Hi, good afternoon. I'm Chigusa Katok u, a multi-industry analyst at JP Morgan. Very excited to have with me here today Ralliant, Tami Newcombe, President and Chief Executive Officer, and Nathan McCurren, Vice President of Investor Relations. I think we'll kick it off with some remarks from Tami.
Excellent. Thank you for having us today. I'll just start a little bit. We're a new public company, three quarters into our life. So I'll give you a little bit about Ralliant and who we are. We're a precision technologies company. We specialize in instruments, sensors, and safety systems, I say where it matters most, and that is often in environments where accuracy, reliability of those measurements, and also safety really matter. Our customers are engineers and innovators who work in end markets like utilities, defense, test and measurement, or industrial technologies. If I think about what we've been doing for the last couple quarters, really been focused on executing our profitable growth strategy. Our profitable growth strategy has three pillars. One pillar is around higher growth vectors and driving higher growth. The next pillar is around stronghold positions.
Our stronghold positions are, you know, low single-digit type growth markets where we are differentiated and have competitive moats with a very large install base, which gives us a recurring opportunity with our customers on maintenance and repair. The third part of our strategy is the Ralliant Business System. This is how we execute with rigor. This is our continuous improvement mindset of getting better every single day. I'll go back to our higher growth vectors, 'cause there's a lot of exciting things happening in our end markets that touch electrification and defense. If you start in electrification, the first layer of electrification is the power grid. With the excitement around AI and electrification around the globe, that first layer of a power grid that is reliable, that keeps the lights on, that is intelligent, is where we have a play.
Our precision sensors attach to the most critical assets in that power grid and ensure that the operators of those power grids get the intelligence that they need to keep those systems up and running. The next piece in electrification is around the data center and how AI is driving that data center. Inside that data center, any of the electronics in there would be, our test and measurement equipment would be used by those engineers and innovators that are building that equipment. Also, in the data center, there is cooling and thermal issues where our industrial sensors for temperature, for flow, and pressure are being used in different cooling systems. At the edge, where AI is showing up in robots and humanoids and different electronic devices, that innovation also requires more test and measurement equipment.
That's the electrification piece of our higher growth and how we play. On the other side of secular trends is the defense space. In defense, we play in the production side, and that's the programs that have been around 10, 20 years, mostly in missiles and munitions, where we are a key critical supplier to many of the programs that are going through a big replenishment cycle. In defense modernization, where you'll find in the R&D labs our test and measurement equipment as the defense community is working on next generation communication protocols. The last piece of defense I think is still to be determined. What does the new budget look like?
The $1.7 trillion in defense spend that's being talked about, not approved yet, but that is the surge or frameworks that we've been talking about that could take our billion-dollar backlog that we have today in defense and space and make it even bigger. That's a little bit on who Ralliant is and how we're executing on our profitable growth strategy.
That's a great overview. Thank you, Tami. Just to follow up on the defense, I think you announced a PacSci award this morning. Can you just talk a little bit about how that ties into overall defense strategy?
Yes. There was an announcement made this morning by the Department of War that our business that is in the defense and space end market is called PacSci EMC. They've been awarded $27 million to help with some of the build-out of the capital equipment required to keep up with the demand in the Standard Missile business that we have. This is in addition to what I talked about last week in our earnings, where we are making organic investments in additional sites and additional equipment, thinking out to 2028 and beyond that we will need some physical capacity. Up until now, we have doubled the business by using productivity initiatives in our factories.
We've added shifts, we've leaned out cells through the Ralliant Business System, and we've built out a strategic sourcing team to ensure that the supply chain keeps up with what we need to do in the factories. It was a exciting award from Department of War. I think it's a testament to the critical nature of our business to some of the key programs.
Yeah, that's great. You highlighted over $1 billion of backlog in defense and space, and it sounds like there's upside to it. You expect double-digit growth in 2026 and beyond. I think at the Investor Day, you highlighted, like, a long-term growth rate of 5%-7% in defense and space, and maybe 2%-4% in communications, where there's a big defense business there, too. Is this still the right framework, or do you think there's upside here?
Let's talk a little bit about what's changed since we were at Investor Day. One thing post-Investor Day, I think it was a couple months later, we started to see this replenishment coming through in our backlog in defense and space. What we can see today in backlog gives us confidence to say that this business is a double-digit grower, maybe double-digit-plus grower, not only in year, but in some of the out years here. Let's stop there with defense and space end market. The other end market that is a little higher than we talked about at Investor Day is in the utility space. Both of those are in sensors and safety systems.
