Zurn Elkay Water Solutions Corp (ZWS) 2017 Q3 法說會逐字稿

Good morning and welcome to the Rexnord third quarter fiscal 2017 earnings Results Conference Call with Todd Adams, President and Chief Executive Officer; Mark Peterson, Senior Vice President and Chief Financial Officer; and Robert 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, February 1. At this time, for opening remarks and introduction, I'll turn the call over to Robert McCarthy.

Thank you, Pollard. 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 language contained in the press release that we issued yesterday afternoon 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, why we use them and why believe they're helpful to investors and contain reconciliations to GAAP data.

Consistent with prior quarters, we will speak to core growth, adjusted EBITDA, adjusted net income and adjusted earnings per share as we feel that these non-GAAP metrics provide a better understanding of our operating results. However, these measures are not a substitute for GAAP data and we urge you to review the GAAP information in our earnings release and 10-Q.

Please note that the presentation of our operating results include adjustments to GAAP recording for the impact of the RHF non-core product line in our water management segment that we are exiting in order to enable investors to better understand and assess our continuing core operating results.

Today's call will provide an update on our strategic execution, our overall core performance for the third quarter of our fiscal 2017 and our outlook for the rest of the year. 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'll open up the call for your questions.

And with that, I'll turn the call over to Todd Adams, President and CEO of Rexnord.

Thanks, Robin. Good morning. Before I start I want to call your attention to some changes well be making to our quarterly calls that we hope will provide everyone on the call with more information on the most critical aspects of our business.

Today and moving forward, you will hopefully notice some changes to the orientation of our formal comments, as well as appreciate some changes to the accompanying charts and appendices that we hope provide, better, more concise information on the platforms.

Our plan is also to provide quarterly updates on various topics like capital allocation, acquisition integration, significant project wins and new product launches, as well as some case studies on how we are leveraging RBS to drive significant improvements across all parts of our business. It has been a very busy quarter on a number of fronts. We have got a lot to cover. So let us get right into it.

Starting on slide three. You have all hopefully had a chance to read the release from last night and Mark will take you through the financials in just a minute. But overall our third quarter was a decent quarter for us. Sales of $452 million were just a little light of where we had guided, primarily due to translations stemming from a stronger dollar, and adjusted EPS of $0.25, was at the high-end of our guidance and that is inclusive of a penny of expense tied with the dividend from the mandatory convertible preferred offering we completed in early December.

We are also affirming our operating outlook for the year based on the order trends throughout the third quarter and through the first month of our Q4. Mark will summarize both the consolidated results and the performance of each platform as part of his comments.

In terms of really important things that happened during the quarter, at the top of the list is we are the nearing the completion of phase one of our supply-chain optimization and footprint repositioning plan that started about 18 months ago. I'm really pleased to report that we are absolutely on track to deliver $30 million of structural cost savings that we expect from the 20% reduction in square footage and the elimination of fixed cost that we embarked on just last fiscal year.

Our last major project milestone is well underway and consistent with what we communicated last quarter, we continue to target completion during our first quarter of our fiscal 2018, which is the June quarter of this calendar year.

As we have discussed on previous calls, this series of initiates will lower our fixed cost base and improve the flexibility of our cost structure, reduce our ongoing capital requirements, and improve our competitiveness over the long-term. A substantial amount of the benefit comes from investing in and leveraging advanced machining capabilities and third-party suppliers as well as incorporating some automation into what had been more manual processes.

We have also put some contingency capacity in McAllen, Texas to enable us to adapt to changes in trade policy should they arise. In the near term, we expect to see significant impact on our margins as we complete the program and realize an approximately $25 million lift on year-over-year EBITDA in our upcoming fiscal 2018 with an incremental $5 million of savings as we fully annualize the benefits in the following year.

In terms of the specifics, we have crossed a significant number of key milestones, but we do have some critical steps remaining, and over the past 18 months our teams have done all the right things to overcome obstacles, mitigate risk, stay on schedule and not impact our customers. We have got some of the larger, more critical physical moves of assembly lines beginning in mid-February.

