Adient plc (ADNT) Q3 2021 Earnings Report, Transcript and Summary

Welcome, and thank you all for standing by. [Operator Instructions] Today's call is also being recorded. If anyone does have any objections, you may disconnect at this time. And I would now like to turn the call over to Mr. Mark Oswald. Thank you. You may begin.

Thank you, Sue. Good morning, and thank you for joining us as we review Adient's results for the third quarter of fiscal year 2021. The press release and presentation slides for our call today have been posted to the Investors section of our website at adient.com. This morning, I'm joined by Doug Del Grosso, Adient's President and Chief Executive Officer; Jeff Stafeil, our Executive Vice President and Chief Financial Officer; and Jerome Dorlack, Executive Vice President, Head of Americas Seating. On today's call, Doug will provide an update on the business followed by Jeff, who will review our Q3 financial results and outlook for the remainder of the fiscal year. After our prepared remarks, we will open the call to your questions. Before I turn the call over to Doug and Jeff, there are a few items I'd like to discuss. First, today's conference call will include forward-looking statements. These statements are based on the environment as we see it today, and therefore, involve risks and uncertainties. I would caution you that our actual results could differ materially from these forward-looking statements made on the call. Please refer to Slide 2 of the presentation for our complete safe harbor statement. In addition to the financial results presented on a GAAP basis, we will be discussing non-GAAP information that we believe is useful in evaluating the company's operating performance. Reconciliations for these non-GAAP measures to the closest GAAP equivalent can be found in the appendix of our full earnings release. This concludes my comments. I'll now turn the call over to Doug. Doug?

