of the new accounting standard:
Notes to
Consolidated Financial
Statements — (continued)
Prior to 2005, we applied APB 25 and the disclosure only
provisions of SFAS No. 123. The following table
illustrates the effect on income and earnings per share if we
had applied the fair value recognition provisions of
SFAS No. 123 to stock-based employee compensation
during 2004 and 2003. The estimated fair value of each Pentair
option is calculated using the Black-Scholes option-pricing
model.
2004
2003
(In thousands, except
per-share data)
Net income
$
171,225
$
141,352
Plus stock-based employee
compensation included in net income, net of tax
6,558
2,414
Less estimated stock-based
employee compensation determined under fair value based method,
net of tax
(17,958
)
(8,015
)
Net Income — pro
forma
$
159,825
$
135,751
Earnings per common
share
Basic — as reported
$
1.72
$
1.44
Plus stock-based employee
compensation included in net income, net of tax
0.07
0.02
Less estimated stock-based
employee compensation determined under fair value based method,
net of tax
(0.18
)
(0.07
)
Basic — pro forma
$
1.61
$
1.39
Diluted — as
reported
$
1.68
$
1.42
Plus stock-based employee
compensation included in net income, net of tax
0.07
0.02
Less estimated stock-based
employee compensation determined under fair value based method,
net of tax
(0.18
)
(0.08
)
Diluted — pro forma
$
1.57
$
1.36
Weighted average common shares
outstanding
Basic
99,316
97,876
Diluted
101,441
99,620
The amounts shown above are not indicative of the effect in
future years since the estimated fair value of options is
amortized on an accelerated basis to expense over the vesting
period, and the number of options granted varies from year to
year.
We estimated the fair values using the Black-Scholes
option-pricing model, modified for dividends and using the
following assumptions:
Notes to
Consolidated Financial
Statements — (continued)
Omnibus
Stock Incentive Plan
In April 2004, the Omnibus Stock Incentive Plan as Amended and
Restated (the Plan) was approved by shareholders. The Plan
authorizes the issuance of additional shares of our common stock
and extends through April 2014. The Plan allows for the granting
of:
•
nonqualified stock options;
•
incentive stock options;
•
non-vested shares;
•
rights to non-vested shares;
•
incentive compensation units (ICUs);
•
stock appreciation rights;
•
performance shares; and
•
performance units.
The Plan is administered by our Compensation Committee (the
Committee), which is made up of independent members of our Board
of Directors. Employees eligible to receive awards under the
Plan are managerial, administrative, or other key employees who
are in a position to make a material contribution to the
continued profitable growth and long-term success of Pentair.
The Committee has the authority to select the recipients of
awards, determine the type and size of awards, establish certain
terms and conditions of award grants, and take certain other
actions as permitted under the Plan. The Plan provides that no
more than 20 percent of the total shares available for
issuance under the Plan may be used to make awards other than
stock options and limits the Committee’s authority to
reprice awards or to cancel and reissue awards at lower prices.
Non-Qualified
and Incentive Stock Options
Under the Plan we may grant stock options to any eligible
employee with an exercise price equal to the market value of the
shares on the dates the options were granted. Options generally
vest over a three-year period commencing on the grant date and
expire ten years after the grant date. Option grants typically
have a reload feature when shares are retired to pay the
exercise price, allowing individuals to receive additional
options upon exercise equal to the number of shares retired.
Non-Vested
Shares, Rights to Non-Vested Shares and ICUs
Under the Plan, eligible employees are awarded non-vested shares
or rights to non-vested shares (awards) of our common stock.
Share awards generally vest from two to five years after
issuance, subject to continuous employment and certain other
conditions. Non-vested share awards are valued at market value
on the date of grant and are expensed over the vesting period.
Annual expense for the value of non-vested shares and rights to
non-vested shares was $7.0 million in 2005,
$6.3 million in 2004, and $3.7 million in 2003. ICUs
are cash incentives granted to employees. Annual expense for
ICUs was $0.0 million in 2005, $0.3 million in 2004,
and $0.9 million in 2003.
