UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended July 1, 2006

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

Pentair, Inc.

Minnesota		41-0907434
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification number)
5500 Wayzata Blvd, Suite 800, Golden Valley, Minnesota		55416
(Address of principal executive offices)		(Zip code)

Registrant’s telephone number, including area code: (763) 545-1730

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule  
12b-2 of the Act).

Large accelerated filer þ                 Accelerated filer o                 Non-accelerated filer o

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

On July 28, 2006, 101,123,144 shares of the Registrant’s common stock were outstanding.

 

 

Pentair, Inc. and Subsidiaries

				Page(s)
Part I Financial Information
Item 1.		Financial Statements
		Condensed Consolidated Statements of Income for the three and six months ended July 1, 2006 and July 2, 2005			3
		Condensed Consolidated Balance Sheets as of July 1, 2006, December 31, 2005 and July 2, 2005			4
		Condensed Consolidated Statements of Cash Flows for the six months ended July 1, 2006 and July 2, 2005			5
		Notes to Condensed Consolidated Financial Statements			6 – 20
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			21 – 29
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			30
Item 4.		Controls and Procedures			30
		Report of Independent Registered Public Accounting Firm			31
Part II Other Information
Item 1.		Legal Proceedings			32
Item 1A.		Risk Factors			32
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			33
Item 4.		Submission of Matters to a Vote of Security Holders			33
Item 6.		Exhibits			34
		Signature			35
Letter Regarding Unaudited Interim Financial Information
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906

PART I FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Pentair, Inc. and Subsidiaries

		Three months ended								Six months ended
		July 1				July 2				July 1				July 2
In thousands, except per-share data		2006				2005				2006				2005
Net sales		$	862,022			$	788,523			$	1,633,411			$	1,498,158
Cost of goods sold			599,333				553,290				1,148,214				1,058,787
Gross profit			262,689				235,233				485,197				439,371
Selling, general and administrative			139,831				117,467				268,920				238,092
Research and development			14,883				10,532				29,746				21,959
Operating income			107,975				107,234				186,531				179,320
Gain on sale of investment			—				5,199				—				5,199
Net interest expense			12,553				11,696				25,837				22,972
Income from continuing operations before income taxes			95,422				100,737				160,694				161,547
Provision for income taxes			26,789				39,358				48,990				59,987
Income from continuing operations			68,633				61,379				111,704				101,560
Loss on disposal of discontinued operations, net of tax			—				—				(1,451	)			—
Net income		$	68,633			$	61,379			$	110,253			$	101,560
Earnings (loss) per common share
Basic
Continuing operations		$	0.68			$	0.61			$	1.11			$	1.01
Discontinued operations			—				—				(0.01	)			—
Basic earnings per common share		$	0.68			$	0.61			$	1.10			$	1.01
Diluted
Continuing operations		$	0.67			$	0.60			$	1.09			$	0.99
Discontinued operations			—				—				(0.01	)			—
Diluted earnings per common share		$	0.67			$	0.60			$	1.08			$	0.99
Weighted average common shares outstanding
Basic			100,509				100,769				100,498				100,566
Diluted			102,429				102,827				102,457				102,715
Cash dividends declared per common share		$	0.14			$	0.13			$	0.28			$	0.26

See accompanying notes to condensed consolidated financial statements.

Pentair, Inc. and Subsidiaries

		July 1				December 31				July 2
In thousands, except share and per-share data		2006				2005				2005
Assets
Current assets
Cash and cash equivalents		$	48,331			$	48,500			$	41,853
Accounts and notes receivable, net			502,982				423,847				457,878
Inventories			380,219				349,312				339,460
Deferred tax assets			45,922				48,971				49,077
Prepaid expenses and other current assets			27,659				24,394				27,734
Total current assets			1,005,113				895,024				916,002
Property, plant and equipment, net			312,146				311,839				324,477
Other assets
Goodwill			1,729,179				1,718,207				1,614,248
Intangibles, net			263,600				266,533				254,233
Other			80,167				62,152				60,538
Total other assets			2,072,946				2,046,892				1,929,019
Total assets		$	3,390,205			$	3,253,755			$	3,169,498
Liabilities and Shareholders’ Equity
Current liabilities
Short-term borrowings		$	4,869			$	—			$	—
Current maturities of long-term debt			6,970				4,137				6,469
Accounts payable			224,237				207,320				195,702
Employee compensation and benefits			83,071				95,552				80,584
Accrued product claims and warranties			41,346				43,551				43,940
Current liabilities of discontinued operations			—				192				192
Income taxes			22,533				17,518				45,123
Accrued rebates and sales incentives			35,723				45,374				38,177
Other current liabilities			83,937				111,026				97,367
Total current liabilities			502,686				524,670				507,554
Long-term debt			801,898				748,477				727,631
Pension and other retirement compensation			164,480				152,780				138,830
Post-retirement medical and other benefits			73,723				73,949				70,309
Deferred tax liabilities			125,418				125,785				143,377
Other non-current liabilities			79,838				70,455				67,576
Non-current liabilities of discontinued operations			—				2,029				2,031
Total liabilities			1,748,043				1,698,145				1,657,308
Commitments and contingencies
Shareholders’ equity
Common shares par value $0.16 2/3; 101,122,243, 101,202,237 and 101,845,021 shares issued and outstanding, respectively			16,854				16,867				16,974
Additional paid-in capital			512,356				518,751				520,968
Retained earnings			1,102,773				1,020,978				963,975
Accumulated other comprehensive income (loss)			10,179				(986	)			10,273
Total shareholders’ equity			1,642,162				1,555,610				1,512,190
Total liabilities and shareholders’ equity		$	3,390,205			$	3,253,755			$	3,169,498

See accompanying notes to condensed consolidated financial statements.

