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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
 
         
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
    For the Fiscal Year Ended December 31, 2007    
OR
   
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
 
Commission file number 000-04689
 
Pentair, Inc.
(Exact name of Registrant as specified in its charter)
 
     
Minnesota   41-0907434
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification number)
     
5500 Wayzata Boulevard,
Suite 800, Golden Valley, Minnesota
  55416-1259
(Zip code)
(Address of principal executive offices)    
 
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. o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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 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 $38.57 per share as reported on the New York Stock Exchange on June 30, 2007 (the last day of Registrant’s most recently completed second quarter): $3,645,896,704
 
The number of shares outstanding of Registrant’s only class of common stock on January 26, 2008 was 99,285,319
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Parts of the Registrant’s definitive proxy statement for its annual meeting to be held on May 1, 2008, are incorporated by reference in this Form 10-K in response to Part III, ITEM 10, 11, 12, 13 and 14.
 


 

 
Pentair, Inc.
 
Annual Report on Form 10-K
For the Year Ended December 31, 2007
 
             
        Page
 
  Business     3  
  Risk Factors     9  
  Unresolved Staff Comments     13  
  Properties     13  
  Legal Proceedings     13  
  Submission of Matters to a Vote of Security Holders     15  
 
PART II
  Market for Registrant’s Common Stock, Related Security Holder Matters and Issuer Purchases of Equity Securities     17  
  Selected Financial Data     20  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     22  
  Quantitative and Qualitative Disclosures about Market Risk     39  
  Financial Statements and Supplementary Data     40  
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     90  
  Controls and Procedures     90  
  Other Information     90  
 
PART III
  Directors, Executive Officers and Corporate Governance     91  
  Executive Compensation     91  
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     91  
  Certain Relationships and Related Transactions, and Director Independence     91  
  Principal Accounting Fees and Services     91  
 
PART IV
  Exhibits and Financial Statement Schedules     92  
    Signatures     93  
 Compensation Plan for Non-Employee Directors, as Amended and Restated
 Omnibus Stock Incentive Plan, as Amended and Restated
 Summary of Board of Director Compensation
 List of Subsidiaries
 Consent of Independent Registered Public Accounting Firm
 Power of Attorney
 Certification of Chief Executive Officer
 Certification of Chief Financial Officer
 906 Certification of Chief Executive Officer
 906 Certification of Chief Financial Officer


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PART I
 
ITEM 1.   BUSINESS
 
GENERAL
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, storage, treatment, and enjoyment of water. Our Technical Products Group, formerly referred to as our Enclosures Group, is a leader in the global enclosures and thermal management markets, designing and manufacturing standard, modified and custom enclosures that house and protect sensitive electronics and electrical components; thermal management products; and accessories.
 
Pentair Strategy
Our strategy is to achieve benchmark Return on Invested Capital (“ROIC”) performance for diversified industrial manufacturing companies by:
 
•  building operational excellence through the Pentair Integrated Management System (“PIMS”) consisting of strategy deployment, lean enterprise, and IGNITE, which is our process to drive organic growth;
 
•  driving long-term growth in sales, income and cash flows, through internal growth initiatives and acquisitions;
 
•  developing new products and enhancing existing products;
 
•  penetrating attractive growth markets, particularly international;
 
•  expanding multi-channel distribution; and
 
•  proactively managing our business portfolio, including consideration of new business platforms.
 
Pentair Financial Objectives
Our long-term financial objectives are to:
 
•  Achieve 5%+ annual organic sales growth, plus acquisitions
•  Achieve benchmark financial performance:
 
     
• Earnings Before Interest and Taxes (“EBIT”) Margin
  14%
• ROIC (after-tax)
  15%
• Free Cash Flow (“FCF”)
  100% conversion of net income
• Earnings Per Share (“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 that was incorporated in 1966.
 
BUSINESS AND PRODUCTS
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.
 
WATER GROUP
Our Water Group is a global leader in providing innovative products and systems used worldwide in the movement, storage, treatment, and enjoyment of water. Our Water Group offers a broad array of products and systems to multiple markets and customers. The core competencies of our Water Group center around flow and filtration. We have identified a target market totaling $60 billion, with our current primary focus on three


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markets: Flow Technologies (formerly referred to as Pump) (approximately 40% of group sales), Filtration (approximately 30% of group sales), and Pool & Spa (approximately 30% of group sales).
 
Flow Technologies Market
We address the Flow Technologies 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 Flow Technologies market include STA-RITE®, Myers®, Aurora®, Hydromatic®, Fairbanks Morsetm, Flotec®, Hypro®, Water Ace®, Berkeley®, Aermotortm, Simer®, Verti-line®, Sherwood®, SherTech®, Diamond®, FoamPro®, Ongatm, Nocchitm, Shur-Dri®, SHURflo®, Edwards®, JUNG PUMPEN®, oxynaut®, and JUNG®.
 
Filtration Market
We address the Filtration market with control valves, tanks, filter systems, filter cartridges, pressure vessels, and specialty dispensing pumps providing flow solutions for specific end-user market applications including residential, commercial, foodservice, industrial, recreation vehicles, marine, and aviation. Filtration products are used in the manufacture of water softeners; filtration, deionization, and desalination systems; industrial, commercial and residential water filtration applications; and filtration and separation technologies for hydrocarbon, medical and hydraulic applications.
 
Brand names for the Filtration market include Everpure®, SHURflo®, Fleck®, CodeLine®, Structuraltm, Pentek®, SIATAtm, WellMatetm, American Plumber®, Armor®, OMNIFILTER®, Fibredynetm, and Porous Mediatm.
 
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, and service.
 
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®, IntelliTouchtm, and Acu-Trol®.
 
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 equipment follows warm weather trends and is at seasonal highs from April to August. The magnitude of the sales spike is partially mitigated by employing some advance sale “early buy” programs (generally including extended payment terms and/or additional discounts). Demand for residential and agricultural water systems is also impacted by weather patterns, particularly by heavy flooding and droughts.


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Competition
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 flow technologies 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, competition focuses on brand names, product performance, quality, and price. 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 is a leader in the global enclosures and thermal management markets, designing and manufacturing standard, modified, and custom enclosures that house and protect sensitive electronics and electrical components; thermal management products; and accessories. We have identified a target market of $30 billion. Our Technical Products Group focuses its business portfolio on four primary industries: Commercial and Industrial (55% of group sales), Telecom and Datacom (20% of group sales), Electronics (20% of group sales), and Networking (5% of group sales). The primary brand names for the Technical Products Group are: Hoffman®, Schroff®, Pentair Electronic Packagingtm, Taunustm, McLean®, Electronic Solutionstm, Birtchertm, Calmarktm 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 electrical and data contractors, electrical and electronic components distributors, and original equipment manufacturers. 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. Recent growth in the Technical Products Group is a result of new products development, overall market growth, continued channel penetration, growth in targeted market segments, geographic expansion and acquisitions. 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.
 
RECENT DEVELOPMENTS
Growth of our business
We continually look at each of our businesses to determine whether they fit with our 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 future growth.


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Acquisitions
On May 7, 2007, we acquired as part of our Technical Products Group the assets of Calmark Corporation (“Calmark”), a privately held business, for $28.5 million, including a cash payment of $29.3 million and transaction costs of $0.2 million, less cash acquired of $1.0 million. Calmark’s results of operations have been included in our consolidated financial statements since the date of acquisition. Calmark’s product portfolio includes enclosures, guides, card locks, retainers, extractors, card pullers and other products for the aerospace, medical, telecommunications and military market segments, among others. Goodwill recorded as part of the purchase price allocation was $11.8 million, all of which is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $14.0 million, including definite-lived intangibles, such as non-compete agreements, customer relationships and proprietary technology of $10.5 million with a weighted average amortization period of approximately 8 years. We continue to evaluate the purchase price allocation for the Calmark acquisition, including intangible assets, contingent liabilities and property, plant and equipment. We expect to revise the purchase price allocation as better information becomes available.
 
On April 30, 2007, we acquired as part of our Water Group all of the capital interests in Porous Media Corporation and Porous Media, Ltd. (together, “Porous Media”), two privately held filtration and separation technologies businesses, for $224.9 million, including a cash payment of $225.0 million and transaction costs of $0.4 million, less cash acquired of $0.5 million. Porous Media’s results of operations have been included in our consolidated financial statements since the date of acquisition. Porous Media brings strong technical ability to our Water Group, including engineering, material science, media development and application capabilities. Porous Media’s product portfolio includes high-performance filter media, membranes and related filtration products and purification systems for liquids, gases and solids for the general industrial, petrochemical, refining and healthcare market segments, among others. Goodwill recorded as part of the purchase price allocation was $128.1 million, all of which is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $73.8 million, including definite-lived intangibles, such as proprietary technology and customer relationships of $60.6 million with a weighted average amortization period of approximately 11 years. We continue to evaluate the purchase price allocation for the Porous Media acquisition, including intangible assets, contingent liabilities and property, plant and equipment. We expect to revise the purchase price allocation as better information becomes available.
 
On February 2, 2007, we acquired as part of our Water Group all the outstanding shares of capital stock of Jung Pumpen GmbH (“Jung Pump”) for $229.5 million, including a cash payment of $239.6 million and transaction costs of $1.3 million, less cash acquired of $11.4 million. Jung Pump’s results of operations have been included in our consolidated financial statements since the date of acquisition. Jung Pump is a leading German manufacturer of wastewater products for municipal and residential markets. Jung Pump brings us its strong application engineering expertise and a complementary product offering, including a new line of water re-use products, submersible wastewater and drainage pumps, wastewater disposal units and tanks. Jung Pump also brings to Pentair its well-established European presence, a state-of-the-art training facility in Germany and sales offices in Germany, Austria, France, Hungary, Poland and Slovakia. Goodwill recorded as part of the purchase price allocation was $123.4 million, of which approximately $53 million is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $135.7 million, including definite-lived intangibles, primarily customer relationships of $71.6 million with a weighted average amortization period of approximately 15 years.
 
On April 12, 2006, we acquired as part of our Water Group the assets of Geyer’s Manufacturing & Design Inc. and FTA Filtration, Inc. (together “Krystil Klear”), two privately-held companies, for $15.5 million in cash. Krystil Klear’s results of operations have been included in our consolidated financial statements since the date of acquisition. Krystil Klear expands our industrial filtration product offering to include a full range of steel and stainless steel tanks which house filtration solutions. Goodwill recorded as part of the purchase price allocation was $9.2 million, all of which is tax deductible.
 
During 2006, we completed several other small acquisitions totaling $14.2 million in cash and notes payable, adding to both our Water and Technical Products Groups. Total goodwill recorded as part of the purchase price allocations was $9.3 million, of which $3.1 million is tax deductible.


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On December 1, 2005, we acquired, as part of our Technical Products Group, the McLean Thermal Management, Aspen Motion Technologies, and Electronic Solutions businesses from APW, Ltd. (collectively, “Thermal”) for $143.9 million, including a cash payment of $140.6 million and transaction costs of $3.3 million. These businesses provide thermal management solutions and integration services to the telecommunications, data communications, medical, and security markets. Final goodwill recorded as part of the purchase price allocation was $71.1 million, all of which is tax deductible. Final identifiable intangible assets acquired as part of the acquisition were $45.6 million, including definite-lived intangibles, such as proprietary technology and customer relationships, of $23.1 million with a weighted average amortization period of approximately 12 years.
 
On February 23, 2005, we acquired, as part of our Water Group, 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. Final goodwill recorded as part of the purchase price allocation was $7.2 million, all of which is tax deductible.
 
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
In February 2008, consistent with our strategy to refine our portfolio and more fully focus on our growing core pool equipment business globally, we agreed to sell our National Pool Tile business unit to Pool Corporation in a cash transaction. National Pool Tile is the leading wholesale distributor of pool tile and composite pool finishes serving professional contractors in the swimming pool refurbish and construction markets. NPT has annual net sales of over $60 million, with the majority of its sales in the refurbish market. The business sale and first quarter results will be treated as discontinued operations. The transaction is subject to customary closing conditions and is targeted to close by the end of the first quarter 2008.
 
Effective after the close of business on October 2, 2004, we completed the sale of our former Tools Group to The Black & Decker Corporation (“BDK”). In January 2006, pursuant to the purchase agreement for the sale of our former Tools Group, we completed the repurchase of a manufacturing facility in Suzhou, China from BDK for approximately $5.7 million. We recorded no gain or loss on the repurchase. In March 2006, we completed an outstanding net asset value arbitration with BDK relating to the purchase price for the sale of our former Tools Group. The decision by the arbitrator constituted a final resolution of all disputes between BDK and us regarding the net asset value. We paid the final net asset value purchase price adjustment pursuant to the purchase agreement of $16.1 million plus interest of $1.1 million in March 2006, resulting in an incremental pre-tax loss on disposal of discontinued operations of $3.4 million, or $1.6 million net of tax. In the third quarter of 2006, we resolved a prior year tax item that resulted in a $1.4 million income tax benefit related to our former Tools Group.
 
In 2001, we completed the sale of our former Service Equipment businesses (Century Mfg. Co. /Lincoln Automotive Company) to Clore Automotive, LLC. In the fourth quarter of 2003, we reported an additional loss from discontinued operations of $2.9 million related to exiting the remaining two facilities. In March 2006, we exited a leased facility from our former Service Equipment business resulting in a net cash outflow of $2.2 million and an immaterial gain from disposition.
 
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.


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INFORMATION REGARDING ALL BUSINESS SEGMENTS
 
Backlog
Our backlog of orders as of December 31 by segment was:
 
                                 
In thousands   2007     2006     $ change     % change  
   
 
Water
  $ 306,906     $ 238,191     $ 68,715       28.8 %
Technical Products
    124,919       100,205       24,714       24.7 %
 
 
Total
  $ 431,825     $ 338,396     $ 93,429       27.6 %
 
 
 
The $68.7 million increase in Water Group backlog was primarily due to increased backlog for pumps used in municipal market applications and growth in Asian markets. The $24.7 million increase in Technical Products Group backlog reflected growth in our electrical markets, recovery in North American Electronics markets and growth in Asian markets. Due to the relatively short manufacturing cycle and general industry practice for the majority of our businesses, backlog, which typically represents less than 30 days of shipments, is not deemed to be a significant item. 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, 2007 will be filled in 2008.
 
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 2007, 2006, and 2005 were $58.8 million, $58.1 million, and $46.0 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 metals 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 metals 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.


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Employees
As of December 31, 2007, we employed approximately 16,000 people worldwide. Total employees in the United States were approximately 9,300, of whom approximately 900 are represented by five different trade unions having collective bargaining agreements. Generally, labor relations have been satisfactory.
 
Captive Insurance Subsidiary
We insure certain 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 arising from acquired businesses, pre-Penwald 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.
 
ITEM 1A.   RISK FACTORS
 
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 other information set forth in this document.
 
General economic conditions, including credit and residential construction markets, affect demand for our products.
 
We compete globally in varied markets. Among these, the most significant are North American industrial and commercial markets (for both the Water and Technical Products Groups) and the North American residential market (for the Water Group). Economic conditions in the United States affect the robustness of our North American markets. Important factors include the overall strength of the economy and our customers’ confidence in the economy; industrial and municipal capital spending; the strength of the residential and commercial real estate markets; the age of existing housing stock; unemployment rates; availability of consumer and commercial financing; and interest rates. New construction for residential housing and home improvement activity fell dramatically in 2007, which reduced revenue growth in our Water Group, especially in the pool and spa and flow technologies markets we address. We believe that recent weaknesses in these markets will likely continue to affect our revenues and margins throughout 2008. 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


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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 future results of operations.
 
Our inability to sustain consistent organic growth could adversely affect our financial performance.
 
In 2007 and 2006, our organic growth was generated in part from expanding international sales, entering new distribution channels, price increases 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. Competitive and economic factors 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 together with any resulting impact on our net income growth, would likely adversely affect the market price of our stock.
 
