Rexnord's (RXN) CEO Todd Adams on Q4 2016 Results - Earnings Call Transcript

| About: Rexnord Corp. (RXN)

Rexnord Corp. (NYSE:RXN)

Q1 2016 Earnings Conference Call

May 19, 2016, 08:00 AM ET

Executives

Robert McCarthy - Vice President of Investor Relations

Todd A. Adams - President and Chief Executive Officer

Mark W. Peterson - Senior Vice President and Chief Financial Officer

Analysts

Charlie Brady - SunTrust Robinson Humphrey

Ronnie Weiss - Credit Suisse

Joseph O'Dea - Vertical Research Partners

Samuel Eisner - Goldman Sachs

Mircea Dobre - Robert W. Baird & Co.

Karen Lau - Deutsche Bank

David Rose - Wedbush Securities

Jeffrey Hammond - KeyBanc Capital Markets

Operator

Good morning and welcome to the Rexnord Fourth Quarter Fiscal 2016 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 that company filed and 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 introductions, I'll turn the call over to Rob McCarthy.

Robert McCarthy

Thank you. 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 release 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 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 performance for the fourth quarter of our fiscal year 2016 and our outlook for the 2017 fiscal year. We will 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.

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

Todd A. Adams

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 we are essentially at the low end of our initial expectations. As the trajectory of a traditional seasonal pickup in our fourth quarter was a little weaker than we had anticipated, and symptomatic of our customer’s tighter spending within a week to a more 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 9% core decline in our Process & Motion Control platform. Adverse currency translation was a headwind that reduced our reported top-line growth by approximately 2%.

Our adjusted earnings per share was $0.37 in the fourth quarter consistent with our previous results and within our original guidance range, we should assume no earnings contributions from a non-core product line that we are well into the process of exiting. Our fiscal 2016 free cash flow of a $171 million was in-line with our expectations, finished the year at a 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 recently acquired Cambridge International which is a globally leader in engineered metal conveying solutions predominantly for the food industry. We are excited about the combined value creation potential Cambridge and Rexnord together and 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 of closer to 18%. For the full-year, water management core operations delivered 5% growth and an EBITDA margin of 20.3% results that we are confidently can build upon.

We did see attractive mid-single digit growth in our North American 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 appointment 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 dependant on specific country and project exposure, but overall are net positive for us. We continue to see this global market as stable to improving in the near-term and there is a relatively stable mid-single digit grower over the longer term.

Turning to our Process & Motion Control platform, we experienced a significant cross currents in our fourth quarter that in total reflected the lead global growth environment and associated volatility across various end-market verticals that produced overall platform results that were modestly below our expectations. As you are likely aware, overall U.S. industrial production and capacity utilization, which includes the mining and energy sectors weakened further in the March quarter but we are generally stable if you focus only on the manufacturing sector.

U.S. capital spending slowed further, but the purchasing managers’ index improved in other words visibility remains challenged across the broader industrial sector. Positively, the stabilization of 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 footprint 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 in 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 a third PMC sales and a larger share returns and we expect to generate positive core growth in both end-markets during the coming fiscal year.

In total, our outlook for PMC and incorporates generally stable investor distribution sell through and that’s improving year-over-year comparisons as we move through fiscal 2017. Generally stable distribution channel inventory levels, improved execution in our aerospace markets and only modest improvement in year-over-year growth comparisons for OEM 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 fiscal 2017 to range between 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 or outlook includes approximately $14 million or $0.08 of non-recurring expenses associated with our supply chain optimization and footprint repositioning initiatives that are not excluded from our estimates.

As you recall, this program is expected to deliver a $30 million of annualized savings beginning at the end of this year or fiscal 2017. The RHF product line exit captures about $5 million of the planned structural savings in this year and going forward and eliminates the 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 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 and equal 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 bringing additional capabilities and opportunities to add value to our long standing customer relationships in the global beverage industry.

