Zurn Water Solutions Corporation
Q4 2013 Earnings Call Transcript

Published: 21 May 2013

[Operator:]

Good afternoon, my name is [John], and I'll be your operator for today's call. At this time, I'd like to welcome everyone to the Rexnord Fourth Quarter and Full Fiscal Year 2013 Earnings Results Conference Call, with Todd Adams, President and Chief Executive Officer, and Mark Peterson, Senior Vice President and Chief Financial Officer of Rexnord. This call is being recorded and will be available on replay for a period of two weeks. The phone numbers for the replay can be found in the earnings release, the company filed on an 8-K with the SEC today, May 21, and they're also posted on the company's website at www.rexnord.com. At this time, for opening remarks and introduction, I'll turn the call over to Mark Peterson, Senior Vice President and Chief Financial Officer of Rexnord.

[Mark Peterson:]

Good morning. 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 the press release we issued today as well as in our filings with the SEC. In addition, some comparisons are for the non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures and why we use them. Today's call will provide an update on our overall performance for the fourth quarter and full fiscal year including details on our two platforms, followed by an overview of our financial statements and liquidity highlights. Afterwards we'll open the call up for your questions. With that, I'll turn the call over to Todd Adams, President and Chief Executive Officer of Rexnord.

[Todd Adams:]

Thanks, Mark, and good morning, everyone. Thank you for joining us today for an overview of our fiscal 2013 fourth quarter and full year financial results. Before we get started, I'll briefly comment on the status of our Board's exploration of strategic alternatives. As we discussed in the release, the Board continues to review alternatives and expects to complete its review during the course of our first quarter. I think you all in advance for your understanding, cooperation and for obvious reasons; we will not comment further or take any questions on the topic. With that, let’s turn to page four. Overall we are quite pleased with our fourth quarter results of sales, profits and cash flow were all in line with our expectations heading into the quarter. We delivered 1% overall core growth in the quarter, which is on top of the 10% core growth we delivered in last year’s fourth quarter. The growth highlight in the quarter was the 11% core growth in our water management platform. Consistent with what we've been communicating over the last year, this is a combination of Zurn growth that is outpacing market and competitive growth as well as the product and geographic diversity within VAG that is allowing us to benefit from the growth in water infrastructure globally. What’s really exciting is the fact that all the strategic work we've been doing in this platform that is driving the growth today will allow us to disproportionately capitalize on the market recovery that we expect to see in the coming years. In Process and Motion Control, we saw good progression in almost all of our end markets from a demand perspective and delivered strong profitability across the platform despite a slightly weaker topline that the prior year. As we look back over the course of the year, it's been very challenging to find a two-to-three-month period of sustained demand in our industrial end markets. It's hard to draw an exact conclusion how that plays forward into our fiscal fourth '14, but a couple of positive points that we see are the following. First, our largest end market of mining, really both material handling or conveyance, crushing and pumping from an application perspective had a tough year and it changed very rapidly from what almost anyone who serves as end market was expecting, but everything we see from an end market perspective is beginning to stabilize. Looking forward, the overall tonnage of processing of various materials is supposed to actually grow globally and that will help us from what an uncharacteristically weak year. Additionally, we made great strides in diversifying our business into other hard rock mining as well as advancing globally, allowing us to capture projects that we expect to improve order rates later in the fiscal year as well as into the future. However, given the long lead times inherent in the sub-segments of this market, we expect to have a year that transitions towards growth in late calendar 2013 and into calendar 2014. The second positive point is that we see the overall levels of industrial production and capacity utilization continuing to remain relatively high and as a result, we expect to short cycle in after market pieces of our business to remain relatively stable during the first half of the fiscal year with some modest improvement towards the back half. Finally, both our aerospace and food and beverage end markets have been good and we expect them to remain solid during the course of fiscal 2014. Turning to our Water Management platform, as we laid out beginning a year ago, the overall end markets are improving and all the momentum indices point to a sustained recovery. For us, the upturn in our served markets should begin to have a meaningful benefit towards the end of this fiscal year and into calendar 2014 and beyond based on the lead-lag effect. This is a real positive because the above market and competitor growth we are delivering today is being driven by the effectiveness of our strategy and execution in both Zurn and VAG. From a performance perspective, we continue to do a good job on controlling the controllable. In our fourth quarter, we delivered a $115 million of adjusted EBITDA or 21.3% of sales, which is up 40 basis points compared to the prior year fourth quarter and drove a 19% increase in our adjusted net income, while continuing to invest in our businesses. For the year, our sales grew 3% and we delivered a 31% incremental margin on that growth, which drove our adjusted EBITDA margin up 40 basis point year-over-year to 20.2%. Our adjusted net income increased 39% from the prior year and our free cash flow exceeded net income again for the year. Finally, we continue to de-lever as our net debt leverage ratio ended the year at 3.9 times. The final thing I want to touch on before I hand it over to Mark to go through the financials is our initial outlook for fiscal 2014, which is on page five of the presentation. Not to get too far ahead of ourselves, but when you look at calendar 2014 and 2015, it's likely that we could be in a position where our two largest end markets, mining and nonresidential construction have very strong momentum and we believe that we will be very well positioned to outpace the growth provided by that market recovery. As it relates to our fiscal 2014, the overarching backdrop to our guidance this year is that we are taking the view that some of the macro uncertainties that continues to exist out there today will not likely materially improve from here and as such, we are taking a cautious view on market growth. As a result, the growth and profitability we are planning on in fiscal 2014 is being driven by our strategic initiatives and execution. With that, we expect core growth for the year to be in the range of 1% to 3% with stronger growth in the second half of the fiscal year and growth in water management outpacing growth in process and motion control. We expect that our incremental margins at both the operating income and adjusted EBITDA level to approximate 30% and our free cash flow to exceed net income. Mark will fill in some of the blanks for you later in the call, but we expect adjusted earnings per share in the range of $1.10 to $1.18, a 16% increase year-over-year at the midpoint. All these numbers exclude the impact of acquisitions, which we don’t predict or include in our guidance but may likely occur given our overall levels of liquidity and strong free cash flow. Looking at our first quarter, we anticipate sales to be in the range of $489 million to $499 million with core growth essentially flat at the midpoint. We expect adjusted earnings per share in the range of $0.17 to $0.19. With that, I'll turn the rest of the presentation over to Mark to cover the numbers.