Stock
Appreciation Rights, Performance Shares, and Performance
Units
Under the Plan, the compensation committee is permitted to issue
these awards; however, there have been no issuances of these
awards.
Notes to
Consolidated Financial
Statements — (continued)
Outside
Directors Nonqualified Stock Option Plan
Nonqualified stock options are granted to outside directors
under the Outside Directors Nonqualified Stock Option Plan (the
Directors Plan) with an exercise price equal to the market value
of the shares on the option grant dates. Options generally vest
over a three-year period commencing on the grant date and expire
ten years after the grant date. The Directors Plan extends to
January 2008.
Stock
options
The following table summarizes stock option activity under
all plans:
2005
Exercise
Remaining
Aggregate
Options Outstanding
Shares
Price(1)
Contractual Life(1)
Intrinsic Value
Balance January 1
5,487,018
$
20.97
Granted
1,774,049
40.83
Exercised
(1,296,432
)
19.25
Forfeited
(4,256
)
26.31
Expired
(87,997
)
32.51
Balance
December 31
5,872,382
$
27.18
7.0 years
$
159,603,865
Options exercisable
December 31
2,856,331
$
22.60
5.6 years
$
64,554,208
Shares available for grant
December 31
9,767,068
(1)
Weighted average
The weighted-average grant date fair value of options granted in
2005, 2004, and 2003 was estimated to be $11.44, $8.64, and
$5.76 per share, respectively. The total intrinsic value of
options that were exercised during 2005, 2004, and 2003 was
$29.5 million, $47.5 million, and $3.8 million,
respectively. At December 31, 2005, the total unrecognized
compensation cost related to stock options was
$9.8 million. This cost is expected to be recognized over a
weighted average period of 9 months.
Cash received from option exercises for the years ended
December 31, 2005, 2004, and 2003 was $8.4 million,
$10.9 million, and $5.8 million, respectively. The
actual tax benefit realized for the tax deductions from option
exercises totaled $10.7 million, $17.2 million, and
$1.7 million for the years ended December 31, 2005,
2004, and 2003, respectively.
The following table summarizes non-vested share activity
under all plans:
Notes to
Consolidated Financial
Statements — (continued)
As of December 31, 2005, there was $12.5 million of
unrecognized compensation cost related to non-vested share-based
compensation arrangements granted under the Plan. That cost is
expected to be recognized over a weighted average period of
1.3 years. The total fair value of shares vested during the
years ended December 31, 2005, 2004 and 2003, was
$6.6 million, $12.4 million, and $3.8 million,
respectively.
During 2005, we increased the contractual term of options for
one individual resulting in additional compensation expense of
$0.4 million under SFAS 123R. In 2004, we recorded
$4.4 million of compensation expense under APB 25
related to the modification of option terms for employees
terminated in association with our Tools Group divestiture.
14.
Business
Segments
We classify our continuing operations into the following
business segments:
•
Water — manufactures and markets
essential products and systems used in the movement, treatment,
storage and enjoyment of water. Water segment products include
water and wastewater pumps; filtration and purification
components and systems; storage tanks and pressure vessels; and
pool and spa equipment and accessories.
•
Technical Products — formerly
referred to as Enclosures, designs, manufactures, and markets
standard, modified and custom enclosures that house and protect
sensitive controls, components; thermal management products; and
accessories. Applications served include industrial machinery,
data communications, networking, telecommunications, test and
measurement, automotive, medical, security, defense, and general
electronics. Products include metallic and composite enclosures,
cabinets, cases, subracks, backplanes, and associated thermal
management systems.
•
Other — is primarily composed of
unallocated corporate expenses, our captive insurance
subsidiary, intermediate finance companies, divested operations,
and intercompany eliminations.
The accounting policies of our operating segments are the same
as those described in the summary of significant accounting
policies. We evaluate performance based on the sales and
operating income of the segments and use a variety of ratios to
measure performance. These results are not necessarily
indicative of the results of operations that would have occurred
had each segment been an independent, stand-alone entity during
the periods presented.