The benefit from this phased approach we have employed throughout the implementation of this multi-site plan has resulted in minimal disruption, and been grounded in having a robust knowledge transfer process. Our associates on both ends of the transfers have been terrific, and we anticipate nothing different as we close out this final phase.

Moving on just a bit. Without question the past couple of years have been tough for our PMC platform, but underneath the progress our team has made on reducing the cyclicality of the platform through targeted share gain initiates and end market diversification has really started to get traction and will play a huge role as we see PMC returning to delivering core growth during the next year.

Specifically, our breakthrough has been to win a disproportionate share of new first fit applications. That is when they are new to us, OEM or end user, with selecting its supplier partner for a new product or capital project and specifies Rexnord. This year alone, we are on track to deliver over $30 million of orders associated with this initiative and expect that to continue to accelerate into next year and beyond. By winning a greater share of these with our product breadth, innovation, quality, reliability and service levels we are expanding our installed base and ultimately positioning Rexnord for longer-term market share growth as the engineered components that we supply to OEMs and end-users were in use and are rebuilt and replaced several times over the life of the application.

We are going to continue to invest in this strategy going forward and extend our competitive advantage as we roll out families of connected products. There is more to come on that, but a little teaser on what you might hear next quarter. On the end market diversification front, this year aerospace and consumer industries will end up being greater than 50% of total PMC sales and an even larger portion of profit.

We think having this sort of diversity of end markets, we are having most of the process industries we serve troughing where we continue to have a very high relative market share positions us well over the coming years. Earlier this fiscal year, we closed the acquisition of Cambridge and added a product line that is woven wire mesh belting that serves a variety of food processing applications. To date the business has performed really well and I will speak to that progress in more detail in just a few moments.

To quickly touch on our water management platform, we welcomed Matt Stillings onboard as our New Group Executive early in the quarter. Matt comes to us from IDEX Corporation where he led multiple businesses, and spent his entire career in roles of increasing scope and responsibility. We are really excited to have Matt at Rexnord. He is a great add to lead the deep and talented teams we have across the water management business.

We also opened the Zurn global headquarters in Milwaukee during the quarter. This 52,000 square foot LEED Gold building sits in a water technology business park that the City of Milwaukee and the State of Wisconsin established to bring together businesses and universities as well as start-ups and regulatory agencies to collaborate and solve some of the worlds water challenges.

By establishing ourselves in Milwaukee, we enabled the bringing together a variety of functions -- engineering, product management, sales and marketing that have been fragmented across the various Zurn sites to work together as one Zurn as well as to attract the next-generation of talent that wants to work in the water industry.

It is also home to a brand new customer experience center that allows us to bring together our customers -- building owners, engineers, architects, contractors and wholesalers in a place where we can provide training and access to world-class tools that include 4D BIM models and simulators to help them build the most water and energy efficient buildings at the lowest total cost of ownership.

It will be particularly important for us to have as we begin to aggressively roll out a number of new products and categories over the next year that will enhance our competitive advantage by adding to the industry-leading content we have for commercial and institutional buildings.

And finally, with the successful execution of our offering of a Mandatory Convertible Preferred Stock offering in early December, we were able to refinance our outstanding debt with favorable terms while extending the maturity by three years out to 2023. Supported by our strong free cash flow and our expanding diversification at the more stable, consumer facing end market verticals we believe we have reduced the risk profile of our equity and enhanced the optionality we have to allocate capital, which should lead to less volatility in our operating results over time.

And last, but certainly not least, we finished our third quarter with the lowest financial leverage since we initially became public, finishing the third quarter with a net debt to leverage ratio of just 3.3 times and within site of 2 to 2.5, 3 times range that we have been ultimately targeting to operate within.

Turning to slide four, I would like to bring you up to date on the acquisition we made in our first quarter of the Cambridge business. We acquired Cambridge in June of 2016 for around $210 million, adding the North American leader in the woven wire mesh belting industry with a strong track record of growth and innovation. Cambridges largest served market is the food and beverage industry, which is firmly in line with our strategy to diversify our end market exposure into less cyclical and more stable growth markets.

