Regal Rexnord - Q2 2023

Transcript

Operator (participant)

Good morning, welcome to the Regal Rexnord Corporation Q2 2023 earnings call. 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 Star, then one on your touchtone phone. Please note, this event is being recorded. I would like now to turn the conference over to Robert Barry, Vice President of Investor Relations. Please go ahead.

Robert Barry (VP of Investor Relations)

Great. Thank you, operator. Good morning, and welcome to Regal Rexnord's Q2 2023 earnings conference call. Joining me today are Louis Pinkham, our Chief Executive Officer, and Rob Rehard, our Chief Financial Officer. Before we get started, I'd like to note that we are experiencing some scattered blackouts in our area this morning, and in the event that we are disrupted during the earnings call, please know that we will rejoin the call shortly thereafter. We do thank you in advance for your patience in the event this disruption occurs. 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 those 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, which are available on the regalrexnord.com website. On slide three, 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.

With that, I'd like to turn the call over to Louis.

Louis Pinkham (CEO)

Great. Thanks, Rob, good morning, everyone. Thanks for joining us to discuss our Q2 earnings, to get an update on our business, and for your continued interest in Regal Rexnord. The Q2 was an exciting one for the Regal Rexnord team, our first full quarter together with our new colleagues from Altra. Bringing together Altra and Regal Rexnord marks another significant milestone on what, for the last four-plus years, has been a steady journey of profound transformation. We have a simple but powerful concept at Regal Rexnord for charting our path forward and for driving a continuous improvement mindset. In short, what we call our from-to.

We are regularly challenging our businesses, functions, and associates to define their from-to, where they are, current state, and where they plan to go, future state, and then identifying the investments, the initiatives, and the actions they must take to navigate that from-to journey. I should add, driven with an 80/20 prioritization mindset and supported by data. As I reflect on our RRX from-to and where we are today, I think about a legacy business that in 2020 had $2.9 billion in sales, which today has annual sales above $7 billion. A business where growth was stagnant to a business more focused on secular growth markets with significant focus on vitality, which we expect to double by 2025 after doubling from 2019 to 2022.

A business that had adjusted gross margins about 27%, now on track to be a 35% gross margin business this year, with adjusted gross margins just over 35% in Q2. A business that treated all products and customers equally to one that views customers, products, really all opportunities through an 80/20 lens. I could go on. In short, a pretty dramatic from-to. The next steps on our

transformation journey will be even more exciting. I am pleased to share that through our first three months together with Altra, we are off to a great start. The teams have come together really well. Altra and Legacy Regal Rexnord are a great cultural fit. Operationally, the legacy Altra business had a great Q2, which exceeded our expectations. By the way, so did Legacy Regal.

Integration activities, activities and initial synergy actions are both well on track, and the teams have already started building a healthy pipeline of cross-marketing opportunities. In fact, we have already seen a few million dollars of wins just 3 months in. I look forward to sharing updates on our progress in future quarters and having you see the further benefits of the combination in our future results.

In addition to all that we are doing with Altra, our teams also executed a very solid Q2, with performance on sales and adjusted EBITDA both tracking modestly ahead of the expectations we laid out last quarter. Sales in the quarter were up 31.1% versus the prior year, or down 5.7% on a pro forma organic basis. For context, this moderate organic sales decline was against a 2-year stacked compare of 40%.

The organic sales decline is being driven by fully anticipated weakness in our PES segment markets, as residential HVAC and parts of the general commercial channel are facing weaker demand and destocking headwinds. Putting PES aside, our other segments in aggregate posted low single-digit organic growth, led by AMC. Turning to orders. Our daily orders were in line with our expectations, coming in down 12.7%. This performance should be considered in the

context of a 2-year stacked compare of 55% and is consistent with a normalizing global supply chain and a return to more typical customer stocking levels. Our orders and sales performance resulted in a quarter-end backlog that is approximately 65% above our normal levels, with book-to-bill at approximately 1.0 in the quarter and on a year-to-date basis. Margins in the quarter were strong.

