Regal Rexnord Corp

NYSE:RRX

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, and welcome to the Regal Rexnord Corporation Second Quarter 2023 Earnings Call. [Operator Instructions] 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, Vice President, Investor Relations]

Great. Thank you, operator. Good morning, and welcome to Regal Rexnord's Second Quarter 2020 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 3, 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 4. Let me briefly review the agenda for today's call. Louis will lead off with his opening comments. Rob Rehard will then provide our second quarter financial results in more detail and provide an update to our 2023 guidance. We will then move to Q&A, after which, Louis will have some closing remarks. And with that, I'd like to turn the call over to Louis.

[Louis Pinkham, Chief Executive Officer]

Great. Thanks, Rob, and good morning, everyone. Thanks for joining us to discuss our second quarter earnings to get an update on our business and for your continued interest in Regal Rexnord. The second quarter 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 4-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. Or 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 quarter 2. A business that treated all products and customers equally to one that use customers, products, really all opportunities through an 80/20 lens. I could go on, but in short, a pretty dramatic From-To.

The next steps on our transformation journey will be even more exciting, and I am pleased to share that through our first 3 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 second quarter, which exceeded our expectations. By the way, so did Legacy Regal.

Integration 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 second quarter 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 stack compare of 40%. The organic sales decline is being driven by fully anticipated weakness in our PES segment market 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 stack 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-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 continue to benefit from our 80/20 efforts and the launch of mix positive new products. The second quarter 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 self-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 adviser 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 & Defense and Agriculture to name a few.

The yellow arrows in each picture illustrates the kind 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 businesses 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 5-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 best customer relationships in play. 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 cost 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, and 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 technology 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 second quarter segment financial performance and discuss our latest guidance.

[Rob Rehard, Executive Vice President and 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 second quarter performance but is helping build the higher-performing Regal Rexnord. Now let's review our operating performance by segment.

Starting with Automation and Motion Control, or AMC, organic sales in the second quarter, 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 Control business along with Regal's Aerospace, Data Center and Conveyance businesses are highly valued by our customers and justifies strong gross margins.

Orders in AMC on a pro forma organic basis were down roughly 20% in the second quarter 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 second quarter order decline is against a 2-year stack of 60% and the segment's backlog at the end of second quarter is roughly 55% above our normal level. So 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 second quarter were up 60 basis points from the prior year. Growth in the quarter reflects strength in the Metals & 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 first quarter for IPS was 23.6%, in line with our expectation and reflects benefits from volume and price cost.

I'll remind you, and 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 second quarter 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' second quarter order decline is against a 2-year stack of nearly 50%, and the segment's backlog at the end of second quarter is roughly 65% above our normal level.

Turning to Power Efficiency Solutions or PES. Organic sales in the second quarter 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 third quarter but to a somewhat lesser degree compared to the second quarter 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 expectations. 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 second quarter level. Shifting to orders. Orders in PES for the second quarter 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 2-year stack on second quarter 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 first quarter. 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 are making several adjustments to our guidance for adjusted earnings per share, which is now in a range of $10.20 to $10.60 versus the prior range of $10.20 to $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 will 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 ranges 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% of 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. And with that, I would now like to turn the call back over to the operator so we can take questions. Operator?

[Operator]

[Operator Instructions] Our first question comes from Mike Halloran with Baird.

[Mike Halloran, Baird]

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

[Louis Pinkham, Chief Executive Officer]

Yes. Mike, this is Louis. To answer your question on -- to the answer the second half first and then go over how we're thinking about markets. So 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. So how are we thinking about it from a market perspective? A little bit slower pace of recovery in the second half, specifically around resi, HVAC, pool and general commercial.

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 is Alternative Energy, but it tends to be a little lumpy, and we're forecasting strength in the second half in Alternative Energy. And 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 steels growth because, as you know, we have strong relationships with our distributors. And so we share openly filled out as well as orders. And in the sales out from our distributors are still quite strong. There was a little bit of -- and we expect going into Q3, continued inventory management, so orders down.

But overall, I feel good about the demand profile in that industrial distribution space. So hopefully, that gives you a view of how we're thinking about our markets, how we're positioned. Again, Mike, I'd tell you, not one of our markets make up more than 20% of our sales. And we like that distribution of early, mid and late cycle exposure.

[Mike Halloran, Baird]

No, that's very helpful. And if you think about that down mid-single digit 3Q transition to plus mid-single-digit orders in the fourth quarter, is this just destocking normalizing and then seeing relatively normal sequential trends with 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 fourth quarter on a sequential basis, just from an underlying demand perspective?

[Louis Pinkham, Chief Executive Officer]

No, I think that's pretty spot on. 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. And as I said before, we're really not expecting any strong recovery in China either, slight in fourth quarter, but we expect it to be pretty muted for the year. So overall, the way you summarized it is spot on.

[Mike Halloran, Baird]

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

[Louis Pinkham, Chief Executive Officer]

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. We rounded out our offering with – in particular, with the clutch and brake and then strengthened our position in gearing geared motors with the Bauer brand, a great global brand and our coupling business. And so I’m excited there.