[Mark Peterson:]

Thanks Todd. Consistent with prior quarters, we'll speak primarily to adjusted operating profit and EBITDA, adjusted net income, and adjusted earnings per share as we feel these non-GAAP metrics provide a better understanding of our operating results. Slide six and seven of the presentation take our reported results and reconciles the adjusted results. So turning to page eight, I'll discuss our operating performance highlights for the fourth quarter. Sales in the fourth quarter of 2013 and 2012 were $540 million, core sales grew 1% over the prior year, offset with the unfavourable impact of foreign currency translation. Adjusted operating income increased 5% from the prior year to $87 million in the fourth quarter and as a percentage of sales, increased 70 basis points to 16% year-over-year. Fourth quarter adjusted EBITDA was $115 million and our adjusted EBITDA margin increased 40 basis points from the prior year to 21.3%. Fourth quarter adjusted net income increased 19% year-over-year to $32 million resulting in adjusted earnings per share of $0.32. This compares to adjusted earnings per share of $0.38 in the prior year. Year-over-year adjusted earnings per share is impacted by the increased shares outstanding tied to our April 3rd, 2012 initial public offering. Free cash flow was $77 million in the quarter, an increase of $18 million or 30% over the prior year quarter. Moving on to slide nine, I'll quickly cover the full fiscal year results. Full year sales increased 3% from the prior year to $2 billion. Acquisitions net of divestitures, contributed 4% of growth, which was partially offset by the 1% unfavorable impact of foreign currency. Core growth was flat year-over-year. Adjusted operating income increased 8% from the prior year to $293 million and as a percentage of sales increased 60 basis points to 14.6% of sales. Full year adjusted EBITDA increased 5% year-over-year to $405 million and adjusted EBITDA as a percentage of sales increased 40 basis points from the prior year to 20.2% of sales. Our adjusted net income increased 39% versus the prior year to $98 million resulting in adjusted earnings per share of $0.98. This compares to prior year adjusted earnings per share of $0.97. Again year-over-year earnings per share was impacted by the increase in shares outstanding tied to our IPO on April 3rd of 2012 last year. Moving on to cash flow, we generated $84 million of free cash flow in the fiscal year, which includes $18 million of non-cash use related to the excess tax benefits recorded in connection with stock option exercises. Excluding that non-cash item, our free cash flow was 105% of adjusted net income. Next, I'll take some time on slide 10 to walk through the operating performance in our Process and Motion Control platform. Sales in the fourth quarter were $304 million [Later corrected by the company to $340 million], Core sales decreased 4%, primarily tied to lower year-over-year shipments to our mining end markets and a flattish to slightly down industrial MRO environment in North America. It's also important to point out that we grew core sales 14% in the prior year quarter and we had one less shipping day this year. Turning to profitability, our adjusted EBITDA decreased $7 million on the $19 million year-over-year sales decline, a decremental margin of 35%, which is in line with our expectations on the sales change. Adjusted EBITDA as a percentage of sales in the quarter was a solid 26.2% as the productivity gains and cost reduction actions we executed this year have allowed us to generate solid margins despite the challenging marketing conditions we faced. For the full fiscal year, sales were $1,266 million compared to $1,311 million in the prior year. Divestitures and unfavourable foreign currency changes accounted for two percentage points to the change in sales and core sales were down 1% for the year. Looking back on the year, the macro environment was challenging globally, but we believe the strategic growth initiatives we've been executing allowed us to outperform a tough market this year. Fiscal 2013 adjusted EBITDA was essentially flat year-over-year despite a $45 million reduction in sales. Productivity gains, targeted cost reductions and focus on [prominent] [ph[ material cost reduction allowed us to deliver a 70 basis point improvement in our EBITDA margin to 24.9%, while still investing in our key growth initiatives. Turning to page 11, I will make a few comments on our Water Management Platform. Water Management sales in the fourth quarter increased 11% from the prior year to $200 million. Core growth was also 11% as the impact of foreign currency