Pentair, Inc. and Subsidiaries

		Six months ended
		July 1				July 2
In thousands		2006				2005
Operating activities
Net income		$	110,253			$	101,560
Adjustments to reconcile net income to net cash used for operating activities
Loss on disposal of discontinued operations			1,451				—
Depreciation			30,386				28,962
Amortization			9,476				8,074
Deferred income taxes			181				2,572
Stock compensation			12,484				13,306
Excess tax benefits from stock-based compensation			(2,605	)			(7,809	)
Gain on sale of investment			—				(5,199	)
Changes in assets and liabilities, net of effects of business acquisitions and dispositions
Accounts and notes receivable			(74,193	)			(72,729	)
Inventories			(28,032	)			(22,340	)
Prepaid expenses and other current assets			(2,809	)			(4,036	)
Accounts payable			12,382				4,590
Employee compensation and benefits			(16,832	)			(29,912	)
Accrued product claims and warranties			(1,793	)			1,228
Income taxes			6,443				18,285
Other current liabilities			(19,933	)			787
Pension and post-retirement benefits			8,722				7,370
Other assets and liabilities			1,565				(5,144	)
Net cash provided by continuing operations			47,146				39,565
Net cash provided by (used for) operating activities of discontinued operations			48				(630	)
Net cash provided by operating activities			47,194				38,935
Investing activities
Capital expenditures			(20,217	)			(39,077	)
Proceeds from sale of property and equipment			221				11,553
Acquisitions, net of cash acquired			(19,694	)			(10,513	)
Divestitures			(24,007	)			(190	)
Other			(4,273	)			23,596
Net cash used for investing activities			(67,970	)			(14,631	)
Financing activities
Net short-term borrowings			4,763				—
Proceeds from long-term debt			414,233				186,610
Repayment of long-term debt			(358,141	)			(186,993	)
Proceeds from exercise of stock options			2,939				6,355
Excess tax benefits from stock-based compensation			2,605				7,809
Repurchases of common stock			(18,330	)			—
Dividends paid			(28,458	)			(26,648	)
Net cash provided by (used for) financing activities			19,611				(12,867	)
Effect of exchange rate changes on cash and cash equivalents			996				(1,079	)
Change in cash and cash equivalents			(169	)			10,358
Cash and cash equivalents, beginning of period			48,500				31,495
Cash and cash equivalents, end of period		$	48,331			$	41,853

See accompanying notes to condensed consolidated financial statements.

Notes to condensed consolidated financial statements (unaudited)

1. Basis of Presentation and Responsibility for Interim Financial Statements

We prepared the unaudited condensed consolidated financial statements following the requirements of the 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 our consolidated financial statements and notes thereto, which are included in our 2005 Annual Report on Form 10-K for the year ended December 31, 2005.

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.

Certain reclassifications have been made to prior years’ consolidated financial statements to conform to the current year’s presentation.

2. New Accounting Standards

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 153, Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions (“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005 and we adopted it on January 1, 2006. The adoption of SFAS 153 did not have a material impact on our consolidated results of operations, financial condition, or cash flow.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs—An Amendment of ARB No. 43, Chapter 4 (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005 and we adopted it on January 1, 2006. The adoption of SFAS 151 did not have on material impact on our consolidated results of operations or financial condition.

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-1 (“EITF 03-1”), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-1 provides guidance on other-than-temporary impairment models for marketable debt and equity securities accounted for under SFAS 115 and non-marketable equity securities accounted for under the cost method. The EITF developed a basic three-step model to evaluate whether an investment is other-than-temporarily impaired. In November 2005, the FASB approved the issuance of FASB Staff Position FAS No. 115-1 and FAS No. 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The FASB Staff Position (“FSP”) addresses when an investment is considered impaired, whether the impairment is other-than-temporary and the measurement of an impairment loss. The FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary. The FSP is effective for reporting periods beginning after December 15, 2005 and we adopted it on January 1, 2006. The adoption of EITF 03-1 did not have a material impact on our consolidated results of operations or financial condition.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS 154”) which replaces Accounting Principles Board Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements—An Amendment of APB Opinion No. 28. SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 on January 1, 2006 has not had a material impact on our consolidated results of operations or financial condition.

In June 2005, the EITF reached a consensus on Issue No. 05-5, Accounting for Early Retirement or Postemployment Programs with Specific Features (such as Terms Specified in Altersteilzeit Early Retirement Arrangements) (“EITF 05-5”). EITF 05-5 addresses the accounting for the bonus feature in the German Altersteilzeit (“ATZ”) early retirement programs and requires recognition of the program expenses at the time the

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

ATZ contracts are signed. The EITF offers two transition alternatives, either cumulative effect or retrospective application. The EITF is effective for fiscal years beginning after December 15, 2005 and we adopted it on January 1, 2006. The adoption of EITF 05-5 did not have a material impact on our consolidated results of operations or financial condition.

In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”) Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement 109. FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file a tax return in a particular jurisdiction. FIN 48 is effective for fiscal years beginning after December 15, 2006. If there are changes in net assets as a result of application of FIN 48, these will be accounted for as an adjustment to retained earnings. The Company is currently assessing the impact of FIN 48 on its consolidated results of operations or financial condition.

