Good morning, and welcome to the Rexnord Third Quarter Fiscal 2018 Earnings Results Conference Call with Todd Adams, President and Chief Executive Officer; Mark Peterson, Senior Vice President and Chief Financial Officer; and Rob McCarthy, Vice President of Investor Relations for Rexnord. This call is being recorded and will be available on replay for a period of two weeks. The phone numbers for the replay can be found in the earnings release the company filed in an 8-K with the SEC yesterday, January 31st. At this time, for opening remarks and introductions, I'll turn the call over to Rob McCarthy.

Thank you, Paula. 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 are 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, and free cash flow 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 10-Q. Please note that the presentation of our operating results includes adjustments to GAAP reporting for the impact of the RHF non-core product line in our Water Management segment that we exited during our fiscal 2017 in order to enable investors to better understand and assess our continuing core operating results. Today's call will provide an update on our strategic execution, our overall core performance for the third quarter of our fiscal 2018, and our outlook for our full year fiscal 2018. We'll cover some specifics on our two platforms, followed by selected highlights from our financial statements and our cash flow. And afterwards, we will open up the call for your questions. With that, I'll turn the call over to Todd Adams, President and CEO of Rexnord.

Thanks, Rob, and good morning, everyone. As you hopefully saw in our release last night, our third quarter results demonstrated the continued positive momentum across our businesses that started around this time last year. With our core growth increasing, the strong growth in adjusted EBITDA as a result of the structural cost reduction achieved with our Supply Chain Optimization and Footprint Repositioning initiatives that we wrapped up earlier this year. We continue to see improving end market demand across most of our served end markets, and we're seeing more evidence every month that the strategic growth initiatives that we've been driving are delivering real value to customers and better core growth in our business. With just one more quarter to go in our fiscal year, we're comfortable taking up our outlook for both core growth and EBITDA, and we'll cover that in a few minutes. Today, I'm going to quickly go through some examples of the few recent wins driven from growth investments we've been making. Then I'll pivot to review the pending acquisition of Centa and its strong strategic fit within our PMC platform. There's a lot to discuss, and we'll try to move through our prepared remarks quickly so we can address your questions. Our third quarter sales of $492 million included core growth of 6%, and we're at the higher end of our expectations for the quarter. Core growth accelerated sequentially in both PMC and Water Management, and profit margins fully reflected the benefits of our structural cost reductions, as well as solid operational execution. Our adjusted EBITDA increased 20% year-over-year to $95 million. Consolidated EBITDA margin expanded 170 basis points and our incremental margin and year-over-year core growth exceeded 45%. Adjusted EPS was $0. 37 for the quarter, including a $0.05 contribution from a lower than…

Thanks, Todd. Please turn to slide number 6. On a consolidated basis, our third quarter core sales increased 6% on a year-over-year basis. Our adjusted EBITDA increased 20% from the prior year third quarter to $95 million and our adjusted earnings per share was $0.37. Our effective tax rate when calculating our third quarter adjusted net income is approximately 22%, and added about $0.05 to our adjusted earnings per share when compared with our tax rate expectations entering the quarter. The lower rate we experienced in the quarter is a function of the rate benefit from U.S. tax reform, as well as the timing of recording certain discrete tax benefits. I'll speak to U.S. tax reform in a couple of minutes. As Todd indicated earlier, we are increasing our financial outlook for fiscal '18. After a solid third quarter and given our favorable outlook for our fourth quarter, we're slightly increasing our outlook for core growth in fiscal '18 to a mid-single digit percentage from our previous outlook for low to mid-single digit growth. As we balance having only one more quarter in the current fiscal year, with the fact that our fourth quarter is historically our largest quarter. To ensure that market expectations don't run ahead of what we expect to deliver, I want to be clear that we currently expect our full year core growth to finish in the lower half of the mid-single digit range. Having said that, we were also adjusting our outlook for adjusted EBITDA to be in the range of $381 million to $387 million, which reflects ongoing order growth, our solid operational execution and incorporates a couple of million dollars of upside from stronger than expected currency translation. The $384 million mid-point is $4 million above the mid-point of our previous guidance and…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Jeff Hammond from KeyBanc Capital Markets. Please go ahead.

