Zurn Water Solutions Corp

NYSE:ZWS

Earnings Call Transcript 2018-Q3

[Operator]

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 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, January 31.

At this time, for opening remarks and introductions, I'll turn the call over to Rob McCarthy.

[Rob McCarthy, executive]

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'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 10-Q.

Please note that the presentation of our operating results include 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 2 platforms, followed by selected highlights from our financial statements and our cash flow. And afterwards, we'll open up the call for your questions.

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

[Todd Adams, executive]

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 1 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 a 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 were 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.

Adjusted EBITDA increased 20% year-over-year to $95 million. Consolidated EBITDA margin expanded 170 basis points and our incremental margin on year-over-year core growth exceeded 45%. Adjusted EPS was $0.37 for the quarter, including a $0.05 contribution from a lower-than-projected tax rate. Mark will review the performance of each platform in our consolidated financial results as well as the impact of U.S. corporate tax reform as part of his comments a little later in the call.

Turning to Slide 3. Looking at our platforms, PMC had a strong quarter with order and revenue growth across most major end market verticals, including another quarter of either stability or growth in most of our key process industry end markets, like mining and energy. Not to sound like a broken record, but our first-fit strategy and investments in product innovation and commercial excellence continue to gain momentum. And we continue to win important new OEM and end-user specifications, which is critical to both our near-term growth and our long-term market share as our products wear and use and are serviced and/or replaced multiple times over the life of the customers' application.

PMC's adjusted EBITDA margin improved 190 basis points year-over-year to 22.5% as core growth increased 6%. We see significant ongoing margin runway for PMC post the completion of our initial SCOFR initiatives. And as we've said throughout the year, we have a follow-on set of opportunities to further improve our long-term cost structure and profitability. And we expect to have more to say about that when we report our results next quarter.

We grew the Water Management platform 12% in the quarter, inclusive of 3 points of growth from the World Dryer acquisition and 7% on a core basis, with Zurn leading the way, as we've been winning a significant number of new opportunities and as our new product pipeline begins to have a more measurable impact.

We see the nonresidential construction market that's healthy and supportive of growth as we move into the 2018 construction season in North America. And we expect to finish this fiscal year with another quarter of good growth in water. Water Management adjusted EBITDA margins increased by 100 basis points year-over-year to 18.6% as we leveraged our top line growth and the ongoing benefits of our past SCOFR actions with solid execution, which together, more than offset higher investments in innovation and market expansion.

Moving to Slide 4. This slide highlights some of the recent wins that illustrate the positive impact of our new product pipeline and our increased commercial focus across both of our platforms. At the top left, we're highlighting Zurn's recent success in winning specifications for essentially all of the specified plumbing content with the Chase Center, the new home of the Golden State Warriors that is currently under construction in San Francisco.

This is a big win in terms of revenue potential. And it illustrates the value of having the industry's broadest product portfolio and our ability to simplify the architect's and contractor's workflow. The main reason that I'm highlighting this is because the architect that has the overall project responsibility has also specified our new line of Sundara Handwashing stations. You can see an example of that on the slide.

As we discussed in the past, Sundara represents an expansion into $150 million product adjacency for Zurn, basically white space. With a high level of design content, with product performance characteristics that address specific market opportunities that were highlighted and identified through our rigorous voice of the customer process, this high-profile specification win with a major architectural firm will amplify our marketing efforts as Zurn continues to introduce Sundara to other building owners and architects.

Moving to the top right. We have recently won a large order that includes multiple units of our Smart Gear Drives for one of the largest U.S. producers of paper and forest products. As we've discussed over the last couple of quarters, the launch of our DiRXN digital productivity platform and our initial offering of IIoT-enabled connected products is being very well received by our OEM and end-user customer base.

And the ability to provide real-time operating data to the customer's plant control systems was a key factor in winning the gear drive specification for this application. I'll also highlight that the win comes at a substantial premium to a non-enabled product, demonstrating the value that our customers place on improving their productivity, reliability and uptime.

Regarding DiRXN, let me just take a minute for a quick update on the additional progress we've made in our third quarter. We're closing in on having online configurators in place for virtually 100% of configurable PMC products. And we have now shipped over 100,000 individual PMC products with Smart Tags. And we've started tagging the 50 highest volume product families at Zurn. We're seeing follow-up RFQs from initial buyers of our connected gear drives. And we're seeing terrific feedback in our e-commerce capabilities through our monthly customer satisfaction surveys. Plus we've initiated the first field test of digitally connected Zurn products.

