PENTAIR plc - Quarter Report: 2012 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended September 29, 2012

OR

Commission file number 001-11625

Pentair Ltd.

(Exact name of Registrant as specified in its charter)

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§223.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

On September 29, 2012, 210,292,400 shares of Registrant’s common stock were outstanding.

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Pentair Ltd. and Subsidiaries

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PART I FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

Pentair Ltd. and Subsidiaries

Condensed Consolidated Statements of Income and Comprehensive Income (Loss) (Unaudited)

See accompanying notes to condensed consolidated financial statements.

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Condensed Consolidated Balance Sheets (Unaudited)

See accompanying notes to condensed consolidated financial statements.

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Condensed Consolidated Statements of Cash Flows (Unaudited)

See accompanying notes to condensed consolidated financial statements.

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Condensed Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

See accompanying notes to condensed consolidated financial statements.

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Condensed Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

See accompanying notes to condensed consolidated financial statements.

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Pentair Ltd. and Subsidiaries

Notes to condensed consolidated financial statements (unaudited)

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 “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 is 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 the historical cost. For periods prior to September 28, 2012, the consolidated statements of income and consolidated statements of cash flows include the historical results of Pentair, Inc. For all reporting periods following the consummation of the Merger, the consolidated financial statements will include the results of Flow Control. The revenues and expenses of Flow Control for the period from the date of the Merger to September 29, 2012 were not material.

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 being adjusted in Capital contribution reserve. Total stockholders’ equity in periods prior to the Merger was unchanged.

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:

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Notes to condensed consolidated financial statements (unaudited)

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. We have retained third-party valuation advisors to conduct analyses of the assets acquired and liabilities assumed in order to assist in the determination of the purchase price allocation. The preliminary purchase price allocation is subject to further refinement and may require significant adjustments to arrive at the final purchase price allocation. These changes will primarily relate to the fair value of tangible and intangible assets acquired and liabilities assumed. 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 following table summarizes our preliminary estimates of the fair values of the assets acquired and liabilities assumed in the Merger:

The excess of purchase price over tangible net assets and identified intangible assets acquired has been preliminarily allocated to goodwill in the amount of $2.5 billion. Goodwill recognized from the Merger has not yet been allocated to reporting segments. Goodwill reflects the value of future income resulting from synergies of our combined operations. None of the goodwill recognized is expected to be deductible for income tax purposes.

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, installs and services products and systems used in the movement, storage and treatment of water. Valves & Controls designs, manufactures and markets valves, actuators and controls throughout the energy and process industries. Technical Solutions designs, manufactures and markets heat management solutions and enclosures that house and protect sensitive electronics and electrical components.

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Notes to condensed consolidated financial statements (unaudited)

We prepared the unaudited condensed consolidated financial statements following the requirements of the U.S. Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States can be condensed or omitted.

We are responsible for the unaudited financial statements included in this document. The financial statements include all normal recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. As these are condensed financial statements, one should also read the consolidated financial statements and notes thereto of Pentair, Inc. included in the Annual Report on Form 10-K of Pentair, Inc. for the year ended December 31, 2011.

Revenues, expenses, cash flows, assets and liabilities can and do vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be indicative of those for a full year.

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

In connection with preparing the unaudited condensed consolidated financial statements for the nine months ended September 29, 2012, we have evaluated subsequent events for potential recognition and disclosure through the date of this filing.

In May 2011, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance to improve the consistency of fair value measurement and disclosure requirements between U.S. Generally Accepted Accounting Principles 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 shareholders’ 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 assets and liabilities which are not recorded at fair value, but where fair value is disclosed. This guidance is 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. In addition, entities must present on the face of the financial statement, items reclassified from OCI to net income in the section of the financial statement where the components of net income and OCI are presented, regardless of the option selected to present comprehensive income. This guidance is effective for fiscal years and interim periods beginning after December 15, 2011. The FASB subsequently deferred the effective date of certain provisions of this standard pertaining to the reclassification of items out of accumulated other comprehensive income, pending the issuance of further guidance on that matter. We have adopted this guidance as of January 1, 2012, and have presented total comprehensive income (loss) in our Condensed Consolidated Statements of Income 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. This guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We believe that the adoption of this guidance will not have a material impact on our financial condition or results of operations.

