Kirby - Q1 2019

Transcript

Operator (participant)

Good morning, and welcome to the Kirby Corporation 2019 First Quarter Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. We ask that you limit your questions to one question and one follow-up. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press the pound key. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Eric Holcomb, Kirby's Vice President of Investor Relations. Please go ahead.

Eric Holcomb (VP of Investor Relations)

Good morning, and thank you for joining us. With me today are David Grzebinski, Kirby's President and Chief Executive Officer, and Bill Harvey, Kirby's Executive Vice President of Finance and Chief Financial Officer. A slide presentation for today's conference call, as well as the earnings release that was issued earlier today, can be found on our website at kirbycorp.com. During this conference call, we may refer to certain non-GAAP or adjusted financial measures. Reconciliations of the non-GAAP financial measures to the directly comparable GAAP financial measures are included in our earnings press release and are also available on our website in the Investor Relations section under Financials. As a reminder, statements contained in this conference call with respect to the future are forward-looking statements. These statements reflect management's reasonable judgment with respect to future events.

Forward-looking statements involve risks and uncertainties, and our actual results could differ materially from those anticipated as a result of various factors. A list of these risk factors can be found in Kirby's Form 10-K for the year ended December 31st, 2018. I will now turn the call over to David.

David Grzebinski (CEO)

Thank you, Eric, and good morning, everyone. Earlier today, we announced first quarter revenue of $745 million and earnings of $0.74 per share. This compares to 2018 first quarter revenue of $742 million and adjusted earnings of $0.63 per share. Although revenues were generally flat year-on-year, adjusted earnings per share improved by 17%, led by a significant increase in marine transportation revenue and profitability despite significant weather and navigational challenges. Although distribution and services revenue declined as a result of lower spending in the oil field, the segment's operating income was similar to 2018 levels. In the Marine Transportation group, our first quarter results were heavily impacted by record delay days.

Throughout the quarter, our operations were challenged by heavy fog along the Gulf Coast, prolonged periods of ice on the Illinois River, and near record high water levels on the Mississippi River. These weather-related issues significantly slowed transit times and negatively impacted the financial performance on our contracts of affreightment. Additionally, the closure of the Houston Ship Channel as a result of a chemical storage facility fire in March and ongoing lock infrastructure projects added further delays to the quarter. Overall, delay days increased more than 80% compared to the first quarter of 2018, and more than 40% compared to the fourth quarter. The impact can be seen in our ton miles, which were down slightly year-on-year, despite our barge count being up significantly.

Ultimately, we estimate that delay days negatively impacted earnings by approximately $0.05 per share in the first quarter. From a demand standpoint, customer activity was strong in the quarter, with barge utilization rates climbing into the mid- to upper 90s in late in the quarter. In mid-March, we closed the purchase of Cenac Marine Transportation Fleet, which included a young fleet of 63 tank barges, 34 inland towboats, and two offshore tugboats. We have moved quickly to integrate that fleet, and I expect this acquisition will begin to contribute to earnings in the second half of this year.

In coastal, market fundamentals continued to slowly improve, with our barge utilization levels increasing into the low 80% range. During the quarter, we saw solid customer demand and limited availability of large capacity vessels, which resulted in mid-single-digit pricing increases on term contract renewals and new spot deals. Similar to the fourth quarter, however, our results were adversely impacted by shipyard maintenance on several large vessels.

Additionally, our operations on the Gulf Coast were hindered by extensive fog throughout the quarter. In distribution and services, results were favorable, with sequential improvement in revenue and operating income despite oil field uncertainty and reductions in customer spending. The improvement primarily came from the oil and gas market, as our manufacturing teams executed well, delivering new pressure pumping units and equipment, both to U.S. customers and international customers. This was partially offset, however, in distribution by a sequential reduction in sales of new engines, transmissions, and parts to oil field customers. In commercial and industrial, we experienced a sizable sequential increase in revenue, due in part to increase in sales in our power generation business. Additionally, we experienced higher levels of activity across much of our marine sector, resulting in increased sales volumes of engines and parts.

In summary, for the quarter, our earnings were challenged by weather and navigational delays in marine transportation, as well as the timing of shipyard maintenance in coastal marine. However, in distribution and services, we executed well and had strong output from manufacturing and strength in our current, in our commercial and industrial portfolio. In a few moments, I'll talk about our outlook for the remainder of 2019, but before I do, I'll turn the call over to Bill Harvey to discuss our first quarter segment results and the balance sheet.

