Good day, and thank you for standing by. Welcome to the Meritor Fourth Quarter and Fiscal Year 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation there will be a question and answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

[Operator Instructions] I would now like to hand the conference over to your speaker, Todd Chirillo, Senior Director of Investor Relations. Please go ahead..

Thank you, Shannon. Good morning, everyone, and welcome to Meritor's fourth quarter and full fiscal year 2021 earnings call. On the call today, we have Chris Villavarayan, CEO and President; and Carl Anderson, Senior Vice President and Chief Financial Officer. The slides accompanying today's call are available at meritor.com.

We'll refer to the slides in our discussion this morning. The content of this conference call, which we're recording, is the property of Meritor, Inc. It's protected by U.S. and international copyright law and may not be rebroadcast without the express written consent of Meritor.

We consider your continued participation to be your consent to our recording. Our discussion may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Let me now refer you to Slide 2 for a more complete disclosure of the risks that could affect our results.

To the extent we refer to any non-GAAP measures in our call, you'll find the reconciliation to GAAP in the slides on our website. Now I'll turn the call over to Chris..

Good morning. Thank you for joining the call today to discuss Meritor's fourth quarter and full year 2021 results. Once again, we delivered solid financial performance. We achieved our full year outlook for adjusted EBITDA margin and exceeded adjusted diluted EPS guidance by $0.23, while simultaneously expanding our reach into electrification.

We accomplished this during significant supply chain disruption and labor issues in the United States. I want to thank the Meritor team and supply partners for working closely with our customers to optimize production and delivery. As shown on Slide 3, we had good conversion on higher revenue as global demand snapped back.

Extraordinarily high input costs obviously impacted our margin for the quarter and the year, but all things considered, we're extremely pleased with the result. Let's turn to Slide 4. While the circumstances were demanding, we remained intently focused on safety, quality and delivery.

We ended the year with strong metrics that give us a path to achieve our M2022 goals. With 50% of our facilities having zero recordable incidents in the year, I commend these teams for the work they did to maintain a safe working culture in a challenging environment. Our excellent quality for the year resulted in customer PPM of 23.

Four of our facilities and three of our joint venture operations received the Daimler Masters of Quality Award, which recognizes outstanding suppliers with scores for quality, delivery, technology and cost performance. We're proud to say that including this year, we have earned 55 Masters of Quality Awards from Daimler over the years.

We believe this level of quality differentiates us in the industry, as does our delivery rate of 96% this year. While not as high as a typical year where we consistently run 99%, we view this as an accomplishment considering the prolonged supply and labor disruption the industry is experiencing.

As the commercial vehicle industry advances towards electric vehicles, we view every prototype agreement, collaboration and partnership as an important opportunity. Each one is a validation of our technology solution that could lead to a production contract as customers finalize their market strategies and architecture choices.

Every quarter this year, we announced new agreements to expand our customer base and for electrification. This quarter is no exception. Please turn to Slide 5. First, Axos is electric mobility company that designs and manufactures medium- and heavy-duty commercial trucks that travel on last mile back-to-base routes of less than 200 miles per day.

Under a prototype agreement, Axos will evaluate and test Meritor's ePowertrain with the intention of taking it to production in future platforms. We also have a new collaboration with Electra commercial vehicles.

Meritor will work with Electra to bring electrified commercial vehicles to Europe city centers, integrating Meritor's electric powertrain into an IVECO-based road sweeper application will allow Electra to replace its remote drive conversion solution and test a more efficient and compact electric powertrain.

With Meritor's technical architecture, Electra can maximize the space for batteries, which will allow the vehicles to sweep more road surface in a single shift. Finally, we're proud to be a part of the U.S. Department of Energy Super Truck 3 program in collaboration with PACCAR.

The goal of this program is to develop zero-emission medium-and heavy-duty trucks. Let's go to Slide 6 for a look at the significant number of diverse electrification agreements we have announced in fiscal 2021. From production awards to prototypes, medium duty to heavy, we're growing through new and existing customer relationships.

