Robert McCarthy - Vice President of Investor Relations Todd Adams - President and Chief Executive Officer Mark Peterson - Senior Vice President and Chief Financial Officer.
Jeff Hammond - KeyBanc Capital Markets Charles Brady - SunTrust Robinson Humphrey, Inc. Julian Mitchell - Credit Suisse Karen Lau - Deutsche Bank.
Good morning and welcome to the Rexnord Fourth Quarter Fiscal 2017 Earnings Results Conference Call with Todd Adams, President and Chief Executive Officer; Mark Peterson, Senior Vice President and Chief Financial Officer; and Rob McCarthyy, Vice President of Investor Relations for Rexnord.
This call is being recorded and will be available on replay for a period of two weeks. The phone numbers for the replay can be found in the earnings release the Company filed in an 8-K with the SEC yesterday, May 17th. At this time, for opening remarks and introduction, I’ll turn the call over to Rob McCarthyy..
Thank you, John. Good morning and welcome, everyone. Before we get started, I need to remind you that this call contains certain forward-looking statements that are subject to the Safe Harbor language contained in the press release that we issued yesterday afternoon as well as in our filings with the SEC.
In addition, some comparisons will refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures, why we use them and why believe they are helpful to investors and contain reconciliations to GAAP data.
Consistent with prior quarters, we will speak to core growth, adjusted EBITDA and adjusted earnings per share 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 or 10-K.
Please note that the presentation of our operating results include adjustments to GAAP recording for the impact of the RHF non-core product line in our Water Management segment that we make 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 fourth quarter of our fiscal 2017 and our outlook for our fiscal 2018. We will cover some specifics on our two platforms followed by selected highlights from our financial statements and our cash flow.
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. I hope everyone has had a chance to read our release from last night and Mark will take you through the financials and our outlook for the coming year in just a minute. To start, I would say that overall we are pleased with progression showing our fourth quarter results.
We saw broadly improved industrial order rates, built backlog in both platforms and executed well the fourth quarter EBITDA year-over-year for the first time and frankly to many quarters.
Most importantly, we think the combination of a slightly better macro environment and the progress we have made an internal growth and productivity initiatives position us really well over the coming years and also in future periods that could include more volatility and uncertainty.
Fourth quarter sales of $504 million were a bit better than we had guided, primarily due to improving core growth in PMC. Adjusted EPS came in at $0.35 for the quarter, including a $0.01 for the conversion accounting that we hadn’t assumed in our guidance.
Mark will review both the consolidated results and the performance of each platform as part of his comments a little later on the call. Turning to Slide 3.
We continued our strong focus on strategic and operational execution in our fourth quarter, and I’m pleased to report that we are close to wrapping up our two year supply chain optimization and footprint repositioning program.
We have essentially completed the last plant move, and we are currently focused on bringing the last pieces of equipment online, fine-tuning our processes and bringing our production rates up and its general efficiency and productivity improvements.
This process was and is incredibly difficult and complex for a variety of reasons, not the least of which is the impact it’s had on literally thousands of people.
There has been a million and one detail that had to be done right, on time and on budget, while limiting any disruption to our customers, and I want to thank all of our associates that have been true professionals over the last two years to make this happen.
Finally, the ultimate measure of success is and will be whether it puts us in a position of perform better than we did before we started this initiative two years ago and I’m confident we have been able to accomplish that.
Just to recap the program briefly, the series of initiatives reduced our overall square footage of manufacturing space by about 20%, lowered our fixed cost base and reduced our ongoing capital requirements.
The improved cost position is also expected to enhance our opportunities to deliver stronger core growth, with our new mid tier bearing product line being just one example.
In addition to the changes in supply chain and footprint we have been engineering over the last two years, we have also invested in increased automation and advanced machining capabilities, which we believe could ultimately help build on the improved competitiveness of our cost position.
As you will see in our outlook, we expect to see a significant impact on our margins as we complete the program and realize an approximately $25 million year-over-year impact on our annual EBITDA, and over the longer term, we expect to continue to leverage the benefit for this plan into creating growth.
Finally, we think our timing has been pretty good, as we took the time to do this during a period where the end-market demand served by many of the facilities was well below where we think it’s heading. All that said, we are definitely on-track to deliver our formal target of $30 million of annual savings.
And I’m increasingly optimistic with the amount of daily, weekly and monthly continuous improvement that’s simply part of our culture will ultimately drive incremental savings above that as we get settled into our new footprint and we leverage the Rexnord Business System to drive further improvements in supply chain, process efficiencies and overall productivity.