Our adjusted gross margin came in just over 35%. Margins continued to benefit from our 80/20 efforts and the launch of mixed positive new products. The Q2 adjusted EBITDA margin was 21.5%, up 50 basis points versus the prior year, or up approximately 80 basis points on a pro forma basis. Finally, free cash flow was a standout positive in the quarter, coming in at $176.3 million, up significantly from the prior year period and continuing to reflect our team's focus on working capital management. The combination of our first half cash flow and deploying excess balance sheet cash allowed us to pay down $600 million in debt this quarter. In short, a very strong quarter and one that I think demonstrates solid execution by our teams.

Whether it is executing our M&A integration and synergies or our base business performance, everyone at Regal Rexnord is working very hard to advance our transformation by pursuing cross-marketing synergies, doubling our product vitality, raising our secular end market exposure, and continuing to drive 80/20 and Lean. We are becoming a faster-growing, higher margin, more cash-generative enterprise.

I want to thank all our associates for their disciplined execution and for their dedication to making Regal Rexnord stronger every day. As I mentioned last quarter, one way we plan to help investors better appreciate how, together with Altra, we are better positioned to accelerate profitable growth, is to spend a few minutes introducing our principal AMC businesses. This quarter, I will discuss Linear Motion.

Our Linear Motion division within the AMC segment, which includes the well-established Thomson, Nook, and Delevan brands, sells actuators and related highly engineered components that enable precision movement in machines, devices, and other applications. These are differentiated, technology-rich products that fit perfectly inside Regal Rexnord's broader portfolio of automation and power transmission components and subsystems. In this regard, the Linear

Motion portfolio significantly advances our strategy of becoming a trusted advisor to our customers. On the right-hand side of this slide are examples of the end markets the Linear Motion business serves, including intralogistics, medical, aerospace and defense, and agriculture, to name a few. The yellow arrows in each picture illustrate the kinds of precision movement our products enable, such as the automation of a packaging line or raising and lowering aircraft wing flaps.

Some relevant common characteristics across these applications include an absolute need for reliability, often in harsh conditions, along with accuracy and precision. In short, our Linear Motion components are critical to the proper functioning of the applications in which they reside, and in many cases, to the safety of the applications' users. As indicated on the lower left-hand side of the slide, our Linear Motion business has established itself as a leading provider through its track record of performance achieved by leveraging proprietary technology, deep application expertise, and a strong channel and online presence that supports high customer service levels.

Most of the business's end markets also have strong secular growth tailwinds, some related to macro trends such as electrification, onshoring, and automating labor-intensive processes, and some to end market-specific factors such as growth in e-commerce or a rising global middle class that is driving demand for aircraft and agricultural products. The strength of our Linear Motion solutions and channels,

plus the secular tailwinds I mentioned, supported a five-year organic growth CAGR for this business of roughly 6%. We believe that we can accelerate that growth going forward into the high single digits by exploiting significant cross-marketing opportunities, leveraging our Regal Rexnord sales force, and increasing our value add to customers by offering a broader portfolio of adjacent automation, power transmission, and high-efficiency electric motor solutions. I want to take a moment to emphasize the power of the broader Regal Rexnord portfolio.

For example, in intralogistics, Legacy Regal already had a strong portfolio of power transmission and conveyance components and subsystems, with strong and vast customer relationships in place. The addition of our Linear Motion portfolio, along with other precision motion solutions from other AMC divisions, enable a more complete and value-added offering, engineered to our customers' specific needs. Similar cross-marketing opportunities exist to an even greater

extent in the aerospace and defense market, and next quarter, we will dig deeper into AMC's now expanded aerospace business, which is approaching $350 million in annual revenue. Lastly, I'd note that our medical market exposure, which has been a priority for us to expand, has now reached 3% of Regal Rexnord sales. Our sales teams are discussing the power of the enhanced Regal Rexnord portfolio with customers, and using an 80/20 approach, they have focused on Quad One.

While it is still very early days, many of these initiatives are, by nature, longer sales cycles, we have already begun building a sales opportunity funnel, and I am excited by what the teams are seeing. I hope this provides a little bit more color on how we believe the scale of Regal Rexnord can help accelerate growth in Linear Motion, and how differentiated Linear Motion technologies enhance our ability to sell our broader power transmission, automation, and high-efficiency motor portfolio. With that, I will now turn the call over to Rob to take you through our Q2 segment financial performance and discuss our latest guidance.

