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Edited Transcript of GRA earnings conference call or presentation 24-Oct-19 1:00pm GMT

Q3 2019 W. R. Grace & Co Earnings Call

COLUMBIA Oct 28, 2019 (Thomson StreetEvents) -- Edited Transcript of W. R. Grace & Co earnings conference call or presentation Thursday, October 24, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Hudson La Force

W. R. Grace & Co. - President & CEO

* Jeremy F. Rohen

W. R. Grace & Co. - VP of Corporate Development & IR

* William C. Dockman

W. R. Grace & Co. - Senior VP & CFO

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Conference Call Participants

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* Anthony Walker

Goldman Sachs Group Inc., Research Division - Research Analyst

* Christopher John Kapsch

Loop Capital Markets LLC, Research Division - MD

* Christopher S. Parkinson

Crédit Suisse AG, Research Division - Director of Equity Research

* Daniel Dalton Rizzo

Jefferies LLC, Research Division - Equity Analyst

* John Ezekiel E. Roberts

UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst, Chemicals

* John Patrick McNulty

BMO Capital Markets Equity Research - Analyst

* Kevin William McCarthy

Vertical Research Partners, LLC - Partner

* Michael Joseph Harrison

Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst

* Michael Joseph Sison

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Paretosh Misra

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2019 W.R. Grace Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded.

I would like to introduce your host for today's conference, Mr. Jeremy Rohen, VP of Corporate Development and Investor Relations. Please go ahead, sir.

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Jeremy F. Rohen, W. R. Grace & Co. - VP of Corporate Development & IR [2]

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Thank you, Michelle. Hello, everyone, and thank you for joining us today for Grace's Third Quarter 2019 Earnings Call. With me this morning are Hudson La Force, Grace's President and Chief Executive Officer; and Bill Dockman, Senior Vice President and Chief Financial Officer.

Our earnings release and presentation are posted on our website under the Investors Section at grace.com. Please note that some of our comments today will contain forward-looking statements based on our current view of our business, and actual future results may differ materially. Please see our recent SEC filings, which identify the principal risks and uncertainties that could affect future performance. We will discuss certain non-GAAP financial measures, which are described in more detail in this morning's earnings materials. Reconciliations of non-GAAP financial measures and other associated disclosures are contained in our earnings materials and posted on our website.

This morning, Hudson will address our third quarter business performance, provide an update on our full year 2019 outlook and discuss our current thinking about 2020. Bill will then review our third quarter financial results and full year 2019 outlook in additional detail. We'll then open the call for your questions.

So with that, please turn to Slide 4 in our earnings presentation, and I'll turn the call over to Hudson.

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Hudson La Force, W. R. Grace & Co. - President & CEO [3]

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Thank you, Jeremy. Good morning, everyone. Our Q3 results were affected by 3 discrete items as we detailed in our second quarter earnings release. As expected, these items will reduce full year sales by about 2% and earnings by $15 million to $17 million, net of mitigating actions. In September, another unusual event occurred. As a result of an attack in the Middle East, our customers in the region temporarily reduced their operating rates and catalyst usage due to reduced feedstock supply. Based on order cancellations and expected order delays, we expect this event to reduce our Q4 '19 earnings by $7 million to $8 million. At this point, all affected customers are back to normal operations.

Our team acted decisively in response to each of these events to adjust our manufacturing operations, reduce costs and identify new sales opportunities. Their actions minimized the earnings and cash cost of these events and ensured our operations and cost structure remain aligned with our growth. Thanks to their focused efforts, our third quarter results were better than we expected 90 days ago.

Clearly, I'm disappointed by the effect of these events on our second half earnings, but I'm proud of how our team adapted quickly to significant changes in our operating environment. Our team offset more than 50% of the negative effect of these events this year. Though these events may delay our progress, they do not change our strategic direction or my conviction about the earnings power of our businesses.

I remain positive on our long-term growth opportunities. Our strong strategic position and competitive advantages in polyolefin catalysts and licensing, refining catalysts and specialty silica gels position us for 4% to 6% sales growth in the long term, reflecting customer demand for our high-value technologies.

For Q3, overall sales and earnings were lower, but there were some important positives. Pricing improved 300 basis points, mix improved in all 3 segments, and we announced 4 new UNIPOL licenses in the quarter, plus we generated $95 million of adjusted free cash flow. Our underlying operating momentum remains strong. Some of this progress is visible in our earnings reports, but some is not directly reported.

For example, our Materials Technologies team is focused on improving segment mix as a cornerstone of their commercial excellence and value-selling initiatives. Since starting this initiative late in 2017, they've delivered a significant mix shift to higher-margin Consumer/Pharma and specialty industrial end markets, adding more than 50 basis points to MT's gross margin. One good example of the mix shift is the accelerating growth of our LUDOX colloidal silica product line. These products are used in a variety of high-performance end-use applications with exacting quality, regulatory and sustainability requirements. This product line is growing roughly twice as fast as our overall MT business with better margins and longer product life cycles than other product lines.

