Regal Rexnord - Earnings Call - Q3 2025

Executive Summary

• Q3 delivered modest top-line growth and stable margins: revenue $1.497B (+1.3% y/y), adjusted EBITDA $339.4M (22.7%), and adjusted EPS $2.51; GAAP EPS was $1.20.
• Versus S&P Global consensus, revenue was a slight beat while EPS was fractionally below and EBITDA trailed: Q3 revenue $1,497.0M vs $1,487.8M*, EPS $2.51 vs $2.535*, and EBITDA $320.2M* vs $337.0M*.
• Guidance cut: FY25 adjusted EPS narrowed to $9.50–$9.80 (from $9.70–$10.30) and GAAP EPS to $4.26–$4.56, primarily due to newly increased tariffs and rare earth magnet supply constraints; adjusted EBITDA margin now ~22.0% (from 22.5%) and FCF guidance lowered to ~$625M.
• Powerful order momentum (daily orders +9.8% y/y; B2B 1.05; backlog +6%) driven by data center wins ($135M in Q3 + $60M in Oct; ~$1B AMC pipeline; ePods push) positions RRX for accelerating growth into 2026 despite near‑term tariff/rare-earth headwinds.
• Potential stock catalysts: 2025 guidance reset vs strengthening 2026 setup (data center ramps, tariff mitigation timeline), and CEO succession process with “business as usual” operating posture.

What Went Well and What Went Wrong

What Went Well

• Data center traction accelerated: $135M Q3 orders plus $60M in October; AMC data center business (Thompson Power Systems) tracking ~$130M in 2025, with bid pipeline approaching $1B and new ePods opportunity (~$10B TAM).
• Orders and backlog improved: daily orders up 9.8% y/y, book‑to‑bill 1.05, backlog up 6% y/y—supporting mid‑single digit organic growth targeted in Q4 and improving trajectory into 2026.
• Segment execution: IPS grew organically (+1.6%) with 26.4% adj EBITDA margin; PES delivered above‑plan margins (19.0%, +120 bps y/y) on mix and cost control; enterprise adj EBITDA margin held ~flat y/y at 22.7% despite headwinds.

What Went Wrong

• Tariffs worsened late in the quarter: gross annual unmitigated impact rose to ~$175M (from $125M) after India tariff hike to 50% and expanded Section 232 scope; FY25 net dollar cost impact now ~-$17M, pushing margin headwinds and guiding FY25 adj EBITDA margin to ~22% (from 22.5%).
• Rare earth magnet constraints intensified: China export license approvals slowed, impacting shipments to medical/defense; headwinds now expected through early 2026 (vs prior expectation of year‑end 2025 relief).
• Residential HVAC mix headwinds: PES air conditioning units down >20% (offset by furnace strength) with management guiding Residential HVAC down low double‑digits in Q4, driving sequential pressure.

Transcript

Speaker 1

Good morning and welcome to the Regal Rexnord Corporation.

Speaker 0

Rexnord Corporation third quarter 2025 earnings conference call.

Speaker 1

All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press.

Speaker 0

star then one on your telephone keypad.

Speaker 1

To withdraw your question, please press Star then two. Please note this event is being recorded. I would now like to turn the conference over to Rob Barry, Vice President of Investor Relations. Please go ahead. Great.

Speaker 0

Thank you, operator. Good morning and welcome to Regal Rexnord's third quarter 2025 earnings conference call. Joining me today are Louis Pinkham, our Chief Executive Officer, Rob Rehard, our Chief Financial Officer, and Rakesh Sachdev, Chairman of our Board of Directors. I would like to remind you that during today's call you may hear forward-looking statements related to our future financial results, plans, and business operations. Our actual results may differ materially from these projected or implied due to a variety of factors, which we describe in greater detail in today's press release and in our reports filed with the SEC.

Speaker 1

Which are available on the regalrexnord.com website.

Speaker 0

Also on this slide, we state that we are presenting certain non-GAAP financial measures that we believe are useful to our investors, and we have included reconciliations between the non-GAAP financial information and the GAAP equivalent in the press release and in these presentation materials. Turning to Slide 3, let me briefly review the agenda for today's call. Louis will lead off with opening comments, an overview of our 3Q performance, and an update on our data center business. Rob Rehard will then present our third quarter financial results in more detail, review our 2025 guidance, provide an update on tariffs, and offer some initial thoughts on 2026.

Speaker 1

We will then move to Q&A.

Speaker 0

After which Louis will have some closing remarks, and with that I'll turn the call over to Louis. Great. Thanks, Rob, and good morning everyone. Thanks for joining us to discuss our third quarter results and to get an update on our business. We appreciate your continued interest in Regal Rexnord. Before discussing our third quarter results, I would like to make some brief comments about the news regarding my succession, which we announced last night concurrently with our third quarter earnings release. It has been an immense honor to lead the company for the past six plus years. We have achieved a lot, inclusive of two major acquisitions and the divestiture of the industrial segment, transformation of our portfolio, significant revenue growth, gross margin expansion, and free cash flow acceleration, and have positioned Regal Rexnord as a valued partner serving our customers' most critical needs.

