Ralliant Corporation ($RAL)

[Audio Gap] or industrials here at TD. As you all know, Extel is open and live, and we appreciate your support, if you think we've earned it. We will be cross-referencing lunch does not get delivered unless you guys vote. So just keep that in the back of your head. Excited to have Ralliant in here with us. We have Neill and Nathan. If anyone has questions as we go, feel free to raise your hand. I'll stop. I assume that won't happen. So we'll just go. Guys, thanks a lot for being here. I appreciate the time. Let's just get right into it. Pretty, pretty uneventful first 2 quarters, right? Out of the gate. So we've had two very different quarters in terms of the reaction in terms of what was said. Maybe let's compare now what you're seeing to when you reported 4Q? And what have been like the biggest changes?

Yes, thanks. And thanks for having us here. Terrific to be here and talk to everyone today. Yes. So I think we have seen kind of an inflection in the business versus where we were. And one thing I think about is we're only 3 quarters old now as a public company. So clearly, we're seeing some changes as we start to manage through this. I think we can talk about this, changes in what's happened since spin even as the world has changed a lot since then and our exposure to areas in hardware and inflection in Test and Measurement and Defense have clearly been a positive for us as we spun out. As you go back to kind of Q4 where we stood, I think even going back to kind of that December quarter, book-to-bills in the business were kind of closer to 1:1 even in Test and Measurement. And I think as we saw things change in power electronics where we're very strong and started to pick up in Q1 in Test and Measurement, that's been a positive for us. We talked about book-to-bill going between 1.1 and 1.2 in the quarter. And a lot of that was in kind of the mid- to later part of the quarter as we started to see that inflection. So I think that's been the biggest thing. But overall, I think it's been relatively broad-based within the business. We see both Test and Measurement stronger. We see defense. We've talked about $1 billion of backlog now in our defense business. So I think overall, very solid. But clearly, the inflection in Test and Measurement has been probably the biggest driver since if you go back and look at where we were 90 days ago.

How much of that snuck up on you versus like Look, I know guidance is one thing that you're speaking externally. But like we saw a lot of competitors starting to see stuff happen and talk about orders growing. And at the time when you reported 4Q, you said book-to-bill around, but it did it feel like this might be something that was coming, but maybe we're not ready to talk about it yet.

Look, I think when you go back at that time frame, and we talked about it last quarter, we were seeing the sales funnel start build. So that would naturally start to translate into better ordering activity, but we haven't seen those funnels translating to actual orders. So while there were positive signs out there, I would say, as we got into I wouldn't say they were strong enough yet to say, hey, we can really count on that to kind of guide and say that's we're starting to see that turn. But clearly, what you saw as those sales funnels continued, and I think they built even stronger throughout the quarter, and then those funnels started translating into real orders. that ordering activity picked up in Q1. And I think that's what gave us the confidence then to say, let's take the guidance up and let's think about a stronger growth rate, not just for Q1 and Q2, but for the year.

Yes. So we're almost in June now. I'm not going to try to pin you down for new guides. But like have those trends, those are probably pretty durable. Has that kind of stayed through the quarter at this point?

Look, I think demand remains healthy. I think it's been healthy in Q1. I think that healthy demand kind of continues. We feel good about what we kind of guided going into the quarter. And I think what we see is still supportive of that.

If I told you -- now let's talk top line, like if I told you, you end up doing better than your guide for the year like what would have been the likely driver of that? Which market?

Look, I think that we talked about a couple of things in terms of the growth rate for the year. I think we talked about 5% to 8% for the year, which is actually would mark a little bit of a lower growth rate in the second half. obviously, with geopolitical events and things like that, we're a little bit cautious on the second half just to see how things are -- are there going to be supply issues or other things that come out of that -- so we've been a little bit cautious on that. But if you break down the business, where we talked about higher growth at the high end of our kind of guidance for Test & Measurement, we talked about sensors and safety systems, still nice growth, maybe towards the lower end of that range, though, but good growth for the year. But the other piece of that, that I don't think we talked a lot about is from an industrial perspective, everyone's seen the PMI pickup. It's been a couple of cold years, so to speak, from an industrial perspective. We did return to growth in sensors and safety systems in the industrial portion of the business. So look, if that continued to pick up, that could be a tailwind for us as we get into the second half of the year. But Again, we don't want to get ahead of ourselves. We'd like to see some more experience in that over the next quarter plus and that continues, and that could be an opportunity for us. But we're going to continue to remain prudent until we start to see stickiness in terms of that type of activity.