Turning to the other 2 wins highlighted on this slide. You'll see that they are both with major food producers and represent key breakthroughs for our Cambridge metal mesh belting product line, the acquisition we completed in mid-2016. First, we've successfully broken in with one of the world's largest packaged food producers, one with a long-term relationship with one of Cambridge's key competitors and represents a beachhead that we're confident we can expand in coming quarters.

Second, we've leveraged another new product introduction in 2017 into a major specification win in the market for spiral conveyors. The technical challenge, besides making a metal belt that can reliably transition from scraped to curved sections and back again, was to create an edge-driven spiral belt with a tight mesh overlay that can handle the most delicate food products in extreme freezing or baking applications with minimal product marking and while eliminating the most common cause of catastrophic failures in spiral conveyor systems.

Similar to the Sundara specification for the Chase Center, we believe this large spec win could influence spiral conveyor design and technology decisions for other end users in the food industry. So there are 4 examples of how our focus on solving customers application issues and delivering real value through product innovation can translate into key specification wins and meaningful new business.

To wrap up my comments on our third quarter, we're definitely feeling better about the progress we've made on the organic initiatives we've been driving over the past couple of years. We're seeing the benefits from significant cost reductions from SCOFR 1 and growth coming from the investments we're making in new products, innovation and commercial excellence. All that being said, we think there's clearly a lot more we can do in all those areas. And we think the continued balance of driving significant cost reductions to invest in growth and improve margins positions us well in all economic environments.

Fortunately, it appears that at least for the time being, reasonable end market growth should provide a decent backdrop to incrementally leverage the organic initiatives we've executed and those we plan to execute moving forward. The global growth environment has clearly improved from where it's been the past several years. And despite some challenges along the way, we're pleased to be on track to deliver the higher end of our original earnings guidance for the year.

Before I turn the call over to Mark, please turn to Slide 5, so I can provide a preliminary overview of our pending acquisition of Centa. In early January, we announced that we have signed an agreement to acquire Centa and that we'd expected to close the transaction in our fourth quarter.

Centa has been on our list of strategic targets for a long time, going back at least a decade. Centa produces flexible torsional couplings that are used in the most demanding engine-driven applications, and thus fills a strategic gap between our comprehensive offering of couplings for motor-driven applications and our Euroflex line of couplings for turbine-driven applications. Highly flexible couplings and shafts are specifically designed to handle the higher and more variable vibration levels inherent in high-output, engine-driven applications.

We're excited about the acquisition from several perspectives. Centa brings a leading market position with competitive scale, a large installed base and a long track record of product innovation and superior customer service. As with many of our other Power Transmission product lines, relatively more stable MRO demand accounts for the largest share of Centa's sales. And it benefits from high rates of like-for-like replacement.

Centa will expand our capabilities in certain industrial applications that are very familiar to us, like gas compression, pumping, power gen and wind energy while other important Centa applications, like mobile hydraulic equipment and marine, represent end markets where our historical presence has been quite limited, which means Centa will add to the broad diversification of PMC's end market exposures and create new sales opportunities in other PMC product lines. As you can see at the bottom of this slide, we've provided a graphic to help you understand how a Centa flexible coupling fits into some representative engine-driven applications.

We're also convinced that we can strengthen Centa's competitive differentiation and value proposition with our DiRXN customer productivity platform. In addition to new growth avenues Centa brings to our PMC platform, we also see substantial opportunities to enhance Centa's profitability as we introduce the Rexnord Business System and provide additional commercial and operational resources.

We'll provide additional details around the composition of Centa's sales and profitability and more specific comments around our short- and long-term expectations for the business once we've closed the transaction. For the time being, I'll just reiterate, we're very excited to add Centa to the Rexnord family and that we're convinced that the acquisition will enable us to create and deliver significant incremental shareholder value.

One final comment, with the acquisition set to close in our fourth quarter, I'll point out that the combination of purchase price multiple and our expected free cash flow in the quarter will allow us to be leverage-neutral from where we are today with further delevering accelerating into FY '19.

Now I'll turn the call over to Mark.

[Mark Peterson, executive]

Thanks, Todd. Please turn to Slide #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, was 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 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 1 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're 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 couple million dollars of upside from stronger-than-expected currency translation. The $384 million midpoint is $4 million above the midpoint of our previous guidance and it does not include any impact from the pending Centa acquisition. The revised range reflects that fiscal '18 year-over-year growth in our adjusted EBITDA will be at least 10% above the comparable $347 million we delivered in our fiscal '17.