Hey, good morning, guys.

Good morning, Jeff.

Good morning, Jeff.

So just on Centa, can you just talk about margin structure or multiple paid? And then where you see some synergy opportunities early on?

Sure. The purchase price is €118.5 million. The purchase price paid on a multiple basis is high single-digit, and we clearly think, with the synergies that we've got, I think really good line of sight, so we think we hunted for sort of mid-single digits within 2 to 3 years. We'll give you more details as we ultimately get closed for obvious reasons, but it's one of those that we'll pencil based on a cost synergy point of view versus any sort of growth. I think the growth will be there with DiRXN integrating into what we think is already the best coupling business in the world. So we are excited about it. It's a super fit for us and highly synergistic because I think you'll see in here after we get it closed and talk about it next quarter.

That sounds like a great deal. And then it sounds like VAG still maybe lagging, we're seeing better growth - global growth. Can you just talk about what you're hearing from your customers quoting activity, maybe expectations for some of that Middle East deferral delays to kind of shake out over the next year?

Yes, I mean, I wouldn't assume that it's lagging. I think that the growth in the quarter was good. We continue to build some backlog. I think from a Middle East standpoint, I think it's still - it hasn't converted much to quarters at this point, but it's clearly far more stable. I think you have seen the region improve. You've seen improvements in Saudi and other places. So I would say that it's incrementally probably a little bit better than it was 12 months ago, 6 months ago. It hasn't really converted into any massive growth at this point. But I wouldn't assume that it's a drag at this point either.

Okay.

And our next question comes from Joe O'Dea from Vertical Research. Please go ahead.

Hi. Good morning.

Good morning, Joe.

Looking at now calling for mid single versus low to mid previously on organic and then thinking about the setup into 4Q, and it looks like representative of a stronger outlook for underlying demand in 4Q versus what you would have seen in the first three quarters of the year. But could you speak a little bit to that at kind of a segment level within PMC, anything in particular that you called out, whether it's end user OEM or whether a little bit better distributor stocking? And then also what you might be seeing a little bit detail on the Water Management side?

Yes, Joe, this is Mark. I think you are right. If you go back 12 months, our outlook for our fourth quarter result for PMC is better than it was even 90 to 180 days ago. We've always felt going into this quarter, we do need a tougher comp, and again look at a stack margin throughout the year, the best stack margin will be our fourth quarter. But if you look at what's really - I said the margin, I meant core growth - the stack core growth, not stack margin, stack core growth, it will be our strongest quarter. So last year, we wanted basically flat core growth. This year requires something that low mid-single-digit range for the quarter. As we kind of said earlier on our comments, we've seen the distribution sell-through modestly improving this past quarter. We haven't seen a lot of change in the stacking levels. And still that could be an opportunity for next year, but we think, you know, we've seen the sales improve from low-single-digits level to be a catalyst in our fourth quarter from where things - we though things were 90 days ago. And overall our general end market demand within our consumer end markets and our profits in the end market has remained stable for us, and in some cases, has couple better. So those are the kind of things that will give us a little more conviction going to the fourth quarter about some better growth rates with PMC. From a water standpoint, water is kind of as we expected. We anticipated solid mid-single-digit growth in the back half the year. You saw that in our third quarter a little bit better than that. In the fourth quarter we expect to be in that solid mid-single-digit range. So on the biggest challenge to your point, we're not really haven't seen PMC we've got a little more conviction on the growth in PMC in our fourth quarter now.

