Regal Rexnord Corporation ($RRX)

Okay. Great. Thank you, Andrew, and welcome, everybody, to our fireside session with Regal Rexnord. Today, special thanks to Louis Pinkham and Rob Rehard for joining us, especially after just reporting yesterday, busy week. And thrilled to be able to have the chance to follow up from earnings and discuss all things Regal Rexnord.

So yes, I just wanted to start out with a high level, Louis, Rob. Just want you to describe as you sit today, Regal Rexnord's strategic positioning, the overall goal of the scale consolidation, how you see that playing out versus your strategy case and the main milestones of the combination to date?

Yes. So Chris, great to be here, and thanks to those listening in and your interest in Regal Rexnord. We've been through quite a journey over the last 6, 7 years. It really all started with a mindset that you determine the value of customer places and your gross margin in your product on your gross margin. And so we've been working on improving our gross margin, which 7 years ago with 26%, today is 38% clear path to 40%. We did that through two large acquisitions and one divestiture. And then leveraging 80/20 and lean to drive value in our business. So our business is very different than the past. Today, it's more weighted to secular market. It's more durable through technology moats of competition as well as scale and scope. And we're now pivoting more to system solution sales where we can integrate all of our products into a differentiated offering that nobody else can compete with. And that's our strategy, and we're working it hard. And it's not an overnight activity by any mean, but we're making some good momentum. You certainly see that in 38% gross margin. You certainly see that with the orders growth we saw all through last year and the 8.5% orders growth we saw in first quarter. You certainly see that with some of the big wins and the verticals we've been investing in, data center and the incredible growth we're seeing with our data center offering in ePODs. Our growth in integrated powertrain solutions. We had -- in first quarter, we commented that we saw a funnel that has increased 18% year-over-year, and we're on track to meet our '27 sales objective in '26 through the activities of cross-sell and the industrial power trade. So all of these things are making us a stronger, more durable, more competitive enterprise to grow for the future.

Okay. Louis, I wanted to jump on something you said in their offerings that no one else can compete with. Maybe there's a little semantics there. That's quite a high bar to put that out there in the most vibrant capitalist society the world's ever known here. So just maybe you could double-click on that nomenclature that you used.

Maybe it's a little strong. But when you think about our scale and scope across the industrial power train, nobody has that scale and scope. So we feel like we're in a leading competition perspective on that. When you think about humanoids, and we've talked about this quite a bit, where we have the ability to provide an entire joint with our solutions and integration of our servo motors, our brakes, our controls all into one system. Nobody has this offering that we can put together in the integrated solution that we can. Now there are other competitors that have offerings that we don't have. So I don't think it's an unfair statement, Chris. It's just what we take the strength of our products and solutions, and we find how we can pull that together to differentiate ourselves from our competitors. That's what we're trying to do.

Yes. No, that's just looking to tie it to a specific application just to land it there in the humanoids with the full joint ability that brings true and clear. Just building off that kind of getting into the differentiation you have, I'm sure others have some. So curious, you described today's industry competitive structure, the degree of fragmentation still out there and maybe 3 or 4 top heavy guys, maybe, I don't know, 1/4 of the market. Like I just like to hear you out on couple of those things. And also if your scale consolidation has altered the competitive dynamics of the day-to-day industry in any particular way?

Yes. So you really have to think about it and look at it segment by segment. So IPS, we believe we are a scale and scope player. Now we have the scope of portfolio of products and brands that we have, nor the scale of manufacturing and capabilities worldwide that we have. However, it's a highly fragmented space. Do I think that puts us in a stronger position at times? Absolutely, especially as we sell an integrated solution where we can prove the value in quality and life cycle of the offering. So I think there's value there. Go to PES. PES has been we've been a scale player for a while, but it's a less fragmented space and we do lead, but there are other couple 2, 3 that we would call out our major leaders as well. And then you go to AMC, and AMC is highly fragmented, and it's all around technology and technology differentiation and how we position ourselves against competitors. And that's where again all parallel to we look for solutions that we can put together with our offering that nobody else can. Now is that a big part of our business? Not right now, but as we grow, we want it to be. So hopefully, that's helpful, Chris.