Slide 7 summarizes our consolidated results in the quarter, which Todd has addressed. So let's move on to Slide 8 and discuss the first of our 2 operating platforms, Process & Motion Control. Total sales increased 8% year-over-year in PMC as core sales growth increased to 6% in the quarter and favorable currency translation added about 2%. PMC again experienced growth in a majority of its end markets during the quarter and benefited from the ongoing, although still somewhat uneven, recovery in our process industry end markets. Global distribution revenue increased by a mid-single digit on a core basis as North American distributor core growth increased sequentially and our distributor sell-through in the quarter improved to a low single-digit range.

In the top right corner of the slide, you can see the end market assumptions that support the outlook for mid-single-digit core sales growth in PMC that is now incorporated into our fiscal '18 guidance. We've changed the stoplights to green from yellow for U.S. and Canada distribution and for global process industries as we've seen demand improving and expect to see growth in both areas in our fourth quarter. We expect to finish the year with a low single-digit growth in our aerospace end market and a range of generally higher core growth rate with our OEM and end-user customers in many of our consumer-facing and process industry end markets.

With respect to profitability, PMC's adjusted EBITDA increased by 18% year-over-year and margin expanded by 190 basis points. The significant year-over-year margin expansion reflects both solid execution in our core growth and the full impact of our Supply Chain Optimization and Footprint Repositioning initiatives that were completed in our second quarter. On a sequential basis, PMC net sales declined seasonally in our December quarter by about $8 million, but adjusted EBITDA increased by almost $4 million.

As I stated earlier, the impact of a weaker dollar on our financial results is running a little ahead of our earlier expectations, which tends to dilute our margins slightly and is expected to hold PMC's full year margin expansion to about 100 basis points. Despite that, we expect strong core incremental margins in our fourth quarter. And PMC's adjusted EBITDA margin is expected to increase by approximately 100 basis points year-over-year in the fourth quarter.

As we turn to our Water Management platform summarized on Slide 9, please recall that we have been excluding the financial impact of the RHF nonstrategic product line we exited during fiscal '17 from the calculation of the core growth and adjusted earnings metrics in order to provide enhanced comparability with our core operating results in fiscal '18. The impact was a slight matter in the third quarter and will be negligible in our upcoming fourth quarter as we fully anniversary the exit.

During our third quarter, our Water Management platform delivered a 12% net sales increase that was consistent with our expectations and was a result of 7% year-over-year core sales growth, a 3% contribution from our acquisition of World Dryer in early October and a 2% contribution from foreign currency translation. Our top line results benefited from fairly balanced year-over-year growth across our primary end markets.

Core sales growth of Zurn commercial-grade plumbing products accelerated in the mid-single-digit range in our third quarter as new product introductions added to the ongoing growth we've seen in Zurn's nonresidential building construction end markets. For example, we've seen a very positive reaction to our new line of larger-diameter PEX piping for nonresidential applications that was launched earlier this fiscal year.

This proprietary new product delivers a best-in-class performance once installed while giving contractors the worksite flexibility to join the pipe with either the Zurn expansion fittings or with traditional crimp systems. Contractors like the flexibility. They like being able to leverage the efficiency of sourcing more of their requirements from the one supplier that offers the industry's broadest portfolio of water-saving and installation timesaving products.

As we look ahead, we expect the U.S. nonresidential building construction market to sustain positive growth in the coming 2018 construction season. And we're excited it's been developing relatively strength in institutional verticals. As we've highlighted before, institutional verticals, like health care and education, typically involve relatively higher investment in plumbing per square foot of construction. And our competitive position is quite good.

As you can see on the top right of Slide 9, our end market outlook is unchanged and continues to incorporate a mixed regional outlook for our water and wastewater infrastructure end markets. We expect to deliver another quarter of core growth in our fourth quarter, supporting our expectations for the overall Water Management platform to deliver mid-single-digit core growth for the full year.

The year-over-year increase in Water Management's EBITDA margin was consistent with our expectations and reflected the core growth during the quarter, leveraged by our ongoing cost reduction and productivity initiatives to offset our sustained investment spending. Given the slightly higher expected impact of currency translation, we expect the Water Management margin to expand by just under 100 basis points in our fiscal '18 while continuing to increase year-over-year in our fourth quarter.