Cambridge generated the majority of its sales in a broad range of food applications of seasoning and grilling meats, decorating and baking cookies, from freezing and packaging ice creams to sorting and cleaning fruits and vegetables. Cambridge conveying price are also used in beverage filling and packaging operations and it’s also the 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 is an end-market that has an attractive and relatively stable growth product profile. And Cambridge has grown nicely in recent years.

Although our products are going side-by-side in some of our customers’ plants, there are more opportunities where we can help each other. The bottom-line is, we have identified significant and specific sales synergies that we expect to convert on in the coming quarters in 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 PMCs and Rexnord’s longer term growth profile and we expect to deliver a double-digit return on this investment within the next couple of years.

Moving to Slide 6, we are presenting a bridge here for our fiscal 2016 adjusted earnings per share and our guidance for fiscal 2017. First, I would note that our non-core product line exit as the effect of elevating the jump off point in fiscal 2016. 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 mid-point of our guidance. Given the RHF exit, non-recurring supply chain optimization and footprint repositioning expenses will increase by about $0.03 to produce a total impact of $0.08 of non-recurring expenses included in our guidance for adjusted EPS in our fiscal 2017.

Now let’s move on to Slide 7, we have made some changes to the composition of our market growth outlook slide that we are hopeful will provide some context of how we are thinking about our fundamental outlook. Specifically, we have added some geographic detail to our outlook for our 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.

We often calibrated the year-to-year trend as we did this time last year, we have also provided a summary of our fiscal 2016 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 fiscal 2017.

We expect a lot more on fiscal 2017 supported by the progress we are making with our commercial productivity, launch of new products and other share gain initiatives. Our intense focus on commercial excellence is improving our customer’s overall experience and we are seeing it in our customer satisfaction survey - and net promoter scores.

Our success of winning strategic first fit specifications is gaining some momentum as if run rate of first fit orders booked in the fourth quarter matched the incremental impact in the first three quarter of the years. Looking across our end-markets and as highlighted earlier, we continue to have a favorable outlet for our key construction end-markets and our guidance we are assuming a modest sell through decline in our investor distribution channels, which will be roughly offset and our results by reduced destocking and high 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 have probably seen the worse of the down cycle, we see the potential for moderating year-over-year declines in the second half of our fiscal 2017.

All-in-all, we see our operating results as stabilizing to improving throughout fiscal 2017 and providing a favorable set up as we complete our equipment initiative later this year and look into to the following year our fiscal 2018 which is only 10-months away at this point.

With that, I’ll turn it over Mark to review the numbers.

Mark W. Peterson

Thanks Rob. Slide 8 of the presentation depicts our quarter’s results and reconciles with the adjusted results. Please recall 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 total results in each quarter of fiscal years 2015 and 2016 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 from 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 four quarters of fiscal years 2016 and 2015 respectively. The earnings adjustments for our RHF are detailed on Slide 8.

Turning to our core operations, the year-over-year decline in our fourth quarter was 3% on this basis are overall detrimental margins was 25%. On the same basis, the drop through for consolidated adjusted EBITDA for the full-year of fiscal year 2016 was approximately 32% which is generally consists with our historical 30% targets.

Next, as we look at the operating performance in our Process & Motion Control on Slide 10. You can see that year-over-year impact on platform margins from the combination of 10% revenue decline and or higher investment spending associated with our footprint actions. While margin improved sequentially as activity levels from our distribution channels remain stable and margins benefited from the seasonally higher contributions in our food and beverage end-markets.

For the full-year, PMC’s adjusted EBITDA margin was 21.3%. As we look into fiscal 2017, we expect the year-over-year core declines in PMC revenue moderate to a low to mid-single digit percentage. Our outlook assumes stables to improving demand in our aerospace and food and beverage end-markets, generally stable sales level in our industrial distribution channels, while support reduced destocking and further substantial but moderating year-over-year declines in our process industry end-markets.

