Zurn Elkay Water Solutions Corp (ZWS) 2021 Q2 法說會逐字稿

Good morning, and welcome to the Rexnord September quarter 2020 investor 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 2 weeks. The phone number for the replays -- for the replay can be found in the earnings release the company filed in an 8-K with the SEC yesterday, October 27.

At this time, for opening remarks and introduction, I'll 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 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 we believe they're helpful to investors and contain reconciliations to the corresponding GAAP data.

Consistent with prior quarters, we will speak to core growth, adjusted EBITDA, adjusted earnings per share, free cash flow and return on invested capital as we feel 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 in our filings with the SEC.

With that, I'm pleased to turn the call over to Todd Adams, Chair and CEO of Rexnord.

Thanks, Rob. I'm here with Mark Peterson, our CFO. And this morning, we're going to cover our financial results for the September quarter. And we'll also provide some updates on our operating environment, the execution of our capital allocation strategy and how we're thinking about our overall strategic positioning. We'll also take a look at the dynamic growth opportunity we have within our touchless and hygienic offerings within Zurn, provide a little more detail on our platforms and how we're planning for the December quarter and into '21, and finally, look at strength and positioning of our balance sheet and cash flow.

Starting on Page 3. The bottom line is we put up another great quarter in September. Our culture and business system, the dedication of our associates and the resilience of our business continues to deliver results. The strong margin

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and significant runway for improvement over the coming years as we execute our strategic plan. Sales were down just 5%, with core growth down 7% and actually only down 2% and 4% core, excluding our aerospace business as continued solid growth within our water platform and sequential improvement in our PT businesses drove the third quarter results in line with our internal expectations.

From an earnings perspective, we delivered $109 million of EBITDA in the quarter, which was 22% of sales and down only 8% year-over-year and down less than 5%, excluding aerospace.

I think it's important to find out that this is inclusive of about $5 million of additional investment in the quarter relative to what we embedded in our prior outlook for things like: number one, to modify our temporary compensation reductions and implement merit increases to all of our nonexecutive associates; and secondly, to invest in commercial resources and product development to continue to accelerate our differentiated growth opportunity in water hygiene, all of which was enabled by the cost response really beginning in March through August.

Looking at our year-to-date results. We think it's particularly impressive that our sales are down only 5%, and our adjusted EBITDA is down only 4% and better than that year-over-year, excluding our aerospace business, which we see stabilizing over the next several quarters.

To close out my comments on the quarter, adjusted EPS in the quarter was $0.47 versus the September quarter record of $0.51 we delivered a year ago. Our free cash flow in the quarter was $59 million, bringing our year-to-date total to $207 million, up 23% versus the prior year and well on our way to annual free cash flow of around $250 million.

Equally important, we see cash flow accelerating into 2021 as a result of the compounding benefit of our SCOFR initiatives and the completion of Phase 3.

Finally, our financial leverage ended the quarter at 2x, and we resumed our share repurchase activity in the quarter, investing $15 million to repurchase shares, bringing the year-to-date total to $96 million to acquire about 3% of our outstanding shares since January 1.

As we said throughout the year, our plan has been to use each quarter to learn and evaluate what a recovery and our outlook might look like and make some course corrections as we move through 2020 to set up 2021 and beyond. As we see it, there's clear evidence that we continue to outperform our end market competitors.

At the same time, we continue to believe that there is a heightened level of uncertainty in the coming months as the pandemic remains uncontained. What we do have is tremendous confidence in our ability to navigate challenging economic conditions as a direct result of the disciplined execution of our strategic plan over the last 4 years to improve almost every aspect of our business.

When you incorporate our fourth quarter guide to our year-to-date results, we see Rexnord positioned to deliver 2020 adjusted EBITDA well within 10% of the record level we achieved in calendar '19, with terrific free cash flow and well-positioned to deliver sales, earnings and free cash flow growth in 2021.

