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Executives

J. Mark Sutherland - Vice President of Investor Relations

Alfred E. Festa - Chairman and Chief Executive Officer

Hudson La Force - Chief Financial Officer and Senior Vice President

Analysts

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Michael J. Ritzenthaler - Piper Jaffray Companies, Research Division

Brian Maguire - Goldman Sachs Group Inc., Research Division

Robert Walker - Jefferies LLC, Research Division

Christopher L. Shaw - Monness, Crespi, Hardt & Co., Inc., Research Division

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

James Barrett - CL King & Associates, Inc., Research Division

Christopher Kapsch - Topeka Capital Markets Inc., Research Division

Patrick Duff

W.R. Grace & Co. (GRA) Q2 2013 Earnings Call July 25, 2013 11:00 AM ET

Operator

A very good morning, ladies and gentlemen. Thank you very much for joining us, and welcome to the Second Quarter 2013 W.R. Grace & Co. Earnings Conference Call. My name is Lisa, and I'll be your event coordinator today. [Operator Instructions] Also, I'd like to remind you this conference is being recorded for replay purposes.

I would now like to turn the conference over to Mr. Mark Sutherland, who is the Vice President of Investor Relations. Please proceed. Thank you.

J. Mark Sutherland

And thank you, Lisa. Hello, everyone, and thank you for joining us today, July 25, 2013, for a discussion of Grace's second quarter 2013 results released this morning. Joining me on today's call are Fred Festa, Grace's Chairman and Chief Executive Officer; and Hudson La Force, our Senior Vice President and Chief Financial Officer. Our earnings release and the corresponding presentation are available on our website. To download copies, go to grace.com and click on Investor Information. Links are available on the upper right corner of the page.

As you know, some of our comments today will be forward looking and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected or implied due to a variety of factors. Please see our recent SEC filings for more details on the risks that could impact Grace's future operating results and financial condition. We will also disclose certain non-GAAP financial measures, which are described in more detail in this morning's release and on our website. Reconciliations to the most directly comparable GAAP financial measures and other associated disclosures are contained 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 question and answers. We want to remind everyone that this webcast contains time-sensitive information that is accurate only as of today. Any redistribution, retransmission or reproduction of this call without company's consent is prohibited.

With that, I'll turn the call over to Fred.

Alfred E. Festa

Great. Thanks, Mark, and good morning to everyone, and thanks for joining us. As you saw in our release, the second quarter came in as we expected. Sales grew organically, 2%; gross margin improved 100 basis points to 37.8%; adjusted EBIT and EBITDA margins increased to 17.7% and 21.6%, respectively; adjusted free cash flow increased to $157 million for this first 6 months. Each segment contributed and executed well in a challenging environment. Catalysts Technologies posted solid results with segment earnings growing 22% from the first quarter. As you recall, the first quarter was impacted significantly by customer operational issues and order delays that are now behind us. Segment gross margin increased to 42%.

Materials Technologies sales grew more than 4% organically and 8% in the emerging regions. Segment margins are ahead of target for the first 6 months with gross margin just over 34% and operating margin at 20%. Construction Products continue to grow nicely, driven by improved construction spending and increased penetration of our high-value waterproofing products. Construction Products sales grew more than 5% organically and 12% in the emerging regions. Segment earnings increased 28%.

Materials Technology and Construction Products are on track to deliver mid single digit sales increases and solid double digit earnings growth for the year. Unfortunately, Catalysts Technologies is not on the track we wanted. In March, we announced changes to our FCC Catalyst pricing, which included eliminating the rare earth surcharge pricing mechanism and increasing the resulting new base price, 10%, as contracts allowed. This increase was intended to support Grace's continued investments in new product development, technical service and manufacturing capability. We noted that this pricing initiative would be a multi-quarter process of negotiations with our customers. We projected some volume loss as customers exercise their negotiating prerogative to trial alternative catalysts.

We are now 4 months into the initiative, and it is clear that our objectives will not be achieved at this time. Based upon actions absorbed in the marketplace, we believe that industry competitors are using our pricing initiative as an opportunity to aggressively increase their sales volumes. Since the March announcement, we have lost about $60 million in annualized sales volume or about 7% of our annual FCC Catalyst sales. This loss is more than we forecasted and more than we are willing to accept. We have not withdrawn our price increase, but it is clear that we'll have to wait for the introduction and acceptance of our higher value new products, improved industry dynamics, before we can benefit from significantly improved pricing. We continue to expect FCC Catalyst capacity to tighten in 2014 due to new refinery startups, the increased need of propylene for petrochemical feedstocks and other actions. We think industry utilization will be above 90% next year and expect us to be a key driver of improved industry dynamics in 2014. We remain focused on the fundamentals to make this business so successful and play to our strengths, namely providing the best product technologies and services available in the market at prices that allow us to make long-term investments in this business.

