Zurn Elkay Water Solutions Corp (ZWS) 2016 Q4 法說會逐字稿

Good morning and welcome to the Rexnord fourth-quarter FY16 earnings results conference call with Todd Adams, President and Chief Executive Officer; Mark Peterson, Senior Vice President and Chief Financial Officer; and Rob McCarthy, Vice President of Investor Relations for 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 in an 8-K with the SEC yesterday, May 18, and are also posted on the Company's website, at investors.rexnord.com. At this time for opening remarks and introduction, I will turn the call over to Rob McCarthy.

Good morning and welcome, everyone. Before we get started, I need to remind you that this call contains certain forward-looking statements that are subject to the Safe Harbor and cautionary language contained in the press releases that we issued yesterday, as well as in our filings with the SEC.

In addition, some comparisons will refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures and why we use them. Consistent with prior quarters, we will 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.

Please note that, consistent with our press release and 8-K filing on April 26, we are excluding the results of a non-core product line which Rexnord is exiting in our Water Management segment from the presentation of our operating results, in order to enable investors to better understand and assess our core operating results.

Today's call will provide an update on our overall core performance for the fourth quarter of our FY16 and our outlook for the FY17. We'll cover some specifics on our two platforms, followed by selected highlights from our financial statements, our liquidity and our cash flow. Afterwards, we will open up the call for your questions.

With that, I will turn the call over to Todd Adams, President and CEO of Rexnord.

Thanks, Rob, and good morning, everyone. Starting on slide 4, our fourth quarter results were a bit mixed. We met our expectations for free cash flow, despite core sales and profitability that were essentially at the low end of our initial expectations, as the trajectory of a traditional seasonal pick up in our fourth quarter was a little weaker than we had anticipated and symptomatic of our customers' tighter spending within a weak global macro environment.

Nevertheless, our year-over-year core sales declined moderated in the quarter to 3% year-over-year, which is a function of 8% core growth in our Water Management platform and a 9% core decline in our Process and Motion Control platform. Adverse currency translation was a headwind that reduced our report top line growth by approximately 2%.

Our adjusted earnings per share was $0.37 in the fourth quarter. Consistent with our previewed results and within our original guidance range, we should assume no earnings contributions from the non-core product line that we are well into the process of exiting.

Our FY16 free cash flow of $171 million was in line with our expectations, finished the year at 113% of our adjusted net income and provides the flexibility to add attractive bolt-on acquisitions. If you didn't see our separate release this morning, we have agreed to acquire Cambridge International, which is a global leader in engineered metal conveying solutions, predominantly for the food industry. We're excited about the combined value creation potential of Cambridge and Rexnord together, and I'll have more to say about Cambridge in just a few moments.

Looking at the performance of our two platforms, our core Water Management operations put up another solid quarter, with high single digit core growth and adjusted EBITDA margin approaching 18%. For the full year, Water Management's core operations delivered 5% core growth and an EBITDA margin of 20.3%, results that we are confident we can build upon.

We continue to see attractive mid-single digit growth in our North America non-resident markets in our fourth quarter, with a narrowing gap between growth rates in our commercial and institutional sectors, as institutional continues to strengthen. Contractor backlogs are up, construction employment is growing, and we are looking forward to another solid year of growth.

On the infrastructure driven side of the platform, demand conditions vary by geography, with North America showing signs of modest growth, Europe showing broadly stable order activity, and developing economies, depending on specific country and project exposure, but overall a net positive for us. We continue to see this global market as stable to improving in the near term, and as a relatively stable mid-single digit grower over the longer term.

Turning to our Process and Motion Control platform. We experienced significant cross currents in our fourth quarter that in total reflected the weak global growth environment and associated volatility across various end market verticals that produced overall platform results that were modestly below our expectations.

As you're likely aware, overall US industrial production and capacity utilization, which include the mining and energy sectors, weakened further in the March quarter, but were generally stable if you focus only on the manufacturing sector. US capital spending slowed further, but the Purchasing Managers Index improved. In other words, visibility remains challenged across the broad industrial sector.

Positively, the stabilization in our industrial distribution channels that we discussed last quarter continued in our fourth quarter. On the other hand, we saw disappointing order flow from some of our end user and OEM customers, including some short-term adjustments driven by planned twin aisle production rate changes in the commercial aircraft sector.

Our incremental margins were penalized somewhat by related short-term inefficiencies in our aerospace operations that impacted PMC's core growth and margin performance in the quarter. We have made the necessary internal changes that we expect to enable us to recapture the top line and earnings that we missed in the fourth quarter during the coming year.

