Regal Rexnord Corporation (RRX) Earnings Call Transcript & Summary

Great. Well, thanks, everyone, for being here. It's my pleasure to have up next Regal Rexnord Corporation; Louis Pinkham, Chief Executive; and Rob Rehard, CFO.

Maybe start off with the broad demand backdrop specifically around the shorter cycle industrial activity in IPS and AMC. A lot of people sort of curious about if there's real green shoots in the U.S. industrial economy. Kind of what's your perspective on that?

I think the indicators are pretty mixed at this point. And by the way, Julian, thank you for hosting us. It's a pleasure to be here, and it's good to see all of our investors, but to your question, I think it's pretty mixed. It's good to see the ISM above 50. The commentary of the ISM though, would say that GI is still pretty sluggish, will correlate it to then what do our orders look like. Our IPS orders were down about 50 basis points in January. They were up 3% in fourth quarter. Our backlog going into the year is up 6%. So some mixed signs. We feel good about what we've been driving and a big piece of our hypothesis through building the industrial powertrain and the IPS segment was around cross-sell. Our cross-sell today is about $90 million incremental in 2025, that was about $210 million. We had put out a goal of $250 million by '27. So we're well on that path. So when the markets do turn 1 month does not make a trend, maybe 3 does. When those markets turn, we're very, very well positioned.

Got it. And within AMC, I suppose you had a good pickup in automation demand, and we've heard that from 1 or 2 other companies here as well. Were there any kind of specific verticals driving that? Was it just an easy comp seeing any color around that automation piece?

Yes. So our automation orders the -- last 12 months are about up 6%, fourth quarter, up 9%. The market, though, that's driving it more than any other is defense, defense vertical. In particular in Europe, we're nicely positioned and have a strong footprint in engineering content in Europe and with the sovereignty drive, it's a good position for us. On top of that, we've been investing pretty heavily in new products -- in defense, it's often application-driven products, and so we feel good about our momentum there. for sure that, that vertical will grow for Regal for a number of years to come.

Great. And it's been a couple of years since the 3 years almost now since the Altra deal closed, kind of how satisfied are you with the automation portfolio as it is, the things that you have done to improve that sort of AMC business that came in to Regal?.

Yes. I mean we're very satisfied. And this was a fantastic acquisition for Regal. We were not in the automation space. The ability to acquire the power transmission part of the business gave us the synergies that allow us to fund and move into automation. We've raised our R&D spend in automation. And so look at some of the programs we've talked about historically on our earnings call, eVTOL, our electromechanical actuator wouldn't have come out of anything but that integration of -- with Altra. And then when you think about our next steps of opportunities Kollmorgen Essentials. Kollmorgen is our brand and motion control that really plays in the ultra-premium space, and essentials moves us down and gives us a much greater served market, and we talked about on our last earnings call, about $1 million of orders in fourth quarter and a path to $50 million by 2028. We're still driving that momentum. And so we love the technology that we got with Altra, especially in the automation space and expect to do much more with it as the years progress.

Great. And then, relatively small part of the business, but within PES, you've had that resi HVAC pressure seems like the OEMs are kind of saying the point of maximum decline for them was maybe 3 months ago now. What are your sort of perspectives on that market? And I think you've dialed in a pretty conservative guide for the year there.

We have. And we wanted to be very measured here. We're expecting the market to be down for us, high single digits. And that actually translates to down about mid-20s in the first quarter, down in the first half and then a slight rebound in the second half. If the OEMs are correct, that's a positive upside for us. But we talked about in the last earnings call that we did gain some share in the resi HVAC space in 2025. It's a good market for us. We like the market, but nobody knows how to forecast it. And we're inclusive of that team. So 9% of our sales, I hope the OEMs are right.

Yes. And then I suppose that was most eye-catching at the results on the top line front was the data center orders maybe kind of remind the audience where you sit today, the total kind of percent of revenue, if you like, from data centers and how that sits in different products in AMC and then PES segment-wise?

