Here with Baird. Thanks for joining the Regal Rexnord session. Pretty standard operations here. We have Louis Pinkham, CEO, who's going to give some prepared remarks. Rob Rehard, CFO. Rob Barry's in the crowd. He's going to give some prepared remarks, and we're going to have a Q&A session. Please, if you have any questions, fire me an email, raise your hand. We'll make sure they get incorporated into the session. With that, Louis, thanks for coming.
Yeah, great. Thanks, Mike. Thanks for having us. Louis Pinkham, CEO. We'll make this short, but wanted to share a few things. Hey, as many of you know, we've transformed the Regal Rexnord business over six years and have made tremendous progress improving our margins and free cash flow and building a much stronger portfolio. Stronger in terms of the markets we serve and the products and technology we offer. Our focus has been shifting to accelerating profitable growth. We have been doing a lot on this front, and our investments are paying off. We remain in early innings, both in terms of end market recovery and our outgrowth initiatives. Before we go to Q&A, I want to cover a couple of things. You saw in slide two the note of forward-looking statements. This slide really gives you an overview of Regal.
I know many of you know us well. We've included this slide for those who don't know us as well. On this slide, on the right side are our principal end markets. We are pursuing growth opportunities across much of our portfolio. On the left are four strategic markets I will focus on today: automation, which includes robotics, and then aerospace, data center, and medical. Together, these represent roughly a third of our business. I'll start with automation. On the left, we picture some of our most relevant products for these verticals. In short, we are providing highly engineered components and increasing solutions that enable high-precision motion and do so reliably. Our verticals of focus are cobots, AGVs, surgical robotics, and humanoids. One of our strategic verticals is clearly humanoids, where we have very deep domain expertise cultivated over decades.
Our products can control motion on 30-50 axes of motion on a humanoid robot. Most of our work historically has been one-off projects, but today, plans are being made to produce humanoids in large numbers. This year, we have booked about $30 million of humanoid-related orders with multiple OEM customers and are working a $100 million bid pipeline. Some forecasts for the humanoid market call for tremendous growth. The bottom line here is we are well positioned for growing demand technologically and in our ability to produce at scale on a global basis. Aerospace is another strategic focus. Our aerospace business is roughly $350 million, includes products such as servo motors, actuators, bearings, couplings, and seals.
Consistent with our strategy of moving up the value chain by providing integrated solutions, late last year, we announced a partnership with Honeywell to provide electromechanical actuators for electric vertical takeoff and landing, or EVTOL, aircraft. Similar to humanoids, this is a market with significant growth potential and where we are similarly well positioned technologically and with ample global production capability. As we discussed on our third quarter call, we are gaining significant momentum in data center, which we believe will be needle-moving to our enterprise growth in the future. Our capabilities span all three of our segments, but our largest presence today is in our Thompson Power System business in AMC, where we produce switchgear and transfer switches to support standby and backup power. We have been in this business for over five decades. Our quality and technology are our strongest capabilities.
This was a $30 million business five years ago and is on track to be $130 million this year. We believe this business can double in the next two years, supported by nearly a billion-dollar pipeline. Our PES business is also working in this space with a $100 million data center-related pipeline. On the right side of the slide, we described the recent wins in data center worth $195 million, clearly gaining momentum. We have been directing our growth investment into data center, including developing new product and adding capacity. One of our highest potential new products is modular EPODs or electrical pods. These turnkey power management solutions can help expedite data center construction by making the installation of critical power management content more plug-and-play. Our commercial team is currently working on an EPOD bid pipeline that exceeds $400 million.
I'm excited to share today that last week, we received our first EPOD order for $4 million. The last market I will touch on is medical, where our products pictured on the left also enable high-precision, smooth, and quiet motion. I'm sure you can appreciate the criticality of attributes such as positional accuracy when performing robotic surgeries or when dispensing microscopic fluid droplets inside a lab testing device. Notably, our relevant products in medical span AMC and IPS. While this dynamic occurs in all of our verticals, it is especially true in medical, where applications presented here can each use over 50 Regal Rexnord products, creating sizable opportunities and cross-sell opportunities. I will conclude with an enterprise perspective on why I believe Regal Rexnord represents a compelling investment case.