To that end, over the next 2 quarters, we are introducing 7 new catalysts and additive technologies that target the unique performance requirements of our customers. This includes 3 new products targeted for shale oil feeds, 2 new products for heavy resid feeds and 2 new products for improved propylene production. These are significant new product technologies, customers are demanding. And I'm personally very excited by the value they will create for our customers and for Grace.

We expect these new technologies to be an important lever for Grace to recover the sales volumes we have lost. As you know, our refining customers face high complexity in their operating environments with a broad range of potential crude sources and increased demands for environmentally friendly fuels and petrochemical feedstocks. Improvement in Catalysts Technology are often the best solution to our customers' challenges, and we are focused on ensuring our technology provides the highest value possible.

In addition, we are taking concrete steps to optimize our catalyst manufacturing operations. Specifically, we are permanently shutting down our silica sol manufacturing capacity in the third quarter. We have advised affected customers that we will be moving them to appropriate current generation technology. Although we're disappointed that our pricing initiative did not achieve its objectives, our refining catalyst business remains highly profitable and strategically strong. At the end of this transition, we expect that we will have restored our historical sales volumes at higher total value with lower manufacturing costs and the exact same focus -- with the exact same focus on product technology and our customers.

Let's discuss how this impacts our 2014 goals. To recap, about 2 years ago, we set a goal of $850 million in adjusted EBITDA by 2014, which included $50 million from bolt-on acquisitions. Since that time, we have achieved many of our sales and earnings growth objectives, including completing 3 acquisitions. We are on a pace to achieve the goals for our growth programs and are ahead of our expectations for productivity. Offsetting this progress, however, has been a significantly weaker global macroeconomic environment, operating challenges and our FCC Catalyst business and headwinds from pension and currency.

The new challenges in our FCC Catalyst business and a downgraded assessment of the global macroeconomic environment for 2014 have eliminated all of the remaining contingency we had in our 2014 adjusted EBITDA goal. As a result, we no longer see a reasonable path to achieve this goal. It is too early for us to give an outlook for 2014, but we think there is up to $30 million to $40 million of risk to our goal, reflecting the net effects of lower earnings in Catalysts Technology, a weaker macroeconomic environment, the benefit from the change in pension accounting and appropriate contingency for unforeseen events.

One final comment regarding our Chapter 11 emergence. Oral arguments for the 5 pending appeals were heard on June 17 before the Third Circuit Court in Philadelphia. At this point, we are simply waiting for the judges to issue their ruling and doing what we can to prepare for emergence. In fact, just yesterday, the court ruled in our favor with respect to the Garlock Sealing Technologies' appeal. We remain confident that we will receive favorable rulings on the other appeals and continue to target emergence by year end.

I'll now turn the call over to Hudson to provide more specifics on the quarter and our 2013 outlook.

Hudson La Force

Thank you, Fred. Please turn to Pages 4 and 5, and we'll start with a quick review of Grace's overall results for the quarter. Second quarter sales were $803 million, down 3% from last year. Pricing decreased 2.5% due to lower rare earth surcharges and currency translation was unfavorable 1.5%. The volumes increased 1%. Gross margin improved 100 basis points to 37.8% due to lower raw material and manufacturing costs. Adjusted EBIT was $142 million, down 1% from last year as lower sales more than offset lower raw material and manufacturing costs.

Adjusted EBIT margin increased 30 basis points to 17.7%, and adjusted EBITDA margin increased 50 basis points to 21.5%. Adjusted free cash flow increased 6% to $156 million for the first 6 months, primarily driven by improved working capital performance. Adjusted EBIT return on invested capital declined to 34% from 36%, reflecting lower earnings in Catalysts Technologies over the last 4 quarters. Adjusted EPS was $1.12 based on diluted shares of 77.6 million.

Let's turn to Catalysts Technologies on Pages 7 and 8. Second quarter sales for Catalysts Technologies were $291 million, down 12% from last year. Pricing decreased 9%, driven by lower rare earth surcharges. Sales volumes decreased 2%, reflecting the scheduled conclusion of a multiyear toll manufacturing contract for a polyolefin catalyst customer, partially offset by higher chemical catalyst sales. Refinery catalyst sales volumes were unchanged. Catalysts Technologies gross margin was 42% for the quarter, an increase of 170 basis points, primarily due to lower raw material and manufacturing costs. Segment operating income was $94 million, down 7%. Segment operating margin increased 170 basis points to 32.2% as lower manufacturing costs and higher ART earnings more than offset lower sales. Our share of ART's net income was $9 million, up $6 million from the prior year quarter. Q2 will be ART's strongest quarter this year.