At the same time, we have been gain momentum with our commercial excellence initiatives within PMC to capture a greater share of new first-fit applications.
By improving the size and quality of our sales funnels and improving our win rate, we expanded our installed base, which through higher rates of like-for-like replacement can ultimately drive a higher share of available aftermarket requirements as the engineered components that we supply to OEMs and end-users, wear in use and are rebuilt and replaced several times over the life of the user’s application.
We exceeded our $30 million target for first-fit wins in our fiscal 2017, and we are targeting a 50% increase for this year.
We are going to continue to invest in this strategy going forward and I expect that the muscle that we have been building and are continuing to build will enhance our ability to extend our competitive advantage as we roll out families of connected products that we will formally launch on May 31st.
Besides the progress we have made on our self-help efforts, I’m also encouraged by the broad improvement in industrial order rates we saw in our fourth quarter. On a core basis, new order Bookings for our Process & Motion Control platform up about 7% year-over-year in March quarter and we saw a good follow through in April.
There is no question that customers as improved, unlike others we saw a stronger willingness to go forward with new capital projects including some had been delayed from prior quarters.
We do however think it’s prudent to maintain a cautious approach to forecasting externally recognizing the still high level of uncertainty around sustainability of improved demand in our process industry end-markets, potential impact that trade policy changes and local demand patterns and the fact that we are providing an outlook through March of 2018.
Having said that, it appears clear to us that if the recent strength in our order rate sustain throughout our fiscal 2018 and we would expect our initial financial guidance for the year to have been proven to be too conservative.
Either way, we expect PMC to return to positive core growth in our fiscal 2018 is our strategies to broaden our industrial end-market diversification and improve the balance between our process industry exposure and our participation in relatively less volatile consumer facing end-markets have in our view enhanced our ability to achieve and sustain positive core growth.
Together, our aerospace and consumer facing end-markets with a source of more than 60% of total PMC sales on our fiscal 2017. And we expect to sustain positive core growth in these end-markets in our fiscal 2018.
With most of the process industries we serve appearing to have either bottomed or in the early stages of the recovery and given the relatively high market share as we have in those end-markets, we feel really good about the prospects for PMC to deliver improving core growth as we move through the year.
Within our consumer driven end-markets, our Cambridge acquisition continues to perform quite well. Operating results in the quarter were again in-line with our expectations and new order bookings again increased by a double-digit percentage on a year-over-year basis.
We continue to see significant growth opportunities across global food and beverage end market verticals as we leverage the leading engineering and service capabilities of historical Rexnord in combination with Cambridge’s leadership position in the woven wire mesh belting for food production and packaging applications.
Turning to our Water Management platform, the forward look remains quite positive even as the financial results in the quarter were a little behind our expectations. Mark will go through the details in a few minutes, but we experienced strong orders and backlog growth in the quarter and we are confident in our initial outlook to start the year.
One specific reason we are excited is due to the fact that of our new product introductions will contribute to our financial results in 2018 and beyond and we are committing to sustain an elevated level of investment and innovation and market expansion as we go forward.
While we experience significant delays in our water and wastewater infrastructure end-markets over the course of fiscal 2017 particularly in the Middle East that translated in a weaker than expected core growth for the platform for the year.
We have worked hard at winning new business and most of the increased order backlog and our water platform addresses end market application that the market needs and we are excited about where the core growth exists in fiscal 2018. Looking at our balance sheet.
We finished fiscal 2017 with free cash flow of $141 million, which helped push our net debt leverage to 3.1 times at the end of the fiscal year, that brings us close to 2.5 to three times range that we expect to operate in our lower financial leverage as we have been public.
As Mark will point out when he takes you through his comments, our outlook puts us around 2.5 within the next 12 months. Before I move onto the next slide, I would like to highlight some of the changes we will making in our practices around providing financial guidance.
Going forward, we plan to focus our guidance on our annual core growth, our adjusted EBITDA and our free cash flow, which are exactly the primary metrics that we use internally to grade our strategic and operational execution.
When we meet with investors most questions are aimed at understanding the drivers of our core growth, EBITDA and our free cash flow.
As we set back and evaluated our past practices of providing detailed quarterly guidance, we came to the decision that the best way to provide insight and comfort to investors our absolute and relative performance was to provide details on the things we consider most critical, provided annually and with an appropriate amount of conservatism built into it.
And finally, to do it at the start of the year when we felt the level of stability in our business, so investors and the sell side don’t read more into the change that actually exists. Before I turn the call over to Mark, please turn to Slide 4.
