Edgar Filing: PENTAIR LTD

Form 10-K Amendment No. 1

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K/A

Amendment No. 1

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

For the Fiscal Year Ended December 31, 2012

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

Commission file number 001-11625

Pentair Ltd.

(Exact name of Registrant as specified in its charter)


Switzerland		98-1050812
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification number)

Freier Platz 10, 8200 Schaffhausen, Switzerland
(Address of principal executive offices)

Registrant’s telephone number, including area code: 41-52-630-48-00

Securities registered pursuant to Section 12(b) of the Act:


Title of each class		Name of each exchange on which registered
Common Shares, CHF 0.50 par value		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 ¨

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 ¨ 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 ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit to post such files). Yes þ No ¨

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. ¨

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 the 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 ¨	Non-accelerated filer ¨	Smaller reporting company ¨
		(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 ¨ 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 $38.28 per share as reported on the New York Stock Exchange on June 29, 2012 (the last business day of Registrant’s most recently completed second quarter): $3,624,092,524

The number of shares outstanding of Registrant’s only class of common stock on December 31, 2012 was 206,137,460.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Registrant’s definitive proxy statement for its annual meeting to be held on April 29, 2013, are incorporated by reference in this Form 10-K in response to Part III, ITEM 10, 11, 12, 13 and 14.

EXPLANATORY NOTE

The sole purpose of this Amendment No. 1 on Form 10-K/A (“Form 10-K/A”) to the Annual Report on Form 10-K of Pentair Ltd. for the year ended December 31, 2012, originally filed with the Securities and Exchange Commission on February 26, 2013 (“Form 10-K”), is to amend Item 8 of the Form 10-K to revise the Reports of Independent Registered Public Accounting Firm on pages 56 and 57 to include the name and signatures of Deloitte & Touche LLP, which were inadvertently omitted when the Form 10-K was originally filed.

Except as described above, no other changes have been made to the Form 10-K. This Form 10-K/A has not been updated for events occurring after the filing of the Form 10-K and no attempt has been made in this Form 10-K/A to modify or update other disclosures as presented in the original filing of the Form 10-K.

ITEM

8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Pentair Ltd. 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, 2012. 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, 2012, the Company’s internal control over financial reporting was effective based on those criteria.

Management has excluded from its assessment the internal control over financial reporting at Tyco Flow Control International Ltd. (“Flow Control”), which we merged with on September 28, 2012 and whose financial statements constitute 60 percent of total assets and 20 percent of total revenues in the consolidated financial statements as of and for the year ended December 31, 2012.

Our independent registered public accounting firm, Deloitte & Touche LLP, has issued an attestation report on the Company’s internal control over financial reporting as of December 31, 2012. That attestation report is set forth immediately following this management report.


Randall J. Hogan		John L. Stauch
Chairman and Chief Executive Officer		Executive Vice President and Chief Financial Officer

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Pentair Ltd.

We have audited the internal control over financial reporting of Pentair Ltd. and subsidiaries (the “Company”) as of December 31, 2012, 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 Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. As described in Management’s Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Tyco Flow Control International Ltd. (“Flow Control”), which was acquired on September 28, 2012 and whose financial statements constitute 60 percent of total assets and 20 percent of total revenues on the consolidated financial statements as of and for the year ended December 31, 2012. Accordingly, our audit did not include the internal control over financial reporting at Flow Control.

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, 2012, 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, 2012 of the Company and our report dated February 26, 2013 expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding changes in certain of the Company’s methods of accounting for defined benefit pension and other postretirement benefit costs.

LOGO

Minneapolis, Minnesota

February 26, 2013

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Pentair Ltd.

We have audited the accompanying consolidated balance sheets of Pentair Ltd. and subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations and comprehensive income (loss), changes in equity, and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pentair Ltd. and subsidiaries at December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

As discussed in Note 3 to the consolidated financial statements, the Company has elected to change its method of accounting for defined benefit pension and other post-retirement benefit plan costs in 2012. Such changes are reflected in the accompanying consolidated balance sheet as of December 31, 2012 and 2011, and the related consolidated statements of operations and comprehensive income (loss), changes in equity and cash flows for each of the three years in the period ended December 31, 2012.

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, 2012, 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 26, 2013 expressed an unqualified opinion on the Company’s internal control over financial reporting.

LOGO

Minneapolis, Minnesota

February 26, 2013

Pentair Ltd. and Subsidiaries

Consolidated Statements of Operations and Comprehensive Income (Loss)


	Years ended December 31
In thousands, except per-share data	2012			2011			2010
Net sales	$	4,416,146		$	3,456,686		$	3,030,773
Cost of goods sold		3,146,554			2,382,964			2,100,133


Gross profit		1,269,592			1,073,722			930,640
Selling, general and administrative		1,158,436			694,841			550,501
Research and development		93,557			78,158			67,156
Impairment of trade names and goodwill		60,718			200,520			—


Operating income (loss)		(43,119	)		100,203			312,983
Other (income) expense
Loss on early extinguishment of debt		75,367			—			—
Equity income of unconsolidated subsidiaries		(2,156	)		(1,898	)		(2,108	)
Interest income		(2,902	)		(1,432	)		(1,263	)
Interest expense		70,537			60,267			37,379


Income (loss) from continuing operations before income taxes and noncontrolling interest		(183,965	)		43,266			278,975
Provision (benefit) for income taxes		(79,353	)		46,417			88,943


Income (loss) from continuing operations		(104,612	)		(3,151	)		190,032
Loss on disposal of discontinued operations, net of tax		—			—			(626	)


Net income (loss) before noncontrolling interest		(104,612	)		(3,151	)		189,406
Noncontrolling interest		2,574			4,299			4,493


Net income (loss) attributable to Pentair Ltd.	$	(107,186	)	$	(7,450	)	$	184,913


Net income (loss) from continuing operations attributable to Pentair Ltd.	$	(107,186	)	$	(7,450	)	$	185,539



Comprehensive income (loss), net of tax
Net income (loss) before noncontrolling interest	$	(104,612	)	$	(3,151	)	$	189,406
Changes in cumulative translation adjustment		35,830			(93,706	)		(32,706	)
Amortization of pension and other post-retirement prior service cost and transition obligation		(253	)		(11	)		153
Changes in market value of derivative financial instruments		(3,630	)		4,375			310


Total comprehensive income (loss)		(72,665	)		(92,493	)		157,163
Less: Comprehensive income (loss) attributable to noncontrolling interest		3,988			2,184			2,274


Comprehensive income (loss) attributable to Pentair Ltd.	$	(76,653	)	$	(94,677	)	$	154,889



Earnings (loss) per common share attributable to Pentair Ltd.
*Basic*
Continuing operations	$	(0.84	)	$	(0.08	)	$	1.89
Discontinued operations		—			—			(0.01	)


Basic earnings (loss) per common share	$	(0.84	)	$	(0.08	)	$	1.88



*Diluted*
Continuing operations	$	(0.84	)	$	(0.08	)	$	1.87
Discontinued operations		—			—			(0.01	)


Diluted earnings (loss) per common share	$	(0.84	)	$	(0.08	)	$	1.86



Weighted average common shares outstanding
Basic		127,368			98,233			98,037
Diluted		127,368			98,233			99,294

Dividends paid per common share	$	0.88		$	0.80		$	0.76

See accompanying notes to consolidated financial statements.

Pentair Ltd. and Subsidiaries

Consolidated Balance Sheets


	December 31
In thousands, except share and per-share data	2012			2011
Assets
Current assets
Cash and cash equivalents	$	261,341		$	50,077
Accounts and notes receivable, net of allowances of $37,455 and $39,111, respectively		1,292,648			569,204
Inventories		1,380,271			449,863
Other current assets		326,108			168,691


Total current assets		3,260,368			1,237,835

Property, plant and equipment, net		1,224,488			387,525

Other assets
Goodwill		4,894,512			2,273,918
Intangibles, net		1,909,656			592,285
Other non-current assets		506,287			94,750


Total other assets		7,310,455			2,960,953


Total assets	$	11,795,311		$	4,586,313



Liabilities and Equity
Current liabilities
Current maturities of long-term debt and short-term borrowings	$	3,096		$	4,862
Accounts payable		569,596			294,858
Employee compensation and benefits		295,067			118,413
Other current liabilities		670,162			223,708


Total current liabilities		1,537,921			641,841

Other liabilities
Long-term debt		2,454,278			1,304,225
Pension and other post-retirement compensation and benefits		378,066			280,389
Deferred tax liabilities		488,102			188,957
Other non-current liabilities		453,587			123,509


Total liabilities		5,311,954			2,538,921

Equity

Common shares CHF 0.50 par value, 213,000,000 authorized and issued at December 31, 2012; 250,000,000 shares authorized at December 31, 2011 and 98,622,564 shares issued and outstanding at December 31, 2011		113,454			47,526
Common shares held in treasury, 6,862,540 shares at December 31, 2012		(315,519	)		—
Capital contribution reserve		5,283,835			457,754
Retained earnings		1,292,288			1,465,780
Accumulated other comprehensive income (loss)		(7,198	)		(37,731	)



Shareholders’ equity attributable to Pentair Ltd.		6,366,860			1,933,329
Noncontrolling interest		116,497			114,063


Total equity		6,483,357			2,047,392


Total liabilities and equity	$	11,795,311		$	4,586,313

See accompanying notes to consolidated financial statements.

Pentair Ltd. and Subsidiaries

Consolidated Statements of Cash Flows


	Years ended December 31
In thousands	2012			2011			2010
Operating activities
Net income (loss) before noncontrolling interest	$	(104,612	)	$	(3,151	)	$	189,406
Adjustments to reconcile net income (loss) before noncontrolling interest to net cash provided by (used for) operating activities
Loss on disposal of discontinued operations		—			—			626
Equity income of unconsolidated subsidiaries		(2,156	)		(1,898	)		(2,108	)
Depreciation		87,835			66,235			57,995
Amortization		75,957			41,897			26,184
Deferred income taxes		(146,896	)		(5,583	)		29,453
Share-based compensation		35,847			19,489			21,468
Impairment of trade names and goodwill		60,718			200,520			—
Loss on early extinguishment of debt		75,367			—			—
Excess tax benefits from share-based compensation		(4,976	)		(3,310	)		(2,686	)
Pension and other post-retirement expense		167,536			84,345			34,098
Pension and other post-retirement contributions		(238,014	)		(40,294	)		(52,992	)
Loss (gain) on sale of assets		(2,276	)		933			466
Changes in assets and liabilities, net of effects of business acquisitions
Accounts and notes receivable		55,720			1,348			(62,344	)
Inventories		125,099			18,263			(44,495	)
Other current assets		(6,696	)		10,032			2,777
Accounts payable		(61,990	)		(24,330	)		55,321
Employee compensation and benefits		(81,313	)		(20,486	)		27,252
Other current liabilities		27,178			(7,954	)		(795	)
Other non-current assets and liabilities		5,632			(15,830	)		(9,250	)


Net cash provided by (used for) operating activities		67,960			320,226			270,376
Investing activities
Capital expenditures		(94,532	)		(73,348	)		(59,523	)
Proceeds from sale of property and equipment		5,508			1,310			358
Acquisitions, net of cash acquired		470,459			(733,105	)		—
Other		(5,858	)		(2,943	)		(1,148	)


Net cash provided by (used for) investing activities		375,577			(808,086	)		(60,313	)
Financing activities
Net short-term borrowings		(3,700	)		(1,239	)		2,728
Proceeds from long-term debt		1,536,146			1,421,602			703,641
Repayment of long-term debt		(1,305,339	)		(832,147	)		(804,713	)
Debt issuance costs		(9,704	)		(8,973	)		(50	)
Debt extinguishment costs		(74,752	)		—			—
Excess tax benefits from share-based compensation		4,976			3,310			2,686
Shares issued to employees, net of shares withheld		68,177			13,322			9,941
Repurchases of common shares		(334,159	)		(12,785	)		(24,712	)
Dividends paid		(112,397	)		(79,537	)		(75,465	)
Distribution to noncontrolling interest		(1,554	)		—			(4,647	)


Net cash provided by (used for) financing activities		(232,306	)		503,553			(190,591	)
Effect of exchange rate changes on cash and cash equivalents		33			(11,672	)		(6,812	)


Change in cash and cash equivalents		211,264			4,021			12,660
Cash and cash equivalents, beginning of year		50,077			46,056			33,396


Cash and cash equivalents, end of year	$	261,341		$	50,077		$	46,056

See accompanying notes to consolidated financial statements.