Bill Harvey (EVP and CFO)

Thank you, David, and good morning, everyone. In the first quarter of 2019, the company's operating income was $72 million or $3.5 million higher than the fourth quarter's adjusted operating income, which excluded several one-time items. In our marine transportation segment, first quarter revenues were $368.1 million, with an operating income of $35.4 million and an operating margin of 9.6%. Compared to the same quarter in 2018, this represents an 8% increase in revenue and operating income more than doubled. Excluding one-time items and severance expenses in 2018, operating income rose by 45%. Compared to the fourth quarter, revenues declined $14.4 million or 4%, and operating income decreased by $9.1 million.

In the inland business, revenues were approximately 12% higher year-on-year due to the contribution from 2018 acquisitions, as well as increased pricing. These were partially offset, however, by the impact of an 82% increase in delay days in the 2019 first quarter compared to the 2018 first quarter. Compared to the fourth quarter, inland revenues declined approximately 3%. During the quarter, the inland business contributed approximately 77% of marine transportation revenue, which is up slightly from the prior quarter, and the average barge utilization rate was in the mid-90s. Long-term inland marine transportation contracts, or those contracts with a term of 1 year or longer, contributed approximately 65% of revenue, with 62% attributable to time charters and 38% from contracts of affreightment.

Term contracts that renewed during the first quarter were on average higher in the mid-single digits on average. Spot market rates increased in the mid- to high-single-digit range sequentially and were more than 20% higher year-over-year. During the first quarter, the operating margin in the inland business was in the low- to mid-teens and was heavily impacted by the effect of high delay days on our contracts of affreightment. In the coastal business, first quarter revenues declined approximately 3% year-over-year, driven by increased shipyard days and poor winter weather conditions along the Gulf Coast. This was partially offset by improved pricing. Compared to the fourth quarter, revenues declined approximately 6% as a result of increased shipyard maintenance, as well as increased weather delays. Our barge utilization improved slightly into the low 80% range.

With regard to pricing, although rates are contingent on various factors such as geographic location, vessel size, vessel capabilities, and the products being transported, in general, average spot market rates improved 10%-15% year-on-year, with sequential improvements in the mid-single digits. We also continue to realize pricing increases on term contract renewals in the mid-single digits. During the first quarter, the percentage of coastal revenues under term contracts was approximately 80%, of which approximately 85% were time charters. Coastal's operating margin in the first quarter was in the negative low- to mid-single digits and was adversely impacted by the increased shipyard days and adverse weather during the quarter. With respect to our tank barge fleet, in the inland sectors in the quarter, we acquired 63 30,000-barrel tank barges with a total capacity of 1.9 million barrels from Cenac.

We also retired 5 barges from our fleet with a total capacity of approximately 90,000 barrels. At the end of the first quarter, the inland fleet had 1,061 barges, representing 23.6 million barrels of capacity. On a net basis, we currently expect to end 2019 with a total of 1,057 inland barges, representing 23.5 million barrels of capacity. In the coastal marine market, we retired one barge and returned one charter barge with a combined capacity of 221,000 barrels during the quarter. During the remainder of 2019, we intend to return one additional small charter barge. On a net basis, we currently expect to end 2019 with 50 coastal barges with 4.8 million barrels of capacity.

Looking at our distribution and services segment, revenues for the 2019 first quarter were $376.5 million, with an operating income of $37.6 million. Compared to the 2018 first quarter, revenues declined primarily due to lower activity in our oil and gas business. This was partially offset by higher demand in commercial marine and power generation. Compared to the 2018 fourth quarter, revenues increased 11% or $37.5 million, and operating income improved $9.4 million, primarily as a result of increased deliveries of oilfield equipment, higher demand in the marine sector, and increased revenues in power generation. During the first quarter, the segment's operating margin was 10%.

In our oil and gas market, revenue and operating income were down compared to the 2018 first quarter, due to softening of activity levels in the oil field, which resulted in a lower demand for new and overhauled transmissions, engines and parts. In manufacturing, we experienced reduced year-on-year demand for new pressure pumping units, but this was mitigated by increased service and pressure pumping unit remanufacturing. Compared to the 2018 fourth quarter, however, revenue and operating income improved with increased deliveries of new pressure pumping units and international oil field equipment. In the first quarter, the oil and gas businesses represented approximately 60% of distribution and services revenue.

