Zurn Elkay Water Solutions Corp Q3 FY2020 Earnings Call

Good morning, and welcome to the Rexnord’s Third 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 the replay for a period of two weeks. The phone numbers for the replay can be found in the earnings release the company filed in an 8-K with the SEC yesterday, January 28. At this time, for opening remarks and introduction, I’ll turn the call over to Rob McCarthy. Please go ahead.

Good morning, and welcome everyone. Before we get started, I need to remind you that this call contains certain forward-looking statements that are subject to the Safe Harbor language contained in the press release that we issued yesterday afternoon as well as in our filings with the SEC. In addition, some comparisons will refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures, why we use them and why we believe they are helpful to investors and contain reconciliations to the corresponding GAAP data. Consistent with prior quarters, we will speak to core growth, adjusted EBITDA, adjusted earnings per share and free cash flow as we feel these non-GAAP metrics provide a better understanding of our operating results. However, these measures are not a substitute for GAAP data, and we urge you to review the GAAP information in our earnings release and in our filings with the SEC. Today’s call will provide an update on our strategic execution, our overall performance for the third quarter of our fiscal 2020 and our outlook for the remainder of the year. We will cover some specifics on our two platforms followed by selected highlights from our financial statements. Afterwards, we will 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. I hope you have had a chance to review our earnings release from last night and have also seen the release we issued on Monday about our enhanced capital allocation strategy. We have a lot to discuss, so I will dive in. Our overall third-quarter results were largely in line with our expectations, continuing the trends observed in the first half of the year. We saw modest core growth, including our product line simplification actions, alongside solid margin expansion that reflects our strong operational execution. Our core growth increased by 1%, which accounts for approximately a 150 basis point impact on our sales growth from our 8020 simplification initiatives. Despite what I would characterize as a generally stagnant growth environment, we achieved year-over-year growth in our adjusted EBITDA and another quarter of over 20% growth in our free cash flow, bringing our year-to-date increase in free cash flow to more than 25%. Our net sales for the third quarter reached $492 million, up 1% compared to last year, accounting for the effect of a stronger U.S. dollar and our product simplification actions. Our adjusted EBITDA rose year-over-year to $107 million, and our margin expanded by 50 basis points. Our incremental drop-through exceeded 50% and was even higher on a core basis, putting us on track for another record year of free cash flow. In our PMC platform, core growth was flat but increased almost 2% after adjusting for our product simplification actions. OE applications across most end markets in North America and Asia met our expectations, while Europe remained relatively weak but showed modest improvement. Our growth in North American distribution improved slightly compared to the September quarter, and we hope to see more demand improvement in the upcoming fourth quarter. Our North American channel inventories are at all-time lows, and inventory turns with partners are at all-time highs, suggesting that any improvement in MRO demand will quickly be reflected in our order rates. The adjusted EBITDA margin for PMC was 22.7%, benefiting from broad growth in aerospace and structural cost reductions from the second wave of our SCOFR initiatives completed last year. In our Water Management platform, core growth registered a solid 3% in the third quarter, as Zurn benefited from steady demand in commercial and institutional plumbing markets and grew its share in adjacent fire protection markets. However, Zurn's core growth was slightly below our target due to an unusually quiet last two weeks of December and aggressive inventory management by channel partners at year-end, which we believe impacted sales by about $2 million to $3 million. Zurn achieved 40 basis points of margin expansion in its adjusted EBITDA margin compared to the record set in last year's third quarter while adeptly managing tariff structures and pricing dynamics, all the while sustaining investments in innovation and market adjacencies. Looking ahead, with nine months behind us and three months to go in fiscal '20, we are narrowing our previous range of adjusted EBITDA to reflect the estimated impact of Boeing's suspension of 737MAX production. While we can mitigate some of the short-term effects, it is now less likely that we will achieve the upper end of our guidance, and we are adjusting our revised adjusted EBITDA range for the year to $460 million to $464 million. We also reaffirm low single-digit core growth for the year, including more than 1.5 from our simplification initiatives. Finally, we expect another record year of free cash flow exceeding our net income. On Monday, our Board approved an enhanced capital allocation strategy, which includes introducing our first-ever quarterly common dividend starting at $0.08 per share, equivalent to $0.32 annually, providing a yield of approximately 1%. We aim to increase the dividend rate annually at a double-digit growth rate for at least the first few years. The Board has also authorized an expansion of our share repurchase program to $300 million, with plans to allocate between $75 million and $150 million annually for regular share repurchases. We believe our equity holds compelling value that has yet to reflect the full impact of the ongoing changes in our growth profile, earnings resilience, and improving free cash flow. While we maintain disciplined investments to drive growth and shareholder returns, we will execute our strategy while keeping a conservative balance sheet and maintaining our net debt to EBITDA ratio within our target range of 2x to 3x. Over the past four years, we have focused on shifting our portfolio composition to yield higher financial returns with lower cyclicality. I've detailed before how we've transitioned towards more stable consumer-facing end markets by exiting project-dependent sectors and expanding our food and beverage segment through innovation and the acquisition of Cambridge, a key supplier to the food processing industry. I've previously discussed our digital strategy and the advancements we've made in introducing digital customer interfaces and families of IoT-connected product solutions. Additionally, we are amplifying these improvements through our 8020 work and product line simplification, which prioritizes our high-potential products and customers. We've implemented structural changes that have freed up internal resources for our digital transformation, while still taking a disciplined approach to acquisitions and expanding margins, resulting in a net leverage ratio below 2x EBITDA and driving returns over 17%. We believe the intrinsic value of Rexnord is significantly higher than its current market valuation. We are prepared to invest part of our free cash flow to repurchase Rexnord shares, confident in earning a return of over 17% on our invested capital, which we anticipate increasing to above 20% in the coming years. Comparing Zurn's adjusted EBITDA margins with those of leading pure water industries that command premium valuations highlights our competitive advantage. Coupled with our aerospace operations, these two segments contribute over half of the company's profit, where we see substantial competitive strengths. In summary, our free cash flow profile supports a moderately leveraged balance sheet, allowing us to provide attractive shareholder returns with manageable volatility while maintaining leverage in the 2x to 3x range. We are introducing a common dividend we intend to grow annually, with plans to allocate a portion of our free cash flow to share repurchases, while retaining flexibility for acquisitions that enhance our competitive strengths and shareholder returns. Our goal is to achieve top quartile shareholder returns among U.S. industrials and work toward a valuation that better represents Rexnord's intrinsic value. With that, I will turn the call over to Mark.