We have assembled a strong technology team of leaders who have built great teams that are focused on leveraging 80/20, expanding secular growth opportunities, and driving continuous improvement. Our portfolio is well positioned to grow, especially when the ISM returns to an expansionary period for industrial production. With third quarter sales up about 2% and orders up about 10%, along with our improving top line momentum, there is a lot to be excited about. In light of some personal decisions that I recently made, the Board and I have agreed that this is a good time to initiate a transition plan to pass the baton to a new leader who will guide Regal Rexnord through the next phase of our growth journey over the coming several years. I look forward to continuing to lead the company until the Board identifies my successor.

Rest assured, we have a strong team and will continue to execute on our profitable growth initiatives for the benefit of our customers, our associates, and our shareholders. In short, it is business as usual and now onto the quarter. Our team delivered solid third quarter performance, nicely ahead of our expectations on orders and roughly in line on sales and adjusted EBITDA, driven by over-execution in PES and strong execution in IPS and AMC. Performance would have tracked even stronger if it were not for larger than expected pressures from two items out of our control, additional tariffs announced in August just after our Q2 earnings call, and incremental challenges sourcing rare earth magnets. Looking forward, our growth potential took a significant step higher in the quarter driven by strong orders.

These results plus our expectation for further order strength in fourth quarter are setting us up for solid growth in 2026. In short, good results, great momentum. Before continuing, I want to take a moment to thank our 30,000 Regal Rexnord associates for their hard work and disciplined execution. Our associates continue to over manage the impacts of tariffs and rare earth magnet constraints and are doing a great job working our commercial funnels to drive improved orders and performance. Now let me provide some specifics on our third quarter. Orders in the quarter on a daily basis were up 9.8% versus prior year and book to bill was 1.05. We ended the quarter with our backlog up 6% versus the prior year. As I will elaborate on shortly, in the quarter we booked $135 million of data center orders and then an additional $60 million order in October.

This is a market where we are clearly gaining traction and we are investing to support further growth. We also saw strong order growth in discrete automation and in our air moving business in PES for the data center and semicon markets while IPS posted its fifth quarter in a row of positive orders growth against a backdrop of generally sluggish end markets. Our sales in the quarter were up 70 basis points versus the prior year on an organic basis in line with our expectations for an inflection to growth in the quarter. We saw particular strength in energy markets, discrete automation, and aerospace net of headwinds in medical as well as some project timing in data center, the latter clearly temporary. As recent orders show, we are building tremendous momentum in our data center business.

For reference, on a year to date basis, enterprise organic sales are up slightly and are expected to be up low single digits for the year. Turning to margins, our third quarter adjusted gross margin was 37.6%, down 80 basis points versus the prior year period on mix and impacts related to rare earth magnet availability. Tariff adjusted EBITDA margin was 22.7%, roughly flat versus prior year and reflects an $11 million synergy benefit mostly offset by mix, tariffs, and rare earth magnet pressure. Adjusted EPS for the quarter was $2.51, up versus the prior year. Lastly, we generated $174 million of free cash flow in third quarter, which was used primarily to pay. We ended the quarter with no variable rate debt.

In summary, a solid third quarter during which we delivered strong orders and a rising backlog, which keeps us optimistic about accelerating top line and earnings growth in fourth quarter and into 2020. Next, I'd like to elaborate on the significant momentum we are gaining in the data center market, which we believe can be needle moving to our enterprise sales growth. On the left side of this slide, we provide an overview of our diverse capabilities in the data center market. You can see that all three segments play, but our largest presence today is in our Thompson Power Systems business in AMC, where we are providing switchgear and transfer switches to support standby and backup power in data centers. This was a $30 million business five years ago and is on track to hit $130 million this year.

The traction we are seeing in this fast growing secular market is being driven by the success factors listed on the lower left of this slide. It starts with the quality of our products demonstrated over five decades of service. What differentiates us is our ability and willingness to customize the system designed to best meet the needs of our customer. Our lead times are competitive, and in a market being fueled by remarkable levels of AI investment, lead times matter a lot. Our enterprise scale has been critical to getting us in the door with new and larger customers because it helps them get comfortable that we can deliver on our service and delivery commitment. Aftermarket service capabilities are a growing part of our value proposition as we invest in our service footprint.

Lastly, and highly relevant in today's market, we are willing and able to make investments to flex our manufacturing capacity, which supports future growth and bolsters our service levels. On the right side of the slide, we describe our recent wins in the data center market worth $195 million. We have been very focused on building our commercial organization, which combined with our enterprise scale, has allowed us to grow our bid pipeline to what today is approaching a $1 billion. We are also seeing good data center growth in PES, which won a $20 million order in the quarter to provide HVAC chiller subsystems to cool hyperscale data centers. For perspective, PES's commercial HVAC business has been benefiting from data center growth for some time, especially in North America. What is different with this order is its scale.

In short, our value proposition of technology-differentiated subsystems to achieve the high levels of energy efficiency required by data center operators is resonating. You may remember that part of our growth strategy for PES is leveraging proven technologies in new secular markets. While not mentioned on this slide, the PES team also won a $7 million project in the quarter for a semicon clean room customer that included multiple fan solutions, including fan filter units. Our PES team is gaining traction, growing its business in new secular markets, and as you can see on the slide, is currently working a $100 million data center-related bid pipeline. As you know, we have been directing the majority of our growth investment to secular markets in data center that has included funding portfolio expansion into modular electrical pods, or ePods.