3. Stock-based Compensation

In the fourth quarter 2005, we adopted SFAS No. 123 (Revised 2004), Share-Based Payment (“SFAS 123R”), using the modified retrospective transition method as permitted by SFAS 123R. Under this transition method, we restated our 2005 interim financial statements. Total stock-based compensation expense for the first half of 2006 and 2005 was $12.5 million and $13.3 million, respectively.

Non-vested shares of our common stock were granted during the first half of 2006 to eligible employees with a vesting period of two to five years after issuance. The non-vested shares were granted at the market price on the date of grant and are expensed over the vesting period. Total compensation expense for non-vested share awards during the first half of 2006 and 2005 was $4.8 million and $4.0 million, respectively.

During the first half of 2006, option awards were granted under the Omnibus Stock Incentive Plan and the Outside Directors Nonqualified Stock Option Plan with an exercise price equal to the market price of our common stock on the date of grant. Option awards granted in the first half of 2006 under the Omnibus Stock Incentive Plan did not have a reload feature attached to the option. The options vest one-third each year over a three-year period and have a ten-year contractual term. Compensation expense equal to the grant date fair value is recognized for these awards over the vesting period. Certain option grants were reloaded during the first half of 2006 for individuals retiring shares to pay the exercise price of options granted prior to 2006. Reload options are vested and expensed immediately. Total compensation expense for stock option awards was $7.7 million and $9.3 million for the first half of 2006 and 2005, respectively.

We estimated the fair value of each stock option award during the second quarter of 2006 and 2005 on the date of grant using a Black-Scholes option pricing model, modified for dividends and using the following assumptions:

		July 1				July 2
		2006				2005
Expected stock price volatility			31.5	%			34.5	%
Expected life		4.5 yrs.				3.6 yrs.
Risk-free interest rate			4.99	%			3.75	%
Dividend yield			1.54	%			1.20	%

The weighted-average fair value of options granted during the first half of 2006 and 2005 was $10.94 and $11.44 per share, respectively.

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 SFAS No. 123R, 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. The increase in the expected life in 2006 compared to 2005 was the result of a decrease in exercise activity and the stock price in the preceding year. 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.

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

4. Earnings Per Common Share

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

		Three months ended								Six months ended
		July 1				July 2				July 1				July 2
In thousands, except per-share data		2006				2005				2006				2005
Earnings (loss) per common share — basic
Continuing operations		$	68,633			$	61,379			$	111,704			$	101,560
Discontinued operations			—				—				(1,451	)			—
Net income		$	68,633			$	61,379			$	110,253			$	101,560
Continuing operations		$	0.68			$	0.61			$	1.11			$	1.01
Discontinued operations			—				—				(0.01	)			—
Basic earnings per common share		$	0.68			$	0.61			$	1.10			$	1.01
Earnings (loss) per common share — diluted
Continuing operations		$	68,633			$	61,379			$	111,704			$	101,560
Discontinued operations			—				—				(1,451	)			—
Net income		$	68,633			$	61,379			$	110,253			$	101,560
Continuing operations		$	0.67			$	0.60			$	1.09			$	0.99
Discontinued operations			—				—				(0.01	)			—
Diluted earnings per common share		$	0.67			$	0.60			$	1.08			$	0.99
Weighted average common shares outstanding — basic			100,509				100,769				100,498				100,566
Dilutive impact of stock options and restricted stock			1,920				2,058				1,959				2,149
Weighted average common shares outstanding — diluted			102,429				102,827				102,457				102,715
Stock options excluded from the calculation of diluted earnings per share because the exercise price was greater than the average market price of the common shares			2,410				561				2,382				549

5. Acquisitions

On June 23, 2006, we acquired as part of our Water Group the assets of Cozad & O’Hara of Cathedral City, Inc. (“Cozad & O’Hara”) for $0.5 million in cash plus a note payable and debt assumed of $0.6 million. Goodwill recorded as part of the initial purchase price allocation was $0.7 million, all of which is tax deductible. We continue to evaluate the purchase price allocation for the Cozad & O’Hara acquisition and expect to revise the purchase price allocation as better information becomes available.

On April 12, 2006, we acquired as part of our Water Group the assets of Geyer’s Manufacturing & Design Inc. and FTA Filtration, Inc. (together “Krystil Klear”), two privately-held companies, for $15.0 million in cash plus debt assumed of $0.4 million. Krystil Klear expands our industrial filtration product offering to include a full range of steel and stainless steel housing filtration solutions. Goodwill recorded as part of the initial purchase price allocation was $8.9 million, all of which is tax deductible. We continue to evaluate the purchase price allocation for the Krystil Klear acquisition, including intangible assets, contingent liabilities, plant rationalization costs, and property, plant and equipment. We expect to revise the purchase price allocation as better information becomes available.

On December 1, 2005, we acquired the McLean Thermal Management, Aspen Motion Technologies, and Electronic Solutions businesses from APW, Ltd. (collectively, “Thermal”) for $140.0 million, including a cash payment of $138.9 million and transaction costs of $1.1 million. During 2006, we paid an additional $2.2 million in transaction costs and paid a final purchase price adjustment of $1.6 million. These businesses provide thermal management solutions and integration services to the telecommunications, data communications, medical, industrial, and security markets as part of our Technical Products Group. Goodwill recorded as part of the initial purchase price allocation was $93.7 million, all of which is tax deductible. We continue to evaluate the purchase price allocation for the Thermal acquisition, including intangible assets, contingent liabilities, plant rationalization costs, and property, plant and equipment. We expect to revise the purchase price allocation as better information becomes available.

