GCP Applied Technologies Inc.

Greetings and welcome to the GCP Applied Technologies third quarter 2021 conference call. As a reminder, today's call is being recorded. During today's presentation, all participants will be in a listen-only mode. Should you need assistance, please signal for a conference specialist by pressing the start key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then 1 on your touchtone phone. To withdraw your question, please press star, then 2. I will now turn the conference over to our host, William Kent, Vice President of Investor Relations. You may begin, sir.

Thank you. Hello, everyone, and thank you for joining us on today's call. With us on the call are Simon Bates, President and Chief Executive Officer, and Craig Merrill, Chief Financial Officer. If you've not done so already, please go to our website, gcpat.com, and click on the Investors tab to obtain copies of our earnings release, which contains tables with our financial results, along with a slide presentation with supporting materials. Some of our comments today will include forward-looking statements under the U.S. federal securities laws. Actual results may differ materially from those projected or implied due to a variety of factors, including but not limited to the impacts of COVID-19. We refer everyone to our more robust forward-looking statement disclaimer and discussion of these risk factors facing our business in our earnings release and SEC filings. We will discuss certain non-GAAP financial measures which are described in more detail in our earnings release and on our website. Our comments on forward-looking statements and non-GAAP financial measures apply both to the prepared remarks and to the Q&A. References to EBITDA refer to adjusted EBITDA. References to EBIT refer to adjusted EBIT. And references to margin refer to adjusted gross margin, adjusted EBITDA margin, and adjusted EBIT margin as defined in our press release. All revenue and associated growth rates in this discussion are stated on a comparable, constant currency basis, which adjusts to the impact of foreign currency. I'll now turn the call over to Simon.

Thanks, Will. Good morning, and thank you for joining today's call. Our financial performance in the third quarter was within the expectations which we laid out in early August. What is notable is that we delivered these results despite cost inflation being significantly higher than we had forecast in the quarter, both for raw materials and transportation. Notably, SG&A was down by more than 8.5% year over year in the quarter, a direct result of our efforts to right-size the business. I am confident we are building a leaner and more agile business and setting GCP up for future success. This will become more evident once macro conditions have normalized. Now I'd like to give a little bit more insight about our segment results. Given the market dynamics, I am very pleased with the performance of the SPM business. For 2021, we forecast both revenue and operating income growth year over year. Our employees have done an outstanding job in improving service and driving better results in this segment. For the SCC business, the supply chain disruptions and year-over-year cost inflation started earlier and have been more severe when compared to the SBM segment. Unfortunately, the cost inflation impact in the SCC segment has accelerated and price recovery is lagging. We are clear on the actions we need to take to improve profitability in the SCC business. The addition of David Campos as our new president of the SCC America's Business is already bringing tangible change. We are working closely with David on developing a revenue and profit improvement plan for this business, and I look forward to sharing more on this in future calls. Since I joined GCP a little over 13 months ago, we have focused on improving the competitiveness of the business so that we can drive revenue and margin improvement. When we last spoke in August, I shared that this was one of the tougher working environments that I have experienced. This remains a very dynamic and challenging period. Our revenue and margins have been negatively impacted by raw material shortages, cost inflation, transportation bottlenecks, and tight labor markets. The GCP team is working diligently to address the challenges. We evaluate every opportunity to streamline production processes, find substitute raw materials where possible, and we continue to prioritize the customer. I want to make sure we recognize our employees for their continued focus on meeting our customers' needs despite the unprecedented challenges. They have done and continue to do a truly remarkable job. Looking into 2022, we will continue to focus on the things that we can control and on repositioning the business for growth. We will accomplish this through the combination of building out our organizational capability and improved focus on the customer. Given our strong balance sheet, we can accelerate our strategic plan through the right M&A. I'd now like to turn the call over to Craig. Craig.