These turnkey power management solutions can help expedite data center construction by making the installation of our critical power management content more plug and play. These ePods would typically contain our switchgear, transfer switches, power distribution units, as well as air moving content. Regal is also project managing assembly of these ePods, including content from third parties. Part of our value proposition is providing a single source of contact for the customer and allowing the customer to procure power management content with a single SKU. We estimate the market size for ePods is roughly $10 billion. There are two particularly compelling attributes of this opportunity. One, it helps customers expedite their installation of new hyperscale data centers today, and two, it positions us to serve a market that many expect will evolve towards a network of smaller data centers that sit closer to the applications they are supporting.

These edge data centers are forecast to number in the thousands and will likely be constructed using a few modular building blocks that contain all the requisite data center content. Our commercial team has been actively engaged with potential ePods customers and our bid pipeline currently exceeds $400 million, so nearly half of AMC's total $1 billion data center bid pipeline I referenced earlier. In short, a tremendous new product opportunity for our customers and for Regal Rexnord. To support the growth we have secured in our bidding on, we are investing to expand our capacity both in our legacy power management systems and to support ePods. As you can see on this slide, the current footprint for our data center business in AMC includes two locations, one in British Columbia and one in Mexico.

We recently started developing new capacity by expanding our British Columbia footprint and also developing a new site near Dallas, Texas, which will grow our footprint by over 50%. The Dallas facility is scheduled to begin shipping product by mid-2026. As a reminder, this business is relatively CapEx light and so our investment is centered on light manufacturing, assembly, and test equipment as well as adding the talent to support our expanding operations. This is a good example of how our significant enterprise resources allow us to respond quickly to attractive market opportunities. While our data center business today represents a small percentage of our enterprise sales, it is growing quickly and we are investing across the spectrum of resources needed to support and fuel further growth starting in the coming quarters.

We believe our data center business can contribute a point or more growth to our enterprise growth rate at company accretive margins. In short, a huge opportunity for Regal Rexnord that we are extremely excited about. With that, I'll turn the call over to Rob.

Speaker 1

Thanks Louis and good morning everyone. Now let's review our operating performance by segment, starting with Automation and Motion Control, or AMC. Sales in the third quarter were down 1% versus the prior year period on an organic basis, which was just shy of our expectations. The performance primarily reflects project timing in data center, weakness in the medical end market, and further challenges sourcing rare earth magnets, which continued to limit our ability to ship certain high margin products in the medical and defense markets. These headwinds were largely offset by strength in discrete automation and in aerospace. Regarding the challenges around rare earths, last quarter we expected these were diminishing, especially for non-defense products where we were making good progress with license approvals for exports from China and with our efforts to find alternative sources of supply.

However, the situation worsened in the quarter as the rate of China license approvals slowed considerably, and it became clear that even in the absence of an official policy change, China was not approving export license applications for India, where we have a large facility making product for surgical applications. At this point, we are continuing to work on securing alternative sources of supply and making strategic production moves that facilitate exports from China. Given our experience navigating rare earth magnet approvals we've described, which is worse than we anticipated coming out of the second quarter, we now believe these headwinds will impact us through the end of the year and into early 2026, after which we expect to see net benefits in the P&L from working down our past due backlog associated with these impacted products. I'll share more on this in the guidance section.

Turning to margins, AMC's adjusted EBITDA margin in the quarter was 20.5%, which was on the lower end of our guidance range. The primary pressure was related to securing rare earth magnets. Orders in AMC in the third quarter were up a strong 31.7% versus prior year on a daily basis, for a book to bill of 1.23. As discussed earlier, this performance is largely tied to winning two large orders in the data center market worth a combined $115 million. Excluding these orders, orders in AMC would have been up 1%, reflecting strength in discrete automation with orders up 17% net of weakness in medical and order lumpiness in the aerospace business. As Louis indicated earlier, this strong momentum in data center continued in October when we booked an additional order worth $60 million for a total of $175 million of recent data center orders in AMC.

A further note, in the quarter we received our first electromechanical actuator production order for EVTOL and we booked $8 million of humanoid related orders, adding to our momentum in both of these spaces. As a reminder, to the extent humanoid or EVTOL adoption grows, we are very well positioned to address this demand. Turning to Industrial Powertrain Solutions, or IPS, sales in the third quarter were up 1.6% versus the prior year on an organic basis, which was modestly above our expectations. The growth largely reflects strength in energy and metals and mining, with the segment's other markets relatively flat. Adjusted EBITDA margin for IPS in the quarter was 26.4%, about 50 basis points below our expectation and down slightly versus the prior year. Performance reflects synergy gains offset by weaker than expected mix, including product and channel mix, along with the impact of tariffs.

