W. R. Grace & Co.
Q3 2014 Earnings Call Transcript

Published: 22 Oct 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the Third Quarter 2014 W.R. Grace & Co. Earnings Conference Call. My name is Tony and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. David Joseph of Investor Relations. Please proceed.

[David Joseph:]

Thank you, Tony. Hello everyone and thank you for joining us today to discuss our third quarter 2014 results released this morning. Joining me on the call are Fred Festa, Grace's Chairman and Chief Executive Officer; and Hudson La Force, our Chief Financial Officer. Our earnings release and corresponding presentation are available on our website. To download copies, go to grace.com and click on Investors. Link to the earnings release and slide deck are available under the Quarterly Results section. Some of our comments today will be forward-looking and are made under Section 27A of the Securities Act [Audio Gap] of the Exchange Act. Actual results may differ materially from those projected or implied due to a variety of factors. Please see our recent FCC filings for more details on the risks that could impact Grace's future operating results and financial condition. We will discuss certain non-GAAP financial measures, which are described in more detail in this morning's release and on our website. Reconciliations for the most directly comparable GAAP financial measures and other associated disclosures are contained in our earnings release and on our website. These comments on forward-looking statements and non-GAAP financial measures apply both to prepared remarks and to the Q&A. With that, I'll turn the call over to Fred.

[Alfred E. Festa:]

Good. Thanks, David, and good morning to everyone, and thank you for joining us. The headline for me was we had a very good quarter. Our sales grew 11%, and earnings grew 27%. All 3 businesses achieved solid sales growth and strong margins, and as important, our cash flow grew 14% year-to-date. The third quarter results gave us the confidence to narrow our earnings outlook and increase our cash flow forecast. We expect 2014 adjusted EBIT to be in the range of $625 million to $630 million, and we expect adjusted free cash flow to be $430 million or more. Over the past couple of weeks, investors have asked how the lower price of crude oil will impact our catalyst business. We believe that recent drop in crude oil prices will have no significant effect. Our business is driven by end-user demand for transportation fuels and plastics. Generally, lower feedstock costs, including lower crude oil prices, are good for end-user demand. Volatility in feedstock cost has little, if any, effect on our catalyst volume or prices. Let's take a look at our Catalyst Technologies business. Overall, catalyst results were better than we expected, with strong growth in all 3 product groups. FCC catalyst grew 10%; specialty catalyst grew 8% before the UNIPOL acquisition; and sales in our ART hydroprocessing catalyst joint venture grew double digits. Adoption of our new FCC catalyst introduced over the last year has been very good. We are ahead of our sales plan for these products and expect them to account for over 10% of the FCC catalyst sales this year. As you will recall, these products were developed to help our customers meet the specific requirements of processing shale feeds, heavier feeds and maximizing propylene production. The quick adoption of these products underscores our ability to commercialize the right technologies to meet our customers' changing requirements. These new products also helped us to return to our historical FCC catalyst position in the third quarter, about 1 quarter earlier than we expected. Our joint venture in ART had a much better quarter with good growth and solid earnings. We addressed the issues we experienced earlier this year, and we expect strong quarter 4 results in the joint venture. Shifting gears to Materials Technologies. Sales grew 4%, led by 7% sales growth in Engineered Materials. We saw good growth in North America and Asia, but sales were weaker in Europe beginning in August. European market demand has slowed, and we expect it to continue to slow in the fourth quarter. In this environment, we're focused on driving growth in the faster-growing markets, where we are -- where we have introduced new products, and reducing cost where growth is slow. Construction Products also had a good quarter, with sales growth of 7% and gross margins of almost 37%. Cement and concrete chemicals grew 9%, with double-digit growth in North America and Asia. Sales of nonresidential building materials grew 10%. We saw a pickup in commercial and infrastructure starts during the quarter, offsetting the project delays we saw in Q2. We're pleased with the growth we're achieving in both FCC and nonresidential building materials. We're growing at or better than the market, with good margins and good earnings leverage. Our North America residential building materials business has performed below our expectations this year. We are working with our channel partners to reposition this business to take advantage of growth opportunities in the future. Grace is well positioned as we exit 2014. I'm excited about the investments we're making to protect and nurture our high-growth opportunities. It is also clear that the global macroeconomic climate will remain challenging. We'll continue to manage our business to maximize performance and ROIC. With that, I'm going to turn it over to Hudson for some more specifics.