That's helpful. Thank you. And then just thinking about free cash flow and kind of the rough $175 million in fiscal 2018, could you outline some of the moving pieces that we have moving into fiscal 2019 to think about what that $175 million would reset to, independent of anything on the organic front? And I guess you really can't talk to the Centa at this point but SCOFR costs and just expense coming down tax should be a little bit lower. What that $175 million resets do before you even get growth?

Sure. Yeah. So talking to prior quarters we've talked about next year fiscal 2019 and beyond I mean the year starts we are in that $200 million range or a little better than that going forward. So you think about moving pieces clearly the restructuring cash - restructuring costs with SCOFR 1 would go away. We've talked about an incremental tax we've been paying for the past several years we went into a deferred gain on that five years ago that moderates next year goes away in 2020. We will see better debt refinancing. Our cash interest will decline. We'll see some benefit from the overall cash tax rate not as much we expected there is moving pieces between this year and next year that you will give it a little bit. Those are the things on the positive side. So I think right now, it's little dangerous to say we still have much conviction as we ever had around our $200-plus million type free cash flow run rate starting next year for us going forward.

Got it. Thank you.

Our next question comes from Charley Brady from SunTrust Robinson. Please go ahead.

Hey. Thanks, guys. Good morning, guys.

Good morning, Brady.

Just Todd the comments you mentioned in your prepared remarks on PMC margin. I guess the comment you see a strong runway or long runway to margin improvement on that business. Obviously, kind of what you have been seeing for a while. But I wonder if you could just may be flesh out a little bit more on a longer-term basis kind of where you see margin going as you had the SCOFR business done now and you are seeing the benefits that come through, has your thinking on where that margin can go to change over the past 6, 12 months?

I don't think so, Charley. I think we've already sort of pointed to the sort of 24% to 26% range as being where we think we can drive it to in its current sort of form. I think nothing is changed there. I think you saw a nice incremental margin in the quarter greater than 50% on a year-over-year growth. And you'll see a nice margin, again, in our fourth quarter. And so we sort of alluded to I think the setup heading into fiscal 2019 includes probably a little bit better growth probably a little more cost reduction as we head into a growth environment. And then when you add Centa into the mix that's another business that you think - that we think can migrate into that range. It's clearly well below that at this point. But if you think about what we could ultimately end up with is $1 billion-plus platform, with very, very strong margins, very low CapEx very high free cash flow. And if you look at where the portfolio is now shifted, much more stable growth in whatever environment without losing any of the, I would say, legacy installed base that we have in process industry. So I think we are sort of playing a little bit of a long game here to get this. But this is going to be a premier industrial segment and we are very confident that nothing's really changed.

Okay good to hear. Just one more, I know its early days of tax reform, but I'm just wondering from a customer standpoint, clearly a lot of cash is being released from this. We are hearing other companies' more optimistic line, spending by customers as it comes in. I'm just wondering on the PMC business, specifically, are you hearing anything from customers to where maybe spending expectations or kind retching up - hubs to your equipment goes into a lot of other equipment and larger systems?

Look, I think I would say that it's largely anecdotal at this point, Charley, versus giving you a firm number. I think that the inquiry rates, the sales funnels all included, a lot of projects that I think we clearly didn't see on the table, two years ago. So there is that - there's a lot more optimism. I think there is a lot more inquiry. I think we are hoping and optimistic that, that translates to orders and shipments over the course of the next year-or-so, but it's more anecdotal than I can tell you that there's been $15 million or $20 million spend as a result of tax reform. I can't really get you that number. But there's clearly more optimism, and we are seeing it show up in our sales levels.

Yes, I guess what I was trying to get - I'm not looking for a specific number, obviously it's too hard to do that. But your guidance, your core growth guidance, I know you can get it for 2019, but you are not really baking in that, right? Obviously, it's all anecdotally, haven't seen it come through yet, if it were to accelerate, then that would be incremental to kind of where you thinking today?