Cambridge had approximately 550 basis points of incremental top-line growth to PMC and fiscal 2017. Core PMC margins are expecting to be flat to down slightly given the anticipated core sales decline and as investment spending increases to support our 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 fiscal 2017.

I’ll turn to Slide 11. I’ll make a few comment on our water management platform where we are again excluding our RHF product line as if in our analysis. Core growth consolidated to 8% in the quarter as sales benefit from city momentum and a non-residential construction market. And stronger private shipments to our water and waste-water infrastructure markets.

Our incremental margin was essentially 100% and long benefited from comparison with the depressed the result in the year ago quarter it also reflects measurable improvements and our operating expectations as we leverage our ongoing RBS led continues improvement initiatives. With a solid margin performance we saw in the fourth quarter, the adjusted EBITDA margin for water management for the full-year of fiscal 20 and again pro forma for our RHF product line was 20.3%.

As we look forward to our fiscal 2017 for water management we are projecting another year of solid core growth in mid-single digit range with slightly higher growth in our non-residential construction market and relatively slower, but still positive core growth in our water infrastructure markets, which accounted for approximately 32% of our platform revenue in our fiscal 2016.

As always, the caution the timing of the project shipments can increase significant variability in quarterly year-over-year core sales growth comparison in our water management platform. In terms of expecting year-over-year margin performance, we note that again given the RHF product line items approximately $5 million of our projected annual supply chain of footprint sales were revised in our industrial results for fiscal 2o16 and therefore are now in the baseline.

Moving onto Slide 12, you will see our strong free cash flow enabled us to further strengthen our cash position and liquidity and it continues 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 this is just to fund the Cambridge acquisition and still reduce our leverage ratio below the current level by the end of fiscal 2017.

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 [indiscernible] 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 terms 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, Slide13 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 fiscal 2017.

In addition, our guidance assumes we do not incur any non-operating and other income or expense as we do not forecast realized and unrealized gains or losses and foreign currency fluctuations. Gains or losses on the disposal of assets, recoveries under the continued dumping and Subsidy Asset Act or other times that are reported in this P&L line item.

Other than the pending acquisition of Cambridge our guidance also excludes the [indiscernible] of incremental potential acquisitions and divestitures for future non-recurring items such as restructuring cost. With respect to restructuring, I will take a minute to provide you with an update.

Please note in 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 of all in summary, supply chain optimization and footprint repositioning parameters expected to [indiscernible] our fiscal 2017 results.

[indiscernible] exited event product line the incremental benefits associated with RHF that were originally projected to be there in fiscal 2017 have been realized in fiscal 2016 are now in our base run rate of our earnings. If we talk about fiscal 2017 and beyond, my comments will focus on the remaining non-RHF actions that we are executing. With respect to those actions, we incur approximately $10 million of cost in fiscal 2016 and we expect to incur approximately $14 million of cost in fiscal 2017, all of which run through our adjusted operating results.

In addition, in fiscal 2017 we will begin to realize benefit in some of the non-RHF actions as we incorporated in my comments last quarter and we have included approximately $57 million of those benefits in our guidance for fiscal 2017. Importantly the total cost that we incurred in fiscal 2016 and the 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 cost and are excluded from our adjusted operating results. Excluded from our guidance for adjusted EPS is approximately $1 million of accelerated depreciation in fiscal 2017. 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. Second, in addition to this program we anticipate incurring restructuring recession 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 bearing levels of pre-tax income as well as the timing of other planned 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 woo 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 rate amortization in tangibles will decline year-over-year by around one-third or approximately $18 million in fiscal 2017 and certain intangibles to our acquisition by [indiscernible] 2006 we can fully amortized. Based on our 2016 revenue levels, the impact amounts to nearly one full point of pre-tax margin.

With that, we will open the call up for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session [Operator Instructions] And our first question comes from Charlie Brady from SunTrust Robinson Humphrey.

