Zurn Elkay Water Solutions Corp (ZWS) 2009 Q3 法說會逐字稿

Good morning. And welcome to the Rexnord third quarter fiscal 2009 earnings results conference call with Bob Hitt, Chief Executive Officer, and Todd Adams, Chief Financial Officer of Rexnord.

This call is being recorded and will be available on replay for a period of one week. The phone numbers for the replay can be found on the earnings release the company filed on an 8K with the SEC yesterday, which is also posted on the company's website www.rexnord.com.

At this time, for opening remarks and introductions, I'd like to turn the conference over to Mr. Todd Adams, Chief Financial Officer of Rexnord.

Thank you and good morning, everyone. Before we get started, just a brief reminder that this call may contain certain forward-looking statements that are subject to the safe harbor language contained in yesterday's press release, as well as in our filings with the Securities and Exchange Commission.

Today's call will provide an update on our overall performance across the company, as well as some further detail on our financial results. After the discussion, we will open up the call to your questions. Now I'll turn the call over to Bob Hitt, Chief Executive Officer of Rexnord.

Thanks, Todd. Good morning, everyone. First and foremost, thank you for joining us on the call today. Yesterday we issued a press release outlining our third quarter and nine months of fiscal 2009 financial results, which I'm hopeful everyone has had the opportunity to review.

First, a quick summary of our operating performance in the third quarter and nine months of the fiscal year. Third quarter sales were $443.1 million, which represented a 1.3% decline from the prior year third quarter. Core sales growth, which is year-over-year sales growth in existing businesses, adjusted for divestitures and excluded currency, declined 1.7%. And for the first nine months, our sales increased 7.3% from the prior year, with core sales growth of approximately 3.3%.

Our adjusted EBITDA in the quarter was $81 million, or 18.3% of net sales, compared to $92.8 million, or 20.7% of sales, in the prior year third quarter.

When you exclude the $2.8 million of out-of-period business interruptions proceeds we recorded in our third quarter of fiscal '08, our third quarter adjusted EBITDA margin declined 180 basis points from the prior year period. For the first nine months of the year, the adjusted EBITDA was $278.3 million, or 19.2% of net sales, resulting in a 20 basis point decline in year-over-year adjusted EBITDA margin when excluding the $11.1 million of out-of-period business interruption proceeds received in the first nine months of fiscal '08.

And finally, we have continued to reduce our leverage, as net debt leverage was 4.8 times at the end of December, compared to 5.1 times a year ago and 6.8 times approximately two years ago at the time of the acquisition of the company by Apollo.

During our third quarter, we began to experience what many industrial companies saw in their third calendar quarter, a very quick and sudden slowing of order activity as a result of the weak macroeconomic environment. And the situation worsened as our third quarter progressed. Although our core sales growth only declined 1.7% in the quarter, our backlog declined by approximately 11% and year-over-year order rates tracked at just over 18% as customers in both our power transmission and water management platforms reduced their inventory levels in an effort to better align their stocking levels with anticipated demand.

As a result of the rapid decline in demand, we began taking action to reduce our cost structure. During the third quarter, we reduced our headcount by approximately 500 employees, or 7% of the employee base we had at the end of our second quarter, and developed actions that will further reduce our headcount during our fourth quarter by another 7%. We estimate that actions taken to date plus those to be executed over the next several months, will result in an annual benefit of approximately $32 million. We anticipate the total cash cost of these actions to be approximately $16 to $18 million, of which $3.6 million was incurred during our third quarter.

In addition to headcount actions, we are cutting spending throughout the business and aggressively working on actions to continue to reduce our material costs.

Next, I'll take a few minutes to walk you through the operating performance in each of the platforms, as well as what we're seeing in some of the key end markets in each of our platforms.

Starting with the power transmission segment, the sales growth in the quarter declined 5.5%. Currency was unfavorable to the prior year by 360 basis points and the divestiture of our non-core business at the end of last year adversely impacted growth in the quarter by 160 basis points. So on a net basis for power transmission, this equates to basically a flat core sales in the quarter. And from a profitability perspective, adjusted EBITDA in the quarter was $61.7 million, or 19.6% of sales compared to $72.1 million, or 21.6% of sales in the prior third quarter.