Thank you, Simon. Good morning, everyone, and thank you for joining us today. As a reminder, all sales and associated growth rates in my comments are on a constant currency basis. I will discuss GCP's third quarter results, including comments on each of our business segments. Lastly, I will provide commentary on the remainder of 2021. GCP's constant currency sales of $246.1 million were 0.9% lower than prior year, but generally in line with our expectations. We had forecasted stable demand year over year with respect to revenues, but with a slight impact from material and logistic constraints globally, which we started to see in the late quarter too. Price for the quarter improved 1.3% compared with third quarter 2020, as price continued to come through from pricing actions implemented earlier in the year. GCP's gross margin decreased 710 basis points to 33.9%, as higher raw material and logistic costs impacted margins at a higher rate versus our Q3 forecast, with a significant impact on the SEC segment. Selling general and administrative costs of $59.2 million decreased 8.5 percent during the quarter, partially offsetting the gross margin compression, and stronger than our forecast due to lower employee costs. GCP's income from continuing operations, attributable to GCP shareholders, totaled $7.8 million, compared with $100 million for the third quarter 2020. Of course, the prior year period included $82.5 million in gains from the sale of the Cambridge corporate office. GCP's adjusted EBIT totaled $24.5 million, compared with $36 million in prior year quarter, down approximately 32%. Adjusted EBIT margin decreased 470 basis points to 9.8%, due to higher raw material and logistics costs. Adjusted EBITDA margin was 14.3% for the third quarter, or 500 basis points lower versus the same period in 2020. Our capital spending year to date is $23.9 million versus $28 million prior year to date, reflecting improved discipline of capital deployment. To better service our customers, we continue to hold higher inventories as we work through significant supply chain disruptions. Therefore, for the first nine months of 2021, net cash provided by operating activities from continuing operations equals $25.8 million versus $59.3 million compared to prior year. Now, looking at the specific performance of our two segments for the third quarter, SEC's constant currency sales were up 1.3% to 140.1 million due to favorable impact of price increases. We saw year-over-year growth specifically around global cement additives and geographically in both in Latin America and Europe. The SEC volume offset was generally in Asia where we saw intermittent government restrictions due to COVID-19 impacting demand. Gross margins in the SEC segment declined year-over-year by 900 basis points to 31% in the third quarter due to high raw material costs and logistics costs, which accelerated in the quarter. FCC gross margins will be unfavorably impacted for the remainder of the year in comparison to 2020, mainly due to the inflation headwinds, including shipping and freight costs. FCC segment operating income was $7.7 million, with segment operating margin of 5.4%. a decrease of 820 basis points compared with the prior year quarter, primarily due to higher raw material costs. Historically, third quarter has been our strongest margin quarter for SCC, and unfortunately, the severity of the inflation will have a significant impact on our SCC full-year results in 2021. Turning to the SBM segment for the quarter, SBM sales constant currency totaled $106 million during the third quarter, a 3.7% decrease versus the third quarter 2020 due to lower sales volumes. The volumes were slightly lower than we expected as we reduced shipments to certain property developers in China to reduce credit risk. We did see solid volume growth in certain product lines, such as our Sterling Lloyd business and our specialty construction products group, which includes the fireproofing, injections, and flooring products. Although SBM's gross margin decreased 460 basis points to 37.9 percent compared with the third quarter of 2020 due to higher raw material costs, it was in line with our expectations. SBM's segment operating income totaled 20.9 million, with operating margins at 19.4 percent, a 390 basis point decrease versus prior year. However, year-to-date, SBM's operating margins continue to outpace 2020 margins due to volume growth, productivity, good mix, and cost leverage to date. Now, looking to quarter four, it is clear that inflation and logistics cost increases will continue to impact our financial results on a year-to-year comparable basis, particularly in the SEC segment. We continue to take actions we believe are needed to offset these costs. However, we do not believe the actions will be sufficient to substantially lift margins sequentially moving into the fourth quarter for FCC. We are using our balance sheet in order to better service our customers and will continue to do so in order to ensure we have product to supply into 2022 without disruption. As a result, we expect to have on hand more physical inventory volume versus our historical trend at year end. Certainly, the second half of 2021 has been an extremely challenging time to operate, with material shortages, global supply chain disruptions, and the changing labor dynamics. The global teams have done a great job working together to manage through the day-to-day disruptions to meet order commitments and keep construction projects on track. We do expect our gross margins to remain compressed for the short term. Price increases continue to be implemented. However, we believe it will take a couple more quarters for price to overcome inflation and stabilize margins. The impacts on gross margin are expected to be more unfavorable on the SEC segment versus the SBM segment, as approximately two-thirds of our inflation is impacting our SEC segment. We forecast SG&A expenses for the full year to be down approximately $8 million year over year, and we expect a further favorable impact in 2022. And this will continue to partially offset the temporary margin compression. Our expense management and restructuring programs are ahead of schedule. We currently have approximately $482 million of cash and cash equivalents on hand at the end of the third quarter, slightly lower than forecast. as we are holding higher inventory. In closing, we are pleased with our progress, and although the environment is challenging on both the supply side and logistics, we expect quarter four revenues to be in line with our regular seasonality following our quarter three results, with higher price capture in Q4 versus Q3. Our strong balance sheet continues to provide significant flexibility and opportunity to deliver shareholder value whether it be return of capital to shareholders, M&A, or a combination. During the year, we have accelerated our efforts to identify and broaden the scope of potential M&A opportunities, which will provide increased capability, scale, and leverage for our organization. I will now turn it back over to Simon. Simon?