Charlie Brady

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 is driving that right now?

Todd A. Adams

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

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

Charlie Brady

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

Todd A. Adams

Yes.

Todd A. Adams

Okay. Thanks.

Operator

Our following question comes from Julian Mitchell, Credit Suisse.

Ronnie Weiss

Hey, guys it's Ronnie Weiss on for Julian. I just wanted to touch on the pricing dynamics which guys saw in fiscal year 2016 and what you are going to see in 2017 and similarly on the raw [material] (Ph) cost, what you guys saw an impact for 2016 and what is kind of expected for 2017?

Mark W. Peterson

Ronnie this is Mark. From a pricing standpoint we didn't see a lot of pricing pressure in 2016, and the distribution channel pricing was stable. Our end-user OEM pieces and PMC is less project base, so you are bidding up projects, we didn't see really any material different deviation pricing dynamics then what we have seen in the past. So I [indiscernible] 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 are not buying a lot of raw commodity, lot of what we are buying has a value add in it. So we saw some benefits but not a huge benefit.

As we look into fiscal 2017 we are not planning on a lot of price, if we think about our sales growth we don't have even a full [indiscernible], so we are not expecting much of a change as far as price dynamic goes positive or negative. And on raw material we think obviously think there are some commodity uptick, when commodities came down we had some benefits, as far as you we don’t expect to have a big negative effect. so we really if you kind of summarize it, it’s still stable on both fronts going into 2017 from what we saw in 2016.

Todd A. Adams

And Ronnie, you know this, but generally speaking we are 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 is 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, had come up a little bit, but I think pricing dynamics across the board are generally stable for us.

Ronnie Weiss

Understood and then back on Cambridge, I think is there any kind of synergy targets that you guys are looking for, have you gone through that analysis that leads to kind of looking for on that front?

Todd A. Adams

We didn't outline it, a couple of things to point out, in my comments, this is not a cost synergy deal, it's a fantastic business, it'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 sale and ability to sort of 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 have got some very good customer relationships where we have the opportunity to go and sell some of our products to their existing customers.

So we think the sales are 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 are buying at a fair value or these are like growth synergies that we can get as a result. And frankly, it's been in our funnel for a couple of years, so we have got a chance to look at it, learn and understand it. And we feel really good about the acquisition.

Ronnie Weiss

Got it. Thank you.

Operator

Next question comes from Joe O'Dea from Vertical Research.

Joseph O'Dea

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

Mark W. Peterson

Yes Joe this is Mark. I think as you saw on the slide, from an OEM manager standpoint mining and the energy end-markets remain tough. As we said in our fourth quarters, we highlighted we saw little modesties seasonal pickup, but when you look at where we have been in prior years, we think the mining, energy and some of the ripple effect out from energy continues into fiscal 2017.

So we are really not looking and this is again end-user OEM perspective, from an MRO standpoint we have seen stabilization and expect that as we relatively as business going forward, when we look at end-user OEM based project work, capital work, it's depressed and we should be able to see a catalyst to change that in the near-term here. So we are just planning on that [indiscernible] plan recruiting over the next year.

Joseph O’Dea

Okay got it and then on the I guess just quickly on the tax rate 27%, is there anything sort of structural underlying that, is that steps a little bit lower of is that more just kind of a next step?

Mark W. Peterson

I would say that one thing Joe that's moved it down where we ended fiscal 2016 as we will be adopting the new accounting pronouncement that requires you to take basically - because when stock comes for exercise for the tax benefit. And that's what run through equity. So, with the new accounting guidance, if you put that up in your tax expense line of the benefit it's worth a few cents for us this year and its really what moves it from that 29% to 27%. So we will be down in that in our first quarter Joe.