There are two important items to be understood here when you analyze our third quarter adjusted EBITDA margins. First, the prior year third quarter included $2.8 million of insurance proceeds related to the Canal Street accident, business interruptions that occurred in fiscal '07. Excluding these proceeds, prior year adjusted EBITDA would have been $69.3 million, or 20.7% of sales. So on an apples-to-apples basis, we saw a year-over-year margin decline of 120 basis points in the third quarter.

Second, we made progress in reducing our material costs from the second quarter as a result of focused cost reduction actions and declining commodity costs. That being said, material costs on a year-over-year basis still adversely impacted our margins by approximately 140 basis points. But we were able to offset a portion of this margin decline with approximately 20 basis points in productivity gains.

In terms of overall business conditions in the end markets we serve in power transmission, the weak macroeconomic environment and turbulent financial markets has driven a decline in order activity in the majority of our end markets. And the magnitude of that decline increased as the third quarter progressed, resulting in, as I mentioned earlier, an approximate 11% decline in our backlog from the end of the second quarter.

When you look at our key end markets of mining, cement, and aggregates, and aerospace, all of these markets have been adversely impacted by the current economic environment. The ability to finance capital projects in the mining and cement end markets is more challenging than it was in early '08, given the state of the financial markets. The rapid decline in commodity costs, while favorably impacting our material costs, has had an adverse impact on our customers in the mining markets and resulted in a near-term reduction in the demand for our products.

The aerospace end markets have seen a reduction in demand for both large and small aircrafts. And the Boeing strike has resulted in major project delays.

With respect to industrial distribution, one key element we track in the power transmission segment is the health of the overall US Industrial Distribution Channel. Through November, US industrial distributors had posted calendar year-to-date sales growth of 4.8%, but experienced a 4.1% decline in year-over-year sales in the month of November, and on inventory turns in the channel declined to 7.2 times from nine times three months ago and 7.6 times at the end of the calendar year '07.

While these times are challenging, we continue to believe that we are very well positioned within the power transmission business to deliver solid core growth and profitability over the long term. In the near term, we'll continue to be aggressive in both our focus on reducing our cost and inventory levels while continuing to make investments in the business to drive future growth.

Now I'll turn my comments to the water management platform. Looking at sales growth in the water management platform in the quarter was 10.8%. The GA Industries acquisition contributed 17.5% growth in the sales during the quarter. This growth was offset by a 1.1% reduction in sales due to unfavorable currency movement and a 5.6% decline in our core sales growth in the third quarter.

From a profitability perspective, water management adjusted EBITDA in the quarter was $20.6 million, or 16.2% of sales, which compares to $22.9 million, or 19.9% of sales last year. The 370 basis point decline in our adjusted EBITDA margin was impacted by two primary items. First, we did see a meaningful improvement in material costs during the quarter, as our material cost as a percentage of sales declined approximately 70 basis points from fiscal '08 second quarter. However, year-over-year material cost pressures, coupled with some product mix changes in the third quarter adversely impacted our margins by approximately 200 basis points.

And second, one of our product lines where we are vertically integrated in the manufacturing process, expands the volume decline just over 20% in the quarter. As a result, our margins were impacted by the reduction and cost absorption in the quarter. We're in the process of moving away from this integrated manufacturing model to a design, procure, assemble, and test model which is similar to our other designed business models. This change will -- which will take place over the next two quarters, will provide us with a more flexible cost structure going forward.

In terms of the overall water management business, we break the business down into three end markets when we analyze performance. The infrastructure and water -- wastewater treatment markets which represents between 45% to 50% of our total water management business, the commercial construction market, which accounts for approximately 35% of our total water management business, and residential construction, which accounts for the balance, which is 20% to 25% of our total business.

During the third quarter, the growth in infrastructure, wastewater treatment, and commercial construction clearly slowed. If you look at the recent McGraw-Hill data, estimates commercial construction growth measured on square foot put in place, contracted 20% for calendar '08, and infrastructure growth was a modest 2% for calendar '08.

Despite these market trends, we experienced low single-digit year-over-year growth in our commercial construction markets during our third quarter, driven by a growth of new products in our water conservation product lines.

Our GA acquisition, which serves the infrastructure and wastewater treatment markets continues to perform well and the backlog for the business has remained solid all year. That being said, the order rates in these businesses clearly slowed as the third quarter progressed.