You may recall from last quarter, we highlighted an RBS case study from our Internal Knowledge Management System, where everybody in the Company has access to a variety of continuous improvement activities and ideas, so that as we solve challenges, everyone, regardless of the location or function can learn from the work that’s been done.
It also creates a way to rapidly deploy really good ideas quickly across the organization. The impact is measured in several ways.
As examples, cash savings from a more efficient or even eliminated manufacturing process greatly improving quality, enhance associate safety through changes in work practices, or improve customer satisfaction to reduced order-to-delivery lead times. Roughly 50% of this year’s thousand posts involve manufacturing.
The other half, from functions like sales, human resources, supply chain and customer care.
In today’s example, our associates in our FlatTop plant in the Netherlands were able to free up more than 10% of the existing footprint to support future growth in Europe from the Cambridge product line with a focused application of continuous improvement principles, leveraged with selective investments and increased automation and advanced manufacturing technologies.
I’ll start by saying that this is a relatively mature, high-performing facility that’s been leveraging RBS for a while. We engaged the team with the challenge less than a year ago to create the space for production and logistics while we finalize some of the product modifications and cultivated customers with direct relationships in Europe.
In less than a year, with great engagement throughout the organization, plus some collective imagination and ingenuity, the team has been able to improve and/or eliminate certain process steps, identify opportunities for the selective and high impact application of robotics, improve quality, reduce cost and reduce lead times.
The benefit is that we can now enable the growth of Cambridge in Europe and an outstanding environment, and it’s all replicable and scalable. What I hope you take away is that RBS runs deep in our organization.
It is truly the enabler of large, strategic things, like our SCOFR plan, we talked about early or the 50 things that happened in The Netherlands in less than a year and delivered a great result.
Over the course of the year, I expect us to be ready to announce and begin to execute another set of initiatives that will continue to improve our margins, operational flexibility and cash flow and yet another significant way.
And this will happen while we relentlessly work every day to create sustainable, incremental value to the practical application of continuous improvement. Now, I’ll turn the call over to Mark..
Thanks, Todd. Please turn to Slide 5. On a consolidated basis, our fourth quarter of fiscal 2017 financial results were broadly in-line with to slightly better than our full-year guidance. Adjusted earnings per share was $0.35, and our adjusted EBITDA of $98 million increased on a year-over-year basis and was also consistent with our guidance.
Our initial outlook for fiscal 2018 incorporates low single-digit core growth and adjusted EBITDA in a range of $365 million to $385 million. The range implies year-over-year growth in adjusted EBITDA of 5% to 11% in the comparable $347 million were delivered in our fiscal 2017.
Our guidance incorporates our targeted $25 million of year-over-year benefit from the completion of our supply chain optimization and incorporates the existing program, plus incremental margin on sales growth that are consistent with our traditional 30% target.
Partially offsetting will be an incremental spending in our innovation pipeline and higher incentive composition expense. All-in and at the midpoint of our guidance, the consolidated incremental adjusted EBITDA margin calculates to approximately 60%.
Slide 6 presents a bridge that quantify the puts and takes in our guidance for year-over-year growth and our adjusted EBITDA [indiscernible]. And Slide 7 summarizes our consolidated results in the quarter. So let’s move to Slide 8 and to discuss the first of two operating platforms, Process & Motion Control.
Total sales increased 7% at PMC as a core sales comparison improved to flat year-over-year and Cambridge contributed 7%. Currency translation was nominal drag.
PMC posted another quarter of positive core growth in its consumer facing and aerospace end-markets, which is offset by the ongoing but moderating headwind in our industrial process end-markets. Global aftermarket revenue demonstrated solid sequential expansion in-line with typical seasonality, but was still down slightly on a year-over-year basis.
Distributor sell through in [North America] (Ph) continued to general stable trend in the quarter and year-over-year comparisons generally gets easier as we move into our second quarter of fiscal 2018.
In the bottom right corner of the slide, you can see the end market assumptions for outlook for low-single-digit core sales growth of PMC and it’s in corporate in our fiscal ’18 guidance.
We believe that we can continue to generate growth in our consumer-facing and aerospace end-markets and our recent quarter rates here confirm that we have indeed seen the worse in our process industry end-markets.
However, we believe there are good reasons to maintain our cost process in our guidance including the ongoing uncertainty of our potential changes in U.S. trade policy on even global economic growth and the ongoing volatility in global energy markets.
PMC’s margins were slightly hover our expectations, the solid operational execution also the somewhat stronger OEM and end user revenue, as well as our ongoing investment spending and enabled the modest year-over-year margin expansion. Despite our plans for incremental investment innovation and market expansion in fiscal ’18.