Great. Okay. And in terms of the organizational structure, you pulled a lot together. And curious where things lie right now in terms of the degrees of centralized administration of the organization versus decentralized. Nowhere is it exclusively one or the other. But just curious as you've evolved through this integration and joining Ultra and Rexnord with legacy Regal. What would have been the learnings along the way and where are those kind of lanes of communication stand now in independence?

We call it smart decentralization, Chris, where it makes sense to be decent -- philosophically, we want our leaders making decisions as close to the customer as possible, but we are smart in the way we approach it. Some businesses have different profiles than others. For example, IPS go-to-market is centralized. It's a global sales force, global sales and marketing force. However, PES is North America sales but North America operations because it makes most sense in the scale and scope of our production in PES. Whereas AMC, it's completely decentralized. We run it as 6 independent division, and so we call that smart decentralization. The day I started at Regal, Regal was centralized, highly centralized. Within 6 months, we were fairly decentralized. Rexnord and Ultra ran their businesses decentralized. Rexnord more aligned with Regal's approach, Ultra was completely decentralized. And so we pulled that back a little bit when it comes to smart decentralization. So for example, strategic sourcing. We have a $3 billion buy at Regal. We do that. We do the large commodities from the center to leverage the scale and scope of Regal. That's smart decentralization for us.

Okay. All right. Great. And so Rob, you'll be bridging CEO tenures here shortly. And again, has just been a lot of change, rapid pace of change kind of nose to the grindstone here for several years. So as CFO, I'm curious what might be your top couple of priorities as you kind of continuously envision the financial organization, the capabilities for long-term enterprise performance. Like where is the organization today versus a couple of years ago? And what are kind of the structural things that you think can move the ball forward in the years ahead?

Yes. So if I think about the last couple of years, I think, first of all, I'll start with talent. And we've made some great strides some progress here. I'd say, overall for the organization, the finance organization, the function, we're probably maybe 3 quarters of the way through where we want to be. We're building the bench. We've got some really strong talent that we've brought in. Each of our businesses we have 20 divisions that operate with the General Manager, CFO and an HR lead. And so we've embedded that structure throughout the entire organization. We've run to the P&L data as a -- the -- we drive the decision through data, and there's always been the way that we've done things here over the -- since we've decentralized and we have P&Ls at every plant. This is the way we run the business today, and that wasn't the way it was run in the past, we didn't have P&Ls at every plant in the past. We've also recently introduced a new consolidation system for the company that we went live on this year, which has been run flawlessly. It also embeds an element of AI within our finance org, which we are -- it's kind of early stages still, but we're working through that functionality and finding the benefits of that as we move forward. And I continue to see that as an area that we'll continue to deploy and expand as we move forward. And then we're just looking as a finance function to provide that value-added insight to help the business grow and partner. And that's evolution and one that we and I, in particular, take very seriously and push very hard throughout the function to ensure that we've got that visibility and that business partnering to ensure that we're doing everything that we can to ensure that our general managers and our EVPs and CEO is very successful in every -- all the strategic deployments that they have. That's where we focus, and that's what I'm most focused on with a new CEO coming on board. Giving that CEO up with the cadence, we have great cadence and rigor within our organization at a fairly detailed level and keeping that cadence and ensuring that there is that ongoing cadence of review through all of the businesses and is paramount for me right now. And I think that, as Omar comes on board, we'll find comfort in that in knowing that it's really dialed in, and we have a very good pulse on the business.

Okay. And then curious how all that plays into the AMC margin story has been pretty interesting. I think the aspirational margins have been dialed back and pulled out. In the construct of what you just described is value-add insights and visibility to the GMs and stuff, curious for a little more context on the AMC margin trends. I understand various macro factors, including supply chain and mix issues. But it also seems like maybe the type of stuff that certain degree of contingency planning and appreciation for natural vagaries might have a little tighter correlation between margin forecasting and margin results. So with that sort of separation of those two wins over the past couple of years and varying degrees at different times, is what you just described as the value-add insight, is that a place -- is that a function that's sort of lagging at AMC because it's more decentralized compared to the other segments?