On February 23, 2005, we acquired certain assets of Delta Environmental Products, Inc. and affiliates (collectively, “DEP”), a privately-held company, for $10.3 million, including a cash payment of $10.0 million, transaction costs of $0.2 million, and debt assumed of $0.1 million. The DEP product line addresses the water and wastewater markets and is part of our Water Group. Goodwill recorded as part of the initial purchase price allocation was $9.3 million, all of which is tax deductible. We finalized the purchase price allocation for the DEP acquisition during the first quarter of 2006.

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

The following pro forma condensed consolidated financial results of operations are presented as if the acquisitions described above had been completed at the beginning of each period presented.

		Three months ended								Six months ended
		July 1				July 2				July 1				July 2
In thousands, except per-share data		2006				2005				2006				2005
Pro forma net sales from continuing operations		$	862,553			$	824,405			$	1,635,534			$	1,566,921
Pro forma net income from continuing operations			68,538				62,472				111,581				102,596
Pro forma earnings per common share — continuing operations
Basic		$	0.68			$	0.62			$	1.11			$	1.02
Diluted		$	0.67			$	0.61			$	1.09			$	1.00
Weighted average common shares outstanding
Basic			100,509				100,769				100,498				100,566
Diluted			102,429				102,827				102,457				102,715

These pro forma condensed consolidated financial results have been prepared for comparative purposes only and include certain adjustments, such as increased interest expense on acquisition debt. They do not reflect the effect of synergies that would have been expected to result from the integration of these acquisitions. The pro forma information does not purport to be indicative of the results of operations that actually would have resulted had the combination occurred at the beginning of each period presented, or of future results of the consolidated entities.

6. Discontinued Operations

Effective after the close of business on October 2, 2004, we completed the sale of our former Tools Group to The Black & Decker Corporation (“BDK”). Pursuant to the purchase agreement for the sale of our former Tools Group, we completed the repurchase of a manufacturing facility in Suzhou, China from BDK for approximately $5.7 million in January 2006. We recorded no gain or loss on the repurchase. On March 8, 2006, we received notice regarding the settlement of an outstanding net asset value dispute with BDK relating to the purchase price for the sale of our former Tools Group. The decision by the arbitrator constituted a final resolution of all disputes between BDK and us regarding the net asset value. We paid the final purchase price adjustment of $16.1 million plus interest of $1.1 million in March 2006, resulting in an incremental pre-tax loss on disposal of discontinued operations of $3.4 million or $1.6 million net of tax.

In 2001, we completed the sale of our former Service Equipment businesses (Century Mfg. Co./Lincoln Automotive Company) to Clore Automotive, LLC. In the fourth quarter of 2003, we reported an additional loss from discontinued operations of $2.9 million related to exiting the remaining two facilities. In March 2006, we exited a leased facility from our former Service Equipment business resulting in a net cash outflow of $2.2 million and an immaterial gain from disposition.

Operating results of the discontinued operations for the second quarter and first half of 2006 and 2005 are summarized below:

		Three months ended								Six months ended
		July 1				July 2				July 1				July 2
In thousands		2006				2005				2006				2005
Loss on disposal of discontinued operations		$	(683	)		$	—			$	(3,937	)		$	—
Income tax benefit			683				—				2,486				—
Loss on disposal of discontinued operations, net of tax		$	—			$	—			$	(1,451	)		$	—

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

7. Inventories

Inventories were comprised of:

		July 1				December 31				July 2
In thousands		2006				2005				2005
Raw materials and supplies		$	173,432			$	146,389			$	136,410
Work-in-process			50,761				49,418				44,527
Finished goods			156,026				153,505				158,523
Total inventories		$	380,219			$	349,312			$	339,460

8. Comprehensive Income

Comprehensive income and its components, net of tax, were as follows:

		Three months ended								Six months ended
		July 1				July 2				July 1				July 2
In thousands		2006				2005				2006				2005
Net income		$	68,633			$	61,379			$	110,253			$	101,560
Changes in cumulative foreign currency translation adjustment			4,594				(12,377	)			8,491				(22,347	)
Changes in market value of derivative financial instruments classified as cash flow hedges			1,111				104				2,674				214
Comprehensive income		$	74,338			$	49,106			$	121,418			$	79,427

9. Goodwill and Other Intangible Assets

Changes in the carrying amount of goodwill for the six months ended July 1, 2006 by segment were as follows:

						Technical
In thousands		Water				Products				Consolidated
Balance at December 31, 2005		$	1,433,280			$	284,927			$	1,718,207
Acquired			9,584				—				9,584
Purchase accounting adjustments			(9,695	)			4,138				(5,557	)
Foreign currency translation			3,898				3,047				6,945
Balance at July 1, 2006		$	1,437,067			$	292,112			$	1,729,179

The acquired goodwill in the Water segment is related to our acquisitions of Krystil Klear and Cozad & O’Hara during the second quarter of 2006.

Purchase accounting adjustments recorded during the first half of 2006 relate to the WICOR, Inc. , DEP, Thermal, and Krystil Klear acquisitions. The purchase price adjustments during the first half of 2006 included adjustments for additional transaction and restructuring costs incurred, and reclassifications related to the WICOR, Inc. purchase accounting.