Now please turn to Slide 5, and I'll address our 2019 outlook and our current thinking about 2020.

Factoring in all the discrete events and our mitigation efforts, we expect 2019 adjusted EPS to be in the range of $4.32 to $4.38. Though our earnings are lower than planned at the beginning of this year, our adjusted free cash flow outlook is unchanged from our February target of $235 million to $250 million. Our team has done a terrific job managing cash flow and inventory levels, given all the changes in our operating environment. For 2020, we expect modest sales growth at this time, assuming a slow growth demand environment. We see slower growth in recent global manufacturing data and in some plastics and industrial end markets.

For 2020, we expect adjusted EBIT to grow 8% to 11% constant currency, reflecting slow demand growth and the onetime nature of the 2019 discrete events. Looking at it another way, based on the midpoint of our original 2019 outlook, this would be 3% to 6% earnings growth in a slow growth demand environment. We are planning for growth, but we're also focused on managing our cost structure and inventory levels and driving productivity through the Grace Manufacturing System.

Obviously, we are not immune to the ongoing uncertainty in the global macro environment, but our growth investments, commercial excellence initiatives and diversified end market exposures reinforce our ability to identify and capture new growth opportunities as they develop. One of our biggest growth drivers for 2020 is the hydroprocessing catalyst capacity addition in our Lake Charles, Louisiana plant. Construction is nearing completion with intermediates and utilities mechanically complete this quarter and the catalyst unit mechanically complete in Q1. We are on track to begin producing catalysts in Q2 after required commissioning and start-up activities. We expect the new capacity to increase ART's net income by about 15% to 20% next year, reflecting the part year benefit of the new capacity. We're pleased to be nearing the commissioning of this investment and very pleased to note that the project has achieved world-class safety performance. As we have done in the past, we will provide our detailed 2020 outlook when we report Q4 earnings in February.

Now let's turn to Slide 6 and look at our third quarter business performance.

In Catalyst Technologies, sales were down 4%. The decline was primarily due to the FCC catalyst customer bankruptcy and the customer-specific inventory correction in specialty catalysts, though we also saw some reduced demand in the Americas and Asia. FCC catalyst pricing momentum continued in the quarter and for the trailing 12 months improved well over 200 basis points. The business remains on track to deliver greater than 200 basis points of improved price for the full year.

In Refining Technologies, we are actively working to replace the lost volume from the customer bankruptcy consistent with our value-selling approach. We expect to recognize insurance benefits in the fourth quarter and in 2020. We did not recognize any insurance benefits related to this incident in the third quarter. Because the insurance benefits will be reported as other income, earnings will be in line, even though sales will be lower until we fully replace this volume.

In Specialty Catalysts, we announced 4 new polypropylene process licenses in the third quarter. Year-to-date, we've licensed 6 new units, totaling nearly 2,500 kilotons of annual resin capacity. The UNIPOL polypropylene process technology enables our customers to manufacture the most advanced and broadest range of polypropylene homopolymers and copolymers at the lowest total capital and operating costs. It's great to see the robust pace of licensing activity, knowing this establishes a strong pipeline for catalyst sales when these units start up in the future.

Now let's turn to Materials Technologies on Slide 7.

In Materials Technologies, Q3 sales were down 7% and down 4% on constant currency. Strength in certain chemical process applications partially offset unfavorable order timing in consumer/pharma. As you may remember, Consumer/Pharma sales were up double digits in the first half of the year and are up nearly 9% year-to-date. Gross margin for the quarter was up 100 basis points on improved pricing and favorable mix, which more than offset the incremental costs from the Q2 equipment failure.

Overall, I am very pleased with how our teams have responded to the challenging operating environment we have faced in the last few months. We've remained agile and acted quickly to address issues head on. I am confident we will finish the year well. Looking to 2020, we have the right strategies, the right people and the right product technologies to drive innovation with our customers and deliver long-term sustainable growth. We'll continue to manage the macro risks and stay focused on commercial excellence, operating excellence, growth and cash flow.

I'll now turn the call over to Bill, who will discuss our financial results and full year 2019 outlook in more detail.

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William C. Dockman, W. R. Grace & Co. - Senior VP & CFO [4]

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Thanks, Hudson. Turning to Slide 9, let's begin with our Q3 results.