Rob Rehard (CFO)

Thanks, Louis, and good morning, everyone. I'll also begin by thanking our global team. We have a lot going on, and the team's hard work and disciplined execution not only drove very strong Q2 performance, but is helping build a higher performing Regal Rexnord. Now, let's review our operating performance by segment. Starting with Automation & Motion Control, or AMC, organic sales in the Q2, pro forma for the Altra acquisition, were up 4% from the prior year, reflecting strength in the aerospace, medical, and data center end markets, tempered by project timing headwinds in the beverage market. Given project timing headwinds, it is useful to look at AMC's growth in the first half, which was 7.8% on a pro forma organic basis.

Adjusted EBITDA margin in the quarter was 25.3%, nicely ahead of our expectation, and reflects favorable price, cost, and volume growth, along with a reinforcement that the product and technology at AMC, which, as a reminder, is a combination of Altra's automation and controls business, along with Regal's aerospace, data center, and conveyance businesses, are highly valued by our customers and justifies strong growth margins. Orders in AMC on a pro forma organic basis were down roughly 20% in the Q2 on a daily basis, with book-to-bill at 0.9. This order reduction is as expected, as supply chains normalize and lead times reduce. In July, book-to-bill tracked at roughly 0.95.

For perspective, AMC's Q2 order decline is against a 2-year stack of 60%, and the segment's backlog at the end of Q2 is roughly 55% above our normal level. We feel good about the growth prospects for AMC in 2023 and into early next year. Turning to Industrial Powertrain Solutions, or IPS, pro forma organic sales in the Q2 were up 60 basis points from the prior year. Growth in the quarter reflects strength in the metals and mining, energy, and marine end markets, partially offset by weakness in the agriculture end market and impacts from the timing of renewable energy projects. Adjusted EBITDA margin in the Q1 for IPS was 23.6%, in line with our expectation, and reflects benefits from volume and price cost.

I remind you, as indicated on the right side of this slide, our legacy Regal IPS business was 26.9% EBITDA in Q2 of 2022, before the Altra acquisition, which reinforces the strength of the PMC synergies and the opportunity to improve IPS EBITDA margins further with the Altra synergies. Our global supply chain and manufacturing scale, along with our 80/20 approach, are the main drivers. Pro forma organic

orders in IPS were down 4% in the Q2 on a daily basis, and book-to-bill was 1.0 in the quarter. In July, book-to-bill also tracked at roughly 1.0. For perspective, IPS's Q2 order decline is against a 2-year stack of nearly 50%, and the segment's backlog at the end of Q2 is roughly 65% above our normal level. Turning to Power Efficiency Solutions, or PES.

Organic sales in the Q2 were down 22.2% from the prior year. The decline was driven by significant channel destocking activity, along with weaker demand in the North America residential HVAC market, and to a lesser extent, weakness in China. This destock pressure was fully anticipated and is directionally consistent with the expectations we outlined in our last earnings call. Note that we expect further headwinds from destocking in the Q3, but to a

somewhat lesser degree compared to the Q2, and expect destocking to be mostly behind us as we enter the fourth quarter. The adjusted EBITDA margin in the quarter for PES was 18.6%, which was modestly ahead of our expectation. Key contributors to the PES margin performance were favorable price cost, mix, and operational performance, partially offset by lower volumes.

We expect this level of margin performance to continue in the back half, potentially with moderate upside versus the Q2 level. Shifting to orders. Orders in PES for the Q2 were down 14.5% on a daily basis, slightly better than our expectation. Book-to-bill in the quarter was 1.1 and tracked at 1.0 in July. For perspective, the two-year stack on Q2 orders is 70%. On the following slide, we highlight some additional financial updates for your reference. Notably, on the right side of this page, you'll see we ended the quarter with total debt of $6.68 billion, which is a $600 million reduction versus the end of the Q1.