Our inability to complete, or successfully complete and integrate, acquisitions could adversely affect our financial performance.
 
Over the past three years, we have grown through acquisitions of businesses within our current business segments, that have generated a significant percentage of our net revenue growth. 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, though we may consider acquisitions outside of these segments as well. Our ability to expand through acquisitions is subject to various risks, including the following:
 
•  higher acquisition prices;
 
•  lack of suitable acquisition candidates in targeted product or market areas;
 
•  increased competition for acquisitions, especially in the water industry;
 
•  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 and other inflation could adversely affect our results of operations.
 
We are experiencing material cost and other 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 raw materials, especially metals, energy and other costs such as pension, 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 in managing our costs or increasing our productivity. Continued cost inflation or failure of our initiatives to generate cost savings or improve productivity would likely 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 equipment follows warm weather trends and is at seasonal highs from April to August. The magnitude of the sales spike is partially mitigated by employing some advance sale or “early buy” programs (generally including extended payment terms and/or additional discounts). Demand for residential and agricultural water


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systems is also impacted by weather patterns, particularly by 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, such as the Horizon litigation discussed in ITEM 3 and Item 8, Note 15 of this Annual Report on Form 10-K. While we currently maintain what we believe to be suitable product liability insurance, we cannot assure you 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, financial condition, results of operations, and cash flows.
 
The availability and cost of capital could have a negative impact on our continued growth.
 
Our plans to continue 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 financing. While we refinanced our primary credit agreements in the second quarter of 2007, future acquisitions may 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 as consideration. There can be no assurance 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, especially our acquisition program, 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 our sales outside of North America to increase in the future. Over the past few years, the economies of some 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, in which our most significant European market is Germany. In addition, we have a significant and growing business in the Asia-Pacific area. We cannot predict how changing market conditions in these regions 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. In 2007, the weakness of the US dollar benefited our financial results in foreign jurisdictions significantly. We do not anticipate continuing US dollar weakness in foreign exchange markets in 2008 of a similar magnitude, which may hurt our financial results on a comparative basis. In addition, we source certain products, components and raw materials throughout the world, the import of which into the United States has raised the cost of these goods in US dollars and has impacted the results of our domestic businesses as well. We expect a continuing impact of the weak dollar in 2008, as well, although we expect that we should be able to offset this continuing impact through increased focus on our sourcing programs, productivity gains in our facilities and other cost reductions.


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We are exposed to political, economic and other risks that arise from operating a multinational business.
 
Sales outside of the United States, including export sales from our domestic businesses, accounted for approximately 32% of our net sales in 2007, up from 27% in 2006. Further, most of our businesses obtain some products, components and raw materials 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 possibility of terrorist action against us or our operations;
 
•  the imposition of tariffs, exchange controls or other restrictions;
 
•  difficulty in staffing and managing widespread operations in non-U.S. labor markets;
 
•  the difficulty of protecting intellectual property in foreign countries;
 
•  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 and other laws, liabilities and litigation.
 
We are subject to federal, state, local and foreign laws and regulations governing our environmental practices, public and worker health and safety and the indoor and outdoor environment. Compliance with environmental regulations could require us to satisfy environmental liabilities, increase the cost of manufacturing our products or otherwise adversely affect our business, financial condition and results of operations. 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 (“PRP”) in a number of environmental clean-ups relating to our current or former business units. We have disposed of a number of businesses in recent 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.
 
Provisions of our Restated Articles of Incorporation, Bylaws and Minnesota law could deter takeover attempts.
 
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.


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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 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. We carry out our Water Group manufacturing operations at 19 plants located throughout the United States and at 18 plants located in 10 other countries. In addition, our Water Group has 65 distribution facilities and 18 sales offices located in numerous countries throughout the world. We carry out our Technical Products Group manufacturing operations at 8 plants located throughout the United States and 11 plants located in 7 other countries. In addition, our Technical Products Group has 11 distribution facilities and 29 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.
 
ITEM 3.   LEGAL PROCEEDINGS
 
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 PRP 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


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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 in recent 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 of these businesses 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 prior years; to date our recorded accruals have been adequate.
 
In addition, there are ongoing environmental issues at a limited number of sites, including one site acquired in the acquisition of Essef Corporation in 1999, which relate to operations no longer carried out at the sites. We have established what we believe to be adequate accruals for remediation costs at these 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 the outcome of the matter 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, 2007 and 2006, our undiscounted reserves for such environmental liabilities were approximately $3.5 million and $5.6 million, respectively. 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.
 
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. 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. The claims against Essef and its involved subsidiaries were based upon the allegation that Essef designed, manufactured and marketed two sand swimming pool filters that were installed as a part of the spa system on the Horizon cruise ship and allegations that the spa and filters contained Legionnaire’s disease bacteria that infected certain passengers on cruises in 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 passenger cases, plus interest of approximately $1.6 million, in January 2004. All of the passenger cases have now been resolved through either settlement or judgment.
 
The only remaining unresolved claims in this case were those brought by Celebrity for damages resulting from the outbreak. Celebrity filed an amended complaint seeking attorney fees and costs for prior litigation as well as out-of-pocket losses, lost profits and loss of business enterprise value. The first trial in 2006 resulted in a verdict against the Essef defendants for Celebrity’s out-of-pocket expenses of $10.4 million. Verdicts at this trial for lost profits ($47.6 million) and lost enterprise value ($135 million) were reversed in January 2007. In the retrial in June 2007, the jury awarded Celebrity damages for lost profits for 1994 and 1995 of $15.2 million


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(after netting for amounts taken into account by the earlier verdict for out-of-pocket expenses). The verdicts are exclusive of pre-judgment interest and attorneys’ fees.
 
In January 2008, the District Court ruled on post-trial motions and other previously undecided issues in this litigation. Our motion to reverse the jury verdict in the second trial on lost profits after 1994 was not granted; Celebrity’s damages for out-of-pocket costs and lost profits were reduced by 30% reflecting an earlier finding of its contributory negligence; and pre-judgment interest was awarded to Celebrity at a rate equal to semiannual T-Bill rates compounded annually. In addition, Celebrity and the Essef defendants settled Celebrity’s claim for attorneys’ fees in the passenger cases for $3 million, inclusive of all interest. This amount was paid and expensed in the fourth quarter of 2007.
 
In the aggregate, damages against the Essef defendants in this litigation total approximately $30.5 million, inclusive of interest through 2007. Judgment on the verdicts has not yet been entered. Once entered, both parties will have thirty days in which to appeal from the judgment. The Essef defendants have not yet determined whether and on what issues they may appeal in this case.
 
We have assessed the impact of the latest ruling on our previously established reserves for this matter and, based on information available at this time, have not changed our reserves, except to take into account appropriate interest accruals.
 
We believe that any judgment we pay in this matter would be tax-deductible in the year paid or in subsequent years. In addition to the impact of any loss on this matter on our earnings per share when recognized, we may need to borrow funds from our banks or other sources to pay any judgment, plus interest, upon settlement or finally determined after exhaustion of all appeals.
 
ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None.


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EXECUTIVE OFFICERS OF THE REGISTRANT
 
Current executive officers of Pentair, their ages, current position, and their business experience during at least the past five years are as follows:
 
         
Name
  Age  
Current Position and Business Experience
 
Randall J. Hogan
  52   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 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.
Michael V. Schrock
  55   President and Chief Operating Officer since September 2006; President and Chief Operating Officer of Filtration and Technical Products, October 2005 — September 2006; 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.
John L. Stauch
  43   Executive Vice President and Chief Financial Officer since February 2007; Chief Financial Officer of the Automation and Control Systems unit of Honeywell International Inc., July 2005 — February 2007; Vice President, Finance and Chief Financial Officer of the Sensing and Controls unit of Honeywell International Inc., January 2004 — July 2005; Vice President, Finance and Chief Financial Officer of the Automation & Control Products unit of Honeywell International Inc., July 2002 — January 2004; Chief Financial Officer and IT Director of PerkinElmer Optoelectronics, a unit of PerkinElmer, Inc., April 2000 — April 2002; Various executive, investor relations and managerial finance positions with Honeywell International Inc. and its predecessor AlliedSignal Inc., 1994 — 2000.
Louis L. Ainsworth
  60   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.
Frederick S. Koury
  47   Senior Vice President, Human Resources, since August 2003; Vice President of Human Resources of the Victoria’s Secret unit of Limited Brands, September 2000 — August 2003; PepsiCo, Inc., various executive positions, June 1985 — September 2000.
Michael G. Meyer
  49   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.


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PART II
 
ITEM 5.   MARKET FOR REGISTRANT’S COMMON STOCK, RELATED SECURITY HOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our common stock is listed for trading on the New York Stock Exchange and trades under the symbol “PNR.” As of December 31, 2007, there were 3,817 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 2007 and 2006 were as follows:
 
                                                                 
    2007     2006  
    First     Second     Third     Fourth     First     Second     Third     Fourth  
   
 
High
  $ 33.22     $ 39.37     $ 39.67     $ 36.59     $ 41.90     $ 41.55     $ 34.43     $ 33.49  
Low
  $ 29.35     $ 30.09     $ 31.47     $ 32.03     $ 34.01     $ 32.05     $ 25.69     $ 26.25  
Close
  $ 31.16     $ 38.57     $ 33.18     $ 34.81     $ 40.75     $ 34.19     $ 26.19     $ 31.40  
Dividends declared
  $ 0.15     $ 0.15     $ 0.15     $ 0.15     $ 0.14     $ 0.14     $ 0.14     $ 0.14  
 
Pentair has paid 128 consecutive quarterly dividends and has increased dividends each year for 31 consecutive years.


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Stock Performance Graph
 
The following information under the caption “Stock Performance Graph” in this ITEM 5 of this Annual Report on Form 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing.
 
The following graph sets forth the cumulative total shareholder return on our common stock for the last five years, assuming the investment of $100 on December 31, 2002 and the reinvestment of all dividends since that date to December 31, 2007. The graph also contains for comparison purposes the S&P 500 Index and the S&P MidCap 400 Index, assuming the same investment level and reinvestment of dividends.
 
By virtue of our market capitalization, we are a component of the S&P MidCap 400 Index. On the basis of our size and diversity of businesses, we have not found a readily identifiable peer group. We believe the S&P MidCap 400 Index is an appropriate comparison. We have evaluated other published indices, but have determined that the results are skewed by significantly larger companies included in the indices. We believe such a comparison would not be meaningful.
 
PERFORMANCE GRAPH
 
                                                 
    Base Period
  INDEXED RETURNS
    December
  Years Ending December 31:
Company/Index   2002   2003   2004   2005   2006   2007
 
PENTAIR INC
    100       135.06       261.25       209.84       194.03       218.97  
S&P 500 INDEX
    100       128.68       142.69       149.70       173.34       182.86  
S&P MIDCAP 400 INDEX
    100       135.62       157.97       177.81       196.16       211.81  


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Purchases of Equity Securities
 
The following table provides information with respect to purchases made by Pentair of common stock during the fourth quarter of 2007:
 
                                 
    (a)     (b)     (c)     (d)  
                Total Number of
    Dollar Value of
 
                Shares Purchased
    Shares that
 
    Total Number
          as Part of Publicly
    May Yet Be
 
    of Shares
    Average Price
    Announced Plans
    Purchased Under the
 
Period   Purchased     Paid per Share     or Programs     Plans or Programs  
   
 
September 30 — October 27, 2007
    30,869     $ 34.64       30,296     $ 12,472,131  
October 28 — November 24, 2007
    532,909     $ 34.91       362,479     $ 0  
November 25 — December 31, 2007
    1,790     $ 36.76           $ 0  
 
 
Total
    565,568               392,775          
 
 
(a) The purchases in this column include shares repurchased as part of our publicly announced programs and in addition, 573 shares for the period September 30 — October 27, 2007, 170,430 shares for the period October 28 — November 24, 2007, and 1,790 shares for the period November 25 — December 31, 2007 deemed surrendered to us by participants in our Omnibus Stock Incentive Plan and the Outside Directors Nonqualified Stock Option Plan (the “Plans”) to satisfy the exercise price or withholding of tax obligations related to the exercise of stock options and non-vested shares.
 
(b) The average price paid in this column includes shares repurchased as part of our publicly announced programs and shares deemed surrendered to us by participants in the Plans to satisfy the exercise price or withholding of tax obligations related to the exercise price of stock options and non-vested shares.
 
(c) The number of shares in this column represents the number of shares repurchased as part of publicly announced programs to repurchase up to $100 million of our common stock.
 
(d) During 2006, the Board of Directors authorized the repurchase of shares of our common stock up to a maximum dollar limit of $100 million. As of December 31, 2006, we had purchased 1,986,026 shares for $59.4 million pursuant to this authorization during 2006. In December 2006, the Board of Directors authorized the continuation of the repurchase program in 2007 with a maximum dollar limit of $40.6 million. This authorization expired on December 31, 2007. As of December 31, 2007 we repurchased an additional 1,209,257 shares for $40.6 million pursuant to this plan. In December 2007, the Board of Directors authorized the repurchase of shares of our common stock up to a maximum dollar limit of $50 million starting in 2008. The authorization expires on December 31, 2008.


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ITEM 6.   SELECTED FINANCIAL DATA
 
                                             
Dollars in thousands,
      Years ended December 31  
except per-share data       2007(1)     2006(1)     2005(1)     2004     2003  
   
 
Statement of operations
                                           
Net sales
                                           
    Water   $ 2,348,565     $ 2,155,225     $ 2,131,505     $ 1,563,394     $ 1,060,303  
    Technical
  Products
    1,050,133       999,244       815,074       714,735       582,684  
 
 
    Total     3,398,698       3,154,469       2,946,579       2,278,129       1,642,987  
 
 
Sales growth
        7.7 %     7.1 %     29.3 %     38.7 %     10.4 %
Cost of goods sold
        2,374,048       2,248,219       2,098,558       1,623,419       1,196,757  
Gross profit
        1,024,650       906,250       848,021       654,710       446,230  
Margin %
        30.1 %     28.7 %     28.8 %     28.7 %     27.2 %
Selling, general and administrative
        587,865       537,877       478,370       376,015       253,088  
Research and development
        58,810       58,055       46,042       31,453       22,932  
Operating income(2)
                                           
    Water     271,367       215,830       267,675       197,310       143,962  
    Technical
  Products
    153,586       148,905       109,229       87,844       51,094  
    Other     (46,978 )     (54,417 )     (53,295 )     (37,912 )     (24,846 )
 
 
    Total     377,975       310,318       323,609       247,242       170,210  
 
 
Margin %
        11.1 %     9.8 %     11.0 %     10.9 %     10.4 %
Net interest expense
        70,237       51,881       44,989       37,210       26,395  
Gain (loss) on sale of investment, net
        (1,230 )     364       5,435              
Equity losses of unconsolidated subsidiary
        (2,865 )     (3,332 )     (537 )            
Provision for income taxes
        93,154       71,702       98,469       73,008       45,665  
Income from continuing operations
        210,489       183,767       185,049       137,024       98,150  
Income from discontinued operations, net of tax
                          40,248       46,138  
Gain (loss) on disposal of discontinued operations, net of tax
        438       (36 )           (6,047 )     (2,936 )
 
 
Net income
      $ 210,927     $ 183,731     $ 185,049     $ 171,225     $ 141,352  
 
 
Common share data*
                                           
Basic EPS — continuing operations
      $ 2.13     $ 1.84     $ 1.84     $ 1.38     $ 1.00  
Basic EPS — discontinued operations
                          0.34       0.44  
 
 
Basic EPS — net income
      $ 2.13     $ 1.84     $ 1.84     $ 1.72     $ 1.44  
 
 
Diluted EPS — continuing operations
      $ 2.10     $ 1.81     $ 1.80     $ 1.35     $ 0.99  
Diluted EPS — discontinued operations
                          0.33       0.43  
 
 
Diluted EPS — net income
      $ 2.10     $ 1.81     $ 1.80     $ 1.68     $ 1.42  
 
 
Cash dividends declared per common share
        0.60       0.56       0.52       0.43       0.41  
Stock dividends declared per common share
                          100 %      
Market value per share (December 31)
        34.81       31.40       34.52       43.56       22.85  
 
 
 
 
(1) In 2005 we early adopted SFAS 123R retroactively to January 1, 2005. The incremental impact of the SFAS 123R to the results of operations for 2007, 2006 and 2005 include after tax expense of $9.2 million, $9.9 million, and $12.0 million, respectively, or ($0.09), ($0.10) and ($0.12) diluted EPS, respectively.
 