Orders in IPS on a daily basis were up 2.3% in the third quarter. This marks the fifth quarter in a row of positive orders growth for the segment and has contributed to the backlog growing 5% year over year. Book to bill in the third quarter for IPS was 0.96. Turning to Power Efficiency Solutions, or PES, sales in the third quarter were up just under 1% versus the prior year on an organic basis, which was in line with our expectations. The result primarily reflects strong growth in pool and in commercial HVAC within the residential HVAC portion of the business, which represents roughly one third of the segment. Sales of air conditioning units were down over 20%, which was offset by strength in furnace, resulting in residential HVAC overall being flat in the quarter.

We would attribute the relative outperformance to our continued strong position in this market. Turning to margins, adjusted EBITDA margin in the quarter for PES was 19%, which was above our expectation, up 120 basis points versus the prior year period, aided by favorable mix and strong cost management. Orders in PES for the third quarter were up 1.7% on a daily basis. As Louis highlighted in his remarks, this team is accelerating its growth in new secular markets such as semicon and data center. Book to bill in the quarter for PES was 1.02. Turning to the outlook on slide 13, we are narrowing and lowering our adjusted EPS guidance to the range of $9.50 to $9.80, or $9.65 at the midpoint. Our revised assumptions are outlined in the table on this slide.

Notably, our sales guidance is rising modestly, primarily to reflect initial revenue from our recent data center project wins and some additional tariff pricing, net of incremental impacts from delayed shipments of products with rare earth magnets. Our adjusted EBITDA margin is now expected to be 22% versus our prior assumption of 22.5%. Factoring what we now forecast to be net unfavorable tariff impacts in the year on a dollar basis and the mixed impacts of rare earth magnet-related shipment delays. We have also made some adjustments to certain below the line items, which are outlined in the table. With all of this said, the majority of our guidance change is due to margin headwinds caused by newly introduced and increased tariffs, along with additional rare earth magnet supply chain constraints. Regarding free cash flow, we are now expecting to generate $625 million this year.

The decline versus our prior guidance largely reflects the impact of the following three items: 1. Higher tariff costs associated with the expanded scope of Section 232 tariffs, coupled with the significantly increased India tariffs. 2. The impact of strategic working capital investments, particularly those tied to the large data center orders we announced, along with supply assurance inventory for rare earth magnets, and 3. higher cash interest costs. Given the timing and amount of cash flows relative to prior expectations, we see both the tariffs and the working capital investments as timing-related, as we expect the impact of pricing on tariffs to flow through once that inventory is sold in the first half of 2026. On slide 14, we are updating our expectations regarding tariff impacts. The gross annual unmitigated cost impact from tariffs as of our last update when we reported second quarter was $125 million.

Based on tariffs in place today, that value has risen to $175 million, largely reflecting the rise in India tariffs to 50% and the expanded scope of Section 232 tariffs on steel, aluminum, and copper. Given the extent of the tariff increases and the limited time left in the year to implement mitigation actions and price changes, we now expect to have a net tariff impact on a dollar cost basis of approximately $17 million this year. Furthermore, we now expect to be dollar cost neutral on tariffs by the middle of next year and to be margin neutral on tariffs by the end of next year. We see opportunity for this to accelerate, especially if the India tariff is meaningfully reduced.

On the right-hand side of the slide, we lay out our principal mitigation actions, which we shared last quarter and which our teams continue to over-manage on a daily basis. On slide 15, we provide more specific expectations for our performance by segment on revenue and adjusted EBITDA margin for fourth quarter and for the full year. Let me outline the primary changes to our full year outlook since our last update by segment. For AMC, we are now expecting sales to be up low single digits versus flat to up single, previously reflecting stronger shipments in data center and discrete automation, net of impacts from rare earth availability on shipments to the medical and defense markets.

Our adjusted EBITDA margin outlook for AMC is now 50 basis points lower at the midpoint, mainly reflecting incremental rare earth volume and mix impacts worth approximately $8 million, of which we recognized about $3 million in third quarter. We expect the recovery of rare earth magnet supply to continue into early 2026 versus by the end of this year as discussed in our last earnings call. Through resourcing efforts aimed at eliminating the need for China to approve export licenses for shipments to India, for IPS, our outlook for the segment's adjusted EBITDA margin is now 50 basis points lower at the midpoint, mainly factoring in an unfavorable net tariff impact primarily associated with the expanded scope of the Section 232 tariffs.

Lastly, for PES, our outlook for the segment's adjusted EBITDA margin is now 50 basis points lower at the midpoint, also factoring an unfavorable net tariff impact primarily associated with the increase in tariff rates on India to 50%, including a 25% penalty tariff added in August. While we are experiencing some margin pressures from tariffs and rare earths, we remain confident in our mid-term ability to achieve our 40% gross margin and 25% adjusted EBITDA margin targets. Our teams continue to execute well on what is in our control. Finally, as I wrap up my prepared remarks, I would like to share a few high-level thoughts on our outlook for 2026.

