PNR-2013.9.28 10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the Quarterly Period Ended September 28, 2013
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-11625
Pentair Ltd.
 
(Exact name of Registrant as specified in its charter)
Switzerland
  
98-1050812
(State or other jurisdiction of incorporation or organization)
  
(I.R.S. Employer Identification number)
 
 
Freier Platz 10, 8200 Schaffhausen, Switzerland
  
 
(Address of principal executive offices)
  
 
Registrant’s telephone number, including area code: 41-52-630-48-00
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 ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§223.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ
  
Accelerated filer o
  
Non-accelerated filer o
  
Smaller reporting company o
 
  
 
  
(Do not check if a smaller reporting company)
  
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
On September 28, 2013, 199,333,916 shares of Registrant’s common stock were outstanding.



Table of Contents

Pentair Ltd. and Subsidiaries
 
 
Page
 
 
PART I FINANCIAL INFORMATION
 
 
 
 
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
PART II OTHER INFORMATION
 
 
 
 
ITEM 1.
 
 
 
ITEM 1A.
 
 
 
ITEM 2.
 
 
 
ITEM 6.
 
 
 
 



2

Table of Contents

PART I FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS
Pentair Ltd. and Subsidiaries
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited)
 
 
Three months ended
 
Nine months ended
In millions, except per-share data
September 28,
2013
September 29,
2012
 
September 28,
2013
September 29,
2012
Net sales
$
1,824.8

$
865.5

 
$
5,563.0

$
2,665.2

Cost of goods sold
1,187.2

587.4

 
3,734.2

1,794.3

Gross profit
637.6

278.1

 
1,828.8

870.9

Selling, general and administrative
366.1

203.1

 
1,191.5

548.5

Research and development
31.5

19.8

 
97.1

61.4

Operating income
240.0

55.2

 
540.2

261.0

Other (income) expense:
 
 
 
 
 
Equity income of unconsolidated subsidiaries
(0.5
)
(0.6
)
 
(1.6
)
(2.3
)
Gain on sale of business
(0.1
)

 
(16.8
)

Net interest expense
17.2

18.6

 
52.6

49.5

Income before income taxes and noncontrolling interest
223.4

37.2

 
506.0

213.8

Provision for income taxes
49.2

4.6

 
123.1

43.7

Net income before noncontrolling interest
174.2

32.6

 
382.9

170.1

Noncontrolling interest
1.4

1.2

 
4.3

4.2

Net income attributable to Pentair Ltd.
$
172.8

$
31.4

 
$
378.6

$
165.9

Comprehensive income (loss), net of tax
 
 
 
 
 
Net income before noncontrolling interest
$
174.2

$
32.6

 
$
382.9

$
170.1

Changes in cumulative translation adjustment
89.1

41.2

 
(29.1
)
(3.8
)
Changes in market value of derivative financial instruments
(0.6
)
(8.4
)
 
(0.3
)
(5.3
)
Total comprehensive income
262.7

65.4

 
353.5

161.0

Less: Comprehensive income attributable to noncontrolling interest
2.6

2.1

 
5.0

4.1

Comprehensive income attributable to Pentair Ltd.
$
260.1

$
63.3

 
$
348.5

$
156.9

Earnings per common share attributable to Pentair Ltd.
 
 
 
 
 
Basic
$
0.87

$
0.31

 
$
1.87

$
1.67

Diluted
$
0.85

$
0.31

 
$
1.84

$
1.63

Weighted average common shares outstanding
 
 
 
 
 
Basic
199.3

100.4

 
202.1

99.5

Diluted
202.8

102.9

 
205.6

101.7

Cash dividends paid per common share
$
0.25

$
0.22

 
$
0.71

$
0.66

See accompanying notes to condensed consolidated financial statements.



3

Table of Contents

Pentair Ltd. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
 
 
September 28,
2013
December 31,
2012
In millions, except per-share data
Assets
Current assets
 
 
Cash and cash equivalents
$
237.7

$
261.3

Accounts and notes receivable, net of allowances of $53.0 and $37.5 respectively
1,299.2

1,274.6

Inventories
1,296.1

1,333.9

Other current assets
378.3

341.1

Total current assets
3,211.3

3,210.9

Property, plant and equipment, net
1,171.9

1,188.2

Other assets
 
 
Goodwill
5,122.0

5,111.0

Intangibles, net
1,817.2

1,926.9

Other non-current assets
481.8

504.8

Total other assets
7,421.0

7,542.7

Total assets
$
11,804.2

$
11,941.8

Liabilities and Equity
Current liabilities
 
 
Current maturities of long-term debt and short-term borrowings
$
3.0

$
3.1

Accounts payable
579.4

567.0

Employee compensation and benefits
317.5

296.7

Other current liabilities
778.5

778.1

Total current liabilities
1,678.4

1,644.9

Other liabilities
 
 
Long-term debt
2,570.7

2,454.3

Pension and other post-retirement compensation and benefits
388.2

378.8

Deferred tax liabilities
497.8

480.9

Other non-current liabilities
467.4

495.1

Total liabilities
5,602.5

5,454.0

Equity
 
 
Common shares CHF 0.50 par value, 213.0 authorized and issued at September 28, 2013 and December 31, 2012, respectively
113.5

113.5

Common shares held in treasury, 13.7 and 6.9 shares at September 28, 2013 and December 31, 2012, respectively
(727.2
)
(315.5
)
Capital contribution reserve
5,066.5

5,292.4

Retained earnings
1,671.1

1,292.5

Accumulated other comprehensive income (loss)
(41.7
)
(11.6
)
Shareholders’ equity attributable to Pentair Ltd.
6,082.2

6,371.3

Noncontrolling interest
119.5

116.5

Total equity
6,201.7

6,487.8

Total liabilities and equity
$
11,804.2

$
11,941.8

See accompanying notes to condensed consolidated financial statements.

4

Table of Contents

Pentair Ltd. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
Nine months ended
In millions
September 28,
2013
September 29,
2012
Operating activities
 
 
Net income before noncontrolling interest
$
382.9

$
170.1

Adjustments to reconcile net income before noncontrolling interest to net cash provided by (used for) operating activities
 
 
Equity income of unconsolidated subsidiaries
(1.6
)
(2.3
)
Depreciation
114.3

48.6

Amortization
109.5

29.4

Deferred income taxes
22.8

4.0

Gain on sale of business
(16.8
)

Share-based compensation
25.3

28.5

Excess tax benefits from share-based compensation
(7.4
)
(2.1
)
(Gain) loss on sale of assets
4.0

(3.3
)
Changes in assets and liabilities, net of effects of business acquisitions
 
 
Accounts and notes receivable
(52.2
)
27.3

Inventories
17.7

(0.6
)
Other current assets
(9.4
)
(4.5
)
Accounts payable
20.6

(30.7
)
Employee compensation and benefits
25.9

(14.9
)
Other current liabilities
4.8

38.7

Other non-current assets and liabilities
(10.6
)
(40.8
)
Net cash provided by (used for) operating activities
629.8

247.4

Investing activities
 
 
Capital expenditures
(126.3
)
(49.9
)
Proceeds from sale of property and equipment
3.7

5.1

Proceeds from sale of businesses, net
30.9


Acquisitions, net of cash acquired
(84.4
)
671.8

Other
(0.8
)
(3.1
)
Net cash provided by (used for) investing activities
(176.9
)
623.9

Financing activities
 
 
Net receipts (repayments) of short-term borrowings

(3.7
)
Net receipts (repayments) of commercial paper and revolving long-term debt
122.5

(125.0
)
Proceeds from long-term debt

90.1

Repayments of long-term debt
(6.2
)
(190.8
)
Debt issuance costs
(1.4
)

Excess tax benefits from share-based compensation
7.4

2.1

Shares issued to employees, net of shares withheld
70.8

22.0

Repurchases of common shares
(540.3
)

Dividends paid
(143.9
)
(66.1
)
Distribution to noncontrolling interest
(2.0
)

Net cash provided by (used for) financing activities
(493.1
)
(271.4
)
Effect of exchange rate changes on cash and cash equivalents
16.6

(7.4
)
Change in cash and cash equivalents
(23.6
)
592.5

Cash and cash equivalents, beginning of period
261.3

50.1

Cash and cash equivalents, end of period
$
237.7

$
642.6

See accompanying notes to condensed consolidated financial statements.

