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Rexnord Corporation (NYSE:RXN)
Q4 2018 Earnings Conference Call
May. 15, 2018 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Rexnord fourth-quarter fiscal 2018 earnings results conference call with Todd Adams, president and chief executive officer; Mark Peterson, senior vice president and chief financial officer; and Rob McCarthy, vice president of investor relations for Rexnord. This call is being recorded and will be available on replay for a period of two weeks. The phone numbers for the replay can be found in the earnings release the company filed in an 8-K with the SEC yesterday, May 14. At this time, for opening remarks and introductions, I'll turn the call over to Rob McCarthy.

Rob McCarthy -- Vice President Investor Relations

Good morning, and welcome, everyone. Before we get started, I need to remind you that this call contains certain forward-looking statements that are subject to the safe harbor language contained in the press release that we issued yesterday afternoon as well as in our filings with the SEC. In addition, some comparisons will refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures, why we use them and why we believe they are helpful to investors and contain reconciliations to the corresponding GAAP data.

Consistent with prior quarters, we will speak to core growth, adjusted EBITDA, adjusted earnings per share and free cash flow as we feel these non-GAAP metrics provide a better understanding of our operating results. However, these measures are not a substitute for GAAP data, and we urge you to review the GAAP information in our earnings release and 10-Q. Please note that the presentation of our operating results includes adjustments to GAAP reporting for the impact of the RHF non-core product line in our water management segment that we exited during our fiscal 2017 in order to enable investors to better understand and assess our continuing core operating results. This is the last quarter in which the RHF product line exits will have an effect on our year-over-year comparison.

Today's call will provide an update on our strategic execution, our overall core performance for the fourth quarter of our fiscal 2018, and our initial outlook for our fiscal year 2019. We'll cover some specifics on the two platforms, followed by selected highlights from our financial statements and our cash flow. And afterward, we will open up the call for your questions. With that, I'm pleased to turn the call over to Todd Adams, president and CEO of Rexnord.

Todd Adams -- President and Chief Executive Officer

Thanks, Rob, and good morning, everyone. As you hopefully saw in our release last night, our fourth-quarter results capped what was a strong year for Rexnord, with our core growth accelerating through the year, our adjusted EBITDA exceeding our guidance, and our free cash flow growing 33% year over year to $188 million. We're seeing reasonable growth in most of our served end markets and more importantly, our organic initiatives around innovation, cost reduction, and commercial excellence are beginning to reap fruit. Incremental to that and as we've been previewing with you the past couple of quarters, this morning we'll take you through the next phase of our supply chain optimization and footprint repositioning initiative, one that will reduce our structural fixed costs by another $15 million over next year with a very high return and with less complexity than SCOFR 1.

Finally, we're initiating our financial outlook for fiscal 2019 that includes the decision to prioritize our focus within the water management platform around our Zurn business and exit VAG.Our outlook for the fiscal year 2019 includes mid-single-digit core growth -- both acquisitions and currency will be on top of that -- EBITDA in the range of $420 million to $440 million and another year of robust free cash flow. Again, just for clarity, our guidance excludes VAG, which we think will generate about $230 million of revenues with a high single-digit EBITDA margin over the next year.Looking at the fourth quarter in isolation, sales of $575 million included core growth of 7% and were up 14% on a reported basis and were at the higher end of our expectations for the quarter. We sustained 6% core growth in our PMC platform and the core growth in our water management platform accelerated to 8% and 7%, excluding VAG. We were able to leverage that growth into 13% adjusted EBITDA growth, which increased to $111 million as strong incremental margin in PMC led the improvement.

Adjusted EPS in the quarter was $0.42. Mark will review both the consolidated results and the performance of each platform as part of his comments a little later in the call.If we can turn to Slide 3, looking at our operating platforms, our PMC platform had a strong quarter, with order and revenue growth across most of our process industry, consumer industry sectors, as well as our aerospace end markets. We also experienced an acceleration in the sell-through of our products for our distribution channels as we wrapped up the year and to start the fiscal year 2019.We continue to aggressively move the ball forward with our DiRXN digital strategy and customer feedback is validating our significantly differentiated and practical approach to the industrial Internet of Things. In fact, we intend to accelerate the pace, in which we are introducing additional categories of products.

That can be easily plugged into a customer's existing control system and thereby immediately enhancing the customer's process reliability and productivity with minimal incremental investment. Our success with our commercial excellence initiatives in the fourth quarter enabled us to exceed our fiscal year target of 50% growth in first-fit wins to right around $50 million, which is our third year of traction on this key initiative to drive long-term market share. As we win a stronger share of initial specifications, which we can, in turn leverage into a growing share of MRO requirements as our components wear in use and are serviced and replaced multiple times over the life of the customer's application.PMC margins were solid as adjusted EBITDA margin improved to 150 basis points year over year to 23.8%. Margins benefited from past SCOFR actions and our core growth, delivering a core incremental margin exceeding 60% for the quarter.

Centa, which we acquired in February, delivered good results over the partial quarter and I'll provide an update on our early progress there in just a few minutes.Results in our water management platform were solid, with the fourth quarter of core growth, excluding VAG, at 7% as contributions from our innovation pipeline continue to accelerate. We continue to see a positive underlying trend in Zurn's primarily North American, non-residential construction markets, particularly within the institution of verticals. And we continue to invest in core product and adjacency innovation while the digital initiatives are beginning to accelerate within Zurn.Our free cash flow finished the year strong, increasing to $188 million and delivering another year of conversion in excess of 100% of net income. At the same time, our leverage ratio declined to 2.7 times EBITDA, inclusive of the Centa acquisition in the quarter, and demonstrates our ability to execute a disciplined acquisition strategy while maintaining our leverage ratio in the 2 to 3 times range.Overall, we finished our fiscal 2018 with another year of steady operational execution, strong free cash flow, and improved trajectory, innovation, growth, and cost reduction, and completed two very complementary strategic acquisitions that expand our addressable markets and then offer substantial value-creation opportunities as we deploy the Rexnord Business System.