Regal Rexnord shares provide investors exposure to some truly substantial growth opportunities: humanoids, data center, EVTOL, medical technology, to name a few, plus strong overall growth opportunities in the other parts of our portfolio, all at what we believe is a very attractive valuation. I look forward to questions.
Thanks, Louis.
Hearing more.
Let's get the simple one out of the way. Obviously, you announced the CEO transition. It's going to take a little time. I had a couple of questions come in already. Just maybe talk about the logic for you to go to the board and say you're ready just for the next phase of life and what the thought process was.
Yeah, probably the toughest decision in my life, but a family decision, a personal decision. Worked with the board, partnered with the board to decide the right timing. I could not be more proud of the portfolio transformation and the talent that we have in the organization. We do not run the organization from the center. Fully decentralized, 20 divisions, three segments. Our leaders there run the business. We are going to work on a smooth transition. I always said I am the one role that if we are going to look both externally and internally for, we have to go public. We have gone public.
Easy enough. Let's talk about two things. The first thought process here, we've known each other a while. I think based on conversation during the quarter, conversation at dinner last night, this is probably as excited as I've heard you talk about demand in a while. Maybe you could just frame the excitement for me. I think part of it is what we're seeing in the orders, what we're seeing currently. Part of it is the growth initiatives that you've got, a lot of that you laid out some of on those slides. Maybe you could just put that together in a package.
Yeah, you summed it up quite well, and I'll just add on. Leaving a quarter at 10% orders growth feels really good. Backlog up 6% in IPS year over year, up 15% in AMC, up 18% shippable in fourth quarter. Plus, we've been driving significant investment in new technology and system solutions. A lot of those I covered, but there are many more. We didn't talk about our COPRA offering and fan filter units that come out of PES that go into clean room applications where we're gaining momentum. We didn't talk about some of the other parts of IPS where we're selling skidded industrial powertrain solutions that are going out to remote mines, and we're providing perceptive technology for oversight and service. This is where Regal's going. I couldn't be more excited about where we are, the opportunity.
Yes, I have some calm around 10% orders growth and the belief that we'll see high single-digit order growth. We already saw part of that with a nice big data center order in October.
Yeah, and frame those slides as well, right, because some of those humanoids, EVTOL, really interesting for you if those work. It's not like you're only relying on those from a growth vector perspective from here. Those would be kickers. At the same time, I think there's a lot of confidence that the outperformance versus market is still on the table. Maybe talk about some of those factors that give you that confidence. If those things hit, then even more so, but.
Yeah, again, when you think about our acquisition of Altra and Rexnord, it was about bringing together this portfolio of offering with almost 100 brands to be able to sell a solution to our customer base. Nobody has the scale and scope of go-to-market that Regal has. Today, only about 20% of our customers buy more than one of our products. If you're buying one of our products, you're likely buying all of them. The cross-sell opportunity here is significant. To date, 2025, we'll see about $175 million of cross-sell with Regal and Rexnord and Altra on path to close to $250 million by the end of next year. This is the momentum we're gaining because of the scale and scope of who we are. That's a big driver of our future. Plus, all those other things that I talked about and our increased investment in R&D.
We've increased since I've been CEO. R&D as a percentage of sales was about 2%. Today, it's about 3%. We believe in technology and differentiating. You see in our gross margins. Our gross margins are 38% today versus 26%. Now, we've changed the portfolio, and rightfully so, but we've got great technology. We're going to continue to invest there. That's going to allow us to accelerate growth.
Good order growth here. Expectation for a solid fourth quarter based on the comments on the recent earnings call. Low- to mid-single digit is the expectation for next year. Maybe help bridge that. There's a little bit of price in there. You've got the data center piece in there. What are the other factors that give you confidence in growth?