(2) Amounts reflect the effects of the reclassification of equity losses of unconsolidated subsidiary described in Item 8, Note 1 of this Form 10-K.
 
* All share and per share information presented in this FORM 10-K has been retroactively restated to reflect the effect of a 100% stock dividend in 2004.
 


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Dollars in thousands,
      Years ended December 31  
except per-share data       2007     2006     2005     2004     2003  
   
 
Balance sheet data
                                           
Accounts receivable, net
      $ 472,222     $ 422,134     $ 423,847     $ 396,459     $ 251,475  
Inventories
        407,127       398,857       349,312       323,676       166,862  
Property, plant and equipment, net
        367,426       330,372       311,839       336,302       233,106  
Goodwill
        2,021,526       1,718,771       1,718,207       1,620,404       997,183  
Total assets
        4,000,614       3,364,979       3,253,755       3,120,575       2,780,677  
Total debt
        1,060,991       744,061       752,614       736,105       806,493  
Shareholders’ equity
        1,910,871       1,669,999       1,555,610       1,447,794       1,261,478  
 
 
Other data
                                           
Debt/total capital
        35.7 %     30.8 %     32.6 %     33.7 %     39.0 %
Depreciation
                                           
    Water     38,056       35,978       35,842       26,751       20,517  
    Technical
  Products
    19,696       19,617       19,318       19,408       19,721  
    Other     1,196       1,304       1,405       904       571  
 
 
    Total     58,948       56,899       56,565       47,063       40,809  
 
 
Other amortization
        25,601       18,197       15,995       7,501       377  
Net cash provided by operating activities
        341,880       231,611       247,858       264,091       262,939  
Capital expenditures — continuing operations
        62,129       51,078       62,471       43,107       29,004  
Captial expenditures — discontinued operations
                          5,760       14,618  
Capital expenditures — continuing and discontinued operations
        62,129       51,078       62,471       48,867       43,622  
Employees of continuing operations
        16,000       14,800       14,700       12,900       9,000  
Days sales outstanding in receivables(1)
        53       54       54       52       54  
Days inventory on hand(1)
        77       76       70       62       59  
 
 
 
 
(1) Calculated using a 13-month average.
 
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 2004, we acquired as part of our Water Group all of the capital stock of WICOR Inc., from Wisconsin Energy Corporation for $889.6 million, including cash payment of $871.1 million, cash acquired of $15.5 million, transaction costs of $5.8 million, plus debt assumed of $21.6 million.

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ITEM 7.   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 and those discussed in ITEM 1A, Risk Factors, of this Form 10-K may impact the achievement of forward-looking statements:
 
•  changes in general economic and industry conditions, such as:
 
  •  the strength of product demand and the markets we serve;
 
  •  the intensity of competition, including that from foreign competitors;
 
  •  pricing pressures;
 
  •  market acceptance of new product introductions and enhancements;
 
  •  the introduction of new products and enhancements by competitors;
 
  •  our ability to maintain and expand relationships with large customers;
 
  •  our ability to source raw material commodities from our suppliers without interruption and at reasonable prices;
 
  •  our ability to source components from third parties, in particular from foreign manufacturers, without interruption and at reasonable prices; and
 
  •  the financial condition of our customers;
 
•  our ability to access capital markets and obtain anticipated financing under favorable terms;
 
•  our ability to successfully limit any final judgment arising out of the Horizon litigation;
 
•  our ability to identify, complete and integrate acquisitions successfully and to realize expected synergies on our anticipated timetable;
 
•  changes in our business strategies, including acquisition, divestiture and restructuring activities;
 
•  domestic and foreign governmental and regulatory policies;
 
•  general economic and political conditions, such as political instability, the rate of economic growth in our principal geographic or product markets or fluctuations in exchange rates;
 
•  changes in operating factors, such as continued improvement in manufacturing activities and the achievement of related efficiencies, cost reductions and inventory risks due to shifts in market demand and costs associated with moving production overseas;
 
•  our ability to generate savings from our excellence in operations initiatives consisting of lean enterprise, supply management and cash flow practices;


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•  unanticipated developments that could occur with respect to contingencies such as litigation, intellectual property matters, product liability exposures and environmental matters; and
 
•  our ability to accurately evaluate the effects of contingent liabilities such as tax, product liability, environmental and other claims.
 
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, storage, treatment and enjoyment of water. Our Technical Products Group is a leader in the global enclosures and thermal management markets, designing and manufacturing standard, modified and custom enclosures that house and protect sensitive electronics and electrical components; thermal management products; and accessories. In 2008, we expect our Water Group and Technical Products Group to generate approximately 70% and 30% of total revenues, respectively.
 
Our Water Group has progressively become a more important part of our business portfolio with sales increasing from approximately $125 million in 1995 to approximately $2.3 billion in 2007. We believe the water industry is structurally attractive as a result of a growing demand for clean water and the large global market size (of which we have identified a target market totaling $60 billion). Our vision is to be a leading global provider of innovative products and systems used in the movement, storage, treatment and enjoyment of water.
 
Our Technical Products Group operates in a large global market with significant potential for growth in industry segments such as defense, security, medical and networking. We believe we have the largest enclosures industrial and commercial distribution network in North America and the highest enclosures brand recognition in the industry in North America. From mid-2001 through 2003, the Technical Products Group experienced significantly lower sales volumes as a result of severely reduced capital spending in the industrial and commercial markets and over-capacity and weak demand in the datacommunication and telecommunication markets. From 2004 through 2007, sales volumes increased due to the addition of new distributors, new products and higher demand in targeted markets.
 
Key Trends and Uncertainties
The following trends and uncertainties affected our financial performance in 2007 and will likely impact our results in the future:
 
•  The housing market and new pool starts slowed in the last three quarters of 2006 and continued to shrink in 2007. We believe that construction of new homes and new pools starts in North America affects approximately 12% of our sales, especially for our pool and spa businesses. This downturn will likely have an adverse impact on our revenues for 2008.
 
•  The telecommunication equipment market, particularly in North America, has slowed over the past year and a half and impacted North American electronics sales within our Technical Products Group. For the full year 2007, North American electronics sales declined approximately 15% when compared with 2006. The revenue decrease was attributable to telecommunication industry consolidation (which has delayed enclosure product sales) and some OEM datacommunication programs reaching end-of-life. Based on some recovery of telecommunications equipment procurement in the second half of 2007, we anticipate continuing improvement in 2008 and growth rates in the low double digits for our North American electronics sales. A weak economy in the United States and Europe could reduce the telecommunications capital investments and therefore our anticipated revenue growth.
 
•  We experience seasonal demand in a number of markets within our Water Group. End-user demand for pool equipment follows warm weather trends and is at seasonal highs from April to August. The magnitude of


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the sales spike is partially mitigated by employing some advance sale “early buy” programs (generally including extended payment terms and/or additional discounts). Demand for residential and agricultural water systems is also impacted by economic conditions and weather patterns, particularly by heavy flooding and droughts.
 
•  We expect our operations to continue to benefit from our PIMS initiatives, which include strategy deployment; lean enterprise with special focus on sourcing and supply management, cash flow management and lean operations; and IGNITE, our process to drive organic growth.
 
•  We are experiencing material cost and other 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 we have experienced in base materials such as stainless steel, carbon steel and copper and other costs such as health care and other employee benefit costs.
 
•  If sales of products into residential end-markets in our Water business continue to slow appreciably, we may consider reducing our investments and consequentially organic growth in those markets and further restructure our operations by closing or downsizing facilities, reducing headcount or taking other market-related actions as we did in 2006 and 2007.
 
•  We have a long-term goal to consistently generate free cash flow that equals or exceeds 100% conversion of our net income. We define free cash flow as cash flow from operating activities less capital expenditures plus proceeds from sale of property and equipment. Free cash flow for the full year 2007 was approximately $285 million, or 135% of our net income. See our discussion of Other financial measures under the caption “Liquidity and Capital Resources” in this report.
 
•  We experienced favorable foreign currency effects on net sales in 2007. Our currency effect is primarily for the U.S. dollar against the euro, which may or may not trend favorably in the future.
 
•  The effective tax rate for 2007 was 30.7%. The tax rate for 2007 includes a favorable adjustment related to the measurement of deferred tax assets and liabilities to account for changes in German tax law enacted on August 17, 2007. We estimate our effective income tax rate for the full year 2008 to be between 33.5% and 34.5%. We continue to actively pursue initiatives to reduce our effective tax rate. The tax rate in any quarter can be affected positively or negatively by adjustments that are required to be reported in the specific quarter of resolution.
 
Outlook
In 2008, our operating objectives include the following:
 
•  Continue to drive operating excellence through lean enterprise initiatives, with special focus on sourcing and supply management, cash flow management, and lean operations;
 
•  Continue the integration of acquisitions and realize identified synergistic opportunities;
 
•  Continue proactive talent development, particularly in international management and other key functional areas;
 
•  Achieve organic sales growth (in excess of market growth rates), particularly in international markets; and
 
•  Continue to make strategic acquisitions to grow and expand our existing platforms in our Water and Technical Products Groups.
 
On February 5, 2008, we reaffirmed our previously issued fiscal 2008 guidance, which anticipates our earnings per share growth between 8% and 15% to approximately $2.25 to $2.40 per share. Our estimate is based on three primary variables. First, we anticipate modest organic growth in the range of 3% to 5%, including some price and product mix improvements, bringing our total revenues to $3.5 to $3.6 billion for the full year. Second, we anticipate that our manufacturing productivity initiatives, in particular our materials sourcing programs, will improve through our lean enterprise initiatives and through somewhat higher unit volumes. Third, we anticipate our selling, marketing and R&D expenses will flex with economic conditions in our primary markets.


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If economic conditions worsen in North America and Europe, then we expect that our sales and productivity increases may deteriorate from current forecast. In that event, we would reduce discretionary selling, marketing and R&D costs in order to minimize the impact of these declines on our earnings per share, which we anticipate would still meet the bottom of our guidance range. Conversely, if economic conditions hold up and improve over the year, we expect our net income should be able to reach the top of our guidance range. We would then have the flexibility to increase expenditures in our selling, marketing and R&D efforts to maximize organic sales growth in 2008 and sustain anticipated growth in 2009.
 
We based our guidance on an absence of significant acquisitions or divestitures in 2008. As noted above, in 2008 our objectives may seek to expand our geographic reach internationally, expand our presence in our various channels to market and acquire technologies and products to broaden our businesses’ capabilities to serve additional markets. We may also consider the divestiture of discrete business units to further focus our businesses on their most attractive markets.
 
The ability to achieve our operating objectives and 2008 guidance 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:
 
                 
Percentages   2007 vs. 2006     2006 vs. 2005  
   
 
Volume
    3.5       4.4  
Price
    2.6       2.5  
Currency
    1.6       0.2  
 
 
Total
    7.7       7.1  
 
 
 
The 7.7 percent increase in consolidated net sales in 2007 from 2006 was primarily the result of:
 
•  an increase in sales volume due to our February 2, 2007 acquisition of Jung Pumpen GmbH (“Jung Pump”) and our April 30, 2007 acquisition of Porous Media Corporation and Porous Media, Ltd. (together “Porous Media”);
 
•  organic sales growth of approximately 2 percent for the full year 2007 (excluding acquisitions and foreign currency exchange), which included selective increases in selling prices to mitigate inflationary cost increases:
 
  •  growth in the Europe and Asia-Pacific markets;
 
  •  higher Technical Product sales into electrical markets;
 
  •  higher second quarter sales of municipal pumps related to a large flood control project; and
 
  •  growth in commercial and industrial water markets.
 
These increases were partially offset by:
 
  •  lower Technical Products sales into North American electronics markets driven by contraction and consolidation in the telecommunication equipment industry which have delayed buying activity and by datacommunication projects reaching end-of-life; and
 
  •  lower sales of certain pump, pool and filtration products related to the downturn in the North American residential housing market and softness in residential pool construction markets; and
 
•  favorable foreign currency effects.


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The 7.1 percent increase in consolidated net sales in 2006 from 2005 was primarily the result of:
 
•  an increase in sales volume due to our acquisitions, primarily the December 1, 2005 acquisition of the McLean Thermal Management, Aspen Motion Technologies, and Electronic Solutions businesses from APW, Ltd. (collectively, “Thermal”); and
 
•  organic sales growth of approximately two percent (excluding the effects of acquisitions and foreign currency exchange), which includes selective increases in selling prices to mitigate inflationary cost increases.
 
Sales by segment and the year-over-year changes were as follows:
                                                         
                      2007 vs. 2006     2006 vs. 2005  
In thousands   2007     2006     2005     $ change     % change     $ change     % change  
   
 
Water
  $ 2,348,565     $ 2,155,225     $ 2,131,505     $ 193,340       9.0 %   $ 23,720       1.1 %
Technical Products
    1,050,133       999,244       815,074       50,889       5.1 %     184,170       22.6 %
 
 
Total
  $ 3,398,698     $ 3,154,469     $ 2,946,579     $ 244,229       7.7 %   $ 207,890       7.1 %
 
 
 
Water
The 9.0 percent increase in Water segment sales in 2007 from 2006 was primarily the result of:
 
•  an increase in sales volume driven by our February 2, 2007 acquisition of Jung Pump and our April 30, 2007 acquisition of Porous Media;
 
•  organic sales were up 2 percent for the full year 2007 (excluding acquisitions and foreign currency exchange), which included selective increases in selling prices to mitigate inflationary cost increases:
 
  •  continued growth in China and in other markets in Asia-Pacific as well as continued success in penetrating markets in Europe and the Middle East;
 
  •  higher second quarter sales of municipal pumps related to a large flood control project; and
 
  •  growth in commercial and industrial water markets.
 
These increases were partially offset by:
 
  •  a decline in sales of certain pump, pool and filtration products into North American residential markets and softness in residential pool construction markets; and
 
•  favorable foreign currency effects.
 
The 1.1 percent increase in Water segment sales in 2006 from 2005 was primarily the result of:
 
•  organic sales growth of approximately one percent (excluding foreign currency exchange), which includes selective increases in selling prices to mitigate inflationary cost increases;
 
  •  strong pump sales in our commercial markets;
 
  •  increased sales in Europe driven by higher pump and filtration sales;
 
  •  sales growth in emerging markets in Asia-Pacific;
 
  •  sales growth of filtration products in our foodservice, commercial, and industrial markets; and
 
•  favorable foreign currency effects.
 
These increases were partially offset by:
 
•  lower sales of pool and spa products due to softening of the U.S. residential housing market and inventory draw-downs by pool distribution customers to position themselves for the softening market.


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Technical Products
The 5.1 percent increase in Technical Products segment sales in 2007 from 2006 was primarily the result of:
 
•  organic sales which were up approximately 2 percent for the full year 2007 (excluding acquisitions and foreign currency exchange), which included selective increases in selling prices to mitigate inflationary cost increases;
 
  •  strong sales performance in Asia; and
 
  •  increased sales into electrical markets.
 
These increases were partially offset by:
 
  •  lower sales into North American electronics markets driven by contraction and consolidation in the telecommunication equipment industry which have delayed buying activity and by datacommunication projects reaching end-of-life; and
 
•  favorable foreign currency effects.
 