Joseph O’Dea

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

Todd A. Adams

Well, we obviously feel pretty good about it or we wouldn't have guided that way. I think what you are going to see is, we are talking about at the company level, core growth of plus two and the minus two. The trajectory we start on is somewhere between flat and down too, so I think when you look through it and in total, we feel pretty good that the trajectory that we are on sort of matches the way we are guiding for the full-year.

So I don't think we are benefitting on and we saw the big pick up, I think really we are talking about stability, controlling what we can control, when we think we know we can win, add some of the Cambridge in. And we feel like this year is not about lift up, I think this year is really about get the Scoper projects done, get the acquisition integrated and be ready for 2018.

So that's sort of how I think we are sort of guiding the year, we hope we are wrong, we hope the pickup is a little bit bigger, but I think at the end of the day given what we see and frankly what we look out of the window, that's what it looks like right now. And so we are trying to guide, I think sort of like that.

Joseph O’Dea

Great. Thanks very much.

Operator

Next question comes from Samuel Eisner, Goldman Sachs.

Samuel Eisner

Yes good morning everyone. So on Rodney Hunt, I was wondering if you can just talk a little bit about what has happened in that business, obviously you are choosing to get out of it given the restatement. This is the first time that you guys are being able to talk publically about it. So if you can just give a little background on kind of what the issues were with that business, why the decision ultimately close it just for better understanding?

Mark W. Peterson

Well, I don’t that we are 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. If you look back, I don't think is tremendously helpful because for the most part it's market driven, it's 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 history in a nutshell.

Samuel Eisner

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

Mark W. Peterson

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

Samuel Eisner

Got it and 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 is a way to kind of explore more so of what that $0.08 is encompassing?

Mark W. Peterson

Within the operating funnel?

Samuel Eisner

Just within the fiscal 2016 to 2017 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 wanted to better understand what the moving pieces are of that $0.08.

Mark W. Peterson

So you have you have used on the Scoper benefit that will be realizing this year than in next year and probably mid-single digit EPS benefit from the Cambridge acquisition with the balance being core operations.

Samuel Eisner

That’s helpful, great. And then lastly just in terms of the 30-day notice here I mean everything. Is pretty much assigned associating with Cambridge is there anything that we need to worry about from a closing or DOJ standpoint that we need to be mindful of?

Todd A. Adams

We don’t believe so Sam.

Samuel Eisner

Great. Thanks so much.

Operator

And a following question comes from Mic Dobre from Baird.

Mircea Dobre

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

Todd A. Adams

We didn’t comment on…

Mark W. Peterson

Yes for the full-year we are planning on PMC organic growth t be down kind of low to mid single digits. And the water growth to be up more mid single digits. That’s the balance of that platform for the year Mic.

Mircea Dobre

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?

Mark W. Peterson

Well Mic there is a couple of things are impacting the first quarter, it’s a heavy quarter for our expenses that we are incurring on the supply optimization and footprint repositioning program. So as the year progresses you start so [indiscernible] all expense in the first quarter and we serve things that benefitted as the year progresses that’s one big piece of it. We talked about some of the initials that we have regarding growth and some breakthroughs in both of our platforms.

So we started to investments in our fourth quarter with full run rate in the first part of the year and we starts getting better over the back half. And then of course as you know we continuously obviously drive our improvement through RBS, through the balance of the year we drive some margin improvement over the course of the year. but [indiscernible] Scoper investments that we have in the first part as well as the growth that we have in the first part of the year and getting the benefit of that as you go through the back half of the year.

Todd A. Adams

Yes Mic, I think kind of using the word ramp, I don’t know that its ramped as much it is some discrete items that Mark talked about and our normal seasonality. So if you parch that out, I think what you are going to see is a relatively down the middle year in terms of the growth assumptions that we have laid out which you can argue they are conservative or you can argue they are too aggressive.

And generally think they are probably more on the conservative side and then the benefit of all the things that we are doing. So that’s how we think about the year, not so much in terms of a ramp, but pretty steady discrete items setting us up for what we think is a transition year to a much higher margins heading into fiscal 2018 as we completed the supply chain optimization projects.