Well, look, I think, first of all, we've owned this business for a couple of years, and we certainly have learned along the process. I mean, as we -- since we've owned it, maybe we've come a long way, and we've upgraded the talent across the board throughout the entire AMC segment. In fact, I think almost every one of our leaders within that segment is new to Regal Rexnord maybe over the last year or so. So yes, we've made some big strides in terms of bringing in really good talent and providing more data to help drive decision making. I think that the business has seen -- the AMC segment has seen some really strong external forces that were absolutely tough to forecast. I mean if you think about how we came into last year, we thought that the year would have been gangbusters, and you get $150 million worth of tariffs come through and where you just don't have that visibility. So I know you kind of made the point, and I think it's valid that we had a lot of external factors that influence the business like rare earth magnets and tariffs. These things have been plaguing the business, but an AMC has been pretty darn impactful, the medical destocking, for example, has been very impactful. I think that the -- I do feel though that the strides that we've made on the system side will help tremendously here because we didn't have great visibility at the level we needed to drive decision-making in the past. We are now on one system. To drive the data has to be consistent and the data management is critical. That's new in the last, let's just say, 6 months or so in terms of us getting on to one system. That is very beneficial for us. And I do think that's going to yield some nice benefits for us going forward.

Okay. So that's just been really kind of instituted about 6 months ago?

Yes, we went live actually at the beginning of this year, but we started to get some of the benefits of that consolidation view over the last 6 months.

Okay. Great. And yes, so you brought up the medical destocking. And orders comparisons when there's been a destocking can be a little tough to interpret externally, but I got to ask you about that number of medical orders. What was it up 53% in the quarter. Can you help put that in context? I mean, is that set -- I know it's not going to grow 53% in sales. You have a range of lead times and maybe some blanket orders in there. But is medical like kind of a pretty V-shaped recovery in the currents.

No. I think -- I mean, you're right. The compare is easier for sure, Chris, because last year, it was a tough year, and I'll just add one other thing. The year before that, it was discrete automation was a tough year, if you recall, and the destocking of discrete automation, both AMC centric product line. But medical for this year, we feel good about the business and the markets rebounding. We think the demand is in the marketplace. We think the destocking is done. And so we would expect more of a a natural rebound. However, we are winning some business that look more longer cycle that gives us a little more visibility because we're selling a system, a solution that's not just an individual part and that brings a little more stickiness, too. And that's all part of the strategy. But we do not expect to be shape recovery in medical. Hopefully, that answers your question.

Yes. And I was curious to hear you call the systems a stickier way of doing business with medical. I would have thought a lot of the -- I mean you're getting designed into specific platforms, right? And so I would have thought in general, that would tend to be more single source type of business or certainly very high-quality dual source. Maybe you implied that before the systems approach that might not have been the case. I'm not sure.

No. I mean historically, we would have sold precision motors in the medical. Now we're able to sell precision motors with micro gearing and micro sealing as an integrated solution. It's still sole sourced. It still typically sole source. It's still spec-ed in, all of those things, but now it's an integrated where we're helping with that design more than just supplying a component. We can do that because we have all those products in our portfolio.

Right. Okay. So a stick year refers to the -- okay, you're a much higher profile the next design cycle and the design cycle after that.

That's right. And we're actually helping with the design versus providing a component to the design, if that helps.

Yes, that's great. And then I want to get to data center because that is the hot topic. But once we get going on that, we probably won't have time for anything else. So I just wanted to have any signs -- I think humanoids is kind of steady-eddie, probably accelerate a bit here and there. But already eVTOL. I mean that's just kind of this like out there in the future. What a cool win, it's so emblematic of everything Regal Rexnord has been talking about for higher-value solutions. I think different geopolitical dynamics are pulling forward a lot of aviation technologies. I think eVTOL maybe a little more civilian based. But curious if there's any opportunity to eVTOL horizon kind of pulls in.