Before I move on to the next slide, hopefully, many of you recall last year that we modified our approach to external financial guidance at the start of the year, focusing on core growth, adjusted EBITDA, and free cash flow, all on an annual basis and then upgrading any change to those elements as we report earnings throughout the year.From an approach perspective, we also made a concerted effort to start each year with an appropriate amount of conservatism built into these elements of guidance, given that our objective both then and now, is to provide what we hope investors appreciate: projections that are meant to be somewhat durable over the course of the next 12 months. The way to interpret this year's outlook is that we've intended to do the very same thing as we started our fiscal 2019, which extends to March of 2019.With that, please turn to Slide 4. As we disclosed in last night's release, we plan to focus and prioritize our water management platform around our Zurn operations that provide and enhance water quality, safety, flow control, and conservation in primarily North American non-residential building applications.As a result, we have initiated a process to divest our VAG operations that serve global water and wastewater infrastructure markets. After a thorough review, we decided that VAG does not have a strong strategic fit as was contemplated when it was acquired during our time as a controlled company, and we have concluded that shareholders' capital is more productively deployed elsewhere.VAG has significant capabilities in Europe, China, and the Middle East, a globally recognized brand, and an experienced and dedicated team that we're confident makes it an attractive business to both strategic buyers as well as financial buyers.

We're not going to say much more on the planned divestiture given that the sale process is under way and we'll provide more updates as we're able. We expect to report VAG operating results as discontinued operations when we report our first quarter, and we are targeting a transaction in the first half of our fiscal 2019 with the proceeds available to reduce our financial leverage and enhance our strategic flexibility.One effect of our updated strategy for the water management platform is that investors will now have a clear view of the growth and profitability characteristics of our Zurn business. Zurn is a leader in the specification-grade plumbing products market in North America with a strong competitive position in later-cycle institutional markets, which are currently strengthening.In our fiscal 2018, Zurn delivered $610 million of revenue, with core growth of 4% and closer to 6% in the second half of the year. For the full year, adjusted EBITDA margin increased by 120 basis points year over year to 25.1% while observing increased investment in our innovation pipeline and including development work on making our products digitally connectable.

The slide highlights four important new products at Zurn that occurred in our fiscal 2018. First being a new series of stainless steel backflow devices for compact installations types [ph]. Second, our installation time-saving EZ1 lineup of floor drains. Our contractor-friendly expansion PEX system.

And finally, the Sundara line of solid-surface integrated hand washing systems. These products all contributed to Zurn's core growth in fiscal 2018 but we expect a more significant impact in our fiscal 2019 as more model choices are becoming available and stronger channel inventories are broadening the product availability.Additionally, we began putting smart ID tags on most of Zurn products during the year in order to bring the same enhanced convenience and productivity to Zurn customers that we are delivering to PMC customers through our DiRXN initiative. Our initial designs of fully connected valves are in the field test, and we expect to begin commercial shipments during our fiscal 2019.Turning to Slide 5, I'd like to review the next wave of actions within our strategic supply chain optimization and the footprint repositioning initiatives. We're calling this SCOFR 2.0 and we have already launched certain actions in our fiscal 2018.

We plan to invest a total of approximately $20 million and expect to structurally reduce our annual fixed cost by $15 million. This set of actions will affect both platforms, and we expect our adjusted EBITDA to include a modest net positive contribution in our current fiscal year 2019 with most of the earnings benefit accruing in our fiscal 2020. On the slide, you can see an artist rendering of our new Aerospace Center of Excellence, which is currently under construction and represents the largest single investment in the current set of actions.Turning to Slide 6, let me briefly highlight the impact of this new facility that we expect will deliver value to both our customers and shareholders. The facility is not designed to operate as an entirely digital environment with integrated processes that will link initial product development to the order process, to product engineering, and onto the plant floor for manufacturing, assembly, inspection, and shipment.

This closed-loop set of digital processes will enhance our customers' operating productivity by promoting and simplifying joint collaboration and design and engineering, and by eliminating inefficiencies and ensuring accuracy through the value chain.Besides the facility itself, the investment also includes advanced manufacturing and material handling techniques that we expect will enhance asset utilization, reduce product development and order lead times, and ultimately, deliver best-in-class customer satisfaction. The slide includes an aerial photo from about a month ago, but you might not be able to tell that the manufacturing space is fully enclosed, and we've been installing and programming equipment and developing production and assembly cells in order to ensure a smooth transition as we move into the facility later this year and begin to deliver the targeted benefits in our fiscal 2020.Other initiatives involving product line simplification, reconfiguration of plant layouts, and facility rationalization within SCOFR 2.0 are also under way and the Rexnord Business System supports our confidence that we can deliver the targeted benefits on the identified timeline.Moving to Slide 7, Let me provide a quick update on our two recent acquisitions, Centa in our PMC platform and World Dryer in our water management platform. As you may recall, we closed the Centa acquisition in February, adding about $100 million of annual revenue and a leading position in the global market for torsionally soft, flexible couplings that are used to protect the power source and downstream components in engine-driven applications. Centa has no overlap with our existing product lines, broadens our end-market diversification and our addressable markets, and generates the majority of its sale from MRO requirements in its large installed base.Integration is well under way and through our initial deployment of RBS, we're validating the significant margin expansion and growth synergies that we identified during our due diligence.

We're off to a good start at Centa, which contribute 5% to PMC's growth in the fourth quarter with its margins ahead of the year-over-year quarter.Moving on to water. We acquired World Dryer in October and our experience there is also validating our investment case. The integration is mostly complete and the customer base is receptive to a more aggressively managed and innovative competitor and to the value of sourcing more commercial washroom content from a single supplier.Margins are in line with the Zurn average, and we're continuing to use voice-of-the-customer inputs to guide our simplification of World Dryer's previously over-complex product line in order to free up and enhance productivity, improve customer experience, and free up incremental resources to support product development and innovation.Before I turn the call over to Mark, I'll briefly touch on the price/cost equation that's probably at the top of most people's minds. I'll start by saying that inherently, our fundamental business model performs are [ph] very well in periods where we see inflation, with a very high like-for-like aftermarket element of PMC sold through distribution, [Inaudible] practices that allow us to increase prices in a matter of days or weeks on a very targeted basis, a well-developed, high-performing supply chain function with true global reach, and not to mention best-in-industry brands and the broadest portfolio component products with true pricing power, which applies both to PMC and Zurn.