Pentair Ltd. and Subsidiaries

Consolidated Statements of Changes in Equity


In thousands, except share	Common shares						Treasury shares				Capital contribution			Retained			Accumulated other comprehensive			Total			Non- controlling
and per-share data	Number			Amount			Number		Amount		reserve			earnings			income (loss)			Pentair Ltd.			interest			Total
Balance - December 31, 2009		98,655,506		$	47,530			—	$	—	$	441,719		$	1,443,319		$	79,520		$	2,012,088		$	114,252		$	2,126,340
Net income		—			—			—		—		—			184,913			—			184,913			4,493			189,406

Change in cumulative translation adjustment		—			—			—		—		—			—			(30,487	)		(30,487	)		(2,219	)		(32,706	)

Amortization of pension and other post-retirement prior service cost and transition obligation, net of $111 tax		—			—			—		—		—			—			153			153			—			153

Changes in market value of derivative financial instruments, net of $229 tax		—			—			—		—		—			—			310			310			—			310

Tax benefit of share-based compensation		—			—			—		—		2,171			—			—			2,171			—			2,171
Dividends declared		—			—			—		—		—			(75,465	)		—			(75,465	)		—			(75,465	)
Distribution to noncontrolling interest		—			—			—		—		—			—			—			—			(4,647	)		(4,647	)
Share repurchase		(726,777	)		(350	)		—		—		(24,362	)		—			—			(24,712	)		—			(24,712	)

Exercise of options, net of 27,177 shares tendered for payment		651,331			314			—		—		14,612			—			—			14,926			—			14,926

Issuance of restricted shares, net of cancellations		(4,122	)		(2	)		—		—		708			—			—			706			—			706

Amortization of restricted shares		—			—			—		—		3,538			—			—			3,538			—			3,538

Shares surrendered by employees to pay taxes		(166,746	)		(80	)		—		—		(5,611	)		—			—			(5,691	)		—			(5,691	)

Share-based compensation		—			—			—		—		10,703			—			—			10,703			—			10,703


Balance - December 31, 2010		98,409,192		$	47,412			—	$	—	$	443,478		$	1,552,767		$	49,496		$	2,093,153		$	111,879		$	2,205,032


Net income (loss)		—			—			—		—		—			(7,450	)		—			(7,450	)		4,299			(3,151	)

Change in cumulative translation adjustment		—			—			—		—		—			—			(91,591	)		(91,591	)		(2,115	)		(93,706	)

Amortization of pension and other post-retirement prior service cost, net of $7 tax		—			—			—		—		—			—			(11	)		(11	)		—			(11	)

Changes in market value of derivative financial instruments, net of $2,884 tax		—			—			—		—		—			—			4,375			4,375			—			4,375

Tax benefit of share-based compensation		—			—			—		—		3,868			—			—			3,868			—			3,868

Dividends declared		—			—			—		—		—			(79,537	)		—			(79,537	)		—			(79,537	)

Share repurchase		(397,126	)		(211	)		—		—		(12,574	)		—			—			(12,785	)		—			(12,785	)

Exercise of options, net of 182,270 shares tendered for payment		657,616			350			—		—		14,358			—			—			14,708			—			14,708

Issuance of restricted shares, net of cancellations		28,603			15			—		—		1,460			—			—			1,475			—			1,475

Amortization of restricted shares		—			—			—		—		1,006			—			—			1,006			—			1,006

Shares surrendered by employees to pay taxes		(75,721	)		(40	)		—		—		(2,758	)		—			—			(2,798	)		—			(2,798	)
Share-based compensation		—			—			—		—		8,916			—			—			8,916			—			8,916


Balance - December 31, 2011		98,622,564		$	47,526			—	$	—	$	457,754		$	1,465,780		$	(37,731	)	$	1,933,329		$	114,063		$	2,047,392


In thousands, except share	Common shares						Treasury shares						Capital contribution			Retained			Accumulated other comprehensive			Total			Non- controlling
and per-share data	Number			Amount			Number			Amount			reserve			earnings			income (loss)			Pentair Ltd.			interest			Total
Net income (loss)		—			—			—			—			—			(107,186	)		—			(107,186	)		2,574			(104,612	)

Change in cumulative translation adjustment		—			—			—			—			—			—			34,416			34,416			1,414			35,830

Amortization of pension and other post-retirement prior service cost, net of $161 tax		—			—			—			—			—			—			(253	)		(253	)		—			(253	)

Changes in market value of derivative financial instruments, net of $3,661 tax		—			—			—			—			—			—			(3,630	)		(3,630	)		—			(3,630	)

Tax benefit of share-based compensation		—			—			—			—			5,555						—			5,555			—			5,555
Dividends declared		—			—			—			—			(141,058	)		(66,306	)		—			(207,364	)		—			(207,364	)
Distribution to noncontrolling interest		—			—			—			—			—			—			—			—			(1,554	)		(1,554	)
Issuance of shares related to the Merger		113,611,537			65,521			(2,712,603	)		(119,626	)		4,977,249			—			—			4,923,144			—			4,923,144
Share repurchase		—			—			(7,291,078	)		(334,159	)		—			—			—			(334,159	)		—			(334,159	)
Exercise of options, net of 45,123 shares tendered for payment		669,361			356			2,319,367			97,549			(7,833	)		—			—			90,072			—			90,072
Issuance of restricted shares, net of cancellations		168,936			90			1,254,449			59,798			(40,904	)		—			—			18,984			—			18,984
Amortization of restricted shares		—			—			—			—			24,209			—			—			24,209			—			24,209
Shares surrendered by employees to pay taxes		(72,398	)		(39	)		(432,675	)		(19,081	)		(2,775	)		—			—			(21,895	)		—			(21,895	)
Share-based compensation		—			—			—			—			11,638			—			—			11,638			—			11,638


Balance - December 31, 2012		213,000,000		$	113,454			(6,862,540	)	$	(315,519	)	$	5,283,835		$	1,292,288		$	(7,198	)	$	6,366,860		$	116,497		$	6,483,357

See accompanying notes to consolidated financial statements.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Background and Nature of Operations

Pentair Ltd., formerly known as Tyco Flow Control International Ltd. (as used prior to the Merger (as defined below), “Flow Control”), is a company organized under the laws of Switzerland. In these notes, the terms “the Company,” “Pentair,” “us,” “we” or “our” refer to Pentair Ltd. and its consolidated subsidiaries. Our business took its current form on September 28, 2012 as a result of a spin-off of Flow Control from its parent, Tyco International Ltd. (“Tyco”), and a reverse acquisition involving Pentair, Inc.

Prior to the spin-off, Tyco engaged in an internal restructuring whereby it transferred to Flow Control certain assets related to the flow control business of Tyco, and Flow Control assumed from Tyco certain liabilities related to the flow control business of Tyco. On September 28, 2012 prior to the Merger (as defined below), Tyco effected a spin-off of Flow Control through the pro-rata distribution of 100% of the outstanding common shares of Flow Control to Tyco’s shareholders (the “Distribution”), resulting in the distribution of 110,898,934 of our common shares to Tyco’s shareholders. Immediately following the Distribution, an indirect, wholly-owned subsidiary of ours merged with and into Pentair, Inc., with Pentair, Inc. surviving as an indirect, wholly-owned subsidiary of ours (the “Merger”). At the effective time of the Merger, each Pentair, Inc. common share was converted into the right to receive one of our common shares, resulting in 99,388,463 of our common shares being issued to Pentair, Inc. shareholders. The Merger is intended to be tax-free for U.S. federal income tax purposes. After the Merger, our common shares are traded on the New York Stock Exchange under the symbol PNR. Tyco equity-based awards held by Flow Control employees and certain Tyco employees and directors outstanding prior to the completion of the Distribution were converted in connection with the Distribution into equity-based awards with respect to our common shares and were assumed by us. Pentair, Inc. equity-based awards outstanding prior to the completion of the Merger were converted upon completion of the Merger into equity-based awards with respect to our common shares and were assumed by us.

The Merger was accounted for as a reverse acquisition under the purchase method of accounting with Pentair, Inc. treated as the acquirer, reflecting the control maintained by the executive management and board of directors of Pentair, Inc. after the Merger. As such, on the acquisition date of September 28, 2012, the assets and liabilities of Flow Control have been assessed at fair value and the assets and liabilities of Pentair, Inc. are carried over at historical cost. For periods prior to September 28, 2012, the Consolidated Statements of Operations and Comprehensive Income (Loss) and Consolidated Statements of Cash Flows include the historical results of Pentair, Inc. The consolidated financial statements include the results of Flow Control from the date of the Merger. Flow Control’s net sales and net loss from continuing operations for the period from the acquisition date to December 31, 2012 were $886.5 million and $117.0 million, respectively.

Our common share balances prior to the Merger have been adjusted to reflect the one-for-one conversion of the Pentair, Inc. shares to Pentair Ltd. shares, with the difference in par value recorded in Capital contribution reserve.

Based on the price of Pentair, Inc. common stock and our common shares issued on the date of the Merger, the purchase price was composed of the following:


In thousands
Value of common shares issued to Tyco shareholders ⁽¹⁾	$	4,811,363
Cash paid to Tyco shareholders in lieu of fractional common shares ⁽²⁾		542
Value of replacement equity-based awards to holders of Tyco equity-based awards ⁽³⁾		111,239


Total purchase price	$	4,923,144

(1)

Equals 110,886,444 Pentair Ltd. shares distributed to Tyco shareholders multiplied by the Merger date share price of $43.39.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

(2)

Equals cash paid to Tyco shareholders in lieu of 12,490 Pentair Ltd. fractional shares multiplied by the Merger date share price of $43.39.

(3)

In accordance with applicable accounting guidance, the fair value of replacement equity-based awards attributable to pre-combination service is recorded as part of the consideration transferred in the Merger, while the fair value of replacement equity-based awards attributable to post-combination service is recorded separately from the business combination and recognized as compensation cost in the post-acquisition period over the remaining service period. The fair value of our equivalent stock options was estimated using the Black-Scholes valuation model utilizing various assumptions.

During the fourth quarter of 2012, we recorded fair value adjustments to our preliminary purchase price allocation, which resulted in an increase to goodwill of $32.6 million.

The purchase price has been preliminarily allocated based on the estimated fair value of net assets acquired and liabilities assumed at the date of the Merger. The preliminary purchase price allocation is subject to further refinement and may require significant adjustments to arrive at the final purchase price allocation. These adjustments will primarily relate to accounts receivable, inventories, property, plant and equipment, certain contingent liabilities and income tax-related items. We expect the purchase price allocation to be completed in the second quarter of 2013. There can be no assurance that such finalization will not result in material changes from the preliminary purchase price allocation. The purchase price is subject to a working capital and net indebtedness adjustment.

The following table summarizes our preliminary fair values of the assets acquired and liabilities assumed in the Merger:


In thousands
Cash and cash equivalents	$	691,702
Accounts and notes receivable		771,576
Inventories		1,046,165
Other current assets		98,212
Property, plant and equipment		822,001
Goodwill		2,520,110
Intangibles		1,425,072
Other non-current assets		275,103
Current liabilities		(856,341	)
Long-term debt		(914,530	)
Income taxes, including current and deferred		(364,573	)
Other liabilities and redeemable noncontrolling interest		(591,353	)


Total purchase price	$	4,923,144

The excess of purchase price over tangible net assets and identified intangible assets acquired was allocated to goodwill in the amount of $2.5 billion. Goodwill has been preliminarily allocated to our reporting segments as follows: $321.4 million to Water & Fluid Solutions, $1,342.6 million to Valves & Controls and $856.1 million to Technical Solutions. None of the goodwill recognized from the Merger is expected to be deductible for income tax purposes. Goodwill recognized from the Merger reflects the value of future income resulting from synergies of our combined operations. Identifiable intangible assets acquired as part of the Merger were $1.4 billion and include $362.3 million of indefinite life trade name intangibles and the following definite-lived intangibles: $905.7 million of customer relationships with a weighted average useful life of 14.2 years, $115.9 million of proprietary technology with weighted average useful life of 13.7 years and $41.2 million of customer backlog with a weighted average useful life of less than one year.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Flow Control is a global leader in the industrial flow control market, specializing in the design, manufacture and servicing of highly engineered valves, actuation & controls, electric heat management solutions and water transmission and distribution products. Flow Control’s broad portfolio of products and services serves flow control needs primarily across the general process, oil & gas, water, power generation and mining industries. Sales are conducted through multiple channels based on local market conditions and demand. A global customer base is served through major manufacturing and after-market service centers around the world. Flow Control, through its valves & controls business, is one of the world’s largest manufacturers of valves, actuators and controls, with leading products, services and solutions to address many of the most challenging flow applications in the general process, oil & gas, power generation and mining industries. Through its thermal management business, Flow Control is a leading provider of complete electric heat management solutions, primarily for the oil & gas, general process and power generation industries. Additionally, Flow Control’s water & environmental systems business is a leading provider of large-scale water transmission and distribution products and water/wastewater systems in the Pacific and Southeast Asia regions.

We believe the Merger combines two complementary leaders in water and fluid solutions, valves and controls and technical solutions, providing us with the ability to achieve operational and tax synergies and increase global revenue. Following the Merger, we are a diversified industrial manufacturing company comprising three reporting segments: Water & Fluid Solutions, Valves & Controls and Technical Solutions. Water & Fluid Solutions designs, manufactures, markets and services innovative water management and fluid processing products and solutions. Valves & Controls designs, manufactures, markets and services valves, fittings, automation and controls and actuators. Technical Solutions designs, manufactures and markets products that guard and protect some of the world’s most sensitive electronics and electronic equipment, as well as heat management solutions designed to provide thermal protection to temperature sensitive fluid applications.