[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. Sales were $856 million, an increase of 11% from last year. Segment gross margin was 38.6%, an increase of 170 basis points. Adjusted EBIT increased 27% to $181 million, and adjusted EBIT margin increased 270 basis points to 21.1%. Adjusted EBIT ROIC was just under 30% and on track to exceed that level by year-end. Adjusted EPS was $1.07 based on diluted shares of 75.6 million. Let's turn to Catalysts Technologies on Page 6. Third quarter sales were $329 million, up 20% from last year and up 9% x UNIPOL. Gross margin was 42.5%, up from 39.2% last year. The higher gross margin primarily was due to higher margin polypropylene catalyst and licensing sales and better manufacturing costs. Segment operating income was 100 -- $101 million, up 30%. Our FCC catalyst business has a strong correlation to end-user demand for transportation fuels on a global basis. We also have a positive correlation to FCC unit utilization rates and an inverse correlation to feedstock quality. We see little, if any, direct impact from absolute oil prices or refinery margins. In the last 5 years, crude prices have moved between $100 and $80 per barrel multiple times, with no discernible effect on our catalyst volumes or prices. From a commercial perspective, changing market dynamics create opportunities for us. When our customers see shifts in their business, they expect us to help them find solutions. The success of the new products we introduced last year demonstrates our ability to leverage our technology to provide our customers with the products they need to optimize their results. Said differently, we're long change in complexity much more than we're long oil [ph], and we expect change in complexity to be at constant in the markets we serve. Let's move to Materials Technologies on Page 7. Third quarter sales for Materials Technologies were $229 million, an increase of 4% from last year. Sales of Engineered Materials increased 7% due to higher sales volumes, favorable currency translation and improved pricing. Sales increased double digits in North America and Asia, more than offsetting weakness in Europe and Latin America. Sales in the coating end uses, our largest end-use segment, increased 12% in the quarter. Segment gross margin increased to 35.3%, driven by improved pricing and investments in manufacturing productivity and energy efficiency. Segment operating income increased 4% to $49 million. Segment operating margin was 21.3%. Please turn to Page 8 for Construction Products. Third quarter sales for Construction Products increased 7% to $298 million. Sales volumes increased almost 5%, and pricing improved 3%. Sales of Specialty Construction Chemicals increased 9%, with strong growth in North America and Asia. Sales of Specialty Building Materials increased 5% overall. Sales in the commercial and infrastructure applications increased 10%, but sales in our North America residential business declined during the quarter. As Fred mentioned, we're working with our channel partners to reposition this business for better growth. This effort began in Q2 and will be complete in Q4. Segment gross margin increased 50 basis points to 36.8%, primarily due to higher sales volumes and improved product mix. Segment operating income increased 7%. Higher operating leverage from our growing FCC and non-res SBM businesses was partially offset by lower sales in residential SBM. Let's touch on a few corporate items and then our outlook. During Q3, we settled the personal injury deferred payment obligation, or PI DPO, and considered this as significant positive for Grace. The original terms of the PI DPO called for a total of $1.55 billion in payments from 2019 through 2033. We settled the obligation for $632 million, representing a discount rate of 9.2%. Compared with our 5.25% financing rate, this represents a pretax cash savings of $250 million over the life of the PI DPO. In addition, the settlement simplifies our capital structure and eliminates the unusual noncash interest accretion we have been reporting since emergence. Finally, the settlement adds to our NOL and extends our low cash tax rate into 2021. The settlement was the primary purpose for the $1 billion bond financing we completed last month. The bond proceeds also will be used to settle the warrant when it is exercised and for other corporate purposes. Cash on the balance sheet at September 30 was $608 million, with net debt of $1.9 billion. Net debt to trailing 12 months adjusted EBITDA is 2.6x at quarter end. Total available liquidity is about $1.2 billion. Adjusted free cash flow for the first 9 months was $330 million, 14% ahead of last year. Year-to-date, we have spent $334 million to repurchase 3.5 million shares. In Q3, we spent $101 million to repurchase 1.1 million shares at an average repurchase cost of about $96 per share. At recent market prices, we would expect to complete our current repurchase authorization before February. Also, during Q3, we recognized [Audio Gap] retiree benefits. Most of the gain relates to current employees or retirees of current businesses and is included in adjusted EBIT. Net of another item in the Q3 P&L, the benefit to adjusted EBIT was about $11 million or $0.09. A couple of quick points on our outlook, and then I'll turn the call back to Fred. We are narrowing our adjusted EBIT outlook to $625 million to $630 million. This reflects our good Q3 results and good business performance, offset by the negative effects of a stronger dollar and lower demand in Europe. Our outlook is based on a euro, U.S. dollar exchange rate of $1.27. The stronger dollar is a substantial headwind to our Q4 results, reducing sales by about 3% and earnings by $5 million to $8 million. With strong year-to-date performance, we've increased our adjusted free cash flow outlook to $430 million or more. At yesterday's closing price, this equates to a 6.3% free cash flow yield. Fred?