As Fred noted in his remarks, our FCC pricing initiative has not achieved its objectives at this time. We have lost about $60 million in annualized sales volumes since announcing the pricing initiative in March. We expect Q3 sales to be -- excuse me, we expect Q3 sales to be about $20 million below Q2's level. We also expect a sequential decrease in segment operating margins of about 4%, reflecting negative operating leverage and lower ART earnings due to its lumpy quarter pattern. Overall, Catalysts Technologies earnings in Q3 will be below Q1 levels. For the full year, we expect sales to be down about $130 million from lower rare earth surcharges, lower sales volumes and lower base pricing. We now expect segment gross margin to be about 41%, flat with last year. Segment operating income will be down more than 10%. We expect sales volumes to recover beginning in Q4 based on the expected success of our new products and anticipated refinery startups.

Given this, we are taking specific actions to improve our returns in this business. First, we continue to drive our technology roadmap hard and recognize this as the best driver of value for our customers and for us. The new products designed for light feed, resid feed, resid to propylene production and other specific applications are exciting and are part of our strategy to recover lost sales volume. Second, we are permanently shutting our silica sol production capacity in Lake Charles this quarter. We expect to take a noncash charge of $3 million to $4 million in Q3 for the write-down of these manufacturing assets. We expect to reduce total manufacturing costs by over $2 million per year as a result of this capacity closure.

Silica sol, the old products, are about 1% of our refining catalyst sales, but have been a significantly higher percentage of our available manufacturing capacity. The catalyst business has had its share of volatility in the last 3 years, including the spike in rare earth costs in 2010 and 2011, refinery closures in 2011 and 2012 and the increase in competitive intensity this year. Although this volatility has had an impact on quarter-to-quarter earnings, the business continues to produce very high returns. Since 2010, we have increased our Catalysts Technologies gross margin by more than 400 basis points and adjusted EBITDA margin by about 600 basis points. We remain bullish on our opportunity to further increase our returns, and we'll do so through new product technologies, improved pricing as industry conditions allow and improved manufacturing productivity.

Let's turn to Materials Technologies on Page 9. Second quarter sales for Materials Technologies were $229 million, an increase of 2% from last year. Increased pricing of 2.5% and higher sales volumes of 2% were offset by unfavorable currency translation. Sales in emerging regions increased 4.5% and 8% organically, due to strong growth in emerging Asia. Sales in advanced regions were flat with last year as 4% growth in Europe offset declines in North America. In North America, sales of packaging products, particularly can sealants, were unfavorably impacted by lower demand for canned beverages due to the wet spring. Segment gross margin was 33.7%, an increase of 20 basis points compared with the prior year quarter. Gross margins declined sequentially due to a purposeful manufacturing strategy adopted in the first quarter as we noted in our Q1 commentary. Gross margin for the first half was 34.4%, an increase of 180 basis points from the prior year period and above our current target for the business. Segment operating income was $45 million, down 3%, largely due to the timing of certain annual operating expenses and unfavorable currency impacts.

Please turn to Page 10 for Construction Products. Second quarter sales for Construction Products were $283 million, up over 3% from the strong year ago quarter. Higher sales volumes of 4% and improved pricing of 2%, more than offset unfavorable currency translation largely from the Brazilian real and Japanese yen. Emerging regions represented 36% of segment sales for the quarter and grew a strong 12% year-over-year, mostly due to growth in emerging Asia and Latin America. Sales in North America, which are 40% of segment sales, were unchanged in Q2 as a 5% increase in Specialty Building Materials sales offset a 3% decrease in Specialty Construction Chemicals. Unusually wet weather in North America may have slowed construction activity and reduced demand for cement and concrete chemicals during the quarter. Sales in Western Europe, which are 14% of segment sales, decreased 4% for the quarter. But earnings grew nicely, reflecting continued success in improving gross margins and reducing costs. Notably, sales in Specialty Building Materials increased 7% due to major projects starts in the region. Segment gross margin improved 170 basis points to 36.8% due to improved pricing and the benefits of higher volume leverage. Segment operating income was up 28% and operating margin increased 300 basis points to 16%. This is our highest segment operating margin since the 2008 second quarter.

One final point before we turn to the 2013 outlook. We have decided to adopt the mark-to-market accounting method for our pension plans. As you know, many of our peers have already made this change. This change has been on our pension management roadmap since 2010, and we decided to make the change at this time for 2 reasons. First, with our March accelerated contribution, we have achieved much of the funding and derisking objectives that are the foundation of our pension management roadmap. And second, because of the recent change in expectations for long-term interest rates. When adopted in the fourth quarter, this new method will reduce our 2013 pension expense, excluding the effects of the annual mark-to-market adjustments by about $45 million compared with the current accounting method. To ensure you can properly and easily reflect the change in your models, we will issue an 8-K in the fourth quarter, summarizing the effect on the 2009 to 2013 full years and the 2012 and 2013 quarters.