From a sales perspective, we are clearly building momentum as we enter next year given our strong orders in the third quarter, the order strength we're already seeing in the fourth quarter, sizable 2026 shippable backlogs in our IPS and AMC segments, and growing tailwinds from our cross sell synergies. Tariff pricing should also be a tailwind, as would any recovery in our end markets, which for the most part we believe are at or near trough levels of demand. Given ongoing macro and tariff-related uncertainties, we are going to remain measured in our approach to framing out the year, and for now we think sales in 2026 should grow at a low to mid single digit rate. From a margin perspective, we have an additional $40 million of cost synergies anticipated in 2026 and would expect upside from achieving price cost and then margin neutrality on tariff headwinds.

Again, the margin neutrality is not expected until the end of 2026. We would expect organic growth to lever at roughly 35% overall, higher in AMC and IPS and lower in PES, consistent with the gross margin differences between these businesses. Finally, from a balance sheet perspective, we expect meaningful further progress in 2026 on deleveraging and for our net debt leverage to end the year at roughly 2.5 times. This assumes we generate almost $900 million free cash flow in the year, which would represent free cash flow margins in the low teens. In short, we are increasingly enthusiastic about our prospects in 2026, especially the potential for improved top line performance, but also more broadly about an ability to drive improvements throughout the P&L, on the balance sheet, and in our cash flow performance. With that, operator, we are now ready to take questions.

We will now begin the question and answer session.

Speaker 0

To ask a question, you may press star then one on your telephone keypad.

Speaker 1

If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press Star, then 2. At this time, we will pause momentarily.

Speaker 0

To assemble our roster.

Speaker 1

The first question today is from Mike Halloran with Baird. Please go ahead.

Speaker 0

Hey, good morning, everyone. Morning, Mike. First off, Louis, thanks for everything.

Speaker 1

Sorry to hear you're leaving, but you're absolutely leaving the company in a better spot. I wish you nothing but the best moving forward.

Speaker 0

Really appreciate that. Thanks, Mike. First, I certainly appreciate.

Speaker 1

Rob's comments on the puts and takes in the fourth quarter. Could you reframe that a little bit and talk more about what that looks like sequentially? What is accelerating from 3Q? How are you framing the furnace versus the air cooling piece within PES? How do the data center pieces roll in? Just maybe talk about what's getting better, what's getting worse, and some of the assumptions around the sequentials.

Speaker 0

Yeah, happy to do that, Mike. When you first look at PES, you know, a solid third quarter, fourth quarter, we're expecting Resi HVAC to be down low double digits. Air conditioning will be down closer to 30%, though, but furnace will be up high teens. On top of that, we're expecting commercial HVAC to be up mid single digits, pool down low single digits, and general commercial should be slightly up as well. When you think about the sequential, the biggest driver of the sequential change and why we're now guiding PF down about 1%, it's really the fact that Resi HVAC in third quarter was flat and it will be down low double digits in fourth quarter. If you then go to AMC, Mike, it's really a big part of the discussion is data centers. Data center actually was down for us in third quarter by 40%.

It's going to be up more than 50% in fourth quarter. We have it in the backlog. It's just around timing and scheduled shipments. That's the biggest driver of what's driving fourth quarter. Some nice improvements that we're continuing to see in discrete automation in aerospace, but we will continue to have headwinds in medical, and we're starting to ramp production in anything that uses rare earth magnets. We saw some slight improvement in Q3 and we're getting stronger in Q4, as Rob commented in his prepared remark. Lastly, going to IPS and the sequential. For IPS, it's really project orders that are in our backlog. Actually, distribution for us in Q3 was down. Aftermarket, we would define aftermarket was down about 1% in Q3. We're not expecting that to tick up in Q4. What we are expecting is to execute on our project backlog. That's in the backlog.

That's how we're thinking about the guide for Q4.

Speaker 1

Thanks. No, super helpful. The follow up is just the data center content you put out there. Obviously those are some pretty big numbers.

Speaker 0

You're putting on the table as far.

Speaker 1

As what the opportunity set looks like, I think you said this year is somewhere around $130 million. You had $190 million plus of orders. What does that look like from a ramp in the next year based on.

Speaker 0

What you see now and then, maybe.

Speaker 1

More importantly, this $1.1 billion between a couple segments of potential, how does that shake out in terms of being meaningful to the Regal Rexnord portfolio over the next few years?

Speaker 0

What kind of ramp are we talking to?

Speaker 1

What's the win rate, entitlement, things like that. Just kind of any framing that you can give us on a multi-year would be helpful.

Speaker 0

Yeah. Let me try to give you my thoughts on it. We're really excited. We're excited. We've been investing and it's kind of all coming to some fruition here. First, I want to, and I said in my prepared remarks, but our Thompson Power Systems data center business has actually been growing at a very nice CAGR over the last five years. It's at about $130 million. We would expect that to actually grow, maybe even double over the next two years. That will give you a little perspective of how we're thinking that translates. The backlog is strong. We're winning because of the scale of our company, our commitment to service, but also our willingness to customize to the specific needs of our customers. Some of our competitors are not as willing to do that, and that has been a benefit. I think they're, of course, right.

We're investing in capacity expansion in both Texas and in our facility in British Columbia. Probably the biggest challenge in the market is the supply chain of components and switching components. Beyond that, we feel really good about our potential here. As I said in my prepared remarks, we would expect this to have meaningful impact on our growth, maybe one to one and a half points for next year. We'll continue to invest and grow here. I think it could be a large part of Regal Rexnord Corporation overall business for the future. Hopefully that's helpful, Mike.