The 22.6 percent increase in Technical Products segment sales in 2006 from 2005 was primarily the result of:
 
•  an increase in sales volume due to our December 1, 2005 acquisition of the Thermal businesses;
 
•  organic sales growth of approximately six percent (excluding acquisitions and foreign currency exchange), which includes selective increases in selling prices to mitigate inflationary cost increases:
 
  •  increased sales in our commercial and industrial markets;
 
  •  increased sales in European test and measurement and telecom markets;
 
  •  higher sales in Asia driven by key OEM programs in China and stronger sales in the telecom and semiconductor markets in Japan; and
 
•  favorable foreign currency effects.
 
These increases were partially offset by:
 
•  lower sales to North American telecom businesses due to weaker markets conditions, customer consolidation and certain key projects reaching end-of-life; and
 
•  lower sales in data markets related to OEM projects that reached end-of-life or were transitioned to our Asian operations.
 
Gross profit
 
                                         
In thousands   2007     % of sales   2006     % of sales   2005     % of sales  
   
 
Gross profit
  $ 1,024,650     30.1%   $ 906,250     28.7%   $ 848,021       28.8 %
 
 
Percentage point change
          1.4 pts           (0.1) pts                
 
The 1.4 percentage point increase in gross profit as a percent of sales in 2007 from 2006 was primarily the result of:
 
•  savings generated from our PIMS initiatives including lean and supply management practices;
 
•  selective increases in selling prices in our Water and Technical Products Groups to mitigate inflationary cost increases; and
 
•  a decrease in costs related to capacity rationalization and market-related actions in 2007 compared to 2006.
 
These increases were partially offset by:
 
•  inflationary increases related to raw materials and labor; and


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•  higher cost as a result of a fair market value inventory step-up related to the Jung Pump and Porous Media acquisitions.
 
The 0.1 percentage point decrease in gross profit as a percent of sales in 2006 from 2005 was primarily the result of:
 
•  inflationary increases related to material, labor and freight costs;
 
•  increased reserves for inventory and warranty expenses in our Water Group due to the effects of the U.S. residential housing market downturn on the spa and bath markets and new pool starts, and also due to inventory reserves established for pump motors that we no longer expect to need;
 
•  lower sales of pool and spa products related to the U.S. residential housing market downturn; and
 
•  operating inefficiencies related to product moves and plant consolidations.
 
These decreases were partially offset by:
 
•  selective increases in selling prices in our Water and Technical Products Groups to mitigate inflationary cost increases;
 
•  savings generated from our PIMS initiatives including lean and supply management practices;
 
•  cost leverage from increased sales volume in our Technical Products Group; and
 
•  absence of start-up costs in new water facilities (incurred in 2005).
 
Selling, general and administrative (SG&A)
 
                                         
In thousands   2007     % of sales   2006     % of sales   2005     % of sales  
   
 
SG&A
  $ 587,865     17.3%   $ 537,877     17.1%   $ 478,370       16.2 %
 
 
Percentage point change
          0.2 pts           0.9 pts                
 
The 0.2 percentage point increase in SG&A expense as a percent of sales in 2007 from 2006 was primarily the result of:
 
•  higher selling and general expense to fund investments in future growth with emphasis on growth in the international markets, including personnel and business infrastructure investments;
 
•  proportionately higher SG&A expenses in the acquired Jung Pump and Porous Media businesses caused in part by amortization expense related to the intangible assets from those acquisitions; and
 
•  exit costs incurred in 2007 related to a previously announced 2001 French facility closure.
 
These increases were partially offset by:
 
•  a decrease in costs related to capacity rationalization and market-related actions in 2007 compared to 2006.
 
The 0.9 percentage point increase in SG&A expense as a percent of sales in 2006 from 2005 was primarily the result of:
 
•  higher selling, general and administrative expense to fund investments in future growth in our Water Group, including personnel and business infrastructure, with an emphasis on growth in our international markets; and
 
•  severance costs in our Water Group and at our corporate headquarters, and increased reserves for accounts receivable due to the effects of the U.S. residential housing market downturn on the spa and bath markets and new pool starts in our Water Group.
 
These increases were partially offset by:
 
•  cost leverage from our increase in sales volume in the Technical Products Group.


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Research and development (R&D)
 
                                         
In thousands   2007     % of sales   2006     % of sales   2005     % of sales  
   
 
R&D
  $ 58,810     1.7%   $ 58,055     1.8%   $ 46,042       1.6 %
 
 
Percentage point change
          (0.1) pts           0.2 pts                
 
The 0.1 percentage point decrease in R&D expense as a percent of sales in 2007 from 2006 was primarily the result of:
 
•  relatively flat R&D expense spending on higher volume.
 
The 0.2 percentage point increase in R&D expense as a percent of sales in 2006 from 2005 was primarily the result of:
 
•  additional investments related to new product development initiatives in our Water and Technical Products Groups; and
 
•  proportionately higher R&D spending in the acquired Thermal businesses.
 
Operating income
 
Water
 
                                         
In thousands   2007     % of sales   2006     % of sales   2005     % of sales  
   
 
Operating income
  $ 271,367     11.6%   $ 215,830     10.0%   $ 267,675       12.6 %
 
 
Percentage point change
          1.6 pts           (2.6) pts                
 
The 1.6 percentage point increase in Water segment operating income as a percent of net sales in 2007 from 2006 was primarily the result of:
 
•  selective increases in selling prices to mitigate inflationary cost increases;
 
•  savings generated from our PIMS initiatives including lean and supply management practices;
 
•  income generated by our February 2, 2007 acquisition of Jung Pump and our April 30, 2007 acquisition of Porous Media;
 
•  curtailment of long-term defined benefit pension and retiree medical plans; and
 
•  a decrease in costs related to capacity rationalization and market-related actions in 2007 compared to 2006.
 
These increases were partially offset by:
 
•  inflationary increases related to raw materials and labor;
 
•  a decline in sales of certain pump, pool and filtration products into North American residential markets;
 
•  amortization expense related to the intangible assets from the Jung Pump and Porous Media acquisitions; and
 
•  higher cost as a result of a fair market value inventory step-up related to the Jung Pump and Porous Media acquisitions.
 
The 2.6 percentage point decrease in Water segment operating income as a percent of net sales in 2006 from 2005 was primarily the result of:
 
•  inflationary increases related to material, labor, and freight costs;
 
•  lower sales of pool and spa products related to the U.S. residential housing market downturn;
 
•  planned investments in new products and new customers, reinforcing international talent, and implementing a unified business infrastructure in Europe;
 
•  unfavorable product mix;


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•  increased inventory, warranty, and accounts receivable reserves and severance costs due to the effects of the U.S. residential housing market downturn on the spa and bath markets and new pool starts; and
 
•  manufacturing inefficiencies resulting from plant and product line moves.
 
These decreases were partially offset by:
 
•  selective increases in selling prices to mitigate inflationary cost increases; and
 
•  savings realized from continued success of PIMS, including lean and supply management activities.
 
Technical Products
 
                                         
In thousands   2007     % of sales   2006     % of sales   2005     % of sales  
   
 
Operating income
  $ 153,586     14.6%   $ 148,905     14.9%   $ 109,229       13.4 %
 
 
Percentage point change
          (0.3) pts           1.5 pts                
 
The 0.3 percentage point decrease in Technical Products segment operating income as a percent of net sales in 2007 from 2006 was primarily the result of:
 
•  inflationary increases related to raw materials such as stainless steel and labor costs;
 
•  lower sales into North American electronics markets driven by contraction and consolidation in the telecommunication equipment industry which have delayed buying activity and by datacommunication projects reaching end-of-life; and
 
•  exit costs incurred in 2007 related to a previously announced 2001 French facility closure.
 
These decreases were partially offset by:
 
•  selective increases in selling prices to mitigate inflationary cost increases;
 
•  savings realized from the continued success of PIMS, including lean and supply management activities; and
 
•  increased sales in our electrical markets.
 
The 1.5 percentage point increase in Technical Products segment operating income as a percent of net sales in 2006 from 2005 was primarily the result of:
 
•  leverage gained on volume expansion through market share growth;
 
•  savings realized from the continued success of PIMS, including lean and supply management activities; and
 
•  selective increases in selling prices to mitigate inflationary cost increases.
 
These increases were partially offset by:
 
•  inflationary increases related to materials, labor and freight costs.
 
Net interest expense
 
                                                                 
In thousands   2007     2006     Difference     % change     2006     2005     Difference     % change  
   
 
Net interest expense
  $ 70,237     $ 51,881     $ 18,356       35.4 %   $ 51,881     $ 44,989     $ 6,892       15.3 %
 
 
 
The 35.4 percent increase in interest expense from continuing operations in 2007 from 2006 was primarily the result of:
 
•  an increase in outstanding debt primarily related to the Jung Pump and Porous Media acquisitions.
 
The 15.3 percent increase in interest expense from continuing operations in 2006 from 2005 was primarily the result of:
 
•  increases in interest rates;


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•  higher average outstanding debt in 2006 primarily as a result of the acquired Thermal businesses and an increase in inventory; and
 
•  incremental interest expense related to the payments made in connection with the final resolution of the net asset value dispute with The Black and Decker Corporation (“BDK”) in the first quarter of 2006.
 
These increases were partially offset by:
 
•  favorable adjustments to interest expense related to the favorable settlement of prior years’ federal tax returns in the second and third quarters of 2006.
 
Provision for income taxes
 
                         
In thousands   2007     2006     2005  
   
 
Income from continuing operations before income taxes
  $ 303,643     $ 255,469     $ 283,518  
Provision for income taxes
    93,154       71,702       98,469  
Effective tax rate
    30.7 %     28.1 %     34.7 %
 
The 2.6 percentage point increase in the tax rate in 2007 from 2006 was primarily the result of:
 
•  higher utilization of foreign tax credits in 2006; and
 
•  the favorable settlement in 2006 of prior years’ federal tax returns.
 
These increases were partially offset by:
 
•  a favorable adjustment in 2007 related to the measurement of deferred tax assets and liabilities to account for changes in German tax law enacted on August 17, 2007.
 
The 6.6 percentage point decrease in the tax rate in 2006 from 2005 was primarily the result of:
 
•  higher utilization of foreign tax credits in 2006;
 
•  the favorable settlement in 2006 of prior years’ federal tax returns; and
 
•  an unfavorable settlement in 2005 for a routine tax exam for prior years in Germany.
 
These decreases were partially offset by:
 
•  a favorable settlement in 2005 related to prior years’ federal tax returns; and
 
•  a favorable adjustment in 2005 related to the filing of our 2004 federal tax return.
 
We expect our full year effective tax rate in 2008 to be between 33.5% and 34.5%. 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, dividend payments and share repurchases 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 2007, we invested $488 million in acquisitions, repurchased $41 million of our stock, and paid $60 million in dividends.
 
We experience seasonal cash flows primarily due to seasonal demand in a number of markets within our Water Group. End-user demand for pool equipment follows warm weather trends and is at seasonal highs from April to August. The magnitude of the sales spike is partially mitigated by employing some advance sale “early buy” programs (generally including extended payment terms and/or additional discounts). Demand for residential and agricultural water systems is also impacted by weather patterns, particularly by heavy flooding and droughts.


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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
 
Days   2007     2006     2005  
   
 
Days of sales in accounts receivable
    53       54       54  
Days inventory on hand
    77       76       70  
Days in accounts payable
    54       56       56  
 
Operating activities
Cash provided by operating activities was $341.9 million in 2007, or $110.3 million higher compared with the same period in 2006. The increase in cash provided by operating activities was due primarily to working capital reductions during 2007 versus 2006 and higher net income. In the future, we expect our working capital ratios to improve as we continue to capitalize on our PIMS initiatives.
 
Cash provided by operating activities was $231.6 million in 2006, or $16.2 million lower compared with the same period in 2005. The decrease in cash provided by operating activities was due primarily to working capital increases related to increased inventory levels and decreases in various accruals. The increase in days inventory on hand as of December 31, 2006 compared to December 31, 2005 was attributable to increased inventory levels to support product moves and plant rationalizations, inventory to support product sourced from low cost countries, higher value of inventories due to rising raw material input costs, and due to the purchase of additional submersible pump motors for competitive reasons.
 
In December 2007 and 2006, we sold approximately $50 million and $30 million, respectively, of accounts receivable to a third-party financial institution to mitigate accounts receivable concentration risk because we did not offer or the customer did not take advantage of the early pay discounts. In compliance with SFAS 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 our Consolidated Balance Sheets and the proceeds are included in the cash flows from operating activities in our Consolidated Statements of Cash Flows. In 2007 and 2006, a loss in the amount of $1.2 million and $0.8 million related to the sale of accounts receivable is included in the line item Gain(loss) on sale of assets, net in our Consolidated Statements of Income.
 
Investing activities
Capital expenditures in 2007, 2006, and 2005 were $62.1 million, $51.1 million and $62.5 million, respectively. We anticipate capital expenditures for fiscal 2008 to be approximately $65 to $75 million, primarily for capacity expansions in our low cost country manufacturing facilities, new product development, and general maintenance capital.
 
On May 7, 2007, we acquired as part of our Technical Products Group the assets of Calmark Corporation (“Calmark”), a privately held business, for $28.5 million, including a cash payment of $29.3 million and transaction costs of $0.2 million, less cash acquired of $1.0 million. Calmark’s results of operations have been included in our consolidated financial statements since the date of acquisition. Calmark’s product portfolio includes enclosures, guides, card locks, retainers, extractors, card pullers and other products for the aerospace, medical, telecommunications and military market segments, among others. Goodwill recorded as part of the purchase price allocation was $11.8 million, all of which is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $14.0 million, including definite-lived intangibles, such as non-compete agreements, customer relationships and proprietary technology of $10.5 million with a weighted average amortization period of approximately 8 years. We continue to evaluate the purchase price allocation for the Calmark acquisition, including intangible assets, contingent liabilities and property, plant and equipment. We expect to revise the purchase price allocation as better information becomes available.
 
On April 30, 2007, we acquired as part of our Water Group all of the capital interests in Porous Media, two privately held filtration and separation technologies businesses, for $224.9 million, including a cash payment of $225.0 million and transaction costs of $0.4 million, less cash acquired of $0.5 million. Porous Media’s


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results of operations have been included in our consolidated financial statements since the date of acquisition. Porous Media brings strong technical ability to our Water Group, including engineering, material science, media development and application capabilities. Porous Media’s product portfolio includes high-performance filter media, membranes and related filtration products and purification systems for liquids, gases and solids for the general industrial, petrochemical, refining and healthcare market segments, among others. Goodwill recorded as part of the purchase price allocation was $128.1 million, all of which is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $73.8 million, including definite-lived intangibles, such as proprietary technology and customer relationships of $60.6 million with a weighted average amortization period of approximately 11 years. We continue to evaluate the purchase price allocation for the Porous Media acquisition, including intangible assets, contingent liabilities and property, plant and equipment. We expect to revise the purchase price allocation as better information becomes available.
 
On February 2, 2007, we acquired as part of our Water Group all the outstanding shares of capital stock of Jung Pump for $229.5 million, including a cash payment of $239.6 million and transaction costs of $1.3 million, less cash acquired of $11.4 million. Jung Pump’s results of operations have been included in our consolidated financial statements since the date of acquisition. Jung Pump is a leading German manufacturer of wastewater products for municipal and residential markets. Jung Pump brings us its strong application engineering expertise and a complementary product offering, including a new line of water re-use products, submersible wastewater and drainage pumps, wastewater disposal units and tanks. Jung Pump also brings to Pentair its well-established European presence, a state-of-the-art training facility in Germany and sales offices in Germany, Austria, France, Hungary, Poland and Slovakia. Goodwill recorded as part of the purchase price allocation was $123.4 million, of which approximately $53 million is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $135.7 million, including definite-lived intangibles, primarily customer relationships of $71.6 million with a weighted average amortization period of approximately 15 years.
 