Please turn to Page 4. Back in January, which feels like a really long time ago at this point, we communicated an enhanced and comprehensive capital allocation strategy, one that we define as being able to be holistically and consistently implemented for a number of years.

In May, we communicated that we are prudently taking a pause in implementing a couple of pillars of that strategy, namely share repurchase and M&A. Then in July, we indicated that we'd likely see both of these elements back in our strategy as we move in the second half of the year and into 2021.

In terms of the first element, I mentioned it earlier, we resumed our share repurchase activity in August, spending $15 million over the balance of the quarter, and we expect to increase our activity in the December quarter. Secondly, we're actively engaged with a couple of strategic acquisition targets that can strengthen our water platform and help further strengthen our competitive advantage. And while we're not in a spot to announce anything today, we're highly confident there'll be more to come on this front between now and our next investor call.

From my vantage point, and I think in a pretty fact-based way, we've never been -- we've never had better strategic optionality or been better positioned strategically, financially and competitively to consider all potential opportunities to enhance total shareholder returns, and we're committed to capitalizing on those opportunities.

I hope it's not lost on everyone that this quarter, the earnings in our water business are just under 50% of our total segment earnings and that our margins there are substantially above any public company water-related business.

Move to Page 5. Before I turn things over to Mark, I'd like to spend just a minute focusing on the value-creation opportunity we're working to maximize our portfolio of hygienic products within our water platform. As I discussed previously, we've been seeing exceptional, really unprecedented demand and growth and order flow for our touchless sensor products for public restroom applications, and we're seeing the market developing along 3 sets of opportunities.

The first leg of the opportunity, which is essentially the only pillar of the growth that we're seeing at this point, is the triage stage of building owners making their restrooms feel more safe and more comfortable for users when they're out of their home environment and either at their place of work or at their school or a local business like a retailer. We're seeing a surge of activity to replace manually operated restroom faucets and flush valves in retrofit applications that began during the second quarter of this year, and that momentum continues to build as we go throughout the year.

As you can see on the slide, the retrofit opportunity is huge, with an estimated $2.5 billion installed base today of manual faucets and flush valves that will convert to touchless sensor products over time at an average selling price that is 2x that of a manual product, which means that the retrofit opportunity is really $5 billion over time. In addition, we have a new annual construction market today for manual products that will also convert to touchless sensor products resulting in an estimated $600 million new installation market opportunity annually.

Second, we're in the final stages of launching an integrated hygienic retrofit capability with a variety of partners that will allow customers to essentially click to install. This integrated, connected and installed solution is generating a significant amount of interest, and it puts us in a spot to essentially own the commercial restroom.

We're engaged with several potential partners and M&A targets that will also enhance our ability to provide those solutions under one brand with one point of contact and engineered to work together to maximize the user satisfaction with the restroom facility. This is starting to gain traction and will be an important part of our strategic plan as we move into 2021 and beyond.

And finally, and third, which you'll see on Slide 6, will have a lasting positive trajectory, and that's the rest in the future. If we've learned anything over the past 10 months, the real estate in a restroom is far more valuable to a building owner than ever before. Having the capability to provide the most safe, hygienic restroom connected to a building management system with turnkey capabilities is something that we're having realtime discussions on with owners and operators of large building populations and with engineers and architects about fundamental changes in restroom design to be incorporated in the next iterations of newbuilds, including things like different layouts, active management of traffic in and out of restrooms and the enhanced digital connectivity necessary to ensure capacity is available when it's needed and it's clean.

We expect this will have an increasing influence on building design and specification as we move through 2021 and, ultimately, into a renewed upcycle in new nonresidential construction and structural remodel activity.

Underpinning all of this is really -- we've developed this next-generation touchless offering over the last several years, which is far more reliable than any of our competitors.

Secondly, the product placement and shelf space we've earned within the wholesale community is better than it's been in the last 13 years we've owned Zurn.

And finally, the e-commerce part of our business is growing like you'd expect an e-commerce type business to grow. Then you compound that with the specification tools, the digital backbone and a comprehensive product offering to leverage these developments and opportunities into further share gains and above-market growth.