Net sales are based on the location in which the sale
originated. Long-lived assets represent property, plant, and
equipment, net of related depreciation.
We offer a broad array of products and systems to multiple
markets and customers for which we do not have the financial
systems to track revenues by primary product category. However,
our net sales by segment is representative of our sales by major
product category.
We sell our products through various distribution channels
including wholesale and retail distributors, original equipment
manufacturers, and home centers. In our Water segment, no single
customer accounted for more than 10 percent of segment
sales in 2005, one customer accounted for about 11 percent
and 12 percent of segment sales in 2004 and 2003,
respectively. In our Technical Products segment, no single
customer accounted for more than 10 percent of segment
sales in 2005, 2004, or 2003.
Future minimum lease commitments under non-cancelable
operating leases, principally related to facilities, vehicles,
and machinery and equipment are as follows:
2006
2007
2008
2009
2010
Thereafter
Total
(In thousands)
Minimum lease payments
$
26,317
$
20,978
$
17,219
$
14,151
$
11,633
$
22,555
$
112,853
Minimum sublease rentals
(487
)
(407
)
(407
)
(339
)
—
—
(1,640
)
Net future minimum lease
commitments
$
25,830
$
20,571
$
16,812
$
13,812
$
11,633
$
22,555
$
111,213
Environmental
We have been named as defendants, targets, or potentially
responsible parties (PRPs) in a small number of environmental
clean-ups, in which our current or former business units have
generally been given de minimis status. To date, none of
these claims have resulted in
clean-up
costs, fines, penalties, or damages in an amount material to our
financial position or results of operations. We have disposed of
a number of businesses over the last ten years and in certain
cases, such as the disposition of the Cross Pointe Paper
Corporation uncoated paper business in 1995, the disposition of
the Federal Cartridge Company ammunition business in 1997, the
disposition of Lincoln Industrial in 2001, and the disposition
of the Tools Group in 2004, we have retained responsibility and
potential liability for certain environmental obligations. We
have received claims for indemnification from purchasers both of
the paper business and the ammunition business and have
established what we believe to be adequate accruals for
potential liabilities arising out of retained responsibilities.
We settled some of the claims in 2005 and 2003 and our recorded
accrual was adequate.
In addition, there are pending environmental issues at a limited
number of sites, including one site acquired in the acquisition
of Essef Corporation in 1999, which relates to operations no
longer carried out at that site. We have established what we
believe to be adequate accruals for remediation costs at this
and other sites. We do not believe that projected response costs
will result in a material liability.
We may be named as a PRP at other sites in the future, for both
divested and acquired businesses. When it is probable and it is
possible to provide reasonable estimates of our liability, with
respect to environmental sites, provisions have been made in
accordance with generally accepted accounting principles in the
United States. As of December 31, 2005 and 2004, our
reserves for such environmental liabilities were approximately
$6.4 million and $9.4 million, respectively, measured
on an undiscounted basis. We cannot ensure that environmental
requirements will not change or become more stringent over time
or that our eventual environmental
clean-up
costs and liabilities will not exceed the amount of our current
reserves.
Notes to
Consolidated Financial
Statements — (continued)
Litigation
We have been made parties to a number of actions filed or have
been given notice of potential claims relating to the conduct of
our business, including those pertaining to commercial disputes,
product liability, environmental, safety and health, patent
infringement, and employment matters.
We comply with the requirements of Statement of Financial
Accounting Standards (“SFAS”) No. 5,
Accounting for Contingencies, and related guidance, and
record liabilities for an estimated loss from a loss contingency
where the outcome of the matter is probable and can be
reasonably estimated. Factors that are considered when
determining whether the conditions for accrual have been met
include the (a) nature of the litigation, claim, or
assessment, (b) progress of the case, including progress
after the date of the financial statements but before the
issuance date of the financial statements, (c) opinions of
legal counsel, and (d) management’s intended response
to the litigation, claim, or assessment. Where the reasonable
estimate of the probable loss is a range, we record the most
likely estimate of the loss. When no amount within the range is
a better estimate than any other amount, however, the minimum
amount in the range is accrued. Gain contingencies are not
recorded until realized.