On April 12, 2006, we acquired as part of our Water Group the assets of Geyer’s Manufacturing & Design Inc. and FTA Filtration, Inc. (together “Krystil Klear”), two privately-held companies, for $15.5 million in cash. Krystil Klear’s results of operations have been included in our consolidated financial statements since the date of acquisition. Krystil Klear expands our industrial filtration product offering to include a full range of steel and stainless steel tanks which house filtration solutions. Goodwill recorded as part of the purchase price allocation was $9.2 million, all of which is tax deductible.
 
During 2006, we completed several other small acquisitions totaling $14.2 million in cash and notes payable, adding to both our Water and Technical Products Groups. Total goodwill recorded as part of the purchase price allocations was $9.3 million, of which $3.1 million is tax deductible.
 
Effective after the close of business on October 2, 2004, we completed the sale of our former Tools Group to The Black & Decker Corporation (“BDK”). In January 2006, pursuant to the purchase agreement for the sale of our former Tools Group, we completed the repurchase of a manufacturing facility in Suzhou, China from BDK for approximately $5.7 million. We recorded no gain or loss on the repurchase. In March 2006, we completed an outstanding net asset value arbitration with BDK relating to the purchase price for the sale of our former Tools Group. The decision by the arbitrator constituted a final resolution of all disputes between BDK and us regarding the net asset value. We paid the final net asset value purchase price adjustment pursuant to the purchase agreement of $16.1 million plus interest of $1.1 million in March 2006, resulting in an incremental pre-tax loss on disposal of discontinued operations of $3.4 million, or $1.6 million net of tax. In the third quarter of 2006, we resolved a prior year tax item that resulted in a $1.4 million income tax benefit related to our former Tools Group.
 
During 2007, we made investments in and loans to certain joint ventures in the amount of $5.5 million.
 
Cash proceeds from the sale of property and equipment of $5.2 million in 2007 was primarily related to the sale of a facility for our Technical Products Group. Cash proceeds from the sale of property and equipment of $17.1 million in 2005 was primarily related to the sale of three facilities for our Water Group.


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On December 1, 2005, we acquired, as part of our Technical Products Group, the Thermal businesses from APW, Ltd. for $143.9 million, including a cash payment of $140.6 million and transaction costs of $3.3 million. These businesses provide thermal management solutions and integration services to the telecommunications, data communications, medical, and security markets. Final goodwill recorded as part of the purchase price allocation was $71.1 million, all of which is tax deductible. Final identifiable intangible assets acquired as part of the acquisition were $45.6 million, including definite-lived intangibles, such as proprietary technology and customer relationships, of $23.1 million with a weighted average amortization period of approximately 12 years.
 
On February 23, 2005, we acquired, as part of our Water Group, 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. Final goodwill recorded as part of the purchase price allocation was $7.2 million, all of which is tax deductible.
 
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 BDK.
 
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 established 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 $0.2 million from the escrow accounts which increased our gain from the sale. During 2006 we received $1.2 million from the escrow accounts which also 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.
 
Financing activities
Net cash provided by financing activities was $222.7 million in 2007 versus a cash use of $117.8 million and $43.8 million in 2006 and 2005, respectively. The increase in 2007 primarily relates to the additional borrowings to fund the Jung Pumpen and Porous Media acquisitions. Financing activities consisted primarily of proceeds from debt issuances and draw downs and repayments on our revolving credit facilities to fund our operations in the normal course of business, dividend payments, share repurchases, cash received from stock option exercises and tax benefits related to stock-based compensation.
 
In June 2007, we entered into an amended and restated multi-currency revolving credit facility (the “Credit Facility”). The Credit Facility creates an unsecured, committed revolving credit facility of up to $800 million, with multi-currency sub-facilities to support investment outside the U.S. The Credit Facility expires June 4, 2012. Borrowings under the Credit Facility will bear interest at the rate of LIBOR plus 0.50%. Interest rates and fees under 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, 2007, we had $106.0 million of commercial paper outstanding that matures within 71 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.
 
In May 2007, we entered into a Note Purchase Agreement with various institutional investors (the “Agreement”) for the sale of $300 million aggregate principal amount of our 5.87% Senior Notes (“Fixed Notes”) and $105 million aggregate principal amount of our Floating Rate Senior Notes (“Floating Notes” and with the Fixed Notes, the “Notes”). The Fixed Notes are due in May 2017. The Floating Notes are due in May 2012 and bear interest equal to the 3 month LIBOR plus 0.50%. The Agreement contains customary events of default.


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We used $250 million of the proceeds from the sale of the Notes to retire a $250 million 364-day Term Loan Agreement that we entered into in April 2007, which we used in part to pay the cash purchase price of our Porous Media acquisition which closed in April 2007.
 
We were in compliance with all debt covenants as of December 31, 2007.
 
In addition to the Credit Facility, we have $29.7 million of uncommitted credit facilities, under which we had drawn $13.5 million in borrowings as of December 31, 2007.
 
Our current credit ratings are as follows:
 
                 
    Long-Term Debt
    Current Rating
 
Rating Agency
  Rating     Outlook  
 
Standard & Poor’s
    BBB       Negative  
Moody’s
    Baa3       Stable  
 
On March 7, 2007, Standard & Poor’s Ratings Services revised its current rating outlook on us from stable to negative. At the same time, Standard & Poor’s affirmed its long-term debt rating of ’BBB’. Standard & Poor’s stated that the outlook revision reflects the additional leverage and stress on credit metrics that would result from the acquisition of Porous Media. The negative outlook indicates the rating could be lowered if financial policies become more aggressive or if operating results are weaker than expected.
 
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. The ratings outlook also 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.
 
As of December 31, 2007, our capital structure consisted of $1,061.0 million in total indebtedness and $1,910.9 million in shareholders’ equity. The ratio of debt-to-total capital at December 31, 2007 was 35.7%, compared with 30.8% at December 31, 2006. Our targeted debt-to-total capital ratio is 40% 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 2007 of $59.9 million, compared with $56.6 million in 2006 and $53.1 million in 2005. We anticipate continuing the practice of paying dividends on a quarterly basis.
 
During 2006, the Board of Directors authorized the repurchase of shares of our common stock up to a maximum dollar limit of $100 million. As of December 31, 2006, we had purchased 1,986,026 shares for $59.4 million pursuant to this authorization during 2006. In December 2006, the Board of Directors authorized the continuation of the repurchase program in 2007 with a maximum dollar limit of $40.6 million. This authorization expired on December 31, 2007. As of December 31, 2007 we repurchased an additional


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1,209,257 shares for $40.6 million pursuant to this plan. In December 2007, the Board of Directors authorized the repurchase of shares of our common stock up to a maximum dollar limit of $50 million starting in 2008. The authorization expires on December 31, 2008.
 
The following summarizes our significant contractual obligations that impact our liquidity:
 
                                                         
    Payments Due by Period  
                                  More than
       
In thousands   2008     2009     2010     2011     2012     5 Years     Total  
   
 
Long-term debt obligations
  $ 18,768     $ 251,176     $ 235     $ 123     $ 290,451     $ 500,238     $ 1,060,991  
Interest obligations on fixed-rate debt
    42,215       42,215       22,590       22,590       22,590       84,225       236,425  
Capital lease obligations
    244       275       182       121                   822  
Operating lease obligations, net of sublease rentals
    27,004       21,176       16,291       14,071       9,673       13,370       101,585  
Other long-term liabilities
    1,452       945       226       226       226             3,075  
 
 
Total contractual cash obligations, net
  $ 89,683     $ 315,787     $ 39,524     $ 37,131     $ 322,940     $ 597,833     $ 1,402,898  
 
 
 
In addition to the summary of significant contractual obligations, we will incur annual interest expense on outstanding variable rate debt. As of December 31, 2007, variable interest rate debt, including the effects of derivative financial instruments, was $202.4 million at a weighted average interest rate of 5.27%.
 
We expect to make contributions in the range of $20 million to $25 million to our pension plans in 2008. The 2008 expected contributions will equal or exceed our minimum funding requirements.
 
As of December 31, 2007, the gross liability for uncertain tax positions under FIN 48 is $23.9 million. We do not expect a significant payment related to these obligations to be made within the next twelve months. We are not able to provide a reasonably reliable estimate of the timing of future payments relating to the non-current FIN 48 obligations.
 
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. We have a long-term goal to consistently generate free cash flow that equals or exceeds 100% 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. 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  
In thousands   2007     2006     2005  
   
 
Cash flow provided by operating activities
  $ 341,880     $ 231,611     $ 247,858  
Capital expenditures
    (62,129 )     (51,078 )     (62,471 )
Proceeds from sale of property and equipment
    5,209       684       17,111  
 
 
Free cash flow
    284,960       181,217       202,498  
Net income
    210,927       183,731       185,049  
 
 
Conversion of net income
    135 %     99 %     109 %
 
 


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In 2008, our objective is to generate free cash flow that equals or exceeds 100% of net income.
 
Off-balance sheet arrangements
At December 31, 2007, we had no off-balance sheet financing arrangements.
 
COMMITMENTS AND CONTINGENCIES
Environmental
We have been named as defendants, targets, or potentially responsible parties (“PRP”) 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 in recent 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 of these businesses 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 prior years; to date our recorded accruals have been adequate.
 
In addition, there are ongoing environmental issues at a limited number of sites, including one site acquired in the acquisition of Essef Corporation in 1999, which relate to operations no longer carried out at the sites. We have established what we believe to be adequate accruals for remediation costs at these 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 the outcome of the matter 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, 2007 and 2006, our undiscounted reserves for such environmental liabilities were approximately $3.5 million and $5.6 million, respectively. 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, 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 primarily to secure our performance to third parties under self-insurance programs and certain legal matters. As of December 31, 2007 and 2006, the outstanding value of these instruments totaled $58.5 million and $59.6 million, respectively.
 
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 of the Notes to 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


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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 2007, 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 Notes to Consolidated Financial Statements. Changes to these assumptions will affect pension expense.
 
In December 2006, we adopted SFAS No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”). SFAS 158 requires that we recognize the overfunded or underfunded status of our defined benefit and retiree medical plans as an asset or liability in our 2006 year-end balance sheet, with changes in the funded status recognized through comprehensive income in the year in which they occur.
 
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 for our U.S. plans of 6.50% in 2007, 6.00% in 2006 and 5.75% in 2005. The discount rates on our foreign plans ranged from 2.00% to 5.25% in 2007, 2.00% to 5.15% in 2006 and 2.00% to 4.90% in 2005. There are no other known or anticipated changes in our discount rate assumption that will impact our pension expense in 2008.
 
Expected rate of return
Our expected rate of return on plan assets in 2007 equaled 8.5%, which remained unchanged from 2006 and 2005. The expected rate of return is designed to be a long-term assumption that may be subject to considerable


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year-to-year variance from actual returns. In developing the expected long-term rate of return, we considered our historical returns, with consideration given to forecasted economic conditions, our asset allocations, input from external consultants and broader longer-term market indices. In 2007, the pension plan assets yielded a return of 7.8%, compared to returns of 12.3% in 2006 and 4.2% in 2005. In 2007, our expected return on plan assets was higher than our actual return on plan assets, in 2006, our expected return on plan assets was lower than our actual return on plan assets and in 2005, our expected return on plan assets was higher 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 was primarily attributable to the fluctuations of our common stock during 2005 which approximates 10% of the plan assets. There are no known or anticipated changes in our return assumption that will impact our pension expense in 2008.
 
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.
 
See ITEM 8, Note 11 of the Notes to Consolidated Financial Statements for further information regarding pension plans.
 
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Market risk
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), short-term borrowing and interest rate swaps. The net market value of these financial instruments combined is referred to below as the net financial instrument position. As of December 31, 2007 and December 31, 2006, the net financial instrument position was a liability of $1,076.5 million and $753.6 million, respectively.
 
Interest rate risk
Our debt portfolio, including swap agreements, as of December 31, 2007 was primarily comprised of debt predominantly denominated in U.S. dollars (97%). This debt portfolio is comprised of 62% fixed-rate debt and 38% variable-rate debt, not 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 and August 2007, our debt portfolio is comprised of 81% fixed-rate debt and 19% 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, 2007, a 100 basis point increase or decrease in interest rates would result in a $2.0 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.


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ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
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, 2007. 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, 2007, the Company’s internal control over financial reporting was effective based on those criteria.
 
Our independent registered public accounting firm, Deloitte & Touche LLP, has issued an attestation report on the Company’s internal control over financial reporting for December 31, 2007. That attestation report is set forth immediately following the report of Deloitte & Touche LLP on the financial statements included herein.
 
     
Randall J. Hogan
Chairman and Chief Executive Officer
  John L. Stauch
Executive Vice President and Chief Financial Officer


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders of Pentair, Inc.:
 
We have audited the internal control over financial reporting of Pentair, Inc. and subsidiaries (the “Company”) as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. 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, included in the accompanying Managements Report on Internal Controls over Financial Reporting. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
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 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, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
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, 2007, of the Company, and our report dated February 25, 2008, expressed an unqualified opinion on those consolidated financial statements and financial statement schedule and included an explanatory paragraph relating to the Company’s changes in its method of accounting for uncertain tax positions in 2007.
 
sig
Minneapolis, Minnesota
February 25, 2008


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the 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, 2007 and 2006, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules 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, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
 
As discussed in Notes 1 and 10 to the consolidated financial statements, the Company changed its method of accounting for uncertain tax benefits in 2007 and as discussed in Notes 1 and 11 to the consolidated financial statements, the Company changed its method of accounting for defined benefit pension and postretirement benefit plans in 2006.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, 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 25, 2008, expressed an unqualified opinion on the Company’s internal control over financial reporting.
 
sig
Minneapolis, Minnesota
February 25, 2008


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Pentair, Inc. and Subsidiaries
 
Consolidated Statements of Income
 
                         
    Years ended December 31  
In thousands, except per-share data   2007     2006     2005  
   
 
Net sales
  $ 3,398,698     $ 3,154,469     $ 2,946,579  
Cost of goods sold
    2,374,048       2,248,219       2,098,558  
 
 
Gross profit
    1,024,650       906,250       848,021  
Selling, general and administrative
    587,865       537,877       478,370  
Research and development
    58,810       58,055       46,042  
 
 
Operating income
    377,975       310,318       323,609  
Gain (loss) on sale of assets, net
    (1,230 )     364       5,435  
Equity losses of unconsolidated subsidiary
    (2,865 )     (3,332 )     (537 )
Interest income
    1,657       745       576  
Interest expense
    71,894       52,626       45,565  
 
 
Income from continuing operations before income taxes
    303,643       255,469       283,518  
Provision for income taxes
    93,154       71,702       98,469  
 
 
Income from continuing operations
    210,489       183,767       185,049  
Gain (loss) on disposal of discontinued operations, net of tax
    438       (36 )      
 
 
Net income
  $ 210,927     $ 183,731     $ 185,049  
 
 
Earnings per common share
                       
Basic
                       
Continuing operations
  $ 2.13     $ 1.84     $ 1.84  
Discontinued operations
                 
 
 
Basic earnings per common share
  $ 2.13     $ 1.84     $ 1.84  
 
 
Diluted
                       
Continuing operations
  $ 2.10     $ 1.81     $ 1.80  
Discontinued operations
                 
 
 
Diluted earnings per common share
  $ 2.10     $ 1.81     $ 1.80  
 
 
Weighted average common shares outstanding
                       
Basic
    98,762       99,784       100,665  
Diluted
    100,205       101,371       102,618  
 
See accompanying notes to consolidated financial statements.