Sales for the quarter were $471 million, down 5% from lower volumes in Catalyst Technologies due to the discrete items, timing on Consumer/Pharma sales at MT and lower demand in some end markets. Unfavorable FX was a 1.2% headwind to sales due to the continued strength of the U.S. dollar versus the euro. As a reminder, less than 2% of our sales are exposed to emerging market currencies and approximately 95% of our global sales are tied to the U.S. dollar, euro or currencies directly linked to these.

Adjusted gross margin for the quarter was down 80 basis points year-over-year from lower sales volumes and unabsorbed overheads, which was partially offset by improved pricing, favorable mix and 50 basis points of lower inflation.

Adjusted EBIT was down 12% and adjusted EBIT margin was down 190 basis points year-over-year primarily due to the discrete items as well as lower earnings from our joint venture.

Year-to-date, ART earnings were lower than the prior year period, reflecting an increase in overhead costs allocated to the joint venture from Grace and Chevron and lower margins on first fill orders supplied to new units starting up. We expect a significantly stronger Q4 as we ship catalysts to customers preparing for IMO 2020 implementation.

Adjusted EPS for the quarter was down $0.13 to $0.98 per share. The impact from the discrete items in the quarter was approximately $0.16 per share.

Year-to-date, adjusted free cash flow was down $11 million. For the quarter, we delivered $95 million of adjusted free cash flow from lower capital expenditures and a focus on working capital and expense management.

Now let's turn to Slide 10 for an update on our capital allocation.

For the quarter, we invested $49 million of capital to expand capacity to meet customer demand and to support ongoing operations. We remain on track to invest between $200 million and $210 million this year. Our strategic growth investments are timed and sized to meet identified customer demand. Over 90% of our growth capital investments are linked to specific customers, contracts or polypropylene licensees, providing a strong line of sight to demand.

In the quarter, we returned $18 million of cash to shareholders through dividends. And year-to-date, our total return to shareholders are nearly $85 million, including approximately $55 million of dividends and $30 million of share buybacks.

As we said in the second quarter, we are prioritizing the use of excess cash to reduce our net leverage versus additional share buybacks. As a result, we did not repurchase common stock this quarter. We remain on track to reach our target net leverage ratio of 2 to 3x by year-end. At the end of the third quarter, our net leverage ratio was 3.2x.

Moving to Slide 11, let's look at our outlook for the remainder of 2019.

For the fourth quarter, we expect year-over-year adjusted EPS growth of 10% to 15%. For 2019, we expect year-over-year sales growth to be in the range of 1% to 2%, which is down from our original outlook of 6% to 7% in February. The decline is driven by lower volumes of approximately 2% relating to the discrete items and 2% from lower demand in some end markets. Unfavorable currency is also a 1% headwind.

Our full year adjusted EBIT outlook range is $470 million to $475 million, down from our July outlook of $475 million to $483 million. This outlook incorporates the expected impact to our results from the discrete items and the Middle East feedstock disruption. Our adjusted EPS outlook for the year is in the range of $4.32 to $4.38 per share, down from $4.35 to $4.43 per share.

For the full year, our outlook on adjusted free cash flow remains unchanged at $235 million to $250 million. We are very focused on managing our working capital and capital spending to generate the cash flow we require to support growth and meet our capital allocation objectives. Our teams remain focused on executing their plans to deliver the year and positioning themselves for sales and earnings growth in 2020. Importantly, we remain on track to deliver on our 2016 to 2021 financial framework.

With that, let's open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Christopher Parkinson with Crédit Suisse.

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Christopher S. Parkinson, Crédit Suisse AG, Research Division - Director of Equity Research [2]

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There's obviously been a lot of noise this year with a lot of variables outside of your control. When we take a step back, can you just simply walk us through what you think the key variables are for 2020 from a base fundamental perspective, just FCC and HPC pricing, competitive landscape, volume trends, especially in HPC and then also just how we should think about price mix in Mat Tech? Just what are the most simplistic 3 trends that investors should be monitoring into next year?

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Hudson La Force, W. R. Grace & Co. - President & CEO [3]

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Chris, this is Hudson. I appreciate your question very much. If I step back and think about 2019, if we hadn't had these events that occurred, we would have tracked to the guidance that we gave at the beginning of this year. We said $490 million to $500 million of EBIT. The midpoint of that range is $495 million. And based on the EBIT guidance that we gave this morning for 2020, that would give us 3% to 6% earnings growth -- adjusted EBIT growth from 2019 to 2020.

Now as you framed it, how should we think about the drivers for that. The first one, I think, is top line growth. We are expecting a slower growth environment next year. When we look at the recent manufacturing data, some of the PMI statistics that have come out, when we think about next year's likely global GDP growth, we're a bit more cautious than we were this time a year ago. And so we are expecting a slower demand environment, slower top line growth. But we do expect that to put us in a position where we can continue to drive margin improvement next year. There are things that are specific to our demand drivers, but there are also things that we're doing on the operating excellence side, and we would expect our earnings to grow faster than our top line next year. So specifically, in the catalyst business, the strong strategic position that we have in specialty catalysts is intact. The value of the licensing, pulling through specialty catalyst sales is operating in our P&L this year. It will benefit next year, and it will benefit the future. If we think about the pricing progress that we've made in FCC catalysts, that will continue to benefit next year, not at the same level as this year, but it will continue to be positive as we go into 2020.