[Alfred E. Festa:]

Thanks, Hudson. I wanted to wrap up the call and just express again how I view how we finished the third quarter. Do I wish the global macroeconomic conditions were better? Yes, but when I look at what we've successfully needed to complete this year, we are well on track or ahead of that. If you remember, going into the beginning of the year, we needed to restore our position in our FCC catalyst business. We completed that with the new product introductions and the market adoption. We needed to integrate our UNIPOL acquisition. That has been flawless, and actually, we're ahead of plan. If you think about our hydroprocessing catalyst business, we were way behind the curve with some of our first quarter and second quarter issues. We have fixed those issues. You see good performance in the third quarter, and you'll see better performance in the fourth. We needed to deliver on our productivity initiatives. Those are behind us and functioning very well for us across the business. We needed to capture the pricing in our construction chemicals business both in North America and Latin America, and we've successfully completed that. And finally, we had a back-end-weighted plan and we needed to deliver the strong second half results. The year is not over, but we've accomplished a lot, and we are better positioned today than we were at the beginning of the year. With that, David, we'll open it up for questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Mr. Mike Sison of KeyBanc.

[Michael J. Sison:]

Fred, in terms of the fourth quarter, given some of the headwinds that maybe are perceived for oil or whatever, which you clearly -- shouldn't be an issue, but Europe is kind of weakening, how do you see the growth in catalyst in the fourth quarter, roughly?

[Alfred E. Festa:]

Yes, it'd probably be good to just replay our third quarter for a minute. I mean, when we went into the third quarter, our third quarter, we were expecting very heavy turnarounds from our customer base, and we got those turnarounds, the heaviest of the year. However, the customers that did not have turnarounds ran harder, which was a very good sign for us. As we go into fourth quarter, we see it's similar to the third quarter. There'll be turnarounds not at the same level, but everything we see in the order books are strong for us on the catalyst side.

[Michael J. Sison:]

Great. And then when you think about FCC catalyst heading into 2015, it does seem that some big projects are coming on for folks. You've done a good job in the last couple of years giving us a feel for where the industry is at and maybe the potential for pricing. Any thoughts as we head into '15 in terms of where we are, in terms of operating rates for the industry and potential for pricing?

[Alfred E. Festa:]

Yes. Our back half or the second half of the year for FCC catalyst will grow about 8%. We're going to have some tailwind behind us, as you said, because some of the projects are coming on, some that have been delayed and so on. On the pricing side of it, we'll evaluate it. It's more product-specific more than across-the-board, and I know our pipeline is good based on some of the new technology we have, especially on the polypropylene side. So yes, I'm encouraged on the Specialty Catalysts as we enter 2015 and where we're exiting at.

[Michael J. Sison:]

Okay, great. And last question, Hudson, you talked about -- Hudson talked about a lot of liquidity availability there, stock buybacks completing up. Can you give us an update on -- so your priorities for cash, anything in the acquisition front? What are your plans are if there are good acquisitions? And we get -- we start to move into '15?

[Alfred E. Festa:]

Yes, let me address the acquisition side, and then I'll turn it over to Hudson. We're seeing more deals, and we're actually seeing some of the pricing start to moderate. As I said in other calls, I thought pricing was very rich going through the year. I think we're seeing some moderation in that, and we're positioned to take advantage if those opportunities come up.