Yes. You mentioned a little bit about the capacity or the supply chain constraints in the defense business, but where are the key kind of constraints there, like around what products? On the margin side for defense, as the defense business grows faster, I think the margins are lower than the company average. Are there any actions you can take to mitigate the mix headwinds?
Yeah. For the defense space, the growth rate, as I talked about, would be double-digit. Given the government is helping us with some of the CapEx, they do put some guardrails on the profit areas. It's called TINA. Compliance is the government language that they use. We have guided our sensors and safety systems about 60% of the overall business, and in that business, we talked about adjusted EBITDA margins from the mid-20s to the high 20s. We're already at the high 20s, and our guidance for people is don't think above that 'cause we're gonna have some pressure on the margins here as we grow that business.
Makes sense. Following up the utilities side, I think this quarter was a little softer due to the shipment lumpiness, but how much visibility do you have here, and what kind of are your expectations for growth for this year? I think you touched on a little bit earlier, but is 5%-7% still the right long-term growth rate for this end market?
The utilities end market is also part of the sensors and safety systems segment, again, 60% of the overall business. In utilities this past quarter, our revenue growth was +1% on a quarter when our orders hit a record. The orders for a historical record, not just an annual record, but historically a highest orders quarter that we've had. Robust demand we're still experiencing in utility space, and this is another market post-Investor Day. Investor Day, we talked about 5%-7%. I see that as more of a high single digit grower this year and into the future. If you know this space, you know that critical assets for the grid are very difficult to get right now. There's a long lead time on them.
We work both with new placements of critical assets, and we also have a play in retrofits for that space.
Yeah, that's very helpful. I guess the defense growth framework and the utility growth framework is both better than, what you expected at the Investor Day. What does that kind of mean for the overall Ralliant organic growth?
Yeah, what you saw is, as we came out of Q1 and our test and measurement business, that's the 40% segment in our portfolio. That business performed about as expected from a revenue standpoint, but we saw the orders come in hotter than we expected, 1.2 or so book-to-bill. That combined with the backlog visibility, test and measurement orders being stronger, combined with the backlog that we have visibility to in defense and space, gave us the confidence to first give you a guide for Q2. We've good visibility in the next 90 days-120 days, as well as raise. We raised all metrics for the year. Moved the growth rate up to 5%-8% on the year.
Following on that, your full year outlook, I think it assumes some deceleration in the second half to the low single-digit to mid-single-digit range from kind of the high single-digit organic growth in the first half. Can you talk about the drivers here?
Yeah. The business across the portfolio is about 70% short cycle business. The other 30% is in services and what we call recurring business around maintenance and repair. The short cycle business, you get about 90 days- 120 days of visibility, and that gave us the guide for Q2. As we thought about the second half, you know, there's still a lot of uncertainty out there in the macro. We have seen some spots where we've seen some supply chain issues. I think we've navigated all of them quite well right now. I mentioned transformers. You know, they've got a backlog right now, and, you know, shipments are out one to two years in that space. I think just we're a little cautionary on the second half.
We'd opened the year thinking 48% of our business in the first half. I think we're 49%, 51%, about a point shifted there, first half, second half.
Just two more questions on sensors and safety before moving on to T&M. On industrial manufacturing, I think this vertical grew 4% this quarter, and we're seeing overall directionally positive trends from others. But I think the strength and length kind of remains a question mark. I was curious what's your outlook for industrial manufacturing this year, and your thoughts on whether you think trends are of gradual recovery or there's an inflection driven by onshoring trends?
Yeah, I'll put together our end market called industrial manufacturing with other, and those are critical environments. All, I guess, somewhat industrial in nature. That's about 30% of the Sensors and Safety Systems segment. And an area which historically, you know, maybe 0%-2% type growth over a period of time, and we're definitely seeing above that right now. I think that, if you look back on the last two years, three years, it's been really tough go in that space. There's been a lot of pent-up demand that we've seen come forward. In some markets, Americas doing very well. China, pretty good, and Europe still suppressed when it comes to industrials. I think this will moderate. I think this will come back over time.
I don't know how many quarters we'll have at this higher growth rate when I think it'll, you know, normalize in the out years more back to what we had seen.
That's helpful. Thank you. Going back a little bit on utilities, I'm guessing margins are quite attractive here. I'm guessing in the 30%+ range. Where are the key capacity or supply chain constraints in the utilities business that might limit growth?
Yeah, for us in utilities, it's, our customers being able to go fast enough.
We have about 30% of the business that's a project business. The rest of the business is tied to customers either retrofitting critical assets or getting critical assets out into the field. They're the bottleneck right now more than we are. We are prepared today for volumes that would go out to 2027, late 2027, then we're adding some capacity that would come online in 2028 and beyond in that space. We, you know, we see lots of opportunity here, and we just work with our customers on the timing of shipments.