5

Table of Contents

Pentair Ltd. and Subsidiaries
Condensed Consolidated Statements of Changes in Equity (Unaudited)

In millions
Common shares
 
Treasury shares
Capital
contribution reserve
Retained earnings
Accumulated
other
comprehensive income (loss)
Total Pentair Ltd.
Noncontrolling interest
 Total
Number
Amount
 
Number
Amount
Balance - December 31, 2012
213.0

$
113.5

 
(6.9
)
$
(315.5
)
$
5,292.4

$
1,292.5

$
(11.6
)
$
6,371.3

$
116.5

$
6,487.8

Net income


 



378.6


378.6

4.3

382.9

Change in cumulative translation adjustment


 




(29.8
)
(29.8
)
0.7

(29.1
)
Changes in market value of derivative financial instruments, net of $0.5 tax


 




(0.3
)
(0.3
)

(0.3
)
Tax benefits of share-based compensation


 


6.2



6.2


6.2

Dividends declared


 


(199.6
)


(199.6
)

(199.6
)
Distribution to noncontrolling interest


 






(2.0
)
(2.0
)
Share repurchase


 
(9.7
)
(540.3
)



(540.3
)

(540.3
)
Exercise of options, net of shares tendered for payment


 
2.5

109.8

(26.6
)


83.2


83.2

Issuance of restricted shares, net of cancellations


 
0.6

28.9

(28.9
)





Shares surrendered by employees to pay taxes


 
(0.2
)
(10.1
)
(2.3
)


(12.4
)

(12.4
)
Share-based compensation


 


25.3



25.3


25.3

Balance - September 28, 2013
213.0

$
113.5

 
(13.7
)
$
(727.2
)
$
5,066.5

$
1,671.1

$
(41.7
)
$
6,082.2

$
119.5

$
6,201.7

 
In millions
Common shares
 
Treasury shares
Capital
contribution reserve
Retained earnings
Accumulated
other
comprehensive income (loss)
Total Pentair Ltd.
Noncontrolling interest
 Total
Number
Amount
Number
Amount
Balance - December 31, 2011
98.6

$
47.5

 

$

$
457.7

$
1,465.8

$
(37.7
)
$
1,933.3

$
114.1

$
2,047.4

Net income


 



165.9


165.9

4.2

170.1

Change in cumulative translation adjustment


 




(3.7
)
(3.7
)
(0.1
)
(3.8
)
Changes in market value of derivative financial instruments, net of $2.6 tax


 




(5.3
)
(5.3
)

(5.3
)
Dividends declared


 


(143.0
)
(66.2
)

(209.2
)

(209.2
)
Issuance of shares related to the Merger
113.6

65.5

 
(2.7
)
(119.6
)
4,985.8



4,931.7


4,931.7

Exercise of options, net of shares tendered for payment
0.7

0.4

 

0.2

20.2



20.8


20.8

Issuance of restricted shares, net of cancellations
0.2

0.1

 


18.8



18.9


18.9

Shares surrendered by employees to pay taxes
(0.1
)

 


(2.7
)


(2.7
)

(2.7
)
Share-based compensation


 


28.5



28.5


28.5

Balance - September 29, 2012
213.0

$
113.5

 
(2.7
)
$
(119.4
)
$
5,365.3

$
1,565.5

$
(46.7
)
$
6,878.2

$
118.2

$
6,996.4


See accompanying notes to condensed consolidated financial statements.


6

Table of Contents

Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

 
1.Basis of Presentation and Responsibility for Interim Financial Statements
The accompanying unaudited condensed consolidated financial statements of Pentair Ltd. and subsidiaries (“we,” “us,” “our,” “Pentair,” or “the Company”) have been prepared following the requirements of the U.S. Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America can be condensed or omitted.
We are responsible for the unaudited financial statements included in this document. The financial statements include all normal recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. As these are condensed financial statements, one should also read our consolidated financial statements and notes thereto, which are included in our Annual Report on Form 10-K for the year ended December 31, 2012.
Revenues, expenses, cash flows, assets and liabilities can and do vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be indicative of those for a full year.
Our fiscal year ends on December 31. We report our interim quarterly periods on a 13-week basis ending on a Saturday.
New Accounting Standards
In February 2013, the Financial Accounting Standards Board issued authoritative guidance surrounding the presentation of items reclassified from Accumulated other comprehensive income (loss) (“AOCI”) to net income. This guidance requires entities to disclose, either in the notes to the consolidated financial statements or parenthetically on the face of the statement that reports comprehensive income, items reclassified out of AOCI and into net income in their entirety and the effect of the reclassification on each affected net income line item. In addition, for AOCI reclassification items that are not reclassified in their entirety into net income, a cross reference to other required disclosures is required. This guidance was effective for fiscal years and interim periods beginning after December 15, 2012. The adoption of this guidance on January 1, 2013 did not impact our financial condition or results of operations. The reclassifications out of AOCI and into net income were not material for the three and nine months ended September 28, 2013.

2.
Acquisitions and Divestitures
Material acquisitions
Pentair Ltd. took its current form on September 28, 2012 as a result of a reverse acquisition (the "Merger") involving Pentair, Inc. and an indirect, wholly-owned subsidiary of Flow Control (defined below), with Pentair, Inc. surviving as an indirect, wholly-owned subsidiary of Pentair Ltd. "Flow Control" refers to Pentair Ltd. prior the Merger. Prior to the Merger, Tyco International Ltd. ("Tyco") engaged in an internal restructuring whereby it transferred to Flow Control certain assets related to the flow control business of Tyco, and Flow Control assumed from Tyco certain liabilities related to the flow control business of Tyco. On September 28, 2012 prior to the Merger, Tyco effected a spin-off of Flow Control through the pro-rata distribution of 100% of the outstanding common shares of Flow Control to Tyco’s shareholders (the “Distribution”), resulting in the distribution of approximately 110.9 million of our common shares to Tyco’s shareholders. The Merger was accounted for as a reverse acquisition under the purchase method of accounting with Pentair, Inc. treated as the acquirer. Our business units comprising the legacy Flow Control business had net sales of $905.2 million and $2,757.7 million and net income of $105.0 million and $195.7 million for the three and nine months ended September 28, 2013, respectively.
Based on the price of Pentair, Inc. common stock and our common shares issued on the date of the Merger, the purchase price was composed of the following:
In millions
 
Value of common shares issued to Tyco shareholders (1)
$
4,811.4

Value of replacement equity-based awards to holders of Tyco equity-based awards (2)
119.8

Cash paid to Tyco in settlement of the working capital and net indebtedness adjustment
84.4

Cash paid to Tyco shareholders in lieu of fractional common shares (3)
0.5

 
$
5,016.1

(1)
Equals 110.9 million Pentair Ltd. shares distributed to Tyco shareholders multiplied by the Merger date share price of $43.39.