Great. Thanks, Mark. Good morning. Thank you to our investors, prospective investors and analysts joining the call this morning as we review our third quarter results for fiscal 2021. Turning to Slide 4. Let me begin with a few comments related to our third quarter. As we anticipated heading into the quarter, the ongoing supply chain disruptions related to semiconductors and the resulting customer production stoppages, combined with escalating commodity prices, provided a difficult operating landscape for the industry and Adient. I'll dig deeper to those macro pressures in just a minute. Despite the many challenges, the Adient team remained focused and successfully executed items within our control, while at the same time took proactive actions to lessen the impact of the production stoppages and lost sales. Starting on the left-hand side of the slide. Adient's revenue for the quarter was $3.2 billion, up significantly from the $1.6 billion reported in Q3 fiscal '20. Last year's results, as you're aware, were significantly impacted by vehicle production shutdowns across Europe and Americas due to COVID-19. Although revenue increased year-over-year, this year's top line was also impacted by significant headwinds, specifically the numerous production stoppages at our customers due to semiconductor supply disruptions. Adjusted EBITDA for the quarter totaled $118 million. And as pointed out on the slide, this included just over $50 million in premiums and temporary operating inefficiencies, again, primarily driven by chip shortages and unplanned production stoppages. Adient's June 30 cash balance totaled $1 billion. I'll point out that the cash balance does not include about $270 million held in other assets as a deposit related to certain assets Adient is acquiring from the YFAS joint venture as part of our China strategic transformation. In addition, about $190 million of cash was used during the quarter to repay a portion of the company's debt. Finally, speaking of debt, Adient's gross and net debt totaled just over $3.7 billion and $2.7 billion, respectively. Approximately $180 million of principal debt prepayment occurred during Q3. Jeff will provide additional color on Adient's financial results, including our capital structure in just a few minutes. Achieving the results just discussed was hard-fought, especially considering the near-perfect storm of temporary headwinds that impacted the industry and Adient. These included supply chain disruptions and unplanned production stoppages, increased freight costs, significant increases in commodity prices and continued costs associated with COVID-19, just to name a few. Rather than dwell on the negatives, the team looked ahead and began to implement actions to help lessen the impact. On the right-hand side of the slide, we've highlighted certain of those proactive measures. Actions taken included: pulling ahead preventive maintenance, reallocating our resources between plants, implementing involuntary/voluntary layoffs at our plants in the U.S. and Canada, forced vacations for impacted salaried team members and keeping very tight controls on discretionary spending, including travel, which is essentially limited to launch activities and hiring. The list shown is not exhaustive, but should provide you an idea of how the company continues to drive the business forward, essentially executing on actions that are within our control. Turning to Slide 5. Let me shift gears slightly and spend a few minutes discussing the current operating environment as the factors shown on the slide are really dominating and influencing the business near term as evidenced in our Q3 results. First, despite the many negative headlines, there are a number of positive influence impacting the industry, including: consumer demand, which remains extremely strong; vehicle inventories, which are at near or historic levels and will continue to drive strong production for several quarters as manufacturers look to rebuild inventory; vehicle mix, which remains strong as manufacturers continue to protect reduction of their most profitable trucks and SUVs; and finally, COVID treatments and vaccines are generally driving the reopening of many economies. We continue to watch closely as certain variants such as the Delta variant could result in disruptions along the way. That said, and focusing on the headwinds column, there are a number of headwinds, which we view as temporary that are masking or limiting the full benefit of the positive influence just discussed. They include ongoing supply chain semiconductor shortages, which continue to result in production downtime at our customers. As seen with our Q2 and Q3 results, these unplanned production stoppages are leading to premiums and operating inefficiencies across our network. That said, for fiscal 2021, we estimate the supply chain disruptions and the resulting lost production, operating efficiencies, premium freight, et cetera, will have a net impact on the top line of about $1.1 billion and adjusted EBITDA by approximately $300 million. I wish I could tell you this will be limited to 2021, unfortunately, as shown in our call-out box on the far right, the visibility of our customers' production schedules has not improved in the course of the past few months. Discussions and commentary from our customers suggest improving supplies of chips and production schedules in the coming weeks and months. Unfortunately, we continue to experience very short notice of production downtime, and it's likely this trend will continue through the rest of our fiscal year and even into 2022. Also having a significant impact on the business, as mentioned in our Q2 earnings call, continues to be escalating steel and chemical prices. As noted on the slide, steel prices in the Americas are up approximately 3x versus the beginning of the year. And although Adient has certain mechanisms and pass-through agreements with our customer, they were never intended to cover movements of this magnitude for this long of duration. For 2021, we estimate the net impact to be about $80 million, consistent with what we shared in our Q2 call. Although these items appear to be temporary in nature and should lessen over time, they are placing a significant amount of strain on the near-term business. The question