That's helpful. Shifting to T&M, you talked about how it's the short cycle, limited visibility here, but this segment grew strongly this quarter, and you now expect it to be up high single-digit for the year versus last quarter, I think you were talking below the midpoint of the 2%-6% guidance range. Can you just talk about what changed over the last three months? What are kind of the indicators that you track internally, and what are they saying maybe today versus 90 days ago?
Yeah, we spun in Q2. At that time, we believed that Q1 would be the lowest point in the quarter for demand, and that turned out to be right. Every quarter, we sequentially improved the business there. As we came into this year, we looked back and said, "Q4 to Q1, typically maybe 3%-8% type step down in revenue." We did see that. We saw a 3%-4% step down in revenue. What surprised us was the order strength. We're seeing strong orders across where our specialty is, which is around power electronics for the power grid, for the data center, for edge electronics, as well as in the defense space and defense modernization. All very strong.
America's again the strongest, actually China finishing a little better than we expected with the investments there in AI and energy. You asked about what are our early indicators. The best indicators are orders. We said that last quarter. We said all of these early indicators are great, but we need to see our funnels convert to orders. That's what we saw happen. We continue to monitor funnels. We model channel inventory. We model channel sell-through in points of sale. Those are all the best indicators for this business.
That's great. maybe can you talk about market share trends in test and measurement? I think Ralliant has strong capabilities in R&D, and you're expanding into validation and production with new products like the MP5000 Series. How is your traction here? High level, if you can talk about the key drivers of your test and measurement business and how it differs versus some of the other players in the T&M space.
Yeah. When you look across the test and measurement, test and measurement tools are used in advanced research, development, validation, production, and then the services part. We predominantly play in advanced research and development. That's probably 40%-45% of where we play. Then validation, production, and services are all 10%, 15% of revenue, getting to the 100% for the whole workflow piece. When you think about share, our highest share is going to be in that R&D space, and where we're particularly good is around power electronics. You add the noise floor in the oscilloscopes, which is brought to life through ASICs we build in-house. With the Keithley portfolio, which I think of as like the atomic clock of precise measurements for current and voltage. With the recent acquisition of Elektro-Automatik, that power portfolio is extremely strong.
Couple that with some new products we announced last year in the high end of the oscilloscope family, the 7 Series, and the strength that we have in defense and some of the communication protocols that are used in that space. I think the best measure of market share is growth rate. Durable growth through the cycle, continual growth, it comes with innovation and it comes with taking share, but at the end of the day, that's the best metric.
It's helpful. Maybe shifting to Just quickly touching on book-to-bill. I think it was 1.1 times for the overall company, and test and measurement, I think you said it was about 1.2, 1.3. How, kind of, do you expect this to trend for the year, if you have any thoughts there?
We're off to a strong start with a 1.2 book to bill. This is something that we monitor on a monthly basis. The business again is a short cycle business, 90 days-120 days. We can see through Q2 and into, you know, halfway through Q3. Every indication is that the business environment is gonna be similar as we go forward. That's probably the key indicator for us on the future of the business.
Okay. Sounds good. Now I'm gonna shift to the margins. The enterprise productivity program, you talked about this quarter, $50 million-$60 million of cost savings targeted by 2028. Can you flesh out the drivers for us? How much is driven by COGS versus SG&A?
You wanna take this one?
I can jump in. We've shared that there's two main buckets, Cost of Sales and G&A specifically. It's about 30/70 the split between those. Cost of Sales about 30% of the savings, G&A about 70% of the savings. Of the $50 million-$60 million, we've already taken action on $20 million of that. We've said that we expect for that $20 million of annualized savings that we've already taken action on to drive about $10 million-$12 million of in-year savings in 2026. We're taking action really over the next 18 months on the remainder of that, expect to complete by the end of 2027, driving to the full run rate of $50 million-$60 million of annualized savings by, you know, into 2028.
Sounds good. What are kind of the lower hanging fruit that you can get in 2026 in terms of the buckets versus the cost savings that'll take more time? How will you kind of govern or verify the real savings versus maybe like the cost avoidance?
Yeah.
I'll talk about that. The actions that we have taken in 2025 and early 2026, the first was around dissynergies in the business as we carved out some of the services business that stayed with our parent company. Second was some restructuring that we did early this year. I'd say of that $20 million, it was predominantly in the test and measurement segment. As we move forward, one of the reasons we put an umbrella program over all the initiatives going on is because we wanted to be sure we had good project management, governance, and real targets for the team. Couple actions we took, we consolidated the IT department, the legal department, and the HR department.