In our commercial and industrial market, compared to the 2018 first and fourth quarters, revenue and operating income increased primarily due to improved demand for marine diesel engines, parts, and services in the inland market, as well as along the Gulf Coast in Florida. Additionally, we had increased revenue and operating income in our power generation business. In the first quarter, the commercial and industrial businesses represented approximately 40% of distribution and services revenue and had an operating margin in the mid to high single digits. Turning to the balance sheet. As of March 31, total debt was $1.67 billion, and our debt-to-cap was 33.8%. The increase, compared to the end of the year, related to the $244 million acquisition of Cenac. As previously announced, we amended and restated our credit agreement during the quarter.

As part of this agreement, we extended the term of Kirby's $850 million revolving credit facility to March 2024, and we also added a new $500 million term loan due in March 2024, which allows for early repayment, payment without penalty. With this amendment, we have enhanced the liquidity of the company significantly. Our financial policies remain unchanged, and in the short term, we intend to prioritize the use of our cash flow on the repayment of debt for the remainder of 2019. As of this week, our debt balance was $1.67 billion. I'll now turn the call back over to David to discuss our outlook for the remainder of 2019.

David Grzebinski (CEO)

Thank you, Bill. In our press release this morning, we reaffirmed our 2019 earnings guidance of $3.25 a share to $3.75 per share, as well as reaffirmed our capital spending plan of $225 million-$245 million. Looking at our segments, in marine transportation, with strong customer demand, modest increases in GDP, additional petrochemical capacity scheduled to start up, and new Permian crude pipelines bringing additional volumes to the Gulf Coast later this year, we believe activity should remain strong for the balance of the year. As a result of these factors, we expect the market will remain tight with our barge utilization rates in the mid-90% range.

In the second quarter, we anticipate that our inland marine operations will continue to be challenged by near-term delays in the Houston Ship Channel and high water conditions on the Mississippi River well into June. However, improved weather across the system and increased pricing should yield sequential improvement in revenue in the high single- to low double-digit % range, with operating margins returning to the mid- to high-teens %. With respect to Cenac, we expect a meaningful contribution to operating income in the second half of the year as we complete our integration and the inherited contract pricing begins to roll off. In the coastal market, we expect utilization will range in the low- to mid-80s % for the duration of 2019, with modest improvements in volumes and possible additional industry barge retirements due to ballast water treatment regulations.

In the second quarter, we expect that reduced shipyard days, improved weather, and seasonal activity improvements in the Pacific should result in sequential improvements in revenue and operating income. Operating margins are expected to be around breakeven for the second quarter. For our distribution and services segment, the first quarter results were favorable, although the outlook for the latter part of 2019 remains unclear. Since the end of 2018, activity in the oil field has recovered modestly, and some E&Ps and service companies have recently pointed to expectations of further improvements. For the second half of the year, the consensus among industry participant varies, with some forecasting that activity could ramp up if oil prices remain above $55 a barrel.

Regardless, many have remained steadfast in their commitment to focus on returns on capital, which we believe is healthy for our industry and their industry. So what does that all mean for Kirby Distribution Services manufacturing businesses? Since the end of the year, we have experienced a slowing in new orders for pressure pumping equipment. We currently expect that revenues and operating income in our manufacturing business will decline in the second quarter, in part due to some shipments that may not incur until the third quarter. However, we do continue to see potential opportunities with various domestic and international customers for new equipment that would be built in the second half of 2019. In distribution, we expect the demand for new engines, transmissions, parts, and service from oil field customers will decline slightly until oil field activity meaningfully improves.

Nonetheless, activity continues, equipment is being run hard, Permian pipelines are coming online, and the industry is getting more disciplined. This is all very positive for the long-term outlook of our business. In commercial and industrial markets, we expect continued growth in revenue and operating income, primarily driven by increased demand for backup power systems and specialty equipment rentals. In 2019, we have additional large projects, which will not only provide for new equipment sales, but also service and maintenance contracts throughout the year. Activity in our commercial marine business is expected to be stable for the duration of the year. In total, for distribution and services, we expect second quarter revenues to be flat to slightly down compared to the first quarter, with reductions in manufacturing being offset by increased revenues in power generation.