Basis of Presentation and Summary of Significant Accounting Policies

Basis of presentation

The accompanying consolidated financial statements include the accounts of Pentair and all subsidiaries, both the U.S. and non-U.S, which 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 Consolidated Statements of Operations and Comprehensive Income (Loss).

The consolidated financial statements have been prepared in United States dollars (“USD”) and in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Certain information described under Article 663-663h of the Swiss Code of Obligations has been presented in the Company’s Swiss statutory financial statements for the year ended December 31, 2012.

Fiscal year

Our fiscal year ends on December 31. We report our interim quarterly periods on a 13-week basis ending on a Saturday.

Use of estimates

The preparation of our consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and accompanying notes of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. These estimates include our accounting for valuation of long-lived assets, including goodwill and indefinite lived intangible

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

assets, percentage of completion revenue recognition, assets acquired and liabilities assumed in acquisitions and the Merger, contingent liabilities, income taxes, and pension and other post-retirement benefits. Actual results could differ from our estimates.

Revenue recognition

Generally, 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); our price to the buyer is fixed or determinable; and collectability is reasonably assured.

Generally, there is no post-shipment obligation on product sold other than warranty obligations in the normal and 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.

Percentage of completion

Revenue from certain long-term contracts is recognized over the contractual period under the percentage of completion method of accounting. Under this method, sales and gross profit are recognized as work is performed either based on the relationship between the actual costs incurred and the total estimated costs at completion (“the cost-to-cost method”) or based on efforts for measuring progress towards completion in situations in which this approach is more representative of the progress on the contract than the cost-to-cost method. Changes to the original estimates may be required during the life of the contract and such estimates are reviewed on a regular basis. Sales and gross profit are adjusted using the cumulative catch-up method for revisions in estimated total contract costs. These reviews have not resulted in adjustments that were significant to our results of operations. Estimated losses are recorded when identified. Claims against customers are recognized as revenue upon settlement.

We record costs and earnings in excess of billings on uncompleted contracts within Other current assets and billings in excess of costs and earnings on uncompleted contracts within Other current liabilities in the Consolidated Balance Sheets. Amounts included in Other current assets related to these contracts were $124.4 million and $54.7 million at December 31, 2012 and 2011, respectively. Amounts included in Other current liabilities related to these contracts were $61.1 million and $17.7 million at December 31, 2012 and 2011, respectively.

Sales returns

The right of return may exist explicitly or implicitly with our customers. Generally, our return policy allows for customer returns only upon our authorization. Goods returned must be product we continue to market and must be in salable condition. Returns of custom or modified goods are normally not allowed. At the time of sale, we reduce revenue for the estimated effect of returns. Estimated sales returns include consideration of historical sales levels, the timing and magnitude of historical sales return levels as a percent of sales, type of product, type of customer and a projection of this experience into the future.

Pricing and sales incentives

We record estimated reductions to revenue for customer programs and incentive offerings including pricing arrangements, promotions and other volume-based incentives at the later of the date revenue is recognized or the incentive is offered. Sales incentives given to our customers are recorded as a reduction of revenue unless we (1) receive an identifiable benefit for the goods or services in exchange for the consideration and (2) we can reasonably estimate the fair value of the benefit received.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

The following represents a description of our pricing arrangements, promotions and other volume-based incentives:

•

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 original equipment manufacturer 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.

•

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 generally 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 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 quarterly 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.

Shipping and handling costs

Amounts billed to customers for shipping and handling are recorded in Net sales in the accompanying Consolidated Statements of Operations and Comprehensive Income (Loss). 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 Operations and Comprehensive Income (Loss).

Research and development

We conduct research and development (“R&D”) activities in our own facilities, which consist primarily of the development of new products, product applications and manufacturing processes. We expense R&D costs as incurred. R&D expenditures during 2012, 2011 2010 were $93.6 million, $78.2 million and $67.2 million, respectively.

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 current trends, aging of accounts receivable, periodic credit evaluations of our customers’ financial condition, and historical collection experience. We generally do not require collateral. No customer receivable balances exceeded 10% of total net receivable balances as of December 31, 2012 and December 31, 2011.

Inventories

Inventories are stated at the lower of cost or market with substantially all inventories recorded using the first-in, first-out (“FIFO”) cost method and with an insignificant amount of inventories located outside the United States recorded using a moving average cost method which approximates FIFO.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Property, plant and equipment, net

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 recorded cost of the assets and their related accumulated depreciation are removed from the Consolidated Balance Sheets 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 or asset group, 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. There was no material impairment charge recorded related to long-lived assets.

Goodwill and identifiable intangible assets

Goodwill

Goodwill represents the excess of the cost of acquired businesses over the net of the fair value of identifiable tangible net assets and identifiable intangible assets purchased and liabilities assumed.

Goodwill is tested annually for impairment and is tested for impairment more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test is performed using a two-step process. In the first step, the fair value of each reporting unit is compared with the carrying amount of the reporting unit, including goodwill. If the estimated fair value is less than the carrying amount of the reporting unit there is an indication that goodwill impairment exists and a second step must be completed in order to determine the amount of the goodwill impairment, if any that should be recorded. In the second step, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation.

The fair value of each reporting unit is determined using a discounted cash flow analysis and market approach. Projecting discounted future cash flows requires us to make significant estimates regarding future revenues and expenses, projected capital expenditures, changes in working capital and the appropriate discount rate. Use of the market approach consists of comparisons to comparable publicly-traded companies that are similar in size and industry. Actual results may differ from those used in our valuations. This non-recurring fair value measurement is a “Level 3” measurement under the fair value hierarchy described below.

In developing our discounted cash flow analysis, assumptions about future revenues and expenses, capital expenditures and changes in working capital, are based on our annual operating plan and long-term business plan

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

for each of our reporting units. These plans take into consideration numerous factors including historical experience, anticipated future economic conditions, changes in raw material prices and growth expectations for the industries and end markets we participate in. These assumptions are determined over a five year long-term planning period. The five year growth rates for revenues and operating profits vary for each reporting unit being evaluated. Revenues and operating profit beyond 2019 are projected to grow at a perpetual growth rate of 3.0%.

Discount rate assumptions for each reporting unit take into consideration our assessment of risks inherent in the future cash flows of the respective reporting unit and our weighted-average cost of capital. We utilized discount rates ranging from 12.0% to 13.0% in determining the discounted cash flows in our fair value analysis.

In estimating fair value using the market approach, we identify a group of comparable publicly-traded companies for each reporting segment that are similar in terms of size and product offering. These groups of comparable companies are used to develop multiples based on total market-based invested capital as a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). We determine our estimated values by applying these comparable EBITDA multiples to the operating results of our reporting units. The ultimate fair value of each reporting unit is determined considering the results of both valuation methods.

Impairment charge

We completed step one of our annual goodwill impairment evaluation during the fourth quarter for 2012 with each reporting unit’s fair value exceeding its carrying value. Accordingly, step two of the impairment analysis was not required for 2012.

For the year ended December 31, 2011, we recorded a pre-tax non-cash impairment charge of $200.5 million in Water & Fluid Solutions as a result of our annual goodwill impairment test. The impairment charge resulted from changes in our forecasts in light of economic conditions and continued softness in the end-markets served by residential water treatment components.

Identifiable intangible assets

Our primary identifiable intangible assets include: customer relationships, trade names and trademarks, proprietary technology, backlog and patents. 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. We completed our annual impairment test during the fourth quarter for those identifiable assets not subject to amortization. As a result, an impairment charge of $60.7 million was recorded in 2012, related to trade names. These charges were recorded in Impairment of trade names and goodwill in our Consolidated Statements of Operations and Comprehensive Income (Loss). There was no impairment charge recorded in 2011 or 2010 for identifiable intangible assets.

The impairment test consists of a comparison of the fair value of the trade name with its carrying value. Fair value is measured using the relief-from-royalty method. This method assumes the trade name has value to the extent that the owner is relieved of the obligation to pay royalties for the benefits received from them. This method requires us to estimate the future revenue for the related brands, the appropriate royalty rate and the weighted average cost of capital. The non-recurring fair value measurement is a “Level 3” measurement under the fair value hierarchy described below. The impairment charge recorded in 2012 was the result of a rebranding strategy implemented in the fourth quarter of 2012.

At December 31, 2012 our goodwill and intangible assets were $6,804.2 million and represented 58% of our total assets. If we experience future declines in sales and operating profit or do not meet our operating forecasts, we

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

may be subject to future impairments. Additionally, changes in assumptions regarding the future performance of our businesses, increases in the discount rate used to determine the discounted cash flows of our businesses or significant declines in our share price or the market as a whole could result in additional impairment indicators. Because of the significance of our goodwill and intangible assets, any future impairment of these assets could have a material adverse effect on our financial results.

Equity and cost method investments

We have investments that are accounted for 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 Operations and Comprehensive Income (Loss). 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. Our investment in and loans to equity method investees was $10.3 million and $6.0 million at December 31, 2012 and December 31, 2011, respectively, net of our proportionate share of the results of their operations.

Investments for which we do not have significant influence are accounted for under the cost method. The aggregate balance of these investments was $6.9 million at December 31, 2012 and December 31, 2011.

Income taxes

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 bases 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. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.

Environmental

We recognize environmental clean-up liabilities on an undiscounted basis when a loss is probable and can be reasonably estimated. Such liabilities generally are not subject to insurance coverage. The cost of each environmental clean-up is estimated by engineering, financial and legal specialists based on current law. Such estimates are based primarily upon the estimated cost of investigation and remediation required and the likelihood that, where applicable, other potentially responsible parties (“PRPs”) will be able to fulfill their commitments at the sites where Pentair may be jointly and severally liable. The process of estimating environmental clean-up liabilities is complex and dependent primarily on the nature and extent of historical information and physical data relating to a contaminated site, the complexity of the site, the uncertainty as to what remedy and technology will be required and the outcome of discussions with regulatory agencies and other PRPs at multi-party sites. In future periods, new laws or regulations, advances in clean-up technologies and additional information about the ultimate clean-up remedy that is used could significantly change our estimates. Accruals for environmental liabilities are included in Other current liabilities and Other non-current liabilities in the Consolidated Balance Sheets.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Asbestos Matters

We recognize asbestos-related liabilities on an undiscounted basis when a loss is probable and can be reasonably estimated. Certain of these liabilities are subject to insurance coverage. Our subsidiaries and numerous other companies are named as defendants in personal injury lawsuits based on alleged exposure to asbestos-containing materials. These cases typically involve product liability claims based primarily on allegations of manufacture, sale or distribution of industrial products that either contained asbestos or were attached to or used with asbestos-containing components manufactured by third-parties. The process of estimating asbestos-related liabilities and the corresponding insurance recoveries receivable is complex and dependent primarily on our historical claim experience, estimates of potential future claims, our legal strategy for resolving these claims, the availability of insurance coverage, and the solvency and creditworthiness of insurers. Accruals for asbestos-related liabilities are included in Other non-current liabilities and the estimated receivable for insurance recoveries are recorded in Other non-current assets 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, 2012 and 2011, reserves for policy claims were $42.9 million ($13.3 million included in Other current liabilities and $29.6 million included in Other non-current liabilities) and $44.3 million ($13.3 million included in Other current liabilities and $31.0 million included in Other non-current liabilities), respectively.

Stock-based compensation

We account for share-based compensation awards on a fair value basis. The estimated grant date fair value of each option 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 award 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, resulting in the inclusion of additional compensation expense in our Consolidated Statements of Operations and Comprehensive Income (Loss). Restricted share awards and units are recorded as compensation cost on a straight-line basis over the requisite service periods based on the market value on the date of grant.

Earnings (loss) per common share

Basic earnings (loss) per share are computed by dividing net income (loss) attributable to Pentair Ltd. by the weighted-average number of common shares outstanding. Diluted earnings (loss) per share are computed by dividing net income (loss) attributable to Pentair Ltd. by the weighted-average number of common shares outstanding including the dilutive effects of common share equivalents.

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 and is effective as a cash-flow hedge, changes in the fair value of the derivative are recorded in Accumulated other comprehensive income (loss) (“AOCI”) as a separate component of equity in the Consolidated Balance Sheets and are recognized in the Consolidated Statements of Operations and Comprehensive Income (Loss) 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. We do not hold or issue derivative financial instruments for trading or

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

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. From time to time, we may enter in to short duration foreign currency contracts to hedge foreign currency risks.

Fair value measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities measured at fair value are classified using the following hierarchy, which is based upon the transparency of inputs to the valuation as of the measurement date:

Level 1: Valuation is based on observable inputs such as quoted market prices (unadjusted) for identical assets or liabilities in active markets.