We're feeling very confident that the sustainable competitive advantage we have in Zurn has gotten appreciably wider over the last year and are excited over the next couple of years as we continue to execute at a very high level.

Still on Page 6. In order to help everyone size the opportunity of how it might influence our growth and profitability as we move into 2021, definitionally, when we refer to touchless, we mean sensor-activated plumbing products like faucets, soap dispensers and flush valves.

Hygienic is a broader term that also includes other products that can further enhance the safety and comfort of restroom users. Today, that includes products like electric hand dryers and sinks with antimicrobial surfaces and other water safety products that control the spread of bacteria and disease. We're on pace to generate about $100 million of revenue from touchless products in 2020 while order rates are currently running at about $140 million to $150 million of an annualized rate. The [size puts] revenue at about 14% of where we expect Zurn's total sales to land in 2020 and offers substantial insulation from a potential downturn in new building construction activity in 2021.

Our supply chain has been ramping its output levels above our order rates, and we're now positioned to easily handle twice the 2020 sales volumes or more in 2021, with the benefit of knowing that we're positioned now to deliver the best lead time and availability in the industry. At the same time, we recognize that many smaller customers may need some help securing the replacement product they need but also finding a local contractor that can most quickly respond to their requirement.

As I mentioned earlier, one of our investments is what we call -- is this click-to-install model that combines online product ordering with immediate online installation scheduling through partnerships with local contractors and adjacent channels. And we have pilots running in multiple markets and expect to roll out the service in most regional markets as we get through the December quarter and the first half of 2021.

Almost 20% of Zurn sales this year are expected to be generated from our broader suite of hygienic products, and we also expect attractive growth in these related product categories moving forward. As I referred to earlier, we intend to expand our portfolio of hygienic solutions as we move through 2021 and to continue to build out the capability to leverage our existing competitive advantages into a sustainable leading position in this rapidly evolving market.

With that, I'll turn it over to Mark. And after he's done, we'll take your questions.

Thanks, Todd. Let's turn to Slide #7. On a year-over-year basis, our consolidated sales were down just 5% and core sales were down just 7%, net of a roughly 80 basis point impact from our product line simplification actions. Positive contributions from currency translation and the Just Manufacturing acquisition in our water management platform added about 1 point each to our reported sales growth.

With respect to profitability, our adjusted EBITDA was down only 8% year-over-year on the 5% sales decline as we delivered a 27% consolidated core decremental margin after excluding a couple of million dollars of onetime duplicative expenses associated with our SCOFR 3 plant move. Our adjusted EBITDA margin was 22%.

Please turn to Slide 8, and we'll view our platform results. At the platform level, the decline in PMC sales moderated sequentially to 13% year-over-year on both a core and reported basis and net of an approximately 110 basis point headwind from our 8020 simplification actions.

Breaking that down a bit, the year-over-year decline in our aerospace operations, which accounted for approximately 15% of PMC sales in calendar '19, was 36% in the quarter compared to a 19% decline in the June quarter. Excluding our aerospace operations, the core decline in the balance of the PMC platform in the September quarter moderated to 9% versus a comparable 15% decline in our June quarter.

While we continue to experience year-over-year sales declines in most end markets, the rate of decline moderated in virtually every industrial end market in the September quarter when compared to the June quarter. We generated sales growth in our power generation end markets. And year-over-year sales declines were more modest relative to platform average in our consumer-facing end markets but were higher than the platform average in our process industry end markets.

Our global industrial MRO business, again, excluding aerospace end markets, also contributed to a sequentially stronger industrial sector comparison. North American distribution channel sell-through, although still somewhat choppy month-to-month was less volatile across the quarter and improved from the June quarter.

Overall, and given support from our backlog, the year-over-year change in our shipments to OEMs and end-users continued to outperform global MRO, but we did see better balance emerging during the quarter.