Free cash flow in the quarter was very strong, coming in at $176.3 million, up from $91.6 million in the prior year period. The teams continue to do a great job improving free cash flow performance, driven in part by improving working capital and, in particular, by lowering inventories. We continue to see significant opportunities to increase our cash flow in 2023 by further lowering inventory. We are now on track to generate greater than $650 million of free cash flow this year, an increase of $50 million from our prior estimate. As we stated previously, capital allocation will remain heavily weighted to paying down our debt. Now, moving to the outlook.

We're making several adjustments to our guidance for adjusted earnings per share, which is now in a range of $10.20-$10.60, versus a prior range of $10.20-$11.10. You will see that the midpoint of our prior range is coming down by $0.25, which primarily reflects higher depreciation expense of approximately $10 million and higher net interest expense of roughly $9 million. The depreciation expense change reflects both a true-up to acquisition-related step-up depreciation, along with an increase related to the latest anticipated cadence of footprint actions and capital investments, many related to Rexnord PMC synergy realization. The interest expense change reflects higher assumed rates, primarily based on the latest SOFR forward interest rate curve. You'll also see that we are lowering the high end of our range.

Given we are now just over halfway through the year, we have better visibility into our expected performance, and we believe some of the modeling assumptions behind our prior range's high end now appear less likely. In particular, we now assume a slower pace of recovery in U.S. consumer markets, including residential HVAC and pool, as well as in certain short-cycle industrial markets. In addition, we are no longer expecting a meaningful recovery in China this year.

Finally, at the bottom of this slide, we present our standard below-the-line modeling items. In summary, we are very pleased with our performance in the quarter. Both the Legacy Regal Rexnord and the newly acquired Altra business performed well. We added roughly 40% to the top line through the acquisition, and our teams are effectively executing on both cost and cross-marketing synergies.

We continue to have lots of levers under our control to accelerate profitable growth and drive meaningful value creation, ranging from doubling our product vitality to shifting into more secular markets and continuing to drive 80/20 and Lean across our businesses. With that, I would now like to turn the call back over to the operator, so we can take questions. Operator?

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Mike Halloran with Baird. Go ahead.

Robert Barry (VP of Investor Relations)

Hey, good morning, everyone.

Louis Pinkham (CEO)

Good morning, Mike.

Michael Halloran (Associate Director of Research and Senior Analyst)

Could you, could you just dig a little bit into what you're seeing from an underlying demand perspective and, and, and how you think orders are gonna track as you look to the back half of the year with some, some granularity as you think about, you know, the, the big chunks of your business, whether it's the resi pieces and the short cycle industrial pieces, and any dynamics you see there?

Louis Pinkham (CEO)

Yeah, Mike, this is Louis, and good morning. You know, to answer your question, I'm gonna answer the second half first and go over how we're thinking about market. We're expecting orders in Q3 to be down year-over-year, mid-single digits, and Q4 to rebound to being up mid-single digits. That's how we're profiling the rest of the year. How are we thinking about it from a market perspective? You know, a little bit slower pace of recovery in the second half, specifically around resi, HVAC, pool, and general commercial. You know, what we like about our portfolio, though, is we're pretty balanced mid, early and late cycle. We have some nice markets, though, that are accelerating growth, aerospace, medical, data center, strength.

A view to strength in alternative energy, but it tends to be a little lumpy, and we're forecasting strength in the 2nd half in alternative energy. Non-res construction has been pretty solid for us, and we're expecting. Other than, we did see headwind pressure in China, in non-res construction. Our North American non-res construction is up nicely. From an industrial distribution standpoint, I'd tell you that we're still seeing the end sales growth, because as you know, we have strong relationships with our distributors, and so we share openly sales out as well as orders. The sales out from our distributors are still quite strong. There was a little bit of, we expect going into Q3, continued inventory management, so orders down.

Overall, I feel good about the demand profile in that industrial distribution space. Hopefully that gives you a view of how we're thinking about our markets, how we're positioned. You know, again, M-Mike, I'd tell you, you know, not one of our markets make up more than 20% of our sales. We like that distribution of early, mid, and, and late cycle exposure.