As we have highlighted previously, our global aerospace and food and beverage end markets account for about 33% of PMC sales and a larger share of its earnings, and we expect to generate positive core growth in both end markets during the coming fiscal year. In total, our outlook for PMC incorporates generally stable industrial distribution sell through, and thus improving year-over-year comparisons as we move through FY17, generally stable distribution channel inventory levels, improved execution in our aerospace markets, and only modest improvement in year-over-year growth comparisons for OEM and end user sales into our process industry verticals as we move through the year.

Given our positive outlook for our Water Management platform, our expectations for stabilizing demand in our industrial distribution channel, and solid demand in aerospace and food and beverage end markets, we expect our overall core growth in our FY17 to range between a 2% decline and a 1% increase. Given that top line outlook and the addition of Cambridge, we project our adjusted earnings per share will be between $1.47 and $1.57.

As Mark will detail in a few minutes, our outlook includes approximately $14 million, or $0.08, of nonrecurring expenses associated with our supply chain optimization and footprint repositioning initiatives that are not excluded from our estimates. As you'll recall, this program is expected to deliver $30 million of annualized savings beginning at the end of this year, our FY17. The RHF product line exit captures about $5 million of the planned structural savings in this year and going forward and eliminates a non-core distraction while also improving the payback on the overall initiative.

To quickly update you on the overall project, first production parts from our new plant in Mexico have been qualified by customers and we made our first customer shipment last week. The benefits from the program will be ramping during the year, most significantly as we move into our third and fourth quarters, to reach the targeted $30 million run rate as we exit this year. Overall, the program is well underway and we remain on track to deliver the planned savings.

Please turn to slide 5, and I'll spend a few moments on the Cambridge acquisition, which has been in our proprietary M&A funnel for about two years and which we expect to close in June. Cambridge led about $80 million of annual revenue and EBITDA, with EBITDA margins in line with PMC's historical performance and will position us to accelerate our penetration into the relatively stable and growing global food processing sector, while bring additional capabilities and opportunities to add value to our long-standing customer relationships in the global beverage industry.

Cambridge generates the majority of its sales in a broad range of food applications, from seasoning and grilling meats to decorating and baking cookies, from freezing and packaging ice cream to sorting and cleaning fruits and vegetables. Cambridge conveying products are also used in beverage filling and packaging operations, and it's also a leading supplier of filtration products to the craft brewing industry. This is a terrific company with a strong brand equity built on a track record of superior customer service, value-added application engineering, and sustained by a culture of product innovation.

The acquisition is exciting for us because it's about growth. We know from experience that food and beverage's end market has an attractive and relatively stable growth profile and Cambridge has grown nicely in recent years. Although our products are used side by side in some of our customers' plants, there are more opportunities where we can help each other. The bottom line is we've identified significant and specific sales synergies that we expect to convert on in the coming quarters and years.

On a pro forma basis, including Cambridge, PMC will be generating between 20% and 25% of its global revenue in food and beverage end markets going forward. To sum it all up, we believe Cambridge will enhance PMC's and Rexnord's longer term growth profile, and we expect to deliver a double digit return on this investment within the next couple years.

Moving to slide 6, we're presenting a bridge here for our FY16 adjusted earnings per share and our guidance for FY17. First, I would note that our non-core product line exit has the effect of elevating the jump-off point in FY16, as you can see; and from that higher base, we expect our core operations plus Cambridge to add $0.08 to adjusted earnings per share, at the midpoint of our guidance. Given the RHF exit, nonrecurring supply chain optimization and footprint repositioning expenses will increase by about $0.03 to produce a total impact $0.08 of nonrecurring expenses included in our guidance for adjusted EPS in our FY17.

Now let's move on to slide 7. We've made some changes to the composition of our market growth outlook slide that we are hopeful will provide some context of how we're thinking about our fundamental outlook. Specifically, we have added some geographic detail to our outlook for industrial distribution channels and expanded our outlook for process industries to cover more than just mining and energy and provide more comprehensive coverage of our end market expectations.

To help you calibrate the year-to-year trend, as we did this time last year, we've also provided a summary of our FY16 core growth across these end markets. This revised presentation covers markets that drive over 90% of our annual sales.

In total, you will see that we are projecting weighted average end market growth to range from flat to down 3% for our FY17. We expect to outgrow our markets in FY17, supported by the progress we're making with our commercial productivity, the launch of new products, and other share gain initiatives.

Our intense focus on commercial excellence is improving our customers' overall experience and we're seeing it in our customer satisfaction survey weight and net promoter scores. Our success in winning strategic first fit specifications is gaining some momentum, as the run rate of first fit orders booked in the fourth quarter match the incremental impact in the first three quarters of the year.

Looking across our end markets and as highlighted earlier, we continue to have a favorable outlook for our key construction end markets. In our guidance, we are assuming a modest sell through decline in our industrial distribution channels, which should be roughly offset in our results by reduced destocking and higher direct shipments.