Thanks, Todd. Please turn to Slide number 10. On a consolidated basis, our third quarter of fiscal '20 financial results were broadly in line with our expectations. On a year-over-year basis, our total and core sales growth were both up 1%, net of the impact from our product line simplification actions. Currency and acquisition contributions to growth were offsetting. Our adjusted EBITDA increased by 4% to $107 million and our adjusted EBITDA margin expanded by 50 basis points year-over-year to 21.8%. Please turn to Slide 11. Our outlook for fiscal year 2020 continues to incorporate low single-digit core growth, which is net of an approximately 150 basis point impact from our product line simplification initiatives. We expect our adjusted EBITDA to be in a range of $460 million to $464 million, representing 4% growth at the midpoint, and for our free cash flow to exceed our net income. Our revised outlook for our fiscal '20 adjusted EBITDA incorporates the expected impact of Boeing's decision to suspend assembly of its 737MAX aircraft in mid-January. On Slide 12, we summarize our consolidated results for the quarter. Let's turn to Slide 13 to discuss the first of our two operating platforms, Process & Motion Control. Total sales were essentially flat year-over-year in PMC, with core sales growth also flat and a 1% acquisition contribution, offset by roughly a 1% adverse impact from currency translation. PMC's top line growth was reduced by approximately a 200 basis point impact of our product line simplification or PLS actions. Breaking PMC down by major end markets, we continue to see good growth from our aerospace operations, and we believe we continue to outperform the broader industry in our global food and beverage end markets in terms of both OE and demand generation. Demand in our process industry end markets was generally stable with the demand trends we experienced in our second quarter. In our North American distribution channels, we saw overall sell-through generally stable sequentially and more in line with our sales to distributors as we expected. All-in and with one quarter to go in our fiscal '20, our broader end market growth assumptions as seen on the slide are unchanged. Turning to profitability. Ongoing strong operating execution combined with the benefits of our SCOFR actions delivered 40 basis point expansion in PMC's EBITDA margin despite the flattish top line. We continue to expect PMC margins to increase year-over-year in our fiscal 2020, and structural savings we are realizing from our PLS and SCOFR initiatives, ongoing growth in our aerospace operations and operational execution through the Rexnord Business System are expected to more than offset our ongoing investment spend. One driver of relatively stronger growth in our food and beverage end markets has been the development and introduction of our premium services offerings. Premium services built on our DiRXN architecture and leverage our Smart Tag technology. The QR codes that we attach to all of our products provide immediate shop floor access to valuable resources like product identification, technical literature and how-to videos covering installation, maintenance and replacement. Consumer starts with a complete line survey performed at one of our technical experts and covers the overall line condition for our products as well as competitor products. We analyze the chain life, configuration and speed to enable our complete line condition optimization report with opportunities to improve the timely product identification and operating performance that will ultimately avoid costly unscheduled downtime because of the enhanced capabilities we provide with our Smart Condition Monitoring and Smart Tag technologies. Please turn to Slide 14 to discuss our Water Management platform. During our third quarter, our Water Management platform delivered a 4% increase in net sales growth with 3% core growth and roughly 1% contribution from Stainlessdrains.com, which we acquired in our first quarter. Our PLS initiatives impact the Water Management's core growth by just under 100 basis points in the quarter. Our underlying North American nonresidential construction markets remain supportive of our core growth as illustrated by our unchanged end market outlook that is summarized on the slide. Growth in overall U.S. nonresidential building construction spending improved in our third quarter, although new starts growth has moderated somewhat against more difficult year-over-year comps. Based on our relatively greater exposure to institutional verticals like public education and health care, and