Michael Halloran (Associate Director of Research and Senior Analyst)

No, that's, that, that's very helpful. If, if you think about that, you know, down mid-single digits, 3Q transition to plus mid-single digit orders in the 4th quarter, is this just destocking, normalizing, and then seeing relatively normal sequential trends with, you know, maybe a couple of markets you feel a little bit more confident in? Or is there an expectation that things are maybe a little stronger cumulatively as you hit the 4th quarter on a sequential basis, you know, just from an underlying demand perspective?

Louis Pinkham (CEO)

No, I, I think that's, that's pretty spot on. We, we expect some continued destocking through 3Q. We expect that to be behind us by the end of 3Q, taking a little bit longer than we anticipated. We do not expect any significant strength going into Q4, necessarily from a demand perspective. As I said before, we're really not expecting any strong recovery in China either. Slight in, in fourth quarter, but we expect it to be pretty muted for the year. Overall, the way you summarized it, is spot on.

Michael Halloran (Associate Director of Research and Senior Analyst)

Great. Last one, just maybe get some context on the cross-selling. You know, what's, what's working on from an early perspective? You know, what kind of pace of progression do you think we can see here on a qualitative basis as you continue to merge these two businesses and, you know, put the R&D efforts on a more joint basis?

Louis Pinkham (CEO)

I'm excited, Mike. I thought we would be spending a lot more time on the industrial powertrain side, and there's definitely opportunity there. You know, we, we rounded out our offering with, in particular, with the clutch and brake, and then strengthened our position in gearing, gear motors, with the Bauer Brand, a great global brand, and our coupling business. And so I'm, I'm excited there. What I didn't expect to be as excited about so quickly is how we're gonna be able to leverage the strength of the total Regal Rexnord with the traditional A&S business, so our AMC business. You know, our aerospace business today is $350 million of Regal, and it's early cycle of growth.

We're now talking at a much higher level with our customers because of the portfolio and the offering that we have, and we think it's positioned to accelerate. You know, we're, I would say that's been a big positive for us and an example of just now the scale and scope of Regal and the potential for our future.

Michael Halloran (Associate Director of Research and Senior Analyst)

Great. Really appreciate the time, Louis. Thanks.

Louis Pinkham (CEO)

Yeah, thanks, Mike.

Operator (participant)

Our next question comes from Julian Mitchell with Barclays. Go ahead.

Julian Mitchell (Equity Research Analyst)

Thanks very much, and good morning. Maybe trying to keep my questions a little concise, if possible. The first one, really, the, the second half guidance, you know, sales of sort of $3.5 billion and $5.60-ish of EPS. Any cadence you're calling out to us between sort of 3rd and 4th quarters as we think about sales and margins?

Rob Rehard (CFO)

Sure, Julian, this is Rob. Let me give you a sense of what we think that looks like in the Q3. I'll go ahead and move through this and through the segments to give you the best color possible. You know, for the PES segment, in the Q3, we would expect revenues in the range of $465 million-$485 million with, you know, margins, you know, in the high teens. Margins similar to the Q2. You know, on the revenue side, you know, we do as I pointed out the number, you'll see that's a slight improvement versus the Q2, you know, based on, you know, better seasonality, less destocking, and better mix.

As you move to industrial, we see industrial at about $130 million-$145 million, so very similar to the Q2, and the margins there, low double digit. Moving to AMC, relative to Q2, relatively flat from the top line, maybe revenues in the range of $445 million-$455 million. Now, when I say relatively flat, you have to remember, there is an impact of the stub period in the Q2 that's obviously not repeated in the third. When you, when you think about that, it, it's fairly flat quarter to quarter. Again, back to AMC, margins in the mid-twenties, so, so very similar to the Q2.

Synergy is driving a piece of that, you know, although volume's down a bit. Moving to IPS, revenue is about $655 million-$670 million. You know, by the way, the margins on that, low to mid-twenties. You know, top line, you know, down a bit because of the agricultural destock. Again, you don't have that stub period impact in the Q3, and short cycle industrial continues to be a headwind there. Overall, you know, in the Q3, that's about $1.695 billion-$1.755 billion as a range on the top line with margins in the low twenties. That's the way we're thinking about it in the Q3.