Finally, by leveraging the Rexnord Business System, we've got a near real-time view of the trends and countermeasures that we're confident, keep us in front of the price/cost curve, because it's being actively managed every day and it's actually something we expect to work in our favor over the course of fiscal year 2019. But we're not taking it lightly. And as we look at a year, we're going to continue to stay ahead of the curve with what is likely a SCOFR 3.0, but only as we wrap up SCOFR 2.0 by late this year and into early fiscal 2020. With that, I'll turn the call over to Mark.

Mark Peterson -- Chief Financial Officer

Thanks, Todd. Please turn to Slide No. 8. On a consolidated basis, our fourth-quarter fiscal 2018 financial results were certainly ahead of our expectations.

Our core sales increased 7% on a year-over-year basis. Our adjusted EBITDA increased 13% in the prior-year fourth quarter to $111 million and our adjusted earnings per share increased by 20% to $0.43. For the full year, our total revenue grew 8% with core growth improving the 5%. Adjusted EBITDA increased 13% year over year to $390 million and our margins increased by 70 basis points to 18.9%.

Adjusted EPS increased to $1.39.Let's turn to Slide No. 9. Our outlook for fiscal 2019 incorporates mid-single-digit core sales growth and 9% to 14% growth in our comparable adjusted EBITDA to a range from $420 million to $440 million and we expect to deliver another year with free cash flow ahead of net income. Please note that our outlook excludes our VAG operations, which we anticipate reporting as discontinued operations when we report the upcoming first quarter of our fiscal 2019.

Moving to Slide 10. Here we're presenting a bridge into the midpoint of our fiscal 2019 outlook for adjusted EBITDA. As you see on the slide, the jumping-off point is adjusted for the required adoption in our fiscal 2019 of an accounting standard that changes the P&L geography of certain pension accounting items and requires a restatement of the prior year as we report each quarter, with an overall annual drag of approximately $3 million to our fiscal '18. In addition, we are removing VAG from the FY '18 reported EBITDA number as our fiscal '19 outlook excludes the VAG operation.

The key elements of the bridge include the incremental year-over-year benefit from the fiscal '18 acquisitions of Centa and World Dryer and an overall net increase in our EBITDA from our operations. As Todd highlighted in his earlier comments, we are following the same approach we established last year with respect to our annual outlook, and that is to provide an outlook that is meant to be durable over the course of the 12 months. Turning to Slide 11, we summarize our consolidated results for the quarter. Let's move on to Slide 12 and discuss the first of our two operating platforms, process and motion control.

In PMC, total sales increased 15% year over year, with core sales growth of 6% in the fourth quarter, in line with PMC's core growth in the third quarter. Currency translation added 4% and the acquisition of Centa added 5%. PMC experienced solid growth in the aerospace end market and in most of the process industry and consumer-facing end markets during the quarter, and we saw improving growth in our distribution channels, including a flow-through [ph] of somewhat stronger retail sell-through [ph] in North America. 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 of PMC that is incorporated into our fiscal '19 guidance.

Our fiscal '19 outlook assumes positive growth across PMC's primary end markets in the process, [Inaudible], and aerospace sectors and in our distribution channels. PMC's EBITDA and margins were certainly ahead of our expectations, as adjusted EBITDA increased 23% year over year and margin improved year over year by 150 basis points to 23.2%. PMC benefited from strong operational execution, pricing was positive, and we were successful in managing the modest impact in material cost inflation in the quarter. The structural benefits from the first phase of our supply chain optimization and footprint repositioning initiatives were fully reflected in PMC's fourth-quarter results, and the first half of our fiscal '19, we will benefit as we fully annualize the benefits SCOFR 1.

As Todd discussed, we also expect [Inaudible] somewhat modest net benefit in our fiscal '19 for the second wave of SCOFR actions, while we fund incremental investments we're planning to accelerate the introduction of our more digitally connected product families as well as [Inaudible] opportunities. We're also aggressively managing our input costs. We are confident in our ability to stay in front of the price/cost curve. So on a net-net basis, we are confident that PMC can deliver additional margin expansion in fiscal 2019.

As you expect, PMC's margin is expected to decline sequentially in our first quarter, reflecting normal seasonality and the lower absolute dollar value core sales when compared with our last quarter. I'd also like to provide a brief update on the progress that we have achieved with our digital customer productivity platform that was formally launched a year ago this month. In our first year of implementation, we successfully launched and built out our DiRXN digital port, through which our customers can improve their productivity as they manage their entire lifecycle of their products in the digital environment. We're handling a growing share of our customer interactions and transactions through this platform, where our customers can access technical files and other engineering resources, configure products through a simple application, quickly acquire pricing and delivery information, place an order and later register the product, and access how-to videos as well as maintenance support.

The majority of the PMC's products are now being shipped with smart ID tags that provide instant, on-the-spot access to all the support in the e-commerce port, where you can order a replacement when necessary. In our fiscal 2018, we successfully launched connected versions of our [Inaudible] gearbox and PMC met their initial targets for commercial orders across a range of end-market applications. As Todd discussed earlier, we expect to introduce digitally connected versions across several other product categories during our fiscal 2019. We're also launching a common digital architecture at Zurn's in support of tags and connected products.

Zurn has expanded its e-commerce capabilities, now has digital capabilities in place to support [Inaudible] products as well.We'll turn to Slide 13 and discuss our water management platform. During our fourth quarter, our water management platform delivered a 13% net sales increase that was a function of 8% year-over-year core sales growth, a 2% contribution from World Dryer, and a 3% contribution from foreign currency translation. Top-line results in line with our customer expectations and benefited from high single-digit year-over-year core growth at both Zurn and VAG. In our fourth quarter, sales of Zurn commercial [Inaudible] plumbing products increased by 7% on a core basis, plus a 2-point contribution from the World Dryer acquisition.

Zurn's growth benefited from the launch of several important new products during the year, including those profiled earlier as well as Zurn's new threshold and elevator drain system, as pictured on this slide. As illustrated by our underlying end-market outlook, we expect Zurn's momentum to carry it through our fiscal '19 and we feel confident that Zurn can deliver mid-single-digit core growth in what is shaping up to be another strong year for U.S. nonresidential construction activity. Although these year-over-year comparisons for Dodge's preliminary estimates for the U.S., non-res started to weaken in the March quarter the Dodge Momentum Index, which measures projects in the design stage of development and is a leading indicator for starts, has resumed its upward trend in March and April.