As we have articulated at times, probably harped on, the Rexnord business system is simply that way we work and the way we run our business. Its incredible power is particularly evident as we deploy it through an acquisition. The Cambridge acquisition is no different. Since the acquisition in June, we have already got the business onto our management teams, and completed dozens of continuous improvement events throughout the manufacturing operations as well as the back-office.

We have leveraged some of these wins in our essential supply-chain organization to drive an incremental $2 million of annual savings into the profit run rate of the business, and also completed a multi-year strategic plan that Cambridge is now deployed to, leveraging one of the core business processes embedded within RBS, our strategy deployment process.

When we announced the deal, we talked about it as having significant revenue synergies and that we felt confident in being able to deliver a double-digit return on invested capital within three years. On the surface, we invested around $210 million for our business with about $80 million of revenue and a valuation on a multiple of EBITDA was just over 10 times.

We felt confident by leveraging RBS and the due diligence we were able to do with Cambridge as a proprietary target that we could successfully execute upon the opportunities to get us there. Our work indicated solid brand recognition for Cambridge in Europe, and we have talked about the potential to grow Cambridges relatively small share of this large and highly fragmented market.

We launched the initial fulfillment program in Europe that leverages our existing commercial resources and infrastructure and allows us to serve the market with incredibly short lead times and take advantage of the customers that Cambridge previously couldnt convert. And while the base is still small, the rate of incoming orders from Europe since we acquired Cambridge has roughly doubled. The sales funnel is up three-fold, and we will be localizing portions of the manufacturing into an existing Rexnord facility by the end of our June quarter.

We have also seen very solid growth in North America, which was a result of having 68 targeted accounts ready to call on as soon as we closed with an unequalled offering of components for the food industry. Our sales funnel in North America are currently in excess of $30 million and year-to-date in total Cambridge orders are up mid-teens over the prior year.

What I hope you take away is that Cambridge is performing in line or actually a little better than our base acquisition case, leveraging RBS to prioritize, invest and execute in an already really good business to make it better is what we are doing, and it is repeatable, scalable and transferable.

Finally, what looked like a 10 times EBITDA multiple in June of 2016, looks more like 9 times today. In 12 to 18 months from now something that starts with a seven annum. We got a lot of great work done by people across the organization and the great team at Cambridge and I really believe the best is yet to come.

Before I turn the call over to Mark please turn to slide five, I want to just highlight a simple RBS case study from the quarter. These case studies are kept in our internal knowledge management system, where everyone in the company has access to a variety of continuous improvement activities and ideas, so as we solve challenges everyone, regardless of the location or function can learn from the work that has been done. It enables our associates when they are faced with a challenge, to be able to collaborate and learn from peers by essentially taking site specific issues, and turning it into a virtual real life classroom. It also creates a way to rapidly deploy really good ideas we create across the organization.

The background of this example is that within PMC we believe that the background on this example is that within PMC we have what we believe is by far the most comprehensive coupling product line portfolio in the industry with the final piece coming a couple of years ago through the acquisition of the high-speed coupling business in India called Euroflex. As we look to the opportunities to leverage our existing strengths and brands globally we needed to figure out how to drastically improve our lead times and cost positions from some of our North American brands to take advantage of the overall portfolio breadth with the same competitive advantages we have in North America, but do it in India and the Middle East.

We already did $2 million of business in the region based on the strong brand and performance of the product. The price was a $10 million market share opportunity for this particular product. The challenge was that we had eight to 15 week lead times and a 40% landed cost disadvantage. In this event, our team in Hyderabad, India, spent a week working with a cross functional team of some RBS resources and was able to accomplish tremendous results.

One, lead times went from roughly 12 weeks to three days. Second, we are now able to price at the market with superior features and benefits, and with multiple customers having put these products through lifecycle testing, we expect significant market share gains over the coming year.

And finally, our facility at Hyderabad has the capacity to support the entire value stream from engineering support to production and customer care. So we have been able to free up the needed capacity in Auburn, Alabama, that had been used to support this incremental volume.

We often get asked, what inning are you in with the implementation of RBS or how is it that you guys are still finding some of these things to do? What I hope you take away from today and going forward is I don't expect whatever be done. What seems great today will be totally unacceptable in the future as we continuously raise our own expectations. And the beauty of that will be to uncover another opportunity for us to get better.