Within Materials Technologies, you've mentioned segment mix. That is an important part of it. And while the Materials Technologies business serves a lot of different end markets, some are growing, some have grown well this year, some have grown not so well. There's an opportunity for us to find -- and our team is very good at this. I tried to highlight it in the prepared remarks -- find the growing niches and follow those growth trends. But then internally, we've done things as well. The Grace Manufacturing System continues to drive productivity. We have the Lake Charles, Louisiana plant coming up, as I commented on. And so we're focused on what we can do internally to continue to drive earnings growth. Chris, that was more than 3, but those are the things that are really in the top of my mind as I think about next year.

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Christopher S. Parkinson, Crédit Suisse AG, Research Division - Director of Equity Research [4]

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Very much appreciated. And then just you're looking at replacing some of the lost volumes from PES. Can you just talk about the process that you're undertaking? I mean you mentioned value-based but -- versus what happened to (inaudible) a few years ago. Are there any kind of key differentials in how we should think about replacing those volumes over the next 12 months?

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Hudson La Force, W. R. Grace & Co. - President & CEO [5]

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Yes. I think of a couple of things, Chris. The most important to me is that in replacing that volume that we do it in a way that's consistent with our current strategy. We refer to it as the value-selling strategy. We want to make sure that we're placing that volume with a customer or customers. It's more likely to be multiple customers that really value our technology. We don't want to be using price as a lever to replace this volume. It's inconsistent with our strategy.

Now in comparison to the incident that happened a couple of years ago, the most important difference is that this was a much smaller FCC unit. The amount of demand that was affected is smaller. And as it turns out, it's within the insurance limits that we -- the business interruption insurance limits that we have. And so it allows us to pursue that value-selling strategy to replace the volume in kind. Compared to 2 years ago, we knew we would hit our insurance limits very quickly, and we had to act to replace that volume much faster than we would have preferred at that time.

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Operator [6]

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And our next question comes from the line of John Roberts with UBS.

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John Ezekiel E. Roberts, UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst, Chemicals [7]

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On Slide 11, where it says sales are expected now to be 2% lower overall. Obviously, those markets are down much more than 2% to drag -- to have a 2% effect there. What's down the most that's more than 2% from where you thought before?

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Hudson La Force, W. R. Grace & Co. - President & CEO [8]

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In terms of the end markets that we're serving, John?

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John Ezekiel E. Roberts, UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst, Chemicals [9]

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Yes. You've got a 2% overall impact to your total sales from selected markets that's there. So some of them have got to be down pretty materially versus what you thought before, and this is underlying before the discrete items.

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Hudson La Force, W. R. Grace & Co. - President & CEO [10]

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I see what you're saying. You're talking about the weighted average effect. So the market that is down the most for us is the coatings market on a percentage basis, the coatings market in Materials Technologies. That's the market that's down the most. We've seen a little bit of softness in polyolefin catalyst demand, but not a big percentage. Those are the 2 that have the most significant effect.

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John Ezekiel E. Roberts, UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst, Chemicals [11]

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Okay. And could you provide some additional color on the ART JV? You mentioned this overhead allocation change that happened in the quarter. And obviously, it sounds like there's an inflection at least coming there from IMO 2020 here in the fourth quarter.

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Hudson La Force, W. R. Grace & Co. - President & CEO [12]

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Sure. We've been preparing the ART joint venture for this IMO 2020 implementation for over a year now. And as part of that, we looked at the resourcing of the joint venture, and we looked at cost allocations between the partners and the joint venture. And at the beginning of this year, both partners did allocate additional costs to the joint venture. That's been running through the P&L all year. And -- but the more important thing, I think, is the inflection in sales that we're expecting in Q4. We do expect Q4 to be a big quarter, significant sequential increase from Q3 to Q4, and we expect that to continue into next year. Our customers are moving quickly to get their equipment ready to begin supplying the low-sulfur fuel. Some of our customers have been able to do that this year, but most of them will not have that equipment up and running until next year. And so the growth from IMO 2020 will be more next year than this year as it turns out.

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William C. Dockman, W. R. Grace & Co. - Senior VP & CFO [13]

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John, one other -- John, it's Bill. One other point on the overhead. You may know this, but ART has no employees of its own. So every time we hire a salesman or a technical person to go after the customers, it's an employee of Grace or Chevron, and that's what increases the overhead. So it's real people that are there to support the business that gets charged in from one of the 2 parents.