Turning to VAG, our product-oriented business serving water and wastewater infrastructure markets, fourth-quarter results include high single-digit core growth and adverse project mix when compared to our expectations coming into the quarter. Water management's overall EBITDA margin was modestly below our expectations for the fourth quarter as the benefits from volume growth during the quarter and a positive price-cost gap were more than offset by the adverse mix of VAG, which was amplified by the stronger euro plus higher incentive compensation accruals and accelerated investments in our innovation initiatives. For the full year, water management's adjusted EBITDA margin was up 20 basis points, driven by the 120-basis-point increase delivered by Zurn. We remain confident in Zurn's ability to manage a rising material cost through a combination of material cost action, supply chain management, and selective price increases, and we anticipate a favorable growth environment to support additional margin expansion for Zurn in our fiscal '19.

Moving to Slide 14, you can see in the chart at top left that our financial leverage, as measured by our net debt leverage ratio, benefited from our strong free cash flow and declined to 2.7 times despite closing the Centa acquisition in the quarter. For the full year, we delivered free cash flow of $188 million. Our short-term [ph] liquidity remains robust. We refinanced our debt during the year to reduce interest expense [Inaudible] some maturities and our forward outlook supports our expectations for free cash flow growth over fiscal '19.

Given our expectations for free cash flow to expand in fiscal '19 and given our strong overall liquidity, we believe we have ample resources to continue to execute our bolt-on acquisition strategy while maintaining our leverage ratio in a range between 2 and 3 times. Before we open the call up for questions, I'd like to comment on our accounting for VAG and restructuring expenses and our effective tax rate, as well as call your attention to the slide in the appendix through our next presentation. First, our fourth quarter includes a $111 million impairment charge to eliminate goodwill associated with the VAG operations as a result of our plans to pursue sales of the business. As we've discussed, we anticipate recording VAG as discontinued operations in our first quarter of fiscal '19.

Second, in the terms of our cost-reduction initiatives, we anticipate total restructuring expenses of $11 million to $13 million in our fiscal '19. We saw some [Inaudible] severance costs and will be 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 our planning initiatives. We anticipate our fiscal '19 adjusted net income [Inaudible] an effective tax rate of approximately 29%.

Excluding our VAG operations, we were anticipating effective tax rate of approximately 26% for fiscal 2019 but during our continued analysis of the new tax law, we determined that we will be adversely impacted by a provision in the new tax known as GILTY, or global intangible low tax income, that will increase our effective rate by approximately 3 percentage points. Long story short, this provision was intended to tax foreign earnings in the U.S. that were in tax jurisdictions with a rate at or below approximately 13.1%. While we do not have any foreign earnings that are out of jurisdiction, the way the law is currently written, we and other companies with a similar profile have gotten caught up in the section of the new law and as a result, certain foreign earnings are now also getting taxed in the U.S.

Over time, we expect to identify discrete tax-planning strategies that can help reduce our effective tax rate. With respect to our first quarter, we anticipate a tax rate of 30% to 31% to be applied to our adjusted net income.Turning to slides in the appendix. First, we've included certain other assumptions incorporated into our guidance for fiscal '19 on a separate slide. I need to remind you that our guidance excludes results of VAG going forward, the impact of potential acquisitions, including potential accounting gains or losses, and future non-recurring items such as restructuring costs.

Second, we've included the fiscal '18 platform sales excluding our VAG end markets, broken down by served end markets and by geographical location and pro forma to include the acquisition of Centa and World Dryer. Third, we've attached a reference table to help you determine the appropriate incremental quarterly share counts we used for modeling our adjusted [Inaudible] earnings per share under the if-converted method if applicable. As you are aware and as illustrated on Slide 16, the if-converted method was dilutive to adjusted EPS by a penny in our fourth quarter but was not dilutive to our full fiscal 2018 and therefore did not apply. Lastly, we include several of pre-tax and after-tax impacts of each adjustment in our calculation of adjusted net income, from the reconciliations [Inaudible] to adjusted EBITDA and adjusted earnings per share that are included in our earnings release each quarter.

With that, we'll open the call up to questions. [Silence]

Questions and Answers:

Operator

Please stand by. [Silence]

OK. And our first question is from Jeff Hammond with KeyBanc Capital Markets.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Hey. Good morning, guys.

Todd Adams -- President and Chief Executive Officer

Hey, Jeff. Apologize to everyone. Somebody hit the drop button instead of the volume button, and that would be me. So, my mistake.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

So, just, I think you highlighted the aerospace piece as part of SCOFR 2.0 and PMC but can you talk about the split between Zurn and PMC in terms of the spend and savings for SCOFR 2.0. And then just as you look at Zurn on a stand-alone, margin's very good out of the gate as we see them alone. What's kind of a long-run margin opportunity for Zurn from your perspective?

Todd Adams -- President and Chief Executive Officer

Sure. The way to think about the split between the cost and the benefit amid for two platforms, it's probably two-thirds PMC, one-third water management, both on the cost and the benefits side, Jeff. And in terms of the long-term margin runway, we continue to see, I would say, reasonable demand. The combination of that with the SCOFR reductions and ongoing new products we think gives us runway for a bit.

And I don't know, the top is another 200 basis points or another 300 basis points but clearly, the business is performing well and the things we're doing around the cost structure, as well as new products we think, give us pretty good confidence in our ability to continue to expand margins over time.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

OK, great. And then how should we think about incremental margins in PMC within the fiscal 2019 guidance? Thanks.

Mark Peterson -- Chief Financial Officer

Jeff, this is Mark. I think the incremental we talked about PMC in the past being 30% to 35%, I think on a core basis still [Inaudible] better than that, obviously from SCOFR. One benefit coming through in some early benefit from SCOFR 2.0. So think about incremental above that 30% to 35% range for the full year of PMC, Jeff.

Todd Adams -- President and Chief Executive Officer

And Jeff, you recall the margins will be more pronounced in the first half of the year as we pick up the full run rate in our first half. And so that's what's driving the incrementals for the year but it's more front half of the year weighted.

Mark Peterson -- Chief Financial Officer

Yeah, and to be clear, the core incremental [Inaudible]

Todd Adams -- President and Chief Executive Officer

Correct.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Then what's the carryover savings from SCOFR 1 that goes into PMC and into fiscal 2019?