Absolutely. We have not - we are sort of rounding home here in our fiscal 2018 and looking at 2019. We haven't really baked in any significant bump as a result of the increase in spending from tax reform. We have not done that. I doubt we'll be in a position to really do that when we announce guidance. But clearly, if you marry that with a good macro, decent backdrop, very constructive on non-spending on the tax fund with a reasonable starting point, it should set us up for a really nice fiscal 2019.

Yeah, thanks.

Our next question comes from Jim Giannakouros from Oppenheimer. Please go ahead.

Hey, good morning, Todd, Mark and Rob.

Good morning.

Good morning.

Question on Zurn, specifically, seems to be humming along nicely, mid-single digits growth that you cited. I think overall, non-res building forecast call for 4% or so growth this calendar year and next, you mentioned new products, but where geographically or by vertical within that are you seeing greater demand or opportunities for share gains?

You know we see - as we talk about for a while, the way that the non-res recovery has worked, started off with, obviously, res followed by some commercial and then they're now sort of migrating to institutional. And as we look at our Zurn business, that's really our sweet spot. So I would say we're starting to see at the very early stages of the institutional market beginning to perform. We know if you think about the 300-bed hospital, we think about - a 12-floor dormitory, things that have a lot of content per square foot, that's what we are starting to see. And you're seeing it all over the country, whether it's - in the Midwest or it the West. Most regions are generally healthier than they've been in a while. And so inquiry rates are up, project backlogs are relatively high, and you marry that with a nice dose of new products and solutions that we have been bringing to market, we are pretty optimistic that the 4% market growth, we'll be able to outperform that.

Yes, and it's been a - an organic story for you. Are there - are you working M&A opportunities there? Or should we be thinking that your M&A is really going to be focused on augmenting PMC?

I think it's going to be both, Jim. We did the World Dry acquisition back in October, so the industrial logic is how do we come in and essentially own the commercial restroom if we are for all applications. So there is more we can do, it's still fragmented there's bits and pieces we can pick up and we think really build even more sustainable competitive advantage in a bigger mold. And there are some geographies we can do it in. So your initial comment that Zurn is humming along, I think that's correct. We see the market being pretty good and constructive and we're happy with the progress we're making internally, and obviously, the M&A story is smaller today but I wouldn't rule it out.

Got it. Thank you. And one more on Water Management for me, just switching over to VAG. Just curious if I'm thinking about the plans there correctly, feels like it's been deemphasized here in the U.S. Is that the case? Or you're still committed to building that brand here and leverage what is apparently a very healthy organic backdrop in the U.S., specifically?

Yes, I mean, look, we are still in the U.S. We're still winning and frankly doing quite well. I think the technology and innovation that we are sort of bringing from the European markets to the U.S. is having a positive impact on our growth. The issue is we are starting from a very small base. And so that it's going to take a long time, but we are happy with the success. I don't see we're deemphasizing it in any way, but it's going to take a while until it rises to the point we are going to talk to and then sort of point it out as a meaningful growth lever.

Got it. Thank you.

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

Yes. Good morning. So sticking with Water Management, can you maybe help break out growth in the quarter between infrastructure and Zurn? And maybe also comment as to how that plays into your full year outlook?

Mig, its Todd. There wasn't any meaningful difference in the numbers of the growth between the two parts of Water Management.

And that is still works for the full year, to?

Core growth - Mig, this is Mark. Core growth we think in our third quarter down to mid to, fourth quarter we're expecting mid-single digits, and I think that's a relatively balanced in between our Zurn end markets and our VAG end markets for the fourth quarter.

Mig, I guess maybe just to clarify, the core growth in the quarter I think was embedded in our outlook, would not include any sort of significant outsized growth in the Water Infrastructure part of the business that will drive the total out. I mean it's a solid performance by the Zurn business and I would say sort of in line with what we would have expected for the Water Infrastructure side. So both very positive contributing to the overall growth.

Got it. I was just wondering because infrastructure is a little lumpier, that's why I was asking the question.