remains, when will these pressures subside? Our best guess is the supply chain disruption and increased commodity costs will likely persist as we enter 2022. Jeff will dig deeper into the impact the rising commodity prices is having on Adient in his prepared remarks. Turning to Slide 6. Shifting back to the theme of executing actions within our control, let me provide a few comments related to Adient's long-term objectives. First, we are on track with our strategic transformation in China. This includes, among other agreements, the termination of the YFAS joint venture and the acquisition of an additional 50% equity interest in CQYFAS, resulting in us owning 75% interest in CQ and 100% equity interest in the YFAS Langfang. I hope to share news of the completion of the agreements in the not-so-distant future. As a reminder, Adient is expecting cash proceeds of about $1.4 billion after tax with the first tranche of proceeds collected at the closing and the remaining proceeds collected prior to the 2021 calendar year-end. The completed transaction will enable Adient to drive our strategy in China independently, which is expected to result in a variety of benefits, including capturing growth in profitable and expanding segments, improving the integration of the company's China operations and allowing for more certain value realization relative to the status quo, where cash and value are generated from dividends at entities not in Adient's control. As mentioned in March, we expect to remain a leader in the China market, essentially a position on par with and among the top 3 seat suppliers in the market. Based on our estimates, this equates to a market share of just under 20%. Equally exciting and in part enabled by the China transformation is the work underway to transform Adient's capital structure. As mentioned earlier, during Q3, we paid down the final $160 million in principal of the company's 7% first lien notes. In total, so far in fiscal '21, the company has prepaid approximately $840 million in debt. When combining the 7% note paydown and the prepayments made to the European Investment Bank loan, I'd also remind you the company made $100 million of voluntary debt prepayment at the end of fiscal 2020, bringing our total voluntary debt paydown to $940 million since the beginning of the capital structure transformation in Q4 fiscal year '20. Adient's capital structure has a lot of flexibility and callability remaining. We expect to continue our deleveraging efforts on completion of the China transaction and collection of the related proceeds. Whether it's the longer-term strategies just discussed or the day-to-day initiatives, such as improving our plant operation and flawlessly executing on launches, Adient is executing actions within our control despite the macro headwinds that are temporarily impacting the industry. The continued push to improve the business has had a positive impact on our relationships with customers as well. We've seen Adient's customers recognize value-added product and process initiatives. At the bottom of the slide, we've included a few awards Adient recently received, including: Stellantis' Best Supplier Competitiveness award, Toyota's Superior Supplier Diversity award, GM's Excellence in On-Time Shipping award, and finally, the Outstanding Quality Launch Performance award from Nissan. I mention this recognition only to provide proof points that the team continues to execute on many fronts, continually looking for ways to drive the business forward. Turning to Slide 7. Let me provide a few comments on Adient's business wins and how we're strengthening our leading market position. What hopefully has been clear as we reported our key wins over the last several quarters is the fact that Adient continues to focus on capital allocation, return on capital when targeting new or incumbent business wins and has not limited our ability to secure new business. Our year-to-date win rate for both targeted new business and targeted incumbent business is tracking in line with our expectations. We've highlighted a number of recent program wins here, including a number of key replacement wins this past quarter, including: Toyota Tacoma, Mercedes A-Class, Mercedes GLA and the Nissan Patrol. In addition to these replacement wins, Adient also secured new SUV program with XPeng in China and the new EV CUV platform at Honda. It should be noted that our recent wins, awards include a good mix, a combination of JIT, foam, trim and metals business. As our new book of business continues to launch, we expect to balance in and balance out platforms to further enable margin expansion. Turning to Slide 8. As we typically do, we've highlighted several critical launches that are complete, in process or scheduled to begin in the near term. I'm happy to report we're heading into the final few months of the fiscal year, and the team continues to focus on process discipline around launch readiness and has driven a very high level of performance, especially considering the launch load and the complexity of launches that were planned for this year. In addition to the number of launches and complexity, the disruption to production schedules presented another layer of challenges that the team successfully managed through though. Again, a testament to the discipline around our processes. We have no intention of letting up and look forward to finishing the year strong with the launches that are in process and scheduled to begin entering fiscal 2022. Before turning the call over to Jeff, flipping to Slide 9, let me just conclude my remarks with a few comments about Adient's guiding principles. These principles are intended to drive Adient forward while focusing on what's most important. The key drivers, customer, quality, people, community and financial discipline, guide and inform our business strategy and our culture. As pointed out today, remaining focused on these drivers enable the team to drive the business forward even while operating in a challenging environment we're currently facing. I'm proud of what we've accomplished and excited about what lies ahead. And with that, I'll turn the call over to Jeff to take us through Adient's third quarter 2021 financial performance and provide a little bit more color on what's expected as we wrap up 2021.