While we believe that a material adverse impact on our
consolidated financial position, results of operations, or cash
flows from any such future charges is unlikely, given the
inherent uncertainty of litigation, a remote possibility exists
that a future adverse ruling or unfavorable development could
result in future charges that could have a material adverse
impact. We do and will continue to periodically reexamine our
estimates of probable liabilities and any associated expenses
and receivables and make appropriate adjustments to such
estimates based on experience and developments in litigation. As
a result, the current estimates of the potential impact on our
consolidated financial position, results of operations, and cash
flows for the proceedings and claims could change in the future.
Product
Liability Claims
We are subject to various product liability lawsuits and
personal injury claims. A substantial number of these lawsuits
and claims are insured and accrued for by Penwald our captive
insurance subsidiary. Penwald records a liability for these
claims based on actuarial projections of ultimate losses. For
all other claims, accruals covering the claims are recorded, on
an undiscounted basis, when it is probable that a liability has
been incurred and the amount of the liability can be reasonably
estimated based on existing information. The accruals are
adjusted periodically as additional information becomes
available. We have not experienced significant unfavorable
trends in either the severity or frequency of product liability
lawsuits or personal injury claims.
Horizon
Litigation
Twenty-eight separate lawsuits involving 29 primary plaintiffs,
a class action, and claims for indemnity by Celebrity Cruise
Lines, Inc. (Celebrity) were brought against Essef Corporation
(Essef) and certain of its subsidiaries prior to our acquisition
of Essef in August 1999. Celebrity has alleged that it had
sustained economic damages due to loss of use of the M/V Horizon
while it was dry-docked.
The claims against Essef and its involved subsidiaries were
based upon the allegation that Essef designed, manufactured, and
marketed two sand swimming pool filters that were installed as a
part of the spa system on the Horizon, and allegations that the
spa and filters contained Legionnaire’s disease bacteria
that infected certain passengers on cruises from December 1993
through July 1994.
The individual and class claims by passengers were tried and
resulted in an adverse jury verdict finding liability on the
part of the Essef defendants (70%) and Celebrity and its sister
company, Fantasia (together 30%).
Notes to
Consolidated Financial
Statements — (continued)
After expiration of post-trial appeals, we paid all outstanding
punitive damage awards of $7.0 million in the Horizon
cases, plus interest of approximately $1.6 million, in
January 2004. We had reserved for the amount of punitive damages
awarded at the time of the Essef acquisition. A reserve for the
$1.6 million interest cost was recorded in 2003. All of the
personal injury cases have now been resolved through either
settlement or trial.
The only remaining unresolved claims in this case are those
brought by Celebrity for damages resulting from the outbreak.
Celebrity filed an amended complaint seeking attorney fees and
costs for prior litigation as well as
out-of-pocket
losses, lost profits, and loss of business enterprise value.
Discovery commenced late in 2004, and was completed in August
2005. Celebrity’s claims for damages exceed
$185 million. Assuming matters of causation, standing,
contribution and proof are decided against it, Essef’s
experts believe that damages should amount to no more than
approximately $16 to $25 million. Dispositive motions in
this matter were filed in August 2005, which were decided in
December 2005. Celebrity’s motion for indemnity from Essef
for payments made by Celebrity for passenger claims of
approximately $2.3 million was denied. Essef’s motion
for dismissal of certain damage claims was denied without
prejudice to renewal in conjunction with both parties’
motions to exclude certain expert testimony. We expect these
motions to be adjudicated in March 2006. Trial has been
scheduled for April 24, 2006. We believe our reserves for
any liability to Celebrity are adequate and intend to vigorously
defend against these claims.