Operating execution was again strong in the quarter as we benefited from our SCOFR structural cost-reduction initiatives executed in recent years, plus the cost actions we initiated earlier this year in response to the ongoing pandemic. Despite some adverse mix through the relative weakness in our aerospace business, PMC managed to a 33% decremental margin after excluding about $2 million of nonrecurring SCOFR 3 costs.

On the slide, we're highlighting another new product launch as we continue to bring innovative product solutions to customers in the food processing industry. During the quarter, PMC launched an upgraded design of metal conveying chain for certain challenging applications in poultry and baked goods processing as we continue to strategically target this end market.

Marketed within the KleanTop family of hygienic conveying solutions for the food processing industry, the design enhancements offer longer product life with increased production uptime while also enhancing both food quality and employee safety, all increasingly important characteristics in today's world.

Moving on to water management, sales were up a solid 5% on a core basis and up 8% after adding the contribution from the Just Manufacturing acquisition, which we completed at the end of January this year.

With most construction sites back to work in the quarter, Zurn's growth provided a clearer view of market demand and the underlying business and enabled a very strong growth in our touchless sensor products to better read through. Although we still expect to -- absolute Zurn sales levels to moderate seasonally in the December quarter, we expect the strong momentum to continue in our touchless and hygienic products as order rates are outpacing shipment growth.

Zurn delivered an 11% increase in adjusted EBITDA as the margin increase of 60 basis points from last year's September quarter to 28% on strong cost control, some benefits from the relative strength in touchless products and contributions from our recent acquisitions. Please note that [most pro] activity ended in June and that the strong operating execution in the September quarter also funded the step-up in our growth investments.

Please turn to Slide 9. With visibility still challenging and given a lot of unusual range of potential outcomes in the upcoming quarter, reflecting in part the resurgent COVID case count in North America and Europe, we will again limit our forward commentary to the upcoming quarter and continue to incorporate wider-than-typical ranges around our assumptions for revenue growth and margins.

The planning guidepost that we're providing for the December quarter are similar to what we provided a quarter ago and are focused around providing a relatively precise guidance for elements where we can exercise financial control [over the] result and incorporate some downside risk for those elements where we have, frankly, less control.

With that said, I'm taking into consideration demand trends through October, our backlog position and the elevated uncertainty, given the persistent strength of the global pandemic, we are projecting that our consolidated revenue could decline between 7% and 11% year-over-year in the December quarter.

Based on that sales outlook and with the winding down and modifications to some of the temporary cost-reduction initiatives, coupled with our stepped up investments in new business, we would expect the combined adjusted EBITDA margin at the platform level, now excluding corporate expenses, to finish the December quarter between 21.5% and 23%. We expect our corporate expenses to be approximately $9 million in the quarter or down about 10% year-over-year.

You'll recall that when we first announced our cost-savings target for 2020 after our March quarter, we indicated that we have decided to be more aggressive with our initial countermeasures with the expectations that we could recalibrate and rebalance our actions as we moved through the year and the shape of the recovery curve across our [spender] markets became more evident.

As stated in our press release, our December quarter outlook incorporates the end of most remaining furlough activity across the company in the September quarter and the restoration of merit-based compensation increases, excluding executives. We're also planning to restore our incentive compensation plans to 100% cash payments versus a combination of cash and stock. These actions impacted our third quarter adjusted EBITDA by approximately $5 million and will impact our fourth quarter EBITDA by approximately $7 million.

On the other hand, salary reductions for the executive management team will remain in place for the balance of 2020, and we expect to continue to realize significant savings from our tight control and discretionary spending in areas like T&E.

As we look around the corner into 2021, I want to highlight some of the moving pieces related to our cost-reduction initiatives. After our March quarter, we laid out our cost-reduction plans for the remaining 9 months of 2020 totaling $51 million. $10 million of that plan was structural workforce reductions, and the balance of the plan was discretionary spending cuts and temporary compensation reductions, mostly furloughs.