Thanks, Doug. Good morning, everyone. Before jumping into the financial results, which, to a certain extent, provides less insight into the ongoing operations given the abnormal operating environments in both Q3 of last year and this year, let me spend a few minutes discussing commodity inflation. Specifically, what we're seeing today, how it's impacting the business and steps the company is taking to lessen the impact, especially as it relates to the out-years. First, on Slide 11, we've provided a chart illustrating price movements and expected price movements for hot-rolled steel in North America. As you can see, despite repeating forecasts that prices will fall, prices have continued to increase while forecast for price decreases continue to be pushed out. For Adient, this has resulted in more than a 3x increase in the cost over the last 12 months for steel. Assuming prices remain constant, the impact on our cost for steel and chemicals would be approximately $650 million higher or more in 2022 than prices paid in 2020. The $650 million is based on current market conditions, such as hot-rolled steel prices in excess of $1,800 a ton. If the current market conditions hold and we do nothing commercially to pass through this increase to our customers beyond our current commercial agreements, net commodity price headwind for fiscal '22 would be approximately $200 million versus 2021. However, as you would expect, we're taking aggressive actions to mitigate the impact, which I'll discuss further on Slide 12. And for that reason, it's premature for us to know how much of this headwind will be realized in 2022. We've spoken at length on prior calls with regard to Adient's recovery mechanisms that are in place to recover material cost changes. As a reminder, our pass-through agreements differ by customers in 2 key attributes, lag and percentage of contractual recovery. For lag, certain customers are nearly immediate. Others, such as our Japanese-headquartered customers, tend to be trued up on an annual basis or essentially a 5-quarter lag. This results in an average lag for Adient of a little more than 2 quarters. For the contractual piece, some customers have 100% pass-through with lag, while others might have only a 60% contractual pass-through. These pass-throughs have generally been effective despite the lag in protecting the company over the cycle as commodity prices have fluctuated. The mechanisms tend to work best against minor, short duration price movements. They are not designed for the extreme increases impacting the business today. Turning to Slide 12. On the left-hand side of the slide, we've provided an illustrative example of how movements in commodity prices impact Adient's financial results. In general, as you would expect, Adient's financial results are negatively impacted as prices rise, but positively impacted as prices decline. Important to point out, prices through the cycle have generally reverted to the mean. As material cost goes up, the revenue change, a true-up from the customer, will lag, resulting in reduced EBITDA. Only when the cost goes down and when revenue change again lags will we recover the lost profits and vice versa. Adient generally recaptures approximately 70% of commodity inflation through automatic mechanisms, while the remaining 30% must be negotiated through hard-fought, roll up the sleeves type negotiations. You'll also see on the chart, we have included a pair of dotted lines, which we view as normal movements in commodity prices over a cycle, call it, somewhere around 15%, plus or minus. As discussed in the prior slide, Adient's mechanisms in place today, combined with manual commercial negotiations, have enabled the company to recapture nearly all cost increases over time in this environment. Unfortunately, this is not the environment we're in today and is the reason the company is executing aggressive actions in an attempt to mitigate the impact of rising commodity cost. These include, but are not limited to, renegotiating commercial agreements with our customers to reduce time lags associated with true-ups and ideally eliminating Adient's portion of the pain share agreements, recognizing Adient's position as a value-add supplier. And finally, making sure the underlying indices that underpin the true-ups are actually aligned with the commodities being purchased. For example, we currently have an agreement in place with one customer where the true-up is based on a scrap steel index, which is not reflective of the steel being purchased. As you might expect, the discussions are not one-size-fits-all. We're tailoring the discussions based on the size of the exposure, relationship with the customer, et cetera. Given Adient's timing of commodity purchases and continued escalation in steel prices and to a lesser extent, chemical prices, it appears commodity prices will remain a headwind entering 2022. That's why it's imperative we move quickly to address this headwind. That said, the outcomes of these ongoing discussions will ultimately determine the magnitude of the headwind next year and that's why it's premature for us to dimension the risk at this time. Speaking of 2022, the team is in process of developing our fiscal '22 plan. We've discussed one of the big unknowns, commodities. The other driver will be vehicle production. As Doug mentioned earlier, our visibility into our customer production schedule is currently quite low. We hope as we exit fiscal 2021 and enter fiscal '22 visibility improves, especially as it relates to the semiconductor supply chain. I anticipate sharing our 2022 planning assumptions with you as we typically do during our Q4 financial results conference call in early November. Now let's move to Slide 14 and shift gears to Adient's Q3 financial results. Adhering to our typical format, the page is formatted with the reported results in the left and our adjusted results on the right-hand side of the page. We will focus our commentary on the adjusted results, which exclude special items that we view as either onetime in nature or otherwise skew important trends in underlying performance. For the quarter, the biggest drivers of the difference between our reported and adjusted results relate to indirect tax recoveries in Brazil, write-off of deferred financing charges resulting from debt repayment, transaction costs, restructuring costs and purchase accounting amortization. One other significant adjustment important to note relates to a derivative loss on the Yanfeng transaction. As a reminder, the proceeds associated with the China strategic transformation were negotiated in RMB. Adient executed a hedge to protect our cash proceeds, movements between the USD and CNY resulted in a noncash loss. Details of these adjustments are in the appendix of the presentation. For the quarter, sales were $3.2 billion, up significantly compared to our third quarter results last year, where much of our production across Europe and America was shut down due to COVID. Although up year-over-year, Adient's sales in the most recent quarter were significantly impacted by lost production, primarily driven by supply chain disruptions related to semiconductors. Adjusted EBITDA for the quarter was $118 million, up $240 million year-on-year, more than explained by an increase in volume and mix. Unfortunately, the benefits from increased volume were significantly offset by numerous temporary operating inefficiencies, which, by the way, masked business performance improvements made to the core ongoing operations. For example, of the approximate $600 million in lost sales in our Americas operation, we received notification of the reduction less than 3 days in advance, while we received more than 7 days notice in less than 20% of the time. This is obviously a difficult environment to run a JIT operation. In addition, rising commodity costs and lower equity income also had a negative impact in the quarter. I'll expand on these key drivers in just a minute. Finally, at the bottom line, Adient reported a net loss of $50 million or a loss of $0.53 per share. Now let's break down our third quarter results in more detail, starting with revenue on Slide 15. We reported consolidated sales of $3.2 billion, an increase of $1.6 billion compared to the same period a year ago. The primary driver of the year-over-year increase was attributed to higher volume and mix, call it, $1.5 billion, and to a much lesser extent, the positive impact of currency movements between the 2 periods of about $68 million. Portfolio adjustments executed in fiscal '20 provided a very minor offset to the benefits of volume and FX, call it, about $16 million. Focusing on the table on