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Table of Contents

Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

(2)
In accordance with applicable accounting guidance, the fair value of replacement equity-based awards attributable to pre-combination service is recorded as part of the consideration transferred in the Merger, while the fair value of replacement equity-based awards attributable to post-combination service is recorded separately from the business combination and recognized as compensation cost in the post-acquisition period over the remaining service period. The fair value of our equivalent stock options was estimated using the Black-Scholes valuation model utilizing various assumptions.
(3)
Equals cash paid to Tyco shareholders in lieu of less than 0.1 million Pentair Ltd. fractional shares multiplied by the Merger date share price of $43.39.
During the nine months ended September 28, 2013, the Company recorded an increase of $93.0 million to its preliminary purchase price, of which $84.4 million related to cash paid to Tyco in settlement of the working capital and net indebtedness adjustment and $8.6 million related to an increase in the value of replacement equity-based awards to holders of Tyco equity-based awards.
The purchase price has been allocated based on the estimated fair value of net assets acquired and liabilities assumed at the date of the Merger. During the nine months ended September 28, 2013, the Company recorded fair value adjustments to the preliminary purchase price allocation reported at December 31, 2012. These adjustments were applied retrospectively back to the date of the Merger.
The following table summarizes the fair values of the assets acquired and liabilities assumed in the Merger as adjusted at September 28, 2013 and as previously reported at December 31, 2012:
In millions
September 28, 2013
 
December 31, 2012
Cash and cash equivalents
$
691.7

 
$
691.7

Accounts and notes receivable
753.5

 
771.6

Inventories
999.7

 
1,046.2

Other current assets
94.1

 
98.2

Property, plant and equipment
785.7

 
822.0

Goodwill
2,741.8

 
2,520.1

Intangibles
1,441.9

 
1,425.1

Other non-current assets
241.1

 
275.1

Current liabilities
(881.4
)
 
(856.3
)
Long-term debt
(914.5
)
 
(914.5
)
Income taxes, including current and deferred
(304.0
)
 
(364.6
)
Other liabilities and redeemable noncontrolling interest
(633.5
)
 
(591.5
)
Total purchase price
$
5,016.1

 
$
4,923.1

The excess of purchase price over tangible net assets and identified intangible assets acquired was allocated to goodwill in the amount of $2,741.8 million. Goodwill has been allocated to our reporting segments as follows: $348.6 million to Water & Fluid Solutions, $1,511.6 million to Valves & Controls and $881.6 million to Technical Solutions. None of the goodwill recognized from the Merger is expected to be deductible for income tax purposes. Goodwill recognized from the Merger reflects the current value of the expected future income resulting from synergies of our combined operations. Identifiable intangible assets acquired as part of the Merger were $1,441.9 million and include $362.3 million of indefinite life trade name intangibles and the following definite-lived intangibles: $920.0 million of customer relationships with a weighted average useful life of 14.2 years, $115.9 million of proprietary technology with a weighted average useful life of 13.7 years and $43.7 million of customer backlog with a weighted average useful life of less than one year.

8

Table of Contents

Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Pro forma results of material acquisitions
The following unaudited pro forma condensed consolidated financial results of operations are presented as if the Merger had been completed on January 1, 2011:
 
Three months ended
Nine months ended
In millions, except per-share data
September 29, 2012
September 29, 2012
Pro forma net sales
$
1,877.7

$
5,659.0

Pro forma net income attributable to Pentair Ltd.
86.7

302.6

Pro forma diluted earnings per common share attributable to Pentair Ltd.
0.41

1.42

The 2012 unaudited pro forma net income excludes the impact of $31.5 million and $49.4 million, respectively, of transaction related costs associated with the Merger, and $21.2 million and $21.8 million, respectively, of non-recurring items related to change of control costs for the three and nine months ended September 29, 2012.
The pro forma consolidated financial information was prepared for comparative purposes only and includes certain adjustments, as noted above. The adjustments are estimates based on currently available information and actual amounts may have differed materially from these estimates. They do not reflect the effect of costs or synergies that would have been expected to result from the integration of Flow Control. The pro forma information does not purport to be indicative of the results of operations that actually would have resulted had the business combination occurred at the beginning of the period presented or of future results of the consolidated entities.
Other acquisitions
On October 4, 2012, we acquired, as part of Valves & Controls, the remaining 25% equity interest in Pentair Middle East Holding S.a.r.l. (“KEF”), a privately held company, for $100.0 million in cash. Prior to the acquisition, we held a 75% equity interest in KEF, a vertically integrated valve manufacturer in the Middle East. There was no pro forma impact from this acquisition as the results of KEF were consolidated into Flow Control’s financial statements prior to acquiring the remaining 25% interest in KEF.
Additionally, during the year ended December 31, 2012, we completed other small acquisitions as part of Water & Fluid Solutions with purchase prices totaling $121.2 million in cash, net of cash acquired. Total goodwill recorded as part of the purchase price allocations was $80.9 million, $67.1 million of which is tax deductible.
Divestitures
During the nine months ended September 28, 2013, we sold a business that was part of Technical Solutions for a cash purchase price of $30.1 million, net of transaction costs, resulting in a gain of $16.8 million. Goodwill of $5.3 million was included in the assets of the business sold.

3.
Share Plans
Total share-based compensation expense for the three and nine months ended September 28, 2013 and September 29, 2012 was as follows:
 
Three months ended    
 
Nine months ended
In millions
September 28,
2013
September 29,
2012
 
September 28,
2013
September 29,
2012
Restricted stock units
$
4.6

$
12.8

 
$
16.4

$
18.6

Stock options
2.6

5.6

 
8.9

9.9

Total share-based compensation expense
$
7.2

$
18.4

 
$
25.3

$
28.5


In the first quarter of 2013, we issued our annual share-based compensation grants under the Pentair Ltd. 2012 Stock and Incentive Plan to eligible employees. The total number of awards issued was approximately 1.2 million, of which 0.9 million were stock options and 0.3 million were restricted stock units. The weighted-average grant date fair value of the stock options and restricted stock units issued was $13.89 and $50.60, respectively.


9

Table of Contents

Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

We estimated the fair value of each stock option award issued in the annual share-based compensation grant using a Black-Scholes option pricing model, modified for dividends and using the following assumptions:
 
2013
Annual Grant
Risk-free interest rate
0.69
%
Expected dividend yield
2.01
%
Expected share price volatility
36.0
%
Expected term (years)
5.7

These estimates require us to make assumptions based on historical results, observance of trends in our share price, changes in option exercise behavior, future expectations and other relevant factors. If other assumptions had been used, share-based compensation expense, as calculated and recorded under the accounting guidance, could have been affected.
We based the expected life assumption on historical experience as well as the terms and vesting periods of the options granted. For purposes of determining expected share price volatility, we considered a rolling average of historical volatility measured over a period approximately equal to the expected option term. The risk-free interest rate for periods that coincide with the expected life of the options is based on the U.S. Treasury Department yield curve in effect at the time of grant.

4.
Restructuring
During the nine months ended September 28, 2013 and the year ended December 31, 2012, we initiated certain business restructuring initiatives aimed at reducing our fixed cost structure and realigning our business. The 2013 initiatives included the reduction in hourly and salaried headcount of approximately 700 employees, consisting of approximately 200 in Water & Fluid Solutions, 200 in Valves & Controls and 300 in Technical Solutions. The 2012 initiatives included the reduction in hourly and salaried headcount of approximately 1,000 employees, consisting of approximately 500 in Water & Fluid Solutions, 300 in Valves & Controls and 200 in Technical Solutions.

Restructuring related costs included in Selling, general and administrative expenses in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) included costs for severance and other restructuring costs as follows: 
 
Three months ended    
 
Nine months ended
In millions
September 28,
2013
September 29,
2012
 
September 28,
2013
September 29,
2012
Severance and related costs
$
0.8

$
0.8

 
$
40.6

$
10.5

Other
3.2


 
11.7

0.7

Total restructuring costs
$
4.0

$
0.8

 
$
52.3

$
11.2

Other restructuring costs primarily consist of asset impairment and various contract termination costs.
Total restructuring costs related to Water & Fluid Solutions, Valves & Controls and Technical Solutions were $3.0 million, $0.4 million and $0.6 million, respectively, for the three months ended September 28, 2013, and $16.7 million, $19.2 million and $16.4 million, respectively, for the nine months ended September 28, 2013.
Activity in the restructuring accrual recorded in Other current liabilities and Employee compensation and benefits in the Condensed Consolidated Balance Sheets is summarized as follows for the nine months ended September 28, 2013: 
In millions
September 28,
2013
Beginning balance
$
59.6

Costs incurred
40.6

Cash payments and other
(57.1
)
Ending balance
$
43.1


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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

5.
Earnings Per Share
Basic and diluted earnings per share were calculated as follows:
 
Three months ended    
 
Nine months ended
In millions, except per-share data
September 28,
2013
September 29,
2012
 
September 28,
2013
September 29,
2012
Net income attributable to Pentair Ltd.
$
172.8

$
31.4

 
$
378.6

$
165.9

Weighted average common shares outstanding
 
 
 
 
 
Basic
199.3

100.4

 
202.1

99.5

Dilutive impact of stock options and restricted stock units
3.5

2.5

 
3.5

2.2

Diluted
202.8

102.9

 
205.6

101.7

Earnings per common share attributable to Pentair Ltd.
 