With the decision we recently implemented related to our incentive compensation plan, the remaining $41 million of temporary savings included in our original 2020 cost-reduction plan is now modified to $34 million with approximately 50% of the revised level coming from discretionary spending reductions and the other 50% coming from temporary compensation adjustments.

As we head into '21, we have taken steps to effectively convert a portion of the temporary compensation reductions to permanent cost reductions, with additional workforce reductions that will generate approximately $7 million of savings in 2021.

Regarding discretionary spending. While we anticipate turning some spending back on next year, we will continue to manage this pool cost very tightly.

With respect to our SCOFR initiatives and incorporating the impact of some COVID-related delays to some of our projects, we expect to realize an initial $12 million to $14 million of structural cost savings during 2021, but we will plan to exit '21 with SCOFR-driven savings running at the targeted $20 million annualized rate.

In addition, our 2020 results include approximately $3 million of nonrecurring duplicate costs related to our SCOFR 3 facility move that will not repeat in '21. When you add it all up, the additional permanent cost out of $7 million plus $15 million to $17 million of year-over-year SCOFR-related savings, we'll have approximately $22 million to $24 million in structural cost savings in '21 to offset the year-over-year impact of 2020 temporary compensation actions that will roll off and any increase we implement in discretionary spending.

Before we discuss free cash flow, just a few comments on our tax rate, interest and depreciation and amortization. We anticipate our tax rate on adjusted pretax earnings in the December quarter to be approximately 25% to 26%, resulting in an adjusted tax rate of approximately 27% for the calendar year 2020. Our interest expense for the December quarter is expected to be approximately $12 million, and our depreciation and amortization will come in at about $23 million.

Please turn to Slide 10. On this slide, we're maintaining the high level of transparency regarding our free cash flow outlook that we provided over the last 2 quarters. On the top half of the slide, you can see our updated outlook for the 9-month interim period now factoring in the results in the September quarter.

In addition to the 9-month numbers, we've included the full calendar year 2020 in the bottom half of the slide which states our actual results for the March quarter and [adds] into the 9-month outlook. We continue to expect to extend our track record of free cash flow conversion above 100% over the 9-month transition period and the entire 2020 calendar year.

Moving to Slide 11. I'll finish with a look on our free cash flow and balance sheet. Starting with the chart on the far left. Our calendar year-to-date free cash flow totaled $207 million. On a year-over-year basis, that's 23% ahead of where we were through the first 9 months of calendar year '19. As Todd mentioned earlier, we believe we are positioned to deliver approximately $250 million of free cash flow for calendar year 2020.

Moving to the chart in the center, you can see that our financial leverage as measured by our net debt leverage ratio finished the quarter at 2x at the low end of our long-term targeted range of 2x to 3x.

In closing, I'd like to mention that in order to help simplify modeling the transition of our fiscal year ended December 31, we will be updating the pro forma calendar year presentation of our financial statements posted on our Investor website to include the most recent quarter.

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

(Operator Instructions) Your first question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

So if we look at this bathroom of the future on Slide 6, clearly, some things that you have and clearly some stuff you don't. Can you just talk about how you think you'd go about broadening out the portfolio, whether it be partnerships or acquisition? Or how much can you do of this internally?

It's going to end up being a combination of all 3, Jeff. When you look back at the path we've taken, we've bought some stainless drain businesses. We developed a solid surface solution. We bought Just Manufacturing. And so it's going to be a combination of the 3.

I think the partnership leg will be really important for us going forward as we integrate connected products into a building management system. So I think it will be really a combination of all 3. I think near term, there's some more M&A that we can do that really deepens and gives us a lot more content. So it will be a combination of all 3, just like we've been doing.

Okay. Great. And then on Slide 5, it looks like basically the touchless kind of 2x the manual. But I'm just trying to understand what's included in this kind of $5 billion market opportunity that's -- if you were -- like if you incorporate everything on Page 6, like what is that market opportunity because it seems like you're limited to the touchless valves?