The overall commercial aerospace market looks to be flattish, and we anticipate further growth in global food and beverage end markets. We also anticipate ongoing strong headwinds in our process industry end markets; but given our view is that we've probably seen the worst of the down cycle, we see the potential for moderating year-over-year declines in the second half of our FY17.

All in all, we see our operating results as stabilizing to improving throughout FY17 and providing a favorable set up as we complete our footprint initiatives later this year and look into the following year, our FY18, which is only 10 months away at this point. With that, I will turn it over to Mark to review the numbers.

Thanks, Tom. Slide 8 of the presentation takes our reported results and reconciles them to the adjusted results. Please recall that we intend to exclude the financial impact of the RHF non-strategic product line exit from the calculations of our core growth and our adjusted earnings metrics in order to focus on our core operating results. The press release we issued last night includes a summary of our quarterly results in each quarter of FY15 and FY16 and excludes the results of the RHF product line that we are exiting.

Turning to slide 9, I'll just comment on a few key metrics from our consolidated results in the quarter. First, please note that we have excluded $7 million and $10 million of the RHF product line revenue from our analysis of the fourth quarters of FY16 and FY15, respectively. The earnings adjustments for RHF were detailed on slide 8.

Turning to our core operations, the year-over-year decline in our fourth quarter core growth was 3%. On this basis, our overall decremental margin was roughly 25%. On the same basis, the drop-through for consolidated adjusted EBITDA for the full year of FY16 was approximately 32%, which is generally consistent with our historical 30% targets.

Next, as we look at the operating performance in our Process and Motion Control platform on slide 10, you can see the year-over-year impact on the platform margins from the combination of a 10% revenue decline and our higher investment spending associated with our footprint actions. But margin improved sequentially, as activity levels in our distribution channels remained stable and margins benefited from the seasonally higher contribution in our food and beverage end markets. For the full year, PMC's adjusted EBITDA margin was 21.3%.

As we look into FY17, we expect the year-over-year core decline in PMC revenue to moderate to a low to mid-single digit percentage. Our outlook assumes stable to improving demand in our aerospace and food and beverage end markets, generally stable sales levels in our industrial distribution channels, while support from reduced destocking, and further substantial but moderating year-over-year declines in our process industry end markets. Cambridge should add approximately 550 basis points of incremental top line growth to PMC in FY17.

Core PMC margins are expected to be flat to down slightly, given anticipated core sales decline and its investment spending increases as (Indiscernible) strategic new product breakthroughs. Nevertheless, we expect to offset most of the top line pressure on margin with RBS-led improvements in operating efficiency. Cambridge is expected to be slightly accretive to PMC's overall adjusted EBITDA margin in FY17.

Let's turn to slide 11. I'll make a few comments on our Water Management platform, where we are again excluding the RHF product line exit in our analysis. Core growth accelerated to 8% in the quarter, as sales benefited from steady momentum in our nonresidential construction markets and stronger project shipments to our water and wastewater infrastructure markets.

Our incremental margin was essentially 100%, and while benefited from comparison with the depressed result in the year ago quarter, it also reflects measurable improvements in our operating execution as we leverage our ongoing RBS-led continuous improvement initiatives. With the solid margin performance we saw in the fourth quarter, the adjusted EBITDA margin for Water Management for the full year of FY16 and again, pro forma for the RHF product line exit, was 20.3%.

As we look forward to our FY17 for Water Management, we are projecting another year of solid core growth in a mid-single digit range, with slightly higher growth in our non-residential construction markets and relatively slower, but still positive core growth in our water infrastructure markets, which accounted for approximately 32% of our platform revenue in our FY16. As always, we caution that the timing of project shipments increase significant variability in quarterly year-over-year core sales growth comparisons in our Water Management platform. In terms of expected year-over-year margin performance, we note that, again given the RHF product line exit, approximately $5 million of our projected annual supply chain of footprint savings were realized in our adjusted results for FY16 and therefore, are now in the base run rate.

Moving on to slide 12, you'll see our strong free cash flow enabled us to further strengthen our cash position and liquidity, as we continue our disciplined approach to capital allocation and seek to reduce our leverage ratio over the coming quarters. We believe that stabilizing annual EBITDA and our strong free cash flow positions us to fund the Cambridge acquisition and still reduce our leverage ratio below the current level by the end of FY17.

In addition, we intend to repay approximately $100 million of debt during our first quarter from our existing cash balances. Our liquidity position remains strong and we have a patient capital structure, given our maturity profile. Going forward, we will continue to evaluate our capital allocation opportunities in the context of our overall capital structure, our liquidity requirements, and our longer term objective to reduce our financial leverage.

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. In addition to the outlook highlights Todd covered earlier in the call, slide 13 of the presentation also highlights our assumptions for interest expense, depreciation and amortization, our effective tax rate, capital expenditures and fully diluted shares outstanding for FY17.