Thanks, Craig. 2021 has been a truly dynamic year. Our operating plan assumed both cost inflation and productivity improvements. I am very pleased to say that between productivity and SG&A reductions, we will realize more than 20 million improvement in operating expense and efficiency by the end of the year. Consequently, had cost inflation been in line with our budget or historical norms, our results would have been well in excess of our operating plan. Unfortunately, in the short term, these unprecedented increases in costs have negatively impacted our consolidated results. Although we feel very good about the progress we are seeing in the underlying business, we have naturally switched our focus to address margin through price and to drive further productivity improvements. I also want to note that we are ahead of schedule on the exit from our Cambridge facility and we have stood up our new head office in Alpharetta, Georgia. Our new state-of-the-art R&D facility in Wilmington, Mass., is under construction and will be ready for occupancy in Q1 2022. The execution of our strategic priorities to date has improved the business, and coupled with the use of our strong balance sheet, we are committed to deliver shareholder value. Thank you for joining our call, and we look forward to taking any questions.

We will now begin the question and answer session. As a reminder, to ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Mike Harrison with Seaport Research Partners. Please proceed.

Hi, good morning.

Good morning, Mike.

I was wondering if you could talk first about the volume impact that you saw related to supply chain disruption, raw material availability, and maybe even labor shortages or labor availability, and maybe kind of parse that out between the SCC segment and SBM segment. I guess the question is, how much higher could volumes have been if not for these disruption impacts?

Mike, I think it's a good question. It's not something we formally capture or calculate, but I can tell you, be it from a production standpoint with the inability to get raw materials or having to switch to alternate raw materials, with the challenges of getting labor in some of our facilities, the inability at times to source materials in a timely manner that is coming across an ocean. We've also seen, as we've tried to ship product, a lack of trucks that are available. And so I would tell you, Mike, Those supply chain disruptions have impacted our volumes in every geography that we operate. These aren't limited or different, honestly, by geography and has equally impacted both the SBM and the SEC segment.

All right, and then on the price versus cost front, Maybe just talk about how you see that trending over the next few quarters. Any thoughts on who expect to see peak margin headwinds and when we might expect to see some margin recovery?

Yeah, Michael, it's Craig. I'm going to give you a little bit more detail here just on the numbers. So we generally had about $25 million worth of freight raw material inflation. in the quarter. We mitigated about half of that through price productivity and our SG&A efforts. And you'll see that in the margin, basically. If you just use those numbers, that's the margin drop. Unfortunately, we expect that to continue into Q4. So really sequentially, I think the margins are going to be about the same. The inflation is going to be about the same. We are going to get a little bit more price. So we're working to do a little more favorable into Q4. Honestly, most of it's around SCC. That's where we've got the challenges. On SCC, normally, in history, we've been able to formulate around and use different materials. One material goes up, another one's neutralized, we change it out, and we formulate. Unfortunately, with a tsunami of price increases and supply chain disruptions, you can't get the product that you want to switch into properly, or the freight's gone up, or the cost has gone up. So that's where we've been challenged on SEC. That's a temporary issue. Our business model's really strong in formulation, and where we've been hampered there, that's why the SEC margins have come down more than we would like them to, obviously, and more than historical even when we've had inflation like this. So we're working through that, and once the supply chain disruptions ease a little bit and stabilize over the next, probably by the end of the year, we're hoping, into next year, we'll start to grab back those margins in SCC.