our strategic investments in adjacent market growth and the growing momentum we're seeing in our sales funnel for digitally enabled products, we believe we are well positioned to continue to outperform overall construction sector growth. Earlier this week, we closed on our strategic bolt-on acquisition in our Water Management platform with the acquisition of Just Manufacturing, the leading manufacturer of stainless steel sinks that represents a natural addition to the Zurn finished plumbing product line. Adding Just sinks to our Zurn business strengthens our position in several key institutional construction verticals, notably including education and health care, and expands our ability to provide more complete solutions in commercial markets like food service and hospitality. Just is expected to be accretive to Zurn margins and was acquired for about 8x trailing EBITDA after factoring in certain tax benefits. Just will add over $20 million of annual revenue for the Water Management platform. Looking at profitability, Water Management's adjusted EBITDA increased by 5% year-over-year in the third quarter with a solid 37% incremental margin. As a result, Zurn delivered 40 basis points of year-over-year margin expansion as we continue to leverage our core growth, while funding our market expansion, connected product development and cost reduction initiatives. Moving on to Slide 15 and starting with the chart in the far left, our free cash flow continued to grow by more than 20% year-over-year in our third quarter and has increased by more than 25% on a year-to-date basis. We remain confident in our expectations for a record level of free cash flow in fiscal 2020. Moving to the chart in the center, you can see that our financial leverage as measured by our net debt leverage ratio declined to 1.9x and finished the quarter just on the low end of our long-term targeted range of 2x to 3x. During our third quarter, we allocated $20 million of share repurchases under our existing authorization. Earlier this week, our Board authorized expanding our existing share repurchase authorization of $300 million of available capacity. The Board also authorized initiation of an $0.08 quarterly common dividend, which translates to about $39 million of annual dividends based on the roughly 122 million shares outstanding at the end of our fiscal third quarter. During our third quarter, our mandatory convertible preferred shares converted into approximately 16 million new shares of common and eliminated the associated $23 million of annual preferred dividends. Separately, we also repaid $100 million of the outstanding term debt under our credit facility, which we refinanced during the quarter and secured a 25 basis point reduction in the effective interest rates. The combination of the debt pay-down and lower interest rate will reduce our annual interest expense by approximately $5 million. So August 2024 maturity is unchanged. Before we open the call for questions, I will just briefly touch on restructuring expenses and our effective tax rate. First, in terms of our cost reduction initiatives, including our scope of three initiatives, we expect total restructuring expenses of $12 million to $14 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 the varying levels of pre-tax 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 25%. In our fourth quarter, we anticipate the rate will be approximately 27%. Turning to the slide deck appendix, we've included certain other assumptions incorporated into our financial guidance for our fiscal 2020 on a separate slide. I remind you that our guidance excludes the impact of potential acquisitions, potential accounting gains or losses, and future nonrecurring items such as restructuring costs. One last note. After further analysis, it has been determined that an if-converted test is still required when calculating our EPS in our third quarter and for our full fiscal year, even though the mandatory convertible preferred has converted to common shares. As you recall, this requires a calculation that assumes the convertible preferred have converted at the beginning of the period and no preferred dividends would have been paid. This method was used in our third quarter and it was $0.01 diluted to our EPS as it was in the first two quarters of the year. The same method will be necessary for our full fiscal year when the if-converted test will be performed with all preferred dividends as nondeductible from net income and using a share count expected to be approximately 124 million shares. With that, we will open the call up for questions.