So with that I will turn it over to Mark.

Thanks, Todd. Please turn to slide number six. Our third quarter fiscal 2017 financial results were broadly in line with our guidance, although foreign currency translation was a slightly larger drag than expected.

Adjusted earnings per share was $0.25, reflecting solid internal execution as our adjusted EBITDA was also consistent with our guidance despite the minor shortfall in total reported sales growth. Our tax rate was slightly lower than we have projected which added a penny to the EPS and offset the one penny impact of accounting for the preferred stock dividend in the quarter.

Our outlook on an operational basis has not changed but we were revising our guidance for fiscal 2017 adjusted earnings-per-share to reflect the capital market transactions we executed during the quarter. Our revised range of $1.27 to $1.33 reflects the $0.05 net impact of three factors -- first, the convertible preferred offering; second the $195 million of debt that we repaid with half of the offering proceeds; and third, the reduced coupon we secured with our successful refinancing with our outstanding debt to august 2023.

Turning to slide seven, we summarize our consolidated results in the quarter. Let us move to slide eight, and discuss the first of two operating platforms, process and motion Control.

Total sales increased 2% to PMC as a 6% core sales decrease was more than offset by the solid quarter turn in by Cambridge as our diversification in a more consumer facing end markets helped moderate the headwind in process industry end markets.

Global aftermarket revenue declined slightly against a tougher comparison, but distributor sell-through continued its generally stable trend in the quarter. In the bottom right corner of the slide, you can see that our end market outlook has not changed since last quarter. We believe that we can continue to generate growth in our consumer-facing and aerospace end markets, and we believe we have probably seen the worst in our process industry end markets given several indicators.

First, commodity price levels have broadly improved and the rate of CapEx declines appear likely to moderate in some key process industry verticals, particularly money and energy during the coming year. Second, our first look focus with delivering results and trending upwards. Third, and as we have been pointing to since last summer, the retail sell-through of our industrial distribution partners, which is a proxy for MRO-driven demand and a key indicator of whats happening in the short cycle part of our business has generally stabilized, and channel inventories at the end of December actually looked a little light when compared with where we think they should be.

We also built some backlog in the quarter and we expect to finish the year with a book-to-bill above one. PMCs EBITDA and margins were in line with our expectations, and reflected ongoing investment spending and disciplined expense management. As Todd discussed, we used the Rexnord business system to drive continuous improvement in our internal processes and productivity, which enable us to sustain the important investments that we are making in new products, processes and people to improve our competitiveness and drive stronger core growth. PMCs margins are expected to expand significantly next year as we wrap up our supply chain optimization and footprint repositioning initiatives.

As we turn to our water management platform summarized on slide nine, please recall that we are excluding the financial impact of the Rodney Hunt Fontaine non-strategic product line exit in the calculations of core growth and adjusted earnings metrics in order to focus on our core operating results.

Our water management platform experienced a 5% sales decline in our third quarter, including a 4% core sales decline that reflects the longer infrastructure project deferrals, particularly in the Middle East that we discussed last quarter. Near term, our outlook for our key end markets, which is summarized in the table on the slide, remains unchanged from last quarter.

Sales of our commercial grade plumbing products were generally stable year-over-year in the third quarter, reflecting the somewhat slower overall US market growth we have seen develop over the last couple of quarters, and the choppy nonresidential construction starts [the beta] from the late 2015 as read through variable equity levels by region.

But as we look forward, we continue to be encouraged by the strength of contractor backlogs, the development of our project funnels, and the improvement in nonresidential construction starts activity we saw over the second half of 2016. We are also excited about our pipeline of new products that are and will be coming to market, and our preliminary view of fiscal 2018 includes a re-acceleration in the North American non-residential construction market. This year, we continue to project that water management will finish the year roughly flat on a core growth basis.

Turning to profitability, EBITDA margin was in line with our expectations as the decremental margin was approximately 32% on the seasonal decline in sales in the third quarter from our second quarter. On a year-over-year basis, the margin decline reflects the difficult comparison due to the timing of certain expenses, variable sales mix across the platform in the prior years third quarter as well as the heavier investment in this years third quarter on the innovation and market expansion initiates that we have been discussing throughout this fiscal year. We expect margin to expand in our fourth quarter and we continue to see water management as a 20% plus EBITDA margin platform longer-term.