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Operator [14]

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And our next question comes from the line of John McNulty with BMO Capital Markets.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [15]

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With regard to catalyst pricing, it looks like it's actually been accelerating throughout the year. And I guess earlier in some of the Q&A, you had indicated next year you expect it to be up, but maybe not as much. I guess what changes that or what causes the deceleration considering kind of the trajectory that it's been on basically throughout the year?

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Hudson La Force, W. R. Grace & Co. - President & CEO [16]

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Well, John, it's Hudson. The -- a lot of this is timing of contract renewals and things like that. And it's sort of at the customer-by-customer level, where we've been looking at what's the right level of pricing for the value of the technology that we're delivering to our customers. And so the pricing momentum really just reflects that activity with our customers.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [17]

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Got it. Okay. And then with regard to the cost cuts that you would initiate. I guess it was around the second quarter or in the second quarter when you had some of the discrete items pop up. I think you were looking for $11 million to $12 million or so. How much of those were permanent cost reductions versus temporary ones to kind of deal with the kind of emergency situations that you were in? And then also, I guess, tied to that, given the slower macro backdrop that you're citing, are there additional cost measures that you were debating about putting in place? And how should we think about that?

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Hudson La Force, W. R. Grace & Co. - President & CEO [18]

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John, most of the cost reductions that we took in response to the discrete events were temporary. Some of them, things like incentive compensation and sales commissions and things like that, adjust automatically as sales volumes go down. But we also took costs out of our manufacturing plants, where the plants wouldn't be running as hard because of the lost volume. We delayed some hiring. We delayed some spending that we had planned to make. It was a combination of things, mostly from the perspective of we've got to keep our costs in line with our growth rates. And if the growth rate is going to slow down, then we've got to slow down the costs. If the growth rate reaccelerated, then we would continue forward with those investments. It's important to me that we keep those matched. It's also important to me that we keep our inventory levels matched with our sales growth. And so as sales growth slowed down because of these events and other factors, we've slowed down our manufacturing rate so that we keep our inventories in line.

As we think about next year, we are planning for slow growth, but there's some uncertainty to that. And we are looking -- as we finalize our plan for 2020, we are looking at what's the right level of spending. We're looking at cost reductions where that's appropriate, but we're also looking at targeted investments where that's important to keep our growth going for the long term.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [19]

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Got it. That's helpful. And then maybe just one last question. So in [Materials Tech] (corrected by company after the call), it seems like your team has really done a good job of kind of high-grading the portfolio in terms of the customers that they're targeting. Can you give us some color as to what portion of that business is now you would call cyclical versus not so cyclical in the consumer and pharma side?

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Hudson La Force, W. R. Grace & Co. - President & CEO [20]

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Yes. I would differentiate it in a different way, John. Rather than cyclical or noncyclical, I would look at it from the perspective of which of the businesses provide above-average growth rates, above-average profitability versus those segments that are either in line or lower growth rates or lower profitability. And we're close to 50-50 on that balance now. With this mix improvement that I was describing, we've brought up the faster growing, more profitable part to about 50-50 of the portfolio at this point.

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Operator [21]

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And our next question comes from the line of Kevin McCarthy with Vertical Research Partners.

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Kevin William McCarthy, Vertical Research Partners, LLC - Partner [22]

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Hudson, your licensing business for UNIPOL polypropylene continues to show a lot of nice momentum. That's really been the case for, I don't know, 2.5, almost 3 years now. So recognizing that those economics flow through in a multiyear period, would you expect licensing to be a source of incremental earnings contributions in 2020 versus 2019?

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Hudson La Force, W. R. Grace & Co. - President & CEO [23]

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We definitely expect the UNIPOL franchise to be an incremental source of earnings. And I use that term, Kevin, to combine the licensing revenue plus the catalyst revenue. In the long term, it's -- the value of the catalyst is actually the bigger piece. Licensing provides us a benefit for 2 or 3 years upfront, 3 or 4 years, depending on the period. But catalyst provides us a revenue and earnings stream for many, many years to come. And as we look at new unit start-ups in 2020, units that -- some are starting up now, some will start up in 2020, we definitely see positive incremental contribution from the UNIPOL franchise, licensing and catalysts together.

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Kevin William McCarthy, Vertical Research Partners, LLC - Partner [24]

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Okay. That's helpful. And then I wanted to follow up on the dialogue related to ART and really ask you to flesh out some of the moving parts for 2020 there. It sounds like you'll get a boost on capacity as well as IMO and I'm assuming no other changes to overhead allocation. So maybe help us think about what kind of contributions we could expect from that JV next year.