They're all working on programs using AI, reducing or optimizing their workflows. We wanted to capture that and make sure we knew how it was hitting the P&L. The enterprise productivity program is really the governance and oversight. The way the work is getting done is all through our Ralliant Business System, leveraging AI.
One thing, Chigusa, that I'd highlight is, you know, this is really possible, like why is now the right time? This is us taking the organization saying, "What's the right custom fit for Ralliant?" 2025 was really focused on get the spin completed, do that successfully. Now it's really saying, now that we've gotten that behind us, it's how do we really organize the company in a way with, you know, six operating companies that all look similar to each other, have a similar business model, and saying, "How can we find some, you know, areas that we take centrally or have synergies across those companies to bring together and drive productivity?
It's helpful. The AI-infused RBS system is really interesting. I think you referenced previously AI foundry and AI enhanced workflows. Can you talk about what are the top use cases that you're deploying and how kind of you quantify the impact?
Yeah, I'll give you a couple. I'll start in manufacturing, 'cause this is one hot off the press from our CEO K aizen, two weeks ago. We had already digitized one of our factories and had access to all of the data that comes out of the factory, which traditionally had been done on what's called a QDIP board and manually entered and manually updated. This had moved all to digital, and now what we're doing, leveraging that data to be able to do more predictive. Can we predict? One thing that's difficult to predict is repair work. If we've got good insights across the business on Monday, Tuesday, Wednesday, Thursday or different months where we tend to get more repair work, we can plan for that ahead of time.
Instead of that hitting us and reacting, we can see it coming through our trending and data analysis and make sure we have the right people, we have the right supply, and everything comes together to be able to take care of that. In our manufacturing lines, we're leveraging AI to make us more productive as we go forward. Second example I would give you is in the commercial space. How do we get our exciting and wonderful portfolio into the hands of more engineers, more innovators, more system integrators? Their persona tends to like looking things up for themselves, and they're pretty savvy. We have put capability into our websites to allow for take a picture of what you're trying to replace, that sensor in the field that you're looking for.
If it's not our sensor, we'll cross-reference you to something that we can supply. We've put all of our technical and knowledge out there so that people can search it and learn how to best use our products for their applications and workflow. The best thing about this is when you put AI and digital together, it works 24/7, 365, any place around the globe. We have pretty small and mighty commercial teams, and this allows them to feel bigger to our customers.
You've been investing in AI, I think ever since you were part of Fortive.
Yes.
It's been a few years.
It has.
planning it.
Yes.
Makes sense. Maybe, on the margins again, I think you laid out a 50% incremental margin target through 2028. How much is this dependent on volumes, and how much growth investments are you embedding?
Yeah, we have, so we have looked at what we think the forecast would be over the coming years, of course. The incrementals are similar to what we said at Investor Day from a base business. What we added to that is our cost program. That's how you get to the 50%, and I'm separating those two things 'cause as we get into the midpoint of our low 20s to mid-20s adjusted EBITDA margins, we will be continuing to invest in the business and some of the organic parts of the business. Just important to us right now that we demonstrate, we demonstrate our profitability, and we demonstrate returning cash to shareholders.
How should we think about the incrementals at T&M as volumes continue to recover versus sensors and safety, where margins are already in the high twenties?
Yeah, the test and measurement incrementals are strong as we get back to growth and get to a bigger volume level. In the sensors and safety systems, you've got two things going on. You've got, you do have high margins today, but we have to keep in mind that as the defense business grows, we will have a lower, or I guess a headwind there in our adjusted EBITDA. Still in that mid-20s to high 20s, with that volume will come some headwinds.
On that point, defense is dilutive to the overall company margin. How big is the margin differential defense versus the other sensors and safety versus T&M?
It's a couple things. The, you know, test and measurement has a significant amount of operating leverage. There's, you know, pretty big fixed cost base in that business. You see in periods of growth that can deliver very meaningful incremental margins. You know, we can see upwards of 50%+, 60%+ type incremental EBITDA margins on that business. Whereas defense, we've said, is more in line with overall company margins, you know, closer to 20% type margins. This is where there is a pretty big difference in terms of where the growth is coming from. There can be a decent mix impact.
The thing we'd point out is, you know, we've taken into account in talking about 50% incremental margins over the next few years, is that that includes double-digit growth within defense. We're already taking that into account that we expect some mix headwinds on the incremental margins. Despite that, and even including some organic growth along the way, expect to be able to drop down 50% incremental EBITDA margins.
Got it. Going back to maybe the AI data center exposure, if you can flesh out for us again the exposure to AI data center and what percent of sales, if you could quantify, are exposed to these verticals, and what are the growth rates you're seeing here?