Then, of course, you know, the implied is that the fourth quarter absolutely would be stronger than the third. So, you know, the next logical question might be, you know, what gives us that confidence that the fourth can be up? You know, I'll answer that by saying that, you know, we do have elevated backlogs in most of our business, as I talked about in my prepared comments. That gives us some pretty good visibility. I talked about the book-to-bill at 1.0, exiting July. That gives us some nice confidence, you know, that we're holding backlog as we're kind of now a month into the Q3. You know, our, our supply chain continues to normalize, and that gives us some rising confidence that we can deliver that backlog.

You know, we do have better visibility, good visibility into some of our more lumpy, you know, project orders, things that we talk about, like data center and renewables and that. Finally, the PES destock, we believe, will be behind us in the Q3, and we'll see some slight improvement in demand in the fourth. That's the cadence of what we're seeing from Q3 to Q4, and, and, and the Q3 detail.

Julian Mitchell (Equity Research Analyst)

That's very helpful. Thank you. Then just to follow up on the amount of destocking left in your sort of short cycle industrial markets, what are the main areas where inventories are still elevated today? What's the pace at which you think we get through those? Are we sort of done by Q4 on the short cycle industrial destocking and any areas it's most acute? Thank you.

Louis Pinkham (CEO)

Yeah, you know, Julian, good morning, this is Louis. I... We do expect to be through in, by the start of Q4. Yeah, we're still working through, really, resi, HVAC, pool. Pool, of course, a small part of Regal, but it, it has had a pretty significant destock, and so has had an impact in Q2 and expecting continuing into Q3 and then that getting to normal in Q4. Industrial distribution, there's no question that there's some balancing of inventory levels. Like I said before, as our lead times are reducing as well, and we're being able to support a reduction in the distribution channel. Again, we expect that to clear up by the end of Q3.

Rob Rehard (CFO)

Operator, next question.

Operator (participant)

The next question comes from Christopher Glynn of Oppenheimer. Go ahead.

Christopher Glynn (Managing Director and Senior Analyst)

Thanks. A lot of good information here and transparency, so, pretty easy to digest. I was curious if there's any markets or channels that, you know, maybe have any unstable patterns. It doesn't really seem with the book-to-bill and, you know, the residential situation's pretty transparent, but, yeah, just curious if anything kind of surprised you in the quarter?

Louis Pinkham (CEO)

Good morning, Chris. Not, you know, nothing more than we've already commented on. You know, maybe China not seeing a bit faster rebound. At the beginning of the year, I was pretty bullish on China rebounding, just based on my history with China over the years. I, I, I have been a little surprised by that. Our forward look doesn't have much of, of any forecast improvement there. Beyond that, everything really played to our expectations. So, nothing more than that.

Walter Liptak (Industry Analyst)

Okay, and then, any update on the industrial process?

Louis Pinkham (CEO)

Yeah. you know, we've made a lot of good progress, and, and we believe we'll be at a position to share more in the next couple months.

Walter Liptak (Industry Analyst)

Great. Thank you.

Louis Pinkham (CEO)

Thank you. You got it. Thanks.

Operator (participant)

As a reminder, if you have a question, please press star, then one. Our next question comes from Nigel Coe of Wolfe Research. Go ahead.

Nigel Coe (Managing Director)

Oh, thanks. Good morning, guys. Good details here, not too much from my side. Just on that 3Q and back half color, Rob, maybe can you just remind us the cadence of the cost synergies from obviously from Altra, also from the PMC transaction? You know, what should we be expecting for 3Q and 4Q? Then just a final point on IPS, you said low to mid-20s. Would that be sort of flattish with what we saw in 2Q?

Rob Rehard (CFO)

Similar to Q2, yes.

Nigel Coe (Managing Director)

Yeah.

Rob Rehard (CFO)

Let me give you the detail on the synergies. You know, we saw about $14 million of incremental synergies in the Q2, which includes both PMC and Altra. You know, if you break that down, you know, you'd think, you know, PMC is about, you know, $10 million-$11 million, and then about $3 million-$4 million for Altra. That's how you get that $14 million. We expect incremental about $45 million from PMC to flow through the P&L in 2023, and about $20 million from Altra to flow through the P&L in 2023. With that means you get an exit rate there for, from Altra about $40 million annually. The total P&L impact in 2023 is about $65 million.