Yes. And that's fair. I think I might push you on -- it seems unlikely that like test and measurement or defense or grid would like reverse any near term. But like I understand the prudence of the second half kind of view here. Maybe...

One thing -- I'd jump in real quick, Joe, is we get asked, are you seeing evidence of prebuy or inventory build or some of these other pieces. And the answer is no, we haven't. And we've been asking our sales leaders and our distributors, are we -- are we seeing evidence of that? And the answer so far is no. But there's -- a big portion of the business, about 70% of the business is short cycle. And so we only have about 90 to 120 days visibility. And so I think that's where there's -- there's some prudence it's built in as we look out more than a quarter out that we're still cautious until we actually see the orders for continue to come in.

So just if you look back over the last 2 -- maybe ask both of you this, like, what lessons kind of came out of that from a communication standpoint, just I mean some of these moves are violent, some of the largest I've seen. So how would you maybe have done that differently if you had a second. Go ahead.

Yes, it's a really good question. Joe, I'm sure that's on other people's mind. So I think, first of all, let me just say this, if you think about Ralliant, what we pride ourselves on is being a company that's based on our business system on the Ralliant business system, and we think about driving continuous improvement every day. This is very important to us and our culture, and that's in everything, including our communication. So as we think about how do we think about that going forward? I think one thing to think about is just being very direct in terms of the communication around how we think about the guidance, how do we think about things over multiple periods. So even if you look at what's out there right now, we talked about -- if you look and look at streams going forward, we talked about 2027 time frame. We gave a framework. As Nathan said, we don't have that much visibility. I think defense has a nice backlog at the rest of the business doesn't -- we talked about a framework in 2027 plus of being kind of that 5% or so growth rate as a framework to help guide where the margin improvements may come from. But I think it would be unlikely that we would guide above that until we got better facility kind of going forward. So those are the type of things we just want to be forward leaning and make sure that we are clear and transparent on SP-9 Going forward.

And is it fair to say if you say something like that at this point about 2027, given that you don't want to overextend yourself, you'd have to see some sort of like negative change to think that in the underlying markets that kind of be below?

Yes. And I think we -- I think -- and that's a little bit of a learning, I think, as we're a new company and looking at the cycles in terms of seasonality and other elements of the business. Like I said, we have a nice [indiscernible] billion in defense. Most of the business that was Nathan had said, is probably 90 to 100 days of visibility. We do see good growth in defense. We do see good visibility, although maybe not the backlog in utilities, but we have good visibility to ordering with our customers. So we do see some nice growth rates there and probably something that's got some legs in it. But because of the visibility we have to be, I'd say, prudent around what we have from a backlog perspective in order to give longer term longer term.

All right. So let's talk about test and measurement a little bit. I think the common belief, at least with investors, is that under prior ownership, this business had been a little bit star for capital. How do you respond to that, first of all? Like do you agree with that? And what's your assessment of the business?

Look, I think that when you think about how the business was invested in previously, it was invested probably for a lower growth rate. We talked about 3% organic coming out of the Investor Day when we spun. So I think about that's probably how the business was invested. And I don't think that was under or over. I think there was just an intentional investment at those levels. I think as you look forward, I think it's really all about focus. Now how do I think about that? I think about it as like competitiveness, like driving competitiveness in the business. So if you take test and measurement, for example, this is a business where we have high exposure to power electronics. We're expanding out beyond that now. I think you think about AI and workflows and semiconductor workflows and other areas, data centers and whatnot. There are opportunities for us but it's about driving competitiveness in the products. We talked about some of the product releases. I think there was the M5000 modular system that we put out recently that can use in a lot of applications. So releasing products, making sure they're very competitive. But also ensuring we're increasing the velocity in R&D in these businesses like test and measurement, become very, very competitive. So I think going forward, it's really just a focus. And I also say that from an investment perspective, we think about having capital to compete within the business. Tammy and I have I think very good visibility to incremental investments in the business. We'll balance margins with investment. And we've got a pretty clean visibility and a framework on how we think about those going forward. So I would say, look, it was invested for what it was before, and I think we just have a different focus, but really balancing margins and capital allocation as we think about doing that going forward.