In 2020, we announced the PACCAR and Volkswagen electrification production program. This fiscal year, as compared to fiscal 2020, we've more than tripled the value of new EV wins and further diversified our customer base. We're also growing our opportunities in the medium-duty application space. Here, we historically have not had a large share.

We have now booked electrification business of almost $0.5 billion. On Slide 7, we wanted to recap the important activity in our core business during the year. We extended contracts with Navistar and IVECO and secured new business with industrial and truck customers in India and the United States.

We're on track to exceed our M2022 new business win target by approximately $100 million. Keep in mind, we expect the sustained growth of our core business to fund the growth of our electrification business as the customer base and product portfolio continues to grow. I will now turn it over to Carl for the financial details..

Thanks, Chris, and good morning. On today's call, I will review our fourth quarter and full year financial results and provide an outlook for fiscal year 2022. Despite significant headwinds in the supply chain and operating environment, we delivered solid financial performance in our fiscal year.

We converted on incremental revenue at 18%, expanded adjusted EBITDA margin by 180 basis points to 10.7%, increased adjusted earnings per share by 176% to $2.68 and generated $107 million of free cash flow. Now let's turn to Slide 8. First, I will review our segment results for the fourth quarter compared to the same period last year.

Sales in Commercial Truck were $740 million, up over 30% year-over-year. The increase in sales was driven by higher global truck production in all markets. A year ago at this time, we were just starting to recover from pandemic-related shutdowns. Segment adjusted EBITDA for Commercial Truck was $54 million, up $30 million from last year.

Segment adjusted EBITDA margin rose to 7.3%, an increase of 300 basis points from a year ago. The increase in segment adjusted EBITDA and margin was driven primarily by conversion on the higher revenue. This was partially offset by higher freight and steel costs.

Aftermarket & Industrial sales were $250 million in the fourth quarter of fiscal year 2021, an increase of 11% compared to the prior year. The majority of this was driven by higher order activity in our North America aftermarket business. Segment adjusted EBITDA was flat year-over-year.

However, margins were impacted by higher freight costs, resulting in a 140 basis point decrease. For the full year, sales rose to over $3.8 billion, up 26% from last year due to strong global demand and higher truck production in all of our markets. Production in India more than doubled.

South America was up 50%, and Class 8 production in North America increased by 20%. Net income from continuing operations was $200 million compared to $244 million in the prior year.

You will recall last year, we recognized more than $200 million of income, net of tax, associated with the termination of the company's distribution arrangement with WABCO.

This was partially offset by the recognition of value-added tax credits in our wholly-owned Brazilian entity of $15 million net of tax during the second quarter of fiscal year 2021. Additionally, we recognized $10 million in net tax benefits from certain tax initiatives that were implemented in the fourth quarter of this year.

Adjusted EBITDA was $411 million in fiscal year 2021, resulting in an adjusted EBITDA margin of 10.7%, an increase of 180 basis points. The increase in adjusted EBITDA and margin year-over-year was driven primarily by conversion on higher sales, partially offset by increased freight, steel and electrification costs.

In total, higher steel and freight costs were an $84 million headwind in 2021. During the year, ocean container costs nearly quadrupled, hot-rolled steel increased over 250% and scrap costs double.

Had we not faced these increased costs in steel and freight, our adjusted EBITDA margin in 2021 would have been significantly higher, demonstrating how well the underlying business is performing. Additionally, we also incurred $21 million in higher electrification expense as we continue to invest for the future.

Adjusted diluted earnings per share was $2.68, an increase of $1.71 from the prior year. This does exclude the $15 million in tax credits from Brazil and the $10 million of tax initiatives I mentioned earlier. And finally, free cash flow was $107 million compared to $180 million last year.