 
 
 
 
Basic earnings per common share
$
0.87

$
0.31

 
$
1.87

$
1.67

Diluted earnings per common share
$
0.85

$
0.31

 
$
1.84

$
1.63

Anti-dilutive stock options excluded from the calculation of diluted earnings per share
0.1

0.3

 
0.9

1.4



11

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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

6.
Supplemental Balance Sheet Information
In millions
September 28,
2013
December 31,
2012
Inventories


Raw materials and supplies
$
581.6

$
615.1

Work-in-process
193.8

207.6

Finished goods
520.7

511.2

Total inventories
$
1,296.1

$
1,333.9

Other current assets


Cost in excess of billings
$
142.7

$
124.4

Prepaid expenses
108.9

89.0

Deferred income taxes
106.3

89.2

Other current assets
20.4

38.5

Total other current assets
$
378.3

$
341.1

Property, plant and equipment, net


Land and land improvements
$
248.5

$
248.6

Buildings and leasehold improvements
508.4

474.4

Machinery and equipment
1,156.4

1,073.0

Construction in progress
121.0

103.0

Total property, plant and equipment
2,034.3

1,899.0

Accumulated depreciation and amortization
862.4

710.8

Total property, plant and equipment, net
$
1,171.9

$
1,188.2

Other non-current assets


Asbestos-related insurance receivable
$
130.1

$
131.0

Deferred income taxes
130.9

121.1

Other non-current assets
220.8

252.7

Total other non-current assets
$
481.8

$
504.8

Other current liabilities


Deferred revenue and customer deposits
$
117.9

$
127.2

Dividends payable
149.5

95.0

Billings in excess of cost
86.5

61.1

Accrued warranty
56.0

54.0

Other current liabilities
368.6

440.8

Total other current liabilities
$
778.5

$
778.1

Other non-current liabilities


Asbestos-related liabilities
$
266.3

$
278.9

Taxes payable
49.6

50.5

Other non-current liabilities
151.5

165.7

Total other non-current liabilities
$
467.4

$
495.1



12

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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

7.
Goodwill and Other Identifiable Intangible Assets
The changes in the carrying amount of goodwill by segment were as follows:
In millions
December 31, 2012
Acquisitions/
divestitures 
Foreign currency 
translation/other 
September 28, 2013
Water & Fluid Solutions
$
2,437.7

$

$
15.4

$
2,453.1

Valves & Controls
1,511.6



1,511.6

Technical Solutions
1,161.7

(5.3
)
0.9

1,157.3

Total goodwill
$
5,111.0

$
(5.3
)
$
16.3

$
5,122.0

Identifiable intangible assets consisted of the following:
 
September 28, 2013
 
December 31, 2012
In millions
Cost
Accumulated
amortization
Net
 
Cost
Accumulated
amortization
Net
Finite-life intangibles



 



Customer relationships
$
1,288.0

$
(221.1
)
$
1,066.9

 
$
1,291.5

$
(152.7
)
$
1,138.8

Trade names
2.1

(0.9
)
1.2

 
1.5

(0.7
)
0.8

Proprietary technology
265.0

(74.8
)
190.2

 
263.7

(57.8
)
205.9

Backlog
28.7

(26.7
)
2.0

 
43.7

(18.2
)
25.5

Total finite-life intangibles
$
1,583.8

$
(323.5
)
$
1,260.3

 
$
1,600.4

$
(229.4
)
$
1,371.0

Indefinite-life intangibles



 



Trade names
556.9


556.9

 
555.9


555.9

Total intangibles, net
$
2,140.7

$
(323.5
)
$
1,817.2

 
$
2,156.3

$
(229.4
)
$
1,926.9

Intangible asset amortization expense was $28.8 million and $9.7 million for the three months ended September 28, 2013 and September 29, 2012, respectively, and $109.5 million and $29.4 million for the nine months ended September 28, 2013 and September 29, 2012, respectively.
Estimated future amortization expense for identifiable intangible assets during the remainder of 2013 and the next five years is as follows:
 
Q4
 
 
 
 
 
In millions
2013
2014
2015
2016
2017
2018
Estimated amortization expense
$
29.2

$
116.0

$
115.5

$
114.5

$
113.0

$
110.4



13

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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

8.
Debt
Debt and the average interest rates on debt outstanding were as follows: 
In millions
Average interest rate at
September 28, 2013
Maturity
Year
September 28,
2013
December 31,
2012
Commercial paper
0.522%
2017
$
539.1

$
424.7

Revolving credit facilities
1.429%
2017
7.6


Senior notes - fixed rate
1.350%
2015
350.0

350.0

Senior notes - fixed rate
1.875%
2017
350.0

350.0

Senior notes - fixed rate
2.650%
2019
250.0

250.0

Senior notes - fixed rate
5.000%
2021
500.0

500.0

Senior notes - fixed rate
3.150%
2022
550.0

550.0

Other
0.030%
2015-2030
5.0

8.9

Capital lease obligations
4.150%
2013-2025
22.0

23.8

Total debt


2,573.7

2,457.4

Less: Current maturities and short-term borrowings


(3.0
)
(3.1
)
Long-term debt


$
2,570.7

$
2,454.3

The 1.35% Senior Notes due 2015, 1.875% Senior Notes due 2017, 2.65% Senior Notes due 2019, 5.00% Senior Notes due 2021 and 3.15% Senior Notes due 2022 (collectively, the “Notes”) were all issued in transactions exempt from the registration requirements of the Securities Act of 1933, as amended. In March 2013, Pentair Ltd. and our 100 percent-owned subsidiary, Pentair Finance S.A. (“PFSA”), filed a Registration Statement with the SEC offering to exchange the Notes for new, registered Notes. The exchange offer expired on April 19, 2013 and did not impact the aggregate principle amount or the terms of the Notes outstanding. The new, registered Notes issued in such exchange offer are guaranteed as to payment by Pentair Ltd.
In September 2012, Pentair, Inc. entered into a credit agreement providing for an unsecured, committed revolving credit facility (the “Credit Facility”) with initial maximum aggregate availability of up to $1,450.0 million. Upon the completion of the Merger, Pentair Ltd. became the guarantor under the Credit Facility and PFSA and certain other of our subsidiaries became affiliate borrowers under the Credit Facility. Borrowings under the Credit Facility generally bear interest at a variable rate equal to the London Interbank Offered Rate plus a specified margin based upon PFSA's credit ratings. PFSA must also pay a facility fee ranging from 10.0 to 30.0 basis points per annum (based upon PFSA's credit ratings) on the amount of each lender's commitment. PFSA is authorized to sell short-term commercial paper notes to the extent availability exists under the Credit Facility. PFSA uses the Credit Facility as back-up liquidity to support 100% of our outstanding commercial paper. As of September 28, 2013 and December 31, 2012, we had $539.1 million and $424.7 million, respectively, of commercial paper outstanding, all of which 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.
Total availability under the Credit Facility was $903.3 million as of September 28, 2013, which was not limited by any covenants contained in the Credit Facility’s credit agreement.
Our debt agreements contain certain financial covenants, the most restrictive of which are in the Credit Facility, including that we may not permit (i) the ratio of our consolidated debt plus synthetic lease obligations to our consolidated net income (excluding, among other things, non-cash gains and losses) before interest, taxes, depreciation, amortization, non-cash share-based compensation expense, and up to $40.0 million of costs and expenses incurred in connection with the Merger (“EBITDA”) for the four consecutive fiscal quarters then ended (the “Leverage Ratio”) to exceed 3.50 to 1.00 on the last day of each fiscal quarter, and (ii) the ratio of our EBITDA for the four consecutive fiscal quarters then ended to our consolidated interest expense, including consolidated yield or discount accrued as to outstanding securitization obligations (if any), for the same period to be less than 3.00 to 1.00 as of the end of each fiscal quarter. For purposes of the Leverage Ratio, the Credit Facility provides for the calculation of EBITDA giving pro forma effect to the Merger and certain acquisitions, divestitures and liquidations during the period to which such calculation relates. As of September 28, 2013, we were in compliance with all financial covenants in our debt agreements.