Mircea Dobre

I see that’s helpful and maybe one last one. Sort of 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 thinking about the margin potential going forward?

Mark W. Peterson

Well, again I think where we are today it’s 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. We think about where we go from there, I think you can expect continued improvement in our overall margins based upon RBS and what we are doing there to continue to eliminate waste and improve our service levels and quality, everything.

And then also there is probably a pretty good opportunity, you are going to see us get into new categories and as we get in, we have great brands, great channels, we have the ability to specify our products support through. So it will be higher than 20, I think we will see improvements in our fiscal 2017 and from what we can tell now based on the elements or the Scoper project that remaining in water you will see improvements again there.

Mircea Dobre

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

Todd A. Adams

I don’t think they are changed. I think historically here we have said 25% to 30% in water. I don’t think that is any different.

Mark W. Peterson

30 to 35 in PMC.

Todd A. Adams

And its 30 to 35 in PMC. Again I think we are retaining or maintaining the way we are thinking about incremental margin, we will get the benefit next year of the supply chain optimization and footprint rationalization benefits, but beyond that we can continue to generate the types of incremental margins that we just offer them.

Mircea Dobre

Thank you.

Todd A. Adams

You bet.

Operator

Following question comes from Karen Lau from Deutsche Bank.

Karen Lau

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?

Mark W. Peterson

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 did in our fourth quarter have adverse mixed impact from distribution that was one piece of it, when you look at year-over-year. We did incur obviously cost 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 and aerospace that will recapture in fiscal 2017, you can appreciate with that, we didn’t operate effectively. We weren’t as efficient as we should and that impacted our detrimental margin in the fourth quarter. Those were the three items Karen.

Karen Lau

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?

Mark W. Peterson

I won't go in what the core detrimentals are in the first quarter by flat. We will talk about that obviously once the quarter unfolds, in 90-days. What I can tell you, as we said earlier, first of all, there are no - that as we know today no unusual items in the first quarter. We are going to have heavier Scoper expense in our first quarter in PMC. And we are going to obviously have the investment cost I talked about growth side into the first quarter.

I think when you look at sequentially from Q4 to Q1 as the quarter unfolds, it won't be surprising detrimental margin sequential in PMC Q4 and Q1. And in Water you are going to see the first quarter margins pop back up in the 19.5 plus or minus type range in the first quarter and what we are looking for.

Karen Lau

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?

Todd A. Adams

It's relatively small Karen.

Karen Lau

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?

Todd A. Adams

Yes, it is. Yes it is.

Karen Lau

Okay, thank you.

Operator

Our following question comes from David Rose from Wedbush Securities.

David Rose

Good morning. Thanks for taking my call. A couple quick ones. On page seven, 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.

Todd A. Adams

It's a relatively noted question David because I don't know if you ask me where to take it down, I'm not going to give you an answer, I think we have got a reasonable view that this is a forecast that we have some weird confidence in, we are inevitably going to be wrong somewhere, the somewhere I'm not sure. But I think that what we try to do is again put together sort of a down to 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.

I mean there is no question, cross industries, they are not in good shape, commodity deflation continues and so I don't think we're going to be surprise to the upside there, so again I think we have 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 have 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 that tell you that we're going to walk away from this forecast 15 minutes after putting it together.

David Rose

Okay. And I appreciate the sentiment around it. And I know you are 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.

Todd A. Adams

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 sort of looks like global food and beverage. So that's what we are acquiring, we will get a very small [stub] (Ph) in our June quarter and then you'll get to sort of see the difference between core FX and acquisition growth, I think for the first time that we talk about our second quarter.

David Rose

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?