Keep in mind, our 2020 free cash flow included the $265 million benefit in cash received from the termination of the distribution arrangement we had with WABCO. In 2021, we also had an approximately $70 million increase in our working capital requirements as we secured supply for our customer needs and prepare for another increase in volumes in 2022.

Now let's review our global production outlook on Slide 9. We continue to see strong demand across our global markets. However, global supply chain constraints continue to impact production for our customers and the industry which we expect to continue into next year.

In North America, we expect Class 8 production to be in the range of 270,000 to 290,000 units, an increase of almost 7% at the midpoint from 2021. While order activity has begun to moderate, there have been over 320,000 Class 8 trucks ordered since January.

Additionally, the backlog in September was approximately 280,000 units, which is approaching the previous all-time high set in October 2018. Overall, we expect production to be limited only by constraints in the supply chain.

In Europe, our production outlook is in the range of 410,000 to 430,000 units as we continue to see stable product levels on the continent. In Brazil, we expect strong demand to continue as 2021 was the highest Class 8 truck production in this region since 2014. We expect production next year in the range of 145,000 to 155,000 units.

And in India, we project a slight increase from the prior year as production in the region continues to rebound. Let's turn to Slide 10 for an update to our fiscal year 2022 outlook. We are projecting our full year sales to be in the range of $4.1 billion to $4.3 billion.

In addition to revenue growth based on the production forecast I discussed, we expect approximately $100 million in incremental sales related to new business wins as part of M2022 plan.

We also continue to recoup steel costs from our pass-through recovery mechanisms, which we expect will increase revenue in the range of $100 million to $150 million compared to last year. Moving to our margin outlook. We expect our adjusted EBITDA margin to be in the range of 11.5% to 12.5%.

Our guidance range is wider than normal due to the continued uncertainty in the overall operating environment. We continue to see significant headwinds from steel and freight and anticipate these costs to be an incremental headwind of $70 million to $110 million as compared to 2021.

We are executing on recovery and pricing actions to help offset some of the cost pressures we are seeing. In total, we currently are planning for $50 million to $80 million of actions, which will be more fully realized starting in our second quarter. In addition, we expect several tailwinds in fiscal year 2022.

First, we will continue to drive operational performance in the business, and we will complete our previously announced footprint consolidation initiative in the first quarter, providing a $12 million to $15 million year-over-year improvement. Moving to adjusted diluted earnings per share, our outlook for 2022 is approximately $3.25 to $3.75.

Keep in mind, this outlook is based on our revised reporting of adjusted income from continuing operations and adjusted diluted earnings per share that we changed in the second quarter of 2021, which excludes the benefit of noncash tax adjustments we had previously included when we announced the M2022 plan back in November 2018.

And finally, we now expect our free cash flow to be in the range of $175 million to $200 million as working capital stabilizes and we convert on incremental sales. Overall, the team continues to remain focused on delivering superior financial performance in the final year of our M2022 plan.

Now I will turn the call back over to Chris for some closing remarks..

As Carl stated, our guidance ranges for this fiscal year are wider than usual due to the volatility we have grown accustomed to in the past few quarters. However, we are focused on delivering excellent financial results. Slide 11 provides M2022 highlights.

We're particularly excited about the growth we see and plan to achieve in our core business and advanced technology. Meritor recognizes the future is electric. Our success in 2021 and our legacy in the commercial vehicle and brake business will position us well to capitalize on the growing adoption of electric vehicles around the world.

As we look at the next decade, we expect the rate of adoption to dramatically increase heading towards 2030. And as the market shifts to electric powertrains, we believe Meritor's content per vehicle will grow significantly. Please turn to Slide 12. We hope you will join us for Meritor's Virtual Strategy Day on December 7.

At that time, we will dimension our growth expectations as the industry transforms to electrification and share exciting new business wins with you. Following that event, we will have a live Q&A. So please mark that on your calendars. We will now take your questions..

[Operator Instructions] Our first question comes from Brian Johnson with Barclays. Your line is open..