Jeff, this is Mark. Yes, those market numbers are really just sensor faucets and flush valves. So if you look at the installed base, they have just manual faucets and flush valves that's going to convert [much] over time. That's the $5 million. This does not incorporate some of the things that Todd was referring to here in the rest of (inaudible) that's all additive to that market opportunity.

Okay. And then just a quick one clarification. You said, I think, $5 million of temp cost came back when you guided you wouldn't have expected. Is that the way to think about it?

Yes. When we provided our outlook for the September quarter and gave you the sketch of segment margins, that would not have included that. We made that decision as we got into mid-August. And so there's $5 million in the third quarter. There would be $7 million in the fourth quarter related to those 2 things.

So whatever you would have assumed off of our run rate, that's $12 million of incremental expense really from sort of mid-August through December.

But the strength of our response and our conviction around investing in our teams now getting ahead of it so it doesn't become a significant headwind as we start next year.

And on top of that, I think, as Mark pointed out, there's $3 million of frictional/duplicative cost, as we round out the third phase of SCOFR and the significant investment we're making to make all the things that we talked around hygienic a reality, we're sort of, to a degree, pulling that ahead.

And so when you can -- you take a big step back, I think if you extrapolate our fourth quarter guidance, you can find yourself to the mid-420s. Had we done nothing and really squeezed everything, you could easily have seen $440 million.

But again, we're trying to play the long game here. We think taking care and investing in our team that we've created and also investing ahead of this terrific growth opportunity was absolutely the right thing to do. And despite all of that, we're going to end up within a very small margin of last year. And cash flows, as Mark said, right around $250 million. So that's how we thought about it.

And your next question comes from the line of Joseph O'Dea with Vertical Research.

You may be on mute or we may have lost you.

All right. First question, just wanted to touch on water management. And Todd, you commented about right now kind of looking into 2021 and a setup. This was sort of total Rexnord comment but about setup for sales, free cash flow, earnings growth and just wanted to address that.

Specific to water management, and I think the really helpful details on what you see for hygienic and what you see as a run rate in touchless, looking at the nonhygienic piece, if that were down like 10%, it's a $55 million, $60 million headwind. And so you've got sort of a pretty good run rate today to eat into that. And so I'm really trying to understand what your confidence is that overall water management can grow, and embedded within that what you kind of expect in the nonhygienic pieces of the business?

Well, I think it's important to note that a couple of things even that are on display I think the last couple of quarters, there is a cannibalization of our manual products embedded in our numbers today.

When you look through our overall mix at the Zurn level, 40% of it is retrofit in total, not just the hygienic piece, but in total. So if you think about 60% of Zurn down 10%, it's more like a potentially a $40 million headwind or a $50 million headwind. When you look at the run rate that we're seeing in just the sensor categories and add in a very conservative 3% to 5% growth in the retrofit market, I think we've got a high degree of confidence that we're going to see growth in water management next year, and this is before some likely M&A between now and when we start the year.

So I really do think that when you look at the split between new and retrofit, you look at touchless and then you look at sort of where we're actually running on the new construction side of the business, it's not as if it's down much, if any, at all.

And I think as Mark pointed out, we saw it strengthen throughout the quarter, month to month to month. And we've started October stronger than we posted for the quarter.

So I think we're going to go into it eyes wide open and -- but I think the competitive advantages that we have, Joe, around driving specification, getting a look at what's happening in a hyperlocal sort of market and winning more, I mean, our close rates are just simply better than they've ever been. I think it positions us really well.

And then the little math equation around new versus retrofit, add in hygienic, I think you can get comfortable that we're going to see growth in 2021.

I really appreciate those details. On the new side of things, can you talk a little bit about what you're seeing in the various kind of major segments within nonres on sort of the commercial/industrial side, institutional side, general tone of the contractors out there in the market?