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 and gains or losses on the disposal of assets, recoveries under the Continued Dumping and Subsidy Offset Act, or other items that are reported in this P&L line item. Other than the pending acquisition of Cambridge, our guidance also excludes the impact of incremental potential acquisitions and divestitures or future non-recurring items, such as restructuring costs.

With respect to restructuring, I'll take a minute to provide you with an update. Please note that the cadence of expenses and benefits associated with our supply chain optimization and footprint repositioning initiatives has changed with our RHF product line exit and the related acceleration of structural savings. So first, let me summarize how the supply chain optimization and footprint repositioning program is expected to impact our FY17 results.

Given the exit of that product line, the incremental benefits associated with RHF that were originally projected to be realized in FY17 have been realized in FY16 and are now in our base run rate of our earnings. As we talk about FY17 and beyond, my comments will focus on the remaining non-RHF actions that we are executing. With respect to those actions, we incurred approximately $10 million of costs in FY16 and expect to incur approximately $14 million of costs in FY17, all of which run through our adjusted operating results.

In addition, in FY17 we will begin to realize benefits from some of the non-RHF actions, as I incorporated in my comments last quarter, and we've included approximately $6 million to $7 million of those benefits in our guidance for FY17. Importantly, the total costs we incurred in FY16 and the estimated impact of all of our non-RHF initiatives are unchanged from our expectations, as updated last quarter.

We expect to report restructuring expenses of $20 million to $22 million, which are primarily made up of severance costs and are excluded from our adjusted operating results. Excluded from our guidance for adjusted EPS is approximately $11 million of accelerated depreciation in FY17. Our forecast for capital expenditures in FY17 related to this program is unchanged and is included in our CapEx outlook of approximately 3% of sales. Second, in addition to this program, we anticipate incurring restructuring costs of approximately $3 million to $4 million related to other cost reduction initiatives during the year.

Next I would like to make a few comments on our effective tax rate. Our effective tax rate will fluctuate by quarter, given the varying levels of pretax income, as well as the timing of other planning initiatives. We currently anticipate that our tax rate will be approximately 18% in our first quarter and approximately 27% for the full fiscal year.

Before we open the call for questions, I'd also like to highlight a change in our expense structure that does not affect EBITDA, but will change our EBIT margins going forward. Before considering the Cambridge acquisition, our annual expense for amortization of intangibles will decline year-over-year by around one-third, or approximately $18 million in FY17, as certain intangibles related to our acquisition by Apollo in 2006 become fully amortized. Based on our FY16 revenue level, the impact amounts to nearly 1 full point of pretax margin.

With that, we'll open the call for questions.

(Operator Instructions)

Charlie Brady, SunTrust Robinson Humphrey.

Thanks. Good morning, guys. On aerospace, it sounds as though, from your commentary in the quarter on the call here, that maybe it came in surprisingly a little bit softer than you were expecting and maybe the outlook is a little bit pared back. Can you just talk about what's driving that right now?

I think it's two distinct issues. In the quarter, it was some internal efficiency things that we dropped the ball on. And so when you think about what that means, we left about $4 million on the table in the fourth quarter that we're going to make up over the course of the coming year. So that issue is internal, behind us, and we're making good progress there.

The adjacent issue is if you look at some of the production cuts for the 777 and 747 that were made, it has the impact of knocking $4 million to $6 million of revenue out of next year, based on that production cut. So two distinct issues. The one, the internal issue, rectified and [fine] moving forward, and we think we've got the guidance bracketed with the production cut embedded into it. So that's the aerospace story.

Okay. Just quickly on Cambridge, just so I'm clear on the margin profile of that business, you said historical PMC segment margins, so we're looking at, on EBITDA basis, mid to high 20%?

Yes.

Okay. Thanks.

Julian Mitchell, Credit Suisse.

It's Ronnie Weiss on for Julian.

Hi, Ronnie.

How are you doing? I just want to touch on the pricing dynamics and what you guys saw in 2016 and what you're going to see in 2017, and similarly, on the raw-mat costs, what you guys saw on the impact for 2016 and what's expected for 2017?

Ronnie, this is Mark. From a pricing standpoint, we didn't see a lot of pricing pressure in 2016. In the distribution channel, pricing was stable. Our end user OEM piece in PMC, is that's project based, so you're bidding on projects. We didn't see really any material differ in deviation in pricing dynamics from what we've seen in the past. So [high gear press], PMC is stable. I think the same thing in our water platform, too. We didn't push a lot of price in the year in 2016, but we didn't see a lot of pressure. As far as raw material goes, we saw some benefit in raw materials. But as you can appreciate, we're not buying a lot of raw commodity. A lot of what we're buying has value added in it, so we saw some benefit, but not a huge benefit.