Level 2: Valuation is based on inputs such as quoted market prices for similar assets or liabilities in active markets or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3: Valuation is based upon other unobservable inputs that are significant to the fair value measurement.

In making fair value measurements, observable market data must be used when available. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.

Foreign currency translation

The financial statements of subsidiaries located outside of the U.S. are measured using the local currency as the functional currency, except for certain corporate entities outside of the U.S. which are measured using USD. Assets and liabilities of these subsidiaries are translated at the rates of exchange at the balance sheet date. Income and expense items are translated at average monthly rates of exchange. The resultant translation adjustments are included in AOCI, a separate component of equity.

Discontinued Operations

In 2010, we were notified of a product recall required by our former Tools Group (which was sold to Black and Decker Corporation in 2004 and treated as a discontinued operation). Under the terms of the sale agreement we are liable for a portion of the product recall costs. We recorded a liability of $3.2 million ($2.0 million net of tax) in 2010 representing our estimate of the potential cost for products sold prior to the date of sale of the Tools Group associated with this recall. In addition, we received the remaining escrow balances from our sale of Lincoln Industrial of $0.5 million, and we reversed tax reserves of $1.0 million due to the expiration of various statues of limitations.

New accounting standards

In May 2011, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance to improve the consistency of fair value measurement and disclosure requirements between GAAP and International Financial Reporting Standards. The provisions of this guidance change certain of the fair value principles related to the highest and best use premise, the consideration of blockage factors and other premiums and discounts, and the measurement of financial instruments held in a portfolio and instruments classified within equity. Further, the guidance provides additional disclosure requirements surrounding Level 3 fair value measurements, the uses of nonfinancial assets in certain circumstances and identification of the level in the fair value hierarchy used for

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

assets and liabilities which are not recorded at fair value, but where fair value is disclosed. This guidance was effective for fiscal years and interim periods beginning after December 15, 2011. The adoption of this guidance did not have a material impact on our financial condition or results of operations.

In June 2011, the FASB issued authoritative guidance surrounding the presentation of comprehensive income, with an objective of increasing the prominence of items reported in Other Comprehensive Income (“OCI”). This guidance provides entities with the option to present the total of comprehensive income, the components of net income and the components of OCI in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance, other than certain provisions pertaining to the reclassification of items out of OCI that were deferred, was effective for fiscal years and interim periods beginning after December 15, 2011. We adopted this guidance as of January 1, 2012, and have presented total comprehensive income (loss) in our Consolidated Statements of Operations and Comprehensive Income (Loss).

In September 2011, the FASB issued an amendment to an existing accounting standard, which provides entities an option to perform a qualitative assessment to determine whether further impairment testing on goodwill is necessary. Specifically, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. The adoption of this guidance did not impact our financial condition or results of operations.

In September 2011, the FASB issued authoritative guidance which expanded and enhanced the existing disclosure requirements related to multi-employer pension and other postretirement benefit plans. The amendments require additional quantitative and qualitative disclosures to provide more detailed information regarding these plans including: the significant multi-employer plans in which we participate, the level of our participation and contributions with respect to such plans, the financial health of such plans and an indication of funded status. These disclosures are intended to provide users of financial statements with a better understanding of the employer’s involvement in multi-employer benefit plans. The disclosure provisions of the guidance were adopted concurrent with the pension disclosures associated with our annual valuation process during the fourth quarter of 2012. We concluded that our participation in any individual multi-employer plan was not significant.

In July 2012, the FASB issued an amendment to an existing accounting standard, which provides entities an option to perform a qualitative assessment to determine whether further impairment testing on indefinite-lived intangible assets is necessary. Specifically, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. This guidance is effective for annual and interim indefinite-lived intangible asset impairment tests performed for fiscal years beginning after September 15, 2012, and early adoption is permitted. We believe that the adoption of this guidance will not have a material impact on our financial condition or results of operations.

In February 2013, the FASB issued authoritative guidance surrounding the presentation of items reclassified from OCI to net income. This guidance requires entities to disclose, either in the notes to the consolidated financial statements or parenthetically on the face of the statement that reports comprehensive income, items reclassified out of AOCI and into net income in their entirety and the effect of the reclassification on each affected net income line item. In addition, for AOCI reclassification items that are not reclassified in their entirety into net income, a cross reference to other required GAAP disclosures is required. This guidance is effective for fiscal years and interim periods beginning after December 15, 2012. We believe that the adoption of this guidance will not have a material impact on our financial condition or results of operations.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Change in Accounting Principle

During the fourth quarter of 2012, we changed our method of recognizing actuarial gains and losses for all of our pension and other post-retirement plans. Historically, we recognized actuarial gains and losses as a component of AOCI in our Consolidated Balance Sheets and amortized them into our Consolidated Statements of Operations and Comprehensive Income (Loss) over the average future service period of the active employees of these plans to the extent such gains and losses were outside of a corridor. We elected to immediately recognize actuarial gains and losses in our Consolidated Statements of Operations and Comprehensive Income (Loss) on the basis that it is preferable to accelerate the recognition of such gains and losses into income rather than to delay such recognition. Additionally, for purposes of calculating the expected return on plan assets, we will no longer use a calculated value for the market-related valuation of plan assets, but instead will use the actual fair value of our plan assets. These changes will improve transparency in our operating results by more quickly recognizing the effects of external conditions on our plan obligations, investments and assumptions. We applied these changes retrospectively to all periods presented. The cumulative effect of the change on retained earnings as of January 1, 2010 was a reduction of $58.9 million, with an offset to AOCI. The annual recognition of actuarial losses totaled $146.6 million, $65.7 million and $13.6 million for the years ended December 31, 2012, 2011 and 2010, respectively. This change did not have an impact on cash provided by operating activities for any period presented.

The following table presents our results under our historical method and our results had we applied these new methods for the periods presented:


In thousands, except per-share data	Computed under previous method			Recognized under new method			Effect of Change
As of and for the year ended December 31, 2012

Statement of Operations and Comprehensive Income (Loss)
Selling, general and administrative	$	1,016,698		$	1,158,436		$	141,738
Provision (benefit) for income taxes		(24,076	)		(79,353	)		(55,277	)
Income (loss) from continuing operations		(18,151	)		(104,612	)		(86,461	)
Net income (loss) attributable to Pentair Ltd.		(20,725	)		(107,186	)		(86,461	)
Amortization of pension and other post-retirement prior service cost and transition obligation		(86,714	)		(253	)		86,461

Basic earnings (loss) per share attributable to Pentair Ltd.	$	(0.16	)	$	(0.84	)	$	(0.68	)
Diluted earnings (loss) per share attributable to Pentair Ltd.		(0.16	)		(0.84	)		(0.68	)

Balance Sheet
Retained earnings	$	1,492,258		$	1,292,288		$	(199,970	)
Accumulated other comprehensive income (loss)		(207,168	)		(7,198	)		199,970

Statement of Cash Flows
Net income (loss) before noncontrolling interest	$	(18,151	)	$	(104,612	)	$	(86,461	)
Pension and other post-retirement expense		25,798			167,536			141,738
Other current liabilities		82,455			27,178			(55,277	)

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements



	Previously Reported			Adjusted			Effect of Change
As of and for the year ended December 31, 2011

Statement of Operations and Comprehensive Income (Loss)
Selling, general and administrative	$	626,527		$	694,841		$	68,314
Provision for income taxes		73,059			46,417			(26,642	)
Income (loss) from continuing operations		38,521			(3,151	)		(41,672	)
Net income (loss) attributable to Pentair Ltd.		34,222			(7,450	)		(41,672	)
Amortization of pension and other post-retirement prior service cost and transition obligation		(41,683	)		(11	)		41,672

Basic earnings (loss) per share attributable to Pentair Ltd.	$	0.35		$	(0.08	)	$	(0.43	)
Diluted earnings (loss) per share attributable to Pentair Ltd.		0.34			(0.08	)		(0.42	)

Balance Sheet
Retained earnings	$	1,579,290		$	1,465,780		$	(113,510	)
Accumulated other comprehensive income (loss)		(151,241	)		(37,731	)		113,510

Statement of Cash Flows
Net income (loss) before noncontrolling interest	$	38,521		$	(3,151	)	$	(41,672	)
Pension and other post-retirement expense		16,031			84,345			68,314
Other current liabilities		18,688			(7,954	)		(26,642	)

	Previously Reported			Adjusted			Effect of Change
For the year ended December 31, 2010

Statement of Operations and Comprehensive Income (Loss)
Selling, general and administrative	$	529,329		$	550,501		$	21,172
Provision for income taxes		97,200			88,943			(8,257	)
Income from continuing operations		202,947			190,032			(12,915	)
Net income attributable to Pentair Ltd.		197,828			184,913			(12,915	)
Amortization of pension and other post-retirement prior service cost and transition obligation		(12,762	)		153			12,915

Basic earnings per share attributable to Pentair Ltd.	$	2.01		$	1.88		$	(0.13	)
Diluted earnings per share attributable to Pentair Ltd.		1.99			1.86			(0.13	)

Statement of Cash Flows
Net income (loss) before noncontrolling interest	$	202,321		$	189,406		$	(12,915	)
Pension and other post-retirement expense		12,926			34,098			21,172
Other current liabilities		7,462			(795	)		(8,257	)

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Other Acquisitions

Other material acquisitions

In May 2011, we acquired, as part of Water & Fluid Solutions, the Clean Process Technologies (“CPT”) division of privately held Norit Holding B.V. for $715.3 million (€502.7 million translated at the May 12, 2011 exchange rate). CPT’s results of operations have been included in our consolidated financial statements since the date of acquisition. CPT is a global leader in membrane solutions and clean process technologies in the high growth water and beverage filtration and separation segments. CPT provides sustainable purification systems and solutions for desalination, water reuse, industrial applications and beverage segments that effectively address the increasing challenges of clean water scarcity, rising energy costs and pollution. CPT’s product offerings include innovative ultrafiltration and nanofiltration membrane technologies, aseptic valves, CO₂ recovery and control systems and specialty pumping equipment. Based in the Netherlands, CPT has broad sales diversity with the majority of revenues generated in European Union and Asia-Pacific countries.

The fair value of the business acquired was allocated to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the fair value acquired over the identifiable assets acquired and liabilities assumed is reflected as goodwill. Goodwill recorded as part of the purchase price allocation was $451.8 million, none of which is tax deductible. Identifiable intangible assets acquired as part of the acquisition were $197.2 million, including definite-lived intangibles, such as customer relationships and proprietary technology with a weighted average amortization period of approximately 10 years.

Pro forma results of material acquisitions

The following unaudited pro forma consolidated financial results of operations are presented as if the Merger described in Note 1 and the CPT acquisition described above were completed at the beginning of the comparable annual reporting period from the date of the transaction. Specifically, the unaudited pro forma results give effect as though the Merger was consummated on January 1, 2011 and as though the CPT acquisition was consummated on January 1, 2010.


	Years ended December 31
In thousands, except per-share data	2012		2011
Pro forma net sales	$	7,409,917	$	7,326,432
Pro forma net income (loss) from continuing operations attributable to Pentair Ltd.		157,471		(47,373	)
Diluted earnings (loss) per common share attributable to Pentair Ltd.		0.75		(0.23	)

The 2011 unaudited pro forma net income includes the impact of $262.0 million in non-recurring items related to acquisition date fair value adjustments to inventory and customer backlog, $21.8 million of change of control costs and $8.7 million of transaction costs associated with the Merger. The 2011 unaudited pro forma net income excludes the impact of $12.9 million in non-recurring items related to acquisition date fair value adjustments to inventory and customer backlog and $8.0 million, respectively, of transaction costs associated with the CPT acquisition.

The 2012 unaudited pro forma net income excludes the impact $57.3 million of transaction related costs, $21.8 million of change of control costs and $178.1 million of non-recurring items related to acquisition date fair value adjustments to inventory and customer backlog associated with the Merger.

The pro forma consolidated financial information was prepared for comparative purposes only and includes certain adjustments, as noted above. The adjustments are estimates based on currently available information and actual amounts may have differed materially from these estimates. They do not reflect the effect of costs or synergies that would have been expected to result from the integration of the acquisitions. The pro forma

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

information does not purport to be indicative of the results of operations that actually would have resulted had the combinations occurred at the beginning of each period presented or of future results of the consolidated entities.

Other acquisitions

On October 4, 2012, we acquired, as part of Valves & Controls, the remaining 25% equity interest in Pentair Middle East Holding S.a.R.L. (“KEF”), a privately held company, for $100 million in cash. Prior to the acquisition, we held a 75% equity interest in KEF, a vertically integrated valve manufacturer in the Middle East. There was no pro forma impact from this acquisition as the results of KEF were consolidated into Flow Control’s financial statements prior to acquiring the remaining 25% interest in KEF.