With respect to residential construction, the market situation deteriorated further during the quarter, and recent McGraw-Hill estimates point towards a 37% contraction in square feet put in place in calendar '08, compared to '07. Within the residential part of our business, we experienced between 15% and 20% decline during the quarter compared to the prior year, meaning despite the significant decline in demand, we grew relative to market as we did in the first half of fiscal '09.

One last comment I'd like to add regarding our water management platform before I wrap up my third quarter comments. On January 16th, we announced that we have entered into a definitive agreement to acquire the stock of Fontaine-Alliance Incorporated. Fontaine, which is based in Quebec, is a manufacturer of sluice gates and other engineered flow-control products for the municipal water and wastewater markets and generates annual sales of approximately 40 million Canadian dollars.

We are very pleased with this acquisition, and as this allows us to further expand our water management platform and specifically our presence in the municipal water and wastewater markets, both domestically and internationally, as Fontaine has a product offering that compliments our acquisition of GA Industries that we made last January. We anticipate funding the 30 million Canadian dollar cash purchase price from our existing cash balances and/or our existing credit facilities.

Over the past year, the acquisition of GA Industries, combined with the Fontaine acquisition we'll be closing our fourth quarter, has really diversified our water management platform, which will be over $100 million of revenue that will be coming from the municipal and wastewater markets. We feel this diversification strengthens our wastewater management platform -- water management platform and makes us well positioned to deliver profitable core growth over the long term.

So as I wrap up the third quarter, just a couple of final thoughts. First, the current macroeconomic environment is clearly challenging and adversely impacting demand and profits in our third quarter, while at the same time reducing our forward-looking visibility. That being said, we still have a $520 million backlog. We have taken cost reduction actions during the quarter and implemented plans to further reduce costs with actions we are executing during our fourth quarter. We will continue to aggressively manage our cost structure as we move forward through these challenging economic times.

Secondly, although material costs still adversely impacted year-over-year margins in the third quarter, the rapid material cost inflation, we, along with everyone else, experienced during the first half of our fiscal year, began to improve during the third quarter. And our diligent and disciplined approach to our procurement processes focused on driving cost reductions, coupled with the improving commodities market, resulted in a reduction of material costs from our second quarter, a trend we anticipate will continue into our fourth quarter.

Next, we feel we have a real opportunity to reduce our inventory levels over the next quarter and to our fiscal '10, and, in turn, continue to improve our liquidity position. This will be a major focus in our business going forward.

And then finally, as we look ahead during the challenging economic environment, we certainly will not lose sight of one of our major assets, which is our Rexnord business system. We will continue to proactively communicate with our customers, focus on their needs and deliver world-class products and services and invest and drive growth opportunities where appropriate by proactively taking appropriate cost-reduction actions, all of which we believe makes us well positioned to outperform.

So with that, I'll turn it over to Todd to provide some more in-depth financial information regarding our third quarter performance. Todd.

Thanks, Bob. I'll start by going over a few details in our third quarter income statement. As Bob mentioned, sales in the quarter were $443.1 million and declined 1.3% from the prior year third quarter. Gross profit in the third quarter was $139.4 million, or 31.5% of sales compared to 32.9% of sales in the third quarter of 2008.

In the quarter, higher year-over-year material costs adversely impacted our margins by approximately 140 to 150 basis points. SG&A expense in the third quarter was $76.6 million, or 17.3% of sales, compared to $74.1 million, or 16.5% of sales in the prior year third quarter. In the third quarter, we did incur a loss from operations of $365.9 million, which included a $402.5 million non-cash impairment charge related to our goodwill and other intangible assets, as well as a $3.6 million restructuring charge that Bob mentioned.

To expand just a little bit on the impairment charge. Our third quarter, our fiscal third quarter, is the period in which we normally and traditionally conduct our annual impairment test as required by the applicable accounting guidance. Additionally, this year, when you look at the macro environment affecting global credit and other general business conditions, it prompted us to take a further look. As a result of our analysis, we recorded a $319.3 million non-cash impairment charge related to our goodwill and an $83.2 million non-cash impairment charge related to our other intangible assets.