Intangible assets, other than goodwill, were comprised of:

		July 1, 2006												December 31, 2005												July 2, 2005
		Gross												Gross												Gross
		carrying				Accum.								carrying				Accum.								carrying				Accum.
In thousands		amount				amort				Net				amount				amort				Net				amount				amort				Net
Finite-life intangibles
Patents		$	18,711			$	(5,123	)		$	13,588			$	15,685			$	(4,135	)		$	11,550			$	15,690			$	(3,179	)		$	12,511
Non-compete agreements			4,129				(2,520	)			1,609				3,937				(2,021	)			1,916				7,463				(4,919	)			2,544
Proprietary technology			51,493				(7,302	)			44,191				51,386				(5,107	)			46,279				45,093				(3,457	)			41,636
Customer relationships			87,741				(11,539	)			76,202				87,707				(8,647	)			79,060				84,526				(6,005	)			78,521
Total finite-life intangibles		$	162,074			$	(26,484	)		$	135,590			$	158,715			$	(19,910	)		$	138,805			$	152,772			$	(17,560	)		$	135,212
Indefinite-life intangibles
Brand names		$	128,010			$	—			$	128,010			$	127,728			$	—			$	127,728			$	119,021			$	—			$	119,021
Total intangibles, net										$	263,600											$	266,533											$	254,233

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Intangible asset amortization expense for the six months ended July 1, 2006 and July 2, 2005 was approximately $6.6 million and $5.7 million, respectively. The estimated future amortization expense for identifiable intangible assets during the remainder of 2006 and the next five years is as follows:

In thousands		2006 Q3 - Q4				2007				2008				2009				2010				2011
Estimated amortization expense		$	6,811			$	12,314			$	11,399			$	11,219			$	10,715			$	10,515

10. Debt

Debt and the average interest rate on debt outstanding is summarized as follows:

		Average
		interest rate				Maturity				July 1				December 31				July 2
In thousands		July 1, 2006				(Year)				2006				2005				2005
Commercial paper, maturing within 48 days			5.62	%						$	217,287			$	144,656			$	172,544
Revolving credit facilities			5.94	%			2010				95,900				112,300				63,100
Private placement — fixed rate			5.50	%			2007-2013				135,000				135,000				135,000
Private placement — floating rate			5.70	%			2013				100,000				100,000				100,000
Senior notes			7.85	%			2009				250,000				250,000				250,000
Other			2.35	%			2006-2016				11,760				6,285				8,499
Total contractual debt obligations											809,947				748,241				729,143
Interest rate swap monetization deferred income											3,790				4,373				4,957
Total long-term debt, including current portion per balance sheet											813,737				752,614				734,100
Less: Current maturities of long-term debt											(6,970	)			(4,137	)			(6,469	)
Short-term borrowings											(4,869	)			—				—
Total long-term debt											$801,898				$748,477				$727,631

We have a multi-currency revolving Credit Facility (the “Credit Facility”) of $800 million expiring on March 4, 2010. The interest rate on the loans under the $800 million Credit Facility is LIBOR plus 0.625%. Interest rates and fees on the Credit Facility vary based on our credit ratings.

We are authorized to sell short-term commercial paper notes to the extent availability exists under the Credit Facility. We use the Credit Facility as back-up liquidity to support 100% of commercial paper outstanding. As of July 1, 2006, we had $217.3 million of commercial paper outstanding that matures within 48 days. All of the commercial paper was classified as long-term as we have the intent and the ability to refinance such obligations on a long-term basis under the Credit Facility.

We have $35 million of outstanding private placement debt maturing in May 2007. We classified this debt as long-term as of July 1, 2006 as we have the intent and ability to refinance such obligation on a long-term basis under the Credit Facility.

We were in compliance with all debt covenants as of July 1, 2006.

In addition to the Credit Facility, we have $25 million of uncommitted credit facilities, under which we had borrowings of $4.9 million as of July 1, 2006.

Long-term debt outstanding at July 1, 2006 matures on a calendar year basis as follows:

In thousands		2006 Q3-Q4				2007				2008				2009				2010				2011				Thereafter				Total
Contractual long-term debt obligation maturities		$	1,664			$	4,426			$	260			$	250,251			$	348,366			$	76			$	200,035			$	805,078
Other maturities			583				1,166				1,166				875				—				—				—				3,790
Total maturities		$	2,247			$	5,592			$	1,426			$	251,126			$	348,366			$	76			$	200,035			$	808,868

11. Derivatives and Financial Instruments

In September 2005, we entered into a $100 million interest rate swap agreement with several major financial institutions to exchange variable rate interest payment obligations for fixed rate obligations without the exchange of the underlying principle amounts in order to manage interest rate exposures. The effective date of the fixed rate swap was April 25, 2006. The swap agreement has a fixed interest rate of 4.68% and expires in July 2013. The fixed interest rate of 4.68% plus the .60% interest rate spread over LIBOR, results in an effective fixed interest rate of 5.28%. The fair value of the swap at July 1, 2006 was $5.2 million and was recorded in other assets at July 1, 2006.

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

The variable to fixed interest rate swap is designated as and is effective as a cash-flow hedge. The fair value of the swap is recorded on the balance sheet, with changes in fair values included in Other Comprehensive Income (“OCI”). Derivative gains and losses included in OCI are recorded in earnings at the time the related interest rate expense is recognized or the settlement of the related commitment occurs.

12. Income Taxes

The provision for income taxes consists of provisions for federal, state and foreign income taxes. We operate in an international environment with operations in various locations outside the U.S. Accordingly, the consolidated income tax rate is a composite rate reflecting the earnings in the various locations and the applicable rates.