Let's now discuss our updated outlook for 2013. We are updating our range for adjusted EBIT to $560 million to $570 million and for adjusted EBITDA to $685 million to $695 million. There are 2 significant changes to our 2013 outlook. First, we expect Catalysts Technologies sales to be down from our earlier expectations due to lower sales volumes in the second half and lower realization on our pricing initiative. We expect segment operating income to be about -- to be down about $35 million from our prior outlook. Offsetting this is lower pension expense of about $45 million due to the change in accounting method in Q4.

In total, we now expect 2013 sales to be just over $3.1 billion with an organic growth rate of about 3% for the year. The year-over-year sales headwind from lower rare earth and currency is about $130 million. The year-over-year decline from lower catalyst sales volumes is an additional $40 million. We continue to expect gross margin to be in the high end of our 36% to 38% range. Adjusted free cash flow should be over $400 million again, in line with our 3-year target of over $1.2 billion. Please continue to use a book effective tax rate of 34% on adjusted earnings and a cash tax rate of 14%. Diluted shares outstanding at year end should be about 78 million shares.

On an operating basis, our updated 2013 outlook is clearly lower than our April outlook. We don't like lowering our outlook, but we believe being transparent with you is more important. Our intent always is to incorporate our best judgment about the opportunities and risks we have and to provide an outlook that is as accurate and balanced as possible. Despite the near-term challenges, our business fundamentals remain solid. We have great businesses managed by strong teams with great growth opportunities, exceptional margins, higher cash flow and higher returns on capital.

With that, we'll open the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question is from the line of Mike Sison of KeyBanc Capital Markets.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

In terms of the losses on FCC due to the price increases, it's pretty big. And are you suggesting to some degree that competitors are not increasing prices to keep -- to sort of -- for the new trial volumes? And that it's unlikely you'll be able to sort of get that back into 2014?

Alfred E. Festa

Yes, Mike. This is Fred. Yes, we are. I mean, what we've seen is that we have seen our competitors not increase pricing and take some volume during this period of time. I mean what we really believe is that we need to present some new products, which we're doing. Those new products will be available for trials, as well as contracts over the next 3- to 6-month period of time, and we'll work our way back given that.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And given that, I don't recall competitors having a lot of capacity. If they actually keep this business, as new business comes up for the new plants in 2014, would you be better positioned to pick that up at better pricing given that you'd have the sort of excess supply, if you will, and that would probably be more of a positive, longer term, for you?

Alfred E. Festa

We hope so, yes. It would be. It would be a positive from that standpoint. When you look at the industry dynamics around FCC, I mean, we've been in the catalyst business a long time, right? And I've been at Grace 10 years. And we've seen this happen 1 or 2 times before and where markets get a little bit out of balance. But generally, the suppliers of catalyst have a goal of increasing their margins over time, getting their returns up. And that's done in the FCC business based on value provided to our customers and based on continuing to provide those values. So we believe that the share ratio will level back out. We're at our low end of our historical range for our share. We believe that we'll level back out over time. But we believe that the way to do that is through acceleration of new products, which we're doing, the adoption of those new products. And then finally, the proof of the value as our customers run those new products that allow pricing to be gained.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And then last question. If you're successful in terms of generating the new products and winning some of this trial business back heading into '14 as new business comes back, does the outlook that you've provided us in the past for catalysts, is that something that is achievable, let's say, in '15?

Alfred E. Festa

Yes. I mean, what's -- yes, is the answer to that. I mean, what the gating factors are, is, on how quick we can get the volume back is based on how quick the adoption of these new products are. The other factor is, how quick can we get -- how quick can we prove the value of these new products out there, as they're in the units? That will allow us to capture the pricing and the value that our customers are getting in and that we deserve. So that's the accordion in this thing. How quick could it happen and so on, and we're trying to put our best judgment out there at this point in time.

Hudson La Force

Mike, I'll just add that the other point that you made in your question was around tighter capacity going forward. We do still see that occurring, and that is all part of this improved industry dynamic that Fred's talking about.

Operator

Our next question is from the line of Mike Ritzenthaler of Piper Jaffray.

Michael J. Ritzenthaler - Piper Jaffray Companies, Research Division

I'd like -- I'm curious a little bit about how the challenges with the price increases have modulated across the various geographies, or if there is any noticeable difference?

Alfred E. Festa

Yes, I would -- Mike, I would say that it's really, really based -- 2 primary regions, one here in the U.S. and one in Southeast Asia. I mean, that's where the biggest effects have been.

Michael J. Ritzenthaler - Piper Jaffray Companies, Research Division

Okay. But less so in Europe? I guess that's a bit surprising.

Alfred E. Festa

Yes, yes, yes, less so in Europe and the Middle East. That's right.

Michael J. Ritzenthaler - Piper Jaffray Companies, Research Division

Okay. I'd like to then dive a bit into the strengths and weaknesses in Construction Products. I guess, a little surprised by poor FCC sales in North America, given some of the competitor numbers that are out there and the number of compare -- repair projects that are ongoing. And I guess, as a follow-up to that, looking at the margin improvement on the cost line, is that a fair characterization that it's cost productivity related, and is it likely to continue?