Excluding the impairment and restructuring charges, our income from operations was $50.8 million, or 11.5% of sales. When you ingest the prior year third quarter income from operations for a $17.4 million gain associated with the Canal Street accident, our fiscal 2008 third quarter income from operations was $61.2 million, or 13.6% of sales. So on a more comparable basis, our operating income as a percentage of sales declined by 220 basis points this year's third quarter, primarily due to the impact of higher year-over-year material costs and reduced leverage on our cost structure as a result of the lower sales volume.

More appropriately, the profitability was probably more significant impacted by the change in our growth trajectory from 7% growth core in September to minus approximate two in the December quarter, and the resulting lag effect of the benefit of the cost actions we took in the third quarter.

Interest expense in the third quarter was $46.1 million, which compares to $47.7 million in the prior year third quarter and reflects primarily the benefit of lower LIBOR rates on our term loan facilities compared to the prior year.

With respect to taxes, we recorded an $11.1 million of tax expense on a $398.1 million pre-tax loss, resulting in a 3% positive effective tax rate. The rate was driven by two items. First, the $319.3 million dollar goodwill impairment charge that impacts our pre-tax loss. We get no tax benefit for that. And secondly, $45.7 million of deferred tax asset valuation allowances were recorded in the period, which ultimately results in tax expense with no impact on pre-tax earnings.

And finally, our net loss in the quarter was $420.5 million, which includes the impact of the impairment restructuring and the valuation allowances I discussed, our income in the prior year third quarter was $19.8 million.

Moving to adjusted EBITDA, our adjusted EBITDA in the third quarter was $81 million, or 18.3% of sales, which compares to $92.8 million, or 20.7% of sales in the prior year third quarter. However, as Bob discussed, in the prior year third quarter, we did record a $2.8 million benefit from business interruption insurance proceeds received in that quarter related to the Canal Street accident, business interruptions we experienced in our fiscal 2007. When you adjust the prior year third quarter to exclude that benefit, adjusted EBITDA was $90 million, or 20% of sales.

Quickly touching on our balance sheet and cash flow highlights. Our cash balances at the end of December totaled $239.5 million, an increase of nearly $98 million from the end of March, and $75 million from the end of September. One point on our cash balances, in October we decided it was prudent to draw a portion of our revolving credit facility in order to increase our cash position in light of the uncertainty in the capital and credit markets and resulted in a $47.5 million borrowing in the quarter.

From a trade working capital perspective, at the end of December, receivables were just over $260 million, inventories were approximately $363 million, and accounts payable were approximately $137 million, for a net trade working capital balance of approximately $486 million. During the quarter, we generated about $4 million from operations from cash flow out of trade working capital, and we continue to see trade working capital as an opportunity to generate cash over the next several quarters, particularly our inventory in both of our platforms.

Cash flow from operations in the first nine months of 2009, was $110 million, which compares to $162.3 million throughout the first nine months of the prior year. Included in the prior year cash flow was $34.4 million of insurance proceeds related to both the business interruption at Canal Street, as well as property and casualty proceeds from the accident. Year-over-year operating cash flow was also impacted by $18 million tax refund in the prior year, compared to $7.6 million this year. Both of those tax settlements relate to favorable resolutions of outstanding issues from prior fiscal years.

From a free cash flow conversion perspective, which is cash flow from operations, less CapEx compared to our net income, when you exclude the non-cash impairment charge related tax impact from the valuation allowance, we generated $57 million of free cash flow in the quarter. That would convert at about 140% to an adjusted net income number. And on a year-to-date basis, we generated $80 million of free cash flow. And adjusting the net income for the valuation as well as the impairment, that would equate to about 126% free cash flow conversion year-to-date.

Capital expending -- capital spending in the first nine months was $29.9 million, or 2.1% of sales. We have been and will continue to closely monitor our capital investments and anticipate capital spending to be in the range of 2% to 2.5% of sales going forward.

Our total debt at the end of the quarter increased by $45 million from the end of March as a result of the $47.5 million October borrowing on our revolver. As previously discussed, our total debt was $2.70 billion. In addition to the borrowings under our revolver, as of the end of the third quarter, we had $767 million of term loan B borrowing, $803 million of 9.5% senior unsecured notes, $150 million of 8-7/8% senior unsecured notes, $300 million of 11.75% senior sub debt, and $3 million of other debt.