Team, this is Jason Stuhldreher on for Brian. Congrats on finishing fiscal year '21. I was hoping maybe just on the outlook first.

The incremental margins that the outlook seems to imply, if we kind of exclude the recoveries that you're getting and then the additional steel and freight cost, it looks to be in sort of the low 30-ish percent range, which is higher than we've seen in the past.

And you kind of mentioned some one-off factors, but hoping you could sort of kind of dimensionalize what your kind of expected standalone incremental margins would be? And then what the benefits of sort of finishing the footprint consolidation and other factors for next year?.

Sure. It's Carl. I can address that question. Yes, as we look at the incrementals going into 2022, a couple of things to keep in mind. I would say kind of just on base revenue, our expectation now with all of the actions we've executed over the last several years is that we will be north of 20% conversion on that incremental revenue.

In addition to the footprint consolidation of $12 million to $15 million tailwind, we also expect to drive significant continued operational performance in the business as well. So that would be an additional up to $30 million plus of operational improvement, and we are also planning for less incentive compensation expense in 2022.

So that all will box you to the higher margin in an absolute sense..

Understood. And then maybe just on the free cash flow conversion, I mean the numbers that you're guiding to are pretty strong for 2022 kind of -- in that 75% range, maybe even a little higher. And I guess we're going to get an update on what sort of cash you guys can generate in your next -- in the next set of planning period.

But as we think about some of the restructuring cash uses kind of rolling off and maybe sort of a normalization of working capital, is it kind of fair to hope for maybe north of 75% kind of going forward?.

Yes. I think obviously, we're driving to achieve the 75% for this year in 2022. And we will obviously provide an update in a couple of weeks at our Strategy Day in a little bit more detail.

But the expectation, just given the improved overall balance sheet and what we expect from working capital, I think it would be a fair assumption we should be driving that number north of 75% as we go forward..

Understood. Okay. Then lots to talk about on the electrification front, but I'll save that for next month. So thanks, team..

Our next question comes from Sherif El-Sabbahy with Bank of America. Your line is open..

So I just wanted to ask about the 140 basis point impact on aftermarket and industrial. It seems like freight is having an outsized impact on that segment.

Could you provide a bit more color? And then when would you expect that freight impact to maybe roll off?.

Yes, as we're seeing -- as we look at kind of just global freight index since -- just in the fourth quarter alone. So this is -- if I go back to when we last talked to you back in July and where we are now, we have seen freight costs increase 50% since that time period. So I think that continues to be a near-term short-term headwind in the business.

But as we kind of go forward, there are actions that we addressed in the call, especially with the aftermarket business around pricing that we expect to go into effect in the -- our second quarter. So you should start seeing that normalize a little bit further as we get out of this first quarter..

Understood.

And then with regards to the Commercial Truck segment, has it seen a similar level? Or is there pass-throughs or something of that nature there that would be offsetting a bit more that isn't present in aftermarket?.

No, it is affecting both segments, we are seeing that. Obviously, we have pass-through mechanisms on our steel, we do not have that in freight. So that is something that we have to -- have further discussions with our customers on for pricing..

Our next question comes from Joseph Spak with RBC Capital. Your line is open..

Carl, if I look at some of the factors for the margin walk in '22 and revenue conversion and operating performance. If I just sort of use sort of normal historical incremental margins on the revenue you're showing, it would seem like maybe half of that 1.4 to 2.2 is from volume and the other half would be more operational performance.

And I know you sort of called out the $12 million to $15 million from actions taken, but what are some of the other areas there where you can sort of drive further operational performance in '22?.

Joe, yes, I think there a couple of other areas in addition to footprint, as I mentioned earlier, would be we are expecting lower incentive compensation. So that was a -- so call that in around that $10 million type of range year-over-year.

And then additionally, our expectation is we will continue to drive significant material performance into the business on a year-over-year basis. So I think those are kind of the key drivers for us to -- for that bridge..