As we look into FY17, we're not planning on a lot of price. As we think about our sales growth, we don't have even a full point of price in it. So we're not expecting much to change as far as price dynamic goes positive or negative. And raw material, we think obviously there's been some cloudy uptick, but as we said when margins came down, we had some benefits. As prices go up, we don't expect it to have a big negative impact. So we really, if you had to summarize it, it feels stable on both fronts going into 2017 from what we saw in 2016.

Hey Ronnie, you know this, but generally speaking, we're talking about low volume, high mix engineered specified products that go through a very set of complex channels, including a big piece of aftermarket. So the pricing environment, generally for us, never varies too much from year to year. And as Mark pointed out, commodities were maybe a little bit favorable this year, have come up a little bit, but I think pricing dynamics across the board are generally stable for us.

Understood. And then back on Cambridge, I didn't hear any kind of synergy targets you guys are looking for. Have you gone through that analysis yet? What are you looking for on that front?

We didn't outline it. A couple things to point out, in my comments. This is not a cost-synergy deal. It's a fantastic business that's got good end-market exposure and growth baked into it. On top of that, we bring to the party close to 400 direct sellers, whereas they had less than 10. So in terms of scale and ability to bring the product to a broad, more diverse customer base, both in North America and Europe, it's a huge opportunity for us on a combined basis, as well as they've got some very good customer relationships where we have the opportunity to go in and sell some of our products to their existing customers. So we think the sales opportunity over a few year period is, frankly, quite big.

So we didn't give you a target, other than to say it's a growth-oriented deal, it's a great business we're buying at a fair value, and we think there's a lot of growth synergies that we can get as a result. And frankly, it's been in our funnel for a couple years, so we've had the chance to look at it, learn it, understand it, and we feel really good about the acquisition.

Got it. Thank you.

Joe O'Dea, Vertical Research.

Good morning. On process and the expectation for the double-digit declines this year, could you talk about where you're seeing the composition of that, maybe the trend in mining and energy, whether or not some of the headwinds are broadening out at all, but as we continue to go through this, where the bigger pressure resides?

Joe, this is Mark. I think as you saw on the slide, we, from an OEM management standpoint, the mining and the energy end-markets remain tough. As we said in our fourth quarter, we highlighted, we saw a little modest seasonal pick up, but when you look at where they've been in the prior years, we think that the mining energy and some of the ripple effect, obviously from energy, continues into FY17. So we're really not looking, and this is, again, end user OEM perspective. From an MRO standpoint, we've seen stabilization, expect that to be relatively consistent going forward. But we look at that end user OEM base, project work, capital work, it's depressed. And we don't see a catalyst to change that in the near term here. So we're just planning on that to make sure we plan prudently over the next year.

Okay. Got it. And then just quickly on the tax rate and at 27%, is there anything structural underlying that as that steps a little bit lower, or is that more a mix effect?

I'd say the one thing, Joe, that's moved it down from where we ended FY16 is we'll be adopting the new accounting pronouncement that requires you to take basically -- as you know, when stock options are exercised, there's a tax benefit. And that's historically run through equity. So with the new accounting guidance, you now need to put that up into your tax expense line as a benefit. It's worth a few cents for us this year and it's really what moves it from that 29% to 27% [down]. So we'll be [done then] with that in our first quarter, Joe.

Okay. And then I think you commented on moderating declines in the back half that you expect right now. I think it's not like the comps swing all that dramatically in PMC as we move through the course of the year, so just visibility confidence in seeing that moderation as we navigate through the year.

We obviously feel pretty good about it or we wouldn't have guided that way. I think what you're going to see is, we're talking about, at the Company level, core growth of plus 1% to minus 2%. The trajectory we start on is somewhere between flat and down 2%. So I think when you look through it and in total, we feel pretty good that the trajectory that we're on matches the way we're guiding for the full year. So I don't think we're banking on any sort of big pick up. I think really we're talking about stability, controlling what we can control, win where we think we know we can win, add some of the Cambridge in, and we feel like this year is not about lift off.

I think this year is really about the [scoper] project's done, get the acquisition integrated and be ready for 2018. So that's how I think we're guiding the year. We hope we're wrong. We hope the pick up is a little bit bigger. But I think at the end of the day, given what we see, and frankly what, when we look out the window, that's what the world looks like right now. So we're trying to guide, I think, to reflect that.

Great. Thanks very much.

Samuel Eisner, Goldman Sachs.

Good morning, everyone. So on Rodney Hunt, I was wondering if you can talk a little bit about what's happened in that business. Obviously, you're choosing to get out of it. Given the restatement, it's the first time that you guys are being able to talk publicly about it. So if you can give a little background to what the issues were with that business, why the decision to ultimately close it, just for a better understanding.

I don't know that we're going to spend a lot of time on it, Sam, because it's a decision that we made because it was a business that was non-core to us and clearly wasn't performing financially. The look back, I don't think is tremendously helpful, because for the most part, it's market driven. It's a highly commoditized business that we chose to simply exit.