Operating margins are expected to decline in the mid- to high single digits, with unfavorable revenue mix driving that reduction. For the full year, we remain optimistic, but our results will be dependent on oil field activities and levels in the second half. If the second half recovery does not materialize, all indications are that 2020 will be more certain. Overall, with regard to our full year guidance range, the lower end assumes softness in the distribution and services oil and gas market, with continued muted demand for new engines, transmission, and parts, as well as limited orders for new and remanufactured pressure pumping equipment in the back half of 2019. The high end of guidance assumes enhanced inland barge utilization levels for the full year, increased pricing momentum, and a stronger contribution from Cenac than originally contemplated.

In conclusion, overall, we're off to a solid start in 2019. Although marine transportation underperformed expectations as a result of temporary weather and navigational delays, the strength and diversity of our distribution and services franchise helped the quarter's results. As we look forward, despite near-term uncertainty in the oil field, we are excited about what lies ahead for Kirby. In inland marine, our series of strategic acquisitions throughout the downturn and the recent closing of Cenac have firmly placed Kirby in an excellent position to capture the benefits of the ongoing inland market recovery. We have the largest, youngest, and most efficient fleet in our history, and we are better able to serve our customers in this very tight market.

With continued strong demand on the horizon and current pricing momentum, inland marine is poised to deliver meaningful increases in revenue and earnings in 2019 and beyond. In coastal, the market continues to show signs of improvement, and we expect this to continue with good customer demand and additional industry barge retirements due to new regulations. We've taken proactive steps in the last two years to improve coastal's cost structure, right-sized our fleet to maximize returns, and invested countercyclically into new and more efficient equipment. Our actions paved the way for year-on-year profitability improvement and potential for positive earnings contribution in the second half of 2019 and into 2020.

In distribution and services, while the oil field presents some uncertainty in the near term, the diversity of our portfolio brings some stability to the segment, with the commercial and industrial market estimated to make up approximately 40% of the revenues this year. Demand for backup power systems is growing, and we will benefit this year from major power generation installations and new service contracts. Beyond 2019, we see a significant opportunity as the oil field is expected to recover, with increased production in the Permian and improvement in other basins. Our investment in Stewart & Stevenson, combined with United Holdings, has created an industry-leading business, which is well positioned to capture this growth, and I firmly believe that our shareholders will be rewarded nicely in the coming years. Lastly, our balance sheet remains strong.

We have recently acted proactively to improve our financial flexibility even further by extending our credit facility and adding a term loan to ensure that we have ample liquidity following our series of recent marine acquisitions. With a strong inland market and the contribution from these acquisitions, we expect to generate significant free cash flow during 2019, and we will prioritize the use of cash flow to reduce our debt balances. However, we could take advantage of a smaller acquisition or two, if it aligns with our strategy and can create positive returns for our company and our shareholders. Operator, that concludes our remarks. We are now ready to take questions.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone.... If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press the pound key. As a reminder, we ask that you please limit your questions to one question and one follow-up. The first question comes from Jonathan Chappell with Evercore.

Jonathan Chappell (Senior Managing Director)

Thank you. Good morning, guys.

David Grzebinski (CEO)

Good morning, John.

Jonathan Chappell (Senior Managing Director)

David, first question, on the inland and the exceptional weather issues in the first quarter, and as it relates to the second as well. Can you just elaborate a bit? You know, mid-90% utilization, really robust pricing improvements. Is the weather issue strictly a function of ton-miles and then cost? And as we think about the second quarter, you know, kind of started late in the first quarter, is the carryover into 2Q similar to what you saw in 1Q, or is it kind of already remedying itself?

David Grzebinski (CEO)

Yeah, it just take the last question first. It is remedying itself. You know, the wind and fog are down on the Gulf Coast, but we still have high water on the river system, and we still have some challenges in the Houston Ship Channel. But it's getting better, and we're flowing better already into May here. April was a little better, but there's still some challenges, particularly with the high water. Yet, you know, John, it, the big part of this weather is that there's some additional costs, particularly on the river system. You have to go slower. Many of the bridges, I think, we were discussing this morning that every bridge south of St. Louis is still under daylight hours only for transiting through bridges.