Moving on to Slide 10. You can see in the chart at top left that our financial leverage, as measured by our net debt leverage ratio, has declined to 2.8x. Based on our fourth quarter outlook and assuming the Centa acquisition closes this quarter as we expect, we would finish the year with our net debt leverage ratio unchanged at approximately 2.8x.

In the chart at the top right, you can see we finished our third quarter with year-to-date free cash flow of $97 million, which includes an approximate $15 million outflow related to our defined SCOFR activities and which was mostly comprised of cash severance payments. We continue to project our free cash flow to exceed our net income and be in a roughly $175 million range for the full year.

Next, I'd like to comment on our restructuring expenses and our effective tax rate, then make a couple comments about the impact of U.S. tax reform. First, in terms of our cost reduction initiatives, we expect to report total restructuring expenses of $13 million to $15 million in our fiscal '18, which is unchanged from our previous outlook. These costs are primarily made up of severance costs and are excluded from our adjusted operating results.

Next, our effective tax rate can fluctuate by quarter, given varying levels of pretax income as well as the timing of other planning initiatives. In our third quarter and due to our March '18 fiscal year-end, under U.S. tax reform, we were required to recognize a year-to-date impact of a lower U.S. corporate tax rate on our overall fiscal '18 financial results. As a result and reflecting on expectations that our fourth quarter adjusted net income will include an effective tax rate of around 35%, we now expect our full year fiscal '18 adjusted net income to incorporate an effective tax rate of approximately 30%.

So when you cut through the puts and takes in the effective tax rate between our third and fourth quarter, the reduction in the full year rate from our previous outlook of 32% is primarily the benefit from the lower U.S. effective tax rate. The biggest impact of U.S. tax reform on our third quarter GAAP financial results was a $55 million noncash and nonrecurring tax benefit that is excluded from our adjusted net income and reflects the impact of adjusting our net deferred tax liability from the new U.S. federal tax rate, partially offset with a onetime tax expense associated with the impact of the deemed repatriated earnings from our non-U.S. subsidiaries.

Before we open up the call for questions, I'd like to share initial thoughts on how the recently enacted changes in U.S. tax regulation will affect Rexnord. I'd like to stress that our analysis is ongoing and my remarks should be considered to be preliminary. In terms of the effective tax rate that we estimate will apply to our adjusted net income in our upcoming fiscal year, which is our fiscal 2019, our best estimate is currently 28% to 29%. While U.S. tax reform headlines focus on the meaningful reduction in U.S. federal rate, there are some moving pieces going in the other direction, the largest being the repeal of the Domestic Production Activities Deduction.

With respect to our cash tax rate, we've been in the low 40s as a percentage of our pretax income. And while we anticipate that rate to be in the high 30s to low 40s in our fiscal '19, due to some timing of puts and takes between fiscal '18 and fiscal '19, we would expect our cash tax rate to drop below 30s as a percentage of pretax income as we look ahead to our fiscal 2020 and beyond.

Let me remind you that my comments are based on our current best estimates of the impacts of the U.S. tax reform. As we continue to refine our estimates for the size of the positive impacts on Rexnord's earnings and cash flow, we anticipate being able to provide more specific tax rate guidance in mid-May, when we provide our initial financial guidance for our fiscal 2019.

We are, of course, optimistic that we'll see some degree of acceleration in capital project approvals and the related component order activity across our end markets. But deploying capital requires operational as well as financial resources, and we would expect the benefits in terms of new orders and incremental revenue to emerge over multiple quarters. One thing is clear, however, a structural increase in free cash flow will further strengthen our financial flexibility and will enhance our ability to execute our disciplined bolt-on acquisition strategy while maintaining Rexnord's net debt leverage ratio below 3x.

Turning to the 6 slides in the appendix. First, we have included the other assumptions incorporated into our guidance for fiscal '18 on a separate slide as you have come to expect. I need to remind you that our guidance excludes the impact of potential acquisitions and divestitures and future nonrecurring items, such as restructuring costs. In today's case, that specifically means the impact of the Centa acquisition is not included in our guidance.

Second, and for your convenience, we've included a table that provides some specific after-tax impact of each individual adjustment we have made in our calculation of adjusted net income. Third, we've 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 is applicable.

And as you are aware and is also on Slide 15, the if-converted method was slightly dilutive to our adjusted EPS, and thus applies to our third quarter results. Lastly, we include the reconciliation tables related to adjusted EBITDA and adjusted earnings per share that are also included in our earnings release each quarter.