You know, that's the simplest way of looking at it, actually, which is say a point and a half of price, a point and a half from the data center opportunity. If everything else stays the same, we'll grow 3%. That's low single digit. There are some other things going on. You've got the AMC backlog up 15%. Discrete automation grew 17%. Order growth grew 17% for us in Q3. We're seeing some momentum there that's coming out of a couple of spaces: defense, humanoid, and it's coming out of just the discrete market starting to come back. The factory automation market starting to come back slowly, very slowly. ISM going above 50 certainly would help us. When you look at IPS, backlog up 6% year over year gives us confidence that we should see low single digit growth.
Now, the one headwind we are seeing right now is ResiHVAC. ResiHVAC is a third of PES, but we have a lot of activity and initiatives in the rest of PES. We are targeting to offset a high single digit decline in ResiHVAC next year with all those other initiatives plus market and believe PES should likely be about flat. To your earliest point, Mike, we are not ready to guide yet. We will guide coming out of fourth quarter, but that is how we are thinking about it right now. We are actually right in the middle of operating plan. PES was Monday, Tuesday. AMC is Thursday, Friday, and IPS is next week. We will have a lot more clarity coming out of that.
Yeah, and maybe this one's for Rob. Maybe can bridge the free cash flow into next year from this year. Certainly something we're getting a question about, but it feels like a healthy ramp coming.
It is. You're talking about 625 up to 900, those are the numbers. If you break it up like this, a third comes from 35% contribution on the low single-digit top line. Think of that as EBITDA contribution. You have a third of it coming from additional working capital improvement, a source of cash primarily coming through inventory. The last third is broken up, I'd say, primarily into $40 million of cash interest expense that should come down and about $25 million of cash restructuring that should come down. A couple of other small things in there, but that's how to break down that. That's how to bridge it from one year to the next.
The last question, kind of bridging to next year before we transition to a couple of other things. Maybe talk to the tariff impact and specifically the rare earth process. I know you're confident that you're working through the rare earth and that when you get to the back half of next year, you're in a really good spot. I think it's a dynamic that a lot of people don't understand necessarily. Any help you can provide on that, what's happening, and then why you're comfortable in the remediation.
Hey, through second quarter earnings, we expected to be tariff cost neutral this year. Within a few days of our second quarter, India tariffs went up 25% and the 232 tariffs came in. 232s will mostly impact IPS, but our ability to go get price for that takes minimum 60-90 days to get into the market with. We have some pressure there. We have said at this point that we will be tariff cost neutral by middle of next year and margin neutral by the end of next year because of this, really India and 232. Now go to rare earth. Rare earth has been tougher than we anticipated. We felt at second quarter earnings call and all of the discussions that were going on between China and the US that applications were getting approved for rare earth supply chain.
We got many of those applications. The one space that got no application approvals was anything out of India. We have a large precision motion plant in India. We have now made a decision, and we were going down this path, but we have accelerated it. Today, we are sourcing 40%. Been working on it year to date, 40% of our rare earth outside of China. By the end of the year, it will be 60%. By the end of next year, it is 80%. We are very clear, and we are starting the ramp in this quarter. We see good line of sight for this quarter and what we guided for the quarter, and we will ramp through first and second quarter of next year. Rare earth will not be a China-related issue for us come the middle of next year.
Yep, makes sense. Maybe a conversation on the data center piece. I know you've been in that side for a while, but what is Regal Rexnord's right to win in that space, and why are you being successful in participating in the build-out on that side?
You know, our right to win in this success, the business has grown at about a 30% CAGR over the last five years. A big driver of that is our customers' confidence in our quality and lead time, but our willingness to customize the controls to meet their specific needs. Many of our competitors provide a singular system set and will work with our customer base to meet their specific control needs. You add on top of that the scale and scope of Regal Rexnord and our balance sheet and our capabilities, and there is confidence from these larger projects. An example was an $80 million project because they knew we could stand behind what we were signing up for for delivery and quality.
No, that makes sense. I think last night you said you had to think about whether or not you've ever greenfielded a facility personally before. One of the challenges you're managing through is how to load the capacity fast enough to meet the demand, right? Maybe talk about the things you're doing there, as well as if there's an ability to see upside to the thought process on the data center side into next year.