the right-hand side of the slide, you can see our consolidated sales failed to keep up with production in both the Americas and EMEA. The primary driver was Adient's customer mix, which was heavily weighted to manufacturers that were significantly impacted by the semiconductor shortages. These customers included Ford, Daimler, Stellantis, Renault and VW. Looking at the various third-party production forecast, it's estimated Adient's portion of the lost Q3 production volume was about 30% and 45% in the Americas and EMEA, respectively. Of course, we view this as temporary and should reverse as the supply chain stabilizes. With regard to Adient's unconsolidated seating revenue, year-over-year results were up approximately 4%, adjusting for FX and executed portfolio changes. Significant year-over-year increases were recorded in both Americas and EMEA, again, largely driven by the fact that these operations were all but shuttered in Q3 of last year. In China, unconsolidated sales were relatively in line with industry production despite an approximate 7% decline at YFAS. Similar to what we saw with our consolidated results, sales at YFAS were heavily impacted by supply chain disruptions at their customers. Moving to Slide 16. We've provided a bridge of adjusted EBITDA to show the performance of our segments between periods. The bucket labeled corporate represents central costs that are not allocated back to the operation, such as executive office, communications, corporate finance, legal and marketing. Big picture, adjusted EBITDA was $118 million in the current quarter versus a loss of $122 million last year. The primary driver of the increase is detailed on the page, but effectively compares 2 very suboptimal quarters. Last year was obviously overwhelmed by COVID-related shutdowns, while this quarter was materially impacted by external factors outside of Adient's control, such as the semiconductor shortage and the storm in Texas earlier this year and its related fallout impact to the chemical supply and cost to name just a couple of the factors. Therefore, I do not plan to go into in-depth discussion on this page, but we've outlined the movements year-over-year in detail for your information. And that said and to give comfort or some proof points on Adient's turnaround in the last couple of years, let me give some statistics comparing Q3 '21 to Q3 2019 or the last Q3 period without significant externally generated shock to our business. Compared to that 2019 Q3, our admin expense was approximately $20 million lower this past quarter, while launch expense, ops waste and premium freight were also better by $30 million. We also realized approximately $70 million of improvements in other operating metrics, but these were unfortunately more than offset by approximately $125 million due to lower volume, $30 million in net commodities, $15 million in FX, $30 million in inefficiencies from chemical and semiconductor supply chain issues, among others. Clearly, the operating environment has been challenging and masked many of these performance improvements. One area worth mentioning in the Q3 2021 versus Q3 2020 comparison is the decline in equity income of roughly $24 million. The year-over-year decline was primarily related to performance and material economics at YFAS and to a lesser extent, the divestiture of our SJA joint venture. In the end, given all the moving pieces, the team worked hard to lessen the impact of the temporary headwinds to deliver the $244 million year-over-year improvement. To ensure enough time is allocated to the Q&A portion of the call, we've provided our detailed segment performance slides in the appendix of the presentation. High level, improved volume and mix benefited each of the regions. Ongoing business performance continued to trend in a positive direction, however, in Americas and EMEA, temporary operating inefficiencies resulting from unplanned production stoppages masked the overall improvement. Let me now shift to our cash, liquidity and capital structure on Slide 17 and 18. Starting with cash on Slide 17, I'll focus on year-to-date results as the longer time frame helps smooth some of the volatility in working capital movements. Adjusted free cash flow, defined as operating cash flow less CapEx, was $176 million. The $445 million improvement in adjusted EBITDA, net of equity, $72 million reduction in cap spending and significant improvement in trade working capital was partially offset by an expected increase in restructuring of $57 million, increase in interest paid of $36 million, elevated non-income-related taxes, specifically VAT payments and the timing of commercial activity. With regard to VAT payments, while some of the year-to-date outflow will continue to reverse as we progress through Q4, we'd expect larger-than-normal outflows in fiscal '21 related to government approved delays out of fiscal 2020 due to COVID accommodations. As noted on the right-hand side of the page, we ended the quarter with more than $1.8 billion in total liquidity comprised of cash on hand of about $1 billion and approximately $850 million of undrawn capacity under Adient's revolving line of credit. Also noted in the call-out, the June 30 cash balance excludes approximately $270 million held as other assets related to funds on deposit to acquire certain assets of YFAS. Cash used during the quarter to voluntarily pay down debt totaled about $190 million, which includes both principal and premium paid. Speaking of debt and flipping to Slide 18. In addition to showing our debt and net debt positions, which totaled just over $3.7 billion and $2.7 billion, respectively, at June 30, we've also provided a snapshot of Adient's capital structure. As you can see, the 7% first lien notes were entirely repaid at quarter end as the final $160 million in principal was paid during the quarter. In addition, $20 million of principal of the European Investment Bank loan was also repaid in Q3. It's clear the transformation of Adient's balance sheet is well underway with approximately $940 million of debt prepayment complete going back to Q4 of fiscal '20. The good news is, we're not done. Additional voluntary paydown of debt is expected as we progress through calendar 2021 with proceeds expected to be received from Adient's China transformation. With that, let's flip to Slide 19 and review our outlook for the remainder of fiscal '21. Adient's fiscal 2021 guidance has been updated to reflect the company's year-to-date results through June, our completed portfolio transactions, executed debt paydown and the current market conditions. Expectations for consolidated sales have been reduced to between $14.3 billion and $14.5 billion. The significant impact of production stoppages at our customers resulting from semiconductor shortages is driving the decline. The impact of lower-than-expected sales, combined with temporary operating inefficiencies driven by continued unplanned production stoppages, elevated commodity costs and increased freight, is expected to place downward pressure on Adient's adjusted EBITDA. Our current forecast is between $925 million and $975 million. Moving on to equity income, which is included in our adjusted EBITDA, continues to be forecast at about $230 million for the year. Interest expense, based on our debt and cash position, is expected to be $215 million, which is consistent to earlier expectations. Cash taxes in fiscal '21 have been revised down modestly, call it, about $80 million. To assist with your modeling, although volatile with fluctuations between quarters and as mentioned earlier, we continue to expect Adient's effective tax rate to be in the mid-20% range. Based on our customer launch plans, we expect capital expenditures to total about $310 million for the year. And finally, one last item for your modeling. We now expect free cash flow to be approximately $100 million in fiscal '21, which is in line with our previous range of between $50 million and $150 million. The team has worked hard to offset the top line and EBITDA pressures. In addition, our cash restructuring, which was previously forecasted at $200 million for the year, has now been reduced to about $150 million. The total remains elevated compared to our typical spend of around $100 million or less. In addition to an elevated restructuring spend, the 2021 free cash flow is negatively impacted by approximately $30 million of VAT payments that were deferred from last year into 2021. Stripping out these one-offs, Adient's free cash flow guide would have been approximately $180 million. With that, let's move to the question-and-answer portion of the call. Operator, first question, please.