Additionally, during 2012, we completed other small acquisitions as part of Water & Fluid Solutions with purchase prices totaling $121.2 million in cash, net of cash acquired. Total goodwill recorded as part of the purchase price allocations was $80.9 million, none of which is tax deductible. During 2011, we completed other small acquisitions as part of Water & Fluid Solutions with purchase prices totaling $21.6 million, consisting of $17.8 million in cash and $3.8 million as notes payable. Total goodwill recorded as part of the purchase price allocations was $14.4 million, none of which is tax deductible. The pro forma impact of these acquisitions was not material.

Total transaction costs related to acquisition activities for the year ended December 31, 2012 and December 31, 2011 were $57.3 million and $8.2 million, respectively, and were expensed as incurred and recorded in Selling, general and administrative in our Consolidated Statements of Operations and Comprehensive Income (Loss).

Earnings (Loss) Per Share

Basic and diluted earnings (loss) per share were calculated as follows:


	Years ended December 31
In thousands, except per share data	2012			2011			2010
Net income (loss) attributable to Pentair Ltd.	$	(107,186	)	$	(7,450	)	$	184,913



Net income (loss) from continuing operations attributable to Pentair Ltd.	$	(107,186	)	$	(7,450	)	$	185,539



Weighted average common shares outstanding
Basic		127,368			98,233			98,037
Dilutive impact of stock options and restricted stock awards ⁽¹⁾		—			—			1,257


Diluted		127,368			98,233			99,294



Earnings (loss) per common share attributable to Pentair Ltd.
*Basic*
Continuing operations	$	(0.84	)	$	(0.08	)	$	1.89
Discontinued operations		—			—			(0.01	)


Basic earnings (loss) per common share	$	(0.84	)	$	(0.08	)	$	1.88


*Diluted*
Continuing operations	$	(0.84	)	$	(0.08	)	$	1.87
Discontinued operations		—			—			(0.01	)


Diluted earnings (loss) per common share	$	(0.84	)	$	(0.08	)	$	1.86



Anti-dilutive stock options and restricted stock awards ⁽²⁾		16,007			8,357			3,711

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

(1)

The incremental share impact from stock options and restricted stock awards was computed using the treasury stock method.

(2)

Stock options and restricted stock awards that were not dilutive were excluded from our calculation of diluted weighted average shares.

Restructuring

During 2012 and 2011, we initiated certain business restructuring initiatives aimed at reducing our fixed cost structure and realigning our business. The 2012 initiatives included the reduction in hourly and salaried headcount of approximately 1,000 employees, which included 500 in Water & Fluid Solutions, 300 in Valves & Controls and 200 in Technical Solutions. The 2011 initiatives included the reduction in hourly and salaried headcount of approximately 210 employees, which included 160 in Water & Fluid Solutions and 50 in Technical Solutions.

Restructuring related costs included in Selling, general and administrative expenses in the Consolidated Statements of Operations and Comprehensive Income (Loss) included costs for severance and other restructuring costs as follows:


	Years ended December 31
In thousands	2012		2011		2010
Severance and related costs	$	61,560	$	11,500	$	—
Other		5,340		1,500		—


Total restructuring costs	$	66,900	$	13,000	$	—

Total restructuring costs related to Water & Fluid Solutions, Valves & Controls and Technical Solutions were $49.1 million, $5.1 million and $12.7 million, respectively, for the year ended December 31, 2012. Total restructuring costs related to Water & Fluid Solutions and Technical Solutions were $11.0 million and $2.0 million, respectively, for the year ended December 31, 2011.

We assumed $17.1 million of restructuring accruals from actions initiated by Flow Control prior to the Merger relating to employee severance, facility exit and other restructuring costs. Activity in the restructuring accrual recorded in Other current liabilities and Employee compensation and benefits in the Consolidated Balance Sheets is summarized as follows:


	Years ended December 31
In thousands	2012			2011
Beginning balance	$	12,805		$	3,994
Acquired		17,062			—
Costs incurred		61,560			11,500
Cash payments and other		(34,868	)		(2,689	)


Ending balance	$	56,559		$	12,805

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Goodwill and Other Identifiable Intangible Assets

The changes in the carrying amount of goodwill for the year ended December 31, 2012 and December 31, 2011 by reportable segment were as follows:


In thousands	December 31, 2011		Acquisitions		Foreign currency translation/other			December 31, 2012
Water & Fluid Solutions	$	1,994,781	$	402,254	$	18,684		$	2,415,719
Valves & Controls		—		1,342,621		—			1,342,621
Technical Solutions		279,137		856,111		924			1,136,172


Total goodwill	$	2,273,918	$	2,600,986	$	19,608		$	4,894,512



In thousands	December 31, 2010		Acquisitions		Foreign currency translation/other			December 31, 2011
Water & Fluid Solutions	$	1,784,100	$	466,182	$	(255,501	)	$	1,994,781
Valves & Controls		—		—		—			—
Technical Solutions		281,944		—		(2,807	)		279,137


Total goodwill	$	2,066,044	$	466,182	$	(258,308	)	$	2,273,918

In 2011, we recorded an impairment charge of $200.5 million in Water & Fluid Solutions which is included in “Foreign currency translation/other” above. Accumulated goodwill impairment losses were $200.5 million as of December 31, 2012 and December 31, 2011.

Identifiable intangible assets consisted of the following at December 31:


	2012							2011
In thousands	Cost		Accumulated amortization			Net		Cost		Accumulated amortization			Net
Finite-life intangibles
Customer relationships	$	1,276,793	$	(152,769	)	$	1,124,024	$	358,410	$	(109,887	)	$	248,523
Trade names		1,525		(686	)		839		1,515		(530	)		985
Proprietary technology		263,647		(57,711	)		205,936		134,737		(43,994	)		90,743
Backlog		41,240		(18,278	)		22,962		—		—			—


Total finite-life intangibles		1,583,205		(229,444	)		1,353,761		494,662		(154,411	)		340,251
Indefinite-life intangibles
Trade names		555,895		—			555,895		252,034		—			252,034


Total intangibles, net	$	2,139,100	$	(229,444	)	$	1,909,656	$	746,696	$	(154,411	)	$	592,285

Identifiable intangible asset amortization expense in 2012, 2011 and 2010 was $76.0 million, $41.9 million and $24.5 million, respectively.

In 2012 we recorded an impairment charge for trade name intangible assets of $49.1 million and $11.6 million in Water & Fluid Solutions and Technical Solutions, respectively.

Estimated future amortization expense for identifiable intangible assets during the next five years is as follows:


In thousands	2013		2014		2015		2016		2017
Estimated amortization expense	$	135,308	$	113,848	$	113,559	$	112,770	$	111,625

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Supplemental Balance Sheet Information


	December 31
In thousands	2012		2011
Inventories
Raw materials and supplies	$	615,809	$	219,487
Work-in-process		207,794		47,707
Finished goods		556,668		182,669


Total inventories	$	1,380,271	$	449,863



Other current assets
Cost in excess of billings	$	124,447	$	54,701
Prepaid expenses		94,950		42,831
Deferred income taxes		68,277		60,899
Other current assets		38,434		10,260


Total other current assets	$	326,108	$	168,691



Property, plant and equipment, net
Land and land improvements	$	247,868	$	41,111
Buildings and leasehold improvements		482,106		244,246
Machinery and equipment		1,096,469		692,930
Construction in progress		114,309		40,251


Total property, plant and equipment		1,940,752		1,018,538
Accumulated depreciation and amortization		716,264		631,013


Total property, plant and equipment, net	$	1,224,488	$	387,525



Other non-current assets
Asbestos-related insurance receivable	$	157,394	$	—
Deferred income taxes		89,040		—
Other non-current assets		259,853		94,750


Total other non-current assets	$	506,287	$	94,750



Other current liabilities
Deferred revenue and customer deposits	$	127,149	$	10,151
Dividends payable		94,967		—
Billings in excess of cost		61,126		17,732
Accrued warranty		53,696		29,355
Other current liabilities		333,224		166,470


Total other current liabilities	$	670,162	$	223,708



Other non-current liabilities
Asbestos-related liabilities	$	234,567	$	630
Deferred revenue		73,397		—
Taxes payable		49,324		26,470
Other non-current liabilities		96,299		96,409


Total other non-current liabilities	$	453,587	$	123,509

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Supplemental Cash Flow Information

The following table summarizes supplemental cash flow information:


	Years ended December 31
In thousands	2012		2011		2010
Cash paid for interest, net	$	66,683	$	54,516	$	37,083
Cash paid for income taxes, net		82,235		64,389		55,991

10.

Accumulated Other Comprehensive Income (Loss)

Components of AOCI consist of the following:


	December 31
In thousands	2012			2011
Unrecognized pension and other post-retirement benefit costs, net of tax	$	364		$	617
Cumulative translation adjustments		1,009			(33,407	)
Market value of derivative financial instruments, net of tax		(8,571	)		(4,941	)


Accumulated other comprehensive income (loss)	$	(7,198	)	$	(37,731	)

11.

Debt

Debt and the average interest rates on debt outstanding were as follows:


In thousands	Average interest rate at December 31, 2012	Maturity year	December 31
In thousands	Average interest rate at December 31, 2012	Maturity year	2012			2011
Commercial paper	0.664%	2017	$	424,684		$	3,497
Revolving credit facilities	—	2017		—			168,500
Senior notes - fixed rate	1.350%	2015		350,000			—
Senior notes - fixed rate	1.875%	2017		350,000			—
Senior notes - fixed rate	2.650%	2019		250,000			—
Senior notes - fixed rate	5.000%	2021		500,000			500,000
Senior notes - fixed rate	3.150%	2022		550,000			—
Senior notes - fixed rate	—	—		—			400,000
Senior notes - floating rate	—	—		—			205,000
Other	0.562%	2014-2030		8,880			16,302
Capital lease obligations	4.313%	2015-2025		23,810			15,788


Total debt				2,457,374			1,309,087
Less: Current maturities and short-term borrowings				(3,096	)		(4,862	)


Long-term debt			$	2,454,278		$	1,304,225

In December 2012, our wholly-owned subsidiary, Pentair Finance S.A. (“PFSA”), completed an exchange offer (the “Exchange Offer”) pursuant to which it exchanged $373 million in aggregate principal amount of 5.00% Senior Notes due 2021 of Pentair, Inc., a wholly-owned, indirect subsidiary of the Company (the “2021 Notes”) for a like amount of new 5.00% Senior Notes due 2021 of PFSA (the “New 2021 Notes”) plus $5.6 million in

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

transaction-related costs. Upon completion of the Exchange Offer, $127 million in aggregate principal amount of 2021 Notes remained outstanding. The remaining 2021 Notes and New 2021 Notes are guaranteed as to payment by Pentair Ltd.

In November 2012, PFSA completed a private offering of $350 million aggregate principal amount of 1.35% Senior Notes due 2015 (the “2015 Notes”) and $250 million aggregate principal amount of 2.65% Senior Notes due 2019 (the “2019 Notes” and, collectively, the “2015/2019 Notes”), which are guaranteed as to payment by Pentair Ltd. In certain circumstances, PFSA may be required to pay additional interest on the 2015/2019 Notes. We used the net proceeds from the sale of the 2015/2019 Notes to repay commercial paper and for general corporate purposes.

In October 2012, we redeemed the remaining outstanding aggregate principal of our 5.65% fixed rate senior notes due 2013-2017 totaling $400 million and our 1.05% floating rate senior notes due 2013 totaling $100 million (the “Fixed/Floating Rate Notes”). The redemptions included make-whole premiums of $65.8 million. Concurrent with the redemption of the Fixed/Floating Rate Notes, we terminated a related interest rate swap that was designated as a cash flow hedge, which resulted in the reclassification of $3.4 million of previously unrecognized variable to fixed swap losses from AOCI to earnings in October 2012. All costs associated with the redemption were recorded as a Loss on the early extinguishment of debt including $0.6 million of unamortized deferred financing costs.

In September 2012, PFSA, completed a private offering of $550 million aggregate principal amount of 3.15% Senior Notes due 2022 (the “2022 Notes”) and $350 million aggregate principal amount of 1.875% Senior Notes due 2017 (the “2017 Notes” and, collectively, the “2017/2022 Notes”), which are guaranteed as to payment by Pentair Ltd. In certain circumstances, PFSA may be required to pay additional interest on the 2017/2022 Notes. The 2017/2022 Notes remained outstanding after the Merger. A portion of the net proceeds from the 2017/2022 Notes offering were used to repay $435 million to Tyco in conjunction with the Distribution and the Merger.

In September 2012, Pentair, Inc. entered into a credit agreement providing for an unsecured, committed revolving credit facility (the “Credit Facility”) with initial maximum aggregate availability of up to $1,450 million. The Credit Facility replaced Pentair, Inc.’s $700 million Former Credit Facility (as defined below). The Credit Facility matures in September 2017. Upon the completion of the Merger, Pentair Ltd. became the guarantor under the Credit Facility and PFSA and certain other of our subsidiaries became affiliate borrowers under the Credit Facility. Borrowings under the Credit Facility generally bear interest at a variable rate equal to the London Interbank Offered Rate (“LIBOR”) plus a specified margin based upon PFSA’s credit ratings. PFSA must also pay a facility fee ranging from 10.0 to 30.0 basis points per annum (based upon PFSA’s credit ratings) on the amount of each lender’s commitment.