So that slows you down. You, you operate smaller tows because the river's running so fast. You put extra horsepower at certain bridges that are difficult to transit through so that the, that, you, you have an extra towboat to help the, the barges get through the, the bridge without damaging or hitting the bridge. And that all adds costs and, and delays. For our portfolio, as you know, we, we have a fair amount of contracts of affreightment. And unlike time charters, you, you, you don't get paid on those unless you're moving and delivering the barrels. So, that's, that's what impacts you in, in, in the quarter when bad weathers.

But by the same token, those contracts of affreightment in the summer, when we're really efficient, and we can get back hauls and move quicker for the customer, you know, they—when you're getting paid by the barrel, the delivered barrel, it pays off. But weather is getting better. Still some challenges, but this first quarter was one of the worst we've seen. I think the river system was as bad as we've seen in a decade. And then the fog and everything else certainly impacted us. The Houston Ship Channel also was, as you know, is a large part of our operation. We have a lot of concentration in and around the Houston area.

With the storage facility catching fire, that shut down the Houston Ship Channel for quite some time and impacted some of our equipment directly. So, you know, that had a factor in the quarter as well.

Jonathan Chappell (Senior Managing Director)

Mm-hmm.

David Grzebinski (CEO)

That's pretty much behind it. There's still some restrictions in and around the Houston Ship Channel, but they're also clearing up.

Jonathan Chappell (Senior Managing Director)

Okay. So that kind of leads then to my follow-up question. If this was the worst weather in a decade, $0.05 impact, let's assume it's something maybe $0.02-$0.03 impact in the second quarter just from the carryover, and yet you still maintain the guidance range for the full year. That means you're most likely even more optimistic, I would think, about the second half of the year, at least as it relates to inland, because of the uncertainty you mentioned in D&S. So you talked about, mid to high teens for the full year for the inland margin, in the outlook commentary. But given the impact on the first quarter, would it be realistic to assume that you can hit maybe a 20% run rate, as we exit this year and into 2020?

David Grzebinski (CEO)

Yeah. It's certainly possible we could get there in the third quarter. You know, that's when the weather's the best. But as you know, the fourth quarter, we start to get impacted by weather, and you usually see the margin dip a little bit in the fourth quarter. You know, I don't think we're gonna get to an average of 20% margins this year. We may bump them in the third quarter. It's hard to say right now, but the momentum's headed in the right direction. One, we've got Cenac that just came on board. As you know, there's some integration work we have to do, and there's costs associated with the integration. They also have a contract portfolio that needs to roll over.

It was set back when rates were a lot lower. So we've got some work to do to get there, but the momentum right now is pretty good. Clearly, the weather does tighten up utilization a bit, but you know, demand's pretty high. Our customers are doing well. There's a lot of new petrochemical plants coming on, as you know, and we're starting to see some incremental volumes there. The U.S. economy is doing okay. I wouldn't say it's robust, but that helps volumes as well. So when we put all that together, we're pretty pleased with where we're headed. And we could get back, you know, to margins in the certainly in the high teens, and maybe we get to close to that 20 in the third quarter.

But, you know, we're pleased with the direction it's going, but it's still a ways before we would average, like, a 20% for a whole year.

Jonathan Chappell (Senior Managing Director)

Mm-hmm. Okay.

David Grzebinski (CEO)

... All right, thanks, John.

Operator (participant)

Your next question comes from Ben Nolan with Stifel.

Ben Nolan (Managing Director of Research)

Yeah, thanks. So, sort of following on, David, with a little of John's questions and kind of the weather-related things. We've heard that that is causing a real tightness in towboat capacity, and from what we understand, was already a very tight market. I know that you guys own the majority of your power, but was curious how that is flowing through, if there might be some inflationary impact from associated with power, and where you guys might slot in relative to your competitors, in that respect?

David Grzebinski (CEO)

Yeah, good question. The, you know, horsepower is, is somewhat tight, but more so on the dry cargo side of the business, where, where there's some larger horsepower, for the bigger tows. You know, that's been pretty tight. There's some limited number of, of those larger horsepower units, like 6,000 horsepower-type units. As you know, we've- we, we own and operate, and, and with our charter fleet, have about 300 towboats under operation on the inland side. We're pretty well set for horsepower. One of the great things about both Higman and Cenac is we, we got relatively young, new horsepower. It's in good shape. It's got, we've got good crews on board. And, you know, both Cenac and Higman operated more in a unit tow environment.