The L.A. Olympics is still supported on eVTOLs moving visitors to the Olympics. Now that's '28. I am questioning that personally, but there's still a lot of time that it's going to happen. We're on those programs. That would accelerate things I'd say. Now what you said, though, is why we really like our positioning here is we have a solution. It's a differentiated solution that's valued by our customer. And so then we're looking at adjacent spaces where that solution fits. So we actually just recently won a program on a space unit, and also on an electrical airplane with an electromechanical actuator. And so this is just moving up that value chain of providing our total solutions to different applications that can value what Regal brings to bear. eVTOL, if that market takes off more in good shape, it's not going to be overnight, that's for sure.

Yes. Yes. Okay. And with the space unit program, is that -- you've got a handful of kind of primes in space, then you have a vast supply chain. Is that space unit program you referred to, can that be horizontal across the primes? Or how does that fit? I haven't heard you mention that before. Yes, I don't know.

No. And it's new and maybe we should have gone public with it before. I mean it's not a significant growth vector yet. But it just is another indicator of what we can do in the system solutions that we can bring to bear.

Okay. We'll pick that up in a broader venue. And then on to the data center. So I wanted to discuss the just really impressive advance of the data center business over the past couple of years and more so in the backlog, in particular, than the actual growth, which is good as it is. But what were the key decision junctures, how the ePODs platform take shape for you guys?

Yes. I actually can go back 6 years. Rob and I were on a trip to see the facility and the technology, and we said we can do more here. And so we've been investing. That business has grown 30% CAGR over the last 5 years. Now that was off of a $30 million base. But last year, we did $120 million in switchgear. We expect to do probably double that by 2027. And so this is all around getting the right leadership, the right resources and growing in the space. But a couple of years ago, we run the business 80/20. So Kollmorgen is very important, Cloud 1, highly valued customers. A couple of our highly valued customers came to us and said, the market's moving in this direction, we want you to move with it because we value you as a supplier, your willingness to customize, your due on on-time delivery and commitments and your quality, and your quality and maybe double hit quality because we are known for providing quality product. And so we developed our program. We launched it at the beginning of last year. We did a number of projects which we won the majority of in the fourth quarter of this last year, and that was the announcements that we made coming out of fourth quarter. And now it's about expanding the universe of potential customers, but we feel really good about our position, and that's also why we increased our capacity in our Canada facility by 50%, and we're doubling our capacity by a new facility in Texas. And so that's really the genesis of -- Rob and I believe, a good business is a good business. It may not be particularly core. Data center is not core to the industrial powertrain as an example, but it's a great business, and we're going to continue to invest there and continue to grow there.

Yes. And I think like maybe by the end of this year, you start to -- that's the timeline for customers that want to reserve supply for '28. I think maybe the '27, that $700 million is probably not going to move a whole lot on that delivery schedule. But in terms of that continuing to grow from that suddenly large level. How does that work in terms of like the foot forward with capital and -- are you capacitizing for beyond '27 now? Or is that sort of like a dance with the customers and what comes first, the commitment or your capital?

It's a capital. Fairly capital-light assembly process. And so our capital that we've invested would allow us to double the output from what we're saying is likely a $900 million plus 2027. So we're not worried about that capital, but we can grow capacity very quickly here. It's all assembly and test, all assemble and test unlike many of our other businesses that are much more vertically integrated. .

Right, right. Okay. So you're suggesting that you've kind of aligned the levers to pull where you can kind of double your output from the $900 million level. And is that an indication that you expect the demand will go to that scope over the longer term?

Yes. But it's a question of timing, Chris. I mean if you look at any of the current forecast in the data center space, it's an expectation to grow significantly. Think we saw a stat of 200 gigawatts of data center capacity by the end of 2030, more incremental. That's a lot. So we see this market as being certainly a double -- a strong double-digit grower. And we'd like to benefit from that as well.