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.

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Pentair Ltd. and Subsidiaries

Notes to condensed consolidated financial statements (unaudited)

In May 2011, Pentair, Inc. acquired, as part of the Water & Fluid Solutions reporting segment, 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 2012 and 2011 revenues generated in European Union and Asia-Pacific countries.

The fair value of CPT 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.

The following pro forma condensed consolidated financial results of operations are presented as if the Merger described in Note 1 and the CPT acquisition described above had been completed at the beginning of the comparable annual reporting period from the date of the transaction. Specifically, the 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.

The 2011 unaudited pro forma net income for the three and nine months ended October 1, 2011 includes the impact of approximately $25.3 million and $75.8 million, respectively, in non-recurring items related to acquisition date fair value adjustments to inventory and $0 and $21.8 million, respectively, of change of control costs associated with the Merger. The 2011 unaudited pro forma net income for the three and nine months ended October 1, 2011 excludes the impact of approximately $5.8 million and $11.1 million, respectively, in non-recurring items related to acquisition date fair value adjustments to inventory and customer backlog and $0 and $7.8 million, respectively, of transaction costs associated with the CPT acquisition.

The 2012 unaudited pro forma net income for the three and nine months ended September 29, 2012 excludes the impact of $31.5 million and $49.4 million, respectively, of non-recurring items related to transaction related costs and $21.2 million and $21.8 million, respectively, of non-recurring items related to change of control costs.

The pro forma condensed consolidated financial information has been 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 differ 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 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.

Additionally, during the nine months ended September 29, 2012, Pentair, Inc. completed other small acquisitions with purchase prices totaling $19.9 million in cash, net of cash acquired, adding to the Water & Fluid Solutions reporting segment. Total goodwill recorded as part of the purchase price allocation was $8.8 million, none of which is tax deductible. During 2011, Pentair, Inc. completed other small acquisitions with purchase prices totaling $21.6 million, consisting of $17.8 million in cash and $3.8 million as notes payable, adding to the Water & Fluid Solutions reporting segment. Total goodwill recorded as part of the purchase price allocation was $14.4 million, none of which is tax deductible. The pro forma impact of these acquisitions was not material.

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Notes to condensed consolidated financial statements (unaudited)

Subsequent acquisitions

On October 4, 2012, we acquired, as part of the Valves & Controls reporting segment, the remaining 25% equity interest in Tyco Flow Control Luxembourg 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. See Note 18 for additional information regarding our interest in KEF.

We made additional acquisitions subsequent to September 29, 2012, adding to the Water & Fluid Solutions reporting segment, for a total purchase price of $27.8 million in cash, net of cash acquired.

Stock-based compensation expense

Total stock-based compensation expense was $18.4 million and $4.2 million for the three months ended September 29, 2012 and October 1, 2011, respectively, and $28.5 million and $14.7 million for the nine months ended September 29, 2012 and October 1, 2011, respectively.

The expense for the three and nine months ended September 29, 2012 included $13.5 million of expense due to the Merger triggering change of control provisions of Pentair, Inc. stock-based compensation plans resulting in immediate vesting of certain outstanding awards.

During the first nine months of 2012, restricted shares and restricted stock units of Pentair, Inc. common stock were granted under the Pentair, Inc. 2008 Omnibus Stock Incentive Plan (the “2008 Plan”) to eligible employees with a vesting period of three to four years after issuance. Restricted share awards and restricted stock units are valued at market value on the date of grant and are typically expensed over the vesting period. Total compensation expense for restricted share awards and restricted stock units was $12.8 million and $2.2 million for the three months ended September 29, 2012 and October 1, 2011, respectively, and was $18.6 million and $8.0 million for the nine months ended September 29, 2012 and October 1, 2011, respectively.

During the first nine months of 2012, option awards were granted under the 2008 Plan with an exercise price equal to the market price of Pentair, Inc. common stock on the date of grant. Option awards are typically expensed over the vesting period. Total compensation expense for stock option awards was $5.6 million and $2.0 million for the three months ended September 29, 2012 and October 1, 2011, respectively, and $9.9 million and $6.7 million for the nine months ended September 29, 2012 and October 1, 2011, respectively.