Moving on to slide ten, you can see that our financial leverage as measured by our net debt leverage ratio has declined by a full turn since the end of last quarter, a specific objective of our third quarter convertible preferred offering. Given normal seasonal patterns we expect our net debt leverage ratio will be approximately 3.1 times at the end of March.

As seen at the bottom of this slide, our total outstanding debt balance has declined by approximately $300 million since the beginning of our fiscal year. As discussed earlier, we successfully refinanced the remaining $1.6 billion of term debt in December which will mature in 2023 and reducing the [coupon] by 25 basis points. Given that we expect our free cash flow to expand meaningfully in fiscal 2018 as we complete our scope initiative and given our strong role of liquidity and cash flow, we believe we have ample resources to continue to execute our bolt-on acquisition strategy and maintaining our leverage ratio in a 3 times of that total. Longer term, as Todd mentioned earlier, we intend to operate the company with net leverage ratio in the range of 2.5 to 3 times.

Next I'll make a few comments on restructuring and cost reduction initiatives. First, the supply chain optimization and footprint repositioning program is expected to impact our fiscal 2017 results as follows. We expect to incur approximately $12 million in net costs that run towards adjusted operating results which is unchanged 90 days ago. 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. The $4 million increase in our prior estimate is primarily due to our non-cash pension adjustments related to our non-facility closure. Also, excluded from our guidance for adjusted EPS is approximately $9 million of accelerated depreciation in the year.

Our forecast for capital expenditures in fiscal 2017 related to this program is unchanged and is included in our CapEx outlook of approximately 3% of sales. So overall these estimates are essentially the same from those we discussed a quarter ago.

In addition to this program, we anticipate in recurring restructuring cost of approximately $11 million to $12 million related to other cost reduction initiatives during the year, which is up about $3 million from last quarter's estimate. The change is primarily due to non-cash charge related to additional restructuring actions that we're executing in our fourth quarter.

Next, I'd like to comment on our effective tax rate. Our effective tax rate will fluctuate by quarter given the varying levels of pre-tax income as well as the timing of other planning initiatives. Our projected effective tax rate for the fiscal year is unchanged that is approximately 25%. We anticipate our fourth quarter adjusted net income on corporate and effective tax rate of approximately 35%.

Before we open the call up for questions, I would like to call your attention to three more slides and an appendix to a revised earnings presentation.

First, we've included the other assumptions and corporate into our guidance with fiscal 2017 in a separate slide as you would come to expect. I need to remind you that our guidance assumes to be non-recurring and non-operating other income or expense, because we do not foresee -- because 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 also excludes the impact of potential acquisitions and divestitures and future nonrecurring items such as restructuring costs.

Second, and for your convenience, we have included the table that provided the after-tax impact of each individual adjustment we have made in our calculated or calculation of adjusted net income.

And third, we've attached a reference table to help you determine the appropriate incremental quarterly share count to use for modeling our diluted earnings per share under the If Converted Method. If it's applicable. Our diluted earnings per share will be calculated with the If-Converted Method only one of this dilutive to our diluted earnings per share. After first calculating our EPS by simply deducting the preferred dividend from our net income and dividing by average diluted shares outstanding, just as we've have done in this quarter.

When calculated an EPS under the If-Converting method, you will assume the preferred stock is then converted to common shares which increased the total shares outstanding using the calculated EPS not limiting to dividends on the preferred shares. The incremental shares added with the If-Converted calculation will depend on whether the average stock [rested] this quarter, as illustrated in the table on the slide one of those between $20.99 and $25.19.

Please note that assuming a given level of net income as our weighted average stock price during the period rises, the potential dilution from using the If-Converted method declines and the traditional method of calculating our EPS based on net income that is our preferred dividend becomes more likely.

Lastly, the appendix to our revise presentation now includes the reconciliation table related to adjusted EBITDA, adjusted earnings per share that are included in our earnings release each quarter.

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

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from Julian Mitchell from Credit Suisse, please go ahead.