[Operator Instructions] Our first question is from Rod Lache with Wolfe Research.

A couple of things. One is, I was just hoping you can clarify the $200 million commodity headwind that you described for next year, that's just 30% of the $650 million, I believe. Just to confirm, is that relative to 2021 or is that relative to 2020 because you are absorbing about $80 million this year? And then secondly, can you just discuss the nature of the inefficiencies? You mentioned on one slide, $300 million for the year, which I think included some revenue impact. And separately, you talked about $53 million for the quarter, which may not have included anything. I'm not sure if that's apples-and-apples. But basically, should we view the $300 million impact is a likely tailwind at some point once production normalizes?

Yes, Rod, I'll start on those. The first question as it relates to the material inflation and the net impact, that $200 million was compared to 2021. And you're right, 2021 had $80 million in it. It doesn't exactly, I think the computation was about that 30%. It's sort of a mix of the lag we have and then the timing of the recoveries. So that would be if we just ran through with the mechanical agreements as they stand today. As I mentioned, we're working, just with the size of the increases, those mechanisms don't make sense for a supplier like ourselves that essentially is putting value add to materials. So we're working with our teams and our customers to help improve that, but that's where it would fall out if no actions were put forward, about $200 million in 2022 versus 2021. As it relates to the second part of your question on the $300 million, about $200 million of it relates to volume. And you can say the rest, there's the chemical supply chain issues were a bit over 40-ish. There's some container and freight type of issues, which were north of $25 million. There are still some COVID-related issues that were sort of the balance there to get you up to the $300 million.

Okay. And what is a reasonable kind of aspirational target for recovery of commodities? And if you could just maybe help us a little bit with bridging beyond 2022. I mean, you'll do $950 million of EBITDA this year. You'll lose about maybe $200 million or so from the China equity income sale, but you're going to recover at least this $100 million of inefficiency and I presume this $80 million of commodities. And then in your last 10-Q, there was some disclosure about 5,000 remaining headcount reduction, which might be $300 million. So just kind of high level, what are you sort of aspiring towards as far as margin recovery as we think beyond this? I know you've got the longer-term mid-8% margin, but as we think about maybe 2023.

Yes. No. All good questions, Rod, and we're in the process of putting a lot of that together, but I'll give you a few crumbs here and we'll obviously work to expand. But right now, I guess I'd start with volume running at $14.3 billion to $14.5 billion or so in volume this year. We think that's a depressed level. And timing of chip production coming back is a bit uncertain here, we expect it probably hits at least our first quarter of 2022 still in some fashion, if not further. But we would expect volume to improve. We certainly would expect a lot of those inefficiencies to improve, if not fully go away. We'll continue to chip away at the material inflation issues. We'd also get a big benefit if we start to see some reductions in material prices. I highlight the steel forecast, everyone you look at continues to show that the next month or next couple of months, it's going to start to go down. It just hasn't done that yet, and that's created some of the challenges for us. We continue to drive the things that are internally within our control. I see nice improvements on our cost structure, see nice improvements on our manufacturing efficiencies, our CI benefits, et cetera, the VA/VE program we've put in place. So the margin expansion and the benefits we have from the restructuring are still there. So it's really going to be largely dependent upon the success we have of going after that material inflation and the pace of recovery on the underlying market.

Rod, this is Doug Del Grosso. I would just add to that, relative to material inflation, I would characterize that it is somewhat concentrated across a small group of customers. As Jeff's mentioned, we've got a wide variety of agreements. Some are working reasonably well and others are working less well, and that's why we've had the impact that we've talked about for this year. And so as we go after that, we're approaching it kind of 3 ways. One is, it can naturally correct itself. We're not sitting on our hands waiting for that to happen. We're heavily engaged with the concentrated customer base where we have those issues. I would say it's a customer base that I feel pretty confident that we can make some ground in those discussions. I'm not here today to peg a number, but it's customers that we've got excellent relationships with. And our level of patience is going to be measured to a certain degree on a longer-term outlook with those customers. Right now, we've not done anything I would call super aggressive as we deal with this issue because we always have to keep in mind, we want a sustained relationship with these customers and taking into account our backlog and new business opportunities is on our mind as we engage in those discussions.