Warranties
and Guarantees
In connection with the disposition of our businesses or product
lines, we may agree to indemnify purchasers for various
potential liabilities relating to the sold business, such as
pre-closing tax, product liability, warranty, environmental, or
other obligations. The subject matter, amounts, and duration of
any such indemnification obligations vary for each type of
liability indemnified and may vary widely from transaction to
transaction. Generally, the maximum obligation under such
indemnifications is not explicitly stated and as a result, the
overall amount of these obligations cannot be reasonably
estimated. Historically, we have not made significant payments
for these indemnifications. We believe that if we were to incur
a loss in any of these matters, the loss would not have a
material effect on our financial condition or results of
operations.
In accordance with FASB Interpretation No. 45
(“FIN 45”), Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Others, we recognize, at the inception of a
guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee.
We have guaranteed the indebtedness of one customer, whose
outstanding debt at December 31, 2005 was
$1.1 million. The debt amount is a declining balance and
scheduled to be paid in full by June 2007. The liability
relating to the guarantee is not material.
We provide service and warranty policies on our products.
Liability under service and warranty policies is based upon a
review of historical warranty and service claim experience.
Adjustments are made to accruals as claim data and historical
experience warrant.
Notes to
Consolidated Financial
Statements — (continued)
The changes in the carrying amount of service and product
warranties for the year ended December 31, 2005 and 2004
are as follows:
2005
2004
(In thousands)
Balance at beginning of the year
$
32,524
$
14,427
Service and product warranty
provision
40,576
35,141
Payments
(44,123
)
(32,237
)
Acquired
2,231
14,899
Translation
2,343
294
Balance at end of the year
$
33,551
$
32,524
Stand-By
Letters of Credit
In the ordinary course of business, predominantly for contracts
and bids involving municipal pump products, we are required to
commit to bonds that require payments to our customers for any
non-performance. The outstanding face value of the bonds
fluctuates with the value of our projects in process and in our
backlog. In addition, we issue financial stand-by letters of
credit to secure our performance to third parties under
self-insurance programs and certain legal matters. As of
December 31, 2005, the outstanding value of these
instruments totaled $38.8 million. As of December 31,2004, the outstanding value of these instruments totaled
$64.9 million, which included a $38.9 million stand-by
letter of credit pertaining to an indemnified legal matter that
was resolved in our favor during 2005, eliminating the bond
requirement.
16.
Selected
Quarterly Financial Data (Unaudited)
In the fourth quarter of 2005, we adopted SFAS 123R,
Stock-Based Payment, using the modified retrospective method as
of January 1, 2005. As a result, quarterly financial
information for 2005 has been restated from the previously filed
quarterly financial information for the impact of the adoption
of SFAS 123R, see Note 13 for the reconciliation. As
we did not retrospectively adopt SFAS 123R for all periods,
the 2004 quarterly financial data remains unmodified.
Notes to
Consolidated Financial
Statements — (continued)
The following table represents the 2005 quarterly financial
information restated for the adoption of SFAS 123R:
2005
First
Second
Third
Fourth
Year
(In thousands, except per-share
data)
Net sales
$
709,635
$
788,523
$
716,308
$
732,113
$
2,946,579
Gross profit
204,138
235,233
200,841
207,809
848,021
Operating income
72,086
107,234
76,880
66,872
323,072
Income from continuing operations
40,181
61,379
44,533
38,956
185,049
Income from discontinued
operations, net of tax
—
—
—
—
—
Loss on disposal of discontinued
operations, net of tax
—
—
—
—
—
Net income
40,181
61,379
44,533
38,956
185,049
Earnings per common
share(1)
Basic
Continuing operations
$
0.40
$
0.61
$
0.44
$
0.39
$
1.84
Discontinued operations
—
—
—
—
—
Basic earnings per common share
$
0.40
$
0.61
$
0.44
$
0.39
$
1.84
Diluted
Continuing operations
$
0.39
$
0.60
$
0.43
$
0.38
$
1.80
Discontinued operations
—
—
—
—
—
Diluted earnings per common share
$
0.39
$
0.60
$
0.43
$
0.38
$
1.80
(1)
Amounts may not total to annual earnings because each quarter
and year are calculated separately based on basic and diluted
weighted-average common shares outstanding during that period.