Mark Peterson -- Chief Financial Officer

Approximately $7 million. The majority of that is in the first half.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

OK, thanks, guys.

Operator

Our next question is from Mig Dobre from Baird.

Mig Dobre -- Robert W. Baird & Company -- Analyst

Yes, thank you. Good morning everyone. If we can, I'd like to talk a little bit about VAG and maybe kind of doing a little bit of a postmortem of fiscal 2018. Obviously, this business has been uneven through the year and EBITDA contribution is lower than the way you're kind of talking about the business contributing to fiscal 2019.

So I guess two questions, maybe some color as to what happened in fiscal 2018. And then it looks to me like Zurn has performed maybe better than you were initially expecting to be able to sort of crowd out the noise from VAG. What kind of happened there? And how sustainable is that performance?

Todd Adams -- President and Chief Executive Officer

Mig, in terms of the performance of each of the pieces, I'll step back and say, VAG had an uncharacteristically difficult sort of second half of the year, really driven by, I think a couple of decisions that we've made to accelerate some restructuring pull forward, recognize some costs over the course of our second half and into our fiscal 2018, to really set us up to think about what the business could look like on a clean basis into 2019, and that's where my initial comments, we talk about high single-digit EBITDA margins where it had been, if you look back over time and actually probably a little bit higher in particular years. And so the run rate into 2019 is clearly supportive of that high single-digit rate, and we did some, I would say modest cleanup of different things that would result in the margins in our fiscal 2018 probably being depressed relative to the underlying historical and projected performance. If we look at Zurn, the way we've run the business for a long period of time has not really surprised us in any way. I don't think it surprised us to the upside.

It's sort of tracking very much with what we expected. It was just difficult to see when you had the VAG business aggregated with it in terms of performance quarterly in terms of growth and also levels of profitability. So I think we're optimistic that with more focus and probably some more investment both organic and inorganic in Zurn, we've got what we think is a best-in-class water management platform. And we also think that VAG is an attractive asset given its global footprint brand and reputation.

So we think we're making the right decision and excited about the future.

Mig Dobre -- Robert W. Baird & Company -- Analyst

I see. And then maybe to ask Jeff's margin question differently, the incremental margins at Zurn, how do we think about that going forward? You've got quite a bit of margin expansion in fiscal 2018, that's my math.

Todd Adams -- President and Chief Executive Officer

So I think the way to think about fiscal 2019 that would be embedded in sort of the outlook we've given is sort of 25% to 30%.

Mig Dobre -- Robert W. Baird & Company -- Analyst

On incrementals, OK.

Todd Adams -- President and Chief Executive Officer

Correct.

Mark Peterson -- Chief Financial Officer

I think, Mig, just add to Todd's comments. That range has been historically shrinking this year, I'd say probably tend to be in the mid- to higher end of that range from an incremental standpoint.

Mig Dobre -- Robert W. Baird & Company -- Analyst

Got it. And lastly, for me, obviously, there's going to be some capital generated here with the sale of VAG. How do you think about capital deployment beyond delevering the balance sheet? I guess I'm wondering what sort of the balance between M&A or potentially removing some of the dilutive impacts of the convertible cohort?

Todd Adams -- President and Chief Executive Officer

Mig, it's a great question. I think it's something we are, obviously, thinking a lot about I think we're sort of too early to give what we expect the proceeds to be but we think they'll be significant. And obviously, we do have a chance to delever the balance sheet. We do have a chance to invest in our business organically and inorganically, as the opportunities arise.

And then as we move leverage down with this core plan plus some proceeds, you get to the leverage area that's right around two times at the end of the year, and we have to start thinking about other ways to return capital to shareholders. So I think it's moving from a pure delevering story with episodic M&A to more balanced capital deployment strategy and this year, I think you'll see that come to fruition.

Mig Dobre -- Robert W. Baird & Company -- Analyst

All right. Appreciate it. Thanks.

Operator

Our next question is from Julian Mitchell from Barclays.

Ronnie Weiss -- Barclays -- Analyst

Hey, good morning, guys. Ronnie Weiss on for Julian. So if I look at the guide from last quarter to this quarter, I guess one of the only places that really changed was the European industrial distribution, so I just wondered if you could go into a little more color of what you're seeing there and kind of what's maybe stepped down from the last time you guys gave an update?

Todd Adams -- President and Chief Executive Officer

I would say it's more nuanced, Ronnie. It's just a little bit less growth than maybe we had in our mind's eye for the next six months or so. So it had been performing pretty well. I think we're sort of stepping down the expectation just a touch so I don't think there's any materially we can point to, other than just a modest tweak to really what we're seeing.

Ronnie Weiss -- Barclays -- Analyst

Got it. And then back on the VAG divestment, I guess was this part of a broader portfolio or view and as you look at the portfolio now is there still kind of items out there that are assets out there that you could potentially divest going forward that mi

Todd Adams -- President and Chief Executive Officer

If you look back, we do well very strategic planning process every year. I think this year, like every business we get reviewed through the lens of do we have a sustainable competitive advantage we want to continue to invest in. And I think we came to the conclusion this year that in the case of VAG, we felt like we had a good plan, we had a reasonable backlog, and if you look at the fundamentals of the business, it just didn't match with the other parts of Rexnord, and so we made a decision based on the facts and circumstances and the work that we have done, but it's part of a normal, ongoing review that we do withl all parts of our business. I would tell you that is getting tougher and tougher to find things that don't match that.

And so I don't anticipate you'd see anything else like this at this point but again, it's part of the review process that we undertake every year.

Ronnie Weiss -- Barclays -- Analyst

Got it. Makes sense. And then lastly, just really quickly on the incremental margins for water, little low this quarter. Can that all justl be explained away by the negative mix you called out?

Mark Peterson -- Chief Financial Officer

It's the negative mix on the VAG side. On the Zurn side as we anticipated going into this year, we knew we'd have a little higher setup cost over the course of the year, particularly in our fourth quarter and some accelerations from investment in our fourth quarter. Those [Inaudible] had planned for going into the quarter. The VAG mix was also negative [Inaudible] throw that incremental down in the quarter.

Ronnie Weiss -- Barclays -- Analyst

Got it. Makes sense. Thanks very much.