[Operator Instructions] Our next question is from Brian Johnson with Barclays.

Yes. Obviously, margins being the topic of the day. How do we get a sense of in EMEA? It still looks like, even if we exclude the $18 million business inefficiencies, a step down from last quarters. You talked about commodities. And obviously, that will help in Americas where you, of course, have your metal footprint that you're working on winding down. But what has to happen in EMEA? And what's your level of confidence in getting that segment back to a 7% and eventually peer margins?

Well, I'll start. And obviously, Jeff can comment as well. I think when you look at EMEA, what we talked about last quarter was, I don't want to say a bit, an unusually high level of commercial settlements that occurred. They occur every year, so it's not completely unusual. It was just calendarized at a higher level than normal that I think distorts a little bit of the margin picture. And I would suggest you have to look at EMEA margin over a longer period than a quarter-to-quarter because of that phenomenon where we just settle up on a lot of issues, and that tends to occur in Q2.

Yes, Q1, Q2. As I think you look at the EMEA picture, the SS&M business has been improving. I think we continue to hit all the operating metrics and other portions there. The metal movements are not helpful for that, so margin certainly there. And it's a region that's been, I highlighted on in my comments the short time frame that we've had to react to call-offs in volume in Americas, but the Europe situation is very similar and their ability to react to those is even less from a worker standpoint to flex cost base. So the operating environment has not been helpful for EMEA in where we're sitting. But from an overall metric standpoint, I think we've been pleased on the operating performance with that region. The restructuring that we're continuing to put through there will continue to drive some improvements as well. But we need a much more stable operating environment. And ideally, a quicker and better sort of mechanisms to deal with the current commodity inflation issues.

Okay. And then secondly, when I toured your plants, one point the plant manager made, it was actually one of your competitors, was that the JIT plant is just the tip of the iceberg. There's a whole supply chain, including freight, cross-docking facilities upstream from that. So to what extent is the nature of your supply chain driving premium freight? And then can that be part of your recoveries?

Sure. With the exception of, I'll say, ocean freight, which has had a pretty significant impact on us when we're bringing components in from namely Asia, both in the U.S., Americas and EMEA region, I would say the impact has been relatively small at this stage. Now that as these mounting pressures continue, certainly, our suppliers will want to come in and talk about it. But we've not experienced a lot of supply chain. In some cases, we've got direct suppliers who were completely immune from any issue associated with it. So I would characterize the issue, the inefficiencies mainly in our internal operation and the fact that we've got a fair amount of vertical integration, so it's all-inclusive. Yes. It hits us hard in the JIT environment because when the customer shuts down with 1 or 2 days notice, we just have to stop immediately. As we go further down the supply chain, we have an ability to manage that a little bit more effectively. We can build inventory. I think you've seen a little bit of increase in inventory as we moved into this quarter. So we can offset some of that. And we've got Jerome here who runs our operations in the Americas region. Anything you want to add to that, Jerome?

Yes. I mean, I think as Doug said, within the JIT site and Jeff quoted some numbers earlier around 1 to 3 days. And in that even maybe smaller window that flows down into our component plants, we're at 60% of notification falls into that, and that really puts the challenge on JIT. But as you flow down in because of our vertical integration, it's not such an impact really. The West Coast, specifically the West Coast and the port delays there for parts coming in from Asia, has been a real constraint for us. And we've actively worked to reroute freight away from the West Coast. So bring it in either on the East Coast of the U.S. now or bring it in further north into Canada and moving it down. So I think, Brian, we've done everything we can to really actively manage those aspects of it to mitigate the impacts further down in the supply chain. JIT has really been the bigger issue for us.

But we have paid a lot of...

Those are the backstop and dedicated?

Yes. I'd say the biggest issue to us has been on cost. Freight expense has gone up, driver shortages, all kinds of things. And I mentioned the $27 million bump in our overall freight. Also, when the chemical supply issues hit us, we were sending airplanes of chemicals to meet customer demand. So freight has definitely been an issue, but it's been more on the cost side.

Yes. And that's embedded in that $300 million number that we put out.

Yes, in the beginning.

So that was very much a specific incident that drove those inefficiencies into the supply base, but not really characteristic, I'd say, of overall chip shortage.

The next question is from Joe Spak with RBC Capital Markets.

As we look through some of the walks in the back, I get the operational impact from these temporary inefficiencies you're talking about. I also noticed, I guess, like in Americas, for instance, and I believe in EMEA as well, there was a year-over-year headwind from launch. So I guess you guys have performed better on launch. Is this just like a lack of execution on launch or just actual like launch costs are higher because you're launching more programs?