[Hudson La Force:]

I don't have anything to add really. I'll just -- I'll remind everybody of the framework that we have in place. We do prioritize our internal investments. We have terrific growth. [Audio Gap] of investments for us over the next 2 years. Fred made a comment on bolt-ons. We don't always -- we're not always able to predict the amount or timing of those, and when we have excess cash, we'll want to return a significant portion of that to shareholders.

[Operator:]

Your next question comes from the line of Mr. John McNulty of Crédit Suisse. [Technical Difficulty]

[Alfred E. Festa:]

John, are you there?

[Operator:]

Your next question is coming from the line of Mr. Brian Maguire of GSK (sic) [GS].

[Brian Maguire:]

Yes, I appreciate all the comments on the impact of lower oil. Just thinking it through, do you see your customers shift their feed slate to lighter crude as the price of Brent or WTI comes down? Or do you just see the heavier sour kind of crudes respond about by going lower? And I know there's also -- you mentioned in the last couple of quarters, in Europe, they've been sort of disadvantaged a bit, but with the strength in the dollar, weakness in the euro, I'm just wondering if there's any benefit from lower Brent to maybe your European customers.

[Alfred E. Festa:]

Yes. Let me start with the last part of the question. Yes, we are seeing some benefit to our European customers. They ran heavy and hard in the third quarter basically because of that advantage they're having. Across-the-board in the U.S, we're seeing -- they're either running very heavy or they're very -- running very light. There's Middle crude. There's West Africa, and it seems to be going more to Asia on that side. So we're following it very closely, working with our customers, trying to give them the most flexibility we can on that side of it, but as we said, Brian, we think as long as demand holds up for both plastic side as well as transportation, we feel we're in a good position.

[Brian Maguire:]

Okay. And Hudson, I appreciate quantifying some of the FX hit. I think you said $5 million to $8 million hit in the fourth quarter from the strength in the dollar. Can you just remind me the sensitivity on the $0.01 move and the euro just so that we can kind of keep track of it as that bounces around versus the $1.28 you guided for? And then if you were just to look out to 2015, what kind of incremental impact might you expect in 2015 if it stays at $1.27?

[Hudson La Force:]

The -- it's $0.01 -- for each $0.01 change in the euro, U.S. dollar exchange rate, that's about $2 million per year annualized for us, and the euro is 2/3 or 3/4 of our total currency exposure. And so what we're seeing now is more about stronger dollar than weak euro. So the euro is the biggest single exposure, but it's not the only exposure. And in terms of the impact on 2015, frankly, the impact that we've quantified from Q4 is a pretty good proxy of what you would expect heading into next year on an annualized basis if currency stayed where they are today.

[Brian Maguire:]

Great. And just one last one, if I could sneak it in. Is there any kind of cost reduction efforts or other things you can do to kind of mitigate some of that FX impact or anything you guys are contemplating at this point?

[Alfred E. Festa:]

Yes. I mean, yes, we're -- I mean, we're looking at it across-the-board. In Europe, in general, some of our short-cycle businesses in the Engineered Materials, we did see a slowdown in the third quarter, and we're taking some cross actions on that side of it. We're also looking at our supply chain. Are there ways to take advantage of the dislocation and move cost around relative to what we'll buy on that side as well? So -- now these programs are active and will continue to accelerate. We won't just take it for what it is. We'll work them very hard, as we always do.

[Operator:]

[Operator Instructions] Your next question comes from the line of Mr. John McNulty of Crédit Suisse.

[John P. McNulty:]

So a question with regard to the catalyst business. I was kind of expecting -- in terms of pricing in the third quarter, I thought you would annualize some of the issues from the prior year and yet, we still saw pricing down a couple of percent. So I guess, I was curious what's driving that, whether it's some mix-related issues or if there's anything else you can maybe shed some light on for us.

[Hudson La Force:]

John, it's 2 specific situations as we work to move that business forward. It's not something that we think is fundamental to the operations.

[John P. McNulty:]

What are those 2 issues?

[Hudson La Force:]

I'm not going to elaborate.

[Operator:]

Your next question comes from the line of Mr. Laurence Alexander of Jefferies.