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Hudson La Force, W. R. Grace & Co. - President & CEO [25]

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Sure. And it's a good clarifying point. We don't -- there's no plan to change the overhead allocations again. And so really, what you should see in ART's earnings growth next year is the flow-through of the sales growth, but please don't double count. The Lake Charles capacity addition is needed to supply the growth that's coming from IMO. And so those are really the same thing in terms of how they work through the P&L. So the capacity addition itself we expect to contribute about 15% to 20% growth next year. There should be a little bit of growth on top of that from other demand improvements and pricing improvements and things like that within the business.

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Operator [26]

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And our next question comes from the line of Bob Koort with Goldman Sachs.

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Anthony Walker, Goldman Sachs Group Inc., Research Division - Research Analyst [27]

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This is Anthony Walker on for Bob. Guys, you prioritized debt repayment in the period with no share buybacks completed. And based on your guidance for next year, you'll be within your target net leverage. How should we think about capital allocation priorities from here? And as it relates to how we expect EBIT growth to translate, how do you expect that to translate into EPS growth?

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Hudson La Force, W. R. Grace & Co. - President & CEO [28]

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We -- Anthony, this is Hudson. I -- we -- the first use of our capital will continue to be investing in the business. I don't think we'll spend as much capital next year as we spent this year as we complete some of the projects that we've been working on for the last couple of years. And then in terms of more specific guidance on 2020, it's really too early to comment in more detail than we have today. We'll give you all those details in February.

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Anthony Walker, Goldman Sachs Group Inc., Research Division - Research Analyst [29]

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Got it. And then just as it relates to kind of what you've provided into 2020 initially, if I go back to last quarter, I think there was a $15 million to $7 million net reduction expected from cost reduction actions offset by the insurance recoveries from some of the onetime issues that you had. Can you just talk about the additional headwinds and tailwinds that might be present within the bridge to next year as we're thinking about EBIT growth? When you've talked about the growth in ART, we've also had some EBIT growth that you would expect from Aramco. I'm just trying to walk through whether or not that guidance implies raw material headwinds or other things that we should be thinking about modeling.

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Hudson La Force, W. R. Grace & Co. - President & CEO [30]

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Yes. The best way I would think about it, Anthony, is if you go back to what we said at the beginning of 2019, our adjusted EBIT guidance was $490 million to $500 million for the year. And through the first half of the year, we were very much on track to deliver that level of earnings. Since then, we've had these discrete events and so forth that have reduced our earnings. But if you took those events aside, we would have landed within the guidance range that we gave at the beginning of the year, $490 million to $500 million, let's call the midpoint $495 million. If you bridge that into 2020, what we've said is 8% to 11% adjusted EBIT growth off of the lower number, the updated outlook. If you bridge that off of the original outlook, it's more like 3% to 6%. And the most important factor in that is our expectation about top line growth. We are a little more cautious when we read the current manufacturing data and look at some of what we're seeing in the world, we're expecting slow growth for next year. When you look at our long-term guidance range, we've said 6% to 8% adjusted earnings growth over time. Next year's outlook would be a little bit less than that, but that really reflects the slower economic environment we're anticipating and the slower top line growth that we're assuming. And again, not to push you off completely, but some of the details, inflation and things like that, it's better to wait until February. We'll give you all those details.

But at the end of the day, Anthony, I think the way you should think about it is slow top line growth translating to slower earnings growth, all the onetime items washing out.

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Jeremy F. Rohen, W. R. Grace & Co. - VP of Corporate Development & IR [31]

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Michelle, do we have another question?

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Operator [32]

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Our next question comes from the line of Mike Sison with Wells Fargo.

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Michael Joseph Sison, Wells Fargo Securities, LLC, Research Division - Senior Analyst [33]

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In terms of FCC, aside your -- the customers set down that you have some excess capacity. Is the industry pretty tight in total when you look around the world? And when you look to move that capacity into -- to a new customer, is there -- is it -- I know you've talked about not really focusing on price, but are there pretty visible opportunities to do that heading into next year?

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Hudson La Force, W. R. Grace & Co. - President & CEO [34]

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Simple answer is yes, Mike. We started looking at opportunities as soon as the incident occurred back in June, and we've started conversations. But it takes time. And a lot of this business is contracted. There's a long cycle time for identifying potential customers, for going through trial and testing processes, contract negotiations and so forth. And so we're 3 months into that at this point, maybe 4 now. And it's not a question of opportunity, it's really just a question of timing, I think, Mike.

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Michael Joseph Sison, Wells Fargo Securities, LLC, Research Division - Senior Analyst [35]

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Okay. And just comments on the industry in terms of supply and demand for FCC?