translation was minimal. In the quarter, we saw a 4% Core growth in our Zurn business driven by share gains and increasing alternatives and market demand. Within our Valve and Gate group, core growth was 22% aided by the timing of several large product shipments during the quarter. Fourth quarter adjusted EBITDA increased 21% to $31 million year-over-year, as a percentage of sales increased 130 basis points to 15.3% in the fourth quarter. The year-over-year improvement in margin was driven by the benefits from the footprint consolidation actions taken in our North American water business late in the prior fiscal year as well as productivity gains and volume leverage in the current year. Turning to the fiscal year, fiscal 2013 sales increased 17% from the prior year to $739 million. Our prior year acquisition of VAG accounted for 16% of the growth and core sales growth was 1% driven by mid single digit growth in our Zurn business despite tough markets, which was partially offset by lower year-over-year shipments to our North American water infrastructure end markets. Adjusted EBITDA was $114 million for the fiscal year or 15.5% of sales, compared to $96 million or 15.2% of sales in fiscal 2012. Moving to slide 12, I'll touch on a few cash flow and liquidity highlights. We finished the year with $524 million of cash, a record $849 million of liquidity and no meaningful debt maturities until 2018. Total debt at the end of the year was $2,104 million and net debt was $1,580 million resulting in a net debt leverage ratio of 3.9 times, which compares to 4.1 at the end of our third quarter and 5.3 at the end of last year. Subsequent to our year end, we re-priced our term loans resulting in a 75 basis point reduction in the interest rate to 275 basis points with a 1% LIBOR floor. In connection with this re-pricing, we also prepaid $150 million of the term loans. As we look through next year, we anticipate our net debt leverage to continue to decline through a combination of incremental earnings and continued strong free cash flow generation. Next, I will provide a few of the financial metrics under our credit agreement and bond indenture. First, under the credit agreement, our senior secured leverage ratio was 1.09 times versus our covenant of five times, and the cumulative credit basket was $622 million. Under the indenture, we finished the year with a fixed charge coverage ratio of 2.7 times and the restricted payment basket totalled $531 million, inclusive of the $25 million general basket. One last comment on the fourth quarter financials, I want to provide some color on the non-cash actuarial loss on pensions of $6 million that was reflected in our fourth quarter and full year results. As you may recall, in the fourth quarter of fiscal 2011, we voluntarily made an accounting change whereby we elected to expense actuarial gains and losses related to pensions in our post retirement benefit plans that exceeded the quarter, which aside to 10% on the PBO or planned assets at the beginning of the year, whichever is greater. Instead of capitalizing these costs, as a component of stockholder's equity and amortizing them into the P&L over time, while both methods of accounting are correct, we feel this new method is preferable as it reflects the impact of current economic conditions on our plans in a more real time fashion. The $6 million loss in the fourth quarter was primarily driven by the 50 basis point reduction in the discount rate during the year and it's also important to note that this change in accounting has no impact on our cash contributions to the plans. Before we turn the call back to the operator to take any questions you may have, I’ll make a few final comments on our outlook. Page 13 of the presentation reiterates the guidance I discussed earlier in the call and also highlights our assumptions for interest expense, depreciation and amortization, stock option expense, effective tax rate, capital expenditures and fully diluted shares outstanding for fiscal 2014. In addition, our guidance assumes we do not incur any non-operating other income or expense as we do not forecast realized and unrealized gains or losses from foreign currency fluctuations, gains or losses on the disposal of assets or other items that are recorded in this P&L line item. Our guidance excludes the impact of potential acquisitions and divestitures and future non-recurring items such as restructuring cost or cost we will incur as a result of the Board’s strategic view process that will be completed in the first quarter of fiscal 2014. With that, I'll turn the call back over to the operator and open up to any questions.