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

[Operator]

[Operator Instructions] And our first question comes from Jeff Hammond from KeyBanc Capital Markets.

[Jeffrey Hammond, analyst]

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

[Todd Adams, executive]

Sure. The purchase price is EUR 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're excited about it. It's a super fit for us and highly synergistic as I think you'll see and hear after we get it closed and talk about it next quarter.

[Jeffrey Hammond, analyst]

It sounds like a great deal. And then it sounds like VAG still may be lagging. We're seeing better 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?

[Todd Adams, executive]

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 orders at this point. But it's clearly far more stable. I think you've 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.

[Operator]

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

[Joseph O'Dea, analyst]

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 3 quarters of the year. But could you speak a little bit to that at kind of the segment level within PMC, anything in particular that you'd call 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 more detail on the Water Management side?

[Mark Peterson, executive]

Yes, Joe, this is Mark. I think, you are right. If you go back several months, our outlook for our fourth quarter, we'll start with PMC is better at the beginning than it was 90 to 180 days ago. We've always felt going into this quarter, we knew we had a tougher comp. And again, look at stack margin throughout the year, the best stack margin will be our fourth quarter. But if you look at what's really set 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 we are probably something that low, mid-single-digit range for the quarter. As we've 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 stocking levels. And still, that could be an opportunity going into next year. But we think we've seen the sales improve from low single digits level be a catalyst [indiscernible] from where things -- we thought things were 90 days ago. And overall, just general end market demand within our consumer end markets and our process industry end market has remained stable for us and in some cases, has gotten a little better. So those are the kinds of things that give us a little more conviction going into the fourth quarter about some better growth rates in PMC. From a water standpoint, I think water is kind of as we expected. We anticipated solid mid-single-digit growth in the back half of the year. You saw that in our third quarter, a little better than that. In our fourth quarter, we expect to be in that solid mid-single-digit range. So the biggest change, to your point, is right on, we've seen PMC, we've got a little more conviction on the growth in PMC in our fourth quarter now.

[Joseph O'Dea, analyst]

That's helpful. And then just thinking about free cash flow and kind of the rough $175 million in fiscal '18, could you outline some of the moving pieces that we have moving into fiscal '19 to think about what that $175 million would reset to, independent of anything on the organic front? And I guess you can't really talk to Centa at this point, but SCOFR costs, interest expense coming down, tax that should be a little bit lower. What that $175 million resets to before you even get growth?

[Mark Peterson, executive]

Sure. Yes, through talking prior quarters, we've talked about next year, fiscal '19 and beyond, [indiscernible] and we're in that $200 million range or better than that going forward. So if you think about moving pieces, clearly the cash restructuring costs with SCOFR 1 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 5 years ago. That moderates next year and goes away in our -- in 2020. We will see better -- with a little bit of debt refinancing, if our cash interest will decline. We'll see some benefit from the overall cash tax rate, not as much we expected. But then there's some moving pieces between this year and next year that will [indiscernible] a little bit. So those are the things that are on the positive side. So I think right now, it's [indiscernible] to say we still have as much conviction as we ever had around a $200-plus million-type free cash flow run rate starting next year for us going forward.

[Operator]

Our next question comes from Charley Brady from SunTrust Robinson.

[Charles Brady, analyst]

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

[Todd Adams, executive]

I don't think so, Charley. I mean, I think we've always 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 has changed there. I think you saw a nice incremental margin in the quarter, greater than 50% on a year-over-year growth. Then 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 '19 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 to that range. It's clearly well below that at this point. But when 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 has 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're sort of -- we've been playing a little bit of the long game here to get this. But this is going to be a premier industrial segment. And we're very confident in that and nothing has really changed.

[Charles Brady, analyst]

Okay, good to hear. Just one more, I know it's 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're hearing other companies' more optimistic on 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 are kind ratching up? Obviously, your equipment goes into a lot of other equipment and larger systems.

[Todd Adams, executive]

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 include a lot of projects that I think we clearly didn't see on the table 2 years ago. So there's a lot more optimism. I think there's a lot more inquiry. I think we're 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 spent as a result of tax reform. I can't really get you that number. But there has been clearly more optimism. And we're seeing it show up in our sales levels.