And just to talk a little bit about our SPM segment, clearly for our waterproofing, building envelope business, and our fireproof business, these are job-driven, contract-driven, and consequently, your pricing is specific to a job. And generally, and our peers would be in the same situation, you're looking at a three to four month drag on the ability to move price specific to the next job. Having said all of that, we did announce global price increases at the beginning of October for our SPM business, and we will be doing the same again in January.

All right, and then as it relates to the SG&A line, those costs appear to be down quite a bit sequentially. You mentioned the restructuring actions that you've taken, but I think also you mentioned in the press release some changes in incentive accrual. So I wanted to get a sense of how much of that SG&A reduction is sustainable and what portion of it might be related to some true-up of accruals. Okay.

Yeah, some is definitely a true-up of some incentive accruals. Listen, it's sustainable. We accelerated some of our moves on our operating expense reduction, so it is sustainable. I think you won't get any further lift, I think, in Q4, honestly, because we are starting to, you know, we've got the Atlanta office that we're now in. That's where we're speaking from right now. honestly. So I think we're probably flat in Q4 with no further uplift, but we will roll over. We haven't even got fully, Michael, the benefit of all of the Cambridge rent for next year. We'll get that benefit because that's certainly more expensive than the Atlanta rent, including the R&D facility in Wilmington. We'll get the benefit of a number of actions we've taken in the second half here with reduction of headcounts. During the year, by the time we end up at the end of the year, we'll be down in GNA 100 headcounts approximately, which will roll over and help us next year, even if we have to put back some incentive next year as we roll through the year. So we'll be net positive, and we're looking good on those programs.

All right. And then my last question for now has to do with a comment that you made about reducing sales into China to limit your credit risk. Can you give us a little bit more detail on, I guess, how you're viewing risk within that environment, given some of the issues that have been in the headlines recently?

Yeah. So payment terms in China, for most of those on the phone probably know it, it's almost between half a year to a year, depending on what customer you're working with. We're just kind of in the middle of that. So I won't get into the details. So we're kind of split right down the middle of that terms. So we thought it more prudent with all the issues going on. We have some developers we sell to. There's one that's fairly into the situation that you read about. And so we've restricted any more volumes to that developer until we get some payment. And so we lost about $3 million to $3.5 million worth of revenue in Q3. And we'll probably lose a little bit more in Q4. It could be $5 million in Q4 on a year-over-year wrap. But we think that's the prudent thing to do. We're not nervous we're not going to get paid. We've got some other... The customers that are paying us very well and we're selling to them, and, in fact, Sterling Lloyd product has been being sold there, and we've really increased those sales in China. But that particular developer we're just holding back and giving up some volume until we get payment. So we can give you a further update, you know, on the next call once we work through it. Does that answer your question, Michael?

Yes, it does.

Maybe I give a bit more color from my perspective, Mike. There's three revenue streams in China, Sterling Lloyd business, our fireproofing business, and our waterproofing business. We're seeing year-over-year growth in our fireproofing and our Sterling Lloyd business. This particular issue impacts our building envelope, our waterproofing business. And I think we've taken a strong stance in terms of protecting our credit risk, and there is a short-term impact to our revenues, but I emphasize the short-term.

Just one more layer of challenges that you have to deal with. Thanks very much. I'll turn it back for now.

Thanks, Michael. Thanks, Michael.

Our next question comes from Rosemarie Morbelli with Gabelli and Company. Please proceed.

Thank you. Good morning, everyone.

Good morning.

Good morning, Rosemarie.