And just one tactical point, Joe, is that we've trying to help people better understand the level of investment that goes into each side of the business because it's quite different than on the test and measurement side, R&D investments, mid-teens, high teens and some years a percent of revenue that goes into the test and measurement side. And then whereas on the Sensor & Safety Systems segment, it's more in line with industrial peers, so more low single-digit percent of revenue that goes into R&D. So the Test and Measurement business has actually had more investment than what people are looking at the total company R&D level, some measurements actually skewed higher in terms of where that investment is coming in.

So what has been the R&D focus at test and measurement now? And how do you kind of weigh to your point on margins. You're doing a lot of research-oriented work, like you almost have to guess correctly on the products that you need as to what your customers may want in the future. So like how are you weighing -- we need to make a bigger investment in order to position ourselves and how do you mitigate that risk?

Well, well, first of all, I would say I think Nathan is exactly right, though. I think there is a reasonable amount of investment that goes in from an R&D perspective into the business. So I think the question -- and competitively, you could benchmark that as well as being a kind of a reasonable level of investment. There can be some incremental investments on top of that for things like you're talking about, Joe, where you think about is there an application or something where we really feel strongly that we need to go drive incremental investment in. So I think we manage that really well. But I'll go back to what I said originally, I think it's about competitiveness. And we really have to think about in each of those -- both segments, but just talk about test and measurement, what are those end applications where we have to compete. And I think step 1 for us as being great at power electronics. This is something that the test measurement business has been very good at over the years. And then we think about expanding out beyond that -- and we talked about that a little bit, I think, on the earnings as you think about electrification, you think about that at the edge, AI applications other workflow applications, validation systems, making sure that we have like the full capability as we start to compete, but balancing that with efficiency in R&D, like leveraging tools that exist today and bringing that into the system so we can be even more efficient by bringing up products even faster. So I think that's a little bit of the focus change too, that I think that we're driving is really pushing on our competitiveness on one hand, and then improving our R&D velocity on the other side. So those are the areas that I think we're really focused on.

How do you benchmark yourself in that framework against the -- your biggest competitors? I know you have an edge in power electronics, where do you think you have a gap? How do you what's involved in trying to fill that gap?

I think it's -- look, I think if you look at the segment and Test & Measurement, I think we have -- like I said, I think our precision instruments that we bring to the market today are very, very competitive. I think we're very strong in these areas. If you think about that both in power electronics and battery testing, I think about -- and we talk about communications as a segment for the business, but a lot of that is -- I think the significant majority of that is military government-type applications for next-generation research. We also sell directly to semiconductor customers. As you see start to see that power electronics transition happen. But I think we can build on that going forward. I think -- like you mentioned before, you think about AI workflows and new AI type of testing applications that are leveraged in these areas or expanding beyond that into workflows or validation, where we can certainly play a role and expand beyond kind of our core base, which we've been good at for many, many years.

And what happens if EV investment feels like an inevitability to meet globally. But like as that starts to pick up again, you have EA in there. What can that what can that look like if some of these larger markets that have been pricing start to come back?

I think if you look at like, for instance, battery testing, I think that's what's going on and certainly with us as EV hasn't panned out exactly like everyone kind of going into that kind of last cycle. We've kind of pivoted towards other opportunities in power electronics and battery specifically. And where that leaves us with EA is like this is a very good business for us. It's got very nice growth rates. It hits a very nice margin. I think they've been able to make the pivot over to other areas like batteries in data centers or battery power systems and things like that outside of EVs. And clearly, look, over time, if EVs come back, then that's an opportunity for us. But I think the business has gone through the transition and we're starting to see nice growth in the battery testing area right now.

So as we start to get into more normal volumes here and probably a pretty decent runway here for growth, how do we think about the multiyear margin opportunity at that business?

I think if you look at the overall business and that specifically, I think there is good margin opportunity. I think that the -- that particularly is running at very solid margins today, we think even above the segment average. -- for those products. So I think it's in good shape, maybe not what we expected overall maybe when it was underwritten originally, but as a business, I think it's performing very nicely. And like I said, I think the team has gone through a great transition. As you step back and just think about the margins overall, obviously, we announced enterprise productivity program. at the company level. And I think all of those things will affect margins in various places. So I think there'll be some tailwinds from that as well.