[Charles Brady, analyst]

Yes, I guess, what I was trying to get -- I'm not looking for a specific number, obviously too hard to do that. But your guidance, your core growth guidance, I know you haven't given for '19. But you're not really baking in that, right? I mean, obviously it's all anecdotal, you haven't seen it come through yet. If it were to accelerate, that would be incremental to kind of where you thinking today.

[Todd Adams, executive]

Absolutely. We have not -- we're sort of rounding home here in our fiscal '18 and looking at '19, we haven't really baked in any significant bump as a result of an increase in spending from tax reform. We have not done that. I doubt that 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 spending on the tax front with a reasonable starting point, it should set us up for a really nice fiscal '19.

[Operator]

Our next question comes from Jim Giannakouros from Oppenheimer.

[James Giannakouros, analyst]

A question on Zurn specifically, seems to be humming along nicely, mid-single-digits growth that you cited. I think overall nonres 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?

[Todd Adams, executive]

We see -- as we've talked, I think, for a while, the way that the nonres recovery has worked, it started off with obviously res followed by some commercial. And then now it's sort of migrating to institutional. And as we look at our Zurn business, that's really our sweet spot. So I would say what we're starting to see is that we're at the very early stages of the institutional market beginning to perform. If you think about a 300-bed hospital, if you think about a 12-floor dormitory, things where there's a lot of content per square foot, that's what we're starting to see. And you're seeing it really all over the country, whether it's in the Midwest or it's 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've been bringing to market, we're pretty optimistic that the 4% market growth, we'll be able to outperform that.

[James Giannakouros, analyst]

Yes. And it's been 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?

[Todd Adams, executive]

I think it's going to be both, Jim. We did the World Dryer acquisition back in October. So the industrial logic is how do we come in and essentially own the commercial restroom for all applications? And so there's more we can do. It's still fragmented. There's bits and pieces that we can pick up and we think really build an even more sustainable, competitive advantage and a bigger moat. And there's other geographies we can do it in. So your initial comment of 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 to date, but I wouldn't rule it out.

[James Giannakouros, analyst]

Got it. And one more on Water Management for me, just switching over to VAG. Just curious if I'm thinking about the plans there correctly. It 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?

[Todd Adams, executive]

Yes, I mean, look, we're 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're starting from a very small base. And so you know that it's going to take a long time. But we're happy with the success. I don't say we're deemphasizing in any way, but it's going to take a while until it rises to the point where we're going to talk to it, and then sort of point it out as a meaningful growth lever.

[Operator]

Our next question is from Mig Dobre from Baird.

[Mircea Dobre, analyst]

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?

[Todd Adams, executive]

Mig, it's Todd. There wasn't a meaningful difference in the numbers of the growth between the 2 parts of Water Management.

[Mircea Dobre, analyst]

And that's still for the full year, too?

[Mark Peterson, executive]

Core growth -- Mig, this is Mark. Core growth, we think, in our third quarter, as Todd said, balanced between the 2, fourth quarter, we're expecting mid-single digits. And again, that's relatively balanced even between our Zurn end markets and our VAG end markets for the fourth quarter.

[Todd Adams, executive]

Mig, I guess, maybe just to clarify, the core growth in the quarter, I think what's embedded in our outlook, would not include any sort of significant outsized growth in the Water Infrastructure part of the business that would drive the total up. 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.

[Mircea Dobre, analyst]

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

[Todd Adams, executive]

Yes, totally understood.

[Mircea Dobre, analyst]

Then in terms of margin, again on your fiscal '18 outlook, it's fair to assume that you're still expecting 100 basis points of expansion in both segments again for the full year?

[Mark Peterson, executive]

That is correct, yes. Basically, 100 basis points in both segments, correct.

[Mircea Dobre, analyst]

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

[Mark Peterson, executive]

That's going to be a little higher, Mig. In the fourth quarter, there's going to be some professional fees that will be -- that we know we'll be incurring, so that's going to run higher, probably closer to, call it, in that $34 million, $35 million range for the full year.

[Mircea Dobre, analyst]

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?

[Mark Peterson, executive]

Stable, it will be stable, yes. If you model next year, you're keeping that $34 million, $35 million range, that's a fair place to be.

[Mircea Dobre, analyst]

Okay, very helpful. And then last question for me, 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 when I'm thinking about the domestic production incentive, and I understand that you're losing that, but it seems to me like it's almost 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'm 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've been paying in the last few years?