Speaker 1

Thanks, Louis.

Speaker 0

Appreciate it, thank you.

Speaker 1

The next question is from Julian Mitchell with Barclays. Please go ahead. Thanks very much. Louis, sorry to see you go but wish you well and thanks for all the efforts down the years.

Speaker 0

Thanks Julian.

Speaker 1

Maybe just wanted to start off with the commentary sort of into next year. You've spoken to that low to mid single digit organic sales growth firm wide. It seems like a point and a half of that is coming from data center, so a couple of points from the rest of the company.

Speaker 0

Maybe a couple of things.

Speaker 1

One is help us understand that sort of data center overall % of revenue or dollar revenue this year so we can understand the jumping off point into 2026, and then should we expect the operating leverage on that volume growth is very limited in the first half because of tariffs and rare earths and so forth.

Speaker 0

Specific to data center tariff in rare earth wouldn't have an impact. Julian, data center for us today and, as you know, the Thompson Power Systems business as I spoke to is about $130 million. Outside of that, data center is about 3% of all of Regal Rexnord. You would say about incremental $50 million. We do expect that to become a more meaningful part in 2026 and as we move forward. I think that answers the majority of your, I think, the.

Speaker 1

Only other part would be that the margins on the data center business be roughly segment average, and we'd see that to be accretive, margin accretive for the enterprise.

Speaker 0

Great, great point.

Speaker 1

Thank you, that's helpful. Just to follow up, sorry my question was on the operating leverage for next year, it was more around total enterprise because I guess you've got this extra headwind, you know, affecting the 2025 guidance from rare earths and tariffs for Regal Rexnord firmwide. Maybe help us understand kind of the phasing of that headwind to profits, you know, as we step through the next couple of quarters versus what you saw in Q3. I'm just trying to understand if there should be, you know, overall much margin expansion the next few quarters from volume leverage or if it's all offset by the tariffs and rare earth headwinds. Overall, the leverage, we expect about 35% overall for the business. I'm going to give you, there's two parts to my answer.

35% in the business, it's roughly 40 to 45% for AMC and IPS and lower for PES. The way that would phase in is you'd get a little better benefit in the back half, obviously as we become more, as we get to margin neutrality. It would be more back half weighted than front half weighted. Overall, about 30 to 35% for the year is what our expectation would be. The first couple quarters will be margin challenged as we expect to be margin neutral, as we talked about, by the time we get to the end of the first half of next year, and margin neutral not till the back half. That's the way it would phase from half to half. That's great. Thank you.

Speaker 0

Thanks, Julian.

Speaker 1

The next question is from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Speaker 0

Hey, good morning, guys. Louis, best of luck and I'll echo Julian and Mike's comments. Thanks, Jeff. Just maybe staying on the margin dynamic. I think you said $40 million of integration savings and then Rob, I think you said you think the tariff thing is maybe a net or price cost is maybe a net tailwind into 2026. How should we think about price cost or this tariff noise maybe getting less bad or better and the rare earth kind of fixing itself in terms of a Delta 2025 to 2026?

Speaker 1

I think it's a bit early to get too specific at this time. We do absolutely expect that rare earths, we will get through the rare earth challenges, you know, early in 2026. That should not be a problem. As I said, we've got about $13 million now of rare earth headwinds as we exit this year, which is incremental $8 million from what we said coming out of the second quarter. We do think that most of that we'll be able to get through pretty quickly, maybe by the first half of next year, and then we'll move through the back half at a much better rate than we're seeing first half. As far as more detail than that, we're not ready to get to that level of detail until we put out fourth quarter results and provide official guidance.

Speaker 0

Okay, great. I guess as your tariff, you know, I know India may come down, but I guess as your tariff pressures kind of moved higher, are you finding it harder to get price and maybe more particularly in PES, given the customer concentration? Just separately, if you could touch on what's driving the furnace growth. I don't know if there's share gains or there's no destocking dynamic or what. Thanks. Yeah. Let me comment on tariffs first. Outside of PES, we will be price, we will be tariff neutral and we'll work to be margin neutral. It's just the timing of that. The Section 232 derivative tariff coming out right after our last earnings call, it just takes time for it to implement for IPS and AMC. We would expect, as Rob said, that will ramp in the first half of next year.

Same for PES, however, a little bit more pressure because of the India influence. We feel good about, and we've talked about this, our global footprint and the differentiation of that global footprint. If tariffs stay at 50% for India, we will need to move that production, but we have not made that decision yet. If we have to, we will. I'm not worried about our ability to offset it, but to Rob's point, it will be margin neutral by the end of next year and cost neutral by the middle of next year. That gives us a little time to manage. Now, let me address your furnace question. Furnace is about 40% of our resi HVAC business. I'll just remind you that furnace was down pretty significantly in 2023, a little bit stronger in 2024, and we think there's actually some more room to return to normal levels.

We believe our outperformance in this market, though, is we are gaining share due to our differentiated and IP protected technology. From that standpoint, we feel very good about furnace and our position in that marketplace. Hopefully, Jeff, that helps. No, that's perfect. Appreciate it. Thank you.