Hi, good morning. Thanks for the extra detail on PMC. First of all, I just wanted a little bit more background of what you're seeing there, so I guess the macro indicators have seen better. Most companies sound better in the last ten days but your organic sales drop was obviously steeper than in the prior two quarters. So may be give an update of how demand in PMC has moved in recent months. Visibility looks a little bit higher, so I just wondered if you are willing to have any view on when sales may turn positive.

Hey, Julian. Thanks. A couple things. If we look at the quarterly growth this quarter compared to last, we sort of expected that based upon where the backlog came into the quarter. So I don't think we were at all surprised by the core growth in the quarter.

I would tell you that I would agree with your statement that our sentiment is much better over the past, call it 60 days than the first part of the quarter. I would tell you that our orders throughout the quarter trended probably in line to maybe a little bit ahead of where we had expected. We have built some backlog. We are through the first months of our fourth quarter and we had a solid January.

So I dont think we want to call an inflection and I don't think you want to call or prognosticate what's going to keep forwards, but the clear improvement that we have seen in the past call, call it, 60 days or so makes us a little bit more confident about our Q4. I think we are optimistic that as we head into our fiscal 2018 which will start on April 1, we will post-core growth during the year, whether its that very first quarter of the year, I don't know at this point, but I think we are confident we are going to see core growth return to PMC and like the post-core growth for the entire year, but that is sort of what we are seeing.

Thanks. Thats very clear. And then secondly on water management, as you said that it sounds like there were lots of project deferrals still going on particularly in the Middle East. I just wondered how the deferrals are one thing, but I guess when you are thinking about new orders and kind of the backlog movement --

Yes.

How was that being trending in different regions in the past few months?

Yes. Maybe just to clarify Julian again, I think we had anticipated the growth performance in the quarter, primarily based on project shipments from the prior year. And so I would say that there have been no new deferrals in the water infrastructure part of the platform in any way, shape or form.

Moving to the order trends, the orders and the backlog in that part of the business is going substantially. Now some of that is obviously growing, because we haven't shipped some of these orders this year, but if I just look at the underlying order growth in the business, it's very solid. You know we will build substantial backlog this year for our water infrastructure business and the order rates have been very good and we think that theyll be really good in four as well.

So I would say no new deferrals, no new news, level of project activity is high. It's high but with smaller more projects than these larger mega projects. And so I would say a backlog is probably in a good in shape or better than it has ever been in the last four to five years.

Thats very helpful. Thank you.

Our next question comes from Mig Dobre from Baird. Please go ahead.

Yes. Good morning gentlemen. Maybe I will start with PMC as well. Yes, I appreciated all the additional color there and your comment that better than 50% of this segment now is driven by aerospace and consumer and I suppose that perhaps you have better visibility on those two portions of the market. How do you think about growth in these two areas as you look at calendar 2017?

Well again, both are positive this year and we expect both to be positive next year. And I think, Mig, the one thing that you point out in aerospace we clearly have I think really good visibility based on the backlog of airplane orders as well as our content on those. So you will see continued good growth there on the consumer side of things. You know this is something we have really gotten after the last, call it, 12 to 18 months and so this year was a lot of building the capability to go out and do it as well as integrating the acquisition and I think that is going to accelerate into next year.

So I would say firmly positive core growth heading into next year. Now, on the process side again I think we are seeing MRO stable as well as and we think we see the trough in some of these process industries to be honest with you and the book-to-bill comes through like we expect in our fourth quarter. It will be the first backlog build in that part of the business and probably three years.

Yes, thank you Todd. I mean if you look back at your process exposure, is there any way to sort of frame the last two to three years in terms of the organic decline that you have seen in that business to get a sense for kind of peak to trough movement here?

If you -- you know what, I will give you a rough range, Mig. I think that if you look at when that peak -- it was probably our fiscal 2013 or fiscal 2014. So call it March 2014. And that was -- a lot of that had to do with backlog, run out and everything else. So the order peak was probably March of 2013.

Since that time, that is down probably close to 50%. And so as we have seen that cycle is down, you build the orders, they come in the backlog, you ship against that, but your book-to-bill is probably the leading indicator what's going to happen over the next couple of years. In our case what we're saying is we think that book-to-bill in that part of the business is actually positive.