Our liquidity continues to remain strong, as we had just over $400 million in available liquidity at the end of our third quarter. In addition to the December cash balances of $239.5 million, we had $96 million available under our $100 million AR facility and approximately $66 million available -- remaining available under our $150 million revolving credit facility. That is adjusted for about $29 million of letters of credit that count towards the facility availability. Additionally, I think everyone's aware that we did have a 5% or $7.5 million exposure in our credit facility to Lehman that did not fund.

Just a few points on our liquidity. As Bob discussed, on January 16th, we entered into a definitive agreement to acquire the stock of Fontaine-Alliance for a cash purchase price of approximately 30 million Canadian dollars, and anticipate that we'll fund that from our existing cash balances or use portions of our existing credit facilities during our fourth quarter.

During the quarter, RBS Global issued a $25 million dividend to Rexnord Holdings, the indirect parent of RBS Global. Rexnord Holdings used substantially all of the dividend to retire a portion of its PIK Toggle Senior Indebtedness which is due in 2013. Subsequent to that, in January 2009, RBS Global issued an additional $35 million dividend to Rex Holding. Again, those were used to retire a portion of the PIK Toggle Senior Indebtedness.

As of the end of the third quarter, our leverage was 5.4 times, an increase of one-tenth from the end of March, but down from 6.8 at the time of the Apollo acquisition just over two years ago. Our leverage was 4.8 on a net debt basis, down a tenth from where we ended our fiscal 2008.

With that financial overview, I'll turn it back over to the operator to take some questions.

Thank you. (OPERATOR INSTRUCTIONS) And our first question will come from Bob Franklin of Prudential Financial.

Hi. On the dividends on the PIK Toggle, what capacity do you have left to do that, and which covenant is driving the capacity?

Bob, our -- within the credit agreement, the amount of dividend capability is really driven by the restricted payment basket which builds from the cumulative credit basket. And at the end of December, it was about $538 million, at the end of December after given effect to the dividend.

All right. So you could do another $538 million of these; is that right?

If the covenant were the only restriction, the answer is yes. I think the -- our view is we're going to continue to monitor the situation. But per the covenant, the answer is yes.

Okay. And I thought there was a basket in there of what, $50 million. So is this the cumulative net income that led up to it?

Yes. The original basket started with $50 million and then builds on an EBITDA basis. It builds fairly generously. And additionally, there is equity contribution, indebtedness. So to the extent that Apollo put in money to acquire Zurn, that counts as part of the basket. That was $282 million. So $282 million of the basket is contribution indebtedness basically given -- giving credit for the Zurn acquisition.

Okay. And what's the amount of the PIK Toggle outstanding right now?

At the end of December, the PIK Toggle, including accrued interest, was approximately $480 million. That's at the end of December.

$480 million. Okay. And are you buying that back at par or is there a market value there?

There is a market and we are not buying it back at par.

Okay. Do you expect to keep the revolver outstanding? I mean, you effectively borrowed on the revolver to -- since money is fungible, you effectively borrowed on the revolver to do this. Do you expect to have revolver borrowings remain outstanding?

It's a good question, Bob. I think we did it in October based on a lot of the uncertainty. We said we'd continue to review it. I don't know that there's been enough clarity around the overall financial system for us to feel comfortable to pay it back at this point. So I'd say we'll monitor it all the time and pay it back appropriately, because obviously there's a negative spread on that. But for the time being, I think we'll probably continue to keep it outstanding.

Okay. And one last question. You mentioned this faster than I could write it down. You said you had 140 basis point margin decline from raw materials costs, but you made some back on cost saves. Did you say 40, or was it a different number?

Yes, it was probably 30 to 40, Bob, is sort of --

Okay.

-- the recovery through cost reductions just in the quarter. Obviously, we think that accelerates a little bit in the March quarter based on some of the actions that we took late in our third quarter.

Okay. And if I could just put out a suggestion going forward. If you could in your press releases or somewhere put the amount of the PIK Toggle that's outstanding, that would be helpful.

Okay. We'll acknowledge your point.

All right. Thank you.

Thanks.

(OPERATOR INSTRUCTIONS) We'll move next to Eddie Chaikas with Penn and Bart.

Hey, guys. Good morning. I just actually had a minor question. I might have missed it in the prior discussion. What's the balance of the Holdco note as of December?

Eddie, when you include the interest that's accrued --

Yes.

-- it would be approximately $480 million.

And after you pay it off, tell me the balance in January, what would the balance -- or what was the balance at that point?