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Pentair, Inc. and Subsidiaries
 
Consolidated Balance Sheets
 
                 
    December 31  
In thousands, except share and per-share data   2007     2006  
   
 
ASSETS
Current assets
               
Cash and cash equivalents
  $ 70,795     $ 54,820  
Accounts and notes receivable, net of allowances of $28,565 and $34,254, respectively
    472,222       422,134  
Inventories
    407,127       398,857  
Deferred tax assets
    51,556       50,578  
Prepaid expenses and other current assets
    36,321       31,239  
 
 
Total current assets
    1,038,021       957,628  
Property, plant and equipment, net
    367,426       330,372  
Other assets
               
Goodwill
    2,021,526       1,718,771  
Intangibles, net
    491,403       287,011  
Other
    82,238       71,197  
 
 
Total other assets
    2,595,167       2,076,979  
 
 
Total assets
  $ 4,000,614     $ 3,364,979  
 
 
 
LIABLITIES AND SHAREHOLDERS’ EQUITY
Current liabilities
               
Short-term borrowings
  $ 13,586     $ 14,563  
Current maturities of long-term debt
    5,182       7,625  
Accounts payable
    231,643       206,286  
Employee compensation and benefits
    112,147       88,882  
Current pension and post-retirement benefits
    8,557       7,918  
Accrued product claims and warranties
    49,382       44,093  
Income taxes
    12,599       22,493  
Accrued rebates and sales incentives
    36,867       39,419  
Other current liabilities
    90,943       90,003  
 
 
Total current liabilities
    560,906       521,282  
Other liabilities
               
Long-term debt
    1,042,223       721,873  
Long-term income taxes payable
    21,306        
Pension and other retirement compensation
    161,042       207,676  
Post-retirement medical and other benefits
    37,147       47,842  
Deferred tax liabilities
    170,033       109,781  
Other non-current liabilities
    97,086       86,526  
 
 
Total liabilities
    2,089,743       1,694,980  
Commitments and contingencies
               
Shareholders’ equity
               
Common shares par value $0.162/3; 99,221,831 and 99,777,165 shares issued and outstanding, respectively
    16,537       16,629  
Additional paid-in capital
    476,242       488,540  
Retained earnings
    1,296,226       1,148,126  
Accumulated other comprehensive income
    121,866       16,704  
 
 
Total shareholders’ equity
    1,910,871       1,669,999  
 
 
Total liabilities and shareholders’ equity
  $ 4,000,614     $ 3,364,979  
 
 
 
See accompanying notes to consolidated financial statements.


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Pentair, Inc. and Subsidiaries
 
Consolidated Statements of Cash Flows
 
                         
    Years Ended December 31  
In thousands   2007     2006     2005  
   
 
Operating activities
                       
Net income
  $ 210,927     $ 183,731     $ 185,049  
Adjustments to reconcile net income to net cash provided by operating activities
                       
(Gain) loss on disposal of discontinued operations
    (438 )     36        
Equity losses of unconsolidated subsidiary
    2,865       3,332       537  
Depreciation
    58,948       56,899       56,565  
Amortization
    25,601       18,197       15,995  
Deferred income taxes
    (16,496 )     (11,085 )     5,898  
Stock compensation
    22,913       25,377       24,186  
Excess tax benefits from stock-based compensation
    (4,204 )     (3,043 )     (8,676 )
Gain on sale of investment, net
    (1,929 )     (364 )     (5,435 )
Changes in assets and liabilities, net of effects of business acquisitions and dispositions
                       
Accounts and notes receivable
    (16,777 )     15,873       (20,946 )
Inventories
    19,057       (39,354 )     (19,201 )
Prepaid expenses and other current assets
    2,504       (5,052 )     (120 )
Accounts payable
    18,134       (18,935 )     6,629  
Employee compensation and benefits
    4,129       (13,229 )     (21,394 )
Accrued product claims and warranties
    4,739       456       (1,099 )
Income taxes
    1,885       9,556       10,357  
Other current liabilities
    (2,947 )     (13,784 )     4,609  
Pension and post-retirement benefits
    6       19,398       16,512  
Other assets and liabilities
    12,963       3,554       (976 )
 
 
Net cash provided by continuing operations
    341,880       231,563       248,490  
Net cash provided by (used for) operating activities of discontinued operations
          48       (632 )
 
 
Net cash provided by operating activities
    341,880       231,611       247,858  
Investing activities
                       
Capital expenditures
    (62,129 )     (51,078 )     (62,471 )
Proceeds from sale of property and equipment
    5,209       684       17,111  
Acquisitions, net of cash acquired
    (487,561 )     (29,286 )     (150,534 )
Divestitures
          (24,007 )     (10,155 )
Proceeds from sale of investment
          1,153       23,835  
Other
    (5,544 )     (7,523 )     (2,071 )
 
 
Net cash used for investing activities
    (550,025 )     (110,057 )     (184,285 )
Financing activities
                       
Net short-term (repayments) borrowings
    (1,830 )     13,831        
Proceeds from long-term debt
    1,269,428       608,975       413,279  
Repayment of long-term debt
    (954,077 )     (631,755 )     (395,978 )
Debt issuance costs
    (1,876 )            
Excess tax benefits from stock-based compensation
    4,204       3,043       8,676  
Proceeds from exercise of stock options
    7,388       4,066       8,380  
Repurchases of common stock
    (40,641 )     (59,359 )     (25,000 )
Dividends paid
    (59,910 )     (56,583 )     (53,134 )
 
 
Net cash provided by (used for) financing activities
    222,686       (117,782 )     (43,777 )
Effect of exchange rate changes on cash
    1,434       2,548       (2,791 )
 
 
Change in cash and cash equivalents
    15,975       6,320       17,005  
Cash and cash equivalents, beginning of period
    54,820       48,500       31,495  
 
 
Cash and cash equivalents, end of period
  $ 70,795     $ 54,820     $ 48,500  
 
 
 
See accompanying notes to consolidated financial statements.


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Pentair, Inc. and Subsidiaries
 
Consolidated Statements of Changes in Shareholders’ Equity
 
                                                                 
                            Unearned
    Accumulated
             
                Additional
          non-vested
    other
             
    Common shares     paid-in
    Retained
    stock
    comprehensive
          Comprehensive
 
In thousands, except share and per-share data   Number     Amount     capital     earnings     compensation     income (loss)     Total     income  
   
 
Balance — December 31, 2004
    100,967,385     $ 16,828     $ 517,369     $ 889,063     $ (7,872 )   $ 32,406     $ 1,447,794          
         
         
Net income
                            185,049                       185,049     $ 185,049  
Change in cumulative translation adjustment
                                            (28,406 )     (28,406 )     (28,406 )
Adjustment in minimum pension liability, net of $3,645 tax benefit
                                            (5,702 )     (5,702 )     (5,702 )
Changes in market value of derivative financial instruments
                                            716       716       716  
                                                                 
Comprehensive income
                                                          $ 151,657  
                                                                 
Effect of accounting change (SFAS 123R)
                    (7,872 )             7,872                        
Tax benefit of stock compensation
                    10,707                               10,707          
Cash dividends — $0.52 per common share
                            (53,134 )                     (53,134 )        
Share repurchases
    (755,663 )     (126 )     (24,874 )                             (25,000 )        
Exercise of stock options, net of 549,150 shares tendered for payment
    747,282       125       1,371                               1,496          
Issuance of restricted shares, net of cancellations
    289,764       48       248                               296          
Amortization of restricted shares
                                                             
Shares surrendered by employees to pay taxes
    (46,531 )     (8 )     (1,920 )                             (1,928 )        
Stock compensation
                    23,722                               23,722          
         
         
Balance — December 31, 2005
    101,202,237     $ 16,867     $ 518,751     $ 1,020,978     $     $ (986 )   $ 1,555,610          
         
         
Net income
                            183,731                       183,731     $ 183,731  
Change in cumulative translation adjustment
                                            28,471       28,471       28,471  
Adjustment in minimum pension liability, net of $1,685 tax benefit
                                            1,513       1,513       1,513  
Changes in market value of derivative financial instruments
                                            657       657       657  
                                                                 
Comprehensive income
                                                          $ 214,372  
                                                                 
Adjustment to initially applu SFAS 158, net of $8,280 tax benefit
                                            (12,951 )     (12,951 )        
Tax benefit of stock compensation
                    3,338                               3,338          
Cash dividends — $0.56 per common share
                            (56,583 )                     (56,583 )        
Share repurchases
    (1,986,026 )     (332 )     (59,027 )                             (59,359 )        
Exercise of stock options, net of 183,866 shares tendered for payment
    310,963       52       2,846                               2,898          
Issuance of restricted shares, net of cancellations
    324,219       54       304                               358          
Amortization of restricted shares
                    10,677                               10,677          
Shares surrendered by employees to pay taxes
    (74,228 )     (12 )     (2,589 )                             (2,601 )        
Stock compensation
                    14,240                               14,240          
         
         
Balance — December 31, 2006
    99,777,165     $ 16,629     $ 488,540     $ 1,148,126     $     $ 16,704     $ 1,669,999          
         
         
Net income
                            210,927                       210,927     $ 210,927  
Change in cumulative translation adjustment
                                            72,901       72,901       72,901  
Adjustment in minimum pension liability, net of $23,784 tax
                                            37,201       37,201       37,201  
Changes in market value of derivative financial instruments
                                            (4,940 )     (4,940 )     (4,940 )
                                                                 
Comprehensive income
                                                          $ 316,089  
                                                                 
Adjustment to initially apply FIN 48
                            (2,917 )                     (2,917 )        
Tax benefit of stock compensation
                    5,654                               5,654          
Cash dividends — $0.60 per common share
                            (59,910 )                     (59,910 )        
Share repurchases
    (1,209,257 )     (202 )     (40,439 )                             (40,641 )        
Exercise of stock options, net of 342,870 shares tendered for payment
    491,618       83       4,348                               4,431          
Issuance of restricted shares, net of cancellations
    313,160       52       530                               582          
Amortization of restricted shares
                    9,256                               9,256          
Shares surrendered by employees to pay taxes
    (150,855 )     (25 )     (4,820 )                             (4,845 )        
Stock compensation
                    13,173                               13,173          
         
         
Balance — December 31, 2007
    99,221,831     $ 16,537     $ 476,242     $ 1,296,226     $     $ 121,866     $ 1,910,871          
         
         
 
See accompanying notes to consolidated financial statements.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements
 
1.   Summary of Significant Accounting Policies
Fiscal year
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% to 50% 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% 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.
 
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.
 
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.
 
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.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
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 our cooperative advertising programs, we agree to pay the customer a fixed percentage of sales as an allowance that may 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 or sales increase. 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.
 
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% of total net receivable balances as of December 31, 2007 and 2006, respectively.
 
In December 2007 and 2006, we sold approximately $50 million and $30 million, respectively, of accounts receivable to a third-party financial institution to mitigate accounts receivable concentration risk because we did not offer or the customer did not take advantage of the early pay discounts. In compliance with Statement


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
of Financial Accounting Standards (“SFAS’) 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 our Consolidated Balance Sheets and the proceeds are included in the cash flows from operating activities in our Consolidated Statements of Cash Flows. In 2007 and 2006, a loss in the amount of $1.2 million and $0.8 million related to the sale of accounts receivable is included in the line item Gain (loss) on sale of assets, net in our Consolidated Statements of Income.
 
Inventories
Inventories are stated at the lower of cost or market with substantially all costed using the first-in, first-out (“FIFO”) method and with an insignificant amount of inventories located outside the United States costed using a moving average method which approximates FIFO.
 
Change in accounting principle
Prior to October 1, 2006, inventories in the United States were costed using both the last-in, first-out (“LIFO”) and FIFO methods, and inventories outside the United States were costed primarily using the FIFO methods with smaller amounts of inventory using the LIFO and moving average methods. Effective that date, we elected to change our method of accounting to cost all inventories previously costed using the LIFO method using the FIFO method to better reflect the current value of inventory in the balance sheet and to provide a better matching of revenue and expense in the consolidated statements of income. In addition, this change results in a more unified method of inventory costing. The result of the accounting change was immaterial to our consolidated financial statements for all periods presented. Accordingly, the cumulative effect of the accounting change was recorded in the consolidated statement of income in the fourth quarter of 2006, rather than retrospectively applied to the prior period consolidated financial statements.
 
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:
 
         
    Years  
 
Land improvements
    5 to 20  
Buildings and leasehold improvements
    5 to 50  
Machinery and equipment
    3 to 15  
 
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.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
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 2007, we completed our annual impairment test of goodwill and determined there was no impairment.
 
Our primary identifiable intangible assets include trade marks and trade names, brand names, patents, non-compete agreements, proprietary technology, and customer relationships. Under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, 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 2007, 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. Our 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 and projected results of operations 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
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement 109 (“FIN 48”). FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file a tax return in a particular jurisdiction. FIN 48 is effective for fiscal years beginning after December 15, 2006 and we adopted it on January 1, 2007. The adoption of FIN 48 increased total liabilities by $2.9 million and decreased total shareholders’ equity by $2.9 million. The adoption of FIN 48 had no impact on our consolidated results of operations.
 
We use 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 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


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
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 current liabilities and Other non-current liabilities in the Consolidated Balance Sheets.
 
Insurance subsidiary
We insure certain 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. As of December 31, 2007 and 2006, reserves for policy claims were $61.4 million ($10.0 million included in Accrued product claims and warranties and $51.4 million included in Other non-current liabilities) and $54.3 million ($10.0 million included in Accrued product claims and warranties and $44.3 million included in Other non-current liabilities), respectively.
 
Stock-based compensation
We account for the fair value recognition provisions of SFAS No. 123R (revised 2004), Share Based Payment, (“SFAS 123R”) which revised SFAS No. 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.
 
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). The estimated fair value of each 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 are 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 Statements 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.
 
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.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
Basic and diluted earnings per share were calculated using the following:
 
                         
In thousands, except per-share data   2007     2006     2005  
   
 
Earnings per common share — basic
                       
Continuing operations
  $ 210,489     $ 183,767     $ 185,049  
Discontinued operations
    438       (36 )      
 
 
Net income
  $ 210,927     $ 183,731     $ 185,049  
 
 
Continuing operations
  $ 2.13     $ 1.84     $ 1.84  
Discontinued operations
                 
 
 
Basic earnings per common share
  $ 2.13     $ 1.84     $ 1.84  
 
 
Earnings per common share — diluted
                       
Continuing operations
  $ 210,489     $ 183,767     $ 185,049  
Discontinued operations
    438       (36 )      
 
 
Net income
  $ 210,927     $ 183,731     $ 185,049  
 
 
Continuing operations
  $ 2.10     $ 1.81     $ 1.80  
Discontinued operations
                 
 
 
Diluted earnings per common share
  $ 2.10     $ 1.81     $ 1.80  
 
 
Weighted average common shares outstanding — basic
    98,762       99,784       100,665  
Dilutive impact of stock-based compensation
    1,443       1,587       1,953  
 
 
Weighted average common shares outstanding — diluted
    100,205       101,371       102,618  
 
 
Stock options excluded from the calculation of diluted earnings per share because the exercise price was greater than the average market price of the common shares
    2,841       3,089       1,040  
 
Derivative financial instruments
We recognize all derivatives, including those embedded in other contracts, as either assets or liabilities at fair value in our Consolidated Balance Sheets. 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 No. 133, Accounting for Derivative Instruments and Hedge Activities, 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.


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Pentair, Inc. and Subsidiaries
 
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
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS 157 is not expected to have a material impact on our consolidated results of operations and financial condition.
 
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS 159 is not expected to have a material impact on our consolidated results of operations and financial condition.
 
In March 2007, the FASB ratified the Emerging Issues Task Force (“EITF”) Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share Based Payment Awards (“EITF 06-11”). EITF 06-11 requires companies to recognize the income tax benefit realized from dividends or dividend equivalents that are charged to retained earnings and paid to employees for nonvested equity-classified employee share-based awards as an increase to additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after September 15, 2007. The adoption of EITF 06-11 is not expected to have a material impact on our consolidated results of operations and financial condition.
 