Well, I think the conversations are cautious. But when you think about health care facilities and educational facilities, those are things that are going to continue to chug along. And we see that you don't pick it up I think necessarily when you look at the aggregated entire domestic market. But when you look at pockets of the country, you see education continuing to grow. And I think health care is going to be very resilient throughout whatever sort of dip we see in the broader commercial part of the market.

And then just a last one on aerospace. Helpful to understand the Q2 into the Q3 trend and for some, I think, stabilization orders over the next few quarters. What do you think that sort of then sets up for the type of decline rate we're going to see? And where do those decline rates kind of bottom out?

I think the way we are seeing it develop today, the fourth quarter decline looks sort of similar to the third quarter, and we start to lap it beginning in March. So March will improve. And then we see it sort of getting better in the June and September quarter of next year. So it's been tough.

It will continue to be difficult through a couple of quarters. But I think it's really important to highlight that despite this sort of decline, the margin profile of the business is above the fleet average. So with the scope of work we've done, we've been able to really -- perform extraordinarily well throughout this and leverage that lead time and cost structure to win new business in the aftermarket.

And so believe me, the new builds are down more than what we're posting. So we're winning new content in aftermarket programs to offset some of that which sets us up for, I think, a decent second half of 2021.

And your next question comes from the line of Bryan Blair with Oppenheimer.

Looking at your calendar fourth quarter guide, I was hoping you could offer a little more color on what you're contemplating in terms of core growth or decline and margin by segment.

I'm particularly curious on the Zurn side. Obviously, really good momentum there. You mentioned seasonality will hit the business a little bit in the fourth quarter then it sounds like significant reacceleration into 2021. Just trying to piece that trend together.

Bryan, I think, hopefully, the pattern recognition is starting to set in for people, which is -- I think Mark pointed out that each month of the quarter, it got better than where we ended. When we look ahead, we're not going to assume that it gets appreciably better over the course of the quarter when we guide externally.

Internally, our expectations are clearly higher. Our results in October are clearly better. But what we're building in is, I think, a level of conservatism just based on the disruption. So that's the third-party sort of external guide view of the world.

When you think about growth in that guide, you have to assume the same, right? We're not going to see much of any change, but we're off to a good start in Q4. And hopefully, we continue on that trend in November and December.

There's nothing that we're doing internally that gives us pause or concern about the improving trajectory. I think we're sort of guarding a little bit against the unknown. I mean if you think about the range of outcomes for the month of November and December, I think it's fair to say that it's skewed to the downside in terms of disruption and things of the like. But from a pure day-to-day demand, we're not seeing it for now, but I think we've tried to embed some level of that into our guidance.

Okay. That's perfectly fair. We know you've made a lot of investments throughout the year to support the ramp in touchless and hygienic, and you've provided some good detail on what that means and what it should mean going forward.

Just to confirm, are there any other foundational moves that need to be made or key investments required? Or is the team more or less ready to handle 2x or more growth in that business?

Without question. I mean we're run rating in 2x relative to where we were a year ago right now and probably a little bit better than that. And so we're going to -- we've been investing. As I mentioned in my sort of opening comments, we went through a complete product redesign. We've been investing in e-commerce. We've established wholesale placement to levels we've never had before.

And so those have all been embedded in sort of the performance we've delivered, and we'll continue to do those. So we're more than ready to deliver at a 2x sort of run rate into 2021.

Okay. Excellent. And just a clarification point on PMC aero. On a trailing basis, what would be your split between new build exposure and the aftermarket?

In aerospace?

Yes.

Roughly 70% new build, 30% aftermarket, plus or minus.

And your next question comes from the line of Andrew Obin with Bank of America.

This is Emily Shu on for Andrew Obin. I just had a follow-up question on the 4Q guidance. So if I do the math, it implies sequentially flat or even down revenue. And I just wanted to dig into what the puts and takes to that are.

Is it just normal seasonality or a potential -- or are you baking in like a potential second or, I guess, even third wave of COVID? And what are you seeing in terms of any impacts from the rising U.S. COVID cases in October to your business?