The effective income tax rate for the six months ended July 1, 2006 was 30.5% compared to 37.1% for the six months ended July 2, 2005. The tax rate for the first half of 2006 includes a favorable adjustment in the second quarter primarily related to the resolution of an IRS exam for the periods of 2002-2003 and a favorable adjustment in the first quarter related to a prior year tax return. The 2005 effective tax rate included an unfavorable settlement related to a routine German tax examination for prior years which was partially offset by a favorable settlement for an IRS exam for the periods of 1998-2001. We continue to actively pursue initiatives to reduce our effective tax rate. The tax rate in any quarter can be affected positively or negatively by adjustments that are required to be reported in the specific quarter of resolution.

13. Benefit Plans

Components of net periodic benefit cost for the three and six months ended July 1, 2006 and July 2, 2005 were as follows:

		Three months ended
		Pension benefits								Post-retirement
		July 1				July 2				July 1				July 2
In thousands		2006				2005				2006				2005
Service cost		$	4,512			$	4,118			$	184			$	213
Interest cost			7,343				7,456				799				947
Expected return on plan assets			(6,974	)			(7,373	)			—				—
Amortization of transition obligation			31				30				—				—
Amortization of prior year service cost (benefit)			77				74				(59	)			(50	)
Recognized net actuarial loss			1,009				698				(212	)			—
Net periodic benefit cost		$	5,998			$	5,003			$	712			$	1,110

		Six months ended
		Pension benefits								Post-retirement
		July 1				July 2				July 1				July 2
In thousands		2006				2005				2006				2005
Service cost		$	9,024			$	8,236			$	368			$	425
Interest cost			14,686				14,911				1,598				1,894
Expected return on plan assets			(13,948	)			(14,746	)			—				—
Amortization of transition obligation			62				59				—				—
Amortization of prior year service cost (benefit)			154				149				(118	)			(100	)
Recognized net actuarial loss			2,018				1,396				(424	)			—
Net periodic benefit cost		$	11,996			$	10,005			$	1,424			$	2,219

14. Business Segments

Financial information by reportable segment for the three and six months ended July 1, 2006 and July 2, 2005 is shown below:

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

		Three months ended								Six months ended
		July 1				July 2				July 1				July 2
In thousands		2006				2005				2006				2005
Net sales to external customers
Water		$	605,516			$	585,657			$	1,122,685			$	1,097,745
Technical Products			256,506				202,866				510,726				400,413
Consolidated		$	862,022			$	788,523			$	1,633,411			$	1,498,158
Intersegment sales
Water		$	55			$	187			$	105			$	209
Technical Products			1,312				630				2,201				1,032
Other			(1,367	)			(817	)			(2,306	)			(1,241	)
Consolidated		$	—			$	—			$	—			$	—
Operating income (loss)
Water		$	84,191			$	92,167			$	139,778			$	152,656
Technical Products			39,678				26,325				77,382				51,497
Other			(15,894	)			(11,258	)			(30,629	)			(24,833	)
Consolidated		$	107,975			$	107,234			$	186,531			$	179,320

Other operating loss is primarily composed of unallocated corporate expenses, costs related to our captive insurance subsidiary and our intermediate finance companies, and intercompany eliminations.

15. Warranty

The changes in the carrying amount of service and product warranty accruals for the six months ended July 1, 2006 and July 2, 2005 were as follows:

		July 1				July 2
In thousands		2006				2005
Balance at beginning of the year		$	33,551			$	32,524
Service and product warranty provision			20,576				20,898
Payments			(22,910	)			(19,596	)
Acquired			—				446
Translation			129				(332	)
Balance at end of the period		$	31,346			$	33,940

16. Commitments and Contingencies

Environmental and Litigation

There have been no further material developments from the disclosures contained in our 2005 Annual Report on Form 10-K, other than those matters identified below.

Horizon Litigation

Twenty-eight separate lawsuits involving 29 primary plaintiffs, a class action, and claims for indemnity by Celebrity Cruise Lines, Inc. (Celebrity) were brought against Essef Corporation (Essef) and certain of its subsidiaries prior to our acquisition of Essef in August 1999. The claims against Essef and its involved subsidiaries were based upon the allegation that Essef designed, manufactured, and marketed two sand swimming pool filters that were installed as a part of the spa system on the Horizon cruise ship, and allegations that the spa and filters contained Legionnaire’s disease bacteria that infected certain passengers on cruises from April 1994 through July 1994.

The individual and class claims by passengers were tried and resulted in an adverse jury verdict finding liability on the part of the Essef defendants (70%) and Celebrity and its sister company, Fantasia (together 30%). After expiration of post-trial appeals, we paid all outstanding punitive damage awards of $7.0 million in the Horizon cases, plus interest of approximately $1.6 million, in January 2004. All of the personal injury cases have now been resolved through either settlement or trial.

The only remaining unresolved claims in this case were those brought by Celebrity for damages resulting from the outbreak. Celebrity filed an amended complaint seeking attorney fees and costs for prior litigation as well as out-of-pocket losses, lost profits, and loss of business enterprise value. On June 28, 2006, the jury returned a verdict against the Essef defendants in the total amount of $193 million for its claims for out-of-pocket expenses ($10.4 million), lost profits ($47.6 million) and loss of business enterprise value ($135 million). The verdict is exclusive of pre-judgment interest and attorneys’ fees. We believe that the jury verdict is not consistent with the law nor the evidence offered

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

at trial. We intend to argue all appropriate post-trial motions, or if unsuccessful to appeal any subsequent judgment, to reverse or substantially reduce this verdict, in particular the claims relating to lost profits and lost enterprise value.