Alfred E. Festa

Yes. Let me put in a couple different perspectives. We -- in Europe, we do have a repair business, which is doing well. However, in North America, we're really not in the concrete repair business at all. So we haven't seen -- I haven't seen that piece of it. We do believe that our volume in construction chemicals, especially in North America, is tied to a lot of commercial activity. We're seeing that pick up. That productivity that we've embedded in it will sustain. So those margins that we're talking about -- we feel very, very good about. And we're -- as we looked at it, coming out of the second quarter, we do believe that the weather did have an impact with all the rain and so on. In the regions where we're strong, there wasn't a lot of pouring. As we see the weather is starting to improve, we're seeing improvements just starting even in the third quarter as July -- the first 2 weeks of July. So I am very bullish and I feel very good about our construction business. Not only that we've restructured it and from a productivity standpoint both in Europe, as well as getting the leverage in North America, the position we have in the emerging markets and it -- the bounce back is coming here.

Michael J. Ritzenthaler - Piper Jaffray Companies, Research Division

Okay. Just one last one for me on the new technologies in refining catalyst. I guess in shale blending in particular. Can you describe a bit about your process for coming up with these new products and how customers pull them in, or how you identify these opportunities? Just a little bit on the philosophy side there.

Alfred E. Festa

Yes. I mean, through this last 3 months, as you can imagine, we've had a lot of conversations with our customers, probably more than we would have liked to have given some of the losses. But through all those conversations, we asked them, "What do you need? What do you want?" And that prioritized down the list. And on the shale blending, they are blending shale. They may have some straight shale that are running, and they would like to have us, which they're not seeing out there now, a product in the marketplace that can handle some of the metals, as well as get the activity that they need. So as I said, it's really been based on those discussions. Now why do we feel good about that? We know there are significant amount of trials coming up in the next 6 months where we can introduce these products to their units, as well as other competitive bid. So there's the combination of those 2.

Operator

Our next question is from the line of Brian Maguire of Goldman Sachs.

Brian Maguire - Goldman Sachs Group Inc., Research Division

I was curious on the refining volume losses that you're seeing from trialing of other competitive materials. Is that more on the low value-added or what you'd consider low value-added, low margin part of the portfolio? Or is it more broad and widespread than that?

Alfred E. Festa

Well, just to recap, we did achieve some pricing and I would call it the high value-added customers. So we did -- even the pricing we went out with, we did achieve some pricing. Where we did see the volume loss, your characterization is correct. It's more on less complex, less value-oriented buyers.

Brian Maguire - Goldman Sachs Group Inc., Research Division

Does that have a -- I understand there'll be some fixed cost absorption issues. But other than that, will there be some margin benefit then to that volume mix shift a bit?

Alfred E. Festa

We hope so. We hope so, for us, moving forward on this, I mean, from -- well, we look at it as, we've had this underutilized silica sol asset. That's a low value product. Customers are moving away from silica sol very quickly. They're not getting the activity that's needed out there. For us, we wanted to shut that capacity down, take the financial benefit of removing those fixed costs that we had to absorb and really move this product slate to what our customers want.

Brian Maguire - Goldman Sachs Group Inc., Research Division

And do you have a targeted cost savings number for the rationalization of that plant?

Alfred E. Festa

Yes. I think it was $2 million to $3 million on that side of it, plus we're looking at across the system of our other assets around the catalyst from an optimization side, and there may be another $2 million to $3 million in the scheme of things.

Operator

Our next question is from the line of Laurence Alexander of Jefferies.

Robert Walker - Jefferies LLC, Research Division

This is Rob Walker on for Laurence. I guess as you think about your -- the new 7, new technologies that you've incorporated into the next -- in this current new line of catalysts -- as you think about that as, collectively, how does that compare to, in terms of, from a technology standpoint, kind of a yield uplift to when you guys came out with the low to no rare earth catalyst, those were clearly very favorably received. Did the new products deliver comparable yield uplift, or are they more evolutionary? And can you talk about the overall R&D pipeline in that business and your confidence to be able to achieve more yield with further generations?

Alfred E. Festa

Yes. I would characterize it this way. I would say that the shale, the lighter is more of an evolutionary new product that's coming out. I would look at our propylene yield, that is truly a new product that will benefit on the yield standpoint. That activity on that catalyst will be significantly higher than our current ZSM-5 type catalyst that are out there. And we're very excited about that side of it, and we're very excited to get that in the units. On the resid -- on the cracking, the heavy, the resid, that's just another typical product step that we make. We -- listen, we feel good about those products. We feel confident about the products. If we could accelerate it, the acceleration is going to be based on how quickly we can get them into these units to get the trials out.