What I didn’t expect to be as excited about so quickly is how we’re going to be able to leverage the strength of the total Regal Rexnord with the traditional A&S business, so our AMC business. Our Aerospace business today is $350 million of Regal and its early cycle of growth. And 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. So we’re – we – 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.

[Operator]

Our next question comes from Julian Mitchell with Barclays.

[Julian Mitchell, Barclays]

Maybe trying to keep my questions a little concise, if possible. The first one, really, the second half guidance sales of sort of $3.5 billion and $5.60-ish of EPS. Any cadence you're calling out to us between sort of third and fourth quarter as we think about sales and margins?

[Rob Rehard, Executive Vice President and CFO]

Sure, Julian. This is Rob. Let me give you a sense of what we think that looks like in the third quarter. And I'll go ahead and move through this -- through the segments to give you the best color possible. For the PES segment, in the third quarter, we would expect revenues in the range of $465 million to $485 million with margins in the high teens, so margins similar to the second quarter.

On the revenue side, we do -- as I pointed out the number, you'll see that's a slight improvement versus the second quarter, based on better seasonality, less destocking and better mix. As you move to Industrial, we see Industrial at about $130 million to $145 million. So very similar to the second quarter and the margins there, low double digit.

Moving to AMC. Relatively -- relative to the second quarter, relatively flat from the top line, maybe revenues in the range of $445 million to $455 million. Now when I say relatively flat, you have to remember, there is an impact of the stub period in the second quarter that's obviously not repeated in the third. And when you think about that, it's fairly flat quarter-to-quarter. And that applies to both, AMC and IPS. But again back to AMC, margins in the mid-20s, so very similar to the second quarter. Synergy is driving a piece of that, although volumes down a bit.

Moving to IPS. Margin is about $655 million to $670 million. So -- and by the way, the margins on that low to mid-20s, top line down a bit because of the agricultural destock. Again, you don't have that stub period impact in the third quarter and short-cycle industrial continues to be a headwind there. So overall, in the third quarter, that's about $1.695 billion to $1.755 billion as a range on the top line with margins in the low 20s. So that's the way we're thinking about it in the third quarter.

And then, of course, the implied is that the fourth quarter absolutely would be stronger than the third. And so the next logical question might be: What gives us that confidence that the fourth can be up? And I'll answer that by saying that we do have elevated backlogs in most of our businesses 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 that we're holding backlog as we're kind of now a month into the third quarter.

Our supply chain continues to normalize, and that gives us some rising confidence that we can deliver that backlog. And then we do have better visibility, good visibility into some of our more lumpy project orders, things like -- that we talk about like Data Center and Renewables in that. And then finally, the PES destock, we believe, will be behind us in the third quarter, and we'll see some slight improvement in demand in the fourth. So that's the cadence of what we're seeing from Q3 to Q4 and the Q3 detail.

[Julian Mitchell, Barclays]

That's very helpful. And then just a 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? And 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?

[Louis Pinkham, Chief Executive Officer]

Yes. Julian, this is Louis. We do expect to be through by the start of Q4. Yes, we’re still working through really resi, HVAC, pool. Pool, of course, is a small part of Regal, but it has had a pretty significant destock. And so it has had an impact in Q2 and expecting continuing into Q3 and then back – getting to normal in Q4. And then Industrial distribution, there’s no question that there’s some balancing of inventory levels. And 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. But again, we expect that to clear up by the end of Q3.

[Operator]

The next question comes from Christopher Glynn of Oppenheimer.

[Christopher Glynn, Oppenheimer]

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

[Louis Pinkham, Chief Executive Officer]

Chris, nothing more than we've already commented on. 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 have been a little surprised by that. But our forward look doesn't have much of any forecast improvement there. Beyond that, everything really played to our expectations. So nothing more than that.

[Christopher Glynn, Oppenheimer]

Okay. And then any update on the industrial process?

[Louis Pinkham, Chief Executive Officer]

Yes. So we’ve made a lot of good progress, and we believe we’ll be in a position to share more in the next couple of months.

[Operator]

[Operator Instructions] Our next question comes from Nigel Coe of Wolfe Research.

[Nigel Coe, Wolfe Research]

Good details here, so not too much from my side. Just on that 3Q and back off color, Rob. Maybe can you just remind us the cadence of the cost synergies from -- obviously from Altra, but also from the PMC transaction. What should we be expecting for 3Q and 4Q? And then just a final point on IPS, you said low to mid-20s. So would that be sort of flattish with what we saw in 2Q?

[Rob Rehard, Executive Vice President and CFO]

Similar to Q2, yes. And then let me give you the detail on the synergies. We saw about $14 million of incremental synergies in the second quarter, which includes both, PMC and Altra. If you break that down, you think PMC is about $10 million to $11 million, and then about $3 million to $4 million for Altra. So that's how you get that $14 million. So 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 '23 with the next.