Thank you. Our first question today comes from Jeff Hammond from KeyBanc Capital Markets. Your line is open.

Hey, good morning, gentlemen.

Good morning, Jeff.

Good morning, Jeff.

Very good presentation. That was very helpful at the front of the deck. Just on Slide 5, you showed the shift from kind of non-growth to growth and just want to get a sense in that other remaining 26%, how much do you think of that can kind of shift into the green, or if there's any other pairing that you would see in the portfolio that end markets maybe where there isn't the growth profile?

Yes. Jeff, I think it's a great question. I think there is room to move it. I think we've focused on the things that we could do both organically and inorganically that we felt had the biggest opportunity. And so there are always going to be elements of the portfolio that aren't positioned to grow above market, maybe just grow with the market. But I do think there's some room that we can wiggle that percentage a little bit higher, I think we would love to see it at 80 plus, primarily through a combination of things that we are doing strategically as opposed to just sort of selling something or divesting something. So I think we are targeting to move it a little bit forward, but I think the lion's share of the lifting over the last four years has put us in a pretty nice place.

Yes, absolutely. And then Todd, you mentioned Zurn, kind of have an acquired end of the year and channel destocking. Can you just kind of talk about trends into January if that's normalized, where you think inventory levels are? And then just kind of a comment on, yes, I think there's some increasing worry that the non-res cycles are maturing and just what you're seeing there from a quoting and project activity? Thanks.

Sure. I think the end of the year phenomenon had a lot to do with the holidays falling in the middle of the week. So people took the opportunity to really dial things back. The other thing to point out is that January is not a great parameter because it's cold across most of North America. And so I would tell you that I don't see anything abnormal in the way we are starting the fourth quarter relative to maybe what we expected. But as you get through February and March and things warm up in parts of the country, that's when we see things accelerate. So nothing unusual from the way we are starting the quarter and February-March are always where the majority of our fourth quarter comes when it relates to Zurn. Back to your second question on what we are seeing in terms of demand, I would tell you we feel pretty good about where starts are, particularly in some of the institutional verticals as we start our fiscal '21. And I think we would sort of point to albeit slower growth market growth over the course of the next 12 months, still positive. And I think when you couple that with some of the things that we're doing around 8020, we are seeing outsized market growth in those areas as well as player protection and sites, which are both growing substantially above the market. The other thing that Mark mentioned was this acquisition. And if you think about what we've been doing in a pretty methodical way is adding to the size of our available markets. So this just opens up another $100 million to $150 million market opportunity where we’ve a chance to really grow the business through what we’ve in place, tremendous spec share, our third-party reps and the ability to bundle and package this product with all the other water labor savings products that we already have. So I think we are pretty excited about where Zurn sits. And again, I think that the market itself is absolutely in the process of slowing, but I think the resilience of the business through all the things we've done and also this retrofit business that we've built and are building, I think put us in a great spot, even if the market slows. So that’s sort of a long-winded answer to your question, Jeff, but I think that's the way we would hope people would think about it.

Great. Thanks a lot.

And our next question comes from the line of Joe O'Dea from Vertical Research. Your line is open.

Yes. Hi. Good morning, everyone. The first question just on cash flow, I think year-to-date you are up $30 million year-over-year, the prior framework was thinking about free cash flow growth kind of mirroring what we might see in EBITDA growth you're ahead of that pace. So just what you're thinking for the fourth quarter, whether that's a little bit of a get back on the year-to-date gains, or whether we should just be thinking that free cash flow might come in a little stronger.