Yeah, so you know we have an integration team. We did two very successful acquisitions, and we have been driving the consolidation and taking capacity out. We still have work to do there. That integration team knows how to manage big projects and ramp big projects and bring in talent to support a greenfield. We feel really confident in our ability to manage this Texas capacity. The one piece that could help us even accelerate further is if we gain some really nice momentum around EPOD.
Yeah.
We're pretty capacity constrained at this point for 2026 around switchgear, but EPOD could be a nice step function for us. I'm pleased that we won our first order. We'll see where it goes from here.
Yeah, and I think one thing that might be underappreciated is how much your scale in and of itself enables even the opportunity to sell an EPOD type application. Twofold question here. One, maybe give other examples of where the scale is coming together. The second piece is also talk about how there's opportunities to start transitioning your products to other areas. I think one example staying on the data center side is what you're trying to do in PES on the air moving side as well. Somewhat interrelated, but just talk about that innovation and how all of these things are coming together.
Yeah, it's a great question. It's really our whole strategy of what we're trying to do is to leverage the strength across our entire portfolio into key verticals of growth. Aerospace, Honeywell, and the EVTOL partnership is all about our technology, but our ability to scale and produce at volume. That's because we're an industrial manufacturer.
Yeah.
That is the value of bringing together all these components into an electromechanical solution that we can then scale with. If you look at data center, for example, and you look at EPOD, EPOD's a great example of this. An EPOD is a container, a modular container, and what's inside? Switchgear, power distribution units, automatic transfer switches, as well as air moving and air moving control. Now, what do not we have? We do not have UPSs. We will source it. We do not have batteries. We will source it. We know how to pull it all together as an integrated solution with a partner. That is what we are looking to try to do more and more of.
The margin profile tracks appropriately?
The margin profile would be fleet average within AMC, as an example.
Which, considering the pass-through costs, implies pretty healthy on your own content.
Yes.
Yeah. Yeah, yeah. On the margin piece, maybe talk to what the aspirations are: 40% plus on the growth, 25% plus on the EBITDA side. How do you think about the timeline? Obviously, the demand piece has not been as favorable as we were thinking a couple of years back. What does that timeline look like from here?
Yeah, I'll take that one. We expect to end 2026 at about 40% gross margins. It's about a year behind, primarily due to what you just explained on the market side, but also just the tariff impact that we've had and the impact on margins. We also expect that the 25% EBITDA margins will come likely closer to the end of 2027. That's the timing. It's about a year off from what we had originally projected based on the items that you described.
Yeah, and maybe talk to switching gears here, talk to some of the things you're doing within PES to diversify away from the traditional Resi refrigeration. I mean, less than 10% of your revenue today, but still gets more attention. What are some of those diversification moves you're making?
We've been investing significantly here. We bought a company about seven years ago that brings impeller technology. That, with our motors technology, we've integrated into package systems that go into fan filter units and into any air moving commercial application. That's actually a smaller package with higher air flow and higher energy efficiency. It competes against two fairly large European companies. That's an example of us trying to move outside of just selling a motor or motor component. That, along with then penetrating certain verticals that are starting to accelerate. Great example is the $20 million PES order of Q3 and in data center. That funnels about $100 million large. We're going to continue to try to grow in those spaces that will bring us growth. ResiHVAC, 9% important.
We need the business, the scale of the business, but it is probably our toughest business from an overall gross margin price attainment part. It is important to us, and we will continue to manage and invest there.
You referenced the pricing. How do you think about the pricing and the price stickiness throughout the portfolio here? Obviously, moving pieces around the tariff side, and then you have some backlog that has to be worked through, I'm guessing. Just a generic thought process, how do you think about the stickiness of the price in the market right now?