Yes, that's a disclosure that we wouldn't make --

Okay.

-- until our fourth quarter.

That's all I had.

Okay.

Thank you.

We have no further questions in the queue at this point. (OPERATOR INSTRUCTIONS) And we'll hear next from Ted [Hage] of ING.

Yes. Thank you. Good morning. Just a quick question. Without disclosing numbers, can you comment on trends in January for the month and also kind of how February's working -- looking at this point?

Yes. Ted, it's a good question. If you look at what we said at the drop off into the third quarter, what we saw as well is if you look at towards the end of December and even into the beginning of January, that the order trend rate was down quite a bit. What we saw was that a lot of manufacturers and distributors as well were, because of the manufacturers, took very extended shutdowns during that period. We've seen that start to improve going into the latter part of January and into February.

So I would classify that as saying that first and foremost we've got the $510 million backlog which helps dampen what's happening currently. But if you look at the order trend analysis, I would say it's running at a similar trend at this point to the third quarter.

I've been on a couple of these types of calls and it seems a lot of people are kind of banking on the distributors to continue to de-stock and ultimately going back to the companies to buy product, call it the second half of the year. Is that kind of how you see this thing playing out?

I think that's a good point that I would say is playing out at this point. And I would include even in that that we tend to see even OEMs de-stocking to whatever they're producing going out to the end markets. So I would classify it in both directions. But we clearly see with the backlog dampening that effect and then the latter back half, that the order trend would improve based on the de-stocking being completed. So I'd say, yes, that's a good statement.

Last question, if I could. Do you guys have any particular, I'll call it new products, with the exception of this recent acquisition that you have got coming forth? Or should we just look at this as go forward kind of what you have will be kind of what the sales will be based upon, excluding the recent acquisition?

Yes, I would say there's -- we've been having success in taking market share. We've been talking about for the last few quarters are water eco-vanish products that are water saving devices. And we continue to see success within those product lines within our water management group. We also see within our power transmission business, that we have a bearing called Sur-Lock (inaudible) that continues to take share. And our Drive One continues to have success within our gear group. So those particular products continue to take good market share and have been exciting products for us. And we have some new coupling products that we've just put out recently as well.

So we're always putting out new products within that. But I would also say we're enjoying the success of what we've been putting out over the last year or so as well. And clearly, we're focused even in this down market, to continue to work on share and growth.

Great. That's all I had. Thank you very much.

You're welcome.

We'll move next to Richard [Starling] of Canyon Capital.

Hi. Thanks for holding the call. My question is similar to Ted's first question in terms of the sales and order trends. I just wondered if you could talk a little bit about whether you saw any progression in the quarter from October to November to December in terms of the sales and order trends.

Yes. Clearly, if you look, we ended in September with sales up, we said --

Core growth in September was 7%.

-- core growth was 7%, declining down pretty dramatically to 1.2%. So we saw that take place more in the back half, as I mentioned, earlier in the quarter, particularly December and then in the front half of January. And as I stated earlier, twofold reason for that is, yes, we're seeing de-stocking taking place in the channel, but we also saw a lot of people taking advantage of the Christmas holidays of taking extended breaks, by almost two weeks on the front end of the break and two weeks on the back end in many cases.

So we're starting to see that trend back upwards to some degree within that. And we're also seeing, which we think will continue for a while here is that some people are actually also taking advantage of the downtime to do further maintenance and repairs that help our business as well.

Richard, I'd say that as you look at October, November, December, the last two weeks of December were abysmal. And I think the first two weeks of January were pretty tough. So I think what we're doing is monitoring it very closely. It's a week-to-week-type thing. But it did deteriorate over the course of the quarter, which I think is very consistent with most other of the industrials that we follow and listen to.

Great. Thanks very much.

We'll hear next from Patrick White of [Wyatt] Capital Management.

Thanks, guys. I was actually wondering if you could just kind of comment on kind of the -- what the breakout of like the down 2% core sales, just kind of what -- or like the breakout between volumes and pricing.

Yes. I mean, Patrick, I would say, from a pricing perspective, I don't think there's really that much price in the quarter. So it's probably more true volume down just a little bit. I think we may have gotten a little bit of price in power transmission relative to the prior year. But if you look at what commodities have done, which drives a lot of the material in our water management platform, it's been tough to get price over the cap, you know, over the quarter, over the first nine months of our fiscal year. So I'd say it's pretty much true volume.