Simon and Craig, I was wondering if you could talk about the specific end markets, the trends you are seeing, and which ones are being affected by COVID. Well, obviously, all of them are being affected by the shortages, are being affected by the logistics and so on. But in terms of demand for the industry overall, have you seen a slowdown? Do you have pent-up demand? Can you give us a feel for what is going on out there in the marketplace?

In a succinct manner, Rosemary, it's probably going to be a challenge when we speak about the segment and geography. But I would say... Broadly, we sell into infrastructure, and we sell into commercial new construction, and we sell into residential repair and remodel. I would say we have been positively surprised by the commercial new construction market this year, in particular in North America, and that's resulted in some good results for our waterproofing and fireproofing businesses. On the residential repair and remodel, we've seen nice growth year over year. I think, as we've pointed out before, our exposure, particularly in North America, to residential new construction is quite limited, and that would have been the strongest segment in North America this year. And then that's really talking specifically about our SBM business, For our SEC business, because our customers are essentially cement producers and ready-mix concrete producers, we get full exposure across all the different segments in terms of residential, commercial, and infrastructure. I think where we've seen nice growth this year, and it's been global growth, that could have been better had we had access to more raw materials has been our infrastructure business. And that's a segment that we enjoy and like and is likely to be more robust over the next three years than residential or commercial.

So looking at the infrastructure, how much do you think you have lost or revenues delayed because of the shortage?

Well, Rosemary, I use math a little bit more than probably I should, but we said at the beginning, if you remember at the beginning of Q3, we said we thought we'd be up about 6% to 8% in revenue for the full year. I think now we're looking at around 5% approximately, between 4% and 5%, as reported. I'm going to say as reported. So if you think about that, you could argue that I would think the global construction market has probably lost a point or two for the full year versus what they expected to. So quite a bit, but we are seeing what happens, Rosemary, in any, especially infrastructure projects, in any one of those projects, if they're missing one product or they're missing one item to finish the sequence of the job, they cannot continue the job and they're having a problem switching out to other items, alternative items, because they can't get it either. So that's slowing down the bigger jobs. One of the reasons why, and we're not in new construction residential, unfortunately, the folks who are in new construction residential or light commercial, they can switch out and they can move to another job and come back to a certain job. They have much more flexibility. On the high-end commercial and the infrastructure, and where we play, the jobs just can't switch out products. So that's delayed it. Now, the good news about that, we'll get that in 2022, because the jobs, what we're seeing in our pipeline is the jobs are not going away. Money is cheap. People are still continuing to invest and still completing those jobs. It's just they'll move into 2022. And this is when we talk about supply chain disruption. It's not just on the inbound. It's also on the outbound, on the demand, and people delaying some need for our products because their projects are delayed. So hopefully that's helpful.

Yes, that is very helpful. Thank you. And so this actually brings up my next question, which is regarding M&A. Is it safe to assume that it is going to open the residential construction market to you in a much larger fashion? And do you have something that could eventually close by year end?

We have put a lot of time and effort, Rosemarie, into M&A. And we're very thoughtful and specific about where we would invest our shareholders' funds. And we are clear on the geographies where we want to play. and we are clear on the segments where we think an investment is prudent. And we've talked about infrastructure as an example. I think the global construction trends or information, for example, from IHS would suggest that global construction should grow at about 2% to 3% the next three years, but that infrastructure spend is likely to grow at more like 6%. And so we think infrastructure would be a prudent investment And we also, of course, when we think about North America, residential new construction, given the pent-up demand that is a decade in the making, we think although growth may be limited, that will remain a strong and robust segment over the next two or three years. And we think that would be a prudent investment too.

Thank you. And one last question, if I may. So you are lagging price increases. I understand that it is difficult to raise price in some particular areas. Are you considering surcharges in order to affect at least the higher cost of logistics?

It's a daily conversation, Rosemary, honestly, and every option is on the table and every option has been discussed and is part of our execution plan.