Operator

Our next question is from Jim Giannakouros from Oppenheimer.

Jim Giannakouros -- Oppenheimer & Company -- Analyst

Thanks. Good morning, everyone. Centa, forgive me if I should know this, but can it get to PMC margins or are there structural barriers there that cap their margin to a few hundred basis points lower than what PMC averages?

Todd Adams -- President and Chief Executive Officer

Without any question, the basis of our investment thesis is that the Centa margins can migrate clearly to the PMC level as it exists today and probably actually a little bit higher over time. So I think we're very confident in what the margin profile looks like for Centa after we finish the integration, which happens over the course of this year.

Jim Giannakouros -- Oppenheimer & Company -- Analyst

And is there any sense as far as the timing of that ramp? Would it take two years, three years? Or it could be even quicker than that? Or is it a much --

Todd Adams -- President and Chief Executive Officer

I think the way to think about it is, we've got some work to do that really happens over the course of this year but within 12 months to 18 months, it should be at that run rate and probably not above it at that point, but clearly within two years, we think we have the opportunity to be above with the current PMC margin profile looks like.

Jim Giannakouros -- Oppenheimer & Company -- Analyst

Thanks. And one more if I may, you guys have set up to meet or beat expectations. You are pretty clear about that, Todd. You exhibited that.

You did very well last year but just looking at the lower end of guidance, I mean what are the bigger variables that would drive guidance to the lower end or below it? Is at macro, potential disruptions from SCOFR 2.0, pace of sales traction of new products? Any color on where your pressure points are, internal or external, that would drive to the lower half of guidance would be helpful. Thanks.

Todd Adams -- President and Chief Executive Officer

Sure. I mean, just to be clear, I think the lower end of the range is not our base case but other scenarios out there that could result in getting to the bottom of the end of the range? I think there are. I think they're largely macro, and I think they're largely sort of second half of our fiscal year thing. So think about the December and March quarters, so from where we are today, the trajectory we clearly point you toward the upper half of the range but if you think about a variety of things that are outside of our control, you can find yourself below the midpoint but I don't think that's our base case.

And I think as we sort of highlighted in our comments, our view is to provide something we think is pretty durable and lasting and we'll update accordingly but I don't think that we're going to endorse the bottom end of the range with a set of facts or circumstances other than to say, are there things out there in the world that can happen that the drive our numbers as low as everyone else's lower, particularly given the second half uncertainty in this relatively short cycle world. I think the answer is, of course, but that's not our base case and clearly, not the trajectory we're on.

Jim Giannakouros -- Oppenheimer & Company -- Analyst

Great. Thank you.

Operator

Our next question is from Charley Brady from SunTrust Robinson.

Patrick Wu -- SunTrust Robinson Humphrey -- Analyst

Good morning. Actually, this is Patrick Wu standing in for Charlie. Thanks for taking my questions. Just going to DiRXN for a little bit, as you guys continue to Smart Tag products on both segments, how should we think about the contribution from sales, and I guess in fiscal 2019 and then possibly beyond that the growth rate that you guys are expecting from just sort of having that digital platform if you will?

Todd Adams -- President and Chief Executive Officer

Again, I think we'll get a little more clarity as we go through the year but in less than a full year, revenues related to DiRXN were right around $20 million, the growth trajectory on that is very high. We think that as we continue to roll out new families and products plus the goal and start to attack of the installed base, we think that the growth rates for the DiRXN initiative can be very high. We're not going to break it out for obvious competitive reasons but if you think about from zero to 20 in essentially nine months with the better growth trajectory heading into next year, I think we feel very confident with the adoption. Customers have really embraced the technology.

Learning cycles that we're going through continue to accelerate, and I think you're going to hear us talking about how do we then go back and start to monetize this technology with our installed base, which is important because in periods of uncertain economic times, the ability to go back and refresh and renew the installed base will be a powerful growth and margin opportunity when end markets aren't as good as they are today. So we're looking at it both ways but really nice traction to start the first year, and we think that builds over time.

Patrick Wu -- SunTrust Robinson Humphrey -- Analyst

That makes a lot of sense. And not sure if you mentioned this but for your mid-singles core growth guidance for 2019, how should we think about it for the PMC segment and water management? Are they pretty balance? And then your expectations for Centa for fiscal 2019 as well, is that tracking in line with the legacy PMC business for above or below, can you just speak a little more about that?

Todd Adams -- President and Chief Executive Officer

Sure. When you look at core growth and midst the two platforms are both would sort of following to that mid-single-digit range. And the Centa margins that would be embedded in our outlook for fiscal 2019 are currently below and as we said, maybe a little bit earlier than the heavy lifting if you will really happen over the course of the fiscal year 2019 and they step up in 2020 and then continue to migrate to that fleet average where PMC is today and ideally above over the next couple of years.

Patrick Wu -- SunTrust Robinson Humphrey -- Analyst

OK, understood. And I was more referring to your expectations for Centa's growth for fiscal 2019. Yeah. I'm aware of the margin commentary that you already made.

Todd Adams -- President and Chief Executive Officer

I'm sorry. Yes, Centa will probably grow again in that mid-single-digit range over the course of fiscal 2019, which is in line with the core platform.

Patrick Wu -- SunTrust Robinson Humphrey -- Analyst

OK. Sounds, I guess, pretty balanced. Thanks.

Operator

Our next question is Andrew Obin from Bank of America. [Silence] Andrew, your line might be on mute. We can go to our next question from Justin Holm from Mesirow Financial.

Justin Holm -- Mesirow Financial -- Analyst

Hi. Just wanted to doublecheck, was VAG's EBITDA in fiscal 2018, cause when I look at the bridge from 2018 to 2019, it only shows VAG as $1 million negative EBITDA for the bridge. So -- not negative, but $1 million adjustment to carve out VAG?

Mark Peterson -- Chief Financial Officer

[Inaudible] million of EBITDA, which we are backing out of the base jump-off point as we bridge to 2019, where we've excluded VAG from the guidance.

Justin Holm -- Mesirow Financial -- Analyst

You broke up for the answer. Can you repeat that?

Mark Peterson -- Chief Financial Officer

VAG [Inaudible] approximately $1 million of EBITDA, which we're then subtracting out of the base number in 2018 kind of a jump-off point to get to our fiscal 2019 guidance because that excludes VAG in fiscal 2019.