Yes, totally understood.

Then in terms of margin, again, on your fiscal 2018 outlook, it's fair to assume that you're still expecting 100 basis points of expansion in both segments, again for the full year?

That is correct. Yes. It's the 100 basis points in both segments. Correct.

Okay. And the corporate expense line item, is that still expected to be around $33 million?

That seems a little higher, Mig. I mean in the fourth quarter there's going to be some professional fees that we know we'll be incurring just one higher probably closer to call it $34 million to $35 million range for the full year.

Okay. And how do you think about this line item going forward? Can this stay stable? Or are you going to have some kind of inflation going forward?

Stable. It will be stable yeah as next year we are keeping that $34 million $35 million range. That's the fair place to be.

Okay, very helpful. And then last question for me, you know, Mark, I'm a little bit puzzled about your tax rate both the P&L and the cash tax. And maybe you can help me understand this. But what I'm thinking about the domestic production incentive I understand that you're losing that, but it seems to me that it's somewhat as if this is an added set of expense if you would within your tax structure rather than simply a benefit that goes away. So I am sure I'm missing something here, but maybe help me understand as to why we're looking at 28, 29 which essentially is maybe a little bit higher than what you have been paying in the last few years?

Well this year we are investing 32 and in that number, there are some discrete items that we're going to rate down. You take all the discrete items Mig our rate is in that 33% to 34% range. Now it's always been discrete that putting item that when I think 28% and 29% next year there's going to be discrete items next year, but we'll just haven't called out yet. If you look at the base rates, our 33% to 34% range is going to 28% to 29%.

Okay, fair enough. I guess I'm just wondering why we are not - most of the company's I am talking to are talking 25%-ish right and they are dealing with the same circumstances.

Well what was their starting point? Were they starting 30% or 31% or 29%?

Well, can I just make an observation? I don't know that this is something that can be solved by a conference call. I would suspect that we're giving you Mig what we think is our best shot at this point. Obviously, all the facts and circumstances are under a year our income is generated and planning obviously are going to be different company to company. The good thing is our taxes are going to go down next year. Our cash taxes are going to go down. And more significantly as we look at 2019 and 2020 a significant headwind on a cash tax basis to the tune of $15 million a year is going to go away. And so it's all it's net-net, it's a bit positive for us. And I think it's going to show up in the results. I am not confident Mig that we can take you through the specific details of where we are. But I don't know that we can sort of talk through all that effectively on the call.

Well. Fair enough. Thank you.

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

Hi. Thanks good morning everyone.

Good morning, Karen.

So Todd, I think fiscal 2018 you had a heavier level of investment with DiRXN launch and so forth. Can you help us kind of frame how we should think about the level of investments going into next year sort of in the context of normal incremental margins?

Karen, again, I think what we try to do if you move back a year or two is take significant actions while things were a little bit tough and creating the capacity for us to invest in growth. As we head into what we think will likely be a better growth environment we are going to continue to take cost out of the business so that we can invest in growth. And we think that so from an incremental investment standpoint, we're going to keep investing at the same rate, perhaps more. I don't think it's going to manifest itself at any sort of change and the way to think about incremental margins because we're really going to do both, right. We are going to leverage the business system and the things that we're doing to take cost out and take wastes out. And convert a significant amount of that back into growth investment but at the platform level. We are not really going to change the outlook for what the incremental margins are going to be as a result. So I think net-net, it's creating a better business. And we're starting to see very early stages of that.

Yes, for sure. I was just curious whether we should assume that core, call it like 33% to 35% incrementals to continue, but in terms of the savings you get from SCOFR or the next SCOFR next year, should we kind of dampen that savings runway a little bit to take into account some of the incremental investments that you want to do? There's, obviously, a lot going on with DiRXN, right? There's more you want to do there?

Yes.

Is that the way we should...

We announced…

Sorry, go ahead.