Yeah, and maybe, Rosemary, I'll weigh in on that. We expect more price in Q4. We actually have committed price from customers that we haven't received price in their current jobs or projects because we don't have the ability to get it on those projects. But they've committed to give it to us on the next projects, which are now being shipped in Q4. And that'll roll through Q4 and Q1. And in SBM, honestly, we're doing well between price and productivity. And this will be our low margin mark for SBM. And it'll pick up through a little bit of Q4, and then it'll come more normalized into next year. SCC is where we're focused, to your point. We have inbound freight and outbound freight on SCC, and it is challenging. And we're attempting to do surcharge and then working with our vendors on some of the extra freight costs overseas and inbound overseas, because it's a global supply chain for SCC. versus SPM, which is a little more local, and it's easier to handle.

All right. Thank you very much.

Thank you.

The next question comes from Lawrence Alexander with Jefferies. Please proceed.

Hey, guys. It's Dan Rizwan for Lawrence. Just one quick question. Is there a way to shorten or change your supply chain? I mean, obviously not right now because you're just dealing with issues, but just to kind of change things so this doesn't happen again, I mean. I guess it's kind of closing the barn door if the horse is out, but I'm just wondering if you're looking at that.

Dan, I truly believe every company that is impacted by the supply chain challenges is asking the very same question. And, again, it's a daily conversation, and – You know, decisions that you would like to make, as Craig said, in terms of switching to an alternate material, it's just not feasible right now. But I think it does beg the question, how do you more fundamentally secure yourself against the prospect of this happening? And it is a current and continuous conversation and will be part of our strategic planning going forward. But to your point, Dan. The horse has already bolted, and it's now thinking about what we can do over the next 12, 24 months rather than what we can do right now, unfortunately.

Dan, I'll just reemphasize that that's predominantly our challenge on the SEC part. And we've actually got the benefit from that global supply chain for years. And unfortunately, with the increase in freight, the blackouts in China now on production on areas and even across Asia, That's challenging getting product, let alone the cost increases going up. So your point's very valid, and we need to have some sort of balance in that.

It sounds like that a lot of the issues, or at least the volume issues in SCC because of the shortages are just pent-up demand. So I'll just make sure I'm thinking about this right. That would suggest that once this is over, be it three months, six months, nine months from now, you should see a pretty large restock cycle as people basically catch up, particularly given the infrastructure demand that are growing worldwide.

Yeah, on SBM, certainly, because we have Sterling Lloyd. We actually have back orders on Sterling Lloyd right now, right through the quarter, and on some of the BE. SCC tends to restock fairly quickly, but I think our customers are not moving the product out to those projects So you are right. I think it will extend the cycle, I think. I don't know if there will be a big bang in Q1 or Q2, but it will extend the cycle on the replenishment of inventory.

And, Dan, to your question, Simon, I'll give a little bit more color. Specific actions that we had taken that actually were going to drive some very nice productivity improvements for us year over year have been negated. by the inability to get the product that we planned to replace, the raw, or the cost of that raw has increased so much that it negates the productivity improvement. The second thing, because you asked what can you do, clearly we have taken the decision to increase our physical inventory, and quite substantially. I think, surprisingly, that's meant for some customers in some segments, we've actually been able to drive an improvement in our on-time and in full on certain projects for certain customers. And I think that's a testament to our supply chain group that we've been able to do that in these challenging times.

Thank you very much.

Thanks, Dan.

Our next question comes from Chris Shaw with Moness Crespi. Please proceed.

Yeah, hi. Good morning, everyone. How are you doing? Hey, Chris. I can follow up on Rosemary's question about M&A. You know, you've lined up the strategy and the target sort of areas and geographies. I think you've had that sort of set for a while now, I guess. What's just sort of the what's the sticking point right now? Is it, is it just, are there no targets? Are they, they not selling or is the multiples too high? Have you lost out on some targets or are you guys, you know, is it COVID or you guys have been distracted with, you know, the supply chain issues? I mean, what's really sort of the sticking point in all getting this done?

No, we, we, we've actually dedicated a lot of time and effort to M&A. Uh, in some cases we have lost out. Um, in some cases we've decided the price is too high. Um, In some cases, we've decided there isn't enough good fit and synergies. And so we want to be thoughtful. We want to be discerning. We actually have a very good pipeline and feel good about some of the targets that we are pursuing. So it's a lot of reasons, I guess.