[Mark Peterson, executive]

Well, this year, we were anticipating 32%. And in that number, there were some discrete items that we driving that rate down. You take all the discrete items, Mig, our rate is in that 33% to 34% range. Now there's always been discrete tax planning item, that when I say 28%, 29% next year, it doesn't include that. There could be discrete items as well next year that we just haven't called out yet. But if you just look at the base rate, our 33% to 34% range is going to 28% to 29%.

[Mircea Dobre, analyst]

Okay, fair enough. I guess I'm just wondering why we're not -- most of the companies that I'm talking to are talking 25%-ish, right? And they're dealing with the same circumstances.

[Mark Peterson, executive]

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

[Todd Adams, executive]

Look, can I just make an observation? I don't know that this is something that we're going to solve on a conference call. I would suspect that we're giving you, Mig, what we think our best shot is at this point. Obviously, I think all the facts and circumstances around where our income is generated and planning it obviously is 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 '19 and '20, 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 -- net-net, it's a big positive for us. And I think it's going to show up in the results. I'm 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 the nooks and crannies in this effectively on a call.

[Operator]

Our next question comes from Karen Lau from Deutsche Bank.

[Karen Lau, analyst]

So Todd, I think fiscal '18, you've had a heavier level of investment with DiRXN launch and so forth. Can you help me -- 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 the normal incremental margins?

[Todd Adams, executive]

Karen, again I think what we tried to do, if you move back a year or 2, 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 in the way to think about incremental margins because we're really going to do both, right? We're going to leverage the business system and the things that we're doing to take cost out and take waste out and convert a significant amount of that back into growth investment. But at the platform level, we're 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.

[Karen Lau, analyst]

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 of some of the incremental investments that you want to do? Because there's obviously a lot going on with DiRXN, right, there's more you want to do there? Is that the way we should...

[Todd Adams, executive]

Yes, we haven't announced SCOFR II. So I guess what I'm 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've said, we're going to have to do some cost reductions to ensure that we can deliver those sort of incrementals, invest in things like DiRXN. And so we're going to do both, which I think is sort of the message that hopefully we're maybe articulating, which is absolutely, we're 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 about products, bringing more and more connected products to market quickly and building a competitive advantage there. And so we're going to invest in that. But the incremental margin assumption that you've got is good, even with that impact.

[Karen Lau, analyst]

Okay, got it, great. And then just a follow-up on the comment on M&A that you made earlier. So it 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 of rebuilding process in North America that you alluded to earlier, that's more of an organic process?

[Todd Adams, executive]

Yes, we're not going to invest in M&A on the water infrastructure side of our business. Any growth that we would do there would be organic.

[Operator]

Our next question comes from Samuel Eisner from Goldman Sachs.

[Samuel Eisner, analyst]

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

[Mark Peterson, executive]

Sam, this is Mark. I think if you look at PMC, and to a lesser degree, water, the SCOFR benefits coming through were the biggest drivers clearly. We anticipated going into this quarter for the first time to have the full run rate in our PMC platform of our move to Mexico. And we saw that bleed through. I think the SCOFR benefits would be, hands down, the largest driver. When you peel that back out, the incrementals are kind of in the range that you'd expect for the platforms.

[Todd Adams, executive]

Yes, I mean, Sam, this is Todd. I think it's -- we have less fixed cost in the business than what we had 2 years ago. And we're taking that and leveraging reasonable core growth on top of it. And so I wouldn't think about it as absorption. I would just think about it as cost that are gone away that aren't coming back. And so the incremental growth in the margin profile that we've talked about, absent any reinvestment, would be better. I think what we're saying is we're 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're 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 quarter sort of played out in line with what we expected.

[Samuel Eisner, analyst]

That's helpful. And maybe just to 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 of low 20s incrementals in the fourth quarter for the total company? So one, does that makes sense to you? And two, are there any -- it sounds like discrete items, it sounds like corporate expense is a bit higher in that fourth quarter than people would have expected. So I'm just curious, what are the drivers of kind of the lower incremental profitability in the implied fourth quarter guide?

[Mark Peterson, executive]

Sure, yes. Sam, your math is directionally correct. I think in PMC, again you'll see a very strong core incremental margin again. In water, when we talk about a range of 25% to 30%, we think we'll be at the lower end of that range in water given the mix we have 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 at the Rex level in the zip code we talked about if you think about it right.

[Operator]

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

[Rob McCarthy, executive]

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 -- in mid-May. Have a great day.

[Operator]

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