You can count on, you know, the synergies coming through, you know, and increasing each quarter. We might expect that next quarter, we might see something closer to $2 million-$3 million, maybe above what we saw in the Q2, and then improving to that exit rate that I commented on in the fourth.

Nigel Coe (Managing Director)

Okay. Then, you know, this, this depreciation pinch you highlighted. Is the accounting now pretty much settled down now, you, you wouldn't expect there to be too many changes from here on?

Rob Rehard (CFO)

Yes, I would not expect additional true ups to any material degree going forward. Might we see slight tweaks? That could be, but it's not gonna be anything material and something that I would expect us to absorb. Yeah, the accounting is largely behind us at this time.

Nigel Coe (Managing Director)

Okay, great. My follow on is, Louis, you've obviously seen a few cycles, like, like we all have. From your perch, you know, when you, you know, the cynic would say, we're seeing the weakness right now in some of the consumer durables and short cycle industrial, which is where you'd expect to see weakness emerging. Therefore, does this then cascade into some of the longer cycle businesses? Based on your experience, you know, are you seeing something different this time that maybe suggests that perhaps non-res, energy, et cetera, can remain stronger for longer?

Louis Pinkham (CEO)

Yeah, you know, it's honestly a great question, Nigel, and something that we are thinking a lot about as we're moving right now into our strategic planning period and getting prepared for our thoughts on next year. You know, for now, things look pretty good in the longer cycle businesses. Our, our backlogs are strong and, and honestly, our orders are accelerating in, in some of the bigger projects and opportunities. I think, you know, as I think about what's drivers for Regal, the trend towards electrification, the opportunity around regulatory, driving performance and energy efficiency, onshoring and automation, these are major drivers. Then, you know, some of the stimulus has helped us.

We, we can't directly pinpoint, but, you know, our mining business has been quite strong. We believe we're getting benefits out of the Infrastructure Investment and Jobs Act. We expect, you know, as, as we move forward, even the CHIPS and Science Act will help the AMC automation and conveying businesses. I think there are some things that should help keep later cycle businesses strong as our early cycles rebound. There's no question, we feel like we're pretty darn close to the bottom in resi and pool, in commercial. We have accelerating markets, as I said before, aerospace, we're just really excited about the growth there, medical, alternative energy.

All of these, hopefully, Nigel, give you a perspective of how we're thinking. We, we do think, 2024 should be a, a pretty solid year for us, and we'll provide more color and guidance on that as we progress into this into the end of this year and the beginning of next.

Nigel Coe (Managing Director)

Yeah, great. Thanks, Louis. That's great perspective. Thank you.

Louis Pinkham (CEO)

Yeah, thank you.

Operator (participant)

Our next question comes from Walter Liptak, from Seaport.

Walter Liptak (Industry Analyst)

Thanks for taking my question. Wanted to ask on the, the working capital. The inventories came down a little bit stronger, and I remember from last quarter, you guys are, you know, you kind of beefed up the, the bonus compensation related to working capital. Is there still more that comes out? Was that, you know, kind of in line with what you were thinking or a little bit better? Any color there?

Rob Rehard (CFO)

Yeah, thanks, Walt. And good to hear from you. You know, we estimate, you know, for 2023 now, somewhere in the range of $200 million-$225 million, specifically from inventory reductions. You know, we saw, as a reminder, about $45 million of that benefit in the 1st quarter. We just saw another $64 million here in the 2nd quarter, so we're largely on track, but even a little a bit ahead of what we originally had expected, to your point there. Now, we also expect, you know, another $100 million-$150 million coming in 2024. If you, if you kind of add all that up, that's about $300 million-$375 million over the next 18-24 months.

You know, obviously, the precise timing's out of our control since it's tied to supply chain normalizing and those sorts of things. Also, you know, some of the challenges that we continue to have in the areas of electronics, to a small degree, and then castings as well. Overall, that's what the picture looks like. We're excited about that, and we see that the ability to use that to continue to pay down our debt is a great benefit from a capital allocation standpoint.

Walter Liptak (Industry Analyst)

Okay, great. All right. Thank you.

Louis Pinkham (CEO)

Thanks, Walt.