Yes. So this is really around, if you take the Americas, in particular, it's the volume of launch that's running through the system. So it isn't inefficiency associated with launch, it's just year-over-year launch load. And so if you look at like P42QR and the programs we're launching in Tennessee for Nissan, as an example, that's a full value chain program for us. So we have the JIT, the trim, the foam and the metals. And so it's a good business. It's a significant amount of launch load coming into the business. But in terms of launch inefficiency and successive launch, we continue to trend very well from that standpoint. And it's reflected, Doug talked a little bit about the customer awards. Nissan was one in particular for a recent launch that we had. And so I'd say we have a high level of control on our launches. It's just the launch load that's coming into the business on a year-over-year standpoint.

And no, a year ago in COVID, there were no launches.

Yes. I guess that's what I was sort of getting at. And then sorry if I missed this, a little bit busy morning. But is there sort of any more refined timing update on all the China transactions when that can close and when we can sort of see that new balance sheet?

Yes. No. The good news is no expected changes at this point. We're still on target, we think, to close the transaction in September, by the end of September. And the proceeds dynamic is still the same as we outlined on March 12 when we announced the transaction. So roughly half the dollars come in on that date and then the rest is paid by the end of December. And we'd still expect that time line.

December of '21?

Correct. Yes, this December.

[Operator Instructions] Our next question is from Dan Levy with Credit Suisse.

I apologize if I missed this earlier, but I think you mentioned in your slides about the commercial negotiations. There's a little bit of roll up your sleeves. So maybe you could give us a sense of how the dynamics work on the commercial negotiations given the higher input cost. What's the typical timing of when you might be able to recover that? And then maybe you could just give us the latest on how that would comp versus typical recoveries, which I think you said is like $300 million in a typical year. So just trying to size out what the commercial recoveries could be. And then what's left on the, call it, lower hanging fruit, which I think you've said is mostly exhausted?

Yes. So I'll start at a macro level. Dan, this is Doug Del Grosso. And then, obviously, Jeff and Jerome can provide some additional details. So I'd first start out, we signaled commodity economic inflation was going to be an issue during our Q2 call. So this isn't anything that we didn't see coming. What's been challenging is what we felt the impact was going to be versus what it is now has been continually changing. And that's the one slide we have in the deck that just shows every preceding month forecast is at a higher level for an extended period of time. That said, we've gotten in front of every single one of our customers. This has not been, I'll say, a traditional discussion that we've had. We've gone to extremely high levels of our customer, explaining with a great amount of transparency the impact that it has relative to each one of their recovery mechanisms and why this is such an issue for us, not only in fiscal year '21, but if inflationary costs continue into '22, and it needs to be addressed. As I mentioned, it's concentrated across a few customers. In some cases, we have mechanisms that are in place that better manage the situation. The issue that they have is, these mechanisms are historic mechanisms that have been in place for quite some time in most cases. And to change these is a pretty fundamental change for our customers to enact. It's not like a specific commercial issue. They felt that they've got a mechanism in place, and it's just this really erratic situation we have right now that's causing it not to work, but they understand it. I think what I feel good about is with those customers, they're customers that we're pretty well positioned with. I think we've got outstanding relationships with, and I think they appreciate the value we bring. The only reason I would say I'm reluctant to put a time on it is, it's still a pretty fluid situation. And as commodity costs continue to increase, it's hard to really peg what the final impact is going to be and put some brackets around it. So we'll be working on it through this quarter. We'll have better visibility of where we're at as we go to Q4 and we start talking about our '22 outlook, but it's more than an issue that will take a quarter to resolve. But I'm fairly confident that over time, we'll be able to work this out with the customer base where we have the most significant problems with.

Great. And then just as a follow-up, I know that once your transaction on the China site closes, the pro forma leverage is going to be far below the, I think the 1.5x to 2x range that you typically flagged. What would be the timing on potentially pursuing other capital allocation options once you get below that target leverage or could there be a period where you're a bit more conservative on the capital allocation side given some of the supply chain issues that we're seeing?

Yes, great question. I think as we finish this year, we'll come to you guys with our guide for expectations for 2022, and we'll give you a better definition around where we see things. But to your point, the more volatile the market, the more, I guess, uncertain things are, the more we'd probably delay a little bit or under those situations, I could see us delaying a little bit. But at the same time, we do think the big element here and what we earmarked a lot of that cash for is to deleverage. That is our primary path forward here. But you're right, I think we have a real good path to get under those metrics that we've outlined in the past and we'll start to outline what the intentions are on capital allocation here. We don't expect the disruption in the market to continue indefinitely, for sure.

Thank you. And it looks like we're at the bottom of the hour. So again, if there's anybody that has additional questions, please feel free to reach out to me. I'll be available for follow-up calls. Operator, thank you very much. This concludes the conference call for today.

Thanks, everyone.

Thank you for participating in today's conference. This concludes today's conference and you may disconnect at this time.