We're able to operate more barges per boat than an average kind of unit tow operator. So we're getting some of that benefit with our horsepower. So we're in pretty good shape from a horsepower standpoint. And also further, we embarked on a build campaign for about 15 inland towboats, and those have been delivering here ratably through this year. I think we took a couple deliveries already this year, and we expect a few more this year. So we're in good shape. I would say the bigger impact's probably on the dry cargo side. But the other part of your question, it is causing a little bit of an inflationary pressure if you think about labor.

You know, labor rates are definitely being challenged a little bit, and we're seeing a little labor inflation, as you would expect as the U.S. economy is had a pretty good run here for a while.

Ben Nolan (Managing Director of Research)

Okay, that's helpful. And then for my second question, just to switch gears over to the D&S side, really quickly. On that. On the midpoint of your guidance range, and I know you kind of laid out the sort of high and low case, was curious what you're assuming, the activity levels for the oil field or the pressure pumping and fracking business will be in the back half of the year in order to get that guidance effectively flat or down a little bit for the midpoint?

And then kind of pairing with that from a longer-term perspective, given how hard equipment's being run and using brown sand versus northern white and all those kind of things, what do you think is the normal or the new normal life cycle of these things, and at what point, even if there is a slowdown, do people have to replace equipment whether they want to or not?

David Grzebinski (CEO)

Yeah. No, it's very clear that they're operating the equipment very hard. I think even Halliburton said on their call that they believe in 2019, there's 7.5 million horsepower that they think will need to be refurbished in, during 2019. That's their number, not ours. But clearly, the equipment's getting worked very, very hard. We estimate you can get about three years before you have to do kind of a major overhaul or refurbishment. So that's all good news, and when you couple that with pretty good capital discipline that you're seeing, there's a balance between building new, refurbishment, and then just general maintenance. We think that's very, very healthy for us and the industry.

But that said, to get to a normalized number for this year is quite difficult. As we've said, we had backlog through the first half, second half, we're going to need to see some activity. And you know, so if you look at the midpoint of our guidance, we assumed some decline in the second half. You know, the question is: How low does that decline go? Or does it just start to come back? And that's why we have the range from low to high. Hard to be more precise than that, Ben. But yeah, we're pretty excited because everything is lining up pretty well. You've got capital discipline, which is good long term. You've got Permian pipelines coming on. Crude pricing is doing okay.

Then you've got the equipment just being worn out. So all that should lead to hopefully some pickup in activity in the second half, but certainly by 2020, we should see some more activity. Now, within our manufacturing business, you know, we do other things than just pressure pumping. You saw we had a pretty good quarter. Part of that was in manufacturing. We do ship oilfield equipment internationally, things like seismic units, and we also do things like Rail King, which is railcar movers. So, you know, there are some inbound orders. And also, I would say that the inquiry level is quite active right now. We're getting a lot of inbounds about pricing and equipment delivery schedules and whatnot.

None of that's really translated to a whole lot of orders just yet, but certainly a lot of conversations happening right now.

Ben Nolan (Managing Director of Research)

All right. Well, that was a whole lot more than I was betting on there. I appreciate it, David. Nice quarter.

Operator (participant)

The next question comes from Mike Webber with Wells Fargo.

Mike Webber (Financial Advisor)

Hey, good morning, guys. How are you?

David Grzebinski (CEO)

Well, Mike, how are you?

Mike Webber (Financial Advisor)

Good. David, wanted to start on—actually, I'll probably both questions on inland. And you mentioned you closed Cenac this quarter, so you'll have that kind of rolling through your book for the balance of the next 12 months. But when we think about the deals that you closed, I guess, a year, year and a half ago, Higman primarily, but then also the barges from Targa, how much of that business has yet to reprice off of those legacy levels? I'm trying to figure out exactly, kind of maybe outside of Cenac, like, how much do you actually—how much are you growing with the market in terms of pricing, or how much do you kind of... Or what kind of levers do you have in terms of repricing some of that legacy business?

David Grzebinski (CEO)

Yeah. Higman's almost all repriced. Most of their contracts were a year. We closed them in mid-February of last year, so they've pretty much all rolled off.