Yes. So today, data center is only really about 3% of Regal. 2% power management. So paralleling switchgear, switchgear, automatic transfer switches, power distribution units and about 1% is in Hermetic motors and Air Moving solutions. Now we're very pleased with the nearly $1 billion of orders that we received in 2025 that likely translates to data center becoming low teens part of Regal in '27, and we want to build off of that. We've got good technology. We're valued by our openness to customize, our say-do is strong. We've been in the industry for 50 years, so this is not new to us. Now the ePOD solution that we announced a big win of $735 million of orders for multiple data centers in 2027. That is a new solution, but the reality is, it's 50% of our content in that solution, which is switchgear power distribution units, other automatic transfer, which is, along with the Air Moving side. And so yes, we're excited about the future of data center and how it's going to have an impact on Regal.

And how do you think sort of about your competitive position in that data center business? Kind of what allowed you think to win those large orders, which no one seems to be expecting from the outside?

Yes. So we have a good reputation in the business. Our say-do around -- oftentimes, it has to do with the ability to meet the schedule of the project and to ship on time bluntly. And we have a good reputation about being able to do that. On top of that, we're very easy to do business with. And we will customize this -- meet the specific needs of the end user or the customer, and that is valued. And so those couple of things and the fact that we are a $6 billion company with a pretty strong balance sheet and capability. We started -- we won a bit more than we expected. We talked about coming out of the third quarter earnings that our funnel was about $400 million of ePODs. We were kind of on the edge, and we weren't really sure. And in the end, we pretty much won everything we expected a little more. And so we're very pleased with that.

And you talked about how it's -- for delivery, a lot of that $700 million is for delivery or rev recognition, I mean, 2027 for Regal. How is your kind of capacity ramp up going for that data center business? How confident are you in your own suppliers being on time, in full there?

Yes. So we had some indication that we were likely going to win some portion of this, even coming out of third quarter. That's why we announced the expansion of our capacity in Canada about the same square footage in Texas. That is well on its path. And by the middle of this year, we'll be able to ship product out of Texas. And so we feel good about the capacity and recognize this is light assembly and test. This is not significant CapEx investment. We talked about $5 million to set up the manufacturing facility or the assembly facility in Texas. So this is not so difficult. It really is all around the supply chain and managing the supply chain. But we have excellent relationships at executive levels at the key suppliers, and I feel pretty confident that we're going to be able to meet those -- the requirements of '27 and beyond because, again, I want to emphasize, this is not -- this is all about Regal continuing to grow in this space and differentiating ourselves in this space. That's our goal.

And how would you frame the sort of remaining funnel of business that you're going for to try and win orders? You overperformed your goal wildly the last 3 or 4 months. How has that sort of led to a revision maybe of the view of how big the funnel is out there?

Well, we're still building on the funnel, honestly. The funnel today for us is about $600 million. It's more leaning towards switchgears than ePODs at this point because we won the majority of what we expected to or even more on ePODs, so the funnel today, but we plan on growing that funnel. The opportunity is significant here, and we believe this is a market that's going to continue to grow, but the reality is we're a very small share player. And so there's plenty of room for us.

And if you wanted to try and sort of help us frame the opportunity, you had that some $800 million of orders in the fourth quarter. again, it seems to sort of erupt from nowhere from the outside. So it's hard to kind of understand what could be left on new orders the year ahead, for example, or next 18 months, any way you'd frame the addressable market or...

We did come out and we said, I believe we said the addressable market was about $25 billion of potential. So compare that to where we play today right? The funnel is $600 million. We want to grow that funnel. We want -- we believe that our sales in '27 as a percentage of Regal could be low teens. So what does that mean for us? Maybe $800 million, $900 million. We want to grow from there. So that means we're going to need to play some -- get some orders this year that will feed '28. That's how I would think about it. We're not going to try to put any more clarity on that because another question our investors like to ask us is, what's our win rate? Well,. our win rate, if you go off of the $400 million funnel, was 175%. So we clearly don't have that locked down yet. This is nascent for us. We're trying to figure it out a little bit but I feel really good about our reputation, our position and the opportunity for us to grow.