Okay. I guess staying there, and you sort of just touched on this a little bit like the recovery in pricing actions.

So it sounds to me like that's a mix of contractual stuff and sort of negotiation, can you just help us sort of understand the split there in terms of sort of what is more just contractual that sort of owed to you? And how much is you guys rolling up your sleeves at the table and sort of trying to get some pricing back and what the reaction to those conversations have been so far?.

So I'll take that one. And just if you break it up, steel is mostly contractual. So we have that on average somewhere between 75% to 80% as passed through. There's obviously the lag associated with when we have that recovery. Most of the conversations are most -- are on the freight side, as Carl mentioned, that is something that is not covered.

And so those negotiations, as you could imagine, are obviously difficult, but our customers understand it, especially when you think about numbers where freight has gone up 400% to 500% depending on which region and the type of freight. So we've had those -- we've started those conversations early.

We've continued to have those conversations, though difficult. What I would say, Joe, is at the end of the day, our customers need us healthy. So we've been able to work with them. And as we see going into '22, those costs continue to rise. So we will have to continue to have those conversations..

And historically, it's been easier to take pricing on the aftermarket side, right, than on the correct?.

Yes, correct. We twice the year and we've usually....

Yes. Okay. Last one for me. Like on the EV stuff, great to hear $500 million in wins, which is, I think, what you were already, which is what you're targeting.

Is there a way to let us know the split between, let's call them, legacy truck makers and some of these newer names? And also like what's the time frame for that $500 million to be recognized over?.

So let me take that one. We don't usually provide the granularity by customer, Joe. What we're doing is essentially taking the full basket or the full revenue that we have from all our customers and risk adjusting, and that's what you see.

However, in terms of, let's call it, timing, that's something that we will provide when you call in on December 7..

Our next question comes from Bruce Chan with Stifel..

This is Matt on for Bruce. Congratulations on the solid fiscal '21.

With regards to the fiscal '22 outlook, could you provide some more color around the key assumptions on labor cost inflation perhaps how good you guys feel about your line of sight into how the salary, wages and benefit line might ultimately impact margins next year? And maybe as a follow-up to that, if you could comment on the hiring and staffing challenges that you're experiencing now in the market, if you have any thoughts on what the impact might be on production, labor and so forth from The Biden Administration's vaccine regulations?.

Thanks, Matt. I'll take the first question and turn it over to Chris for the second. As it relates to the inflation for the workforce that we're seeing, it is embedded in our guidance right now.

I think it is definitely obviously increasing depending on where we're operating and what we're in, but I would say it's fully reflected in what our guidance is from an assumption perspective. So I'll turn it over to Chris..

And so on the second half, Matt, if you think about it, I would say Q4 for us was probably one of our most challenging quarters thinking about labor coming with the -- obviously, the impact of the Delta variant as well as the inability to really get a good view of the line rates because of the impacts of the semiconductor shortages.

So we were seeing quite a bit of sporadic shutdowns through Q4. We do see that normalizing in Q1. So our OEs have adjusted line rates based more from the visibility they have ahead of them, and that's provided us the ability to then appropriately staff.

One of the other things we have done and it's a true testament of the Meritor the employees of Meritor is we were able to respond, in many cases, by moving some of our salaried folks to respond into the plants.

And as we think through some of our strategies at least stabilizing through the next quarter, those are some of the, let's call it, the elements that we continue to deploy..

And lastly, if I could sneak one more in. Could you provide any updates on the Blue Horizon platform? Perhaps some color around the planned product portfolio, production time line, maybe the order book with existing customers or any new customer activity would be great..

Yes, I'd love to. So perfect.

So I think Blue Horizon -- under Blue Horizon, we captured both our ePowertrain as well as, let's call it, the full system with the full system, which is where we provide the PACCAR, the battery system as well as the ePowertrain, which we're launching with PACCAR, we're all aligned to go into production at the end of this year.