Operator (participant)

The next question comes from Jeffrey Hammond of KeyBanc Capital Markets. Go ahead.

Jeffrey Hammond (Managing Director)

Hey, guys. Morning.

Louis Pinkham (CEO)

Hey, Jeff. Morning, Jeff.

Jeffrey Hammond (Managing Director)

Just wanted to dig in a little bit on some of the margin differences. It seems like IPS running a little lower. I don't know if that's mix of Altra doing better and your legacy doing a little worse. You know, PES, really nice step up there and, just, you know, maybe a sense of what, what drove that versus your expectation.

Louis Pinkham (CEO)

Yeah, let, let me take that, Jeff, and this is Louis. I'll start with PES. You know, I couldn't be more pleased with the performance of PES. It really starts with our operations performing very well, and it's really indicative of the strong 80/20 and Lean journey that we've been on. Even when volumes are down, we're executing well. Now, we've had some additional benefits, continue to get price to cover our non-material inflation.

Mix has definitely helped us and, you know, as, as the mix of the business through aftermarket and distribution versus OEM. And we've seen some benefit from new product that we've launched that is a mix positive to that segment overall. I think the business is doing very well and really nicely positioned for when demand does rebound.

A solid performance there. You know, IPS, so that was PES. I, I would tell you, IPS really performed pretty much as we expected. There was a bit of mixed headwind, notably in the short cycle, this stocking that we talked about. As you know, distribution tends to be a positive margin mix for us. We continue to see some pockets of inflation, labor, certain metal alloys, castings for sure. Definitely castings and business supply chain constraints. Overall, though, I'm really pleased with the IPS's performance. We have many levers in the future to pull on to drive margin improvement, synergies, 80/20, and then continued investments in doubling our vitality and launching more margin mixed positive margin products.

Overall, really spot on to our expectations.

Jeffrey Hammond (Managing Director)

Okay, great. Then just the, the, the higher interest expense, I just want to understand. It looks like you paid down quite a bit of debt. I'm, I'm assuming your free cash, which is coming in better, would pay down debt in the second half. Is it just, you know, something with, with the rate dynamic or, or something else?

Rob Rehard (CFO)

Yeah, it's primarily related to the rate dynamic. I mean, You know, we, we did rate it, as I, as I said, you know, about $9 million for the year here, and, I mean, that's the net of both the interest expense and the interest income. It, it's primarily related to the change in the interest in the SOFR curve that's pitched up more steeply. You know, there's a little bit of dust still settling, you know, in terms of getting everything tied down relative to the acquisition, but that, that was fairly small dollar.

It's primarily related to SOFR curve true-up, and if, if we don't continue to see additional increases above and beyond what's built in today, I would expect that to, to come in where we see it, with potential to actually beat it a bit based on some of the cash flow opportunities that we've been talking about.

Jeffrey Hammond (Managing Director)

Okay, just last one. Just on the charges and how they kind of flow through SG&A versus, versus gross margin, I just wanna be able to kinda get back to that kind of 35% adjusted gross margin you talked about.

Rob Rehard (CFO)

Yeah, I, I would recommend on that one, Jeff, may we follow up offline? There's, there's some schedules in the back of the, of the, the workbook or the 8-K that we can certainly talk to, and I think that's the easier way to get through that. It's, it's not as simple as, it's not a simple answer. There's, there are quite a few dynamics in play on that one.

Jeffrey Hammond (Managing Director)

Okay, no worries. Thanks a lot.

Rob Rehard (CFO)

You got it.

Louis Pinkham (CEO)

Thanks, Jeff.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Mr. Louis Pinkham for any closing remarks.

Louis Pinkham (CEO)

Thank you, operator, thanks to our investors and analysts for joining us today. As you heard this morning, there are so many opportunities in front of us to enhance value creation for our key stakeholders. As a scale player in the markets we serve, with differentiated technologies, strong channel positions, ample financial resources, and a great team that continues to execute at a high level, we are excited about pursuing these opportunities with discipline, a sense of urgency, and always in accordance with our Regal Rexnord values. Thank you again for joining us today, thank you for your interest in Regal Rexnord. Have a good day.

Operator (participant)

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.