What can you do broadly for T&M to smooth the cyclicality? Just even in a normal year, you're having huge declines in 1Q from fourth quarter, and it's just volume driven. But is there anything you can do to make that a little smoother ride.

I think it goes back to exactly what we said. I think there's -- naturally, I think that business or market is going to have some level of cyclicality or seasonality in the business. But how do we think about it going forward? I think it goes back to competitiveness. How can we create great products with high level of velocity of getting them out into the marketplace and invest in those things. And I think the other piece of that is you just kind of talked about it in terms of the battery testing business that we have. if that can drive a different cycle, expand out into different areas like workflows or validations that make validation that makes sense for us. And those are areas that I think if we compete better, then you kind of have a better baseline and kind of a better bottom to the business through cycle. So I think focusing on that competitiveness for us is absolutely #1.

Let's shift over to defense. We recently got an investment announcement from DoD to increase capacity at Pakai. Where are you running on that business now? Is it like you pull out on capacity?

Well, I mean -- well, one thing I think one is yes, we have -- we talked about the $1 billion plus the backlog. We did get a award recently, which we're thrilled about. Think about that as capacity growth for kind of 2028 and beyond, like facilities expansion over time, which we -- I think that will need. If you look at where the business is today with a significant amount of backlog, clearly, the execution is a big part of this. But this is where we go back to lag the business system. So we look at RBS. We have legacy teams who are very good practitioners system, driving kaizen and lean within the facilities that we have. So a lot of the growth that you're seeing today, I think if you look back at defense, we've grown double digit for kind of a number of years now. I think we posted 20% growth here in Q1. And a lot of that's off the back of execution within the facilities we had and leveraging RBS. Now we're investing into the business as well for that. You think about industrial engineering resources to drive more lean process in the business and drive performance. Think about by diversifying our supply base, we have a strategic sourcing team that we've put in place to think about diversification there and readiness for build how we bring on capacity. So I think in the meantime, it's a lot of self-help on driving performance, but -- you've seen that's what we've been doing the last several years. That's been off of the back of a team that's very, very good and very, very focused on driving lean process and driving capacity expansion until we start bringing on additional capacity through some of these awards that we talked about.

So how should we think about a $1 billion backlog for a business that's, I don't know, give or take, 350 or something 400-ish now? Like should we think about that as being delivered over 2 years? Is that...

Yes, 2 to 3 years, I think that we get delivered. Now I don't think that's the end of the ordering SP1 For sure. But I think the backlog, you can think about that over the next couple of years.

And you have the capacity as...

I think it's still an execution story. So I think we have to go and execute within what we've got and continue to build out and leverage the investments that we've been making to make that happen. And then as you get out beyond '27 into '28 plus, then you have to start thinking about different facilities that will bring online to support that capacity. I think there's a limitation eventually. I think physically as execute on. But it's obviously a very exciting time for the business to be able to support that level of capacity expansion and growth.

And I think it's going be important for both of you guys on the messaging on this, like -- so it is margin dilutive. How do we think about what this does, if we have this type of growth here over the next couple of years? Like much of this is cost plus, how much is so we're all kind of aligned on this.