So that means you get an exit rate there from Altra about $40 million annually. So the total P&L impact in '23 is about $65 million. You can count on the synergies coming through and increasing each quarter. We might expect that next quarter, we might see something closer to $2 million or $3 million maybe above what we saw in the second quarter and then improving to that exit rate that I commented on in the fourth.

[Nigel Coe, Wolfe Research]

Okay. And then this depreciation pinch you highlighted, is the accounting now pretty much settled down now? You wouldn't expect them to be too many changes from here on?

[Rob Rehard, Executive Vice President and 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 going to be anything material and something that I would expect us to absorb. So yes, the accounting is largely behind us at this time.

[Nigel Coe, Wolfe Research]

Okay. Great. And then my follow-on is, Louis, you've obviously seen a few cycles that we all have. But from your perch, when [indiscernible] 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 and therefore, this is then cascade into some of the longer cycle businesses. So based on your experience, are you seeing something different this time that maybe suggests that perhaps non-res, Energy, et cetera, can remain strong for longer?

[Louis Pinkham, Chief Executive Officer]

Yes. It’s obviously a great question, Nigel. It’s something that we are thinking a lot about as we are moving right now into our strategic planning period and getting prepared for our thoughts on next year. For now, things look pretty good in the longer cycle businesses. Our backlogs are strong, and honestly, our orders are accelerating in some of the bigger projects and opportunities. I think – as I think about what drivers for Regal, the trend towards electrification, the opportunity around regulatory driving performance and energy efficiency, onshoring and automation. These are major drivers. And then some of the stimulus has helped us. We can’t directly pinpoint, but our mining business has been quite strong, and we believe we’re getting benefits out of the Infrastructure Investment and Jobs Act.

And the – we expect as we move forward, even the Science and CHIPS Act will help the AMC Automation and Conveyance businesses. So I think there are some things that should help keep later cycle businesses strong as our early cycles rebound and there’s no question, we feel like we’re pretty darn close to the bottom in resi and pool and commercial.

And then we have accelerating markets, as I said before, Aerospace, we’re just really excited about the growth there, Medical, Alternative Energy. So all of these, hopefully, Nigel give you a perspective of how we’re thinking. We do think ‘24 should be 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.

[Operator]

Our next question comes from Walter Liptak from Seaport.

[Walter Liptak, Seaport]

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

[Rob Rehard, Executive Vice President and CFO]

Yes. Thanks, Walt, and good to hear from you. We estimate for ‘23 now, somewhere in the range of $200 million to $225 million, specifically from inventory reductions. We saw, as a reminder, about $45 million of that benefit in the first quarter. We just saw another $64 million here in the second quarter. So we’re largely on track, but even a little bit ahead of what we originally had expected to your point there.

Now we also expect another $100 million to $150 million coming in 2024. So if you kind of add all that up, that’s about $300 million to $375 million over the next 18 to 24 months. Obviously, the precise timing is out of our control since it’s tied to supply chain normalizing and those sorts of things. But – and also some of the challenges that we continue to have in the areas of electronics to a small degree and then castings as well.

But overall, that’s what the picture looks like. So 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.

[Operator]

The next question comes from Jeff Hammond of KeyBanc Capital Markets.

[Jeff Hammond, KeyBanc Capital Markets]

So just want to dig in a little bit on some of the margin differentials. 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. And then PES, really nice step up there and just maybe a sense of what drove that versus your expectation?

[Louis Pinkham, Chief Executive Officer]

Yes. Let me take that, Jeff, and this is Louis. I'll start with PES. I couldn't be more pleased with the performance of PES. It really starts with our operations performing very well in Israel. Really indicative of the strong 80/20 and lean journey that we've been on. So even when volumes are down, we're executing well. Now we've had some additional benefits continue to get priced to cover our nonmaterial inflation. Mix has definitely helped us as the mix of the business through aftermarket and distribution versus OEM. And we've seen some benefit from new products 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. So a solid performance there. IPS -- so that was PES. I would tell you, IPS really performed pretty much as we expected. There was a bit of mix headwind, notably in the short cycle destocking that we talked about. And as you know, distribution tends to be a positive margin mix for us. We continue to see some pockets of inflation, labors, certain metal alloys, castings for sure, definitely casting and been a supply chain constraint. Overall, though, I'm really pleased with IPS' performance. We have many levers in the future to pull on to drive margin improvement, our synergies, 80/20 and then continued investment in doubling our vitality and launching more margin -- mix positive margin product. So overall, really spot on to our expectations.

[Jeff Hammond, KeyBanc Capital Markets]

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

[Rob Rehard, Executive Vice President and CFO]

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

So it's primarily related to SOFR curve, true-up. And if we don't continue to see additional increases above and beyond what's built in today, I would expect that 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.

[Jeff Hammond, KeyBanc Capital Markets]

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

[Rob Rehard, Executive Vice President and CFO]

Yes. I would recommend on that one, Jeff, may we follow up offline. There are some schedules in the back of 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 not as simple as – it’s not a simple answer. There are quite a few dynamics in play on that one.

[Operator]

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, Chief Executive Officer]

Thank you, operator. And 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, and thank you for your interest in Regal Rexnord. Have a good day.

[Operator]

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