Yes. So in that vein as this has caught up quite a bit with the white space now growing crazy on a little bit of a lag to some of the gray space in the early years of this cycle manifesting and arriving. Now you're seeing more suppliers come in and have some share and in some cases, pretty suddenly, you guys are a case in point, Genrec, another one. So with that backdrop, I'm curious if there are maybe other greenfield solutions, greenfield from your perspective, that you're like, hey, we're evaluating 10 of these things and -- or well, we might have 1 or 2 that work or kind of ePODs where we're going to where we're going to nest. So how would you kind of respond to that kind of...

It'd be a little unfair for me to say that we're going to have -- there are other opportunities that are going to grow the way that the data center and the ePOD space has grown for us. But we are -- we work on a number of them, and we've talked about a number of them. The access solution for humanoids. We're betting early on that. We're spending money to get ready for that market to take off. But if it takes off, we're in good shape. We're great transition. We talked about eVTOL. So I won't talk about that again. We've been working this in air moving for a while. We haven't -- we're not a major -- we weren't a major player in air moving or more so of a major player in air moving because of the new products and solutions that we've come out with. This is our strategy is understanding the application very well, then leveraging the broad portfolio of our products to provide an integrated solution that brings value. The industrial powertrain is a great example of that. More bespoke to whatever the application is, so there's not a standard offering, but it's no different. And it's, again, I emphasize, our goal is to grow our system sales as a greater percentage of our total sales, and that's a big part of our focus. Hopefully, that was helpful.

Yes. No, I think you took in a little different direction than I intended, but it was certainly helpful nevertheless. I understand that broad strategy and humanoids and eVTOL. I think what's distinctive about the data center market is that the opportunities come quickly maybe out of the blue, and they would scale, add a quicker and -- more sudden level in some cases than eVTOL. You can see it coming a mile away and then you see it come in half a mile away.

Except when it takes off, it's going to take off quick. That's our view.

But kind of ideation to specification to a selling cycle with data center is a totally different ball game. So I was wondering if you have other specific applications named or unnamed that the data center, the integrators there saying, "Hey, we need to hear."

Yes. I mean other than to talk about the air moving solutions that we've been in, in trying to position ourselves more in data center -- but beyond that, nothing is coming to mind.

Okay. Yes. So could PES start to see a very discernible growth curve from air moving in the data centers?

It could. And it has been seeing some of that. Our commercial HVAC business has been growing pretty well. North America for sure, mid-teens for the last couple of years. And so could that even take off further? We think so. Now that's about 15%, 20% PES is commercial HVAC North America.

Okay. Great. And then as we're winding down the last couple of minutes, I just wanted to kind of have a little capital allocation priorities, how you see them shifting over the next couple of years? Any maybe different balance sheet structures, converts? Any sort of thoughts you're thinking about as you move ahead with interest expense is still a pretty large percent of EBIT.

Yes. So -- we do think we'll probably land at the end of this year, about 2.7x net leverage. We think that we'll probably -- once we get into that range. I think early next year is a time where we'll look at some of these capital allocation priorities. We've been prioritizing debt for quite a number of years here as we should have to get down to where we are. I've made commitments to the ratings agencies that we wouldn't really do anything until we're closer to 2.5. And then I think at that time, I think it makes sense to start looking at maybe some inorganic or possibly even buying back our shares, especially if we're trading at the multiple we are today, that would make a lot of sense. But that would be probably early next year at best. As far as the balance sheet and where we're structured today, I mean we don't -- our variable rate debt should be largely extinguished here as we kind of exit this year into next year in short order. And the composition of the bonds passed that point, pretty long tenure there. So we've got plenty of capacity as we continue to generate cash to do kind of whatever we need to do. I don't see a point in the future. And again, I caveat everything by saying kind of CEO transition going on. And so we'll obviously be -- one of the points of discussion here will be once arrives. But that I don't see us raising our leverage anywhere close to where it's been in the past. I think we could stay within that 2.5x or less on anything we want to do going forward. And our goal is to get under 2 and closer to 1.5x in the not-too-distant future, absent anything that we do that's kind of bolt on and maybe some more sizable; repos.

Great. Appreciate that color. We're at the hour. So great to see you guys. Appreciate the discussion and the timing running the meetings throughout the day with us here.

Thank you, Chris. Good to see you.

Thank you.