We expect PMC’s margin to expand by roughly 150 basis points as we complete our supply chain optimization and footprint repositioning initiatives.
As we turn to our Water Management platform summarized on Slide 9, please recall that we are excluding the financial impact of the RHF non-strategic product line exit in the calculations of core growth and adjusted earnings metrics in order to focus on our core operating results.
Exiting this product line that’s completed in our fourth quarter and will administrative affect in our year-over-year product sales comparisons as we move through fiscal ’18. Our Water Management platform experienced a 4% net sales decline in our fourth quarter that includes core sales down 1%.
Sales of our commercial grade plumbing products increased year-over-year by solid low-single-digit core growth rate in our fourth quarter as we saw growth across our product portfolio. We believe that overall end market growth and strengthen in fiscal ’18 as the reacceleration in growth of new U.S.
non-residential construction starts that emerge in the second half of calendar ’16 that expense in the current calendar year. As we highlight the last quarter, contractor backlogs have grown and our project funnels have continued to develop favorably.
We expect to somewhat [cellular] (Ph) end market growth that we anticipate in fiscal ’18 with key product introductions in our drain and finished plumbing product offerings. Turning to our process activity in our water and wastewater infrastructure markets.
We did experience minor changes in certain project schedules as our fourth quarter progressed reflect the incremental changes in our customer construction schedules and related shipment request dates.
Given these changes and combined with the strong double-digit year-over-year growth we experienced in the quarter, these end-markets - we entered the new year of increased backlog and expectations for return of positive core growth in our water infrastructure end-markets in fiscal ’18.
With our expectations for positive core growth across the majority of water management’s end-markets as seen on the slide, our fiscal ’18 outlook includes low to mid single-digit core growth of the overall water management platform in the fiscal year.
EBITDA margin increased sequentially and year-over-year, both was modestly lower expectations reflecting the volume shortfall on the infrastructure side. We expect margin to expand by around 100 basis points in fiscal 2018 and to make good progress towards the 20% plus EBITDA margins that we believe we can achieve with the platform longer term.
Moving on to Slide 10, you can see in the chart the top left on our financial leverage as measured by our net debt leverage ratio has declined to 3.1 times, in-line with my comments last quarter.
Given normal seasonal patterns for our free cash flow, we expect our net debt leverage ratio to remain in the range of around three times until we reach the second half of fiscal 2018.
But excluding any impact from potential acquisitions in the coming year, we would expect our net debt leverage ratio to approach 2.5 times by the end of our fiscal year. In the chart on the top right, you can see that we finished our fiscal 2017 with free cash flow of $141 million, including a drag of roughly $42 million from our SCOFR initiatives.
Looking at our earnings growth expectations for fiscal 2018 and considering the remaining cash investments of about $50 million required to complete our SCOFR activities, we expect our free cash flow to exceed our net income and be in a $175 million range.
In other words, we expect our free cash flow to be approximately $190 million in our fiscal 2018 before factoring in the $15 million of cash required to complete our SCOFR projects.
Given that we expect our free cash flow to expand on fiscal 2018 and given our strong liquidity, we believe we have ample resources to continue to execute our bolt-on acquisition strategy while maintaining our leverage ratio in a range between 2.5 and three times.
Next a few comments on our restructuring and cost reduction initiatives and on the expected cadence of our sales and earnings in fiscal 2018. First, the supply chain optimization and footprint repositioning program is expected to impact our fiscal 2018 results as follows.
We expect to generate roughly $25 million year-over-year increase in adjusted EBITDA. We separately reported restructuring expenses of $5 million to $7 million, which are primarily made up of severance and exit facilities costs and are excluded from our adjusted operating results.
Our forecast for capital expenditures in fiscal 2018 related to this program is immaterial and will be included in our CapEx outlook of approximately 2% to 2.5% of sales.
In addition to this program, we currently anticipate incurring restructuring costs of approximately $2 million to $3 million related to other cost reduction initiatives during the year. Next, I’ll make a few comments on our effective tax rate.
Our effective tax rate can fluctuate by quarter, given the varying levels of pretax income as well as the timing of other planning initiatives. That said and going forward, we currently expect substantially less quarter-to-quarter volatility in our effective tax rate than we have experienced in that recent years.
We currently anticipate our fiscal 2018 adjusted net income will incorporate an effective tax rate of approximately 32%, with effective rate in the 33% to 34% range for the last three quarters of the year.
Given that we finished our fiscal 2017 with a comparable adjusted tax rate of about 24%, the higher effective rate in 2018 is expected to be an approximate $0.17 headwind to our reported year-over-year adjusted EPS growth. And we expect that about 75% of the year-over-year impact to be realized in the first half of fiscal 2018.
Recall that our adjusted tax rate during the first half of last year, fiscal 2018, was only 16%. As we fine-tune our financial models for fiscal 2018, you may want to consider the following observation regarding the likely cadence of our sales and adjusted EBITDA.
Consistent with these history, we expect will generate about 49% of sales in the first half of the fiscal year. We currently expect Water Management to generate about 51% of sales in the first half of fiscal 2018.
Turning to earnings, PMC adjusted EBITDA will be more weighted to the second half of the year, given that we are wrapping up the SCOFR program during our first quarter, while Water Management earnings are expected to be more weighted to the first half, consistent with the seasonal trends in our U.S. non-residential construction end-markets.
We anticipate PMC margins will be expanding year-over-year throughout fiscal ’18 with stronger margin expansion in the second half of the year, given the timing of the SCOFR savings.
With respect to Water Management, we do expect Water Management margins to expand sequentially from Q4 of fiscal 2017, but resulted down year-over-year in the first quarter, reflecting some expense timing and coupled with the year’s most difficult year-over-year top-line compares.
We currently expect that the year-over-year Water Management margin compression to turn positive in our second quarter as also second half of fiscal year. Before we open the call for your questions, I would like to call your attention to the six slides and an appendix to our earnings presentation.
First, we have included the other assumptions incorporate in our guidance for fiscal ’18 in a separate slide as you would come to expect. I need to remind you that our guidance excludes the impact of potential acquisitions and divestitures and future non-recurring items, such as restructuring costs.
Second for your convenience, we have included the table that provided the specific after-tax impact of each individual adjustment we have made in our calculation of adjustment in net income.
Third, we have attached a reference table to help you determine the appropriate incremental quarterly share count to use for modeling our diluted earnings per share under the If Converted Method, if it’s applicable.
As described on this slide, our diluted earnings per share will be calculated with the If-Converted Method only when its dilutive to our diluted earnings per share. After first calculating our EPS by simply deducting the preferred dividend from our net income and dividing by average diluted shares outstanding.
In the fourth quarter, and as highlight on Slide 15, our adjusted EPS was calculated using the If-Converted Method, which resulted in a penny of adjusted EPS dilution compared to the base calculation.
As seen over the last two quarters, the [indiscernible] EPS converted for multiple one quarter to the next based on levels of income, as well as the average price being used to determine the number of converted shares assumed for the converted EPS calculation.
Lastly, the appendix to our presentation includes the reconciliation table related to adjusted EBITDA and adjusted earnings per share that are included in our earnings release each quarter. With that, we will open the call up for your questions..
Thank you. We will now begin the question-and-answer session. [Operator Instructions]. And our first question is from Jeff Hammond from KeyBanc Capital Markets..
Hi. Good morning. Guys. So just on water, I mean, I just wanted that kind of, you get the 30% backlog growth.
Certainly, you have had some project timing deferrals, but just help me kind of how that translates only into low to mid-single-digit growth as you kind of think about quoting visibility and some of these projects had slipped?.
Well, I guess if I take it as good piece, Jeff, if I look at our business at certain non-res construction. We saw sort of low to mid-single-digit growth in the quarter. And I think we are sort of projecting that growth probably will be slightly better than mid-single-digit growth as we start-up off 2018.
On the infrastructure side, it’s been a year with probably an above average amount of volatility. We tried to sort of mitigate that and we provided the second half update a couple of quarters ago and I think as we take a look at our outlook.
We have tried to perhaps incorporate an equal amount of that volatility heading into next year, recognizing that we do have a nice backlog and that there should be some opportunities to do little bit better..
Okay. That’s helpful. And then can you just talk about a couple of things on the U.S. distribution channel, I think you still have that as yellow.
So what are you seeing there, specifically in terms of trend and maybe why a little more caution there versus international and then just talk about the response to your new product introductions in the mid-tier within distribution? Thanks..
Sure. Just to clarify, the stop light charts and the color coding is sort of what is reflected in our guidance. So I think what we have reflected in our guidance is sort of stable to low single-digit growth in industrial distribution.
I think we continued to feel confident that the channel inventories are probably too low relative to sort of the incoming demand that we are seeing. But that being said, I think from our guidance standpoint, we are taking maybe a slightly more cautious view on industrial distribution.
If I think about mid-tier, obviously, the mid-tier product category is targeted really two things, being able to go in OEMs and end user at an initial price point and provide the highest quality service, lead times and recognition of our [Rex] (Ph) on that first-fit application, so that we open up a broader market, we are having really good success with that category.
And if you follow us next logical conclusion, distribution is going carry it because the demand will be there. And so I think we are excited about, number one, getting it off the ground over the course of the year. And then as we look into fiscal 2018 and beyond, continue to add categories of products under the strategy.
And so it’s really helping drive our first-fit win rate. And ultimately, we will result in a bigger aftermarket for these products as well..
Thanks a lot..
Yes, sounds good..
Our next question is from Charlie Brady from SunTrust Robinson..
Hi, guys, this is actually [Indiscernible]. Good morning. Just want to quickly touch base on for the water products as well.
I guess the deferrals that you guys saw in the Middle East in 2017, is that currently embedded in your low singles to mid-singles growth guidance? As in like, are you guys expecting that to come back in 2018?.
Yes, sure. I mean, I think the way to think about it, Patrick is there is no new news in the Middle East. So to the degree, we saw some of these deferrals, we clearly moved them. There’s an element of some of it has been put into 2018 for sure in our guidance.
In terms of the way we are thinking about it, from a demand standpoint and those want dates would be in fiscal 2018, as we sit here today. I don’t know that we have put them all in to the outlook that we provided just to maybe cautious on what could be happening over the course of the next 12 months in oil producing countries.
So probably not exactly what you want to hear, but when you take them out of 2017, we think it was prudent. We think the developments are, no new news there. We put some of them into 2018 from an external standpoint, but from a want date, they would currently still all be on fiscal 2018. That’s the way to think about it..
Okay, great. So it sounds like the guidance doesn’t really have much of that some act potential upside that comes back little earlier. And then the corporate expense line appears a little low I guess in the quarter I think historically the fourth quarter for corporate expenses has been higher than the other quarters.
So I just want to square up, what is the delta here? And is this the new run rate and I guess if not what should be assuming moving forward?.
This is Mark. It’s not a new run rate. And typically you can think corporate expense around 33 million. We have been in that 33 million to 34 million range consistently. In the quarter year, we just made some adjustments at the year-end based upon, incentive compensation of the organization, based on how the ultimate year ended.
So that’s something that you don’t really end of the year, you trued up in the fourth quarter, which resulted in lower expense in our fourth quarter. So going forward make up of 33 million plus or minus for corporate expense in our fiscal 2018..
Got it. And how much additional restructuring are you guys expecting in 2018? Again, I think you guys said sprinkling in a couple of - sort of sprinkled throughout the first and second quarter. But how much….
You will see some related to the SCOFR projects recent about $5 million to $7 million, the majority of that coming in the first quarter of fiscal 2018. And we think over the course of the year, just for some other potential costs reduction initiatives, that could be two million to three million over the course of the fiscal year..
Perfect. Thank you..
You are welcome..
Our next question is from Julian Mitchell from Credit Suisse..
Thanks. Good morning. Just my first question on the PMC core sales growth guidance. Should we assume that your guidance embeds a steady sort of low-single-digit-ish growth rate each quarter through the year? And maybe clarify within PMC, the process industries seem to be a headwind.
Is that something that you are assuming is a steady headwind or in the second half, there is some normalization back to the flat line or something with the PMC?.
This is Mark. This is pretty consistent. I think in the first half of the fiscal year, our guidance implies to be lower end of low-single-digit basically. In the back half, we think we would be at more to the mid to the higher end of single-digit range, if you think about the cadence of core growth.
So not too significantly different really if you look at our first half versus second half, Julian, in our outlook..
And process industries within that, you’re assuming it down throughout the year then?.
You would be assuming down in the first half of the year [indiscernible] flat to nearly down modestly by mid of the fourth quarter. Up modestly, I apologize, when you start fourth quarter..
Understood. Thank you. And then maybe one for Todd, just to talk a little bit about, I think you had alluded to potentially some further streamlining or productivity measures later in the year. So I owned, if you could give any more color on that.
And also I guess within the adjusted EBITDA bridge, you have the $11 million figure for incentive comp and investments.
Just wanted within that is there any way of pausing out how much is investments and should we assume that investments ramp up is an ongoing annual phenomenon?.
I think, so thanks for the question Julian. In terms of, I would say Phase 2 significant class reductions, these are things we have started working on as we were wrapping up Phase 1. I think we want to ensure that Phase 1 is done completely, and it’s in the run rate before we would, I would say, launch a second series of initiatives.
But I do think that when you think about them in terms of scope, they are probably not as big in terms of the overall savings, but the overall cost is far less as well. So I think the near-term return will be much higher on the second phase.