Well, there's a lot to unpack there, Emily. But the biggest, I think, thing to understand is in North America, the construction season sort of slows in October through December. And so that will have sort of a traditional seasonal impact sequentially from the third to the fourth.

Aside from that, I don't think there's anything notable other than there's a couple of fewer days due to the holidays. And obviously, year-over-year, the aerospace business will be down in roughly the same magnitude as it was in Q3. And so that's how to think about the sequential trend. I don't think it's an unusual pattern.

Our revenues are traditionally down in the fourth quarter based on those same attributes. So it's nothing specific that we could point to related to the COVID cases and the spikes in the last several weeks. But I think we're sort of embedding the potential for some of that to happen in the way we've guided externally.

Okay. Great. Got it. And then my follow-up question is any comment on how channel inventory levels are? And have you heard anything from your distributors on a restocking cycle that could come?

I wouldn't say anything significant. I think we've been talking about channel inventories for quite a while, particularly in the industrial side of our business, and they remain at sort of record lows.

And so while I think there's a potential that as sell-through picks up, we'll see that increase some level of inventory. The way we operate the business is really on a demand basis, so the inventory turns wouldn't move a lot. So I don't think that we're going to see any significant restocking activity. And it's not something that you should sort of think about one way or the other I think in our industrial business and it has been that way for the last 5 to 8 years.

(Operator Instructions) And your next question comes from the line of Julian Mitchell with Barclays.

This is Trish on for Julian. So last quarter, you guys had mentioned you're making some incremental investments within the PMC business, kind of similar to how you're doing in water management. Can you just talk about kind of where you are with that? Is there more to do in the fourth quarter?

And then I'm not sure if you can size in any way, but when we think about the year-over-year margin declines within that segment, how much of that was a function of these increased investments or a portion of the cost coming back versus mix given the aero weakness?

Patricia, this is Mark. I mean if you think about the incremental investments, it's (inaudible) All right. Can you hear me okay?

Yes.

All right. Sorry, I had a microphone issue there. Regarding incremental investment, I think there's nothing that's at a different pace in PMC outside of what Todd referred to earlier. If you think about the investment we made in our associates, obviously, that steps up in our fourth quarter versus our third quarter.

As far as growth investments, there is not a step-up in pace and growth [in the business] in the fourth quarter from where we would have had it earlier in year.

I think your second question is tied to margins. With, obviously, with the -- we think about the guide that we've put in place, if you think about the decline in sales sequentially, obviously, you've got a decremental margin on that.

The incremental cost or EBITDA impact of the actions around merits and incentive compensation that actually took place obviously impact the margin sequentially. And SCOFR 3 is probably kind of mostly on par, maybe down a little bit. So those are the kind of the moving pieces that are embedded in the segment margin guidance that we gave.

Yes. One final thought is when you give some credit to the frictional costs from the SCOFR move, the decremental margin in PMC in 2020 will be right around 30%. And if you -- so that's sort of been very much inside the range of what we've communicated. And that's sort of using the fourth quarter guidepost as a proxy to get to the full year. So I think it's well inside of what we've been communicating really for a long time.

Yes. You go back -- that's right. You go back to our first call post-COVID, and we said, "Look, for the year, we have high confidence that overall decrementals will be less than 30% at [rational] level for the calendar year." That's where we'll end up.

Understood. That's helpful. And then the detail on the retrofit was very helpful as well. I think last quarter, you guys had expected retrofit to comprise 40% to 45% of water revenue for the next 12 months. And then before, it seems that's already 40%. Any updated outlook on that over the next 12 months?

Well, that was a forward look that we provided last quarter. I think, fortunately, we're well on track to be in that range for 2021.

And there are no further questions at this time. I will turn the call back over to the presenters for closing remarks.

I'd like to thank everybody who joined us on the call today. We appreciate your interest in Rexnord, as always, and look forward to providing our next update when we announce our December quarter results in February. Have a great day, and please stay safe.

This concludes today's conference call. You may now disconnect.