Yeah, I think there are some two answers to that question. One is directly tied to the AI data center, which across our entire portfolio is probably 10%-15% higher in test and measurement, maybe 20% in test and measurement. I give you a approximate 'cause I think AI is sort of lifting all boats across the portfolio. We had an example last week of an industrial tool manufacturer that's using one of our pressure sensors in a device that's specifically made for cutting cables for data centers. I think there's an ecosystem out here and a wider tail to how things are being lifted by what's happening in the AI data center attributing to the power grid, attributing to electronics at the edge, and even industrials that are being used for some of the capital build-out.
Yeah. It seems like there's good direct and indirect exposure to-
Correct
that theme. Maybe touching on capital allocation. I think you're now targeting repurchases around 50% of free cash flow and announced a $100 million ASR in the second quarter. How do you weigh this share repurchase versus funding incremental growth CapEx or tuck in M&A?
We have a strong bias for the value of this company, and we believe that we're doing all the right things to grow that valuation. With that, we think this is the right time to be buying our stock. We also, as we thought forward to being a new company, we wanted to lay out, or we wanted to put a stake in the ground that we're not just gonna say we're gonna do this, we're actually going to do this in Q2. Therefore, we instituted a program, a share repurchase program for $100 million, as you stated. This is on top of the $50 million that we executed in Q1, which means this year our free cash flow, about 50% of it, is going to buy back and dividend.
This is what we've said over time we will continue to do. We have been very specific in saying over time. That means that it's not every quarter, you know. We may span a year, and it'll be lighter in some years. Right now we believe it's a good use of our dollars. We will continue even in the incrementals we talked about, that leaves us some room for organic investment, and we continue to cultivate M&A. Tuck in M&A for us will be something that fits into the portfolio that we have. We are estimating double-digit returns on capital in a three-year type or less period.
On that point, what is missing in your portfolio that you could look to add? On the flip side, are there any areas of the portfolio that are non-core and you could look to prune?
Yeah, I'll start, I'll work backwards. Before we spun, we did prune a couple parts of the portfolio that we got out of two different areas. We actually consolidated some businesses. It's something we're constantly evaluating and constantly looking at, like what's core and what's not, and what do we wanna do with that business. We have options to invest, to divest, or just stop doing something, shut something down, and we make those trade-offs all the time.
Okay. Sounds good. On the CapEx, you touched on it a little bit earlier, too. You indicated the CapEx is moving towards 2%-3% of revenue, and I think investments are focused in defense and utilities business. What are maybe two or three of the high return projects in these end markets that you're targeting the CapEx investments to do, and when should they show up in revenue and margins?
Yeah. Exactly right. The traditional CapEx for this business has been around 2%. We talked about that moving 2%-3% in this year and maybe some of the near term years as we invest in production capacity for both the defense space and the utilities. That's business that would come online late 2027 and into 2028. An opportunity to continue to grow those businesses.
That's one thing I'd add, is that this is really a continuation of growth. We've been seeing in utilities and defense about high single digit growth for the past five years or so. That hasn't shown up as much at the segment level because there's been some headwinds on the industrial manufacturing side, which Tami mentioned was about 30% of total revenue, so half of that segment is industrial manufacturing and other. It's really saying, how do we keep that growth going? The high single digit utilities growth, double digit defense growth. It's, you know, starting to invest to be able to, like, continue that growth and accelerate that going forward.
Makes sense. I'd like to turn it over to the audience to see if there are any questions. Okay. Yeah, go ahead.
Thank you. Could you reference your historical margins in test and measurement? I think you were at 23% in 2023 and around 21% in 2024. Just wondering if there was anything unusual from a pricing perspective or supply chain that caused those?
I don't think that's gonna be apples to apples or oranges to oranges.
Yeah, not sure.
That wouldn't have the public company cost. At the core of our corporate expense, we have segment costs and then corporate costs.
Yeah. Wait, I would say.
a last
you know, it's about a point and a half that you'd take off of that for what the, what the segment is now receiving as an allocation of the post-spin cost. I would say to make it apples to apples, take about 1.2 to 2 off of that.
'Cause there was allocated cost at the segment back at the time, but we are smaller now. It's a little bit higher.
Anything unusual making that adjustment in those two years?
Not that I can think of.
No. I'd say that's in line with the, you know, saying that the target for that segment is mid-teens to low 20s. The low 20s would be kind of indicative of a year like 2022, 2023, which were you know, we'd seen the last two years of three years of pretty significant growth.
Okay. With that, I think we're up on time. Thank you so much for coming today and for your time.
Thank you.
Thank you, Tami and Nathan.