So, I guess, what I am highlighting is we're guiding to those 35% incrementals. You can continue to think about the incrementals as that number into next year with the same level of investment. I think we'll probably, as we said, we are going to have to do some cost reductions to ensure that we can deliver those sort of incrementals to invest in things like DiRXN. And, so we're going to do both. Which I think is sort of the message that hopefully we are may be articulating, which is absolutely, we are going to continue to invest in these growth initiatives. You can see some of the examples we've talked about. We've been able to bring what we think is a game changer from a digital productivity platform to market next year. It's going to be a lot of products, bringing more and more connected products to market quickly, and building a competitive advantage there, and so we are going to invest in that but the incremental margin assumption that you got is good even with that impact.

Okay. Got it. Great. And then just a follow-up on the comment on M&A that you made earlier. So sounds like there's more to do on the Zurn side, maybe on geographic expansion and then you, obviously, did Centa at PMC. Is there anything more meaningful that you would do on the Water Infrastructure side? Or is the kind the rebuilding process in North America that you alluded to earlier that's more of an organic process?

Yes. We are not going to invest in M&A on the Water Infrastructure side of our business.

Okay.

And any growth that we would do there would be organic.

Okay. Got it. Thank you.

Our next question comes from Samuel Eisner from Goldman Sachs. Please go ahead.

Yeah. Good morning, guys.

Good morning, Sam.

Just a quick question on the incrementals here. So you know, I recognize you guys had about 45% organic incrementals, 37% at the kind of total line here, obviously, strongest for the year. Just curious what the major drivers of that? Is it absorption? Is it price cost? Maybe walk through the various components of what's driving the incrementals stronger?

Sam, this is Mark. If you look at PMC and to lesser degree, water, the SCOFR benefits coming through were the biggest, really anticipate going this quarter, the first time we're fully levering our PMC platform, move to Mexico and we saw read through. So I think the SCOFR benefits will be hands down, the largest driver. When we fill that back out, the incrementals are going to in the range that we would expect for the platforms.

I mean - Sam, its Todd. It's - we have less fixed cost in the business than what we had two years ago, and we're taking that and leveraging reasonable core growth on top of it. So I wouldn't think about it as absorption. I would just think about it as cost that have gone away that aren't coming back. And so the incremental growth in the margin profile that we talked about, absent any reinvestment, would be better. I think we are saying is that we are going to also do some investment and that's why you wind up with that 35% rate. And so I think this is sort of exactly what we had in our mind's eye when we said we are going to do the Supply Chain Optimization plan a couple of years ago, get it done and also launch, I would say, a pretty significant dose of growth investment back in. And so the quarters would have played out with what in line of what we expect.

And that's helpful. Maybe just a follow-up on the guide here. Assuming I think, Mark, you said low end of the mid-single-digit range, so I don't know, 4% or so type of organic growth for the full year, I think that implies only kind the low 20s incrementals in the fourth quarter for this whole company? So one, does that makes sense to you? And two, are there any - sounds like discrete items, it sounds like corporate expenses a bit higher in that fourth quarter than people would have expected. So just curious, what are the drivers of kind the lower incremental profitability in the applied fourth quarter guide? Thanks.

Sure, yes, Samuel, your math is definitely correct. I think in PMC again, you will see a very strong core incremental margin, again. In water, when we start in the range of 25% to 30%, we think we'll be in the lower end of that range in water, given this mix in the fourth quarter and the corporate expenses as I mentioned earlier, will be higher in the fourth quarter. So all those combined together put that incremental margin, the rest level and that's probably we talk about so you think about right.

Thanks, guys.

Thank you.

I will now turn the call back over to Rob McCarthy for closing comments.

I'd like to thank everybody for joining us on the call today. We appreciate your interest in Rexnord and we're looking forward to providing our next update when we report our fiscal year 2018 fourth quarter results in mid-day - sorry, in mid-May. Have a good day.

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