Yes. Really good question. So I think if you look at the defense business, so let's focus on the -- we talked about low to mid-20s margin over time with the inclusion of the productivity program. Breaking that down, we see sensors and safety systems more in that kind of mid- to high 20s EBITDA kind of zone over time. The defense products run at the -- I'd say, more towards the company average, which is like we guided this year about 20%. So -- and then within those products, you're going to see more and more of the defense business go to TINA compliance, which basically means there's guardrails around the margins that we would achieve in that business over time. So what you'd expect then is that not only will it be a bit of a mix headwind because it's lower overall, but you'll see some transition within the business as well. Now that being said, those are still very good margins, I think, competitively and at a high growth you're seeing -- you'll see, I think, still very, very solid margins in the business. So what does that mean going forward? I think it's what we have baked into that mid- to high 20s is a double-digit growth rate for defense. Obviously, if it went higher than that, you'd see a little bit of a drag, but at a higher growth rate, which I think will still be good dollars for us as we think about that going forward. But right now, what we've baked in is kind of a double-digit growth rate some degradation of the margins, but that's baked into the incrementals that we communicated. But we want to be clear about that. I think as we're bringing on capacity right now and executing that, there's going to be some variation as some of these programs flip over to compliance. From a margin perspective, there's going to be some change in the absorption rate in factories that are bringing on a lot of capacity. So I would expect some variability probably in the profitability moving forward. Somewhat of a drag, but at a higher growth rate as you think about this over multiple years. Is it fair to think like the fastest parts of defense may be more like a mid-teen-ish EBITDA multiple margin? You can think about closer to the company level and maybe going a little bit below that. And one thing -- a proof point of this is we talked about incremental margin framework for the next few years. And we said 20 think baseline incremental margin, 35% to 40% add in our productivity program gets you to 45% to 50% total company, whereas '27 and '28, we said baseline incremental margin were 30 to 35. So about 5 points lower than what we're expecting in '26 is because 26, 'we're expecting higher growth from Test & Measurement and that Test and Measurement growth moderating a little bit in '27 and '28 whereas more contribution, I would say, continuous contribution from the defense business. And so just highlighting that there's a pretty broad spectrum of incremental margins between test and measurement and the defense business. So where that growth come from comes from really matters in terms of the margin trickle down that it has.

So that was an interesting framework that when you put that out how -- like when you come up with that, like how bottoms-up is that? Like are you really doing -- are you building that out of, okay, here's our expected growth of these this piece of and what are we going to make because it's easy to kind of say 35% to 40% and then shift it down 500 bps. But like how granular was that analysis?

I'd say a pretty solid buildup from the team. And we're also -- it's not just like I think the bottoms-up build up, but you have to look at the various corner cases that can happen. And I think that what that's led us to is say, look these are the guardrails around what we think are reasonable -- a reasonable framework. But we also want to include with that really transparent communication around some of the variability that can happen around depending on what the various scenarios are. And I think what Nathan talked about was exactly right. I think as you look at 2026, you see a buildup of, okay, you're probably looking at 45% or so, I think, fall through. If you look at the 20% midpoint EBITDA margins we talked about this year. The mix of that will change. I think the natural fall-through going forward has not changed. I think it's about 30% to 35%. That includes some mix degradation, include some investment back into the business. Naturally, I think we'd want to be a little bit higher than that, but we've judged it back a bit because of those headwinds we think are in there. And then separately, we add on the productivity program, which gets us closer to that 50% fall through. So we've leveraged -- we've looked at a lot of different corner cases. But I think what's really important is to ensure they have that transparent communication around what makes up those pieces because, obviously, things can change as time goes on. So if we think about Qualitrol and grid, what's the backlog visibility look like there right now? As you look at utilities, and you mentioned Qualitrol, I think from an orders perspective, I think in Q1, we had a record order quarter -- the growth rate wasn't as high as you normally expect. I think that's timing on shipments as kind of what we talked about. But as you start to look forward, I think the visibility is strong. I think we plan to play in 2 components there. One you kind of think about smart sensors on Transformers that shift. There's a long backlog of these. So we think that provides good visibility. It's not a backlog business per se, just because the ordering pattern is closer to one of the actual transformersip. But about half of that of those products are more or less half you can think about as like project based. So if someone's doing a refurbishment of a power plant or transmission, area you would think about we would do probably work with them as well. So I would say good visibility to both what's shipping for new projects, but also in terms of some of the solutions project work that we're doing.

It just seems like that's a business that should be growing above trend for like several years here. What's standing in the way of that? Is there a capacity constraint here?

I think the growth rate would say that we have -- similarly, we have to drive capacity expansion and execution in terms of doing that, but it's the same playbook. I think we leverage RBS, I think the team is very good at this in terms of executing I think in Q1, we likely built some backlog there. I don't normally do that, but we did see some backlog build in the business. The growth rate we've taken up from -- we talked, I think, at Investor Day, mid-single plus kind of digit growth in utilities, and now we're thinking it's high single-digit even with the lower growth rate in the first half of this year. I think as you get into the back half of the year and get into next year, we'd anticipate some of those -- that capacity work we're executing on in alignment with the strong demand that we're seeing to pick up and kind of -- and that's all kind of built into what we talked about and seeing that kind of a growth rate as you get into 2027.