Well, are you guys giving up pricing right now, as I guess looking into the first quarter, do you guys see yourself giving up pricing or are you --

To date, no.

No.

To date --

No, we have not, Patrick.

-- we have not.

All right. Great. Thank you.

Adam Steinberg of Arch Capital Management has our next question.

Thanks, guys, for having the call.

Yes.

You know, I just -- obviously industrial production has been in the news quite a bit. And obviously utilization rates are very correlated with the statistics. I was wondering if you could give us an indication of what your plants are running at right now.

I think it really depends facility-to-facility, Patrick -- Adam. But I would say overall it's a difficult number to give. But maybe the 70% range.

Okay.

I don't think it's surprising, Adam, that it's come down from where it was.

Right.

I think it depends on our business. If you look at the mix, we clearly have some business with -- businesses with larger backlogs than others. I'd say those we haven't really seen any fall off, obviously, because we're working through the backlog. But the shorter cycle, less backlog businesses, I would say are probably right around 70 as the midpoint as what Bob said.

Hence, the reduction in headcount, the actions that were taken.

Correct. You kind of talked a little bit about with this down time that there's a little bit more of maintenance repair cycle going on right now. Can you give me a sense of what percentage of your business as a fraction of sales would be attributed to this maintenance and repair --

Yes.

-- going forward?

We're starting to see trickles of it. I wouldn't call it as a big huge boom. I want to make sure I characterize that. But even in the Gulf War basis, we, and I don't see this changing at all, we've always said that our business runs about 50-50 between MRO and replacement and original. So I don't see that, as far as trend-wise, changing. So over the long haul, as the de-stocking takes place, we certainly see that as an advantage for us where the magnitude of the downturn tends to get cushion for us.

I think, Adam, just to clarify it, that's in our power transmission business.

Right. Yes. Excuse me.

Our water management business is primarily, at this point, new construction.

Right.

We're looking at after-market opportunities. But the 50-50 split between maintenance repair and new install is really true of the power transmission business.

Yes. Good point, Todd.

Okay. I guess speaking on your water division, is there a specific -- are there any specific regions that you guys haven't talked about that you're still seeing growth in? I mean, I'm talking geographically here.

No. I don't -- I wouldn't classify any region as still seeing growth. We continue to see, obviously, the same as what you'll see in construction spend in the south is -- really has been bad for quite some time. The west has been pretty -- southwest has been low for quite some time. But clearly, if you look at the McGraw-Hill data, what they're talking about is a clear 15% to 18% reduction in square footage build. There's -- certainly that's going on, I would say countrywide.

Okay. And then just after you kind of restructured your business with your staffing rationalization and whatnot, can you give us a sense of what your fixed versus variable costs would be on a go-forward basis?

The -- I guess the way we'll probably answer it, Adam, is, if you look at our prime costs which are material and sort of labor used to manufacture the product, it's probably 45% to 50% of our -- of sales. The remaining variable and fixed overhead is probably weighted probably 15% of variable and the balance being fixed as a percentage of sales.

Okay. Thank you very much.

Sure.

You're welcome.

We'll go next to WhiteHorse Capital's Josh Weinstein.

How's it going? Just a couple quick questions. First on the headcount, just to make sure I heard you guys right. You guys made about 6% headcount reduction in the third quarter and then you expect an additional 7% in the fourth quarter; is that right?

Close. Seven percent has been done in the third quarter, with an additional 7% in the fourth quarter.

Okay. So 7% each quarter?

Correct.

Okay. And then have you guys disclosed any type of rough multiples you've paid for either of those water management acquisitions you made?

We have not, Josh.

Okay. Thanks a lot.

[Minish Simia] with Citi has our next question.

Thank you. Good morning, Bob and Todd. Thanks for holding the call. Couple of quick questions. One, I think, Bob, you mentioned that you potentially saw some likelihood that the distributor base might start ordering in the second half. And I just want to kind of get a bit of clarity as to what you are basing that comment on. As I kind of look at most industrial companies, no one's really kind of calling for a recovery any time in the near future. And, obviously, as you probably know, visibility is awfully poor. So I'm just trying to get a sense as to if there are any barometers or indicators that I should be looking at that you look at to kind of assess how the second half may play out.