So who knows, but this long into the cycle -- the downcycle, it feels more like inflection point than, a head fake and I think it also has a lot to do with what we're doing on our own, right?

So some of these new first fit wins are also going back into some of these process industries where there's still spending going on, there's still opportunity in winning some of those. So it's a combination we think a little bit of troughing as well as some self-help.

So I think we're probably more optimistic about that part of business than we have been in a while. It's got to read out and I don't think it's going to explode back. I think it's going to move slowly back, but I think positive nonetheless.

Okay. Thank you. I will jump back in queue.

(Operator Instruction) And our next question comes from Charley Brady from SunTrust Robinson Humphrey, Inc. please go ahead.

Hi guys this is actually Patrick Wu standing in for Charlie. Thanks for taking my question.

Okay, Patrick.

In your comments about the first fit win initiatives, can you remind us or can you maybe talk about the timeline of that and sort of what end markets are you looking and are you seeing or expecting a lift in expenses related to that?

No. And so I will start with the second question first. So this is essentially we started with a sales efficiency break through probably about 18 months ago, and that was to absorb some of the work that was being done by our current field sellers and use automation and technology to sort of drive some of that inside and reduce the costs and free up selling time.

With that available selling time we have pointed those resources towards, again, two to us OEMs or end users that we felt like we could go out and take share from -- take share frankly from competitors.

So the primary I would say end-markets would be our process industries as well as our consumer. Probably overweight consumer because that's got just a frankly a better secular growth profile, but at the same time some wins across the (inaudible). So that's really the timeline and the success we have had in a relatively short period of time.

Got it. And turning over to water management. Can you possibly bucket for us in terms of the margin decline relative to sales an mix and alsoI guess you talked about more expenses on the market expansion in product innovation portion of it and can you give a little bit more detail on what those may be?

Yes, this is Mark. I can walk you through it. So if you look at the this overall on the sales were down $9 million and the EBITDA was down $11 million in the quarter so a little of course half of that was just coming from the overall sales decline in the mix we have last year. I mean I noted in my comments we had, the (inaudible) of process down the business and in our non res side of the business. So the mix of the big piece of that.

You look at overall roughly the balance -- the next large piece is coming from just an -- spend time we had in the last year's quarter. Now if you look at last year's, that margin of the quarter was not in any of the quarter.

And then last piece was something (inaudible) that we have in the business of this year tied to our initiatives primarily around new product development. A lot of that is now just getting rolled down really a bigger piece of a puzzle but incurring investment spend as we have all year this quarter.

So if you look at the quarter is really where we are expecting to land sequentially from our Q2 to Q3 until the sale decline margin. I think of our margin is about 32%, this is where we expect. The year-over-year as we really more of what was last year's quarter to what's in this year's quarter.

Okay, great. And then in initiatives, maybe a little bit color on that?

Yes, well initiatives -- I mean the lobby is that spending has been really tied to as I said new products. You know we are not on a spot here to talk about the details Todd referenced in his comments. You are going to see as we roll into our fiscal 2018, a lot more discussion around some new product and new categories, some space in Quebec we haven't played before that we're excited about but more to come on that in part of our next call as we talk more about fiscal 2018.

Great. Sounds exciting. Thanks guys.

Thanks.

Thanks.

Our next question comes from Karen Lau from Deutsche Bank. Please go ahead.

Thank you. Good morning.

Good morning, Karen.

Good morning.

Morning. Talk about the -- you know, as these process first well, first fit and process orders coming but what type pricing dynamic are you seeing? And in terms of the first fit that you are winning, do they tend to go more towards the mid-year products that you recently launched or are they more traditional products?

Yes. That's a great particular question, Karen. I would say from a pricing perspective we are not really seeing any material difference. I mean we are selling based on value and features app benefits an reliability and up time that we ultimately provide to the outpatient and the customer. So from a pricing standpoint I would say it's been very good and consistent with sort of where we predict.