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Hudson La Force, W. R. Grace & Co. - President & CEO [36]

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I think it's -- yes, I don't -- we don't detect any real changes in the industry dynamics. There's nothing that we see in the customer environment or the competitive environment that really changes our view for the industry health and industry dynamics. It's a slow growth market, as you know, but a healthy one.

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Michael Joseph Sison, Wells Fargo Securities, LLC, Research Division - Senior Analyst [37]

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Got it. And a quick follow-up. In terms of -- there's a lot of polyethylene and polypropylene capacity coming on stream in the next couple of years. Is that -- does that tend to be a positive for you?

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Hudson La Force, W. R. Grace & Co. - President & CEO [38]

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Yes, it should be. Our demand for specialty catalysts is really driven by polypropylene and polyethylene production. And so as our customers make investments and bring on their new units, that translates directly into demand for catalysts. And from a macro perspective, all of that is driven by the growing demand for these high-performing polyethylene and polypropylene plastics.

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Operator [39]

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And our next question comes from the line of Mike Harrison with Seaport Global.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [40]

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Just another question on the ART joint venture. Is that new Lake Charles volume that you expect to be commercially ready by Q2? Is that already contracted at this point? And can you comment on the pricing of that versus existing business? Or are you still working to place that additional volume?

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Hudson La Force, W. R. Grace & Co. - President & CEO [41]

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It's a great question, Mike. Thank you. Most of that incremental capacity has been sold already. And I won't comment specifically on the pricing for that new volume, but as a broad statement, ART has done a very good job at raising their average prices and raising their average margins over the last couple of years, which is not to say that the plant will start up sold out. I want to clarify that. But the volume is sold. The timing of it will follow over a few quarters once the plant starts up. But you can get a sense for the earnings impact that we're expecting with the 15% to 20% comment that we made in the prepared remarks.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [42]

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Got it. And then my other question was on specialty catalysts. Can you just give us an update, the customer that was taking an outage through year-end, any change in their expectation on when they're going to restart? And are you seeing any signs that other specialty catalyst customers may need to take some downtime to manage inventory levels as we get into year-end?

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Hudson La Force, W. R. Grace & Co. - President & CEO [43]

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It's a great question, Mike. We have not seen any indication from other customers that they're -- that they need to do a rate reduction or an inventory correction. This really was limited to the unique situation of this one customer, and we don't see that developing with any other customers at this time.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [44]

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And that specific customer is still expected to come back on at year-end?

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Hudson La Force, W. R. Grace & Co. - President & CEO [45]

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That's a customer-specific data point, and I'm not going to give color on a specific customer.

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Operator [46]

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And our next question comes from the line of Laurence Alexander with Jefferies.

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Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [47]

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This is Dan Rizzo on for Laurence. If we think about ART for next year, you said, obviously, there's a ramp in the fourth quarter here in anticipation of IMO 2020, and there's another surge when Lake Charles comes online. I was just wondering if that's the cadence. If you see a demand surge next quarter, it stays kind of at that level, another surge in the second quarter of 2020. And then from there, does it keep going up? Or how does it play out over -- on a quarterly basis?

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Hudson La Force, W. R. Grace & Co. - President & CEO [48]

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Dan, ART's an inherently lumpy business. Q4 this year will be a high-volume quarter. You should expect Q1 volumes to be lower than that. Some of the Q4 volume in ART is product that was manufactured earlier in this year in anticipation of Q4 deliveries. And then as you noted, as the new plant comes on in Q2, you'll start to see some ramp up as we begin supply out of that new capacity. But ART's inherently lumpy, and we can give you some color on that in February how it will play out for next year.

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Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [49]

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Okay. And then just given IMO 2020 and the outlook for HPC, I mean, are there thoughts -- are you reviewing maybe doing additional capacity expansions at Lake Charles or elsewhere?

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Hudson La Force, W. R. Grace & Co. - President & CEO [50]

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It is something that we routinely look at. We haven't made any decisions or announcements about the next step yet.

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Operator [51]

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And our next question comes from the line of Chris Kapsch with Loop Capital Markets.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [52]

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I don't want to beat the IMO 2020 to death, but one more slightly nuanced question following up on that. So I appreciate the explicit guidance expectation for earnings next year based on the ramp. But there's -- the refiners have talked a lot about sort of extended downtimes as they install the equipment to prepare for IMO 2020. And I'm curious if those extended downtimes or refinery turnarounds have, in any instances, dampened demand on the FCC side. And so therefore when IMO ramps up next year over the next several quarters, do you see any potential amplified benefit as those operations come back online?