We can still access the product category into larger project opportunities, but done through an outsourced way. And that was ultimately what the decision was, meaning we don't need to stay vertically integrated or even partially integrated to provide this product to our customers as part of larger water infrastructure projects. And rather than spend the time, money, and effort to do that, we decided to simply exit the product line entirely and source it as needed when projects call for it. So that's, I think, the decision and history in a nutshell.

That's helpful. And so on the Cambridge transaction here, given that you guys plan to close it within 30 days, can you talk a little bit about what's embedded in the first quarter guidance number? And then would love to try to break apart the $0.08 on the bridge that you guys talked about.

It's really not that much. So a couple million bucks. I think the reality is, we'll get it closed here in the June quarter, where quarter earnings will come back and it will be fully baked into our second quarter and the remainder of the year, when we talk about overall growth. So I don't know that we're -- there's not much in the first quarter at all.

Got it. And then for the $0.08 for the year, so the $0.08 on your earnings walk here, so operations in Cambridge, can you talk a bit about what the moving pieces are in there? Obviously, the cost savings that you referred to, about $6 million to $7 million, or roughly $0.04. So I was wondering if there's a way to explode more so of what that $0.08 is encompassing.

Within the operating column?

Yes, just within the FY16 to FY17 adjusted EPS bridge on slide 6, you talk about $0.08 worth of benefit, and it seems as though Cambridge is already embedded in there for the year. So I just want to better understand what the moving pieces are of that $0.08.

Yes, so with that, you have a few cents from the scoper benefit that we'll be realizing this year going into next year, call it mid single digit EPS benefit from the Cambridge acquisition, with the balance being core operations.

Got it. That's helpful. Great. And then just lastly, in terms of the 30-day notice here, everything is pretty much signed associated with Cambridge. Is there anything that we need to worry about from a closing or DOJ standpoint that we need to be mindful of?

We don't believe so, Sam.

Great. Thanks so much.

Mic Dobre, Baird.

Good morning, gentlemen. I don't know if I missed this in your comments, but can you give us a sense for how you're thinking about full year organic growth in PMC versus water management?

We didn't comment on it.

For the full year, we're planning on PMC organic growth to be down low- to mid-single digits and the water growth to be up low- to mid-single digits, more mid-single digit. That's the balance by platform for the year, Mic.

Sure. Sure. I appreciate that. And then I guess I'm scratching my head a little bit with regards to your guidance in the first quarter and trying to get to the full-year number. Because at least to me, it looks like we're talking about EBITDA margin overall for the Company being down maybe 100 basis points or something to that effect in the first quarter, and then really ramping up as the year progresses. What are some of the drivers, frankly, that are impacting the first quarter and how do we get to this ramp looking at the back half?

Well, Mic, a couple of things that are impacting the first quarter. It's a heavy quarter for our expenses that we're incurring from the supply optimization footprint repositioning program. So as the year progresses, you start, so you're basically all expense in the first quarter, then you start getting to the benefit as the year progresses. So that's one big piece of it.

We talked about some of the initiatives that we have regarding growth and some breakthroughs and growth of our platforms. So we started some investment in our fourth quarter. That's full run rate in the first part of our year, and then we start getting benefit from that over the back half. And over the course of the year, as you know, we continuously, obviously, drive our improvement through RBS, through the balance of the year, which drives the margin improvement over the course of the year.

But the two biggest (inaudible) now would be the scoper investment that we have in the first part, as well as our growth investments that we have in the first part of the year, given the benefit of that as you go through the back half of the year.

Mic, I think using the word ramp, I don't know that it's ramp as much as it is some discreet items that Mark talked about and our normal seasonality. So if you parse that out, I think what you're going to see is a relatively down-the-middle year in terms of the growth assumptions we've laid out, which you could argue they're conservative or you can argue they're too aggressive. We generally think they're probably more on the conservative side, and then the benefit of all the things that we're doing.

So that's how we think about the year, not so much in terms of a ramp, but pretty steady discreet items setting us up for what we think is a transition year to much higher margins heading into FY18, as we complete the supply chain optimization project.

I see. That's helpful. And maybe one last one, looking at water management now that Rodney Hunt is out of there and business mix is maybe a little bit different. You used to talk about 20% EBITDA margins. How are you think about the margin potential going forward?

Well, again, I think where we are today is something that we felt like we could get to if we were to continue down the path of doing what we were doing with the Rodney Hunt business. By not doing it, we simply got there a little bit faster.

Thinking about where we go from here, I think you can expect continued improvement in our overall margins, based upon RBS and what we're doing there to continue to eliminate waste, improve our service levels, a quality everything. And then also, there's probably a pretty good opportunity you're going to see us get into new categories. And as we get in, we have great brands, great channels, and we have the ability to specify our products and pull it through. So it will be higher than 20%. I think you'll see improvement in our FY17, and from what we can tell now, based on the element of the scoper project that remains in water, you'll see improvement again in [FY18].