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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

In addition to the Credit Facility, we have various other credit facilities with an aggregate availability of $91.5 million, of which none was outstanding at September 28, 2013. Borrowings under these credit facilities bear interest at variable rates.
Debt outstanding at September 28, 2013 matures on a calendar year basis as follows:
 
Q4
 
 
 
 
 
 
 
In millions
2013
2014
2015
2016
2017
2018
Thereafter
Total
Contractual debt obligation maturities
$

$

$
350.0

$

$
896.7

$

$
1,305.0

$
2,551.7

Capital lease obligations
0.8

3.0

5.9

1.0

1.0

1.0

9.3

22.0

Total maturities
$
0.8

$
3.0

$
355.9

$
1.0

$
897.7

$
1.0

$
1,314.3

$
2,573.7

Capital lease obligations relate primarily to land and buildings and consist of total future minimum lease payments of $23.9 million less the imputed interest of $1.9 million as of September 28, 2013.
As of September 28, 2013 and December 31, 2012, assets under capital lease were $41.2 million and $40.5 million, respectively, less accumulated amortization of $7.1 million and $6.0 million, respectively, all of which were included in Property, plant and equipment, net on the Condensed Consolidated Balance Sheets.

9.
Derivatives and Financial Instruments
Derivative financial instruments
We are exposed to market risk related to changes in foreign currency exchange rates and interest rates on our floating rate indebtedness. To manage the volatility related to these exposures, we periodically enter into a variety of derivative financial instruments. Our objective is to reduce, where it is deemed appropriate to do so, fluctuations in earnings and cash flows associated with changes in foreign currency rates and interest rates. The derivative contracts contain credit risk to the extent that our bank counterparties may be unable to meet the terms of the agreements. The amount of such credit risk is generally limited to the unrealized gains, if any, in such contracts. Such risk is minimized by limiting those counterparties to major financial institutions of high credit quality.
Interest rate swaps
During 2012, we used floating to fixed rate interest rate swaps to mitigate our exposure to future changes in interest rates related to our floating rate indebtedness. We designated these interest rate swap arrangements as cash flow hedges. As a result, changes in the fair value of the interest rate swaps were recorded in AOCI on the Condensed Consolidated Balance Sheets throughout the contractual term of each of the interest rate swap arrangements. During 2012, all of our interest rate swaps expired or were terminated and, as a result, we had no outstanding interest rate swap arrangements at December 31, 2012 or September 28, 2013.
Derivative gains and losses included in AOCI were reclassified into earnings at the time the related interest expense was recognized or the settlement of the related commitment occurred. Interest expense from swaps was $1.0 million and $4.9 million for the three and nine months ended September 29, 2012, respectively, and was recorded in Net interest expense in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).
In April 2011, as part of our planned debt issuance to fund the Clean Process Technologies acquisition, we entered into interest rate swap contracts to hedge movement in interest rates through the expected date of closing for a portion of the expected fixed rate debt offering. The swaps had a notional amount of $400.0 million with an average interest rate of 3.65%. In May 2011, upon the sale of the 2021 Notes, the swaps were terminated at a cost of $11.0 million. Because we used the contracts to hedge future interest payments, this was recorded in AOCI in the Condensed Consolidated Balance Sheets and will be amortized as interest expense over the 10 year life of the 2021 Notes. The ending unrealized net loss in AOCI was $8.3 million and $9.2 million at September 28, 2013 and December 31, 2012, respectively.
Foreign currency contracts
We conduct business in various locations throughout the world and are subject to market risk due to changes in the value of foreign currencies in relation to our reporting currency, the U.S. dollar. We manage our economic and transaction exposure to certain market-based risks through the use of foreign currency derivative financial instruments. Our objective in holding these derivatives is to reduce the volatility of net earnings and cash flows associated with changes in foreign currency exchange rates. The majority of our foreign currency contracts have an original maturity date of less than one year. At September 28, 2013 and

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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

December 31, 2012, we had outstanding foreign currency derivative contracts with gross notional U.S. dollar equivalent amounts of $143.9 million and $163.7 million, respectively. The impact of these contracts on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) is not material for any period presented.
Gains or losses on foreign currency contracts designated as hedges are reclassified out of AOCI and into Selling, general and administrative expense in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) upon settlement. Such reclassifications during the three and nine months ended September 28, 2013 were not material.
Fair value measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities measured at fair value are classified using the following hierarchy, which is based upon the transparency of inputs to the valuation as of the measurement date:
 
Level 1:
  
Valuation is based on observable inputs such as quoted market prices (unadjusted) for identical assets or liabilities in active markets.
 
 
Level 2:
  
Valuation is based on inputs such as quoted market prices for similar assets or liabilities in active markets or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
 
 
Level 3:
  
Valuation is based upon other unobservable inputs that are significant to the fair value measurement.
In making fair value measurements, observable market data must be used when available. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.
Fair value of financial instruments
The following methods were used to estimate the fair values of each class of financial instruments: 
short-term financial instruments (cash and cash equivalents, accounts and notes receivable, accounts and notes payable and variable-rate debt) — recorded amount approximates fair value because of the short maturity period;
long-term fixed-rate debt, including current maturities — fair value is based on market quotes available for issuance of debt with similar terms, which are inputs that are classified as Level 2 in the valuation hierarchy defined by the accounting guidance; and
interest rate swaps and foreign currency contract agreements — fair values are determined through the use of models that consider various assumptions, including time value, yield curves, as well as other relevant economic measures, which are inputs that are classified as Level 2 in the valuation hierarchy defined by the accounting guidance.

The recorded amounts and estimated fair values of total debt, excluding the effects of derivative financial instruments, were as follows:
 
September 28, 2013
 
December 31, 2012
In millions
Recorded
Amount
Fair
Value
 
Recorded
Amount
Fair
Value
Variable rate debt
$
546.7

$
546.7

 
$
427.7

$
427.7

Fixed rate debt
2,027.0

2,013.5

 
2,029.7

2,081.3

Total debt
$
2,573.7

$
2,560.2

 
$
2,457.4

$
2,509.0


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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Financial assets and liabilities measured at fair value on a recurring and nonrecurring basis were as follows:
 
September 28, 2013
In millions
Level 1
Level 2
Level 3
Total
Recurring fair value measurements




Foreign currency contract assets
$

$
4.0

$

$
4.0

Foreign currency contract liabilities

(1.2
)

(1.2
)
Deferred compensation plan (1)
30.6



30.6

Total recurring fair value measurements
$
30.6

$
2.8

$

$
33.4

 
December 31, 2012
In millions
Level 1
Level 2
Level 3
Total
Recurring fair value measurements




Foreign currency contract assets
$

$
2.9

$

$
2.9

Foreign currency contract liabilities

(0.5
)

(0.5
)
Deferred compensation plan (1)
22.4



22.4

Total recurring fair value measurements
$
22.4

$
2.4

$

$
24.8

Nonrecurring fair value measurements




Trade name intangibles (2)
$

$

$
63.7

$
63.7

Total nonrecurring fair value measurement
$

$

$
63.7

$
63.7

(1)
Deferred compensation plan assets include mutual funds and cash equivalents for payment of certain non-qualified benefits for retired, terminated and active employees. The fair value of these assets was based on quoted market prices in active markets.
(2)
In the fourth quarter of 2012, we completed our annual intangible assets impairment review. As a result, we recorded a pre-tax non-cash impairment charge of $60.7 million for trade names intangibles. The fair value of trade names is measured using the relief-from-royalty method. This method assumes the trade name has value to the extent that the owner is relieved of the obligation to pay royalties for the benefits received from them. This method requires us to estimate the future revenue for the related brands, the appropriate royalty rate and the weighted average cost of capital.