[Operator:]

Thank you. We will now begin the question-and-answer session (operator instructions). Our first question comes from Mig Dobre from Robert W. Baird. Please go ahead.

[Mig Dobre:]

Good morning, guys.

[Todd Adams:]

Good morning.

[Mark Peterson:]

Good morning.

[Mig Dobre:]

So I am wondering may be you can provide a little more color on your growth expectations for PMC, how are you thinking about the full year growth and do you expect positive growth here for the year as a whole and then looking at progression, how should we flow that through?

[Todd Adams:]

We do for the year Mig expect PMC growth to be positive for the year. I think the progression will be the inflection point is probably in the September timeframe in terms of moving from low single digits to positive is sort of how we modeled in at this point. So that’s how we would think about core growth over the course of the year in PMC.

[Mig Dobre:]

I see. Okay. That’s helpful and you highlighted mining and this isn’t the first time I guess when I am looking back at 2012 mining, from when the coal was a little better than $230 million in revenue in PMC, so as you are exiting the year now, how big is mining? What kind of declines have you seen in that business in 2013 and can you also remind us what your exposure to U.S. coal is?

[Todd Adams:]

Mig, the overall growth in mining and I want to be clear and when we say mining what it is we actually mean? It's conveyance, crushing and pumping. So it's virtually nothing to do with construction equipment or mobile equipment. It's probably a little bit bigger than $230 million. So when we look at the exposure there, from a coal standpoint, coal is probably close to half a year ago. I think that number is less than that now based upon the diversification efforts that we've made over the course of the last year into other hard rock mining. So we've had a conscious strategy to diversify away from North American coal and so while it was a tough year last year, we do expect growth albeit slow and low growth for the year, that market is turning plus the diversification efforts. The issue is it takes time to work its way through the shipments. So we expect the backlog to continue to improve over the course of the year and by the time we get to the end of our fiscal year, really late calendar '13 into calendar '14, you know that’s when we start to see growth again.

[Mig Dobre:]

I'll jump in the queue after this question, but I guess my last one for now would be on your unallocated expenses, they sort of came in below what we expected for this quarter and I am wondering how we should be thinking about this looking at the upcoming year?

[Mark Peterson:]

Mig, are you referring to the corporate segment?

[Mig Dobre:]

Yes, yes.

[Mark Peterson:]

Yes, so for the corporate segment, there is a lot of professional fees, there is timing in there around some deal fees and what not. So I think it's -- it can be -- it can be kind of lumpy throughout the quarter and if you look forward, next year I think you know I would say the number in the 27 to 20 range call it about seven a quarter will be the right way to think about it.

[Mig Dobre:]

All right. Very well. Thank you, guys.

[Operator:]

Thank you. Our next question comes from Julian Mitchell from Credit Suisse. Please go ahead.

[Charlie Boorady:]

Hi guys, its Charlie for Julian.

[Todd Adams:]

Good morning.

[Mark Peterson:]

Good morning, Charlie.

[Charlie Boorady:]

Just a question on organic growth. First in the PMC business, just wondering if you guys have seen any destocking from customers and whether or not you could kind of see snapback there moving forward and then on the Water Management side, just may be some incremental color on the strength there. I mean, it doesn’t look like the comp from last year was particularly easy and just a big step up in the numbers the year-over-year numbers sequentially. Thanks.