We have assessed the impact of the verdict on our previously established reserves for this matter and based on information available at this time, have deemed it unnecessary to adjust our reserves. First, several issues have not been addressed by the court, including whether Celebrity is entitled to recovery of its attorneys’ fees and related costs in the passenger claims phase of the case ($4.1 million), and, with respect to pre-judgment interest, the length of the interest period and the rate of interest on any eventual judgment. In addition, the court has not decided Essef’s contribution claim to reduce Celebrity’s recovery by 30% to account for its contributory negligence. Second we believe that we will ultimately be successful in obtaining substantial relief from this misguided verdict. While we are not able to determine the amount of the eventual liability at this time, we believe that an appropriate result would be substantially less than the verdict the jury rendered. As a result, we are maintaining our accruals at the same level as before, which we believe are within the range of reasonable outcomes for this case.

If judgment were subsequently entered on this verdict and upheld on appeal as it currently stands, which we believe is unlikely to occur for the reasons noted above, the interest incurred through June 2006 would range from approximately $75 to $171 million, depending on interest rate and interest period used. In this worst case situation, the gross amount that we would have pay in this matter would then total from $268 to $364 million. While we believe the majority of the amount would be tax-deductible in the year paid or in subsequent years, we are still analyzing the tax impact of a loss of that magnitude. In addition to the impact of a loss on this matter on our earnings per share when recognized, we would also need eventually to borrow funds from our banks or other sources to pay any judgment finally determined after exhaustion of all appeals. We expect that we would have available adequate funds to allow us to do so, based on discussions with our lending sources and our estimates of the results of our business operations over the next two years.

During the period prior to final determination and payment of any ultimate recovery to Celebrity, we believe that we will be able to operate in the normal course of business, although interim acquisition plans and other discretionary spending may be reduced. Any final judgment paid would also increase our indebtedness or reduce cash available for other uses. Any such payment could impact our ability to execute our long-term strategic plans to their full extent, but we do not believe our ongoing financial and operational condition will be compromised.

Other

We are occasionally a party to other litigation arising in the normal course of business. We regularly analyze current information and, as necessary, provide accruals for probable liabilities based on the expected eventual disposition of these matters. While it is possible that the Company’s cash flows and results of operations in a particular quarter or year could be materially affected by the one-time impacts of the resolution of such contingencies, it is the opinion of management that the ultimate disposition of these matters will not have a material impact on the Company’s financial position, or ongoing results of operations and cash flows.

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

17. Financial Statements of Subsidiary Guarantors

The $250 million Senior Notes due 2009 are jointly and severally guaranteed by our domestic subsidiaries (the “Guarantor Subsidiaries”), each of which is directly or indirectly wholly-owned by Pentair (the “Parent Company”). The following supplemental financial information sets forth the condensed consolidated balance sheets as of July 1, 2006 and December 31, 2005, the related condensed consolidated statements of income for the three months and six months ended July 1, 2006 and July 2, 2005, and statements of cash flows for the six months ended July 1, 2006 and July 2, 2005, for the Parent Company, the Guarantor Subsidiaries, the non-guarantor subsidiaries and total consolidated Pentair and subsidiaries.

Pentair, Inc. and Subsidiaries

		Parent				Guarantor				Non-Guarantor
In thousands		Company				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Net sales		$	—			$	722,090			$	179,670			$	(39,738	)		$	862,022
Cost of goods sold			222				509,036				130,599				(40,524	)			599,333
Gross profit			(222	)			213,054				49,071				786				262,689
Selling, general and administrative			9,264				98,082				31,699				786				139,831
Research and development			—				11,549				3,334				—				14,883
Operating (loss) income			(9,486	)			103,423				14,038				—				107,975
Net interest (income) expense			(16,369	)			29,800				(878	)			—				12,553
Income from continuing operations before income taxes			6,883				73,623				14,916				—				95,422
Provision for income taxes			2,388				19,035				5,366				—				26,789
Net income		$	4,495			$	54,588			$	9,550			$	—			$	68,633

Pentair, Inc. and Subsidiaries

		Parent				Guarantor				Non-Guarantor
In thousands		Company				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Net sales		$	—			$	1,355,150			$	360,955			$	(82,694	)		$	1,633,411
Cost of goods sold			347				968,259				262,672				(83,064	)			1,148,214
Gross profit			(347	)			386,891				98,283				370				485,197
Selling, general and administrative			15,485				191,623				61,442				370				268,920
Research and development			—				23,333				6,413				—				29,746
Operating (loss) income			(15,832	)			171,935				30,428				—				186,531
Net interest (income) expense			(31,901	)			59,586				(1,848	)			—				25,837
Income from continuing operations before income taxes			16,069				112,349				32,276				—				160,694
Provision for income taxes			5,580				32,071				11,339				—				48,990
Income from continuing operations			10,489				80,278				20,937				—				111,704
Loss on disposal of discontinued operations, net of tax			(1,451	)			—				—				—				(1,451	)
Net income		$	9,038			$	80,278			$	20,937			$	—			$	110,253

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Pentair, Inc. and Subsidiaries