Can you help us think about incremental margins, though, at this point?

I don't think they're changed. I think historically, we've said 25%, 30% in water. I don't think that is any different.

35% in PMC.

And 30% to 35% in PMC.

On the core.

So again, I think we're retaining or maintaining the way we're thinking about incremental margins. We will get the benefit next year of the supply chain optimization and footprint rationalization benefits. But beyond that, we think we can continue to generate the types of incremental margins that we just talked about.

Thank you.

You bet.

Karen Lau, Deutsche Bank.

Thank you. Good morning, everyone. So I noticed in the fourth quarter for PMC incremental margins or decremental margins, despite the very high contribution/distribution business having stabilized, destocking being over it, the decremental actually got a little bit worse. How much of that is due to the redundancy cost and investments and the aerospace disruption, things like that? Could you parse it out for us?

Yes, those were the two real pieces when you cut through it. Even though we saw some stabilization, we're talking about stabilization sequentially. So industrial distribution was still down for us year over year. So we still [bid] in our fourth quarter have adverse mix impact from distribution. So that was one piece of it when you look at it year over year.

We did incur, obviously, costs related to our scoper project in our fourth quarter that were not in last year. And as Todd pointed out, we left some shipments on the table in aerospace that we'll recapture in FY17, for 2017. You can appreciate with that, we didn't operate effectively. We weren't as efficient as we should, and that impacted our decremental margin in the fourth quarter. Those are the three items, Karen.

Okay. And then what kind of core decremental margins are you baking in for the first quarter, and then how much investments have you baked in into your guide? And are there any one-time charges associated with the transaction?

I won't get into what the core decrementals are in the first quarter by platform. We'll talk about that once the quarter unfolds in 90 days. But what I can tell you is, as we said earlier, first of all, that there are no, as we know today, no unusual items in the first quarter. As I said, we're going to have heavier scoper expense in our first quarter in PMC, and we are going to obviously have the investment costs (technical difficulties) on the growth side into the first quarter.

I think when you look at it, when you look at it sequentially from Q4 to Q1 as the quarter unfolds, it won't be a surprising decremental margin sequentially in PMC Q4 to Q1. And in water, you're going to see the first quarter margin pop back up into the 19.5%, plus or minus type range, in the first quarter, where it was before.

Okay. Got it. And then maybe on the transaction, so I noticed they have, aside from the food and beverage exposure, they also have some architectural and environmental business. How big is that piece?

It's relatively small, Karen.

Okay. And then on the food and beverage side, so is the pricing dynamic similar to your flat top business? Your flat top business has always enjoyed good pricing and very stable margins, but these guys are more metal. Is the pricing dynamic similar?

Yes, it is. Yes, it is.

Okay. Thank you.

David Rose, Wedbush Securities.

Good morning. Thanks for taking my call. A couple quick ones. On page 7, if you can go back to the slide, which of the assumptions do you have the least amount of confidence in and what would make you revise these assumptions downward, if you had to? I get the sense that mining and energy is still unknown, but that's a small amount. So maybe if you can point out some of the bigger buckets that might be at risk.

It's a relatively loaded question, David, because I don't know -- if you asked me where to take it down, I'm not going to give you an answer. I think we've got a reasonable view that this is a forecast that we have some degree of confidence in. We are inevitably going to be wrong somewhere. The somewhere, I'm not sure.

But I think that what we've tried to do is, again, put together a down-the-middle view of the world with maybe a little bit of bias towards trying to be conservative, particularly in areas where we still are seeing declines. There's no question, process industries are not in good shape. Commodity deflation continues. And so I don't think we're going to surprise to the upside there.

So again, I think what we've got here is our best cut. When you look back on it, you can see where we were wrong last year, okay? I think we tried to get a little bit smarter in the areas we got wrong last year, and we will see where we end up. But I wouldn't try to tell you that we're going to walk away from this forecast 15 minutes after putting it together.

Okay. And I appreciate the sentiment around it. And I know you're trying to be conservative. Maybe on Cambridge, and I may have missed it, but what was the year-over-year growth in that business last year? And I didn't see the revenue number, I didn't hear it. Maybe I missed it, but just a sense.

We didn't tell you what -- it hasn't closed yet. But it's got about $80 million of revenue and it's got a growth profile that looks like global food and beverage. So that's what we're acquiring. We'll get a very small stub in our June quarter and then you'll get to see the difference between core FX and acquisition growth, I think for the first time, when we talk about our second quarter.

Okay. And then lastly on Cambridge, it looked like you did a recap, is it 2012, and maybe can just provide some color around the incentive to sell and what was the motivating factor behind it?