In May 2011, Pentair, Inc. completed a public offering of $500 million aggregate principal amount of the 2021 Notes. Pentair, Inc. used the net proceeds from the offering of the 2021 Notes to finance in part the CPT acquisition in 2011. The 2021 Notes which remain outstanding subsequent to the Exchange Offer are guaranteed as to payment by Pentair Ltd.

In April 2011, Pentair, Inc. entered into a Fourth Amended and Restated Credit Agreement that provided for an unsecured, committed revolving credit facility (the “Former Credit Facility”) of up to $700 million, with multi-currency sub-facilities to support investments outside the U.S. Borrowings under the Former Credit Facility bore interest at the rate of LIBOR plus 1.75%. We used borrowings under the Former Credit Facility to fund a portion of the CPT acquisition in 2011 and to repay $105 million of matured senior notes in May 2012. The Former Credit Facility was terminated in September 2012 in connection with the Merger and replaced by the Credit Facility, at which time the subsidiary guarantees in place under the Former Credit Facility ceased to exist.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

PFSA is authorized to sell short-term commercial paper notes to the extent availability exists under the Credit Facility. PFSA uses the Credit Facility as back-up liquidity to support 100% of commercial paper outstanding. As of December 31, 2012 and 2011, we had $424.7 million and $3.5 million, respectively, of commercial paper outstanding, all of which was classified as long-term as we have the intent and the ability to refinance such obligations on a long-term basis under the Credit Facility.

We used borrowings under the Credit Facility and proceeds from the 2017/2022 Notes offering, to repay the Former Credit Facility and to pay other fees and expenses in connection with the Merger. Total availability under the Credit Facility was $1,025.3 million as of December 31, 2012, which was not limited by any covenants contained in the Credit Facility’s credit agreement. Subsequent to the Merger, we used the remaining proceeds from the 2017/2022 Notes offering and issuances of commercial paper to redeem the Fixed/Floating Rate Notes as discussed above, to repurchase shares in conjunction with our share repurchase as discussed in Note 15 and to purchase the remaining 25% interest in KEF for $100 million as discussed in Note 4.

Our debt agreements contain certain financial covenants, the most restrictive of which are in the Credit Facility, including that we may not permit (i) the ratio of our consolidated debt plus synthetic lease obligations to our consolidated net income (excluding, among other things, non-cash gains and losses) before interest, taxes, depreciation, amortization, non-cash share-based compensation expense, and up to $40 million of costs and expenses incurred in connection with the Merger (EBITDA) for the four consecutive fiscal quarters then ended (the “Leverage Ratio”) to exceed 3.50 to 1.00 on the last day of each fiscal quarter, and (ii) the ratio of our EBITDA for the four consecutive fiscal quarters then ended to our consolidated interest expense, including consolidated yield or discount accrued as to outstanding securitization obligations (if any), for the same period to be less than 3.00 to 1.00 as of the end of each fiscal quarter. For purposes of the Leverage Ratio, the Credit Facility provides for the calculation of EBITDA giving pro forma effect to the Merger and certain acquisitions, divestitures and liquidations during the period to which such calculation relates. As of December 31, 2012, we were in compliance with all financial covenants in our debt agreements.

In addition to the Credit Facility, we have various other credit facilities with an aggregate availability of $89.0 million, of which $3.0 million was outstanding at December 31, 2012. Borrowings under these credit facilities bear interest at variable rates.

Debt outstanding at December 31, 2012 matures on a calendar year basis as follows:


In thousands	2013		2014		2015		2016		2017		Thereafter		Total
Contractual debt obligation maturities	$	—	$	65	$	350,000	$	—	$	777,706	$	1,305,793	$	2,433,564
Capital lease obligations		3,096		3,171		6,036		1,236		1,236		9,035		23,810


Total maturities	$	3,096	$	3,236	$	356,036	$	1,236	$	778,942	$	1,314,828	$	2,457,374

As part of the Merger and CPT acquisition, we assumed capital lease obligations related primarily to land and buildings. As of December 31, 2012 and December 31, 2011, the recorded values of the assets acquired under those capital leases were $35.5 million and $22.7 million, respectively, less accumulated amortization of $6.0 million and $5.1 million, respectively, all of which were included in Property, plant and equipment, net on the Consolidated Balance Sheets.

Capital lease obligations consist of total future minimum lease payments of $26.1 million less the imputed interest of $2.3 as of December 31, 2012.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

12.

Derivatives and Financial Instruments

Derivative financial instruments

We are exposed to market risk related to changes in foreign currency exchange rates and interest rates on our floating rate indebtedness. To manage the volatility related to these exposures, we periodically enter into a variety of derivative financial instruments. Our objective is to reduce, where it is deemed appropriate to do so, fluctuations in earnings and cash flows associated with changes in foreign currency rates and interest rates. The derivative contracts contain credit risk to the extent that our bank counterparties may be unable to meet the terms of the agreements. The amount of such credit risk is generally limited to the unrealized gains, if any, in such contracts. Such risk is minimized by limiting those counterparties to major financial institutions of high credit quality.

Interest rate swaps

During 2012 and 2011, we used floating to fixed rate interest rate swaps to mitigate our exposure to future changes in interest rates related to our floating rate indebtedness. We designated these interest rate swap arrangements as cash flow hedges. As a result, changes in the fair value of the interest rate swaps were recorded in AOCI on the Consolidated Balance Sheets throughout the contractual term of each of the interest rate swap arrangements.

During the year ended December 31, 2012, all of our interest rate swaps expired or were terminated and, as a result, we had no outstanding interest rate swap arrangements at December 31, 2012.

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 principal amounts in order to manage interest rate exposures. The effective date of the swap was August 30, 2007. The swap agreement had a fixed interest rate of 4.89% and expired in May 2012. The fixed interest rate of 4.89% plus the .50% interest rate spread over LIBOR resulted in an effective fixed interest rate of 5.39%. The fair value of the swap was $1.7 million at December 31, 2011 and was recorded in Other current liabilities in the Consolidated Balance Sheets.

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 principal 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 was set to expire 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%. This swap was terminated in October 2012. The fair value of the swap was $6.3 million at December 31, 2011 and was recorded in Other current liabilities in the Consolidated Balance Sheets. A loss of $3.3 million was recognized upon termination and was recorded in Loss on early extinguishment of debt in the Consolidated Statements of Operations and Comprehensive Income (Loss) for the year ended December 31, 2012.

Derivative gains and losses included in AOCI were reclassified into earnings at the time the related interest expense was recognized or the settlement of the related commitment occurred. Interest expense from swaps was $5.3 million and $9.3 million in 2012 and 2011, respectively, and was recorded in Interest expense in the Consolidated Statements of Operations and Comprehensive Income (Loss).

In April 2011, as part of our planned debt issuance to fund the CPT acquisition, we entered into interest rate swap contracts to hedge movement in interest rates through the expected date of closing for a portion of the expected fixed rate debt offering. The swaps had a notional amount of $400 million with an average interest rate of 3.65%. In May 2011, upon the sale of the 2021 Notes, the swaps were terminated at a cost of $11.0 million. Because we

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

used the contracts to hedge future interest payments, this was recorded in AOCI in the Consolidated Balance Sheets and will be amortized as interest expense over the 10 year life of the 2021 Notes. The ending unrealized net loss in AOCI at December 31, 2012 was $9.2 million.

Foreign currency contracts

We conduct business in various locations throughout the world and are subject to market risk due to changes in the value of foreign currencies in relation to our reporting currency, the U.S. dollar. We manage our economic and transaction exposure to certain market-based risks through the use of foreign currency derivative financial instruments. Our objective in holding these derivatives is to reduce the volatility of net earnings and cash flows associated with changes in foreign currency exchange rates. The majority of our foreign currency contracts have an original maturity date of less than one year. At December 31, 2012 and 2011, we had outstanding foreign currency derivative contracts with gross notional U.S. dollar equivalent amounts of $163.7 million and $79.9 million, respectively. The impact of these contracts on the Consolidated Statements of Operations and Comprehensive Income (Loss) is not material for any period presented.

In March 2011, we entered into a foreign currency option contract to reduce our exposure to fluctuations in the euro related to the planned CPT acquisition. The contract had a notional amount of €286.0 million, a strike price of 1.4375 and a maturity date of May 13, 2011. In May 2011, we sold the foreign currency option contract for $1.0 million. The net cost of $2.1 million was recorded in Selling, general and administrative on the Consolidated Statements of Operations and Comprehensive Income (Loss).

Fair value of financial instruments

The recorded amounts and estimated fair values of total debt at December 31, excluding the effects of derivative financial instruments, were as follows:


	2012				2011
In thousands	Recorded Amount		Fair Value		Recorded Amount		Fair Value
Variable rate debt	$	427,706	$	427,706	$	406,978	$	406,978
Fixed rate debt		2,029,669		2,081,264		902,109		954,053


Total debt	$	2,457,375	$	2,508,970	$	1,309,087	$	1,361,031

The following methods were used to estimate the fair values of each class of financial instrument measured on a recurring basis:

•

short-term financial instruments (cash and cash equivalents, accounts and notes receivable, accounts and notes payable and variable-rate debt) — recorded amount approximates fair value because of the short maturity period;

•

long-term fixed-rate debt, including current maturities — fair value is based on market quotes available for issuance of debt with similar terms, which are inputs that are classified as Level 2 in the valuation hierarchy defined by the accounting guidance; and

•

interest rate swaps and foreign currency contract agreements — fair values are determined through the use of models that consider various assumptions, including time value, yield curves, as well as other relevant economic measures, which are inputs that are classified as Level 2 in the valuation hierarchy defined by the accounting guidance.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Financial assets and liabilities measured at fair value on a recurring basis were as follows:


Recurring fair value measurements	December 31, 2012
In thousands	Level 1		Level 2			Level 3		Total
Foreign currency contract assets	$	—	$	2,924		$	—	$	2,924
Foreign currency contract liabilities		—		(551	)		—		(551	)
Deferred compensation plan assets⁽¹⁾		22,394		—			—		22,394


Total recurring fair value measurements	$	22,394	$	2,373		$	—	$	24,767



Nonrecurring fair value measurements
Trade name intangibles ⁽²⁾	$	—	$	—		$	63,700	$	63,700



Recurring fair value measurements	December 31, 2011
In thousands	Level 1		Level 2			Level 3		Total
Foreign currency contract assets	$	—	$	242		$	—	$	242
Foreign currency contract liabilities		—		(341	)		—		(341	)
Interest rate swap liabilities		—		(8,034	)		—		(8,034	)
Deferred compensation plan assets⁽¹⁾		22,987		—			—		22,987


Total recurring fair value measurements	$	22,987	$	(8,133	)	$	—	$	14,854



Nonrecurring fair value measurements
Goodwill⁽³⁾	$	—	$	—		$	242,800	$	242,800

(1)

Deferred compensation plan assets include mutual funds and cash equivalents for payment of certain non-qualified benefits for retired, terminated and active employees. The fair value of these assets was based on quoted market prices in active markets.

(2)

In the fourth quarter of 2012, we completed our annual intangible assets impairment review. As a result, we recorded a pre-tax non-cash impairment charge of $60.7 million for trade names intangibles. The fair value of trade names is measured using the relief-from-royalty method. This method assumes the trade name has value to the extent that the owner is relieved of the obligation to pay royalties for the benefits received from them. This method requires us to estimate the future revenue for the related brands, the appropriate royalty rate and the weighted average cost of capital.

(3)

In the fourth quarter of 2011, we completed our annual goodwill impairment review. As a result, we recorded a pre-tax non-cash impairment charge of $200.5 million in a reporting unit part of Water & Fluid Solutions. The fair value of each reporting unit is determined using a discounted cash flow analysis and market approach. Projecting discounted future cash flows requires us to make significant estimates regarding future revenues and expenses, projected capital expenditures, changes in working capital and the appropriate discount rate. Use of the market approach consists of comparisons to comparable publicly-traded companies that are similar in size and industry. Actual results may differ from those used in our valuations. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

13.

Income Taxes

Income from continuing operations before income taxes and noncontrolling interest consisted of the following:


	Years ended December 31
In thousands	2012				2011				2010
Federal ⁽¹⁾		$	39,177			$	(31,471	)		$	196,101
International			(223,142	)			74,737				82,874


Income (loss) from continuing operations before income taxes and noncontrolling interest		$	(183,965	)		$	43,266			$	278,975

(1) As a result of the Merger, “Federal” reflects income (loss) from continuing operations before income taxes and noncontrolling interest for Switzerland in 2012 and U.S. for 2011 and 2010.