And as you said, it's sort of a wide gap from the $600 million final to the $25 billion TAM. The delta there is what is a mix of -- assuming you don't capture a majority of things you go for? Or it's a constraint of capacity on your end to ramp like -- what are some of the factors...

The biggest delta is we know the market, it's visibility. So our visibility is you don't put it -- we don't put an opportunity in our funnel unless it's an active opportunity that we're working to win. So we're also trying to grow our sales force, and we're trying to grow our position. And so I would expect the funnel to grow. That's the biggest differentiator between $600 million and $25 billion.

Got it. And the profitability on this activity is sort of commensurate with segment, the respective kind of segment level or...

Yes. We say a little above 20%. I mean we've got about 50% of the content on the ePODs so it nets to about 20%. Of course, we'll continue to work productivity measures to improve that as we go forward, but that's kind of our starting point here as we kind of get through this and kick off the project. We'll get a little water under the bridge, and then we'll kind of true that up as we move along, but that's our expectation.

Great. And when you think about the top line, it's been a very hard market to forecast the last couple of years, not just PES, but the industrial side as well. So when you kind of went into this year and we're framing the guidance. Is there any kind of change in approach attempt to be more conservative, perhaps just given the last couple of years have been difficult to forecast revenue?

I would say, very similar to last year, measured. We came out for '25 to be flat. We were up 1 point. Most of that point was tariff pricing, but so we forecasted on the aggregate of Regal pretty well. We're coming into this year and thinking about the same thing. We're not seeing a lot of market tailwind. We believe it should come but we're not betting on it. Pleased to see ISM above 50, but again, we're not betting on it. Where we are betting is it's pretty clear that data centers to grow for us. And so 1.5 points out of the data center. And it's pretty clear that we're going to get some price to still overcome some of the tariff challenges, so 1 point, 1.5 points, and that's why we came out and we said low single-digit growth for this year. Now we think we're at bottom in many of these markets. And as they inflect up, we're going to benefit from that.

And how should we think about the earnings or margin cadence through the year? Sort of comps move around with tariffs and some of the rare earth headwinds and that type of things. So if we're thinking about kind of sequential progression or quarterly sort of phasing of earnings or margin, anything we should bear in mind this year?

Yes. We came out and said first quarter is going to be a bit pressured. Think about 21% EBITDA margins in the first quarter. And then we progressively get better from there as we ellipse -- we are getting past the rare earth magnet supply chain issues by the -- mid part of the year. Tariffs, we get a little bit -- we should be priced which should be priced at $1 neutral by the middle of the year and work towards margin neutral by the end of the year. Mix benefits us as we move towards the back half of the year, particularly in AMC where we would expect -- and where we see the highest growth opportunity in the year as we get to some of those higher margin businesses like automation and defense and medical, these others very higher margin relative to the rest of the business coming online. If you look at it from just a cadence of improvement as we go through the year and we start with 21% we expect around 200 to 250 basis points from that 21% range to kind of move quarter-to-quarter pretty ratably as we move through the year. And so we'll end the year at a much better position than when we start the year. And that's what we have built into the guide. The EPS -- by the way, it's about 45%, 55% first half, second half EPS. Remember, we also get about $30 million of interest expense savings as we move through the year as well. So that's benefiting the earnings side.

Great. And when you think about margin levers this year, price cost is sort of mutualist by midyear, so that's not really a factor. You have some synergies in there that I think you characterized as a sort of cushion effectively. So maybe help us understand kind of the levers there because you're not dialing in a lot of volume growth.