[Laurence Alexander:]

So first, could you give some incremental -- some sequential color on the trends in Materials Technologies and the end markets that you're seeing acceleration or deceleration?

[Alfred E. Festa:]

Yes. Laurence, it's Fred. In our packaging business, the DAREX business, we've seen that business basically flat, really tied to a lot of the consumer beverage side of it, as well as some canned packaging and so on. On the flip side, our Discovery Science, our fine chemicals, that is experiencing double-digit growth on that piece of it, and we're seeing strong growth in our silica business related to coatings, coatings applications that go into be the white goods, through architectural coating. So we feel good about that.

[Laurence Alexander:]

And in catalyst, it's been a while since we've had a noticeable spike in the raw materials. So as you look at the Q1 sort of cost spikes in the past, the zeolite or rare earth or molybdenum, are any -- what's your comfort zone on the supply, demand balances in those over the next, say, 4 to 6 quarters?

[Alfred E. Festa:]

Yes, we are very comfortable with that side of it. We -- both from rare earth to -- all the way through the hydroprocessing catalyst, the metals as well. We don't see any dislocations coming on that side of it.

[Operator:]

[Operator Instructions] Your next question comes from the line of Mr. Mike Ritzenthaler of Piper Jaffray.

[Michael J. Ritzenthaler:]

Can you remind us on where we are for Grace's share of ART net income for the year -- for year-to-date versus '13 and what the full year expectations are for ART versus last year?

[Hudson La Force:]

I think we're $11 million year-to-date, thereabouts. Mike, it was $6 million in the third quarter, and I don't -- I'm sorry. I don't have an exact year-to-date number in my mind, but it's pretty close to that. Full year, we expect to be about flat from last year.

[Michael J. Ritzenthaler:]

Flat to last year, okay. And then what's the year-to-date contribution so far from UNIPOL? Is that something that you can break out separately?

[Hudson La Force:]

Yes, we said when we bought it that we would expect about $30 million EBIT contribution this year, and the business is on track. We expect it to achieve that on a full year basis and -- in the first 2 quarters, we had the integration costs and all of that. That's all behind us now, and Q3 was a pretty clean read on what the UNIPOL contribution would be. I'm not going to be exactly specific, Mike, with what it was in Q3.

[Michael J. Ritzenthaler:]

No, that's fine.

[Hudson La Force:]

We're exactly where we want it to be in terms of our acquisition plan, and we did say that $30 million number for the full year.

[Michael J. Ritzenthaler:]

Yes, okay. That's helpful. And just one last thing. On interest rates, given when that deal closed, is there -- can you provide us just kind of some goalposts around what the interest rate expense could be in Q4 and maybe starting in '15?

[Hudson La Force:]

Let me follow up on that, Mike. I -- we know the numbers. I don't have them off the top of my head.. Everything is fixed at this point. So it's just a matter of -- but we'll send that out in an e-mail letter today to everybody.

[Operator:]

Your next question comes from the line of Mr. Jim Barrett of CL King.

[James Barrett:]

Fred, just can you tell us -- can you compare your current growth, your outlook for growth in your emerging markets versus your mature markets with some added color on what's happening in Latin America with and without the Venezuela piece?

[Alfred E. Festa:]

Yes, yes, we're clearly getting good growth in North America. The growth in Europe is -- across the corporation is not at -- obviously, at that same pace. Latin America still remains challenging. I mean, in our construction chemicals side, we're experiencing growth not at the same rate we'd like but still experiencing growth. So net-net, the emerging markets have not grown as fast as last year but were being offset and balanced by the North American growth.

[James Barrett:]

Okay. So are emerging markets growing? Is it a mid-single, upper single-digit type of growth rate? Can you give us some general...

[Alfred E. Festa:]

Yes, yes. That would -- I mean, again, you've got this whole -- you've got currency fluctuations especially with the strong dollar, but net of the currency fluctuation, it's about 5%.

[James Barrett:]

I see. And then my second question is given that the demand -- or the decline in demand for your residential products related to the SBM category in North America appears to be more related to the category as opposed to what's occurring at Grace, can you comment on how you're repositioning those products for growth given where the end markets seem to be?