[Todd Adams:]

Sure Charlie. We really don’t have any adverse impact from destocking in our numbers in Process and Motion Control as best we can tell. I think we monitor channel inventories quite well and really the decline in core growth is fundamentally based on shipment timing and as Mark talked about really just one fewer day in the quarter. So the impact of destocking and Process and Motion Control for the year into next year on a down side is zero. We think that as the industrial end markets and MRO capacity utilization in industrial production stay high, we could see a little bit of a bump. We are not modeling any bump in at this point, but we do think that there is no downside from destocking in our numbers this year or heading into next year. As it relates to Water Management, the growth there is frankly exactly as we've been expecting. Zurn has continued to perform really well and if you look at the Zurn growth numbers, that Mark talked about for the quarter and sort of that mid single digit number, that’s on top of a 5% number last year and if you will recall, last year we had an unusually warm construction season. So the growth last year was likely a little bit hot relative to the market. If you look at this year, we had a very difficult winter, spring and so therefore the comp of mid single digit growth on top of 5% last year is really strong and if you look at VAG, that we've articulate all year long, that quarter is a very difficult to look at just because of the project based nature, some of the shipments, but when you look at the course of half of a year, we are clearly seeing the benefits of having the portfolio that we have of products as well as the geographic coverage to capture all the growth opportunities in the water infrastructure space globally. So the growth in the quarter is outstanding, it's very consistent with we've been anticipating and I think it's really a testament to our teams and the strategy and execution.

[Charlie Boorady:]

Great. Thanks.

[Todd Adams:]

Sure.

[Operator:]

Thank you. Our next call comes from Charley Brady from BMO Capital Markets. Please go ahead.

[Andrew Breichmanas:]

Hi. Good morning, guys. This is Andrew Breichmanas for Charley Brady.

[Todd Adams:]

Good morning.

[Mark Peterson:]

Good morning, Andrew.

[Andrew Breichmanas:]

I was just wondering if you guys could break out the split between VAG and Zurn for our sales. The nominal sales amount, sales growth and if you had order for both of those?

[Todd Adams:]

I don’t think we are going to break it out specifically. I think we can give you some color around it. Again the Zurn business grew about 5% to 7% in the quarter and VAG grew in the high teens to low 20s is sort of on a relatively basis how to think about the growth.

[Andrew Breichmanas:]

Okay. Do you have any color on may be like how orders have been in those businesses?

[Todd Adams:]

Order rates in Zurn have been over consistent and solid, very similar to the sales rate. We don’t operate with a big backlog in that business. If you look at the VAG business in any given quarter, the order rates can be, I don’t want to say volatile, but they can -- they can be pronounced very positively one quarter and flattish for the year. The book-to-bill was over one per VAG.

[Mark Peterson:]

Wobbly, yes.

[Andrew Breichmanas:]

Okay. Great and I guess you know, you guys have been speaking about how your outlook for both segments throughout the call, but kind of along the same line, like what gives you the confidence for the second half of the year in your guidance and then also specifically PMC I guess but also with our management too.

[Mark Peterson:]

I think the guidance that we provided of 1% to 3% core and 30% incremental taken as a whole has an element of conservatism to it in terms of how we think about the industrial end markets and so we think that the water business is going to continue to perform quite well. The cost management efforts that we work on all the time through RBS gives us great confidence that we can drive the right side of productivity in a low growth environment could generate 30% incremental. So I don’t think we are counting on anything heroic in terms of the market recovery. I think it's prudent given the uncertainty in some of these end markets given some of the lead lag in our largest end market of mining or both material handling to sort of go in with a very low growth number and then simply outperform over the course of the year. So that’s sort of how we've thought about the guidance. We don’t think it's in any way, shape or form inconsistent with what we see or what we can execute to.

[Andrew Breichmanas:]

Okay. Great. Just one more question. I was wondering if you guys could speak to any of -- you mentioned kind of growth initiatives throughout 2014 if you may be could be more specific about that?

[Mark Peterson:]

Going back a couple of years started to orient ourselves towards becoming the industry expert across a number of key verticals, which has driven everything from the way we go to market to product development, to our geographic expansion plans. So that in and of itself is broad and pretty high level, but when you get underneath, you start to see some modifications in channel strategy, so you get to see some modifications into getting into adjacencies we previously hadn’t played as well as driving deeper specification with OEMs, end users, engineering, architects, CPC firm. So it's really the combination of all those different things that we've been working on and we expect that over the medium term will drive well above competition in market growth just because we are focused very deeply on these end markets and we that we feel -- we feel really good about the management teams we have and the progress we are making on those strategic plans.