		Parent				Guarantor				Non-Guarantor
In thousands		Company				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Assets
Current assets
Cash and cash equivalents		$	9,832			$	7,634			$	30,865			$	—			$	48,331
Accounts and notes receivable, net			642				403,759				149,483				(50,902	)			502,982
Inventories			—				285,489				94,730				—				380,219
Deferred tax assets			19,532				33,946				5,591				(13,147	)			45,922
Prepaid expenses and other current assets			3,349				10,727				16,375				(2,792	)			27,659
Total current assets			33,355				741,555				297,044				(66,841	)			1,005,113
Property, plant and equipment, net			5,059				219,631				87,456				—				312,146
Other assets
Investments in subsidiaries			1,983,413				43,942				94,715				(2,122,070	)			—
Goodwill			—				1,492,452				236,727				—				1,729,179
Intangibles, net			—				240,433				23,167				—				263,600
Other			54,596				19,703				5,868				—				80,167
Total other assets			2,038,009				1,796,530				360,477				(2,122,070	)			2,072,946
Total assets		$	2,076,423			$	2,757,716			$	744,977			$	(2,188,911	)		$	3,390,205
Liabilities and Shareholders’ Equity
Current liabilities
Short-term borrowings		$	—			$	—			$	4,869			$	—			$	4,869
Current maturities of long-term debt			1,166				291				28,157				(22,644	)			6,970
Accounts payable			1,925				185,237				87,249				(50,174	)			224,237
Employee compensation and benefits			10,869				45,541				26,661				—				83,071
Accrued product claims and warranties			—				26,458				14,888				—				41,346
Income taxes			(2,141	)			16,473				8,201				—				22,533
Accrued rebates and sales incentives			—				33,871				1,852				—				35,723
Other current liabilities			13,428				48,960				24,336				(2,787	)			83,937
Total current liabilities			25,247				356,831				196,213				(75,605	)			502,686
Long-term debt			800,811				1,787,051				11,763				(1,797,727	)			801,898
Pension and other retirement compensation			81,385				29,614				53,481				—				164,480
Post-retirement medical and other benefits			23,634				50,089				—				—				73,723
Deferred tax liabilities			(51,407	)			162,806				27,166				(13,147	)			125,418
Due to / (from) affiliates			(475,844	)			100,682				241,804				133,358				—
Other non-current liabilities			30,436				7,323				42,079				—				79,838
Total liabilities			434,262				2,494,396				572,506				(1,753,121	)			1,748,043
Shareholders’ equity			1,642,161				263,320				172,471				(435,790	)			1,642,162
Total liabilities and shareholders’ equity		$	2,076,423			$	2,757,716			$	744,977			$	(2,188,911	)		$	3,390,205

Pentair, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Pentair, Inc. and Subsidiaries

		Parent				Guarantor				Non-Guarantor
In thousands		Company				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Operating activities
Net income		$	9,038			$	80,278			$	20,937			$	—			$	110,253
Adjustments to reconcile net income to net cash provided by (used for) operating activities:
Loss on disposal of discontinued operations			1,451				—				—				—				1,451
Depreciation			801				22,756				6,829				—				30,386
Amortization			2,924				6,069				483				—				9,476
Deferred income taxes			1,973				(4,646	)			2,854				—				181
Stock compensation			5,868				5,617				999				—				12,484
Excess tax benefit from stock-based compensation			(1,225	)			(1,172	)			(208	)			—				(2,605	)
Changes in assets and liabilities, net of effects of business acquisitions and dispositions
Accounts and notes receivable			(1,055	)			(64,438	)			(25,571	)			16,871				(74,193	)
Inventories			—				(17,761	)			(10,271	)			—				(28,032	)
Prepaid expenses and other current assets			14,798				(1,887	)			(13,450	)			(2,270	)			(2,809	)
Accounts payable			1,223				16,485				11,545				(16,871	)			12,382
Employee compensation and benefits			(6,050	)			(11,702	)			920				—				(16,832	)
Accrued product claims and warranties			—				(1,664	)			(129	)			—				(1,793	)
Income taxes			(531	)			11,170				(4,196	)			—				6,443
Other current liabilities			(16,530	)			(15,414	)			9,741				2,270				(19,933	)
Pension and post-retirement benefits			5,047				1,731				1,944				—				8,722
Other assets and liabilities			(3,656	)			(3,015	)			8,236				—				1,565
Net cash provided by continuing operations			14,076				22,407				10,663				—				47,146
Net cash provided by (used for) operating activities of discontinued operations			1,451				—				(1,403	)			—				48
Net cash provided by operating activities			15,527				22,407				9,260				—				47,194
Investing activities
Capital expenditures			(178	)			(11,891	)			(8,148	)			—				(20,217	)
Proceeds from sale of property and equipment			—				120				101				—				221
Acquisitions, net of cash acquired			(19,477	)			(217	)			—				—				(19,694	)
Investment in subsidiaries			9,603				(2,680	)			(6,923	)			—				—
Divestitures			(18,246	)			—				(5,761	)			—				(24,007	)
Other			(1,750	)			(2,523	)			—				—				(4,273	)
Net cash used for investing activities			(30,048	)			(17,191	)			(20,731	)			—				(67,970	)
Financing activities
Net short-term borrowings (repayments)			4,763				—				—				—				4,763
Proceeds from long-term debt			414,233				—				—				—				414,233
Repayment of long-term debt			(358,141	)			—				—				—				(358,141	)
Proceeds from exercise of stock options			2,939				—				—				—				2,939
Excess tax benefits from stock-based compensation			1,225				1,172				208				—				2,605
Dividends paid			(28,458	)			—				—				—				(28,458	)
Repurchases of common stock			(18,330	)			—				—				—				(18,330	)
Net cash provided by financing activities			18,231				1,172				208				—				19,611
Effect of exchange rate changes on cash			3,118				(3,116	)			994				—				996
Change in cash and cash equivalents			6,828				3,272				(10,269	)			—				(169	)
Cash and cash equivalents, beginning of period			3,004				4,362				41,134				—				48,500
Cash and cash equivalents, end of period		$	9,832			$	7,634			$	30,865			$	—			$	48,331