[Alfred E. Festa:]

Yes, yes. I mean, we -- I -- we called it out because we believe it's an opportunity for us. That segment, for [Audio Gap] It's a good profitability -- profitable segment. It represents an opportunity. We need to make sure we have the right products in the channel with those distributors in the right geographic areas. So we're looking and repositioning with our channel partners on that to make sure -- if it's Midwest, we need this type of product versus New England, this type of product, and working with those distribution partners on that; so again, called out because we think it's an opportunity for us to do better.

[Operator:]

Your next question comes from the line of Mr. Chris Kapsch of Topeka Capital Markets.

[Christopher Kapsch:]

My questions are focused on the catalyst segment, and looking at the positive variants and gross margin year-over-year of 330 basis points, I know you mentioned that the biggest piece of that was the addition of UNIPOL. That makes sense. I'm just wondering if you were to exclude UNIPOL, what would that gross margin comp look like. And the reason I asked, I'm just wondering -- as you are gaining back your position in the marketplace with these advanced products, I was just wondering if those are contributing favorably to pricing and mix and, therefore, margins.

[Hudson La Force:]

Chris, it's Hudson. It's -- probably, half of the improvement is related to UNIPOL, and the balance is related to better operating leverage with our FCC catalyst business as it's -- as we have more volume in that business on a year-over-year basis. And also, these new products that we've introduced are selling at better gross margins to us. And finally, frankly, there's some productivity that we're doing in the catalyst business. That's not fully in the P&L yet, but it will flow through more as we get into next year.

[Christopher Kapsch:]

Okay. And then another follow-up. I appreciate your comments about the correlation of FCC catalyst demand. Clearly, there were some, perhaps, misguided acute selling pressure on your stock associating Grace is just purely about some energy play during the quarter. And so I understand the correlation to transportation fuels and the refinery utilization rates. You made an interesting comment that you correlate inversely the feedstock quality. I think that's sort of another way of saying, like covering Engelhard in the past and Grace years ago, there was -- the focus was always on crack spreads, and I think that's sort of another way of saying inversely correlated feedstock quality. So I'm just -- the question is, as the global crude -- the slate -- the global feedstock slate changes and given the further introduction of the shale oil, I'm just wondering how you feel now a couple of years into this fracking phenomenon about the continued migration of the crude slate. Is it something that's favorable to the crack spreads that will -- should drive incremental demand for FCC volumes? Or is this something that ultimately could be a headwind for FCC catalyst?

[Alfred E. Festa:]

No, no. I mean, we see it as a positive. I mean, the light frac crude has its own challenges with it, and those challenges are metal contaminations and so on. So it's requiring the catalyst to be able to handle that side of it. And then if you look where these new big units, refineries are being built, they're using heavy -- the new refineries in the Middle East, they're using heavy crude slate. So those 2 dynamics play well in the balance of the North America. These refineries only can take so much of the light side of it. So you're seeing a combination of light, which we need to continue to work with our customers on mitigating some of the properties, and then a heavier slate across the globe.

[Christopher Kapsch:]

So the international slate is becoming -- is less quality for that favorable and then the light-type slate is not an adverse trend given the complexity of some of these contaminants?

[Alfred E. Festa:]

That's a good way to summarize it. Thanks, I should -- probably should thank you for that explanation.

[Operator:]

Your next question comes from the line of Mr. Tyler Frank of Robert W. Baird.

[Tyler Frank:]

I was wondering if you can talk a little bit about the recent price increase that you put through for silica products and how that's going and to the fluctuation in FX rates. Can you give a little bit of color on how that may impact your decision to put their price increases maybe over the next year or so if the dollar remains strong?

[Alfred E. Festa:]

Yes, I mean, we initiated that price increase because our silica business was almost in an oversold position across the globe in our -- the applications that we've been -- we sell into have been strong. Now I will tell you it's early. We put it out in October. It's early in that cycle. I think in the end of the day, it will be more rifle shot and selective, where we're seeing strength in certain applications or certain geographies. We'll be able to achieve that and others. Maybe we're -- the growth is not as robust because of some of the macroeconomic trends that have -- recently, we've been seeing. We may wait 1 quarter or 2 on that side. So it will be a little more selective as we go, but it's clear, the silica products [Audio Gap] demand is there, and there have been very good receptivity to some of the new applications we've put out.