Yes. Joe, this is Mark. I think if you look at the fourth quarter, obviously it's our always our strongest quarter. I think if you look at kind of the level that we did last year, we will be in that similar ZIP code of the free cash that we did last quarter, obviously plus or minus $3 million to $4 million to $5 million, but Q4 will be strong. We will finish record year this year with momentum going into our fiscal '21 when it comes to free cash.

Great. And then there were a couple of comments in the press release about progress on the connected products direction side of things both within PMC and Water Management. And I was looking for any additional context in terms of what you see is a revenue run rate, or what you see is a revenue growth opportunity over the next 12 months or so?

We have just completed our strategic planning cycle and established a three-year goal of over $100 million. The revenue run rate has been slower than we anticipated initially. However, we believe that fiscal '21 will be a pivotal year as we have refined some of our offerings, developed our go-to-market strategy, and created solutions that our customers truly need. We expect significant growth in our revenue run rate starting in fiscal '21, leading to valuable opportunities in both areas of our business that we couldn't tap into without this solution. For instance, our connected retail stores offer excellent visibility into water safety, quality, and flow control, addressing various aspects within buildings. Customers are very enthusiastic about these solutions, and we have gained valuable insights and experience across our entire portfolio. It is essential to remember that our connected product solutions encompass the widest range of products tailored to our target markets, which is a complex challenge. Additionally, our solution is compatible with any building control or factory automation systems customers may already have, thanks to our cloud accessibility. It is a highly flexible and scalable solution that accommodates a broad range of products. We are excited about this development and anticipate a significant turning point in '21, considering it a $100 million-plus opportunity over the next three years.

And just a clarification. Is that an incremental $100 million? And what would the base be in fiscal '20 roughly?

We do think it's an incremental $100 million and the base is probably close to $20 million.

Okay. Thanks very much.

Our next question comes from the line of Bryan Blair from Oppenheimer. Your line is open.

Good morning, everyone. Solid quarter.

Good morning. Thanks, Bryan.

Thanks, Bryan.

Question on portfolio composition over time. You signaled and started to act on Zurn weighted M&A, is the idea to have relatively balanced revenue and EBITDA contribution from the platforms over time, or is that too rigid a construct?

Bryan, I think that we haven't said that as a sort of discrete goal. But I think our view is that adding more heft to the water platform certainly can't hurt us in terms of the way the company is valued or thought. And so if you were to look at the priorities that we laid out on one of those pages, water-related M&A is our number one priority with a second to consumer-facing end market-related applications in PMC. So, I don't think we’re looking at expanding through M&A and things related to Process industries because we’ve got such a terrific share already. And so without question, I think we're going to target those areas, but without a mandate to do it in this period of time. We are going to continue to stay disciplined. And if you look at the acquisitions that we’ve done over time and frankly, when we just talked about in Just, we are retaining the discipline of financial profile that creates a great return, while adding significant runway to these businesses that we can bolt on and run with quickly.

All makes sense. And just a clarification point on, Jeff. Did you say that margin accretive to Zurn?

Yes, that's correct.

Yes, that's impressive. One last one, if I could. On SCOFR 3, any update you can offer on how that's progressing? And if there's further line of sight on the timing of cost savings, how much of that we should expect to hit in fiscal '21?

So we've started to make some internal announcements. You will see some costs in our fourth quarter related to that. You will see some incremental costs to implement as we start our fiscal '21; we will outline what those are. But it's sort of in the $5 million to $7 million range of cost to implement in our fiscal '21. Maybe just a little bit in our fourth quarter, and we should start to see some level of benefit from those efforts towards the end of fiscal '21. So think about it as a little bit of upfront spending just like we did in SCOFR 1, just like we did in SCOFR 2, but then that spending goes away, and we begin to accrete all the fixed cost and cash flow benefits from the actions. And so a little bit in fourth quarter, a little bit in the first part of the year, $5 million to $7 million, a little bit of benefit in the fourth quarter of our fiscal '21 with the run rate really starting in our fiscal '22.

Okay. I appreciate the color.

Our next question comes from the line of Andrew Obin from Bank of America. Your line is open.

Hey, good morning. This is Emily Shu on for Andrew Obin.

Good morning, Emily.

Good morning, Emily.