10.
Income Taxes
The provision for income taxes consists of provisions for Swiss federal and international income taxes. We operate in an international environment with operations in various locations outside Switzerland. Accordingly, the consolidated income tax rate is a composite rate reflecting the earnings in the various locations and the applicable rates.
The effective income tax rate for the nine months ended September 28, 2013 was 24.3% compared to 20.4% for the nine months ended September 29, 2012. Our effective income tax rate was higher due to the favorable resolution of U.S. federal and state tax audits during the nine months ended September 29, 2012, which was not recurring during the nine months ended September 28, 2013, and the timing of losses in jurisdictions where we recognize no tax benefits. The increases were partially offset by the mix of global earnings, including the impact of the Merger.
We continue to actively pursue initiatives to reduce our effective tax rate. The tax rate in any quarter can be affected positively or negatively by adjustments that are required to be reported in the specific quarter of resolution.
The liability for uncertain tax positions was $52.0 million and $52.9 million at September 28, 2013 and December 31, 2012, respectively. We record penalties and interest related to unrecognized tax benefits in Provision for income taxes and Net interest expense, respectively, on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss), which is consistent with our past practices.

17

Table of Contents

Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Tax sharing agreement and other income tax matters
In connection with the Distribution, we entered into a tax sharing agreement (the “2012 Tax Sharing Agreement”) with Tyco and The ADT Corporation (“ADT”), which governs the rights and obligations of Tyco, ADT and us for certain pre-Distribution tax liabilities, including Tyco’s obligations under a separate tax sharing agreement (the “2007 Tax Sharing Agreement”) that Tyco, Covidien Ltd. (“Covidien”) and TE Connectivity Ltd. (“TE Connectivity”) entered into in connection with the 2007 distributions of Covidien and TE Connectivity by Tyco (the “2007 Separation”). The 2007 Tax Sharing Agreement governs the rights and obligations of Tyco, Covidien and TE Connectivity with respect to certain pre-2007 Separation tax liabilities and certain tax liabilities arising in connection with the 2007 Separation. More specifically, Tyco, Covidien and TE Connectivity share 27%, 42% and 31%, respectively, of income tax liabilities that arise from adjustments made by tax authorities to Tyco's, Covidien's and TE Connectivity's U.S. and certain non-U.S. 2007 and prior income tax returns. The 2012 Tax Sharing Agreement provides that we, Tyco and ADT will share (i) certain pre-Distribution income tax liabilities that arise from adjustments made by tax authorities to our, Tyco’s and ADT’s U.S. income tax returns, and (ii) payments required to be made by Tyco in respect to the 2007 Tax Sharing Agreement (collectively, “Shared Tax Liabilities”). Tyco is responsible for the first $500 million of Shared Tax Liabilities. We and ADT will share 42% and 58%, respectively, of the next $225 million of Shared Tax Liabilities. We, ADT and Tyco will share 20%, 27.5% and 52.5%, respectively, of Shared Tax Liabilities above $725 million. Under these tax sharing agreements, the amount ultimately assessed would have to be in excess of $1.85 billion before we would be required to pay any of the amounts assessed.
In the event the Distribution, the spin-off of ADT, or certain internal transactions undertaken in connection therewith were determined to be taxable as a result of actions taken after the Distribution by us, ADT or Tyco, the party responsible for such failure would be responsible for all taxes imposed on us, ADT or Tyco as a result thereof. Taxes resulting from the determination that the Distribution, the spin-off of ADT, or any internal transaction is taxable are referred to herein as “Distribution Taxes.” If such failure is not the result of actions taken after the Distribution by us, ADT or Tyco, then we, ADT and Tyco would be responsible for any Distribution Taxes imposed on us, ADT or Tyco as a result of such determination in the same manner and in the same proportions as the Shared Tax Liabilities. ADT will have sole responsibility for any income tax liability arising as a result of Tyco’s acquisition of Brink’s Home Security Holdings, Inc. (“BHS”) in May 2010, including any liability of BHS under the tax sharing agreement between BHS and The Brink’s Company dated October 31, 2008 (collectively, the “BHS Tax Liabilities”). Costs and expenses associated with the management of Shared Tax Liabilities, Distribution Taxes and BHS Tax Liabilities will generally be shared 20% by us, 27.5% by ADT and 52.5% by Tyco. We are responsible for all of our own taxes that are not shared pursuant to the 2012 Tax Sharing Agreement’s sharing formulae. In addition, Tyco and ADT are responsible for their tax liabilities that are not subject to the 2012 Tax Sharing Agreement’s sharing formulae.
The 2012 Tax Sharing Agreement also provides that, if any party were to default in its obligation to another party to pay its share of the distribution taxes that arise as a result of no party’s fault, each non-defaulting party would be required to pay, equally with any other non-defaulting party, the amounts in default. In addition, if another party to the 2012 Tax Sharing Agreement that is responsible for all or a portion of an income tax liability were to default in its payment of such liability to a taxing authority, we could be legally liable under applicable tax law for such liabilities and required to make additional tax payments. Accordingly, under certain circumstances, we may be obligated to pay amounts in excess of our agreed-upon share of our, Tyco’s and ADT’s tax liabilities.
On July 1, 2013, Tyco announced that the Internal Revenue Service (“IRS”) issued Notices of Deficiency (“Tyco IRS Notices”) to Tyco asserting that several of Tyco's former U.S. subsidiaries collectively owe additional taxes in the aggregate amount of $883.3 million plus penalties of $154 million based on audits of the 1997 through 2000 tax years of Tyco and its subsidiaries as they existed at that time. These amounts exclude interest and do not reflect the impact on subsequent periods if the IRS challenge to Tyco's tax filings as described below is ultimately successful. If the IRS should successfully assert its position, our share of the collective liability, if any, would be determined pursuant to the 2007 Tax Sharing Agreement and the 2012 Tax Sharing Agreement.
As we have previously disclosed, in connection with U.S. federal tax audits of Tyco and its subsidiaries, the IRS has previously raised issues and proposed tax adjustments for periods beginning with the 1997 tax year. The adjustments now asserted by the IRS under the Tyco IRS Notices primarily relate to the treatment of certain intercompany debt transactions. The IRS has asserted in the Tyco IRS Notices that substantially all of the intercompany debt originated during the 1997 - 2000 period should not be treated as debt for U.S. federal income tax purposes, and has therefore disallowed interest and related deductions recognized associated with that intercompany debt on the U.S. income tax returns for those periods totaling approximately $2.86 billion. If the IRS is successful in asserting its claim, it would have an adverse impact on interest deductions related to the same Tyco intercompany debt in subsequent time periods, totaling approximately $6.6 billion, which Tyco has advised us that it expects the IRS to disallow. Under the 2012 Tax Sharing Agreement, Tyco has the right to administer, control, and settle all

18

Table of Contents

Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

U.S. income tax audits for periods prior to and including the Distribution. Tyco has advised us that it intends to petition the U.S. Tax Court to contest the IRS assessment. Tyco has further advised us that it strongly disagrees with the IRS position and believes (i) it has meritorious defenses for the respective tax filings, (ii) the IRS positions with regard to these matters are inconsistent with applicable tax laws and Treasury regulations, and (iii) the previously reported taxes for the years in question are appropriate.
No payments with respect to these matters would be required until the dispute is resolved in the U.S. Tax Court, which Tyco has advised us, based on the experience of other companies, could take several years. However, the ultimate resolution of these matters is uncertain, and to the extent we are responsible for any Shared Tax Liability or Distribution Tax, including if the IRS were to prevail with respect to the matter set forth above, there could be a material adverse impact on our financial condition, results of operations, or cash flows in future reporting periods.

11.
Benefit Plans
Components of net periodic benefit cost for our pension plans for the three and nine months ended September 28, 2013 and September 29, 2012 were as follows:
 
U.S. pension plans
 
Three months ended
 
Nine months ended
In millions
September 28,
2013
September 29,
2012
 
September 28,
2013
September 29,
2012
Service cost
$
3.9

$
3.2

 
$
11.7

$
9.6

Interest cost
3.6

7.1

 
10.8

21.3

Expected return on plan assets
(2.4
)
(7.3
)
 
(7.2
)
(21.9
)
Net periodic benefit cost
$
5.1

$
3.0

 
$
15.3

$
9.0

 
Non-U.S. pension plans
 
Three months ended
 
Nine months ended
In millions
September 28,
2013
September 29,
2012
 
September 28,
2013
September 29,
2012
Service cost
$
2.4

$
0.6

 
$
7.2

$
1.8

Interest cost
4.4

1.1

 
13.2

3.3

Expected return on plan assets
(3.8
)
(0.1
)
 
(11.4
)
(0.3
)
Net periodic benefit cost
$
3.0

$
1.6

 
$
9.0

$
4.8

Components of net periodic benefit cost for our other post-retirement plans for the three and nine months ended September 28, 2013 and September 29, 2012 were not material.