[Tyler Frank:]

Great. And then just to touch on the residential SBM market. So you're repositioning that for better growth and hope to have those initiatives complete by the end of this year. Can you just go on a little bit more detail on what you're doing there?

[Alfred E. Festa:]

Yes, it's -- remember, our residential building materials products is primarily underlayments and some specialty products for -- primarily for reroofing and so on. We need to make sure that we've got the right products in the right channel with the right distributors around the right geography. I mean, you're trying to match all of that sides of it as kind of anticipate the weather and so on and anticipate where we're going. So I feel good about the work that's being done with our teams, and as we highlighted -- listen, we are down in the third quarter in that business year-over-year, and that's a big -- not a big. That's an opportunity for us to get that back and we will.

[Operator:]

Your next question comes from the line of Mr. John Roberts of UBS Global Asset Management.

[John Roberts:]

Some of the slowdown in oil demand seems centered on China, but since China makes their own FCC catalyst, do we see production of Chinese FCC catalyst sort of absorb Chinese oil demand fluctuations? Or does it basically come out of the Rest of the World, where you serve the market the oil imports -- oil and gasoline imports into China, fluctuate and therefore, if they slow down and we see yours, we think global catalyst market slowed down, not just the Chinese.

[Hudson La Force:]

I think your observation is right. On the FCC catalyst side, they're 90% self-supplied on -- so if crude demand in China slows, that would come out of Chinese FCC catalyst supply more than through our global competitors.

[John Roberts:]

Really? They wouldn't hold their production, and their imports accrued would -- refined products up and, therefore, it would come out of the western world?

[Hudson La Force:]

Maybe I misunderstood your question, John.

[John Roberts:]

Do they hold their FCC production sort of irrespective of their demand for crude products and oil?

[Hudson La Force:]

No, I think it varies with their local requirements.

[Operator:]

Your next -- ladies and gentlemen, your next question comes from Chris Shaw of Monness, Crespi.

[Christopher L. Shaw:]

You spoke briefly, I think, a little bit on margins on the margin opportunities on catalysts. I was just curious in the other 2 segments, construction and materials. What's the near term -- and maybe looking into '15, are there specific margin opportunities? And are there those that we should be looking for either on a cost productivity or pricing side?

[Alfred E. Festa:]

Yes. On our construction side of it, we've been able to expand our EBIT margin -- that -- for construction, the more relevant factor is the EBIT margin versus our gross margin because we're trying to get that leverage through it. Those opportunities are in volume leverage and will continue. So we see, as market dynamics continue to get better, that there will be those opportunities to leverage that margin up on the construction side. In materials, we're focused on making sure where do we see if there is geographies where there is a slowdown to make sure we're reducing our cost in those operations proactively, getting out in front of that side of it as well as looking across the whole materials segment to make sure that the productivity investments we're spending, like the big investment we did here in our Curtis Bay facility pays off. So there's -- on the materials segment, it's really how do we protect these margins if the slowdown, the global economics get worse, construction. The opportunity is to continue to expand those margins.

[Christopher L. Shaw:]

And it's like a follow-up for the question about commercial construction demand. It looked pretty good in the quarter. Is that -- do you view that as sort of ongoing? I mean, I know there -- I was wondering if there was any makeup during the quarter for the sort of -- I know the second quarter was impacted by weather. So was that sort of demand level we saw from commercial construction in 3Q sort of what your -- what's really true to the market? Or was that some makeup at all?

[Alfred E. Festa:]

Yes. There was probably a little bit of a makeup in it, but still, the coal books look good, the architectural index, the jobs we're seeing. So out of that 10% -- this is my estimate. 80% is probably a true market. 20% is just to catch up on that side of it. So I mean, we're encouraged by what we saw.

[Operator:]

Ladies and gentlemen, thank you for your participation in the question-and-answer session. We will now proceed with the closing and/or any additional remarks.

[David Joseph:]

Thanks, Tony. I'd like to thank everyone for joining the call today. If there are any further questions, please contact me at [phone]. Thanks again. Bye.

[Operator:]

Ladies and gentlemen, thank you for your participation. You may now disconnect, and everyone, have a great day.