Good morning. So my first question. So I noticed the outlook for commercial aerospace in PMC has a green light. Has that changed, given you know there's some risk from Boeing 737MAX production halt in the first half of 2020 and also the Coronavirus outbreak reducing basically air traffic?

Yes, we are aware of the production changes related to the 737MAX and the impact of the Coronavirus. The green light indicates an optimistic outlook despite these challenges. Like many others, we believe there will be a resolution to the issues with the MAX, although it is difficult to gauge the long-term effects of the virus situation. Currently, we have a record backlog in our aerospace business and anticipate some short-term obstacles due to the slowed production rate of the 737MAX. However, we remain hopeful for a resolution to the virus in China. We believe there are still good years ahead in the aerospace cycle, which is why we maintain a positive outlook. While we are not ignoring the challenges mentioned, we are realistic in expecting that most issues will be resolved relatively soon, and we have many opportunities ahead.

Okay, great. And just a follow-up question. Is there any January data that you could provide on your industrial distribution businesses? Are there any early signs of green shoots or anything you're hearing in the channel that would give you confidence of short cycle recovery in fiscal '21?

Well, again, I think we are not looking out into fiscal '21; we're not guiding to that yet. I think the data that we’ve so far in January supports kind of the thesis that I spoke about Mark laid out, which is the fourth quarter is sort of tracking to what we had anticipated to deliver that low single-digit core growth number, EBITDA, that will end up being a record and record free cash flow. So I think we will get to fiscal '21 in a couple of months, but so far everything seems to be tracking in line with the way we've guided and really no surprises.

Okay, great. Thank you so much.

Our next question comes from the line of Mig Dobre from Baird. Your line is open.

Thank you. Good morning, guys.

Good morning, Mig.

Good morning, Mig.

Yes. Just wanted to follow-up on the 737 question. Can you …

Sure.

… maybe help us understand, better understand the impact in the fourth quarter on the top line for PMC. And I think it's pretty clear on EBITDA given that you said that accounts for your changing in guidance, but, yes, I’m curious on the top line and how you sort of think this will play out over the next couple of quarters based on what you've heard from your customers?

Sure. So the run rate, Mig, of our MAX exposure is in that sort of $22 million to $25 million range. So you can look at what that is per quarter. In our fourth quarter, that gets impacted by $3 million to $4 million, and the related profitability on that is sort of the majority of the change to the top end of our prior EBITDA guidance. If we were to look ahead, we are assuming that the run rate in our fiscal '21 is substantially lower, at least through the first half, if not the full year based on what we've been told. So we've been told to modify the production rates down to that 20 to 30 range over the course of the year. If you were just to look at it on a digital basis, it would impact next year by $7 million to $10 million. Now we think there's opportunities for us to go win some additional business with the capacity that we have. And so I wouldn't flag really an issue at this point other than to say production rates at least for the next six months, maybe nine months are going to be a little bit less than what they were running at the first nine months of the year. Those aircraft, we believe, still get delivered. So maybe it just pushes a little bit. In the meantime, I think we've highlighted the fact that we've got an amazing center of excellence that is a competitive weapon that we can win business with, and we're using that to try to fill some of that dividend in the near term. Frankly, we're doing our best to fill some of that dividend in the fourth quarter with that capacity. And so that's what we think happens. But as you can see, the relative impact is pretty low for us relative to the size of our aerospace business and the size of Rexnord. It's just a little bit of an acute issue in the fourth quarter as we dial that back very quickly and deal with sort of the incremental profitability challenges when you do that. But it hurts, but it's certainly not something that we're overly concerned with at this point.

Okay, great. Thanks for clarifying that. Then the next question I had was on product line simplification.

Sure.

And you know I'm wondering really what you're doing here, I mean, I understand the concept, but I'm wondering what you've done through the year. And can you maybe help us understand if this is a continued drag going forward? Was there something special about fiscal '20 just the puts and takes?