So we're in great shape there. And then with the which is -- 14Xe, which is the ePowertrain, we announced obviously the two prototype announcements today. So that stream continues to build, and we look forward to talking more about it on our Strategy Day on the 7..

Our next question comes from Ryan Brinkman with JPMorgan. Your line is open..

Given that you're mostly protected in customer agreements with regard to steel cost recoveries with the biggest consideration there, I think being mostly timing differences and the optics on margin, et cetera. I thought to ask some more questions on these non-commodity supply chain costs.

A number of light vehicle suppliers this quarter have called out these costs, including ocean shipping, freight, electricity, natural gas, diesel, even labor, suggesting that they are unusual and that they would seek to at least partially recover them via commercial negotiations with their customers.

I heard you guys mention ocean shipping and freight a number of times.

To what extent should we think about these costs as needing to be offset more through productivity and other cost savings? Is that how you've tended to handle lower rates of inflation of these costs in the past versus to what extent do you expect to pass on higher non-commodity supply chain cost to customers? If you do intend to pass along those costs, what would that process or timing of that process look like? And does it make sense to potentially formalize into future agreements, I mean not labor, but certainly maybe ocean shipping, for example, in the way that commodities began to be formalized in the contracts in the 2000s?.

Well, it's a great question, Ryan. I think when you think about the size and scale it isn't something that we can truly absorb when we think about the business. I mean you come to a point where it becomes detrimental over time.

So for us, the -- conceptually, when you look at the other elements and you've identified them well, whether it's power and portions of labor, we certainly will be looking to pass some of these on to our customers.

We've started with freight because that was the most significant discussion we've had, but we certainly have had other baskets we've started discussing with our customers. As we look at the last year and just preparing for the next year, you know that a significant portion of this needs to be moved out of the business.

We started early coming into the pandemic by reacting -- by adjusting our headcount as well as looking at all nondiscretionary costs. So we've done quite a bit of, let's call it, internal work. But when it comes to a point where you have increases of 200% to 500%, we certainly will be looking to have conversations with our customers..

And then my last question is on the labor front. You did get a question there already, so I'll try to ask it from a bit of a different angle.

In the past, mostly in the industry downturns, I think you have highlighted the relatively higher percent of your workers that are temporary or were temporary at the time with the implication being that maybe there could be more easily or cost effectively let go when not needed, which is seemingly the opposite of the situation today, right? So I'm just curious what your mix of permanent versus temporary workers looks like today.

If you're thinking any differently about permanent versus temporary with the benefit of temporary maybe being as much as sort of greater in downturns than upturns. And generally, what your retention looks like at the moment, you did get the question of how labor costs might track going forward.

But just how about ensuring that you have sufficient continuity of experienced employees to meet quality and productivity goals, et cetera..

So when it comes to -- so I'll break the question into two parts. When it comes to our full-time employees, I would say that retention has been still quite good. And it's -- part of it, Ryan, is the, let's call it, the legacy of Meritor's 110 years of Rockwell heritage.

And on average, when I look through our facilities, we have employees somewhere in that 14 to 17 years that are full time.

So we've been -- we've done a great job in retaining those employees, and those employees based on the brand and the fact that they've worked with the same team and the same company have provided that level of loyalty, and we've seen very little issues on the retention side there.

Specific to the temp side, the temp ratio is lower than what we have had previously. And that is, as you could imagine, the same pressures that we're experiencing in -- that the industry is experiencing. So we are -- the way we've been attempting to fix that is by, obviously, bringing down our temp ratio, and that's how we've addressed that.

Overall, our full time, let's call it, retention is up running north of 96%..

And if just sneak a couple more in on capacity, where do you stand on capacity with all these new electrification awards? I don't know how intensive they are in terms of number of employees or square footage or whatnot, but it does seem like some of these awards might be incremental to existing business.