Notes to
Consolidated Financial
Statements — (continued)
The following table represents the 2004 quarterly financial
information:
2004
First
Second
Third
Fourth
Year
(In thousands, except per-share
data)
Net sales
$
488,453
$
530,433
$
607,767
$
651,476
$
2,278,129
Gross profit
140,073
161,651
169,784
183,202
654,710
Operating income
50,110
70,984
64,099
62,049
247,242
Income from continuing operations
28,242
41,993
33,092
33,697
137,024
Income from discontinued
operations, net of tax
11,968
13,470
14,810
—
40,248
Loss on disposal of discontinued
operations, net of tax
—
—
—
(6,047
)
(6,047
)
Net income
40,210
55,463
47,902
27,650
171,225
Earnings per common
share(1)
Basic
Continuing operations
$
0.29
$
0.42
$
0.33
$
0.34
$
1.38
Discontinued operations
0.12
0.14
0.15
(0.07
)
0.34
Basic earnings per common share
$
0.41
$
0.56
$
0.48
$
0.27
$
1.72
Diluted
Continuing operations
$
0.28
$
0.42
$
0.32
$
0.33
$
1.35
Discontinued operations
0.12
0.13
0.15
(0.07
)
0.33
Diluted earnings per common share
$
0.40
$
0.55
$
0.47
$
0.26
$
1.68
(1)
Amounts may not total to annual earnings because each quarter
and year are calculated separately based on basic and diluted
weighted-average common shares outstanding during that period.
Notes to
Consolidated Financial
Statements — (continued)
17.
Financial
Statements of Subsidiary Guarantors
The $250 million Senior Notes due 2009 are jointly and
severally guaranteed by domestic subsidiaries (the
“Guarantor Subsidiaries”), each of which is directly
or indirectly wholly-owned by Pentair (the “Parent
Company”). The following supplemental financial information
sets forth the condensed consolidated balance sheets as of
December 31, 2005 and 2004, the related condensed
consolidated statements of income and statements of cash flows
for each of the three years in the period ended
December 31, 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 Year Ended December 31, 2005
Changes
In and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
Item 9A.
Controls
and Procedures
Our management, with the participation of our Chief Executive
Officer and our Chief Financial Officer, evaluated the
effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the year ended
December 31, 2005, 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 year
ended December 31, 2005 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.
Management’s
Annual Report on Internal Control Over Financial
Reporting
The report of management required under this ITEM 9A is
contained in ITEM 8 of this Annual Report on
Form 10-K
under the caption “Management’s Report on Internal
Control Over Financial Reporting.”
Attestation
Report of Registered Public Accounting Firm
The attestation report required under this ITEM 9A is
contained in ITEM 8 of this Annual Report on
Form 10-K
under the caption “Report of Independent Registered Public
Accounting Firm.”
Changes
in Internal Control over Financial Reporting
There was no change in our internal control over financial
reporting that occurred during the quarter ended
December 31, 2005 that has materially affected, or is
reasonably likely to materially affect, our internal control
over financial reporting.
Directors
and Executive Officers of the Registrant
Information required under this item with respect to directors
is contained in our Proxy Statement for our 2006 annual meeting
of shareholders under the captions “Corporate Governance
Matters”, “Election of Directors” and
“Section 16(a) Beneficial Ownership Reporting
Compliance” and is incorporated herein by reference.
Information required under this item with respect to executive
officers is contained in Part I of this
Form 10-K
under the caption “Executive Officers of the
Registrant.”