Robert Walker - Jefferies LLC, Research Division

And given the increased pushback, I guess relative to maybe your initial expectations, can you guys pull forward more R&D to try to create more value with -- to make the conversation easier?

Alfred E. Festa

Well, that's exactly what we're doing. I mean, we've shifted student body right on the technology side, moving people from other business areas into the R&D technologies area for the FCC, just to do that side of it. I mean, that's been the last 6 weeks, as well as reconfiguring some of the operations to be able to run these trial runs very quickly.

Robert Walker - Jefferies LLC, Research Division

Great. And then just briefly, any update to your free cash flow guidance? I guess before you talked about 2012 to 2014 being greater than $1.2 billion on adjusted basis. Any change there? And I guess, could you talk about what allows you to keep your free cash flow guidance this year unchanged?

Hudson La Force

That's still our expectation, Rob. As sales volumes come down, working capital requirements come down naturally. And we did have some -- we thought we would do better than $400 million this year. We know we'll still hit $400 million. I guess the other thing I should say is, we are going to cut back a little bit on capital spending this year, really driven more by a reassessment of the macro environment into next year. As you know, we work hard to make sure that we're spending our capital at the right time, and so we are going to delay some projects until we see the macro environment firm up.

Operator

Our next question is from the line of Chris Shaw of Monness, Crespi.

Christopher L. Shaw - Monness, Crespi, Hardt & Co., Inc., Research Division

I'm going to ask about the $60 million on the catalyst again. I just want to make sure that's all that's anticipated volume loss -- none of its sort of the anticipation of not getting pricing in that number?

Hudson La Force

That's all volume.

Christopher L. Shaw - Monness, Crespi, Hardt & Co., Inc., Research Division

And you've characterized some of it, I think, as customers using trial volumes of competitor product. Does that -- how -- if that's the case, I mean, do the customers typically -- is there a trial period, and then they make a decision? Or the $60 million -- that $60 million number reflect that you don't think those people trialing are going to come back to you guys afterwards or...

Alfred E. Festa

Yes, Well, it is a combination. There are trials that are out there, but there are actual accounts that -- we had these accounts and because of the raising of the pricings -- because of the undercutting of the pricing, that we lost that volume.

Christopher L. Shaw - Monness, Crespi, Hardt & Co., Inc., Research Division

Okay. And then just on the pension. Is the $45 million impact -- would that be a sort of similar impact for 2014? Or do you think that will fluctuate one way or the other?

Hudson La Force

No. That's what we've got in our model for 2014, too.

Operator

[Operator Instructions] So moving on, our next question is from the line of Ben Kallo of Robert W. Baird

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

Overall, on the catalyst business, I think you've touched on this all, but it sounds like it's becoming more competitive and people are willing to cut on price. Is -- do you think this is because of your competitors', maybe, weakness, characterize it like that, in their business units? And do you see it persisting? Or does that -- does that just -- is it ebb and flow? And then, as I think about Al Dahra, is there any change there in how you look at expanding capacity?

Alfred E. Festa

Yes. Just to answer the second first, around the Al Dahra and that's the new plant in the venture in Abu Dhabi. No, we don't see it -- this phenomenon impacting that at all. I don't know what -- we've been through these cycles before and there's a lot of factors that move up a seller of a catalyst and some may not be related to the catalyst business at all. So I really couldn't speculate that. I know that catalyst suppliers want to continue to move their margins up and the only way to do that is through value -- providing value to our customers and helping them solve their issues.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

And I guess, big picture, I think you're 10 years deep into this bankruptcy navigation. As you think about whether it's Q4, Q1 or sometime next year, emerging, I guess, where do you see yourself and what direction do you think you take the company from here?

Alfred E. Festa

Well, we've done a nice job of separating the 2, the bankruptcy side of it from the growth. And I don't see any reason whether we emerge -- as we emerge here shortly, that we won't continue on the path of growing this company and the platforms we have. We've had nice growth in construction by going into emerging regions with new products. We've got some new technology on the horizon on that side of it. If you think of the engineered materials, it's been the same. It's been the same with some new products as we've expanded in the discovery science side of it and the bios -- in the bioscience side as well. And then you look at catalyst. Catalyst, where we built out our propylene -- our polypropylene franchise where it was only polyethylene, what, half a dozen years ago. And as we have expanded the capacity on the hydrocracking side and got into that business and run the hydroprocessing. So I continue to see it -- we'll continue to push this playbook.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

And my final one, maybe Hudson, as I look at the construction side of the business, how much more leverage is there if we get uptick? Can you give us a little thought on where operating margins can go?

Hudson La Force

We've said, we think we get to high teens, 18%, 19% type teens, once we're back to that peak spending levels in North America. And I think, if you look over the last 4 quarters -- I might be off a quarter or 2 there, but the last few quarters, we've seen fantastic flow-through on the volume increase in North America. It's -- we're seeing high-30s, even 40% incremental margins. And we think that will continue. That's part of what we saw in Q2, and we're not back to peak. We're not going to be back to peak next year, probably even the year after that but that's the earnings potential in this business.