Justin Holm -- Mesirow Financial -- Analyst

I see. So can you tell me what was the VAG EBITDA in fiscal year 2018?

Mark Peterson -- Chief Financial Officer

We just finished our fiscal 2018 and it was about $1 million.

Justin Holm -- Mesirow Financial -- Analyst

OK. So when you said earlier about it being high-single digits, is that gross margin then?

Todd Adams -- President and Chief Executive Officer

Yes. The high-single-digit margin for VAG is what we would expect the margins to be in our fiscal 2019, which begins sort of April 1 of 2018 and runs through March of 2019. So, it's more of a forward-look margin versus a, as Mark pointed out, the reported earnings for our fiscal '18, which is in March of '18.

Justin Holm -- Mesirow Financial -- Analyst

OK, great. Thank you.

Operator

And our next question is from Isabelle Dawson from Goldman Sachs.

Sam Eisner -- Goldman Sachs -- Analyst

Hey, good morning, guys. This is Sam Eisner. How are you?

Good morning.

Mark Peterson -- Chief Financial Officer

Yeah. Good morning.

Sam Eisner -- Goldman Sachs -- Analyst

Good morning. Thanks. Along the same lines of questions, can you maybe just provide some historical detail on EBITDA dollar turnover percentages, the business associated with the VAG business? I understand that was mainly [Inaudible] but if we go back farther maybe from fiscal 2013 to fiscal 2018, how much EBITDA was generated? You made a comment that you expected, or there was a good amount of cost in the business last year, so relatively low base. I'm more interested in prior history, not just fiscal '18.

Todd Adams -- President and Chief Executive Officer

Sam, I think I appreciate the question and as I'm sure you can appreciate we are in the midst of a sale process. And so that information will be provided once we get to a sale and in discontinued operations, you'll be able to see that, and will report Zurn on a stand-alone basis starting on our first quarter here that ends in June. So we're not going to sort of go back to rehash everything because we do have an active sales process. And it will all become sort of a parent for everyone over the course of the next hopefully quarter or so.

I think the thing to point out is on a recurring basis, you can see the Zurn margins, where they are today, and I think if you look back over the last several years, you've seen a steady march up over time, 100-plus basis points a year of margin improvement, and that's what's the continuing operation view of the world and will be able to get you all the historical VAG stuff and everyone else in time and as we're able.

Sam Eisner -- Goldman Sachs -- Analyst

Can you give us an update on where that sale process stands? Obviously [Inaudible] being able to move something into discontinued ops on some kind of reasonable basis for a timeline? So presumably you guys expect to sell this business in fiscal '19. Is it an auction process? Is it negotiated? Just give us an update on where that sale process stands today.

Todd Adams -- President and Chief Executive Officer

I don't know that we're going to go into great detail on it other than to say, it is an auction process along with, I would say, some selective buyers that we've engaged with, and we're well into the process. It's not weeks away, it's months away, but it's clearly something we expect to have done in the first half of our fiscal '19.

Sam Eisner -- Goldman Sachs -- Analyst

Got it. And is Rodney Hunt completely written down or sold off at this point? I think the beginning of the last year, fiscal '18, you guys have moved that to discontinued ops, I believe in an expectation to either sell and [Inaudible] down the entirety of that business. Where do we stand in that process?

Mark Peterson -- Chief Financial Officer

Sam, it's Mark. That's behind us. Yeah. [Inaudible]

Sam Eisner -- Goldman Sachs -- Analyst

Got it. And maybe, just lastly, as you think about the kind of multi-industry platform nature of the business, discontinuing or moving out of a business that maybe was less cyclical than some of your other businesses may have enhanced the multiple or may have announced the business. Just how do you think about full-year cyclicality now that you're getting out of [Inaudible] cyclical some of your other businesses? Thanks.

Todd Adams -- President and Chief Executive Officer

Sam, you broke up really over the course of the question but I think where we are today as we think we have two terrific concentrated platforms with great brands, very high margins, and real competitive advantages that are sustainable. And I think we're pretty excited about where we are, I think obviously, the decision was taken lightly but we think it's the highest return that we can provide to shareholders is, focus on these two core businesses and run them exceedingly well. So I didn't get every part of your question but I think the essence of a response would be something along those lines.

Sam Eisner -- Goldman Sachs -- Analyst

Got it. Thanks so much.

Operator

Our next question is from Mig Dobre from Baird.

Mig Dobre -- Robert W. Baird & Company -- Analyst

Yes. Thanks for taking my follow-up. I want to talk a little bit about free cash flow if we can, and I understand the guidance that is north of where your net income will be for fiscal '19, but any more color on some of the idiosyncratic portions of the cash flow? I know there are some movements in '19 that we need to be aware of, maybe you can remind us of that.

Mark Peterson -- Chief Financial Officer

Well, in fiscal 2019, obviously, we think our free cash flow will be better than we had in '18. As we go to phase in, the phase-in will look similar to last year, where the back half of the year tended to be stronger free cash flow [Inaudible] from a phase-in standpoint. Cash interest, modestly better. I think outside of that --

Todd Adams -- President and Chief Executive Officer

And the old tax bill.

Mig Dobre -- Robert W. Baird & Company -- Analyst

Right.

Mark Peterson -- Chief Financial Officer

The fact is [ph], overall cash taxes will actually be higher, given the fact that we have generated more taxable income and some timing issues. So as we said in our call 90 days ago, our cash tax [Inaudible] in the low 40s, the percentage of pre-tax income this year, dropping to low 30s in our fiscal '21 due to some timing issues. Those are probably the two, I think, things that really wouldn't come out of our initial guidance. We gave capex guidance, cash [Inaudible] should be about the same.

So I think really it's really the earnings power year over year driving incremental free cash flow in the business.

Mig Dobre -- Robert W. Baird & Company -- Analyst

OK. Are you willing to maybe put a dollar amount around the free cash flow number?

Todd Adams -- President and Chief Executive Officer

Well, I don't think it's a stretch, Mig to talk about it being in excess of $200 million. Now it's probably not the precision that you're looking for but I think where we are is, we have a great degree of comfort that everything we've been doing over the past couple of years, it really enhances the free cash flow profile permanently and also there is some legacy tax liability that is in the base that anniversaries itself in our fiscal 2020. So clearly run rating above $200 million with more to go. And so probably, not the degree of precision you were looking for, but clearly in excess of $200 million.