Our Board of Directors has adopted Pentair’s Code of
Business Conduct and Ethics and designated it as the code of
ethics for the Company’s Chief Executive Officer and senior
financial officers in accordance with SEC rules. The Code of
Business Conduct and Ethics also applies to all employees and
directors in accordance with New York Stock Exchange Listing
Standards. We have posted a copy of Pentair’s Code of
Business Conduct and Ethics on our website at
www.pentair.com/code.html. Pentair’s Code of
Business Conduct and Ethics is also available in print to any
shareholder who requests it in writing from our Corporate
Secretary. We intend to satisfy the disclosure requirements
under Item 5.05 of
Form 8-K
regarding amendments to, or waivers from, Pentair’s Code of
Business Conduct and Ethics by posting such information on our
website at www.pentair.com/code.html.
We are not including the information contained on our website as
part of, or incorporating it by reference into, this report.
Item 11.
Executive
Compensation
Information required under this item is contained in our Proxy
Statement for our 2006 annual meeting of shareholders under the
captions “Election of Directors” and “Executive
Compensation” and is incorporated herein by reference.
Item 12.
Security
Ownership of Certain Beneficial Owners and
Management
Information required under this item is contained in our Proxy
Statement for our 2006 annual meeting of shareholders under the
captions “Security Ownership of Management and Beneficial
Ownership” and “Securities Authorized for Issuance
under Equity Compensation Plans” and is incorporated herein
by reference.
Item 13.
Certain
Relationships and Related Transactions
No matters require disclosure here.
Item 14.
Principal
Accounting Fees and Services
Information required under this item is contained in our Proxy
Statement for our 2006 annual meeting of shareholders under the
caption “Independent Auditor Fees” and is incorporated
herein by reference.
Consolidated Statements of Changes in Shareholders’ Equity
for the Years Ended December 31, 2005, 2004, and 2003
Notes to Consolidated Financial Statements
(2)
Financial Statement Schedules
Schedule II — Valuation and Qualifying
Accounts
All other schedules for which provision is made in the
applicable accounting regulations of the Securities and Exchange
Commission have been omitted because they are not applicable or
the required information is shown in the financial statements or
notes thereto.
(3) Exhibits
The exhibits of this Annual Report on
Form 10-K
included herein are set forth on the attached Exhibit Index
beginning on page 98.
Pursuant to the requirements of Section 13 or 15(d) 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 February 27, 2006.
Executive Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities indicated, on
February 27, 2006.
Second Restated Articles of
Incorporation as amended through May 1, 2002 (Incorporated
by reference to Exhibit 3.1 contained in Pentair’s
Quarterly Report on
Form 10-Q
for the quarterly period ended March 30, 2002).
3
.2
Third Amended and Superceding
By-Laws as amended through May 1, 2002 (Incorporated by
reference to Exhibit 3.2 contained in Pentair’s
Quarterly Report on
Form 10-Q
for the quarterly period ended March 30, 2002).
3
.3
Statement of Resolution of the
Board of Directors Establishing the Series and Fixing the
Relative Rights and Preferences of Series A Junior
Participating Preferred Stock (Incorporated by reference to
Exhibit 3.1 contained in Pentair’s Current Report on
Form 8-K
dated December 10, 2004).
Form of Indenture, dated
June 1, 1999, between Pentair, Inc. and U.S. Bank
National Association, as Trustee Agent (Incorporated by
reference to Exhibit 4.2 contained in Pentair’s Annual
Report on
Form 10-K
for the year ended December 31, 2000).
Supplemental Indenture between
Pentair, Inc. and U.S. Bank National Association, as
Trustee, dated as of August 2, 2004 (Incorporated by
reference to Exhibit 4.1 contained in Pentair’s
Quarterly Report on
Form 10-Q
for the quarterly period ended October 2, 2004).
4
.5
Second Amended and Restated Credit
Agreement dated as of March 4, 2005 among Pentair, Inc.,
various subsidiaries of Pentair, Inc. and various financial
institutions therein and Bank of America, N.A., as
Administrative Agent and Issuing Bank. (Incorporated by
reference to Exhibit 99.1 contained in Pentair’s
Current Report on
Form 8-K
dated March 4, 2005).
4
.6
First Amendment to
Note Purchase agreement dated July 19, 2005 by and
among Pentair, Inc. and the undersigned holders (Incorporated by
reference to Exhibit 4 contained in Pentair’s
Quarterly Report on
Form 10-Q
for the quarterly period ended July 2, 2005).