12.
Shareholders’ Equity
Share repurchases
Prior to the closing of the Merger, our board of directors, and Tyco as our sole shareholder, authorized the repurchase of our common shares with a maximum aggregate value of $400.0 million following the closing of the Merger. There are no remaining shares available for repurchase under this authorization. On October 1, 2012, our board of directors authorized the repurchase of our common shares with a maximum aggregate value of $800.0 million. This authorization expires on December 31, 2015 and is in addition to the $400.0 million share repurchase authorization. During the nine months ended September 28, 2013, we repurchased 9.7 million of our common shares for $540.3 million pursuant to these authorizations. As of September 28, 2013, we had $325.5 million remaining available for share repurchases under these authorizations.
Dividends payable
At our 2013 annual meeting of shareholders held on April 29, 2013, our shareholders approved a proposal to pay quarterly cash dividends through the second quarter of 2014. The authorization provides that dividends of $1.00 per share will be made out of our Capital contribution reserve equity position in our statutory accounts to our shareholders in quarterly installments of $0.25 for each of the third and fourth quarters of 2013 and first and second quarters of 2014.

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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

The balance of dividends payable included in Other current liabilities on our Consolidated Balance Sheets was $149.5 million and $95.0 million at September 28, 2013 and December 31, 2012, respectively.

13.
Segment information
Financial information by reportable segment is shown below:
 
Three months ended
 
Nine months ended
In millions
September 28,
2013
September 29,
2012
 
September 28,
2013
September 29,
2012
Net sales
 
 
 
 
 
Water & Fluid Solutions
$
814.3

$
605.5

 
$
2,546.1

$
1,868.0

Valves & Controls
611.5


 
1,817.2


Technical Solutions
405.9

261.5

 
1,213.3

801.6

Other
(6.9
)
(1.5
)
 
(13.6
)
(4.4
)
Consolidated
$
1,824.8

$
865.5

 
$
5,563.0

$
2,665.2

Operating income (loss)
 
 
 
 
 
Water & Fluid Solutions
$
105.9

$
69.2

 
$
316.8

$
224.9

Valves & Controls
76.6


 
114.9


Technical Solutions
82.2

52.3

 
200.6

153.4

Other
(24.7
)
(66.3
)
 
(92.1
)
(117.3
)
Consolidated
$
240.0

$
55.2

 
$
540.2

$
261.0

 
14.
Commitments and Contingencies
Asbestos Matters
Our subsidiaries and numerous other companies are named as defendants in personal injury lawsuits based on alleged exposure to asbestos-containing materials. These cases typically involve product liability claims based primarily on allegations of manufacture, sale or distribution of industrial products that either contained asbestos or were attached to or used with asbestos-containing components manufactured by third-parties. Each case typically names between dozens to hundreds of corporate defendants. While we have observed an increase in the number of these lawsuits over the past several years, including lawsuits by plaintiffs with mesothelioma-related claims, a large percentage of these suits have not presented viable legal claims and, as a result, have been dismissed by the courts. Our historical strategy has been to mount a vigorous defense aimed at having unsubstantiated suits dismissed, and, where appropriate, settling suits before trial. Although a large percentage of litigated suits have been dismissed, we cannot predict the extent to which we will be successful in resolving lawsuits in the future.
As of September 28, 2013, there were approximately 1,800 lawsuits pending against our subsidiaries. A lawsuit might include several claims, and we have approximately 2,100 claims outstanding as of September 28, 2013. This amount is not adjusted for claims that are not actively being prosecuted, identified incorrect defendants, or duplicated other actions, which would ultimately reflect our current estimate of the number of viable claims made against us, our affiliates, or entities for which we assumed responsibility in connection with acquisitions or divestitures. In addition, the amount does not include certain claims pending against third parties for which we have been provided an indemnification.
Periodically, we perform an analysis with the assistance of outside counsel and other experts to update our estimated asbestos-related assets and liabilities. Our estimate of the liability and corresponding insurance recovery for pending and future claims and defense costs is based on our historical claim experience and estimates of the number and resolution cost of potential future claims that may be filed. Our legal strategy for resolving claims also impacts these estimates.
Our estimate of asbestos-related insurance recoveries represents estimated amounts due to us for previously paid and settled claims and the probable reimbursements relating to our estimated liability for pending and future claims. In determining the amount of insurance recoverable, we consider a number of factors, including available insurance, allocation methodologies and the solvency and creditworthiness of insurers.
Our estimated liability for asbestos-related claims was $266.3 million and $278.9 million as of September 28, 2013 and December 31, 2012, respectively, and was recorded in Other non-current liabilities in the Condensed Consolidated Balance

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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Sheets for pending and future claims and related defense costs. Our estimated receivable for insurance recoveries was $130.1 million and $131.0 million as of September 28, 2013 and December 31, 2012, respectively, and was recorded in Other non-current assets in the Condensed Consolidated Balance Sheets.
The amounts recorded by us for asbestos-related liabilities and insurance-related assets are based on our strategies for resolving our asbestos claims and currently available information as well as estimates and assumptions. Key variables and assumptions include the number and type of new claims filed each year, the average cost of resolution of claims, the resolution of coverage issues with insurance carriers, the amounts of insurance and the related solvency risk with respect to our insurance carriers, and the indemnifications we have provided to and received from third parties. Furthermore, predictions with respect to these variables are subject to greater uncertainty in the latter portion of the projection period. Other factors that may affect our liability and cash payments for asbestos-related matters include uncertainties surrounding the litigation process from jurisdiction to jurisdiction and from case to case, reforms of state or federal tort legislation and the applicability of insurance policies among subsidiaries. As a result, actual liabilities or insurance recoveries could be significantly higher or lower than those recorded if assumptions used in our calculations vary significantly from actual results.
Environmental Matters
We are involved in or have retained responsibility and potential liability for environmental obligations and legal proceedings related to our current business and, including pursuant to certain indemnification obligations, related to certain formerly owned businesses. Our accruals for environmental matters are recorded on a site-by-site basis when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. Based upon our experience, current information regarding known contingencies and applicable laws, we have recorded reserves for these environmental matters of $41.4 million and $49.2 million as of September 28, 2013 and December 31, 2012, respectively. We do not anticipate these environmental conditions will have a material adverse effect on our financial position, results of operations or cash flows.
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.
We recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee.
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.
The changes in the carrying amount of service and product warranties for the nine months ended September 28, 2013 were as follows: 
In millions
September 28,
2013
Beginning balance
$
54.0

Service and product warranty provision
46.5

Payments
(44.4
)
Foreign currency translation
(0.1
)
Ending balance
$
56.0

Stand-by Letters of Credit, Bank Guarantees and Bonds
In certain situations, Tyco guaranteed Flow Control’s performance to third parties or provided financial guarantees for financial commitments of Flow Control. In situations where Flow Control and Tyco were unable to obtain a release from these guarantees in connection with the spin-off, we will indemnify Tyco for any losses it suffers as a result of such guarantees.

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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

In disposing of assets or businesses, we often provide representations, warranties and indemnities to cover various risks including unknown damage to the assets, environmental risks involved in the sale of real estate, liability to investigate and remediate environmental contamination at waste disposal sites and manufacturing facilities and unidentified tax liabilities and legal fees related to periods prior to disposition. We do not have the ability to reasonably estimate the potential liability due to the inchoate and unknown nature of these potential liabilities. However, we have no reason to believe that these uncertainties would have a material adverse effect on our financial position, results of operations or cash flows.
In the ordinary course of business, we are required to commit to bonds, letters of credit and bank guarantees that require payments to our customers for any non-performance. The outstanding face value of these instruments fluctuates with the value of our projects in process and in our backlog. In addition, we issue financial stand-by letters of credit primarily to secure our performance to third parties under self-insurance programs.
As of September 28, 2013 and December 31, 2012, the outstanding value of bonds, letters of credit and bank guarantees totaled $478.9 million and $493.2 million, respectively.