Mig Dobre -- Robert W. Baird & Company -- Analyst

Right. I mean to be clear about what I'm asking here, I'm trying to figure out as you're looking at '19, say, exiting fiscal '19, what your firepower essentially is going to be at that point from an M&A perspective. And I don't know if you are able or willing to provide some kind of a figure that investors should consider but obviously, it's important to the story.

Todd Adams -- President and Chief Executive Officer

I mean if you take the base case and use that $200 million of free cash flow, you can find your way to leverage in the very low 2s by the end of March. Incremental to that, there will be proceeds from VAG. And so you're right at or perhaps a little bit below. If you do think the side leverage ratio of 2:3, that's $440 million at the high end plus cash on the balance sheet, plus future cash flows that easily eclipse the $200 million mark beginning in fiscal 2020.

So I think our M&A wallet continues to grow but in concert with, ensure you've got the right leverage on the balance sheet. And so I think it's a good problem to have but in the cash flow that we've been working to generate starts to I think to accelerate over the next couple of years and we're pretty confident that that increases our financial flexibility and keeps the leverage ratio at a relatively conservative level.

Mig Dobre -- Robert W. Baird & Company -- Analyst

Got it. Then lastly from me, one last clarification on guidance. Can you give us a sense for how much incremental investment and incremental compensation '19 versus '18 is currently baked in at the, call it midpoint?

Mark Peterson -- Chief Financial Officer

Yeah. [Inaudible] compensation year over year, we see that [Inaudible] coming off fiscal '17, so incentive comp should be neutral year over year. Investment [Inaudible] investments in the platforms. Probably, I'd say a little more on the PMC side, as Todd pointed two-thirds of that PMC, a third that on the water side.

Think of that as a mid-single-digit investment number over the course of the year.

Mig Dobre -- Robert W. Baird & Company -- Analyst

I see. Mid-single-digit millions?

Mark Peterson -- Chief Financial Officer

Yes.

Mig Dobre -- Robert W. Baird & Company -- Analyst

OK, understood. Thank you.

Operator

And our final question is from Joe O'Dea from Vertical Research.

Joe O'Dea -- Vertical Research Group -- Analyst

Hi. Good morning. The first question, just on the pricing side of things, understand that segment level I guess and PMC and both water management. What you've done on pricing in response to some of the pricing costs and whether that's deviated from normal pricing at all meaning were there normal beginning of the calendar year pricing actions and maybe done anything incremental for that and just where it stands on that front?

Todd Adams -- President and Chief Executive Officer

It varies by segment. So we did have different, I would say, historical practices of when we would institute price increases. Obviously over the course of the last 90 days or so, we've formed what we call an internal team called an inflation task force. And that is really multidiscipline that's working both the price side and the cost side.

And we think we've got a pretty, again, very real-time view of when we're implementing price and how we're managing input costs. I would tell you that in fiscal '19, it's very likely that in some cases, we've already prevented incremental price increases to what we would have ordinarily done, or we have planned future price increases that match the timing of input costs rising over the course of the year. So I think we've got what will be above-average year in price, and we think it's sort of matches, probably is a little bit ahead of where the input cost lay out over the course of the year.

Joe O'Dea -- Vertical Research Group -- Analyst

It doesn't sound like cost inflation is margin-dilutive, so maybe just to confirm that. So what you're getting on the pricing side is not just cost-capture, but the incrementals you're talking about, it's not like cost inflation is posing an incremental margin headwind for you.

Todd Adams -- President and Chief Executive Officer

That is correct.

Joe O'Dea -- Vertical Research Group -- Analyst

And then the last question just on kind of philosophy around the outlook and talking about the importance of the durability of the outlook, and I think when you look at where there could be pockets of conservativism and some pretty good incrementals underlying the outlook. And so I don't know if that conservatism would lean more toward the top line, and we've seen an acceleration in some of the organic growth recently, but I guess also importantly just with some of the headlines we've been working through over the course of the past three months and whether or not you've seen that generate a higher degree of uncertainty in the customer base now that we've got half of May under way. Just the customer behavior and I guess the strength of kind of the acceleration in some of the end-market demand that we've seen, and stability there. So looking for kind of confirmation of that or anything you've seen in response to some headline uncertainty.

Todd Adams -- President and Chief Executive Officer

Yeah. I don't think I can point there anything specific Joe, from a customer standpoint where we've seen any behavioral changes as a result of the headlines. I think as we talk to our sales force, our independent reps, we'll look at our funnels, we continue to see good activity that supports, I think, the outlook that we provided. I think our view has been let's take a really good look at the next six months and then assume that the following six months could be less.

And I think that's where we've got, I would say, maybe a little conservatism. So if the trajectory of where we are sort of finishing the year and starting the new year continues, there could be upside in the second half but that's also six months away. And so the way we've approached it is, take a look at the full year with a pretty sharp look at the first half, be a little more conservative over the course of the second half, and then update accordingly based on where things are.

Joe O'Dea -- Vertical Research Group -- Analyst

Thank you. Appreciate it.

Mark Peterson -- Chief Financial Officer

Thank you.

Operator

And we have no further questions.

Rob McCarthy -- Vice President Investor Relations

So thank you, everyone. Thanks, Sean, and thank you, everybody, for joining us on the call today. We appreciate your interest in Rexnord and we look forward to providing our next update when we announce our fiscal 2019 first-quarter results in early August. Have a great day.

Operator

[Operator signoff]

Duration: 64 minutes

Call Participants:

Rob McCarthy -- Vice President Investor Relations

Todd Adams -- President and Chief Executive Officer

Mark Peterson -- Chief Financial Officer

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Mig Dobre -- Robert W. Baird & Company -- Analyst

Ronnie Weiss -- Barclays -- Analyst

Jim Giannakouros -- Oppenheimer & Company -- Analyst

Patrick Wu -- SunTrust Robinson Humphrey -- Analyst

Justin Holm -- Mesirow Financial -- Analyst

Sam Eisner -- Goldman Sachs -- Analyst

Joe O'Dea -- Vertical Research Group -- Analyst

More RXN analysis

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