Operator

Our next question is from the line of Jim Barrett of CL King & Associates.

James Barrett - CL King & Associates, Inc., Research Division

Fred, a question for you. Is the price reaction in FCC Catalyst, is it one competitor who is reacting, or is it 2 or more?

Alfred E. Festa

Well, I think there's only 3 basic competitors.

James Barrett - CL King & Associates, Inc., Research Division

Right. Only 3, understood. Yes. So that was -- I guess then it would be the -- have 2 competitors not followed your lead or just one?

Alfred E. Festa

No, it's -- I mean, Jim, it's generally the industry. I'm not going to single out anybody on this call.

James Barrett - CL King & Associates, Inc., Research Division

Well, I was really more interested in whether it was multiple competitors or just one competitor who is not following your lead. But sort of a related question, of your 7 new products, if they meet your sales target, can you give us some general sense of what percentage of your sales they would represent on a normalized basis as we look to 2014, maybe 2015?

Hudson La Force

Jim, we're not going to be that specific. But I will tell you, these are more significant new product introductions than we typically have. More -- much more, significantly more than we typically have, but not nearly the impact that we saw from the rare earth catalysts a couple of years ago.

James Barrett - CL King & Associates, Inc., Research Division

That's helpful. And the final question, Hudson, if I'm reading the comments on the pension accounting correctly. I understand it's noncash, but should I conclude that going forward, your GAAP pension expense will fairly approximate your cash pension expense going forward in '14, '15?

Hudson La Force

Yes. There will still be some differences, Jim. But the 2 numbers will be much, much closer.

Operator

Our next question is from the line of Chris Kapsch of Topeka Capital Markets.

Christopher Kapsch - Topeka Capital Markets Inc., Research Division

Just don't want to beat this one to death, but did want to follow-up on the competitive dynamic in the FCC space, given what's happened on your pricing initiative. So just curious if the -- based on what you're saying, if you're sort of abandoning the price increase initiative on your core products, notwithstanding your comments about positioning newer products later in the year to try to regain some of this lost market share?

Alfred E. Festa

I mean, Chris, we're not. I mean, we've initiated some product pricing. We've got some of that product pricing. I think it's a matter of timing, so that's not off the table. But to achieve that product pricing, our customers want to know, okay, give me additional value then. Give me -- what's that value play I'm going to get? And that's through the products, the new products.

Hudson La Force

We've tried to be very clear that we remain focused on improving the returns in this business. We're doing it the way that we've done it for 70 years, which is to drive value for our customers through new products and we're also reducing our manufacturing costs at the same time. That's the equation.

Christopher Kapsch - Topeka Capital Markets Inc., Research Division

Got you. And then -- so one of the innovations that you've brought to the table over the last couple of years when rare earth prices went through the boom-bust cycle was the reduced lanthanum content products, which you migrated your customers to. And so I'm wondering, now that lanthanum prices have sort of more normalized back to historic levels, is there any demand or mix shift from your customers trying to shift back towards the sort of older or higher lanthanum containing products as a way for them to achieve higher activity levels or better yields? And then I'm wondering if that's playing into the dynamic whatsoever in terms of the increased competitiveness that you've alluded to or any of the share shifts that are taking place?

Alfred E. Festa

Yes -- no. I've -- some have requested products that contain a higher level. But we really don't believe that, that has any impact on the share loss that has occurred. It's in specific isolated accounts and so on.

Christopher Kapsch - Topeka Capital Markets Inc., Research Division

Okay. And then if I could just follow-up on -- the contribution from ART in the quarter was -- just wondering if that strong earnings performance from the JV -- was that more seasonally related or obviously, that business, more hydroprocessing tends to be lumpier, not consumable like FCC? So I'm wondering if the performance there was just some lumpiness in order shipments or I think you called out of that being down sequentially for the balance of the year versus these second quarter levels. Could you speak to that?

Hudson La Force

It's a combination. It's a combination, Chris. There is a lumpiness to this business as you pointed out. And that was -- that's part of what we're seeing. This Q2 was the strongest -- will be the strongest quarter for this year. I think we were comparing to the weakest or maybe one of the weaker quarters last year on the base business. We're also seeing very nice progress with our commercial agreement on hydrocracking catalysts. And when we look at ART for the full year, we see it up strong double digits. I think we've said, up 20% for the year. We're having a good HPC catalyst year and the hydrocracking agreement -- commercial agreement is working well for us.

Operator

Our next question is from the line of Mike Sison of KeyBanc Capital Markets.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Just a follow-up. I guess if you had a do-over, would it have made sense to maybe raise prices a little bit less on the FCC business versus what you did or -- to sort of protect some of that volume?