Speaker 1

The next question is from Kyle Menges with Citigroup. Please go ahead.

Speaker 0

Thank you, guys. And Louis, sad to see you go. It was great working with you and best of luck. Yeah, thank you. Yep. I would love to just maybe unpack the $1 billion or so data center pipeline that you identified. I suppose, how did you guys kind of arrive at that figure? What's your sense of what win rate could be, or maybe what a respectable win rate would be for you guys would be helpful. Yeah, Kyle, it's really quite a great question, but it's hard to give you a very clear answer. I can tell you, though, that the funnel is made up of a number of large projects with a number of customers. We have been investing significantly in our commercial team, and this is not a focus view. There's a number out there. There's a couple that are big projects. They're hyperscale related.

We've also invested pretty significantly in expanding our portfolio into ePods. Being able to provide that solution set, to give you a number on win rate would be tough. It really would. The recent two really nice, bigger orders that we received, we were hopeful and negotiating and feeling good, but that was a big win for us. I think where I would go with this for now is be assured we're investing. We've invested in our commercial teams, we're investing in capacity, and we're going to continue to drive growth in this space. We believe it will be a meaningful part of Regal Rexnord for the future. We'll have to come back to give you a little more clarity on how we think about win rates after a bit of time. Makes sense.

Speaker 1

Maybe turning to free cash.

Speaker 0

I can appreciate some of the reasons why free cash flow guide was lowered for this year. I am just curious your confidence level in free cash flow being better.

Speaker 1

Next year, and then ability to execute on further deleveraging.

Speaker 0

It'd be helpful to hear a ballpark of how much.

Speaker 1

Lower interest expense could potentially be next year as well. Thank you. Yeah. The free cash flow going into next year, if we bridge off of this year, which we're saying $625 million, and I said in my prepared remarks that we expect to be at almost $900 million next year. Where we get there is, you know, we would expect some growth, so some EBITDA expansion, and then we would expect maybe there's $60 million, $70 million coming through working capital to help us bridge the gap a bit along with lower cash restructuring. Cash interest comes down, we expect by a good $40 million next year. There are some offsets, of course, on cash taxes and a bit of CapEx. Those are the main bridge items to get to $900 million. We feel pretty good.

The free cash flow this year was certainly hampered by some of the inventory challenges that I've talked about. While we're still expecting this year that we'll get some improvement in working capital as we close out the year, it was not where we expected it to be as we entered the year from a working capital standpoint. We feel good about next year being able to drive out more of that inventory and bridging more of that gap as far as the leverage standpoint. From a leverage standpoint, we expect that we'll end next year at roughly 2.5 times. That incorporates the $900 million that we have in free cash flow helping to pay down the debt. We have a bond that's coming due that we are currently working through and finalizing the strategy here. We expect to have that done here in the next month or so.

We will have a term loan that is also prepayable. We expect that to be as much, maybe about $900 million. That should execute in the first quarter and we will then make progress paying down that loan, which would come from the $900 million of free cash. That's what we're thinking about. Our ability to get down to 2.5 times we think is very good. We do expect that we can generate this cash flow and have good visibility on how to get there.

Speaker 0

Helpful.

Speaker 1

Thanks guys.

Speaker 0

Great, thank you.

Speaker 1

The next question is from Tomo Sano with JP Morgan. Please go ahead. Hello, this is Tomo. Louis, although we have only just recently met, I wanted to say thank you for your leadership and wish you continued success.

Speaker 0

Thank you, Tomo. Thank you so much.

Speaker 1

Thank you. My question is, could you share more details on the CEO succession process, including timeline, criteria for the new leader, and how you are ensuring continuity in strategies and execution, please?

Speaker 0

Yeah, Tomo, thank you. I'm actually going to pass it initially to Rakesh Sachdev, our Chairman of the Board, who has some prepared remarks that he'd like to share. Rakesh.

Speaker 1

Thanks Louis and good morning. Yes, you know, I think as you look at where the company is and the work that Louis and the team have done over the last six years, it's really quite remarkable the transformation that has taken place. You know, this is a company that is now very decentralized and has a strong bench of leaders. You heard Louis talk about the cash flow generation in this business. It's a high gross margin business. We've got scale and we are at the heels of seeing some significant growth. We're in a great place. You know, Louis and the board, we've been having this discussion about the next phase of growth in this company for the next several years. We decided this might be a good time and we have started a process. We have recruited a leading executive search firm.

We have kicked off the process just now and we'll be very thoughtful and very deliberate in appointing the successor to Louis. Louis is of course going to stay on and, as he said, it's business as usual until we find and appoint the new CEO. I expect it will take about four to six months before we appoint somebody, but there is no rush. We want to make sure we find and appoint the best leader. We have a search committee in the board. There are four of us, three CEOs, one active CEO, two former CEOs, so we've got some great eyes on making this decision. Rest assured, we will find a great person to fill in this role. With that, Louis, I'll turn it back to you.