The provision (benefit) for income taxes consisted of the following: For 2012, Federal represents Swiss taxes, while International represents non-Swiss taxes, including U.S. federal, state and local taxes. For 2011 and 2010 Federal represents U.S. federal taxes, while International reflects non-U.S. taxes.


	Years ended December 31
In thousands	2012			2011			2010
Currently payable
Federal	$	6,490		$	51,158		$	44,766
State		—			6,980			6,591
International		61,053			24,005			17,877


Total current taxes		67,543			82,143			69,234
Deferred
Federal		1,270			(26,223	)		18,188
International		(148,166	)		(9,503	)		1,521


Total deferred taxes		(146,896	)		(35,726	)		19,709


Total provision (benefit) for income taxes	$	(79,353	)	$	46,417		$	88,943

Reconciliations of the federal statutory income tax rate to our effective tax rate were as follows:


	Years ended December 31
Percentages	2012			2011			2010
Federal statutory income tax rate ⁽¹⁾		7.8			35.0			35.0
Tax effect of international operations ⁽²⁾		23.6			(25.3	)		(4.1	)
Non-deductible transaction costs		(4.7	)		—			—
Impact of debt-financing		10.8			—			—
Resolution of tax audits		5.6			—			—
Goodwill		—			104.4			—
Domestic manufacturing deduction		—			(8.4	)		(1.5	)
State income taxes, net of federal tax benefit		—			4.3			2.0
All other, net		—			(2.7	)		0.5


Effective tax rate		43.1			107.3			31.9

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

(1) As a result of the Merger, the statutory rate for 2012 reflects the Swiss statutory rate of 7.83 percent. For 2011 and 2010, the statutory rate reflects the U.S. statutory rate of 35 percent.

(2) As a result of the Merger, the tax effect of international operations for 2012 consists of non-Swiss jurisdictions. For 2011 and 2010, the tax effect of international operations consists of non-U.S. jurisdictions.

Reconciliations of the beginning and ending gross unrecognized tax benefits were as follows:


	Years ended December 31
In thousands	2012			2011			2010
Beginning balance	$	26,469		$	24,260		$	29,962
Gross increases for tax positions in prior periods		2,198			2,042			286
Gross decreases for tax positions in prior periods		(641	)		(192	)		(2,490	)
Gross increases based on tax positions related to the current year		13,641			3,201			1,431
Gross decreases related to settlements with taxing authorities		(13,202	)		(2,465	)		(4,182	)
Reductions due to statute expiration		(370	)		(377	)		(747	)
Gross increases due to acquisitions		25,938			—			—
Gross increases due to currency fluctuations		438			—			—


Ending balance	$	54,471		$	26,469		$	24,260

Included in the $54.5 million of total gross unrecognized tax benefits as of December 31, 2012 was $38.6 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, 2012 may decrease by a range of $0 to $36.9 million during 2013, primarily as a result of the resolution of non-Swiss examinations, including U.S. federal and state examinations, and the expiration of various statutes of limitations.

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 the Pentair, Inc. U.S. federal income tax returns through 2009 with no material adjustments. A number of tax periods from 2004 to present are under audit by tax authorities in various jurisdictions, including Germany and Italy. We anticipate that several of these audits may be concluded in the foreseeable future. We are also subject to the 2012 Tax Sharing Agreement, discussed below, which generally applies to pre-Distribution Tyco tax periods beginning in 1997 which remain subject to audit by the IRS.

We record penalties and interest related to unrecognized tax benefits in Provision (benefit) for income taxes and Interest expense, respectively. As of December 31, 2012 and 2011, we accrued $3.1 million and $0.9 million, respectively, for the possible payment of penalties and $19.5 million and $5.9 million, respectively, for the possible payment of interest expense, which are recorded in Other current liabilities in the Consolidated Balance Sheets.

Deferred taxes in the amount of $21.0 million have been provided on undistributed earnings of certain subsidiaries. Taxes have not been provided on undistributed earnings of subsidiaries where it is our intention to reinvest these earnings permanently or to repatriate the earnings only when it is tax effective to do so. It is not practicable to estimate the amount of tax that might be payable if such earnings were to be remitted.

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

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

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 Operations and Comprehensive Income (Loss)).

Deferred taxes were recorded in the Consolidated Balance Sheets as follows:


	December 31
In thousands	2012		2011
Other current assets	$	68,277	$	60,899
Other non-current assets		89,040		—
Deferred tax liabilities		488,102		188,957


Net deferred tax liabilities	$	330,785	$	128,058

The tax effects of the major items recorded as deferred tax assets and liabilities were as follows:


	December 31
In thousands	2012		2011
Deferred tax assets
Accrued liabilities and reserves	$	86,714	$	58,420
Postretirement benefits		79,065		82,823
Employee compensation & benefits		95,170		49,404
Tax loss and credit carryforwards		398,921		24,350
Other		53,531		4,698


Total deferred tax assets		713,401		219,695
Valuation allowance ⁽¹⁾		167,640		13,242


Deferred tax assets, net of valuation allowance		545,761		206,453
Deferred tax liabilities
Property, plant and equipment		97,370		43,572
Goodwill and other intangibles		779,176		290,939


Total deferred tax liabilities		876,546		334,511


Net deferred tax liabilities	$	330,785	$	128,058

(1)

The increase in valuation allowance from 2011 to 2012 was primarily related to balances acquired in the Merger.

As of December 31, 2012, tax loss carryforwards of $1,460.9 million were available to offset future income. A valuation allowance of $163.8 million exists for deferred income tax benefits related to the tax loss carryforwards which may not be realized. We believe sufficient taxable income will be generated in the respective jurisdictions to allow us to fully recover the remainder of the tax losses. The tax losses relate to Non-U.S. carryforwards of $903.4 million which are subject to varying expiration periods and will begin to expire in 2013. In addition, there were $367.1 million of U.S. federal and $190.4 million of state tax loss carryforwards as of December, 31, 2012, which will expire in future years through 2032. When realized, $6.2 million of tax benefits will be recorded as an increase in equity.

Tax sharing agreement and other income tax matters

In connection with the Distribution, we entered into a tax sharing agreement (the “2012 Tax Sharing Agreement”) with Tyco and The ADT Corporation (“ADT”), which governs the rights and obligations of Tyco,

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

ADT and us for certain pre-Distribution tax liabilities, including Tyco’s obligations under a separate tax sharing agreement (the “2007 Tax Sharing Agreement”) that Tyco, Covidien Ltd. (“Covidien”) and TE Connectivity Ltd. (“TE Connectivity”) entered into in 2007. The 2012 Tax Sharing Agreement provides that we, Tyco and ADT will share (i) certain pre-Distribution income tax liabilities that arise from adjustments made by tax authorities to our, Tyco’s and ADT’s U.S. income tax returns, and (ii) payments required to be made by Tyco in respect to the 2007 Tax Sharing Agreement (collectively, “Shared Tax Liabilities”). Tyco is responsible for the first $500 million of Shared Tax Liabilities. We and ADT will share 42% and 58%, respectively, of the next $225 million of Shared Tax Liabilities. We, ADT and Tyco will share 20%, 27.5% and 52.5%, respectively, of Shared Tax Liabilities above $725 million.

In the event the Distribution, the spin-off of ADT, or certain internal transactions undertaken in connection therewith were determined to be taxable as a result of actions taken after the Distribution by us, ADT or Tyco, the party responsible for such failure would be responsible for all taxes imposed on us, ADT or Tyco as a result thereof. Taxes resulting from the determination that the Distribution, the spin-off of ADT, or any internal transaction is taxable are referred to herein as “Distribution Taxes.” If such failure is not the result of actions taken after the Distribution by us, ADT or Tyco, then we, ADT and Tyco would be responsible for any Distribution Taxes imposed on us, ADT or Tyco as a result of such determination in the same manner and in the same proportions as the Shared Tax Liabilities. ADT will have sole responsibility for any income tax liability arising as a result of Tyco’s acquisition of Brink’s Home Security Holdings, Inc. (“BHS”) in May 2010, including any liability of BHS under the tax sharing agreement between BHS and The Brink’s Company dated October 31, 2008 (collectively, the “BHS Tax Liabilities”). Costs and expenses associated with the management of Shared Tax Liabilities, Distribution Taxes and BHS Tax Liabilities will generally be shared 20% by us, 27.5% by ADT and 52.5% by Tyco. We are responsible for all of our own taxes that are not shared pursuant to the 2012 Tax Sharing Agreement’s sharing formulae. In addition, Tyco and ADT are responsible for their tax liabilities that are not subject to the 2012 Tax Sharing Agreement’s sharing formulae.

The 2012 Tax Sharing Agreement also provides that, if any party were to default in its obligation to another party to pay its share of the distribution taxes that arise as a result of no party’s fault, each non-defaulting party would be required to pay, equally with any other non-defaulting party, the amounts in default. In addition, if another party to the 2012 Tax Sharing Agreement that is responsible for all or a portion of an income tax liability were to default in its payment of such liability to a taxing authority, we could be legally liable under applicable tax law for such liabilities and required to make additional tax payments. Accordingly, under certain circumstances, we may be obligated to pay amounts in excess of our agreed-upon share of our, Tyco’s and ADT’s tax liabilities.

With respect to years prior to and including the 2007 separation of Covidien and TE Connectivity by Tyco, tax authorities have raised issues and proposed tax adjustments that are generally subject to the sharing provisions of the 2007 Tax Sharing Agreement and which may require Tyco to make a payment to a taxing authority, Covidien or TE Connectivity. With respect to adjustments raised by the IRS, although Tyco has resolved a substantial number of these adjustments, a few significant items remain open with respect to the audit of the 1997 through 2004 years. As of the date hereof, it is unlikely that Tyco will be able to resolve all the open items, which primarily involve the treatment of certain intercompany debt issued during the period, through the IRS appeals process. As a result, Tyco expects to litigate these matters once it receives the requisite statutory notices from the IRS, which may occur as soon as within the next three months. However, the ultimate resolution of these matters is uncertain and could result in Tyco being responsible for a greater amount than it expects under the 2007 Tax Sharing Agreement. To the extent we are responsible for any Shared Tax Liability or Distribution Tax, there could be a material adverse impact on our financial condition, results of operations, or cash flows in future reporting periods.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

14.

Benefit Plans

Pension and other post-retirement plans

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 provide certain post-retirement health care and life insurance benefits. Generally, the post-retirement health care and life insurance plans require contributions from retirees. In December 2007, we announced that we will be freezing certain U.S. pension plans as of December 31, 2017. Since the announcement, we have pursued a strategy of gradually shifting our U.S. pension asset allocations towards liability hedging assets such as fixed income instruments and away from equity securities. During the last quarter of 2012 we made significant progress in reducing the risk and volatility of our U.S. pension plans by taking the following steps:

•

We paid $331 million to settle pension obligations through a combination of lump sum payments to deferred vested participants and through the purchase of an annuity contract to settle obligations to plan participants in retiree status.

•

We made a special contribution of $190 million to fund our U.S. pension plans.

•

We accelerated our transition to increase the allocations of investments to liability hedging assets.

During the fourth quarter of 2012, we changed our method of recognizing actuarial gains and losses for all of our pension and other post-retirement plans. Historically, we recognized actuarial gains and losses as a component of AOCI in our Consolidated Balance Sheets and amortized them into our Consolidated Statements of Operations and Comprehensive Income (Loss) over the average future service period of the active employees of these plans to the extent such gains and losses were outside of a corridor. We elected to immediately recognize actuarial gains and losses in our Consolidated Statements of Operations and Comprehensive Income (Loss) on the basis that it is preferable to accelerate the recognition of such gains and losses into income rather than to delay such recognition. Additionally, for purposes of calculating the expected return on plan assets, we will no longer use a calculated value for the market-related valuation of plan assets, but instead will use the actual fair value of our plan assets. These changes will improve transparency in our operating results by more quickly recognizing the effects of external conditions on our plan obligations, investments and assumptions. Generally, these gains and losses are measured annually as of December 31 and accordingly will be recorded during the fourth quarter. We have applied these changes retrospectively, adjusting all prior periods (see Note 3).