Yes. I think that -- so you called out the one, the $40 million of cost synergies, which we're saying, hey, we're going to use that as a hedge or as you get into the year just because it's not -- in other words, it's not in our guide today because we need a little buffer knowing that there's some unknowns out there that we're going to likely counter. The other things that we're talking about are the main things on the margin side are what we just kind of went through quite frankly, had to do with the tariffs getting back to margin neutral, it's about the rare earth magnets getting behind us and in the mix and then volume comes in as well. The other things that are quite frankly, aren't built into our guidance today. We've got -- we're assuming at this point that the markets in which we're participating are kind of where they are today, and we don't see a lot of inflection at this point. So ISM is a great example. We talked about it a little bit earlier. We're not banking on anything inflecting yet, even though 50% of IPS, for example, is correlated to the ISM, we want a few months before we start seeing that. That would be a nice benefit to us in the year should that stay above 50 like it is in January. Again, as Louis mentioned, we were down a bit in January and IPS about 0.5 point. So again, wait and see a bit. And then the other markets that are coming back, as we talked about in AMC, in particular, are very good. And so that could be a bit of a benefit to us as well. We're not banking on that at this point. It's not built into the guide, should I say, but certainly supports a better -- especially a better second half as we go through the year.

And how are we thinking about operating leverage, what's assumed in that second half margin guide for operating leverage at Regal? And what should we expect sort of medium term?

Look, we say about 30%, 35% in leverage. I think if you think about it from the standpoint of we exited '25 at about a 38% gross margin fall-through is pretty good. We should get 30%, 35% is very reasonable. Our current guide embeds about 39% gross margin for '26. So again, very reasonable to assume that, and it's certainly a little stronger on the IPS side, and then from there, it steps down AMC and then PES. But overall, 35% is very reasonable, and that's what's embedded in our current guidance.

Great. And on the pricing front, you sounded pretty confident on getting that price. No signs of kind of fatigue by customers or them starting to push back? Is everyone kind of keeping rank competitively and handling costs the same way.

Yes. I wouldn't say there's no fatigue, and I wouldn't say there's no pushback because our sales leaders are doing an excellent job of managing this, but you'd be blind not to know that there's inflation and there's tariffs and there's things that you have to cover. And our customers are looking for us to try to put our best foot forward, which we always do. One of the things that you're talking about margin potential and what we drive. We're -- Regal Rexnord business system is very important to how we run our business, and it's built off of 80/20, driving Quad-1and our customers are highly valued customers and a highly valued product. But it's also lean and it's taking waste over burning variation out of all processes. Now think about what we've done over the last 3.5 years, we've combined 3 big, relatively large companies. And we had no more plans of consolidation going into 2027. I'm sure there will be 1 or 2 plant consolidation, but nothing to what we've been going through for the last few years. And so now it's doubling down on lean and driving lean in our factories. And I think we're at probably third, fourth innings of opportunities there to drive further margin growth.

Got it. And if you think about the sort of segments there for a second, is it fair that PES might be more leaned out than the rest just because they didn't have the acquisition.

That's very fair. Yes. And then it tends to be a bit higher volume, there's much mix. There's still plenty of mix, but it's not to the level of our AMC or IPS businesses. That's absolutely right.

And PES' place in the portfolio, you made a good case for it at the Investor Day a couple of years ago. I guess is the experience in the interim of the end markets or how you see it the motors there fit with the powertrain. Any sort of dilution of that view of the PES place in the business or not.

No, if anything, I think it's accelerating that. We're seeing some nice momentum moving more and more into Air Moving. We talked about coming out of the third quarter call, about $20 million of orders in data centers. We didn't talk about this in the fourth quarter call, but we're winning more in Air Moving, in data centers, in clean rooms. It's a business that will grow. It will grow with Regal. And we like the margin potential and our position in by the way, thank goodness for its cash flow because it's paying for the 2 big acquisitions we did.