Amended and Restated Pentair, Inc.
Outside Directors Nonqualified Stock Option Plan as amended
through February 27, 2002 (Incorporated by reference to
Exhibit 10.7 contained in Pentair’s Annual Report on
Form 10-K
for the year ended December 31, 2001).*
Trust Agreement for Pentair,
Inc. Non-Qualified Deferred Compensation Plan between Pentair,
Inc. and State Street Bank and Trust Company (Incorporated by
reference to Exhibit 10.18 contained in Pentair’s
Annual Report on
Form 10-K
for the year ended December 31, 1995).*
10
.7
Amendment effective
August 23, 2000 to Pentair’s Non-Qualified Deferred
Compensation Plan effective January 1, 1996 (Incorporated
by reference to Exhibit 10.8 contained in Pentair’s
Current Report on
Form 8-K
filed September 21, 2000).*
10
.8
Pentair, Inc. Executive Officer
Performance Plan as Amended and Restated, effective
January 1, 2003 (Incorporated by reference to
Appendix 1 contained in Pentair’s Proxy Statement for
its 2003 annual meeting of shareholders).*
Pentair’s Flexible Perquisite
Program as amended effective January 1, 1989 (Incorporated
by reference to Exhibit 10.20 contained in Pentair’s
Annual Report on
Form 10-K
for the year ended December 31, 1989).*
Form of Key Executive Employment
and Severance Agreement effective August 23, 2000 for Louis
Ainsworth, Richard J. Cathcart, Michael V. Schrock, Karen A.
Durant, David D. Harrison, Frederick S. Koury, Michael G. Meyer,
Jack J. Dempsey, and Charles M. Brown (Incorporated by reference
to Exhibit 10.13 contained in Pentair’s Current Report
on
Form 8-K
filed September 21, 2000).*
10
.14
Employment Agreement dated
October 17, 2001, between Pentair, Inc. and Richard J.
Cathcart. (Incorporated by reference to Exhibit 10.31
contained in Pentair’s Quarterly Report on
Form 10-Q
for the quarterly period ended September 29, 2001).*
10
.15
Pentair, Inc. International Stock
Purchase and Bonus Plan, as Amend and Restated, effective
May 1, 2004 (Incorporated by reference to Appendix I
contained in Pentair’s Proxy Statement for its 2004 annual
meeting of shareholders). *
10
.16
Pentair, Inc. Compensation Plan
for Non-Employee Directors, as Amended and Restated, effective
May 1, 2004 (Incorporated by reference to Appendix F
contained in Pentair’s Proxy Statement for its 2004 annual
meeting of shareholders). *
10
.17
Pentair, Inc. Omnibus Stock
Incentive Plan, as Amended and Restated, effective May 1,2004 (Incorporated by reference to Appendix G contained in
Pentair’s Proxy Statement for its 2004 annual meeting of
shareholders). *
10
.18
Pentair, Inc. Employee Stock
Purchase and Bonus Plan, as Amended and Restated, effective
May 1, 2004 (Incorporated by reference to Appendix H
contained in Pentair’s Proxy Statement for its 2004 annual
meeting of shareholders). *
10
.19
Amendment effective
December 10, 2004 to the Pentair, Inc. Outside
Director’s Nonqualified Stock Option Plan for Non-Employee
Directors (Incorporated by reference to Exhibit 10.1
contained in Pentair’s Current Report on
Form 8-K
dated December 10, 2004).*
10
.20
Summary of Board of Director
Compensation, approved December 10, 2004 (Incorporated by
reference to Exhibit 10.2 contained in Pentair’s
Current Report on
Form 8-K
dated December 10, 2004).*
Confidentiality and
Non-Competition Agreement, dated January 6, 2005, between
Pentair, Inc. and Michael Schrock (Incorporated by reference to
Exhibit 10.2 contained in Pentair’s Current Report on
Form 8-K
dated January 6, 2005).*