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Obligations and funded status

The following tables present reconciliations of plan benefit obligations, fair value of plan assets and the funded status of pension plans and other post-retirement plans as of and for the years ended December 31, 2012 and 2011:


	U.S. pension plans						Non-U.S. pension plans						Other post-retirement plans
In thousands	2012			2011			2012			2011			2012			2011
Change in benefit obligations
Benefit obligation beginning of year	$	572,068		$	502,657		$	89,503		$	84,151		$	35,081		$	33,715
Service cost		12,867			10,270			3,295			2,196			219			180
Interest cost		28,208			28,647			7,545			4,121			1,860			1,889
Amendments		372			—			—			—			—			—
Benefit obligations assumed in Merger		10,821			—			338,532			—			16,815			—
Settlements		—			—			—			(257	)		—			—
Actuarial loss		128,817			58,672			26,647			4,079			8,159			2,494
Translation (gain) loss		—			—			1,502			(2,477	)		—			—
Benefits paid		(358,854	)		(28,178	)		(6,175	)		(2,310	)		(2,837	)		(3,197	)


Benefit obligation end of year		394,299			572,068			460,849			89,503			59,297			35,081


Change in plan assets
Fair value of plan assets beginning of year		408,837			374,934			10,934			10,549			—			—
Actual return on plan assets		43,944			27,628			6,413			343			—			—
Plan assets acquired in Merger		7,482			—			227,253			—			—			—
Company contributions		224,786			34,453			10,391			2,644			2,837			3,197
Settlements		—			—			—			(257	)		—			—
Translation gain (loss)		—			—			166			(35	)		—			—
Benefits paid		(358,854	)		(28,178	)		(6,175	)		(2,310	)		(2,837	)		(3,197	)


Fair value of plan assets end of year		326,195			408,837			248,982			10,934			—			—


Funded status
Benefit obligations in excess of the fair value of plan assets	$	(68,104	)	$	(163,231	)	$	(211,867	)	$	(78,569	)	$	(59,297	)	$	(35,081	)

Amounts recorded in the Consolidated Balance Sheets were as follows:


	U.S. pension plans						Non-U.S. pension plans						Other post- retirement plans
In thousands	2012			2011			2012			2011			2012			2011
Current liabilities	$	(3,490	)	$	(3,303	)	$	(4,925	)	$	(2,442	)	$	(4,520	)	$	(3,307	)
Non-current liabilities		(64,614	)		(159,928	)		(206,942	)		(76,127	)		(54,777	)		(31,774	)


Benefit obligations in excess of the fair value of plan assets	$	(68,104	)	$	(163,231	)	$	(211,867	)	$	(78,569	)	$	(59,297	)	$	(35,081	)

The accumulated benefit obligation for all defined benefit plans was $804.2 million and $625.9 million at December 31, 2012 and 2011, respectively.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Information for pension plans with an accumulated benefit obligation or projected benefit obligation in excess of plan assets as of December 31 are as follows:


	Projected benefit obligation exceeds the fair value of plan assets				Accumulated benefit obligation exceeds the fair value of plan assets
In thousands	2012		2011		2012		2011
U.S. pension plans
Projected benefit obligation	$	158,063	$	572,068	$	87,147	$	572,068
Fair value of plan assets		85,332		408,837		15,499		408,837
Accumulated benefit obligation		—		—		77,165		539,453

Non-U.S. pension plans
Projected benefit obligation	$	436,652	$	89,503	$	431,271	$	89,503
Fair value of plan assets		222,387		10,934		217,174		10,934
Accumulated benefit obligation		—		—		420,044		86,431

Components of net periodic benefit cost for our pension plans for the years ended December 31 were as follows:



	U. S. pension plans									Non-U.S. pension plans
In thousands	2012			2011			2010			2012			2011			2010
Service cost	$	12,867		$	10,270		$	9,743		$	3,295		$	2,196		$	1,845
Interest cost		28,208			28,647			27,518			7,545			4,121			4,153
Expected return on plan assets		(29,400	)		(27,952	)		(24,679	)		(3,928	)		(461	)		(433	)
Amortization of transition obligation		—			—			—			—			—			13
Amortization of prior year service cost (benefit)		17			17			17			(15	)		(17	)		(10	)
Actuarial loss		114,272			58,995			6,990			24,162			4,196			7,305


Net periodic benefit cost	$	125,964		$	69,977		$	19,589		$	31,059		$	10,035		$	12,873

Components of net periodic benefit cost for our other post-retirement plans for the years ended December 31 were as follows:


	Other post-retirement plans
In thousands	2012			2011			2010
Service cost	$	219		$	180		$	200
Interest cost		1,860			1,889			2,013
Amortization of prior year service benefit		(24	)		(27	)		(27	)
Actuarial (gain) loss		8,159			2,494			(647	)


Net periodic benefit cost	$	10,214		$	4,536		$	1,539

The components of comprehensive income (loss) for our pension and other post-retirement plans for the years ended December 31, 2012, 2011 and 2010 are not material.

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

The amounts in AOCI at December 31, 2012 and 2011 that have not yet been recognized as components of net periodic benefit cost and the amounts in AOCI expected to be recognized as components of net periodic benefit cost in 2013 for our pension and other post-retirement plans are not material.

Assumptions

Weighted-average assumptions used to determine benefit obligations as of December 31 were as follows:


	U.S. pension plans			Non-U.S. pension plans			Other post-retirement plans
Percentages	2012	2011	2010	2012	2011	2010	2012	2011	2010
Discount rate	3.67	5.05	5.90	3.85	4.82	5.10	3.40	5.05	5.90
Rate of compensation increase	4.37	4.00	4.00	3.02	2.98	3.00	—	—	—

Weighted-average assumptions used to determine net periodic benefit cost for years ended December 31 were as follows:

	U.S. pension plans			Non-U.S. pension plans			Other post- retirement plans
Percentages	2012	2011	2010	2012	2011	2010	2012	2011	2010
Discount rate	5.05	5.90	6.00	4.82	5.13	5.50	5.05	5.90	6.00
Expected long-term return on plan assets	7.50	8.00	8.50	4.09	4.50	4.50	—	—	—
Rate of compensation increase	4.21	4.00	4.00	2.98	2.98	3.00	—	—	—

Uncertainty in the securities markets and U.S. economy could result in investment returns less than those assumed. Should the securities markets decline or medical and prescription drug costs increase at a rate greater than assumed, we would expect increasing annual combined net pension and other post-retirement costs for the next several years. Should actual experience differ from actuarial assumptions, the projected pension benefit obligation and net pension cost and accumulated other post-retirement benefit obligation and other post-retirement benefit cost would be affected in future years.

Discount rates

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 bonds rated AA or higher available in the marketplace, adjusted to eliminate the effects of call provisions. This produced a discount rate for our U.S. pension plans of 3.67%, 5.05% and 5.90% in 2012, 2011 and 2010, respectively. The discount rates on our non-U.S. pension plans ranged from 0.50 % to 4.50%, 0.75% to 5.00% and 0.75% to 5.40% in 2012, 2011 and 2010, respectively. There are no other known or anticipated changes in our discount rate assumptions that will impact our pension expense in 2013.

Expected rates of return

Our expected rates of return on U.S. pension plan assets were 7.5%, 8.0% and 8.5% for 2012, 2011 and 2010, respectively. The expected rate of return is designed to be a long-term assumption that may be subject to considerable year-to-year variance from actual returns. In developing the expected long-term rate of return, we considered our historical returns, with consideration given to forecasted economic conditions, our asset allocations, input from external consultants and broader longer-term market indices. U.S. pension plan assets yielded returns of 10.8%, 7.8% and 11.2% in 2012, 2011 and 2010, respectively. As a result of our de-risking

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

strategy to reduce U.S. pension plan, our expected rate of return on plan assets is 3.75% for 2013. Any difference in the expected rate and actual returns will be included with the actuarial gain or loss recorded in the fourth quarter when our plans are remeasured.

Healthcare cost trend rates

The assumed healthcare cost trend rates for other post-retirement plans as of December 31 were as follows:


	2012			2011
Healthcare cost trend rate assumed for following year		7.4	%		7.5	%
Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)		4.5	%		4.5	%
Year the cost trend rate reaches the ultimate trend rate		2027			2027

The assumed healthcare cost trend rates can have a significant effect on the amounts reported for healthcare plans. A one-percentage-point change in the assumed healthcare cost trend rates would have the following effects as of and for the year ended December 31, 2012:


	One Percentage Point
In thousands	Increase		Decrease
Increase (decrease) in annual service and interest cost	$	59	$	(52	)
Increase (decrease) in other post-retirement benefit obligations		2,748		(2,390	)

Pension plans assets

Objective

The primary objective of our investment strategy is to meet the pension obligation to our employees at a reasonable cost to us. This is primarily accomplished through growth of capital and safety of the funds invested.

During 2012, we adopted an investment strategy for our U.S. pension plans with a primary objective of preserving the funded status of the U.S. plans. This is achieved through investments in fixed interest instruments with interest rate sensitivity characteristics closely reflecting the interest rate sensitivity of our benefit obligations. Shifting of allocations away from equities to liability hedging fixed income investments is currently in progress. As equity investments are redeemed, proceeds are reinvested in fixed income instruments. After we have completed the transition, the U.S. pension plans will have in excess of 90 percent allocation to fixed income investments.

Asset allocation

Our actual overall asset allocation for our U.S. and non-U.S. pension plans as compared to our investment policy goals as of December 31 was as follows:


	U.S. pension plans
	Actual				Target
Percentages	2012		2011		2012		2011
Equity securities		32%		41%		—		50%
Fixed income		56%		50%		100%		40%
Alternative		7%		6%		—		10%
Cash		5%		3%		—		—

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements


	Non-U.S. pension plans
	Actual						Target
Percentages	2012			2011			2012			2011
Equity securities		51	%		66	%		55	%		75	%
Fixed income		42	%		20	%		45	%		25	%
Alternative		3	%		—			—			—
Cash		4	%		14	%		—			—

While the target allocations do not have a percentage allocated to cash, the plan assets will always include some cash due to cash flow requirements.

Fair value measurement

The fair values of our pension plan assets and their respective levels in the fair value hierarchy as of December 31, 2012 and December 31, 2011 were as follows:


	December 31, 2012
In thousands	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	6,238	$	21,235	$	—	$	27,473
Fixed income:
Corporate and non U.S. government		—		164,255		—		164,255
U.S. treasuries		—		69,375		—		69,375
Mortgage-backed securities		—		23,382		—		23,382
Other		—		28,111		—		28,111
Global equity securities:
Mid cap equity		—		6,726		—		6,726
Large cap equity		—		88,985		—		88,985
International equity		—		89,768		—		89,768
Long/short equity		—		47,597		—		47,597
Other investments		—		11,215		18,290		29,505


Total fair value of plan assets	$	6,238	$	550,649	$	18,290	$	575,177



	December 31, 2011
In thousands	Level 1		Level 2		Level 3		Total
Cash equivalents	$	—	$	13,084	$	—	$	13,084
Fixed income:
Corporate and non U.S. government		—		76,046		150		76,196
U.S. treasuries		—		82,989		—		82,989
Mortgage-backed securities		—		40,286		629		40,915
Other		—		7,958		219		8,177
Global equity securities:
Small cap equity		7,094		—		—		7,094
Mid cap equity		7,528		4		—		7,532
Large cap equity		—		47,398		—		47,398
International equity		19,942		19,652		—		39,594
Long/short equity		—		56,575		—		56,575
Pentair Ltd. common shares		16,645		—		—		16,645
Other investments		—		4,563		19,009		23,572


Total fair value of plan assets	$	51,209	$	348,555	$	20,007	$	419,771

Pentair Ltd. and Subsidiaries

Notes to consolidated financial statements

Valuation methodologies used for investments measured at fair value were as follows:

•

Cash and cash equivalents: Cash consists of cash held in bank accounts and was classified as Level 1. Cash equivalents consist of investments in commingled funds valued based on observable market data. Such investments were classified as Level 2.

•

Fixed income: Investments in corporate bonds, government securities, mortgages and asset backed securities were value based upon quoted market prices for similar securities and other observable market data. Investments in commingled funds were generally valued at the net asset value of units held at the end of the period based upon the value of the underlying investments as determined by quoted market prices or by a pricing service. Such investments were classified as Level 2. Certain investments in commingled funds were valued based on unobservable inputs due to liquidation restrictions. These investments were classified as Level 3.

•

Global equity securities: Equity securities and our common shares were valued based on the closing market price in an active market and were classified as Level 1. Investments in commingled funds were valued at the net asset value of units held at the end of the period based upon the value of the underlying investments as determined by quoted market prices or by a pricing service. Such investments were classified as Level 2.

•

Other investments: Other investments include investments in commingled funds with diversified investment strategies. Investments in commingled funds that were valued at the net asset value of units held at the end of the period based upon the value of the underlying investments as determined by quoted market prices or by a pricing service were classified as Level 2. Investments in commingled funds that were valued based on unobservable inputs due to liquidation restrictions were classified as Level 3.

The following tables present a reconciliation of Level 3 assets held during the years ended December 31, 2012 and 2011, respectively:


In thousands	January 1, 2012		Net realized and unrealized gains (losses)		Net issuances and settlements			Net transfers into (out of) level 3		December 31, 2012
Other investments	$	19,009	$	1,051	$	(1,770	)	$	—	$	18,290
Fixed income investments		998		22		(1,020	)		—		—


Total	$	20,007	$	1,073	$	(2,790	)	$	—	$	18,290



In thousands	January 1, 2011		Net realized and unrealized gains (losses)		Net issuances and settlements			Net transfers into (out of) level 3		December 31, 2011
Other investments	$	12,991	$	251	$	5,767		$	—	$	19,009
Fixed income investments		1,777		87		(866	)		—		998


Total	$	14,768	$	338