In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R replaces SFAS No. 141. SFAS 141R retains the purchase method of accounting for acquisitions, but requires a number of changes, including changes in the way assets and liabilities are recognized in the purchase accounting. SFAS 141R also changes the recognition of assets acquired and liabilities assumed arising from contingencies, requires the capitalization of in-process research and development at fair value, and requires the expensing of acquisition-related costs as incurred. SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We are currently evaluating the impact of adopting SFAS 141R on our consolidated results of operations and financial condition.
 
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB 51 (“SFAS 160”). SFAS 160 changes the accounting and reporting for minority interests. Minority interests will be recharacterized as noncontrolling interests and will be reported as a component of equity separate from the parent’s equity, and purchases or sales of equity interests that do not result in a change in control will be accounted for as equity transactions. In addition, net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement and upon a loss of control, the interest sold, as well as any interest retained, will be recorded at fair value with any gain or loss recognized in earnings. SFAS 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, except for the presentation and disclosure requirements, which will apply retrospectively. We are currently evaluating the impact of adopting SFAS 160 on our consolidated results of operations and financial condition.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
Reclassifications
The 2006 and 2005 Consolidated Statements of Income and the Consolidated Statements of Cash Flows has been reclassified from the 2006 and 2005 presentation to conform to the 2007 presentation. The reclassification reflects the presentation of Equity losses of unconsolidated subsidiary of $3.3 million and $0.5 million, respectively, as a separate line item below Operating income in the Consolidated Statements of Income rather than as a component of Selling, general and administrative, and as a separate line in the Adjustments to reconcile net income to net cash provided by operating activities in the Consolidated Statements of Cash Flows, rather than as a component of Other assets and liabilities. This reclassification corrects the previous presentation and was not material to the financial statements. It did not affect Net income within the Consolidated Statements of Income or net cash provided by (used in) operating, investing or financing activities within the Consolidated Statements of Cash Flows.
 
2.   Acquisitions
On May 7, 2007, we acquired as part of our Technical Products Group the assets of Calmark Corporation (“Calmark”), a privately held business, for $28.5 million, including a cash payment of $29.3 million and transaction costs of $0.2 million, less cash acquired of $1.0 million. Calmark’s results of operations have been included in our consolidated financial statements since the date of acquisition. Calmark’s product portfolio includes enclosures, guides, card locks, retainers, extractors, card pullers and other products for the aerospace, medical, telecommunications and military market segments, among others. Goodwill recorded as part of the purchase price allocation was $11.8 million, all of which is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $14.0 million, including definite-lived intangibles, such as non-compete agreements, customer relationships and proprietary technology of $10.5 million with a weighted average amortization period of approximately 8 years. We continue to evaluate the purchase price allocation for the Calmark acquisition, including intangible assets, contingent liabilities and property, plant and equipment. We expect to revise the purchase price allocation as better information becomes available.
 
On April 30, 2007, we acquired as part of our Water Group all of the capital interests in Porous Media Corporation and Porous Media, Ltd. (together, “Porous Media”), two privately held filtration and separation technologies businesses, for $224.9 million, including a cash payment of $225.0 million and transaction costs of $0.4 million, less cash acquired of $0.5 million. Porous Media’s results of operations have been included in our consolidated financial statements since the date of acquisition. Porous Media brings strong technical ability to our Water Group, including engineering, material science, media development and application capabilities. Porous Media’s product portfolio includes high-performance filter media, membranes and related filtration products and purification systems for liquids, gases and solids for the general industrial, petrochemical, refining and healthcare market segments, among others. Goodwill recorded as part of the purchase price allocation was $128.1 million, all of which is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $73.8 million, including definite-lived intangibles, such as proprietary technology and customer relationships of $60.6 million with a weighted average amortization period of approximately 11 years. We continue to evaluate the purchase price allocation for the Porous Media acquisition, including intangible assets, contingent liabilities and property, plant and equipment. We expect to revise the purchase price allocation as better information becomes available.
 
On February 2, 2007, we acquired as part of our Water Group all the outstanding shares of capital stock of Jung Pumpen GmbH (“Jung Pump”) for $229.5 million, including a cash payment of $239.6 million and transaction costs of $1.3 million, less cash acquired of $11.4 million. Jung Pump’s results of operations have been included in our consolidated financial statements since the date of acquisition. Jung Pump is a leading German manufacturer of wastewater products for municipal and residential markets. Jung Pump brings us its strong application engineering expertise and a complementary product offering, including a new line of water re-use products, submersible wastewater and drainage pumps, wastewater disposal units and tanks. Jung Pump also brings to Pentair its well-established European presence, a state-of-the-art training facility in Germany


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
and sales offices in Germany, Austria, France, Hungary, Poland and Slovakia. Goodwill recorded as part of the purchase price allocation was $123.4 million, of which approximately $53 million is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $135.7 million, including definite-lived intangibles, primarily customer relationships of $71.6 million with a weighted average amortization period of approximately 15 years.
 
On April 12, 2006, we acquired as part of our Water Group the assets of Geyer’s Manufacturing & Design Inc. and FTA Filtration, Inc. (together “Krystil Klear”), two privately-held companies, for $15.5 million in cash. Krystil Klear’s results of operations have been included in our consolidated financial statements since the date of acquisition. Krystil Klear expands our industrial filtration product offering to include a full range of steel and stainless steel tanks which house filtration solutions. Goodwill recorded as part of the purchase price allocation was $9.2 million, all of which is tax deductible.
 
During 2006, we completed several other small acquisitions totaling $14.2 million in cash and notes payable, adding to both our Water and Technical Products Groups. Total goodwill recorded as part of the purchase price allocations was $9.3 million, of which $3.1 million is tax deductible.
 
On December 1, 2005, we acquired, as part of our Technical Products Group, the McLean Thermal Management, Aspen Motion Technologies, and Electronic Solutions businesses from APW, Ltd. (collectively, “Thermal”) for $143.9 million, including a cash payment of $140.6 million and transaction costs of $3.3 million. These businesses provide thermal management solutions and integration services to the telecommunications, data communications, medical, and security markets. Final goodwill recorded as part of the purchase price allocation was $71.1 million, all of which is tax deductible. Final identifiable intangible assets acquired as part of the acquisition were $45.6 million, including definite-lived intangibles, such as proprietary technology and customer relationships, of $23.1 million with a weighted average amortization period of approximately 12 years.
 
On February 23, 2005, we acquired, as part of our Water Group, 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. Final goodwill recorded as part of the purchase price allocation was $7.2 million, all of which is tax deductible.
 
The following pro forma consolidated condensed financial results of operations for the years ended December 31, 2007, and 2006 are presented as if the acquisitions had been completed at the beginning of each period presented:
 
                 
    Years Ended December 31  
In thousands, except per-share data   2007     2006  
   
 
Pro forma net sales from continuing operations
  $ 3,428,601     $ 3,314,976  
Pro forma net income from continuing operations
    210,173       184,931  
Pro forma net income
    210,611       184,895  
Pro forma earnings per common share — continuing operations
               
Basic
  $ 2.13     $ 1.85  
Diluted
  $ 2.10     $ 1.82  
Weighted average common shares outstanding
               
Basic
    98,762       99,784  
Diluted
    100,205       101,371  
 
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


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
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 on October 2, 2004, we completed the sale of our former Tools Group to The Black & Decker Corporation (“BDK”). In January 2006, pursuant to the purchase agreement for the sale of our former Tools Group, we completed the repurchase of a manufacturing facility in Suzhou, China from BDK for approximately $5.7 million. We recorded no gain or loss on the repurchase. In March 2006, we completed an outstanding net asset value arbitration with BDK relating to the purchase price for the sale of our former Tools Group. The decision by the arbitrator constituted a final resolution of all disputes between BDK and us regarding the net asset value. We paid the final net asset value purchase price adjustment pursuant to the purchase agreement of $16.1 million plus interest of $1.1 million in March 2006, resulting in an incremental pre-tax loss on disposal of discontinued operations of $3.4 million or $1.6 million net of tax. In the third quarter of 2006, we resolved a prior year tax item that resulted in a $1.4 million income tax benefit related to our former Tools Group.
 
In 2001, we completed the sale of our former Service Equipment businesses (Century Mfg. Co. /Lincoln Automotive Company) to Clore Automotive, LLC. In the fourth quarter of 2003, we reported an additional loss from discontinued operations of $2.9 million related to exiting the remaining two facilities. In March 2006, we exited a leased facility from our former Service Equipment business resulting in a net cash outflow of $2.2 million and an immaterial gain from disposition.
 
Operating results of the discontinued operations 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.
 
                         
In thousands   2007     2006     2005  
   
 
Gain (loss) on disposal of discontinued operations before income taxes
  $ 762     $ (3,621 )   $ (4,197 )
Income tax (benefit) expense
    324       (3,585 )     (4,197 )
 
 
Gain (loss) on disposal of discontinued operations, net of tax
  $ 438     $ (36 )   $  
 
 
 
We recorded a pretax gain on the disposal of discontinued operations of $0.8 million as of December 31, 2007 and pre-tax losses on the disposal of discontinued operations of $3.6 million and $4.2 million as of December 31, 2006 and 2005 respectively. The 2007 gain was primarily due to the decrease of accruals as we settled certain obligations. The 2006 loss was primarily due to an unfavorable arbitration ruling resulting in a purchase price adjustment associated with the sale of our former Tools Group. The additional 2005 loss relates to increased reserve requirements for product recalls and contingent purchase price adjustments associated with the sale of our former Tools Group. Income tax expense of $0.3 was recorded for the year ended December 31, 2007 and income tax benefits of $3.6 million and $4.2 million were recorded for the years ended December 31, 2006 and 2005, respectively. The effective tax rate for discontinued operations in 2007 differs from the statutory rate primarily due to the settlement of prior period tax returns. The effective tax rate for discontinued operations in 2006 differs from the statutory rate primarily due to the reversal of prior years’ tax reserves and research and development tax credits. 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.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
4.   Goodwill and Other Identifiable Intangible Assets
 
The changes in the carrying amount of goodwill for the year ended December 31, 2007 by segment is as follows:
 
                                 
                Foreign Currency
    December 31,
 
In thousands   December 31, 2006     Acqusitions     Translation     2007  
   
 
Water
  $ 1,449,460     $ 253,380     $ 26,193     $ 1,729,033  
Technical Products
    269,311       11,634       11,548       292,493  
 
 
Consolidated Total
  $ 1,718,771     $ 265,014     $ 37,741     $ 2,021,526  
 
 
 
The acquired goodwill in the Water Group is related primarily to our acquisitions of Jung Pump and Porous Media acquisitions during 2007. The acquired goodwill in the Technical Products Group is related primarily to our acquisition of Calmark during 2007.
 
                                 
                Foreign Currency
    December 31,
 
In thousands   December 31, 2005     Acqusitions     Translation     2006  
   
 
Water
  $ 1,433,280     $ 5,357     $ 10,823     $ 1,449,460  
Technical Products
    284,927       (22,253 )     6,637       269,311  
 
 
Consolidated Total
  $ 1,718,207     $ (16,896 )   $ 17,460     $ 1,718,771  
 
 
 
The acquired goodwill in the Water Group is related primarily to our acquisition of Krystil Klear during 2006. The acquired goodwill in the Technical Products Group is related primarily to a purchase price allocation adjustment of our December 2005 Thermal acquisition and one small acquisition during 2006.
 
The detail of acquired intangible assets consisted of the following:
 
                                                 
    2007     2006  
    Gross
                Gross
             
    Carrying
    Accumulated
          Carrying
    Accumulated
       
In thousands   Amount     Amortization     Net     Amount     Amortization     Net  
   
 
Finite-life intangible assets
                                               
Patents
  $ 15,457     $ (7,904 )   $ 7,553     $ 15,433     $ (6,001 )   $ 9,432  
Non-compete agreements
    4,922       (4,110 )     812       4,343       (3,091 )     1,252  
Proprietary technology
    59,944       (12,564 )     47,380       45,755       (8,240 )     37,515  
Customer relationships
    238,712       (30,378 )     208,334       110,616       (15,924 )     94,692  
 
 
Total finite-life intangible assets
  $ 319,035     $ (54,956 )   $ 264,079     $ 176,147     $ (33,256 )   $ 142,891  
Indefinite-life intangible assets
                                               
Brand names
  $ 227,324     $     $ 227,324     $ 144,120     $     $ 144,120  
 
 
Total intangibles, net
  $ 546,359     $ (54,956 )   $ 491,403     $ 320,267     $ (33,256 )   $ 287,011  
 
 
 
Intangible asset amortization expense in 2007, 2006, and 2005 was $21.8 million, $13.2 million, and $11.7 million, respectively.
 
The estimated future amortization expense for identifiable intangible assets during the next five years is as follows:
 
                                         
In thousands   2008     2009     2010     2011     2012  
   
 
Estimated amortization expense
  $ 22,365     $ 21,831     $ 21,158     $ 21,031     $ 20,004  


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
5.   Supplemental Balance Sheet Information
 
                 
In thousands   2007     2006  
 
 
 
Inventories
               
Raw materials and supplies
  $ 199,330     $ 186,508  
Work-in-process
    51,807       55,141  
Finished goods
    155,990       157,208  
 
 
Total inventories
  $ 407,127     $ 398,857  
 
 
Property, plant and equipment
               
Land and land improvements
  $ 35,038     $ 28,989  
Buildings and leasehold improvements
    211,079       181,335  
Machinery and equipment
    558,424       521,245  
Construction in progress
    30,737       38,312  
 
 
Total property, plant and equipment
    835,278       769,881  
Less accumulated depreciation and amortization
    467,852       439,509  
 
 
Property, plant and equipment, net
  $ 367,426     $ 330,372  
 
 
 
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% 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 established 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. During 2006 we received $1.2 million from the escrow accounts which also increased our gain from the sale. 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.
 
Equity method investments
We have a 50% investment in FARADYNE Motors LLC (“FARADYNE”), 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 in and loans to FARADYNE were $8.7 million and $5.4 million at December 31, 2007 and December 31, 2006, respectively, which is net of our proportionate share of the results of their operations.
 
6.   Supplemental Cash Flow Information
 
The following table summarizes supplemental cash flow information:
 
                         
In thousands   2007     2006     2005  
 
 
 
Interest payments
  $ 68,034     $ 52,957     $ 44,403  
Income tax payments
    98,798       77,225       79,414  


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
7.   Accumulated Other Comprehensive Income (Loss)
Components of accumulated other comprehensive income (loss) consist of the following:
 
                         
In thousands   2007     2006     2005  
   
 
Minimum pension liability adjustments, net of tax
  $ 8,229     $ (28,972 )   $ (17,534 )
Foreign currency translation adjustments
    117,417       44,516       16,045  
Market value of derivative financial instruments, net of tax
    (3,780 )     1,160       503  
 
 
Accumulated other comprehensive income (loss)
  $ 121,866     $ 16,704     $ (986 )
 
 
 
In 2007, the minimum pension liability adjustment decreased by $37.2 million compared to the prior year primarily due to the increase in the discount rate and the curtailments of certain pension plans and retiree medical benefits. In 2006, the minimum pension liability adjustment increased compared to the prior year primarily due to the adoption of SFAS 158, as noted in Note 11. The net foreign currency translation gain in 2007 and 2006 of $72.9 million and $28.5 million, respectively, was primarily the result of the weakening of the U.S. dollar against the euro. Changes in the market value of derivative financial instruments were impacted primarily by the 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.
 