[Andrew Breichmanas:]

Okay. Great. Thanks guys.

[Mark Peterson:]

Sure.

[Operator:]

Thank you. Our next question comes from Andrew Noorigian from Vertical Research. Please go ahead.

[Andrew Noorigian:]

Good morning, guys.

[Todd Adams:]

Good morning.

[Mark Peterson:]

Good morning, Andrew.

[Andrew Noorigian:]

I was wondering if there was some way to kind of dig a little deeper into water margins and how much of the strength there was driven by the 22% growth at the valves and gates and I guess what I'm getting at, is if that's a little lumpy, should we expect margins to kind of bounce around or can they continue to go higher from here?

[Todd Adams:]

There is no question that the margins can go higher across the segment. We believe that the growth there over time moderates. We are not going to grow 22% in the quarter in valves and gates moving forward at least the next couple of quarters just based on shipment timing, but I wouldn’t conclude that the margin expansion is as a result of that 22% growth. It's a combination of continued very strong margin performance against -- in our Zurn business as well as strong margins in VAG, but offset with some investment to continue to extent our global reach. So the overall margin performance at 15.5% in the quarter can go up from here. It does not require 22% growth in VAG to do that. We think that the margins across Water Management can get to the high teens low 20s in aggregate over the next three or four years.

[Andrew Noorigian:]

Okay. And then just following up, could you comment a little bit more on what you're seeing in the non-res markets? I think you made some comments that it's starting to pick up a little bit. What do you see in terms of just customer discussions, bookings, things like that?

[Todd Adams:]

What we are seeing is all the momentum endacies that we look at which are projects that are effectively funded and in the planning phase, that backlog continues to build quite nicely and when we look out, we expect that that really comes to fruition for us very late in the calendar year and then into the next couple of years. So looking at the backlogs, looking at the lead lag, looking at the increase in specifications that we've driven throughout the downturn, we are very confident that the overall market recovery is real. It's not at anywhere -- not anywhere near the peak at this point, but just from the progression standpoint there are a number of projects that we know are going to happen. We are really well positioned there and so that’s the discussion. It's really a sustained long term discussion around driving preference at the owner level and as well as through the channel and architects and everything else. So we are really confident in our ability to outgrow the market as that market recovers and if you look at where the backlog sits, they continue to build and the momentum is very strong there.

[Andrew Noorigian:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from [Alex Gomez from Trust]. Please go ahead.

[Unidentified Analyst:]

Yes, hi, guys. Actually just a very quick question. And I apologize if you guys went through this already in much more detail. But I read in your press release you were talking about the Board is reviewing very strategic alternatives and then previously they're going to report on Bloomberg. Can you kind of comment on that a little bit more?

[Todd Adams:]

Alex, I think in my opening remarks, we sort of outlined the fact that Board continues to review its various alternatives and we expect to come back by the end of our first -- that’s really I will be able to say about the process.

[Unidentified Analyst:]

All right. Great. Thanks.

[Todd Adams:]

Sure.

[Operator:]

Thank you. Our next question comes from Matt Vittorioso with Barclays. Please go ahead.

[Oscar Bate:]

Yes, hi, guys. Oscar Bate in for Matt here. How are you guys doing?

[Todd Adams:]

Oscar, you are a little bit faint, if you could speak up, that would be great.

[Oscar Bate:]

Yes. Can you hear me now?

[Todd Adams:]

Yes, that’s much better thanks.

[Oscar Bate:]

Okay. Sorry about that. I just had a question on free cash flow. Fourth quarter was pretty strong and I think you guys stated in your comments that you expect net leverage to decline as you continue to generate cash, which makes sense, but can you guys just give us an idea of how you're looking to use the cash you generate going forward? Will you consider paying down debt? Are there acquisitions in the pipeline that you're looking at? If so, sort of what size and where? Any comment there?

[Mark Peterson:]

Yes, I think as we talk about the free cash flow we are talking about on our calls previously, you just saw us we are using our $50 million to pay down debt, so I think looking at from our balance and working up the opportunities in the acquisition funnel, I guess our strategy is still focused on bolt on [tuck and type builds] in our existing platforms that we have today. As we are balancing that opportunity funnel, with debt pay down as we have for several quarters now and making best use as we go forward based on those opportunities. So I think we will be looking at both as we go forward.

[Todd Adams:]

Oscar, may be just to follow on to what Mark said, we don’t provide any guidance that would include potential acquisitions in terms of size. We think that we can do M&A inside the existing platforms while de-levering very predictably over the next couple of years. So our funnels are in really good shape. I cannot predict timing, but it's not inconceivable that we could be adding $150 million plus spend our investment over the course of the next couple of years towards M&A at reasonable multiples.

[Oscar Bate:]

Okay. That's fair. That's very helpful. And then just quickly, with regard to the 8.5% notes, I think they are callable in a little under a year at 104.25%. Would you guys just comment on how you're thinking about those bonds and possibly refinancing them in the future?

[Mark Peterson:]

Yes, I think that you are right. It was May of next year the calls 104.25%, so I think you know, it's all dependent on our marketing conditions at the time, but I think it's something that we would obviously consider and you know we have options when that time rolls around and dependent upon what the market looks but if the market remains robust like it is today, it's something that we will definitely consider doing.

[Oscar Bate:]

Okay. Thanks guys. Good quarter.

[Todd Adams:]

Thank you.

[Mark Peterson:]

Thank you.

[Operator:]

Thank you. We have a follow-up from Mig Dobre from Robert W. Baird. Please go ahead.

[Mig Dobre:]

Thanks for taking my follow-up, guys. Just a couple of quick ones. First one, I'm wondering if you can give us a little more color as to what you're seeing from a pricing environment standpoint in both water and PMC.

[Todd Adams:]

Generally Mig, I would say the pricing environment is fine. If you look at what we sell through distribution and channel partners, the traditional price increases that we've been able to capture, we continue to see those being available to us. We don’t see much -- much change there at all. I think where we've been more focused is on driving that preference end users as well as OEMs and from a pricing standpoint that’s tough to gauge how much is price versus how much is the price of entry. So for us we see the pricing environment being reasonable and stable.

[Mig Dobre:]

But you wouldn't highlight any sort of differences by end markets, because obviously not all end markets are enjoying the same level of demand, if you would.

[Todd Adams:]

Sure, I think that as I look at, I wouldn’t spend a whole lot of time trying to differentiate by end market and price. For us stuff that we would sell through channel partners on an aftermarket basis, we continue to get a reasonable to low single digit price increases that we historically would achieve on the new business and new projects and new platforms, it's market pricing, so to say that’s it's depressed because the end markets are down I think it's probably the wrong assumption. I think there are some natural price points for the products we sell and the applications and the value they bring. So we are not really suggesting or seeing any material price pressures or any material pressure the other way into the process and I think a pretty stable pricing environment from everything we see.

[Mig Dobre:]

All right. That's great. And you provided some comments on water margins. I guess I'm wondering if you can talk a little bit about PMC margins as well and how you expect those to progress. Also wondering if there is maybe a little bit of mix benefit that you could get presuming that the mining end market is reaching some sort of stability.

[Todd Adams:]

Well margins for the year were right around 25% and all that margin expansion over the course of the last three or four years has come through gross profit environment that has been flat. So most of the productivity and margin expansion -- most of the margin expansion has been really driven through productivity and things that we can control. So we feel very good about the sustainability of the gross margins obviously to the extent we get more volume through our businesses, the greater the margin expansion from there, I think we can continue to expand margins in a slower growth environment as we've shown this year to the extent we get some tailwind from certain end markets obviously that go through margin will be very good. So I wouldn’t think about it as at all being done. I think over the last four years, I think our gross margins in Process and Motion Control have moved from 31% to 38% and we've had the ability to come back and reinvest in new growth and we sit here today in a market environment that is okay, not great with things pointing positively to the future. So we feel like we are really well positioned to capture the growth on the upside because of the investments we've made over the course of the last couple of years that we are really we were able to invest and afford by driving sustainable productivity each and every day. So I think we are really happy with where the margins are. They can go higher, obviously volume helps.

[Mig Dobre:]

All right. Good luck guys.

[Todd Adams:]

Thanks Mig.

[Mark Peterson:]

Thanks Mig.

[Operator:]

Thank you. We have no further questions at this time. I will now turn the call over to Todd Adams for closing statements.

[Todd Adams:]

I want to thank everyone for joining us this morning. We appreciate your interest in Rexnord, and look forward to providing further updates when we announce our fiscal year 2014 first quarter results in early August. Thank you.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.