It transacted in 2012 between private equity. We started cultivating it in late 2013, early 2014. So it was a sale of the business. So the current owner has owned it for about four years.

We've been knocking on the door for two years and getting to know the business and the management team. And ultimately, they decided it was a fair valuation and a good time to transact and it was a good home and a good fit. And it's a permanent home for, I think, the associates and the brand. So we're excited about having the opportunity to do this one.

Okay. Great. Thank you very much.

You bet.

Jeff Hammond, KeyBanc Capital Markets.

Good morning, guys. So I just wanted to go through the supply chain optimization, just with the moving pieces and Rodney Hunt moving around. So just to be clear on this year, it's $4 million of incremental cost, $14 million total, but $4 million incremental?

Correct. Year over year, yes.

And then an incremental $6 million to $7 million of savings, so net $2 million to $3 million?

That's correct, Jeff, yes.

Okay. So as we go into FY18, does that $14 million completely go away?

It will. It doesn't go away day one, but it will go away, yes. (Inaudible) as soon as we wind that down. Correct. You are correct.

Okay. And then how much carryover final savings do we get into FY18?

So as you go back, I'll give you two answers. When Todd talks of the $30 million, that's looking at it from the time we announced the project. That's obviously intact. $5 million of that, because we've gotten out of Rodney Hunt, has effectively been recognized. So we look at what this is, $25 million left, to put $5 million aside for taxes, call it $20 million on an EBITDA basis. So that's $6 million to $7 million in FY17 then goes to $20 million to $21 million in FY18.

Okay. So really the big opportunity from this comes in FY18 when all those costs go away and you get the largest bucket of savings.

You're thinking about it exactly right, Jeff.

That's right, Jeff.

Okay. Perfect. Okay. Can you just talk about, you said you're paying down $100 million of debt. Can you talk about the cost of the debt for paying for this Cambridge deal and how you're thinking about your blended interest rate for FY17?

Jeff, I'll just highlight. I think where we sit, we've got a high degree of confidence in our ability to generate strong free cash flow this year. And frankly, when you look ahead, the savings and the benefits underpin an even better free cash flow number into FY18.

We've just made the investment in Cambridge. We're going to have a strong year this year. We felt like taking the opportunity to pay down $100 million in gross debt was just frankly prudent, given interest expense at roughly 5%. Mark will give you maybe a little -- a few more decimal points.

That's the correct blend, yes.

But we've got outstanding free cash flow. We've got earnings stabilizing. We've got a bunch of self-help on the way. And we just felt like eventually, we've got to start paying back some of this debt, let's just tell people that we'll pay back $100 million, and keep generating cash and then continue to do the right things with bolt-on acquisitions and paying down debt going forward.

Right. And it obviously reduces our gross leverage, Jeff, as you know.

Okay. Great. And then just last question, I think you've got some decent market growth for the commercial construction markets. There's been some choppy data and concern about that market peaking, how are you thinking about the commercial construction cycle in North America, growth into the out years and based on what your customers are telling you?

We feel good, obviously through 2017. And I would tell you, we feel good about 2018. Again, I think that the amount of activity, the size of the backlogs, and then just frankly, the labor shortage is going to extend the cycle, we see, for at least a couple more years.

So I think this year, we're not counting on it being a whole lot better than it was last year. And based on the number of projects and what we see, we feel like that's pretty achievable. Look, we'll keep monitoring the data like everybody else, but we see solid backlogs, we see a pretty stable, good outlook heading really throughout this year and into next year.

Okay. Thanks, guys.

You bet.

Samuel Eisner, Goldman Sachs.

Thanks very much. Just two follow-ups here. So on free cash flow, I see that you guys are guiding to a little bit over 100%. Just curious if you're willing to plant a flag in the ground. Do you think that free cash flow will grow in FY17 on a year-over-year basis?

Free cash flow in absolute dollars is going to be down year over year. Two reasons. One, a lot of the cash restructuring related to the scoper project hits in FY17. So we've obviously expensed in [2016]. But from a cash standpoint, you've got more coming through in FY17. And our cash taxes will be going up, as well, in FY17, as we've used up some of our foreign tax credits. So those are the two engines that will drive the absolute dollars down a bit from where they were in FY16.

That's super helpful. And I just want to make sure that we're not getting numbers mixed up here. The $80 million of Cambridge, that's an annual number or is that a nine-month number that you guys are citing?

That's a 12-month number, Sam. So we'll have essentially nine months in our FY17.

Got it. And you said it has roughly similar EBITDA margins to that of the existing PMC business?

20% to 25%.

Got it. Super helpful. Thanks so much.

You bet.

Thanks, Sam.

We have no further questions at this time.

Thank you, everybody, for joining us on the call today. We appreciate your interest in Rexnord and look forward to providing additional further updates when we announce our first-quarter FY17 results in August. Have a great day.

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