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Hudson La Force, W. R. Grace & Co. - President & CEO [53]

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It's an interesting question, Chris. And there's no way to answer it in a general sense. A customer could continue to run their FCC unit while they're bringing up an HPC unit. They're not necessarily in line. It all depends on the individual refinery configuration. As a broad statement, I would expect most of our customers would continue to run their FCC units as they continue to bring up new capacity or bring new equipment online, but that wouldn't be true in every case.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [54]

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Okay. And then just wanted to take one more swipe at this bridge to 2020 EBIT, if I could. So on the revised lower number, you're saying 8% to 11%. If you get back the discrete items, even if you -- some of those offsetting costs are given back, if you get that back and then the implied earnings through just from ART, it looks like roughly 7% EBITDA -- I'm sorry, EBIT growth from that lower base number and that would -- one way to think of it might be just the rest of the business organic growth of 100 to 400 bps based on 8% to 11% growth from the lower range. So wondering if that's another way to think about it and if that could be thought of as conservative if you think your core business would grow sort of that sort of magnitude.

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Hudson La Force, W. R. Grace & Co. - President & CEO [55]

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Yes. I -- Chris, I didn't quite follow your math, but let me restate it the way we're thinking about it. If you think about our current outlook, $470 million to $475 million of EBIT for this year, we're saying plus 8% to 11% on that for next year. If you do the math another way and say what if these discrete events had not occurred, we would have been on track to deliver between $490 million and $500 million of adjusted EBIT this year. If you do the math that way, then that translates into 3% to 6% adjusted EBIT growth year-over-year. That factors in everything that we know at this point. It's based primarily on an expectation of slower growth next year. But it does factor in what we know about capacity additions. There's margin benefit from capacity additions. There's depreciation costs from capacity additions. So you've got to think about that, and it incorporates everything that we can see at this point.

We're about 90 days out from when we would normally give guidance and so some of the details will be better to communicate in February.

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Operator [56]

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And our next question comes from the line of Paretosh Misra with Berenberg.

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Paretosh Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [57]

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In your specialty chemicals business, how big is the licensing component now?

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William C. Dockman, W. R. Grace & Co. - Senior VP & CFO [58]

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Licensing itself, we've said -- Jeremy is shaking his head. If we go back to our Investor Day in 2018, you'd see in a pie chart there a breakout that would give you directionally what it was at that point, but we don't give that specific breakout of the business based on today's numbers.

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Hudson La Force, W. R. Grace & Co. - President & CEO [59]

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And what was it based on that pie chart?

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William C. Dockman, W. R. Grace & Co. - Senior VP & CFO [60]

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It was about 5%.

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Hudson La Force, W. R. Grace & Co. - President & CEO [61]

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About 5%. So you can -- I mean, we've said that publicly. You should expect it's a little bit more than that now. But the real importance of the licensing business is setting up the future UNIPOL catalyst sales. And when you think about our overall specialty catalyst business, it's roughly half-half between polypropylene and polyethylene.

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Paretosh Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [62]

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I see. Yes. I just asked because it seems like a lot of growth there. So -- and then the other -- on your FCC catalyst business, have you been able to place those volumes that you lost because of the loss of that North American customer?

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Hudson La Force, W. R. Grace & Co. - President & CEO [63]

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Not at this time. We have started the selling efforts. But we want to make sure that we're replacing that volume without disrupting our value-selling strategy, without disrupting any of the balance in the marketplace. And so that will take some time. And it's a function of customer contract cycles. It's a function of testing and trialing protocols. And it will take some time. But importantly, the business interruption insurance that we have that covered that event will replace the earnings from that customer even if it doesn't replace the sales dollars.

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Paretosh Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [64]

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Got it. And you still think that insurance coverage will be there next year also?

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Hudson La Force, W. R. Grace & Co. - President & CEO [65]

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Yes. We'll receive some insurance benefits in Q4 this year, but most of it will come in 2020.

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Operator [66]

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And our last question is a follow-up question from the line of John McNulty with BMO Capital Markets.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [67]

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A question on the ART joint venture. It's my understanding there's not really any leverage on that venture. If there was something that was opportunistic for the venture to be investing in, if both sides agreed, is there an ability to put leverage on that asset?

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Hudson La Force, W. R. Grace & Co. - President & CEO [68]

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Yes, John. The partners -- it's a partnership. We can kind of agree to do whatever makes sense at a point in time. I have a feeling that you're thinking about M&A opportunities that might make sense for that joint venture. If I'm right about that, we could do that through the joint venture or we could do it side-by-side to the joint venture. But either way, the partners have the flexibility to do what they want to do.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [69]

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Perfect. And yes, that's exactly the angle we were coming at. So...

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Operator [70]

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Thank you. This does conclude our Q&A session, and I would like to turn the conference back over to Mr. Jeremy Rohen for any further remarks.

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Jeremy F. Rohen, W. R. Grace & Co. - VP of Corporate Development & IR [71]

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Thanks, Michelle. And thank you, everyone, for your time today and your interest in Grace.

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Operator [72]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.