2012 Stock and Incentive Plan

Prior to the Merger, our board of directors approved, and Tyco as our sole shareholder approved, the Pentair Ltd. 2012 Stock and Incentive Plan (the “2012 Plan”). The 2012 Plan became effective on September 28, 2012 and authorizes the issuance of 9,000,000 of our common shares. The 2012 Plan terminates in September 2022. The 2012 Plan allows for the granting to our officers, directors, employees and consultants of nonqualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, restricted shares, restricted stock units, deferred stock rights, annual incentive awards, dividend equivalent units and other equity-based awards.

The 2012 Plan is administered by our compensation committee (the “Committee”), which is made up of independent members of our board of directors. Employees eligible to receive awards under the 2012 Plan are managerial, administrative or other key employees who are in a position to make a material contribution to the continued profitable growth and long-term success of our company. The Committee has the authority to select the recipients of awards, determine the type and size of awards, establish certain terms and conditions of award grants and take certain other actions as permitted under the 2012 Plan. The 2012 Plan prohibits the Committee from re-pricing awards or cancelling and reissuing awards at lower prices.

In connection with the Distribution, we issued a total of $108.9 million like-kind equity-based awards under the 2012 Plan to former Tyco equity-based award holders in replacement of a portion of their Tyco equity-based awards. Such awards do not deplete the 9,000,000 of our common shares reserved for issuance under the 2012 Plan. Of the total issued, $37.6 million in like-kind equity-based awards were issued to former holders who are active employees of our company, and $71.3 million like-kind equity-based awards were issued to former holders who are not employees of our company. As no change of control provisions related to Tyco equity-based awards were triggered by the Distribution or the Merger, the original vesting and exercise term provisions remain in effect for all such replacement equity-based awards.

The 2008 Plan terminated upon the completion of the Merger. Prior grants of restricted stock units and stock options made under the 2008 Plan and earlier stock incentive plans outstanding at completion of the Merger were converted into equity-based awards with respect to our common shares and were assumed by us on the terms in effect at the time of grant and are outstanding under the 2012 Plan.

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Notes to condensed consolidated financial statements (unaudited)

Fair value of options granted

The weighted-average fair value of options granted during the third quarter of 2012 and 2011 were $13.18 and $10.00 per share, respectively. All options granted in the third quarter of 2012 were replacement equity-based awards issued in connection with the Merger; no options were granted in the ordinary course of business in the third quarter of 2012. We estimated the fair value of each stock option award on the date of grant using a Black-Scholes option pricing model, modified for dividends and using the following assumptions:

These estimates require us to make assumptions based on historical results, observance of trends in our stock price, changes in option exercise behavior, future expectations and other relevant factors. If other assumptions had been used, stock-based compensation expense, as calculated and recorded under the accounting guidance, could have been affected.

We based the expected life assumption on historical experience as well as the terms and vesting periods of the options granted. For purposes of determining expected volatility, we considered a rolling average of historical volatility measured over a period approximately equal to the expected option term. The risk-free rate for periods that coincide with the expected life of the options is based on the U.S. Treasury Department yield curve in effect at the time of grant.

Basic and diluted earnings per share were calculated using the following:

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 153 employees, which included 98 in Water & Fluid Solutions and 55 in Technical Solutions. The 2011 initiatives, initiated in the fourth quarter, included the reduction in hourly and salaried headcount of approximately 210 employees, which included 160 in Water & Fluid Solutions and 50 in Technical Solutions.

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Notes to condensed consolidated financial statements (unaudited)

Restructuring related costs included in Selling, general and administrative expenses on the Condensed Consolidated Statements of Income and Comprehensive Income (Loss) include costs for severance and other restructuring costs as follows for the three and nine months ended September 29, 2012, and October 1, 2011:

We assumed $17.1 million of restructuring accruals from restructuring 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 on the Condensed Consolidated Balance Sheets is summarized as follows for the nine months ended September 29, 2012, and October 1, 2011, and the year ended December 31, 2011: