Zurn Elkay Water Solutions Corp
F:4RX0
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Zurn Elkay Water Solutions Corp
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Good morning and welcome to the Rexnord First Quarter Fiscal 2020 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 2 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, July 30.
At this time, for opening remarks and introduction, I'll turn the call over to Rob McCarthy.
Good morning, and welcome, everyone. Before we get started, I need to remind you that this call contains certain forward-looking statements that are subject to the safe harbor language contained in the press release that we issued yesterday afternoon as well as in our filings with the SEC.
In addition, some comparisons will refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures, why we use them and why we believe they're helpful to investors and contain reconciliations to the corresponding GAAP data.
Consistent with prior quarters, we will speak to core growth, adjusted EBITDA, adjusted earnings per share 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 in our filings with the SEC.
Today's call will provide an update on our strategic execution, our overall performance for the first quarter of our fiscal 2020 and our outlook for fiscal year 2020. We'll cover some specifics on our 2 platforms followed by selected highlights from our financial statements. Afterwards, we'll open up the call for your questions.
And with that, I'm pleased to turn the call over to Todd Adams, President and CEO of Rexnord.
Thanks, Rob, and good morning, everyone. Our first quarter results overcame some short-term weather challenges at Zurn and with a strong finish to the quarter ended up about where we expected. Overall, our core growth was 2%, which was in line with our outlook and does include a roughly 150 basis point impact on our sales growth from our simplification initiatives. Despite a bit of a headwind from currency translation, we delivered 6% year-over-year growth in our adjusted EBITDA to $111 million, which is a record for any first quarter for us, and our adjusted EPS grew 17% year-over-year.
Our strong near-term execution reflects the importance of the Rexnord Business System and our relentless focus on continuous improvement. In a macro environment that makes everything feel very short cycle, doing the little things to get better each day compound into meaningful improvements when we look back over years and quarters. Taking a step back, we're essentially exactly where we had planned to be 3 years ago, delivering strong earnings and free cash flow in a slower-growth environment with a balance sheet in a great place, a significant number of structural fixed cost actions behind us and with the Phase 3 well underway.
We've put ourselves in a leading position amongst our competitive set when it comes to delivering a connected products platform that's right down the middle in terms of where the industry is heading, and we've also invested in a number of organic growth initiatives and portfolio actions that create a more resilient business than ever before.
I'll also add we've added substantial talent to continue to scale our business through acquisition as we execute our disciplined acquisition strategy to grow various parts of our 2 great platforms. I'll add that we've done all of this with very little disruption and, I guess, the macro backdrop that's proven to be unpredictable to say the least. From navigating the unprecedented tariff dynamic to making major footprint changes, our teams have delivered great results and are poised to continue to build on that success in the coming years.
It feels to us by continuing to execute the strategy we laid out 3 years ago we'll further distinguish Rexnord as a high-performing, concentrated multi-industry business with 2 great platforms that can grow above the market while delivering very high returns and cash flow that we can leverage into a $3 billion to $5 billion enterprise over time. 2 excellent examples of this dynamic are visible in our results over the last 1.5 years.
We've been executing the integration of Centa for about 5 quarters now since making the acquisition in February of 2018. You may recall that at the time we established a 3-year objective of a 10 percentage point increase in Centa's already double-digit EBITDA margins. The rigorous deployment of RBS at Centa has transitioned the business from a company with a great reputation for its products and brand to one that's flourishing as part of Rexnord.
Orders have grown double digit since the acquisition as we've improved lead times and productivity. We've worked with the local team on how to identify and eliminate waste. And in less than 1 year, we saw a 500 basis point improvement in margins.
With the success and sustainability of the initial integration, we've raised our internal goal of getting to the 10-point lift in margins to just 2 years, which is where we're tracking to close our fiscal '20.
While there's still work to do, I'm optimistic that there's even more room for margin expansion as we get into our fiscal '21. Centa is a great example of leveraging our proven operating philosophy to create a competitive advantage in a market that over time should grow faster than our underlying industrial markets.
The next example has been playing out in real time for the last year as the combination of accelerating input costs and the implementation of import tariffs in early 2018 created what could have been a $50 million cost challenge for us at then current run rates. Leveraging our cross-functional supply chain and commercial teams, we've been able to very successfully navigate this challenge and ended up delivering solid, absolute margin expansion in our fiscal 2019 and, as you can see from our first quarter, an additional 100 basis points of margin expansion to start our fiscal '20. These examples speak to our confidence that we can perform well across a wide range of end-market conditions.
Stated more broadly, the primary focus of our strategic actions over the last 3 years has been to transform our business profile, to develop more levers to drive growth and reduce our overall cost structure while making it more variable and flexible.
We think that macro uncertainty is frankly just a reality at this point. So having the organization conditioned to be nimble, relying on a business system that places a priority on continuous improvement and having great teams that love to compete gives us a lot of confidence in our ability to create value over the coming years.
Please turn to Slide #3 and we'll take a look at our first quarter results. Our net sales finished at $508 million, up 1% from last year, but 3% before factoring in currency translation. Our product line simplification initiative reduced our sales by approximately 150 basis points, and we again saw Zurn's growth constrained by unusually bad weather in April and especially May. Despite the headwinds to growth, our adjusted EBITDA continued to expand 6% year-over-year to $111 million and margin expanded by 100 basis points.
Looking quickly at our operating platforms. Core growth in our PMC platform was in line with our expectations, as we saw solid growth in OE applications and in distribution sell-through in North America with somewhat slower growth in Asia and further declines in Europe. Compared with last year's challenge first quarter in our aerospace business, we experienced double-digit core growth in this year's first quarter.
PMC adjusted EBITDA margin was 22.4% as we continued to offset the impact of overall cost inflation on our margins and benefited from the strength in our aerospace operations and the structural cost reductions being delivered in the second wave of SCOFR that we completed last year. I'll have a bit more to say about our aerospace business in just a moment.
We delivered solid growth in our Water Management platform in the quarter despite the weather, and Zurn continues to benefit from steady end growth demand in commercial and institutional end markets as well as growing penetration of the adjacent fire protection and site works markets. Zurn's 100 basis point EBITDA margin expansion provides the best evidence that we can continue to manage the ongoing tariff structures and price cost equation in both the immediate and over the long term.
Our balance sheet leverage was unchanged to June 30, and we continue to evaluate our expanded option set to drive increased shareholder value as we go forward. Given our outlook for free cash flow in 2020 and assuming no additional M&A, our leverage ratio is tracking to the 1.6x range at the end of fiscal 2020. Mark will review the consolidated results and the performance of each platform as part of his comments a little bit later in the call.
Please turn to Slide 4, and I'll make a few comments about our new Aerospace Center of Excellence. The graphic at the bottom left profiles our product offering and the range of aircraft applications where we have content. The COE was the largest individual project within our second wave of our Supply Chain Optimization and Footprint Repositioning projects that we completed last year.
We constructed a new facility near our established operations in the Chicago area, took a clean sheet of paper approach to laying out the plan and invested in a new state-of-the-art new machine and equipment for certain critical operations.
Productivity increases are ramping quickly and on pace to hit our near-term 25% improvement objective. Our customer base was excited to learn about the new investment when it was announced, and they've been more pleased now that they've seen the result, as almost all of our strategic customers have toured the facility and at this point the reviews have been strongly positive.
More importantly, we've been winning new long-term commitments from key customers and continuing to expand our penetration of the Airbus supply chain. Recent share gains have effectively doubled our first bid position on Airbus aircraft in the last 5 years, and we won specifications on additional content that goes into production after this year.
Compared with the low single-digit core growth delivered in our fiscal 2019, we expect our aerospace core growth to be in the high single-digit range in fiscal '20. Our aerospace experience demonstrates that combining our 80-20 simplification work with our investments in innovation, commercial excellence and our digital transformation, our scope for initiatives are contributing to steady progress we're making towards the higher growth, higher return and higher cash-generating business model with the flexibility to perform well in all stages of business cycle and deliver stronger shareholder returns over time.
With that, I'll turn the call over to Mark.
Thanks, Todd. Please turn to Slide #5. On a consolidated basis, our first quarter of fiscal '20 financial results are mostly in line with our expectations. On a year-over-year basis, our total sales grew 1% with core sales increasing 2%. Our adjusted EBITDA increased by 6% to $111 million, and our adjusted earnings per share increased by 17% to $0.48.
Please turn to Slide #6. Our outlook for our fiscal year 2020 continues to incorporate low to mid-single-digit core growth before factoring in a 150 to 200 basis point impact from our product line simplification initiatives. So on a net basis, our outlook continues to incorporate low single-digit core growth. We expect our adjusted EBITDA to be in a range of $460 million to $475 million, representing 6% growth at the midpoint and for our free cash flow to exceed our net income.
On Slide 7, we summarized our consolidated results for the quarter. But before I move on, I'd like to draw your attention to a new schedule we've added to our earnings release that provides a bridge from our GAAP income statement to an adjusted income statement.
In addition, we've also restructured and expanded our schedule of quarterly platform results to include the composition of quarterly sales growth and a summary reconciliation of GAAP income from operations to adjusted EBIT and adjusted EBITDA for each platform.
Now let's turn to Slide 8 and discuss the first of our 2 operating platforms, Process & Motion Control. Total sales decreased 1% year-over-year in PMC as positive core growth of 1% and a 1% contribution to growth from M&A were more than offset by the 3% impact of the stronger dollar. At recent exchange rates, we would expect currency translation to remain a modest headwind through the balance of our fiscal year.
PMC core growth moderated in the quarter as the weakness we discussed in Europe during last quarter's call became more pronounced and our growth profile in Asia weakened. Core growth was also reduced by approximately 2% from our product line simplification initiatives. On the other hand, we continue to see good demand on our aerospace end markets and in our domestic food and beverage, power generation, mining and construction-related end markets.
We also continue to see low single-digit growth in sell-through of our products in our North American distribution channels. The only change in the end market assumptions we have incorporated into our guidance is to shift our outlook for the rest of world distribution to assume roughly flat market demand in our fiscal 2020 based on the trends over the past quarter.
Strong operating execution and the good growth in our aerospace operations delivered a 90 basis point expansion in PMC's EBITDA margin, and we continue to expect PMC margins to increase year-over-year in our fiscal 2020 as the structural savings we're realizing from our Supply Chain Optimization and Footprint Repositioning initiatives and operational execution through Rexnord Business System is expected to more than offset our ongoing investment spending.
As you update your models for PMC, we remind you that in our second quarter, we're up against PMC's strongest growth quarter from last year when core growth was 7% and 300 to 400 basis point stronger than any other quarter of fiscal '19.
Please turn to Slide #9. We'll discuss our Water Management platform. During our first quarter, our Water Management platform delivered a 4% net sales increase on both a core and as-reported basis. Our product line simplification initiatives had a relatively minor impact on Zurn's core growth in the quarter. But for the second consecutive quarter, poor weather conditions, particularly during May, had a negative impact on our core growth. Growth reaccelerated in June. And despite the more difficult second quarter comp from last year, we expect relatively stable core growth from Water Management in our second quarter as 2 years stacked growth reaccelerated sequentially.
Underlying North American nonresidential construction market demand remains robust, we're looking forward to another year of solid growth at Zurn based on additional demand growth, our innovation pipeline and favorable price realization.
As illustrated by our unchanged end market outlook that is summarized in the slide, demand conditions in our core nonresidential construction end markets remain favorable. Year-over-year growth in overall U.S. nonresi building construction spending has been pressured somewhat by the persistently adverse weather issues this spring, but overall growth in institutional verticals has remained relatively more stable.
Commercial sector growth has slowed as declines in the retail sector are detracting from the ongoing solid growth in office verticals. And our outlook continues to incorporate a relatively more cautious posture toward the commercial sector outlook in our second half.
Institutional sector spending, where specification grid and plumbing content was great and our relatively share is stronger, is expected to continue to grow at a relatively higher rate.
During our first quarter, we formally launched our first digitally connected faucets and flush valves for commercial and institutional washrooms. As illustrated by the graphic displayed in the lower right-hand of the slide, our digitally enabled Zurn sensor faucet connects wirelessly to a Zurn gateway or hub that can be connected to the cloud and accessed 24/7 through Zurn's plumbSMART secured web portal.
Our customers gain real-time visibility of water consumption as well as usage patterns and trends for each connected fixture. Alerts can be sent directly to their mobile device when the need for preventive maintenance arises. With improved visibility into the functioning of the building's plumbing system, our customers are going to expect to better manage total water usage, gain control over the timing and need for regular or preventive maintenance and respond more quickly to sudden changes in system status.
Run on faucets and plug pellets are a daily concern in commercial and institutional buildings, and Zurn connected products can detect the problem and immediately send an alert to a local maintenance team and thereby mitigate any impact.
Our products connect seamlessly into the customers' building control system and can be easily retrofit, which is where we see the relatively larger opportunity. You may recall that we launched our connected backfill solution in December. We plan to introduce a connected drain solution later this year. Together, these visually enabled product solutions present a combined capability that can deliver substantial water saving and economic benefits to owners and operators whether we're talking about a single office building, local school system or national health care network.
Now turning to profitability. Water Management's adjusted EBITDA increased by 9% year-over-year in the first quarter and delivered 100 basis points of year-over-year margin expansion as we continued to leverage our core growth and manage through a favorable price cost equation while funding our market expansion and cost reduction initiatives.
Moving on to Slide 10 and starting with the chart on the far left, our free cash flow increased year-over-year although our first quarter typically accounts for less than 10% of our full year free cash flow. We remain confident in our expectations for free cash flow growth in our fiscal 2020.
Moving to the chart in the center, you can see that our financial leverage, as measured by our net debt leverage ratio, is near the low end of our target range even as our net debt increased slightly to fund the acquisition of stainless drains.
Before we open the call up for questions, I'll touch on restructuring expenses and our effective tax rate. First and in terms of our cost reduction initiatives, including our SCOFR 3 initiatives, we continue to expect total restructuring expenses of $14 million to $16 million in our fiscal '20. These costs are primarily made up of severance costs and are excluded from our adjusted operating results.
Next, our effective tax rate will fluctuate by quarter given varying levels of pretax income as well as the timing of other planning initiatives. We anticipate our fiscal 2020 adjusted net income will incorporate an effective tax rate of approximately 26% to 27%. In our second quarter, we anticipate the rate will be approximately 27%.
Turning to the slides in the appendix. First, we've included certain other assumptions incorporated into our guidance for fiscal 2020 on Slide 13. I'll remind you that our guidance excludes the impact of potential acquisitions, potential accounting gains or losses and future nonrecurring items such as restructuring costs. As has been our practice, the appendix with today's presentation also includes a reference table on Slide 14 to help you reconcile the incremental quarterly share count to use for modeling our adjusted diluted earnings per share under the if-converted method as required under our accounting for our outstanding mandatory convertible preferred.
As illustrated on Slide 15, the if-converted method was dilutive to adjusted EPS in the first quarter and therefore was applied.
I'd also like to make sure everyone is clear on how to determine the correct share count to use when estimating our fiscal 2020 earnings per share. Given that the preferable has converted into common shares on November 15, our average full year share count will include the converted shares only after that date. Our current estimate for average diluted shares outstanding in fiscal 2020 is approximately 114.5 million shares.
With that, we'll open the call up for questions.
[Operator Instructions] Our first question comes from Joe O'Dea.
Starting on PMC and just thinking about kind of where you get confidence as you move through the year and perhaps some of your comments around just how short cycle things feel out there and understandably with a tougher comp in 2Q. But just generally kind of what you're looking at across various end markets there that continue to give you confidence in kind of that full year low single-digit organic? And maybe with that, anything that's perhaps changed within the complexion that you talked about in the first quarter and expectations around what you're seeing on the price side, what you are seeing on the volume side?
Sure. I think as we look at PMC, a couple of things. Absolute sell-through to the end-market has been up low single digits for the last couple of quarters. Our base case is that continues, which is a combination of, I would say, relatively low market growth plus some price looking -- and that's roughly, Joe, as you know, about half of PMC. We also have a solid outlook for aerospace that gives us good visibility from a backlog perspective to that high single-digit core growth number. And then when you looked at all the other sort of end-user OEM end markets, I think, we're taking a cautious view, right? I think, as Mark pointed out, North America, food and beverage things like that have been good, still getting good growth from Centa. But I think we're taking a rather cautious view on the remainder of the year, but that's how we're sort of playing it out. And again, I think when we guided relatively short time ago, we had visibility to a lot of that. So when we guided to low single-digit core growth, we contemplated much of the same environment that we're seeing today. I don't think much has changed. And I think the confidence we get is from absolute sell-through and industrial production is still in a reasonable place, we get good views on Centa and aerospace and then a couple of other things that are going well from an end-market perspective. So I think that's sort of where we're thinking about it at least today, but I don't see a significant downside from where we peg things.
And then on Water Management and some of what you're doing on the digital launches, can you talk a little bit about the way that go-to-market has worked and how potentially it could change in terms of kind of faucets, backflow drains, are those generally a separate kind of sale avenue? And when you get connected product across those ranges, does it become more of a system sale opportunity really getting at how substantial a market share opportunity, something like that can be?
Yes, I think the nice thing is these components all work together in an integrated way with a building control system. And so where we're seeing a lot of traction is with performance contractors and contractors in general who are able to offer a solution to the building owner that integrates all of these components that prior to having the capability were a critical part of both the water quality and safety inside of a nonresidential building that can be integrated into whatever interface the end user or the building owner has. And so from a system sale, we were always sort of selling these as components that work well and integrate well together to not only do the job when it comes to safety and flow control, but also lower labor and installation cost.
This takes it to another level where we're actually monitoring these things real time so that the contractor can work with the building owner and actually set up the right maintenance schedule and everything else to put in there really intelligent way. So it's -- the path to market is the same, but I think, we're finding additional channel partners that can see the value of this, and also this fills a critical void in that building control performance contracting world where they've been monitoring HVAC and lighting and all that for a long period of time but nothing has really gone down the route of being able to monitor water inside of a nonres building. So we're seeing a lot of interest from that part of the world where performance contractors see this as a real value-add. And so they're really pulling us into opportunities that we think are going to be pretty significant over time.
Your next question comes from the line of Julian Mitchell.
This is Jason on for Julian. Just one question on Water Management. I guess, just if -- I realize it's difficult to size, but if there is any color that you could give as to what growth would have been in the quarter without sort of poor weather conditions, particularly in May, just so we can sort of get a picture as to what run rate demand was in the quarter.
I mean, it's got to be 2 to 3 points would be our guess. If we looked at April, by the time we had guided, we had perfect visibility to what April looked like. May was really bad, and June picked up pretty substantially. So we ended at a pretty good rate. That continues into July. And we're into the sort of heart of construction season now. So we would anticipate that growth would be better as we get through our second quarter, and then we go through that seasonal sort of tapering down in North America, and then obviously March quarter is less, but the May weather was tough, June finished strong, July is in a good place.
Great. And then just following up a little bit on that PMC color that you gave earlier. You mentioned how compared relative to when you guided post-Q1, you didn't really see anything in the demand environment that you did see back then. Is that to imply that demand didn't really get too much worse in PMC throughout the quarter or demand did get worse, so you just saw a solid come in, and that's why you guided what you guided after Q1, just trying to clarify that point?
Well, again, when we guided sort of mid-May, so we had good visibility to April and the first half of May, and I would tell you that not much changed over the course of the first quarter from what we guided, and I don't think that we're saying that it's substantially different from what we thought 90 days ago. So I'm not sure exactly the distinction in your question other than to say we gave everyone what we thought was our best look. We haven't seen a material change to that, and we are sort of I think confident that the outlook that we provided is still the right one for a whole lot of different reasons.
[ Jason ], this is Rob. If this is what you're looking for, our growth did not tail off in June.
Your next question comes from the line of Jeff Hammond.
Just on the product line simplification, I think, you called out the 200 basis points. Is that kind of we should have run rating through each of the next 3 quarters, and then you lap that or does that move around at all quarter-to-quarter?
I think it probably moves around a little bit, but I would tell you that it is more pronounced in PMC, relative to Water Management. And so I would expect between the first 3 quarters, you will see the majority of the impact in PMC. And then by the fourth quarter, we start to sort of anniversary the prior year. And then in water, it probably picks up a little bit as we get into the second and third quarter and then starts to again tail back into the fourth quarter. So I would say by platform that's how it rolls out and -- but by the fourth quarter should be relatively clean.
Was there any impact in water this quarter?
Yes, it was modest. It was probably only 50 basis points or so.
And then I know you don't give quarterly guidance. But just given the comp in PMC, how should we think about the core growth rate into 2Q for PMC? I think you had the timing issue with aero.
Yes. Jeff, this is Mark. I think if you look at sequentially, you'll see a step-up in the absolute sales dollars, Q1 to Q2, like you saw last year. But that tough comp put that core growth closer to that, call it, plus 1% to flattish type range in Q2, just given last year's 7% number.
And then just on the end markets, I think the softening in Europe and maybe the change in rest of world, are there any particular end markets that are jumping out where you're seeing some of that softer activity?
Well, we've seen that softer activity, Jeff, in Europe, in our beverage business that's continued. Well, that's partially Europe but also partially lot of the large equipment manufacturers are producing product for Asia there. So it's partially driven by some of the Asia stocks as well.
But I think that's probably the most pronounced area for us in our process industries. It's been slower, but not to the same extent as the beverage side. So not a lot new there. I think that trend has kind of continued from what we've seen for the past couple of quarters. So beverage would be the leading category that brought expenses lower in Europe and Asia.
Okay. And then just finally on the stainless drain acquisition, it looks like you paid around $25 million. Anything you can give us on the growth profile of that business, margin profile, what you paid on a multiple basis, what the revenue contribution would be kind of on a run rate basis quarterly?
Yes, it's relatively small, Jeff. It's a nice little tuck-in. It's accretive to margins. It's accretive to, I think, what we sort of viewed from a return on invested capital within a year. So I think, thinking about it as a couple of million bucks a quarter, it may be $3 million a quarter, great EBITDA margins. We paid a relatively low multiple for it, and we think within a year, it's well into double-digit return on invested capital. Nice little tuck-in for us, gives us extension of our leading drain line and something that we thought made a lot of sense, and it's off to a great start.
Your next question comes from the line of Mig Dobre.
Just sort of sticking with this comps theme here. When we're looking at Water Management, sequentially maybe in the second quarter given the weather disruptions that you mentioned before and just normal seasonality, should we expect a sequential uptick in revenue here as well?
Yes. Mig, this is Mark. We would expect a sequential uptick in revenue from Q1 to Q2, as we've historically seen. I think from a growth standpoint though, as we laid out, last year, we posted 12%. So similar phenomena as we talked about in PMC. So I think we're expecting that core growth number to look similar to what we saw in Q1 year-over-year core basis, but the absolute dollars will definitely step up from Q1.
Great. That's helpful. And then I'm wondering in C&I and resi, the 2 areas where you have yellow lights, if you would, on the slide, kind of how you're thinking about the market here. Is it a function of contractor is kind of working through backlogs and your sales through -- to these end markets still be in positive with potential slowness down the line? Or is this something that you're actually seeing currently in terms of weaker growth? How does that work?
I think what we're do, Mig, is trying to flag that -- it's been -- starts have been inconsistent. And if you look at the start data, for June, on a stand-alone basis, it says it's down 15% commercial starts. The problem with that is, last year's June was over $40 billion, right, which is an all-time record, and there's only been 5-or-so months in the last 10 years that have been above $30 billion, and this June happened to be one of them. So on a relative basis, yes, the number is less than it was a year ago from a starts basis, but it's still very robust. And I think all what we're trying to do is sort of flash the fact that you're going to see months to where the starts number is really good, you're going to see starts where the numbers are a little bit weaker. And how that sort of manifest itself over a bill cycle is going to be maybe less predictable, but again I think we still see contractor backlogs in a great place.
And again you know this, but it's a hyper-regional business, right? So there's parts of the country that are doing really well. There's parts that aren't. And I think we're just trying to sort of flag the fact that it's not green everywhere all day. It's a function of having to -- having to work for it. And I think the market is still good. The backlogs are big, the labor constraints are real. And when weather happens, it doesn't get caught up in a quarter, it extends things. And so I think that's really all we're trying to maybe signal is that as you look out, we still see growth, but it's probably not at that 12% range but still solidly mid-single digits. And on the res side, res for us is a relatively small thing. And I think just that's sort of well-documented in terms of the where that market sits relative to where it's supposed to be.
Right. And I mean, fair enough. I guess, we all understand the kind of like the end-market data, that everybody is looking at it. It's more of a question of what you're really seeing in a business, and I think your comments, I guess, have made that clear. When -- going to PMC now, how are you thinking about the puts and takes to margin for the rest of the year. I mean are there any specific quarters that you'd like to call out in any way based on investments that you know you might have to make or mix or anything else that we should be aware of?
Yes. Mig, this is Mark. Starting in Q2, we'll start incurring some of our SCOFR 3 duplicative costs that will run through the operating results. So you'll see sequentially not a big margin step-up from Q1 to Q2, probably the same thing in Q3 and some margin pick up in Q4. So starting our Q2, the thing that's going to be a little bit different that we will start incurring some of those duplicative costs as we start executing some of SCOFR 3 and that will dampen the margin a little bit. But overall, if you look at the full year, we are still projecting full year margin expansion in PMC despite those incremental costs.
And I mean the incrementals in the first quarter were really good, Mig. I think, if you look at Q2 to Q4.
They will be good.
Even net of the duplicative costs, you'll see incrementals at the higher end of the range of what we've communicated to expect over time.
Okay. And then maybe last question. When you look at your leverage, you're expecting to be down to 1.6 by the end of the year, which is great. Cash flow generation is good. How are you thinking about deploying this capital that you obviously have available amount? Your convert is set to -- actually convert in November. So I'm wondering how you're thinking about that? And then from a M&A perspective, what are the things that you're looking at? And is there anything more material rather than just a tuck-in acquisition that would be considered?
Yes. Well, again, Mig, I think we feel really good about margin, the leverage to where it's that. I think as we communicated over time, we're going to continue to be disciplined in our approach to M&A, and that would include things that are both bolt-on tuck-in in nature as well as things that could be larger, but always keeping in mind we want to keep the leverage at a very manageable place not only in today's environment, but as we would look forward and into a scenario where we did see a recession. So I think we're going to continue to be very disciplined. And I would say use the balance sheet in a way that is very manageable and appropriate.
Beyond that, we always have the opportunity to think about incremental ways to give some money back to shareholders in the form of dividend and/or buybacks. At this point, our view is that we are likely going to allow the mandatory 2 converts, and then we have the option to sort of continue to see how we want to approach that from a dilution standpoint, if you wanted to buy some back down the road or not.
So I'm not going to get too specific about it, but I think expect the form of our M&A to continue to be disciplined, high return hurdles, and using the balance sheet in a way that keeps leverage very manageable across a variety of scenarios. So we don't envision doing anything that takes leverage to 4x or anything like that.
[Operator Instructions] Your next question comes from the line of Joe O'Dea.
Just wanted to also ask about Water Management margins in the quarter that were well ahead of what we expected and anything that might have been a benefit to 1Q or normally from a sort of cadence perspective, we see things improve as you move into 2Q, and so just I mean, anything that's more kind of contained to the quarter or thinking about this just kind of like a structural level?
Nothing unusual relative to the prior year. And I think when you think about margins that usually get better into the second quarter, I think you can expect that as well. So I think it's really the compounding effect, Joe, of a lot of the things that we've done with the SCOFR initiatives, the simplification initiatives, and I think staying well ahead on the price cost equation. And so nothing unusual with respect to mix or one-timers. So really happy with, I think, the quality of the performance in both the first quarter and what we expect in the second.
And then just a comment kind of I think raises one other question. Just I think some of the commentary over the course of earnings season and hearing from some with sort of distribution channel and distributors, there's been so much price pushed through distribution in response to the cost inflation and thinking of sort of slowing environment, you're hearing about maybe some pushback. Are you seeing evidence of that at all from your distribution partners?
Well, I would say not in any pronounced way. Again, I think when you look at how we've managed it, it hasn't all been price. I mean we've done a significant amount of rerouting our supply chains, doing things to avoid the tariffs in addition to passing along some price. So I think if we were to look at the Pareto, I think price is a component, but we're not pushing it to the level where we're forcing distributors into a spot where they're getting significant pushback. And so I think we've tried to manage it across all the different levers we have, and I would not say that we've seen any significant pushback on the water side in particular around the price increases we pass through. Because frankly we try to manage it appropriately because what we don't want to do is when you pass along significant price increases through the channel and then on to the building owner, all of a sudden, the things become unaffordable, right, and so we're trying to be, I think, pretty disciplined in how we go about it but not overdo it to the point of people doing things that hurt demand.
We have no further questions at this time.
So I'd like to thank everybody that could join us on the call today. We appreciate your interest in Rexnord, and we look forward to providing our next update when we announce our fiscal 2020 second quarter results in late October. Have a great day.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.