15.
Financial Statements of Parent Company Guarantor
Pentair Ltd. (the “Parent Company Guarantor”), fully and unconditionally, guarantees the Notes of Pentair Finance S.A. (the “Subsidiary Issuer”). The Subsidiary Issuer is a Luxembourg public limited liability company formed in January 2012 and 100 percent-owned subsidiary of the Parent Company Guarantor.
The following supplemental financial information sets forth the financial information of:
Parent Company Guarantor;
Subsidiary Issuer;
Non-guarantor subsidiaries of Pentair Ltd. on a combined basis;
Consolidating entries and eliminations representing adjustments to:
a.
eliminate intercompany transactions between or among the Parent Company Guarantor, the Subsidiary Issuer and the non-guarantor subsidiaries;
b.
eliminate the investments in subsidiaries; and
c.
record consolidating entries.
Pentair Ltd. and subsidiaries on a consolidated basis.
The following present the Company’s Condensed Consolidating Statement of Operations and Comprehensive Income (Loss), Condensed Consolidating Balance Sheets and Condensed Consolidating Statement of Cash Flows. The historical consolidated financial statements of Pentair Ltd. for the three and nine months ended September 29, 2012 include all non-guarantor subsidiaries. Consequently, no consolidating financial information for the three and nine months ended September 29, 2012 is presented.


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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

 Pentair Ltd. and Subsidiaries
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
Three months ended September 28, 2013
In millions
Parent
Company
Guarantor
Subsidiary
Issuer
Non-guarantor
Subsidiaries
Eliminations
Pentair Ltd.
and
Subsidiaries
Consolidated
Net sales
$

$

$
1,824.8

$

$
1,824.8

Cost of goods sold


1,187.2


1,187.2

Gross profit


637.6


637.6

Selling, general and administrative
(0.7
)
3.1

363.7


366.1

Research and development


31.5


31.5

Operating (loss) income
0.7

(3.1
)
242.4


240.0

Loss (earnings) from investment in subsidiaries
(173.3
)
(177.3
)

350.6


Other (income) expense:





Equity income of unconsolidated subsidiaries


(0.5
)

(0.5
)
Gain on sale of business


(0.1
)

(0.1
)
Net interest expense
1.3

0.6

15.3


17.2

Income (loss) before income taxes and noncontrolling interest
172.7

173.6

227.7

(350.6
)
223.4

Provision for income taxes
(0.1
)
1.3

48.0


49.2

Net income (loss) before noncontrolling interest
172.8

172.3

179.7

(350.6
)
174.2

Noncontrolling interest


1.4


1.4

Net income (loss) attributable to Pentair Ltd.
$
172.8

$
172.3

$
178.3

$
(350.6
)
$
172.8

Comprehensive income (loss), net of tax





Net income (loss) before noncontrolling interest
$
172.8

$
172.3

$
179.7

$
(350.6
)
$
174.2

Changes in cumulative translation adjustment
87.9

87.9

89.1

(175.8
)
89.1

Changes in market value of derivative financial instruments
(0.6
)
(0.6
)
(0.6
)
1.2

(0.6
)
Total comprehensive income (loss)
260.1

259.6

268.2

(525.2
)
262.7

Less: Comprehensive income attributable to noncontrolling interest


2.6


2.6

Comprehensive income (loss) attributable to Pentair Ltd.
$
260.1

$
259.6

$
265.6

$
(525.2
)
$
260.1




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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

 Pentair Ltd. and Subsidiaries
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
Nine months ended September 28, 2013
In millions
Parent
Company
Guarantor
Subsidiary
Issuer
Non-guarantor
Subsidiaries
Eliminations
Pentair Ltd.
and
Subsidiaries
Consolidated
Net sales
$

$

$
5,563.0

$

$
5,563.0

Cost of goods sold


3,734.2


3,734.2

Gross profit


1,828.8


1,828.8

Selling, general and administrative
(1.5
)
10.1

1,182.9


1,191.5

Research and development


97.1


97.1

Operating (loss) income
1.5

(10.1
)
548.8


540.2

Loss (earnings) from investment in subsidiaries
(381.1
)
(396.4
)

777.5


Other (income) expense:
 
 
 
 
 
Equity income of unconsolidated subsidiaries


(1.6
)

(1.6
)
Gain on sale of business


(16.8
)

(16.8
)
Net interest expense
4.4

6.7

41.5


52.6

Income (loss) before income taxes and noncontrolling interest
378.2

379.6

525.7

(777.5
)
506.0

Provision for income taxes
(0.4
)
1.3

122.2


123.1

Net income (loss) before noncontrolling interest
378.6

378.3

403.5

(777.5
)
382.9

Noncontrolling interest


4.3


4.3

Net income (loss) attributable to Pentair Ltd.
$
378.6

$
378.3

$
399.2

$
(777.5
)
$
378.6

Comprehensive income (loss), net of tax
 
 
 
 
 
Net income (loss) before noncontrolling interest
$
378.6

$
378.3

$
403.5

$
(777.5
)
$
382.9

Changes in cumulative translation adjustment
(29.8
)
(29.8
)
(29.1
)
59.6

(29.1
)
Changes in market value of derivative financial instruments
(0.3
)
(0.3
)
(0.3
)
0.6

(0.3
)
Total comprehensive income (loss)
348.5

348.2

374.1

(717.3
)
353.5

Less: Comprehensive income attributable to noncontrolling interest


5.0


5.0

Comprehensive income (loss) attributable to Pentair Ltd.
$
348.5

$
348.2

$
369.1

$
(717.3
)
$
348.5




24

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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Pentair Ltd. and Subsidiaries
Condensed Consolidating Balance Sheet
September 28, 2013
In millions
Parent
Company
Guarantor
Subsidiary
Issuer
Non-guarantor
Subsidiaries
Eliminations
Pentair Ltd.
and
Subsidiaries
Consolidated
Assets
Current assets





Cash and cash equivalents
$

$
0.2

$
237.5

$

$
237.7

Accounts and notes receivable, net
5.7

20.7

1,305.7

(32.9
)
1,299.2

Inventories


1,296.1


1,296.1

Other current assets
10.8


378.3

(10.8
)
378.3

Total current assets
16.5

20.9

3,217.6

(43.7
)
3,211.3

Property, plant and equipment, net


1,171.9


1,171.9

Other assets





Investments in subsidiaries
6,488.9

7,953.9


(14,442.8
)

Goodwill


5,122.0


5,122.0

Intangibles, net


1,817.2


1,817.2

Other non-current assets
31.6

1,544.9

443.1

(1,537.8
)
481.8

Total other assets
6,520.5

9,498.8

7,382.3

(15,980.6
)
7,421.0

Total assets
$
6,537.0

$
9,519.7

$
11,771.8

$
(16,024.3
)
$
11,804.2

Liabilities and Equity
Current liabilities





Current maturities of long-term debt and short-term borrowings
$

$

$
3.0

$

$
3.0

Accounts payable
0.5

6.0

605.8

(32.9
)
579.4

Employee compensation and benefits


317.5


317.5

Other current liabilities
150.4

15.8

623.1

(10.8
)
778.5

Total current liabilities
150.9

21.8

1,549.4

(43.7
)
1,678.4

Other liabilities





Long-term debt
286.2

2,412.1

1,410.2

(1,537.8
)
2,570.7

Pension and other post-retirement compensation and benefits


388.2


388.2

Deferred tax liabilities


497.8


497.8

Other non-current liabilities
17.7


449.7


467.4

Total liabilities
454.8

2,433.9

4,295.3

(1,581.5
)
5,602.5

Equity





Shareholders’ equity attributable to Pentair Ltd. and subsidiaries
6,082.2

7,085.8

7,357.0

(14,442.8
)
6,082.2

Noncontrolling interest


119.5


119.5

Total equity
6,082.2

7,085.8

7,476.5

(14,442.8
)
6,201.7

Total liabilities and equity
$
6,537.0

$
9,519.7

$
11,771.8

$
(16,024.3
)
$
11,804.2




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Pentair Ltd. and Subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Pentair Ltd. and Subsidiaries
Condensed Consolidating Statement of Cash Flows
Nine months ended September