Alfred E. Festa

Yes. It would be -- yes, is the answer to it. I mean, if I had a do-over, I would do it a little bit differently. Maybe I would have brought out some of the new products first. But yes is the answer.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Is there a change in the way customers -- I mean, because I can imagine that trialing products are better -- superior than yours, for what it's worth. In addition, given you're the incumbent, you tend to have the better sort of feel, if you will, in terms of how to optimize the plants. Are they willing to take maybe a slightly less good catalyst for a better price?

Alfred E. Festa

No, I don't really think there is any change in the customer behavior. I think this is an abnormality that manifested itself at a higher degree than -- these happen all the time. I think it just -- they've happened in the past. I think it just manifested itself at a higher level than it has in the past just because of certain circumstances. That's all. But the consumer behavior really hasn't changed.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. So the bottom line is, as you roll out these new products and you start getting some trialing of some of these incumbent business or maybe some other areas, as we head into '14, if you're successful, we should see maybe a similar commentary that you have volume wins that can carry some growth next year.

Alfred E. Festa

That's what we believe and that -- we believe that we will reap -- the share levels across the industry will come back to equilibrium and our share will be based on what it's been.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And then on the bankruptcy, you had one win. The -- any update on the timing, judging, going forward?

Alfred E. Festa

No. I mean, we were surprised, not by -- not surprised by the results, just surprised by the timing. As you know, the opinions on these appeals have been all coming at once, and we're cautiously optimistic that maybe the judges are working on them all and they may not wait for them all to be done and they may come out this way, so it's encouraging.

Operator

[Operator Instructions] So moving on, our next question is from the line of Patrick Duff of Gilder.

Patrick Duff

Most of the questions I was going to ask, I think have been addressed. Just a couple of, I mean, small things here. Any update or insight on the Lummus joint venture that was announced last year? How that's going so far? What results you're seeing in the market with the enhanced relationship with them?

Hudson La Force

Pat, this -- I referred to it as the commercial agreement on hydrocracking when we were talking about ART, but that's the agreement that we're talking about. It's going well. It's an important part of our ART earnings growth this quarter. We're off to a good start. We're quite pleased with it.

Patrick Duff

Right, great. And this might not be the forum, but I'm just going to take the opportunity to ask. Considering the continued buildup of the free cash flow, and you've all been public about how you plan to use your balance sheet post emergence. I'm just wondering if you've considered, similar to the arrangement that you struck with the warrants, whether or not you have considered having any discussion with any financial intermediaries for -- I mean, I know you cannot go in and do any repurchases of the stock, but whether or not you've considered to doing any kind of phantom repurchases through derivatives or what have you to try and set up a predetermined price at which you might repurchase stock in the post emergence?

Hudson La Force

Pat, it's a fair question. We look at a lot of different things to optimize our balance sheet, our operations, our capital structure, but nothing that we could comment on at this point.

Patrick Duff

Okay. And then just lastly, I mean, you -- Fred, you touched upon the fact that you were a little bit surprised with the timing of the Garlock ruling. And to the best of my knowledge, I don't believe -- as you said, they've always been blanket rulings. I don't want to be any kind of a pessimist, but is there any reason to think that any of the other rulings are getting enhanced scrutiny by the Third Circuit as opposed to earlier courts, any cautionary thoughts about this?

Alfred E. Festa

We don't think so. I mean, we really don't. We think -- as we've said before, we thought these opinions would take 3 months to come out. This one came out in 4 weeks -- 5 weeks. So we look at that as an encouragement that these -- that judges are working on these.

Operator

We have one more question, and it's from the line of Chris Shaw of Monness, Crespi.

Christopher L. Shaw - Monness, Crespi, Hardt & Co., Inc., Research Division

Just one follow-up, just to continue to beat the FCC dead horse. But do you think -- was the price negotiations any trickier because of getting rid of the metal surcharge? And I'd actually somewhat thought maybe because with metals prices coming down that overall pricing was coming down and that they wouldn't be as sensitive to your price increase. But was there any dynamic there with the metal surcharge and all that you could see?

Hudson La Force

I don't think so, Chris. It's -- we've been pretty transparent with our customers on this over the last few years. They're sophisticated, and there's a careful communication, careful analysis that has to happen. But I don't think it affected decisions.

Operator

So ladies and gentlemen, that now concludes your question-and-answer session. I would now like to turn the conference over to Mr. Mark Sutherland for closing remarks.

J. Mark Sutherland

Yes. So I thank you, Lisa. And I just like to say thank you to all of you who signed on this morning and heard our comments. I'm available for direct follow-up. My direct line is (410) 531-4590. And we'll be in touch with you throughout the quarter. Thank you.

Operator

Thank you very much. Ladies and gentlemen, that concludes today's conference. You may now disconnect your lines. Have a good day. Thank you.

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