The easiest way to look at it that we look at is 40% of our business goes through aftermarket, and you hold that price pretty darn well. We are the leader in our product and portfolio, in particular in IPS. It's pretty sticky. AMC, it's technology. I mean, IPS is a 42-43% gross margin business. AMC will be north of 40% when the discrete automation volume starts coming back. Good position. PES is the toughest. Now, we are price cost positive in PES. India tariffs will be the one challenge for us in PES into 2026. I believe that has to go away. I think 25% is fine. We'll be able to manage with our customers at 25%. We can't manage with our customers at 50%.
Yeah. Maybe talk to the discrete automation piece and how you think about the recovery curve on that side. What gives you confidence that there could be some legs here?
It's slower than we anticipated.
Yeah.
Where we're seeing the acceleration is in certain verticals where we're really nicely penetrated and we're growing. Defense. Defense will grow mid double digit. Humanoid, $30 million of orders this year versus $5 million of sales last year. That's growing. The factory piece is not growing at an accelerated pace. I do think there's a correlation a bit to ISM. There needs to be that turn. We're not, by the way, it's up 6% on a 12-month rolling. I think we've hit bottom and we're coming back, but it's not coming back in a fast way. We're not planning on it coming back in any significant manner beyond where we're at right now next year.
What are the drivers within IPS that are signaling growth for you as you look into the fourth quarter and next year? Maybe just parse out some of the end market favorability versus where there's still some headwinds.
Yeah, we're certainly seeing, first, I'll start with backlog being up 6%, moving more to a project-based business, longer cycle business. That certainly gives us some confidence. The markets that are feeling pretty good are metals and mining and our ability to provide a total solutions there that has been a positive. Oil and gas. I know we hear lots of noise about alternative energy. We put it all under energy. We put oil and gas, which has been quite positive actually for us, and mostly in power gen and gen sets. In alternative energy, solar has been strong in 2025, and the funnel we have with our customers suggests it's going to continue into 2026. Now, if ISM turns positive, and I argue that ISM has been down for almost three years now, and it's only been lifted because of data center.
At some point, that has to turn. When that turns, that's going to be a big benefit for Regal.
Growth has to broaden at some point.
Yeah.
Yeah, agreed, agreed. Twofold question here. Maybe the first half for Rob and the second half for both of you. Rob, maybe just talk to how you look at the leverage and how it tracks. The second question is, when you do get back towards a range you're comfortable with playing a little bit more offense, how do you think about buyback versus going after a tuck-in strategy?
Okay, first, from the timing perspective, we do expect to end the year close to about three times and continue to pay down debt next year and therefore end next year about two and a half times. From a capital deployment standpoint, look, once we get below three times, buying back our shares is a pretty, if we're trading at the multiple we are today, it's a pretty darn easy decision. Question is, at what time do we start doing that? Quite frankly, it's probably going to be closer to the end of 2026. Should we opportunistically take that path? Because we'll be closer to that two and a half times range, which is a level that I've talked to the ratings agencies about that we've looked to get to before we start anything of significance moving forward.
Last question here. How do you think about AI usage internally? What are you using to leverage it and pursue it internally? How do you ensure return focus to the outlay associated with it?
We have lots of use cases for AI. Most of them, though, that have proven out are around efficiency and productivity versus revenue growth. I mean, if you go onto our website and you call out a gear drive, you're going to automatically get a commercial around, "Here's a motor that could go with it. Here's a coupling that could go with it," etc. The use case hasn't really proven out to a significant growth. Bluntly, the last number I saw was $600,000 year to date. For a $6 billion business, my CDIO gets really excited about it. I don't get so excited, but that's okay. I think that will take off in time. Worth paying off is the efficiency and some productivity drivers. For example, we have 28,000 suppliers. We have hundreds of thousands of SKUs.
We have to manage the lead times, the safety stocks of all of that. Think about doing it in an automated fashion. That's what AI is doing for us. AI is helping to better plan our plans so that we can be more efficient and support our service to our customers. AI in the end will be very beneficial from a productivity and efficiency standpoint at Regal Rexnord.
Great. Louis, Rob, thank you for your time today.
You got it.
Management will be available just outside here for a breakout session. If you have any other questions, come join us. Thanks for your time.