And I think we will be probably is ready to announce those either at the end of our first quarter or probably the end of our second quarter. We feel good about the progress we have made and the plan here.
In terms of the investments in next year, there is a fair amount of investment in our digital interface and its connected products launch that will be happening on May 31. In terms of the way to think about it, think about it as half and half.
There is a lot of heavy lifting that’s being done on the infrastructure and back I would say, the internal side of the language, the software, the faces and everything, that we will be able to leverage, not just for PMC, but for our water product as well.
So I would say that in terms of next year, about half of that investment bucket is for direction. It’s a little bit heavier than on an ongoing basis just because of that, I will say, that startup phase that will get the leverage across all future connected product families as well as on the water side..
Great. Thank you..
You bet..
Our next question is from [Indiscernible] from Baird..
Yes, good morning, gentlemen. Just a quick clarification on the prior question on Water Management. So my recollection is that there were maybe about $15 million worth of project business in the Middle East that got pushed out of 2017.
And I want to be clear, is that $15 million included in the 2018 guidance, not included or only partially included and if so, how much?.
In the guidance, maybe part of it is included..
Can you help us, is it half, is it....
It’s less than half..
Okay. All right..
I think one thing you may recall, we talked about the Middle East, as far as everything kind of puts right and Todd spent quarters, two quarters ago, sets of [Indiscernible] but what we have been planned for fiscal 2018 also pushed to fiscal 2019. So there was a big catch up in fiscal 2018, it’s really the another point [indiscernible]..
Yes, maybe I think what we are trying to do is protect everyone’s thinking around the business a little bit because we have had, I would say, a very good couple of years of quarter rates.
If you strip out some of these larger megaprojects that we have had, we have had a solid mid-single-digit growth rate in our orders and its manifested itself in a pretty bad big backlog heading into the year. The difference has been over the last couple of years, the projects have come in smaller pieces.
So where before we had these big megaprojects, a number of those the world has gone down because they usually happen in emerging markets, oil producing areas. So the quality of our backlog is higher, the order rate has ticked up and we feel really good about it.
What we are trying to do, I think is provide a little bit of air cover, to just the reality of the volatility of the business. And so we are not talking about it every quarter. And the conventional logic is the business big quarter where everything catches up, I mean, sort of talk you through why may be that could be the case or couldn’t be the case.
I think it’s safe to say that our guidance excludes in a catch-up. We haven’t put it all in, and we are trying to continue to work to build the backlog in the business both in terms of its size..
Okay. Then going back to this bucket on your bridge for investment and incentive comp. I guess on the incentive comp. Can you sort of give us some historical perspective here vis-à-vis where you are in incentive comp versus what you would considered in normalized basis for the company. Maybe put differently.
What sort of drags can we expect from incentive comp going forward on incremental margins and I guess related to this, when you are thinking about, all your initiatives, whether they are incremental investments compensation anything else that might come.
How should we think about sort of the net incremental margins for both your businesses?.
Yes, I mean, perspective on incentive comp will be, this is substantially below any level of compensation that we have seen in the last four years.
And the increment that we are talking about, which is usually half of that investment bucket, gets us back to what we consider to a full payout, which we haven’t been in the last three plus years, at least three years based on where we have been.
So just from a content standpoint, if we deliver, so what we think we can do the incremental go to our incentive comp not that much in fiscal 2019 for sure. If we think about, maybe speaking to the second part of your question again. So my answer is both..
Yes. So you have some part of it with the incentive comp, and I guess with everything else that you are contemplating vis-à-vis either investments or any other potential expenses for the Company.
What are kind of the net normalize incremental margins from this point going forward, for each segment?.
Yes. Again, I think nothing has changed. I think, we think certainly on the PMC side with the work we have done to eliminate fixed cost and also, I would say substantially increased the level of investment and new products innovation and connected products, we still believe, it’s 30% to 35%.
I would say, while it’s not embedded in our guidance, to the degree we see a steeper rate of recovery, the incremental margins are going to be better. On the water side, it’s a benefits of some of the cost reduction initiatives behind us and some of the investments sort of continue to make, we think again it’s 25% to 30%.
So again, I think we are, we have done a lot in the last two years to reduce fixed cost, increase the level of innovation, steer the business awards what we believe is more steady sustainable growth, we are not losing anything on the process side.
Where we have, as I said very high relative market share is and great operating leverage is that recover. So I think we have eaten the elephant and I think maybe in a lot of ways in terms of the significant expenses to reposition in the portfolio and I think what we think is really good incremental to each of the platform going forward..