Todd A. Adams

It transacted in 2012 between private equity. We started cultivating it in sort of late 2013 early 2014. So it was a sale of the business. So the current owner has owned it for about four-years. We have been knocking at the door for three-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 it’s good and it’s a permanent home for I think the associates in the brand and that’s why we are excited about having the opportunity to do so.

David Rose

Okay. Great. Thank you very much.

Operator

And our following question comes from Jeff Hammond from KeyBanc Capital Markets.

Jeffrey Hammond

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

Mark W. Peterson

That’s correct Jeff, yes.

Jeffrey Hammond

Okay. So as we go into fiscal 2018, does that $14 million completely go away?

Mark W. Peterson

It will. It doesn’t go away day one, but it will go away, yes [indiscernible] buying that down correct you are correct.

Jeffrey Hammond

Okay. And then how much carryover final savings do we get into fiscal 2018?

Mark W. Peterson

So if you go back, I’ll give you two answers. When high costs are $13 million that’s looking at it from the time we announced the price, that’s obviously intact. In spite of that because we have gotten out of Rodney Hunt [indiscernible] it’s been recognized. So when you look at the $25 million left [indiscernible] call it 20 on an EBITDA basis so that six to seven in fiscal 2017 then it goes to 20 to 21 in fiscal 2018.

Jeffrey Hammond

Okay. So really the big opportunity from this comes in fiscal 2018 when all those costs go away and you get the largest bucket of savings.

Mark W. Peterson

You are thinking about it exactly right Jeff.

Todd A. Adams

That’s right Jeff.

Jeffrey Hammond

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 fiscal 2017?

Todd A. Adams

Jeff, I’ll just highlight. I think where we sit we get a relative we have got high confidence in our ability to generate strong free cash flow this year and frankly when you look ahead the savings and the benefits underpin even better free cash flow number in fiscal 2018. We just made the investment and in Cambridge, we’re going to have a strong year this year and we felt like taking the opportunity to pay down a $100 million of gross that was just frankly prudent given the interest expense roughly 5%.

Mark will give you maybe a little - few more investment points, but we have got outstanding free cash flow, we have got earnings stabilizing, we have got a bunch of self help underway, we just felt like it eventually there we are paying back some of the debt. And just though people that we have to payback $100 million and keep generating cash and continue to do right things with bolt-on acquisitions and paying down debt going forward.

Mark W. Peterson

Right and obviously reduces our gross leverage Jeff as you know.

Jeffrey Hammond

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?

Todd A. Adams

We feel good obviously through 2017 and then 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 these for a couple of more years. So I think this year we are 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 you know we feel that’s pretty achievable. Look we will keep monitoring the data like everybody else but we see solid backlogs, we see pretty stable good outlook heading really throughout this year and into the next year.

Jeffrey Hammond

Okay. Thanks guys.

Todd A. Adams

You bet.

Operator

A following question from Samuel Eisner from Goldman Sachs.

Samuel Eisner

Yes, 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 are willing to kind of plant a pike in the ground. Do you think that free cash flow will grow in fiscal 2017 on a year-over-year basis?

Mark W. Peterson

Free cash flow in absolute dollars is going to be down year-over-year. Two reasons, one a lot of the cash restructuring, rolling into the Scoper project kits in fiscal 2017 so we will obviously expense but from cash you have got more coming through in fiscal 2017 and our cash taxes will be going up as well in fiscal 2017 as well used some of our foreign tax credits. [indiscernible] drive the absolute dollars down from where there were in fiscal 2016

Samuel Eisner

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?

Todd A. Adams

It's 12-month number Sam, so we will have essentially nine months in our fiscal 2017.

Samuel Eisner

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

Todd A. Adams

Yes 20 or 25 is a good difference.

Samuel Eisner

Got it. Super helpful. Thanks so much.

Todd A. Adams

You bet.

Mark W. Peterson

Thanks Sam.

Operator

We have no further questions at this time.

Robert McCarthy

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 fiscal year 2017 results in August. Have a great day.

Operator

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

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