Okay. Fair enough. And on the point on free cash flow, a bit of a hit to conversion this year partly for sort of funding the growth investments. When do we see that free cash you think normalized.

Absolutely, we expect that in '27. I mean, as we're going to make about $100 million, $150 million investment, working capital investment to support the $735 million ePOD data center order we've been talking about. We start -- that starts to come through in '27. We would expect that to move to a much better position at that time. We also have some opportunity on just the rest of the working capital side of things in terms of inventory and that -- we absolutely have room to improve our inventory position and our days to free up some capital there as well. So free cash flow, absolutely, we should see an improvement back to more of what we would expect and would have expected once we get past this -- the data center investment side.

And how are we thinking about kind of leverage? There was the securitization in 2025, cash flows increasing this year even with some of those headwinds investing for growth, any sort of contemplated measures to accelerate delevering or it's more around the EBITDA increase and that will bring leverage down naturally.

Yes. I think that we'll end this year probably around 2.7x on a net basis. We should be there for -- below 2x by the time we get through the next year. Once we get around 2.5x use of cash could change a bit. We're going to prioritize paying down debt at this time. We may change. We will likely once we get below 2.5x to start looking at maybe a little more opportunistic share buybacks. Maybe look to increase the dividend, get back to that schedule again. And then we have a good funnel of opportunities in terms of smaller bolt-ons, nothing transformative, smaller bolt-ons that we certainly in our AMC segment along the automation side that would make a lot of sense for us. But again, I see that we could get to below 2x and stay around below 2x with the cash that we generate, still doing all those things I just talked about. So I think it should be fairly balanced down the road. But we've got to get below that 2.5x quite frankly, which should happen early next year.

And Louis, you talked about the sort of leaning into 80/20 and lean in the IPS and AMC segments and has a clear view on products and customers to focus on. Just wondering if you thought that doing that organically was enough? Or is there some view to do you chip away any of the -- or divest any of the pieces of those 2 segments now you've seen how that played out for several years each after the 2 big acquisitions or you think actually now, what you have it all sort of fits together.

Yes. No, we like everything in our portfolio today. We think we have good scale and scope and IPS and PES. AMC, there's still some opportunities. So we would say, in time, when it makes sense, there's bolt-ons that could make us stronger. We have no intent to see any kind of at least at this point of looking at any kind of divestiture in those 2 segments. My point earlier though, and I want to emphasize this, I think we're further along with 80/20. 80/20, we know how to run our business by 80/20, where there's opportunity still though, is lean, and that's what we're going to be driving.

Is that going to be a sort of a very centralized push? Or what's the mechanism to make sure...

No. I mean -- so we actually have a Regal Rexnord business system leadership team meeting going on right now. We have 100 plants roughly. Every plant above $25 million has an RBS leader that focuses on continuous improvement that reports to a plant manager. Every division, we have 20 divisions, has an RBS Director who facilitates our CI road maps and are driving our plan. Every segment has an RBS SVP and then we have an SVP at my level. it's important to us. Continuous improvement is critically important, and we have invested there, and we will continue to invest there.

Great. And with that, we'll switch to audience response survey questions, please. So the first 1 is around the current ownership of Regal Rexnord? So popular name. Secondly, it's around general bias to Regal at present? So generally very positive. Thirdly is on through-cycle EPS growth versus the multi-industry average here? Slightly above the peer set. Next question is around usage of cash? And we were just having that discussion a little bit. Mostly debt paydown still. Next question is valuation, what's the appropriate PE multiple for Regal? Blends to 20-ish times. And then last question, what's the biggest kind of anchor or a headwind on the valuation multiple today? Organic growth. Great. So with that, thanks very much. I think Louis, it's maybe your last time here. So thanks for all the support down the years and really appreciate you being here answering these questions, and we wish you all the best. And thanks, Rob, as well for being here.

Yes. Thanks, Julian.

Thank you very much.

Thanks.