Good problem, but you have multiple businesses running really hard right now. So what do you need to do from like a supply chain standpoint to make sure you have what you need and how are you balancing paying extra to get stuff versus maintaining margins and keeping up with demand?

Yes. Look, I think this is something that falls right into the RBS kind of playbook. And something that -- it's really nice to see and work with teams that have that level of focus on operational execution. I've said it so many times as they come into this business. We have this really, really, really strong operating discipline, leveraging the RBS. And I think this is an area and supply chain that we talk about and think about just about every day. And when you start to think about supply chain security, that's all part of that diversifying our supply base, looking at country for country type supply, managing through these things. You also saw our inventory was a little bit higher in Q1, and we're just going to go out and ensure that we have raw material supply for the build-out that we want to do. Now I think this is also, as you look forward, that can be challenging, right? It's always in that one area that you that you get surprised by and we're trying to limit the amount of risk that we have and ensuring that we've got the right capability from a supply base perspective, bring on the reasonable amounts of inventory to support potential growth not just in the second half of this year but into 2027 and ensure we're positioned to do that. And that's what we're focusing on, and that's what we're prioritizing.

You mentioned RBS a couple of times. I'm interested in both of your takes just I guess you're both coming from the outside. So Danaher Business System becomes Fortive Business System becomes Ralliant business system, what is the ability to like challenge this thing? Like when you have new people coming in, like is this the ideal framework, can we do this differently? Can we do this better? Like to me from an outsider who has never baked in any of those companies, sometimes it almost gets annoying the conversation around these things because it's just a thing that's existed forever, and we keep saying in different -- different letters around it. But like how much does this really get challenged and optimized for this iteration of this company?

I think that's a great question because I think a lot of people probably think is that we're taking RBS, we're more focused on kind of hardware business. You can kind of go back to with legacy, right? This is where was built and it was kind of for, which is great. But that's not actually how it's like approached internally. I think there is a lot of challenge on it. I think we've just done a refresh of all the RBS tools. We have new leadership, who's thinking about how do we implement and combine AI with our RBS full sets. So we're always thinking forward in terms of implementation of new programs and projects. So I think the discipline that's associated with. I'm super impressed by. I think -- it's actually great to be working with teams with that level of operating rigor. But I think that's also been challenged by some of the team that Tammy has brought in around how do we modernize it with new tools but also embedding AI into that. There's been a lot of workshop and a lot of workshops and a lot of work put into modernizing those tools for what we're looking at today.

So we've got a couple of minutes left. Maybe we just touch on capital allocation quickly. You talked about $100 million accelerated repurchase program. You have $500 million out there, I think, is the total. How should we think about how opportunistic you want to be versus how consistent do you want to be on those programs? And how do you weigh that versus M&A?

Yes. Look, I think our capital allocation priorities have not changed. So I think, number one, it's organic investments and thinking about how do we improve our growth rates and profitable growth through organic. We talked about that. We have a, I think, a very disciplined capital allocation program for organic investments about how we think about capital competing across the portfolio for incremental investments ensure we get the best return for shareholders as we think about those investments. And that doesn't change as you move down to returning capital to shareholders, number two, and then looking at M&A number 3. Now you talked about the shareholder piece. I think it was important that we said, look, that's number two, we have to be clear and direct on what we're going to go do there. So I think the accelerated share repurchase program we put in place gets us to about I think, roughly 50% of free cash flow for the year. So we want to kind of be clear with that. It also leaves what do you do with the other 50%. So I do think that at the right return, where we've got great ROIC where we believe we can execute tuck-in acquisitions, that's something we would think about doing and talking between those two things. As it relates to the share repurchase, I wouldn't think of this as programmatic going forward. I think we would -- I think that as a target over time of approximately 50%, and then we'll balance that with tuck-in M&A. So I don't think it's different than what we've said, but being a new company, we wanted to be clear with that as we kind of get out of the gate here with our capital allocation.

Fair to think of some modest baseline though, right?

Yes. I think that's a good way to frame it going forward, yes.

Okay. I just got 40 seconds left. So any questions from the audience? We can take it. If not, I think we'll probably just leave it there.

Great. Thank you, guys.

Thanks. Appreciate it.