Do you have sufficient capacity to the electrification wins that you've been securing or might you need to add capacity when was the last time that you've done something like that?.

So we've actually broken up -- I'll break that into two elements. So the full powertrain where we build the PACCAR, the battery system and the axle, there, we have -- that is through our acquisition in TransPower. We have two buildings, and we're constantly looking at expanding our capacity there as we see that business growing.

When it comes to our ePowertrain just the axle -- the integrated axle, here, what we are doing -- we have been able to integrate it into our manufacturing sites in North Carolina between Asheville and Forest City. So here, we feel that we have enough capacity to be able to respond to the market as we see it over the next few years..

And then just finally, there's so much excitement right now about last-mile delivery vans, the leverage to e-commerce, think about bright drop and some of their competitors.

To what extent are Ford transit or sprinter van considered to be in the Class 5 through 7 or how positioned are you or aren't you to compete in the light commercial vehicle space? What's your interest in that portion of commercial vehicles?.

Well, that's a great question. I'd love to answer that one. So when you take out -- so when you think about it, we have historically been on the heavy side. And so we started off with the 14Xe. And so if you think about Lion highly on Autocar, PACCAR, that's been the 14Xe.

But the best part about our, let's call it, [indiscernible] into electrification is the wins on the medium-duty side. And so as you guys know, historically, we have had about 15% share here, and we've been winning here. So as we think about Class 7, Class 6, this is Volta, which is Hexagon, and that's where we see significant growth.

And it's just been a true testament to the product that we've brought to the market right now. So we have the 14Xe that comes to Class 7 or the bottom end -- the top end of medium duty or the bottom end of heavy. And so that's what both Volta and Hexagon are using.

And beyond that, we have the 12Xe that we plan to bring to the market in '23 as well as our agreement with Electric, which helps us get us into, let's call it, the top end of Class 5, Class 6 and 7. So it's not that we decided on, let's call it, a sequential strategy.

We came up with parallel strategies on the medium side, and it's great to see that we're winning..

[Operator Instructions] Our next question comes from Itay Michaeli with Citi. Your line is open..

Just two follow-up financial questions for me.

First, can you just touch upon what you're assuming for R&D in fiscal 2022? And then second, going back to the recovery and pricing actions, particularly for the noncontractual freight portion, how do you go about kind of modeling that? Is there sort of a percent success rate or recovery that you're assuming, just given that there might be a bit of a, I guess, an uncertain nature in terms of how those discussions may go?.

Sure. Yes, I think on R&D, we are currently assuming about 2% R&D as a percent of sales is kind of what's in the modeling and the forecast embedded in our guidance.

And then as it relates to just those discussions, whether it's freight, steel, in some cases as well because we don't always recover 100%, I think it's just -- we do build certain assumptions in there. But I would say what's happening is the pricing continues to change, and we're still seeing that kind of run up.

And so those discussions are just extremely critical for us. And so at this point, we will be driving to achieve everything from all customers as it relates to the pricing actions that we need to deliver on as we go forward. And we've had some success to date.

But in this rising inflationary environment, especially on some of these costs, they continue to run. So there's more work and discussions we need to have..

Maybe a quick follow-up, Carl. I think you mentioned working capital obviously a drag with all that's been going on in the supply chain.

Are you assuming a full recovery in fiscal '22? Or will there still be some additional recoveries beyond '22 just for all the recent volatility?.

Yes. As we look at it, we -- as I mentioned, we had about a $70 million headwind in '21 compared to 2020 expectations. I don't know if we'll claw all the way back, but I would say we should definitely see a $50 million-plus improvement in working capital on a year-over-year basis..

Thank you. And I'm currently showing no further questions at this time. I'd like to turn the call back over to Todd Chirillo for closing remarks..

Thank you for joining our call today. If you have any questions, please feel free to reach out to me directly. Thank you, and have a great day..

This concludes today's conference call. Thank you for participating. You may now disconnect..