Minish, I appreciate the question. Thank you. If you look at it from a power transmission distributors, what I referred to was that their inventory turns, and we've been always watching this very diligently, and ours with them, was running previously about nine, 9.5 turns. It fell in the quarter based on the demand to about 7.6 times. And clearly we keep very close contact with our distributors, both in water management and power transmission. And they are clearly, as a result of the downturn, not only taking because of their point of sales down, but adjusting to try to get their inventory turns back up to that nine, 9.5 level.

So based on those facts, and you're right, none of us have a clear mirror ball of what's going to happen here. But based on those facts alone, as they stand today, I would anticipate that the last half or the back half of the calendar year, we would see somewhat of an improvement just based on an inventory correction being completed.

Yes. Minish, I think we're, I think like other industrials, clearly the order rate declines we're experiencing now are higher than what we're sort of thinking our next fiscal year looks like from a top line perspective. And I think what Bob's talking to is really there's a period here and we're notionally four months into it where we're seeing distributors and OEMs taking the opportunity to reduce inventories.

Right.

We think that goes on for a while longer. It could be three months. It could be nine months. But at some point the rate of decline levels out a little bit. And I think based on the business model of significant maintenance and repair and replacement parts, that's how we feel like at some point it levels out a little bit. So I wouldn't necessarily say it's growth, but the rate of decline sort of levels out at a substantially lower rate than what we're sort of currently experiencing.

Right. And do you guys have a sense for the health of the distributor base that you sell into?

We do.

Yes.

Yes, we do.

Yes, we do. And base -- we monitor that very closely. And I would say right now we feel very comfortable with our distributor base.

And are these mainly, so the big Granger-type distributors? Are you basically selling into sort of the private mom-and-pop-type --

There's a mix. But a substantial portion of it goes into the large distributor. So like, for example, in power transmission is Applied Industrial Technologies, Motion Industries, Command that's part of Commatix. These are all very large companies attached as public companies, Fortune 500 companies.

On the water management side, there's [Welton]. You got Ferguson as one example. [Hyjuncta] as well. There are smaller distributors, but we carefully monitor those as well. So I would say, yes, we feel very comfortable with the base and they have the means around them that make us feel comfortable.

And I guess as we look at cash flows over the next several quarters, Todd, I guess this is probably more appropriate question for you. How should we be thinking about Rexnord balancing debt reduction at the Opco versus the Holdco? And then related to that, can you give us a sense for potential additional pension funding requirements that you may have?

Sure. I think, Minisha, you knowing the company a little bit as you do, I think we turned very cautious on the economy back 2007, September. In fact, that's when we stopped actually paying down some of the term debt and holding cash onto our balance sheet. Based on the outlook, I don't think we'll do anything different. Looking ahead, I think from a cash flow perspective, we will generate free cash flow north of potentially $100 million at where we think we are today. And the balance is going to be liquidity more than anything. I think we're going to monitor the situation with respect to our Holdco notes. We're going to monitor our situation with respect to our overall liquidity and we're going to look at it relative to potential bolt-on acquisitions.

So I think our view for a very, very long time has been making sure that we have preserved our liquidity and shored up our balance sheet in a way that allows us to ride through a very difficult time. And I think you've seen us do that for a -- since September of '07, and I don't think anything's going to change.

Okay. Thank you, gentlemen.

(OPERATOR INSTRUCTIONS) We'll take a follow-up question from Bob Franklin.

Target EBITDA margin that you think you're capable of achieving through a cycle?

Bob, I think our long-term target is to be able to grow our top line 5% to 7% and earnings 12% to 15%. Through -- that's over a length of a cycle.

Right.

At a point in time within a cycle, it'd be tough to give you an absolute answer. But I think we're pretty comfortable that we can ride through in the very high teens through a pretty tough cycle.

The high teens EBITDA margin?

Yes.

Yes.

Okay. Thank you.

(OPERATOR INSTRUCTIONS) Mr. Hitt, we have no further questions. I'll turn it back to you for any --

Yes. I'd like to thank everyone for listening and for your attention on our call today. We appreciate your interest in Rexnord and certainly look forward to providing further updates when we announce our fourth quarter results in the coming months. Everybody have a good day. Thank you.

And again, that concludes today's conference. Thank you all for your participation and have a great day.