The second part of your question was are they going more towards the mid-tier product categories or sticking with sort of higher end. I would say it's a combination of both, right? I think customers are looking for value reliability and up time and depending on who the customer is I would say the end-user side of things, you know, is there interested in special line products because it's crucial and vital to their revenue earning and OEM may not have the same view. They want the equipment to work well throughout a period of time but ultimately they are not there as the end-user and the ultimate revenue -- the revenue-generating application so they may opt a little bit more towards the mid-tier.

In either scenario I think as you well know the margin that we generate on each -- the premium -- more premium brands product or some of the mid-tier offerings we have is roughly the same. So our ability to compete with these OEMs with having mid-tier product is far better than it has ever been by the introduction of it but from a pricing standpoint I would say it is still good. Margins are consistent with the fleet average.

That is great so as these -- more of these first fit wins come and the process orders, sales come back, the incremental margins performance should be very consistent with historical, right?

Yes. I mean, thats our business. Right. We get in, we solve the problem for a customer and application, we hopefully do a really good job with servicing over the life cycle of the equipment and when it openly wears out, it gets replaced like-for-like a really high percentage of the time and that has been the foundation of the business. We are investing heavily in it as well as diversifying the end-market exposure we have. So you get it. That is the business.

Okay. Great. And that kind of leads me to my next question and please correct me if I'm wrong, but my understanding of part of the SCOFR plan part of it is like moving some of the footprint to Mexico, but I guess like part of the rationale is to have the lower more efficient cost base to support the mid-tier products so that you can sustain a similar kind of margins, but if you look at all these kind of potential headwinds in terms of tariffs or tax policy, how does what change the economics of the mid-tier products longer-term.

Karen, that is a really good question. I would tell you that we feel -- first of all, we do not have any privileged information about what is going to transpire with tariffs and tax policy, but I would tell you that a portion of that -- the portion of the rationale was that. Not the entire rationale for the move was that. And so we feel very comfortable with having to retain a very global footprint to support customers in whatever region they may be in.

Obviously, to the extent there are changes to that. We will obviously have to review it, but at this point nothing we see would lead us down a path of thinking that the benefit or the decision that we made was going to at least be something that we would regret, but to be determined, obviously, depending on what happens, but I think we are very much a US manufacturer, but we have global customers and certain global market so we sort of have to manufacture in a lot of different places to be an effective participant in the marketplace and that's really part of the rationale. Hopefully that answers your question.

Yes. Definitely. And then maybe along similar lines, but switching gears to Zurn a little bit. My understanding is that business very much around design and assembly so I am assuming you source a lot of components. Are you seeing any kind of price costs changes given that we have seen some raw materials inflation in the past few months? So I guess first on price cost on these components. And then in terms of the sourcing can you give us a sense of how much of those is like kind of domestically sourced? How much would be sort of imported components? So if there is some changes in the tax policy some of that could get impacted?

Yes. I will answer your first question first, Karen. So on the price cost side of things I do not think we are seeing anything adverse in our ability to pass on some of that material cost increase through to the end-market is very much intact. And to be honest with you the way we go about our sourcing program, we sort of feather in purchases so we have the ability to sort of I would say almost match any significant increases in costs on the priceline and also productivity on our end.

The second question I think was on --

Sourcing. Yes.

-- sourcing. Yes. You are right. We source product from all over the world. We have in most cases at least two, if not three, sources for almost everything we have and so depending our on, again, what transpires we will obviously be flexible, but this is something we have been doing for a very long time and I think we are confident in our abilities to adapt to the changes in the market and we will have to wait and see, but I think we are absolutely geared up and then well capable of handling whatever comes down the pike, I think.

Okay. So if anything happens on the tax fronts, I mean there are enough alternative kind of domestically that you can switch to, you know, if you had to (inaudible) --

We certainly believe that, Karen, yes.

Okay. Got it. Thank you very much.

Yes.

And we have no further questions at this time. I will now turn the call to Rob McCarthy for closing comments.

Rob McCarthy Thanks, everyone for joining us on the call today. As always, we appreciate your interest in Rexnord and we will look forward to providing further updates when we announce our fiscal fourth quarter of fiscal 2017 and provide our initial financial guidance for fiscal 2018 in mid May. Take care.

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