8.   Debt
 
Debt and the average interest rates on debt outstanding as of December 31 are summarized as follows:
 
                                 
    Average
                   
    interest rate
                   
    December 31,
    Maturity
    December 31
    December 31
 
In thousands   2007     (Year)     2007     2006  
   
 
Commercial paper, maturing within 71 days
    5.39 %           $ 105,990     $ 208,882  
Revolving credit facilities
    5.31 %     2012       76,722       25,000  
Private placement — fixed rate
    5.65 %     2013-17       400,000       135,000  
Private placement — floating rate
    5.54 %     2012-13       205,000       100,000  
Senior notes
    7.85 %     2009       250,000       250,000  
Other
    4.49 %     2008-16       20,792       21,972  
 
 
Total contractual debt obligations
                    1,058,504       740,854  
Fair value of outstanding swaps
                    2,487       3,207  
 
 
Total debt, including current portion per balance sheet
                    1,060,991       744,061  
Less: Current maturities
                    (5,182 )     (7,625 )
Short-term borrowings
                    (13,586 )     (14,563 )
 
 
Long-term debt
                  $ 1,042,223     $ 721,873  
 
 
 
In June 2007, we entered into an amended and restated multi-currency revolving credit facility (the “Credit Facility”). The Credit Facility creates an unsecured, committed revolving credit facility of up to $800 million, with multi-currency sub-facilities to support investments outside the U.S. The Credit Facility expires June 4, 2012. Borrowings under the Credit Facility will bear interest at the rate of LIBOR plus 0.50%. Interest rates and fees under 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, 2007, we had $106.0 million of commercial paper outstanding that matures within 71 days.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
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.
 
In addition to the Credit Facility, we have $29.7 million of uncommitted credit facilities, under which we had $13.5 million outstanding as of December 31, 2007.
 
In May 2007, we entered into a Note Purchase Agreement with various institutional investors (the “Agreement”) for the sale of $300 million aggregate principal amount of our 5.87% Senior Notes (“Fixed Notes”) and $105 million aggregate principal amount of our Floating Rate Senior Notes (“Floating Notes” and with the Fixed Notes, the “Notes”). The Fixed Notes are due in May 2017. The Floating Notes are due in May 2012 and bear interest equal to the 3 month LIBOR plus 0.50%. The Agreement contains customary events of default.
 
We used $250 million of the proceeds from the sale of the Notes to retire the $250 million 364-day Term Loan Agreement that we entered into in April 2007, which we used in part to pay the cash purchase price of our Porous Media acquisition which closed in April 2007.
 
We were in compliance with all debt covenants as of December 31, 2007.
 
Debt outstanding at December 31, 2007, matures on a calendar year basis as follows:
 
                                                         
In thousands   2008     2009     2010     2011     2012     Thereafter     Total  
   
 
Contractual debt obligation maturities
  $ 17,555     $ 250,254     $ 187     $ 75     $ 290,403     $ 500,030     $ 1,058,504  
Other maturities
    1,213       922       48       48       48       208       2,487  
 
 
Total maturities
  $ 18,768     $ 251,176     $ 235     $ 123     $ 290,451     $ 500,238     $ 1,060,991  
 
 
 
9.   Derivative and Financial Instruments
 
Cash-flow hedges
In August 2007, we entered into a $105 million interest rate swap agreement with a major financial institution to exchange variable rate interest payment obligations for a fixed rate obligation without the exchange of the underlying principle amounts in order to manage interest rate exposures. The effective date of the swap was August 30, 2007. The swap agreement has a fixed interest rate of 4.89% and expires in May 2012. The fixed interest rate of 4.89% plus the .50% interest rate spread over LIBOR results in an effective fixed interest rate of 5.39%. The fair value of the swap was a liability of $3.7 million at December 31, 2007 and is recorded in Other non-current liabilities.
 
In September 2005, we entered into a $100 million interest rate swap agreement with several major financial institutions to exchange variable rate interest payment obligations for fixed rate obligations without the exchange of the underlying principle amounts in order to manage interest rate exposures. The effective date of the fixed rate swap was April 25, 2006. The swap agreement has a fixed interest rate of 4.68% and expires in July 2013. The fixed interest rate of 4.68% plus the .60% interest rate spread over LIBOR, results in an effective fixed interest rate of 5.28%. The fair value of the swap was a liability of $2.5 million and an asset $1.9 million at December 31, 2007 and 2006, respectively and is recorded in Other non-current liabilities and Other assets, respectively.
 
The variable to fixed interest rate swaps are designated as and are effective as cash-flow hedges. The fair value of these swaps are recorded as assets or liabilities on the Consolidated Balance Sheets, with changes in their fair value included in Accumulated 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. No hedging relationships were de-designated during 2007.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
In anticipation of issuing new debt in the second quarter of 2007 and to partially hedge the risk of future increases to the treasury rate, we entered into an agreement on March 30, 2007 to lock in existing ten-year rates on $200 million. The treasury rate was fixed at 4.64% and the agreement was settled on May 3, 2007. The treasury rate lock agreement was designated as and was effective as a cash-flow hedge. The treasury rate lock agreement was settled at an interest rate of 4.67% and the corresponding settlement benefit of $0.5 million is included in OCI in our Consolidated Balance Sheet and is recognized in earnings over the life of the related debt.
 
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:
 
                                 
    2007     2006  
    Recorded
    Fair
    Recorded
    Fair
 
In thousands   amount     value     amount     value  
   
 
Total debt, including current portion
                               
Variable rate
  $ 407,398     $ 407,398     $ 347,920     $ 347,920  
Fixed rate
    651,106       662,906       392,934       403,807  
 
 
Total
  $ 1,058,504     $ 1,070,304     $ 740,854     $ 751,727  
 
 
Derivative financial instruments
                               
Market value of variable to fixed interest rate swap (liability) asset
  $ (6,198 )   $ (6,198 )   $ 1,901     $ 1,901  
 
 
 
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 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; 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:
 
                         
In thousands   2007     2006     2005  
   
 
United States
  $ 224,120     $ 205,049     $ 219,556  
International
    79,523       50,420       63,962  
 
 
Income from continuing operations before taxes
  $ 303,643     $ 255,469     $ 283,518  
 
 


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
The provision for income taxes for continuing operations consisted of the following:
 
                         
In thousands   2007     2006     2005  
   
 
Currently payable
                       
Federal
  $ 68,846     $ 51,834     $ 59,355  
State
    9,552       9,998       7,369  
International
    19,820       14,273       23,796  
 
 
Total current taxes
    98,218       76,105       90,520  
Deferred
                       
Federal and state
    3,610       (8,063 )     5,837  
International
    (8,674 )     3,660       2,112  
 
 
Total deferred taxes
    (5,064 )     (4,403 )     7,949  
 
 
Total provision for income taxes
  $ 93,154     $ 71,702     $ 98,469  
 
 
 
Reconciliation of the U.S. statutory income tax rate to our effective tax rate for continuing operations follows:
 
                         
Percentages   2007     2006     2005  
   
 
U.S. statutory income tax rate
    35.0       35.0       35.0  
State income taxes, net of federal tax benefit
    2.6       2.5       2.3  
Tax effect of stock-based compensation
    0.3       0.4       0.6  
Tax effect of international operations
    (5.2 )     (8.2 )     (1.2 )
Tax credits
    (0.8 )     (1.1 )     (1.5 )
Domestic manufacturing deduction
    (1.3 )     (0.8 )     (0.5 )
ESOP dividend benefit
    (0.2 )     (0.3 )     (0.3 )
All other, net
    0.3       0.6       0.3  
 
 
Effective tax rate on continuing operations
    30.7       28.1       34.7  
 
 
 
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).
 
We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we recorded an adjustment that decreased retained earnings by $2.9 million.
 
Subsequent to the adjustment to retained earnings of $2.9 million, our total liability for gross unrecognized tax benefits as of January 1, 2007, the date of adoption of FIN 48, was $16.9 million. If recognized, $15.0 million would affect our effective tax rate. Included in the total liability for unrecognized tax benefits of $16.9 million at the date of adoption of FIN 48 was $2.5 million related to discontinued operations. If recognized, $1.8 million would affect the effective tax rate for discontinued operations.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
Reconciliation of the beginning and ending gross unrecognized tax benefits follows:
 
         
In thousands      
   
 
Gross unrecognized tax benefits upon adoption on January 1, 2007
  $ 16,923  
Gross increases for tax positons in prior periods
    4,476  
Gross decreases for tax positions in prior periods
    (305 )
Gross increases based on tax positions related to the current year
    3,617  
Reductions for settlements and payments
    (832 )
Reductions due to statute expiration
     
 
 
Gross unrecognized tax benefits at December 31, 2007
  $ 23,879  
 
 
 
Included in the $23.9 million of total gross unrecognized tax benefits as of December 31, 2007 was $21.2 million of tax benefits that, if recognized, would impact the effective tax rate. It is reasonably possible that the gross unrecognized tax benefits as of December 31, 2007 may decrease by a range of $0 to $4.4 million during the next twelve months primarily as a result of the resolution of federal, state and foreign examinations and the expiration of various statutes of limitations.
 
We record penalties and interest related to unrecognized tax benefits in Provision for income taxes and Net interest expense, respectively, which is consistent with our past practices. As of January 1, 2007, we had recorded approximately $0.3 million for the possible payment of penalties and $1.5 million related to the possible payment of interest. During 2007 we recognized additional interest expense of $1.9 million. As of December 31, 2007, we had recorded approximately $0.3 million for the possible payment of penalties and $3.0 million related to the possible payment of interest.
 
During 2007, our effective tax rate was impacted by a favorable adjustment related to the measurement of deferred tax assets and liabilities to account for the changes in German tax law enacted on August 17, 2007.
 
During 2006, our effective tax rate was impacted by favorable resolution of prior years’ federal tax returns and higher utilization of foreign tax credits.
 
During 2005, our effective tax rate was impacted by R&D tax credits, and favorable resolution of prior years’ federal tax returns. Our effective tax rate was also impacted favorably by tax deductions for profits associated with qualified domestic production activities. These favorable items were offset by an unfavorable settlement for a routine German tax examination related to prior years as well as the tax impact of the adoption of SFAS 123R.
 
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, 2007, approximately $139.0 million of unremitted earnings attributable to international subsidiaries were considered to be indefinitely invested. It is not practicable to estimate the amount of tax that might be payable if such earnings were to be remitted. Foreign tax credits would be available to reduce or eliminate the resulting United States income tax liability.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
The tax effects of the major items recorded as deferred tax assets and liabilities are as follows:
 
                                 
    2007 Deferred Tax     2006 Deferred Tax  
In thousands   Assets     Liabilities     Assets     Liabilities  
   
 
Accounts receivable allowances
  $ 3,508     $     $ 5,984     $  
Inventory valuation
    2,954             1,864        
Accelerated depreciation/amortization
          16,205             20,116  
Accrued product claims and warranties
    38,736             36,940        
Employee benefit accruals
    87,645             111,046        
Goodwill and other intangibles
          177,611             163,256  
Other, net
          46,819             31,665  
 
 
Total deferred taxes
  $ 132,843     $ 240,635     $ 155,834     $ 215,037  
 
 
Net deferred tax liability
          $ (107,792 )           $ (59,203 )
                                 
 
Other Long-Term Assets includes a deferred tax asset of $10.7 million, reflected above in other, related to a foreign tax credit carryover from the tax period ended December 31, 2006. This foreign tax credit is eligible for carryforward until the tax period ending December 31, 2016.
 
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 2003 with no material adjustments. The IRS has also completed a survey of our 2004 U.S. federal income tax return with no material findings. In connection with the completion of the 2002 to 2003 federal income tax audit and the 2004 survey, we recognized benefits of $8.0 million and $1.8 million in our second and third quarter 2006 income statements, respectively. We were notified during February, 2008 that the IRS will be initiating an exam of our 2005 and 2006 federal tax returns. 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 $27.0 million and $9.1 million were available for carryforward at December 31, 2007 and 2006, respectively. A valuation allowance reflected above in other, of $2.4 million and $1.6 million exists for deferred income tax benefits related to the non-U.S. loss carryforwards available that may not be realized as of December 31, 2007 and 2006, 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. The non-U.S. operating losses are subject to varying expiration periods and will begin to expire in 2009. State tax losses of $69.0 million and $64.4 million were available for carryforward at December 31, 2007 and 2006, respectively. A valuation allowance reflected above in other, of $2.4 million and $2.6 million exists for deferred income tax benefits related to the carryforwards available at December 31, 2007 and December 31, 2006, respectively. Certain state tax losses will expire in 2008, while others are subject to carryforward periods of up to twenty years.
 
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.


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Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
On December 31, 2006, we adopted SFAS 158 which requires that we recognize the overfunded or underfunded status of our defined benefit and retiree medical plans as an asset or liability in our 2006 year-end Consolidated Balance Sheets, with changes in the funded status recognized through other comprehensive income, net of tax.
 
In 2007, 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 pension curtailment gain of $5.5 million related to the announcement that we will be freezing certain pension plans as of December 31, 2017. Also, we recognized a curtailment gain of $4.1 million related to the termination of certain post-retirement health care benefits.
 
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  
In thousands   2007     2006     2007     2006  
   
 
Change in benefit obligation
                               
Benefit obligation beginning of year
  $ 563,895     $ 542,104     $ 51,577     $ 57,566  
Service cost
    17,457       18,411       585       736  
Interest cost
    31,584       29,676       2,983       3,195  
Amendments
    76                    
Benefits curtailed
    (16,323 )           (4,126 )      
Actuarial gain
    (44,069 )     (10,473 )     (6,639 )     (6,345 )
Translation loss
    7,700       8,057              
Benefits paid
    (25,672 )     (23,880 )     (3,544 )     (3,575 )
 
 
Benefit obligation end of year
  $ 534,648     $ 563,895     $ 40,836     $ 51,577  
 
 
Change in plan assets
                               
Fair value of plan assets beginning of year
  $ 373,229     $ 351,656     $     $  
Actual return on plan assets
    27,286       40,173              
Asset transfer — divestiture
          (99 )            
Company contributions
    13,000       4,308       3,544       3,575  
Translation gain
    194       1,071              
Benefits paid
    (25,672 )     (23,880 )     (3,544 )     (3,575 )
 
 
Fair value of plan assets end of year
  $ 388,037     $ 373,229     $     $  
 
 
Funded status
                               
Plan assets less than benefit obligation
  $ (146,611 )   $ (190,666 )   $ (40,836 )   $ (51,577 )
 
 
Net amount recognized
  $ (146,611 )   $ (190,666 )   $ (40,836 )   $ (51,577 )
 
 
 
Of the $146.6 million underfunding at December 31, 2007, $113.9 million relates to foreign pension plans and our supplemental executive retirement plans which are not commonly funded.


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Table of Contents

 
Pentair, Inc. and Subsidiaries
 
Notes to consolidated financial statements — (continued)
 
Amounts recognized in the Consolidated Balance Sheets are as follows:
 
                                 
    Pension benefits     Post-retirement  
In thousands   2007     2006     2007     2006  
   
 
Noncurrent assets
  $ 154     $ 2,458     $     $  
Current liabilities
    (4,578 )     (4,183 )     (3,689 )     (3,735 )
Noncurrent liabilities
    (142,187 )     (188,941 )     (37,147 )     (47,842 )
 
 
Net amount recognized
  $ (146,611 )   $ (190,666 )   $ (40,836 )   $ (51,577 )
 
 
 
The accumulated benefit obligation for all defined benefit plans was $482.7 million and $490.4 million at December 31, 2007, and 2006, respectively.
 
Information for pension plans with an accumulated benefit obligation or projected benefit obligation in excess of plan assets are as follows:
 
                 
In thousands   2007     2006  
   
 
Pension plans with an accumulated benefit obligation in excess of plan assets:
               
Fair value of plan assets
  $ 90,449     $ 365,615  
Accumulated benefit obligation
    198,108       485,204  
Pension plans with a projected benefit obligation in excess of plan assets:
               
Fair value of plan assets
  $ 371,297     $ 365,615  
Projected benefit obligation
    518,062       558,738  
 
Components of net periodic benefit cost are as follows:
 
                                                 
    Pension benefits     Post-retirement  
In thousands   2007     2006     2005     2007     2006     2005  
   
 
Service cost
  $ 17,457     $ 18,411     $ 16,809     $ 585     $ 735     $ 850  
Interest cost
    31,584       29,676