When we began the process, we had to evaluate our '20s customers and products, making difficult decisions about either exiting certain markets or increasing prices. By the end of our fiscal '20, most of that work was largely completed. There will still be some ongoing adjustments as we reassess, but I expect this to be less significant in fiscal '21 compared to fiscal '20. We are currently focusing on growth. The resources we've optimized by concentrating on our most valuable customers and our most profitable products are now being directed towards growth opportunities. The 8020 initiative helps reduce costs, but its primary goal is to reallocate resources to achieve above-market growth. This is evident when we examine the progress in various segments of Zurn and our consumer-facing markets within PMC. The chart in the presentation illustrates our product line revenue, showing where we stand today compared to three years ago. We've indicated the drag for this year, and I hope you start noticing market outgrowth in specific areas. For instance, in our beverage business, we've streamlined the metal product line by reducing 60% to 70% of the SKUs, yet we’re seeing 12% to 14% growth this year with strong margins. These developments will contribute to the incremental growth we anticipate in '21 from these initiatives.

Great. Lastly, a question on pricing. Is there any updated thoughts there in terms of trends? And I know you're not talking about '21, but I'm going to ask it anyway as you think about pricing into '21, is there anything different versus '20 at segment level that you would call out?

Mig, this is Mark. As the year has progressed, the price impact has eased compared to last year. In the recent quarter, we saw just under a point in PMC and a couple of points to 0.5 in water, indicating that the overall impact is moderating as we compare against the price increases we implemented last year. Assuming the tariff environment remains stable from our current perspective, I expect pricing next year to be moderate for us. It will not be as severe or challenging as it has been in the past year and a half.

I think maybe to put a fine point on it, Mig, the incremental margins in the third quarter were about 50%, and that's what probably very little price dividend. So as we transitioned in the fourth quarter in the next year, most of the incremental profitability comes from the operating leverage from RBS and the things we're doing there 8020 and then obviously the net impact of all the scope for initiatives that’s done in our implementing. And so we expect that to sort of keep the incremental margins in that 35% range as we've been communicating.

Absent the SCOFR.

I believe Mark explained it well, and I am optimistic that our incremental margin will remain at a very high level as we move into a more normalized input cost environment.

Very helpful. Thank you.

Our next question comes from the line of Julian Mitchell from Barclays. Your line is open.

Good morning. This is someone filling in for Julian. Looking at PMC as we exit the second quarter, it appears that you all have adopted a more cautious outlook, although core growth for the quarter was stronger than anticipated. Were there any end-markets that exceeded expectations this quarter? Additionally, could you elaborate on your observations from the end-markets by geography, specifically for food and beverage in North America compared to Europe, as well as any trends you noticed in processing through January?

I will try to walk through that.

There's a lot to unpack there.

In our third quarter, PMC's sales growth aligned with our expectations. There were no unusual factors affecting this growth. As we look toward the fourth quarter, market conditions remain generally stable but somewhat muted, similar to what we experienced in the second quarter. Moving into the fourth quarter, we anticipate some impact from Boeing and face tougher comparisons, particularly due to a couple of projects in the process industry that will not repeat this year. Consequently, we expect our core growth to decline by a few points for those reasons. When examining the end markets by geography, they are consistent with our previous discussions. The food and beverage sector has been strong for us, driven by our efforts in simplification and new products. We've seen good growth from our European operations, which also serve North America. In the process industries, North America remains stable, while Europe has been weak, both in original equipment and maintenance, repair, and operations. Asia represents a smaller segment for us, where we are working to gain market share. Please let me know if I've overlooked anything.

That's all of it. Thank you. That's very helpful. And then just maybe one on just manufacturing. Is there any significant seasonality within that business that we should be aware of? And then, maybe just from a higher level perspective, if you could elaborate a little bit more on kind of how that fits within Zurn's current distribution?

Yes, I believe it will align with the traditional cycle we observe at Zurn. There will be no deviations from the seasonal patterns we usually see in North America. It is a valuable addition to our portfolio and fits perfectly into our focus on education and healthcare within our institutional sectors. Overall, this acquisition is straightforward and strategically sound. It enhances our strongest verticals and expands our product range, making Zurn more relevant than before the acquisition and allowing for accelerated growth in this product category, thanks to our established commercial framework. We are truly excited about the potential of this product category under the Zurn brand.

Great. Thanks so much, guys.

Joe Ritchie from Goldman Sachs. Your line is open. Joe Ritchie, your line is open. We have no further questions in queue.

So this is Rob McCarthy. Thanks everybody who was able to join us on the call today. And we will look for Joe, see if we can find him. We appreciate your interest in Rexnord and we look forward to providing our next update when we announce our fiscal year 2020 fourth quarter results in May. Have a great day.

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