Speaker 0

Yeah, thanks, Rakesh. Thomas, just to emphasize Rakesh's point there, as I said earlier, we are going to ensure it's a smooth and orderly transition. With our team, our team has never been stronger deep into the organization. The message is business as usual. That's where we're going to be focused on what's in our control and continue to execute as we have done in the past. Hopefully that was helpful. Tomo.

Speaker 1

This is really helpful. Thank you very much.

Speaker 0

Thank you.

Speaker 1

The next question is from Nigel Coe with Wolfe Research. Please go ahead.

Speaker 0

Oh, good morning. Maybe a question for the Chairman again. Are you fully committed to an external candidate or are there other internal options as well? When you're thinking about the profile of the person you're seeking, would it be with a very similar background to Louis in terms of operational chops, or are you looking for maybe slightly different attributes? Thanks.

Speaker 1

Thanks for the question. Yeah, absolutely. We are doing a comprehensive search. We are looking at external candidates. We're not going to rule out internal candidates, but you can imagine that this is going to be a very comprehensive, thoughtful search. Yes, we will be looking for a candidate who's demonstrated strong leadership skills like Louis has had running complex global businesses. You know, we're going to be focused on growth. Operations has always been in the DNA of Regal Rexnord and we've got some great folks who are leading that. We also need commercial and growth leadership, which we'll be looking for in the next leader who's going to lead this company. The cultural aspect is also very important. We have created a great culture in this company and we want to make sure that whoever leads this company will continue to foster that culture going forward.

Speaker 0

That's great. Thanks for the color there, Louis. Look, I've covered the stock for 20 years and the last seven years have easily been, you know, the best. You've done an incredible job of really changing the change for this company. It'll be sad to see you go. Thank you. Maybe, the data center, I mean, I know we've—how should we think about the contribution margins on the back of your building? Can you maybe just be a little bit more precise on when you expect to have this new facility up and running? Yeah, so I'm going to go backwards. Nigel, you're cutting out a little bit, but I think I got the intent here. We are initiating the program for setting up that new facility as we speak. We will be hiring personnel through this quarter into next, starting training.

We would expect that we will have product flowing through the facility in Q1, but not shipping until Q2 and later part of Q2. That's the initial project plan. From a contribution margin perspective, all of our evaluation at this point, Nigel, based on what we've bid and quoted, is that this will be fleet average margins for AMC, which is actually accretive for Regal Rexnord. This will be a benefit for Regal Rexnord as a total business. Now, realize when you think about these pods, a big part of the bill of material is our Regal Rexnord product, our paralleling switchgear, automatic transfer switches, our PDUs. I also want to emphasize that we're going to put our air moving products in these systems as well. We feel really good about where they're positioned and with the market margins that we will receive.

Speaker 1

I would just add that the investments we're making today that we mentioned earlier are very CapEx light. You know, this is more of assembly and test, and that's important to note. This should not weigh on margins as we move forward.

Speaker 0

Yeah, great. Thanks, guys. Yeah, thanks. The next question is from Christopher Glynn with Oppenheimer.

Speaker 1

Please go ahead. Hey, thanks Louis.

Speaker 0

It's been a pleasure working with you and best of luck there. It sounds like we'll be with you for a couple more quarters.

Speaker 1

Anyway, I had a question on the discrete automation orders. I think you said they're up 17%. Just curious, you know, you characterize that.

Speaker 0

Narrow, big project lumpy or pretty diversified?

Speaker 1

Is it a hockey stick, or did you have a pretty, you know, an easier comparison? I can't recall 3Q last year.

Speaker 0

Is this just a significant sequential move?

Speaker 1

Is really kind of the.

Speaker 0

On top of that, we talked about this at our investor day. We did lose. We are starting to get orders, and this is just another indicator of we are investing more in technology. We're trying to expand our served market and feel really good about our position in discrete automation. Probably the one piece I would call to emphasize the point is defense was quite strong in the quarter.

Speaker 1

Thank you for that.

Speaker 0

Quick follow up on the EVTOL initial order there. Is that going to be kind of very sporadic or is that starting to ramp? It's sporadic for now. It's not ramping. The point of emphasizing it though, and I know you all know this, in the aerospace industry, when you start a production order, that means you're moving forward. If you listen to some of the announcements, for example, the LA Olympics has a contract out for 50 EVTOLs for four taxis. We'll see if that comes to true fruition. This is a market that if it accelerates, Regal Rexnord is well positioned. That's why we shared it in the prepared remarks. Great thanks, Dr. Great thanks, Chris.

Speaker 1

This concludes our question and answer session. I would like to turn the conference.

Speaker 0

Back over to Louis Pinkham for any closing remarks. Thank you, operator, and thanks to our investors and analysts for joining us today. Our team delivered strong performance in third quarter in all segments for what was in our control. Most importantly, strong orders in the quarter and order strength in fourth quarter should set us up for solid growth in 2026. Stronger growth, anticipated additional margin gains, including improved tariff and rare earth mitigation, expectations for further cash flow growth, and plans to reduce net leverage ratios below 3 times means we are poised to create increasingly significant value for our shareholders and other key stakeholders in 2026 and beyond. Thank you again for joining us today and thank you for your interest in Regal Rexnord. The conference has now concluded.

Speaker 1

Thank you for attending today's presentation. You may now disconnect.