Yes. And then if I could ask, Historically, I can't remember in both your businesses, when you've had to raise prices a decent amount, is there any impact to demand or is there some sort of elasticity or is there any switching out to a more commodity-like product or anything like that? I forget the sort of historical when that has happened in the past.

Yeah, generally, I mean, we're managing the balance between price and volume. And generally, there's not switching out as long as we are sensible, we communicate effectively, and we're clear to the customer on exactly why they're getting the price. And the challenge is the timing. I mean, certainly if we're going to jam the customer and put them in a very difficult position with his pricing to his customer or their project or her project, that's a That's an issue. Hence the reason why the delay a little bit on our part, because we don't want to lose volume. We haven't lost volume that we know of as we're tracking. I think about two or three years ago, we did move price and we lost volume. You can see in 2019, it came back to haunt us on the SBM side. We're very thoughtful on this price approach. Of course, we've got the the wind in our back with the inflation. So we're going to get the price. We are driving productivity to offset it too. And I think at the end of this, we'll be more competitive and we'll be able to grow the business on the backs of that versus just working on price and margin, honestly. Got it. All right. Thanks, guys. Thanks, Chris.

As a reminder, if you do have a question, please press star then one on your touchtone phone. Our next question is a follow-up from Mike Harrison with Seaport Research Partners. Please proceed.

Hi. Yeah, just one last one for you around free cash flow. Looking even at the adjusted number, you're quite a bit behind where you were last year. I know you mentioned the higher inventory levels. But maybe just as we're starting to think about free cash flow for next year, maybe walk us through some of the puts and takes there. Presumably working capital becomes less of a headwind. Expect to see some earnings growth in there. But also, how do we think about the cash for restructuring and repositioning into next year as well as CapEx next year versus this year?

I mean, I'll give you a general comment, Mike, and then Craig will probably follow up with more specific data. But very deliberate decision on Craig and my part early this year as we saw challenges on raw material pricing and the indications of shortages that we bought early and we bought a lot. We're very deliberate. So I'd say the majority of the change in the free cash flow comes from increasing physical inventory. What I am pleased to say is that throughout the course of this year, we've made some changes within our supply chain group, and I think we have a very talented group, and I think that's part of the reason why we've been able to improve service levels to some customers, even in these challenging times. But we will definitely be targeting that group with a reduction in physical inventory once the supply chain disruptions have abated and driving that improvement in free cash flow next year. Craig?

Yeah, so Michael, I'll play in on Chris's question a little bit on this too. We decided to carry this extra inventory. One of the reasons was to support some of our – I'm from the commercial – I have a commercial background to support the commercial teams on pricing. The last thing you want to do with customers is give them a price increase and then tell them that you can't service them with the product. So we're supporting our commercial teams and our customers on that. We have about – 15% to 20% more cost in our inventory this year than we did last year. About half of that is inflation, and the other half is the decision Simon and I made to carry extra volume to make sure we can service the customers. So we'll reap the benefit of that next year, not at the end of this year because the supply chain disruptions are keeping on, but next year we'll reap the benefit of that because we expect to bring that down slightly next year. But just to give you some numbers, we do expect to spend – probably about $5 million to $8 million more CapEx next year than this year. That would be on the projects. We've identified some nice productivity projects in mostly North America on the SPM side. So that's where the number will be at. We'll be at $45 million, give or take, on CapEx. Interest expense will stay the same next year right at this moment, unless we do M&A and we can get a target closed, which would change it. Restructuring. We're trying to accelerate the restructuring, not just for the savings, but we want to get over it so we can operate the business effectively just from an operating point of view. So you're going to see less cost on dollars in restructuring next year. So that's probably going to give us a bump of $10 million or $15 million. So you're going to see probably our anticipation, our best cash conversion year will be 2022 once we get past this current restructuring.

Very helpful. Thanks.

At this time, we are showing no further questions in the queue and this concludes both our question and answer session as well as today's conference. Thank you for attending today's presentation and you may now disconnect.