Sure. Fair enough. And maybe last question for me. You made it abundantly clear that you have embedded some conservative in your guidance. So related to that, if I’m looking maybe at the low-end of your EBITDA guidance 365.
Maybe you can give us a little bit color as to what sort of environment or scenario would be embedded at that low-end just so we understand just kind of your thinking around this guidance?.
Yes, I mean again, I don’t know that I can paint a particular scenario for you, but we are talking about the next 12 months. We are talking about changing the way we guided to an annual basis. I think what we wanted to do was provide, the word I would use is a durable set of guidance that people can count on REX.
And so if you look at the last three or four days, I mean, the world changes week-to-week, month-to-month fairly volatile, and what we want to do is give you that low end, and say you don’t have to worry about us delivery the low end.
It’s more how do we get to that midpoint to the high end over the course of the year and do it in a pretty deliberate way.
And so I don’t know that there is an exact scenario that I can give you, but there is a scenario, right, I mean, if you think about all the things that happened in the world, every day, every month, the buying patterns, the supply chains, the levels of inventory are really low all over the place. If things are smooth, we could see upside.
But if the world gets spooked for whatever the reason and investments seizes a little bit, you could see yourself at the low end in any scenario. What that is, I’m not exactly sure. But I think that’s the way to characterize the guidance. We are trying to put something that’s durable, that’s going to last over the course of the year.
Listen, if it’s in our prepared remarks, but if the trends in the business continue, the bottom end of the range will clearly be [indiscernible]. We could talk about the mid-point or the rest of it as we go through the year, but that’s I think the way to think about it..
All right. Thank you..
[Operator Instructions] We have a question from Karen Lau from Deutsche Bank. Please go ahead..
Thank you, good morning, everyone. Just wanted to follow-on [Nick’s] (Ph) question a little bit on the investments.
So in terms of sensitivity, how should we think about that investment bucket? I mean, if things get a little worse or get a little bit better, would you be spending more or less in that investment bucket? And I guess, maybe follow-up to the net incremental a little bit more, I mean, should we assume that that normal 35%, mid-30s incremental margins going forward to be diluted a little bit by ongoing investment, because I would assume you would continue to invest in new products and digital initiatives and things like that or is it something about this year that represents of significant step up that is not going to repeat in future years?.
Thanks for the question, Karen. In terms of investments over the next 12 months, I think we are going to protect those in a pretty significant way.
To the degree things would get weaker, I think would figure out other cost reductions, and we are going to protect those investments because so critical to the future growth of our platforms, to have this digital platform up and running and in place.
So don’t think about us as cutting those, think about just cutting it somewhere else, if in fact, the world is worse than we think today. I’ll let Mark give you details on the incrementals, but I don’t think we expect any drag on incrementals. I mean, part of the SCOFR plan was to enable investment.
So if we didn’t put some of that money back in for growth, the incrementals will be better. So I think the 30% to 35% kind of PMC basis or the 25% to 30% in the water basis are net of future investments. And so I don’t think there is any reason to hedge the way we think about those going forward in any way. And Mark may be….
Todd’s comment spots both, one part of your question here, is fiscal 2018 a bit of an overweight year? I mean, to Todd’s earlier point. There is a lot of initial investments tied to our initiative. It’s that type of level around our initiative should not replicate in the same degree next fiscal year.
So there is a bit of a push here this year around this initiative that as Todd pointed out, we are going to protect, because we need that for the future growth of our business..
Okay, that’s helpful. And then just maybe a little housekeeping on the stock comp. You mentioned some of the dynamics on the incentive comp side that is included in the adjusted EBITDA that is recent higher, is it the same dynamic with the stock comp that is not included in the adjusted EBITDA.
But so it’s going some like 13 million to 19 million next year.
That’s a pretty big jump?.
Yes. Part of that is couple of things. One if you go back four years ago, we were ramping the stock, because we are kind of coming out of [Apollo] (Ph), granting options about have five year vesting life. Over the past couple of years, we modified that more consistent with public companies and have gone to a three year about investing life.
So what you are getting a year. If you saw that we had jump last year and a jump this year, where you don’t have rolling out from prior years and are getting more than amortization because the investment is very short that’s what is driving the year-over-year increase in that non-stock comp expense. And then of course our with our platform out there..
Okay. Got it. Very helpful. Thank you..
I’ll turn the call back over to Rob McCarthy for closing remarks..
Thank you everyone for joining us on the call today. We appreciate your interest in Rexnord and we look forward another update, when we announce our fiscal 2018 first quarter results in early August. Have a great day..
Thank you, ladies and gentlemen. That concludes today’s conference. Thank you for participating and you may now disconnect..