Mike Webber (Financial Advisor)

Right.

David Grzebinski (CEO)

I think there's a black oil contract or two, relatively small, that still haven't rolled off. Most of the Targa equipment that we got has repriced, so that's pretty good. It's really just the Cenac equipment. Some of that stuff was contracts from over a year ago, almost two years ago, back when pricing was probably 30% lower than it is now.

Mike Webber (Financial Advisor)

Right.

David Grzebinski (CEO)

So it's got some makeup to do, and you know, but that's part of the deal and part of our calculus as we think through, you know, second quarter versus the second half of the year and as some of those start to reprice.

Mike Webber (Financial Advisor)

Yeah, and it's not a huge number of barges, but should we assume that's pretty evenly spread throughout the next 12 months in terms of repricing that fleet?

David Grzebinski (CEO)

That's probably a safe assumption.

Mike Webber (Financial Advisor)

Okay.

David Grzebinski (CEO)

You know, there tends to be a year-end bubble, if you will, not-

Mike Webber (Financial Advisor)

Mm-hmm.

David Grzebinski (CEO)

Not enormous bubble, but ratable's not a bad assumption.

Mike Webber (Financial Advisor)

Okay. That's helpful. And then to follow up on inland, in just looking at the supply side, it's pretty interesting. It looks like the order book's sitting at about kind of 3.5, 3.4% of the fleet. You've had some production capabilities permanently shut down. But if I look at it over the last, you know, even last six months, that order book has actually come down from, I mean, about a point, which isn't a big number, but it's a bit surprising, just considering where pricing is and the fact that you would... I guess, we would've thought that would have at least remained flat, that, you know, what can be produced, would be produced, considering that pricing is generally back at a point where people are making money.

So I'm just curious, one, is that a little surprising to you? I know it's not a big figure, but is it surprising that you haven't seen more orders from maybe your competitors? And then is that a function of capital availability, or just, again, that kind of narrower capacity, kind of limited to Madisonville and Caruthersville and Ashland City?

David Grzebinski (CEO)

I think it's a combination of a number of things. You know, as far as we're concerned, any building's too much, to be honest, but,

Mike Webber (Financial Advisor)

Yeah, sure.

David Grzebinski (CEO)

Taking, trying to be facetious away. We are seeing barge costs are up considerably. If you go back to the beginning of 2018, 30,000-barrel barge, you could have probably purchased for about $2.2 million, depending on bells and whistles. Now it's about $3.2 million. So you've got, you know, quite a bit of a price increase in there. A good portion of that, steel, the other portion of it's probably a combination of just the higher cost of labor and also consolidation in the shipyard market. So we're... That's probably some of it. You know, we still think that you could have 150-200 barges built this year with about 100-150 retired this year.

So, you know, maybe it's lower than that in terms of retirements, but it's that order of magnitude. So we do need some capacity added to the system because just the volumes continue to increase, but it feels as if the industry's adding it at a reasonable rate. And look, the cost of doing business has also gone up. You've heard some of the high water stuff, but-

Mike Webber (Financial Advisor)

Right

David Grzebinski (CEO)

When you look across what's happening from a legislation standpoint, environmental compliance, inspected towboats, for example, Subchapter M, that's adding cost to the whole system, where all operators have to spend more money for compliance. So even though rates are going up, they need to go up to cover some of that compliance cost and some of the additional costs. For example, you got Tier 4 engines going into towboats, and, you know, they're more expensive to operate, they're more expensive to buy, more expensive to maintain. So there is some cost inflation. So even though rates are going up, you need them to go up to offset some of that. Plus we're coming off the bottom, obviously.

But, there's a long-winded answer to say, I think, the capacity additions or the supply additions are about where they need to be, to keep the market in balance. And, I don't think they're enough to take it away from a tight situation.

Mike Webber (Financial Advisor)

Sure.

David Grzebinski (CEO)

I'm not surprised that, given the cost of barges nowadays and the cost creep, that there's not a boom in building for, as an example. I don't think that would be warranted at these price levels.

Mike Webber (Financial Advisor)

Yeah, no, it looks better than we would expect it, certainly. No, but very helpful. I appreciate it, Dave. Thanks.

David Grzebinski (CEO)

Yeah, thank you.

Operator (participant)

The next question comes from Ken Hoexter with Bank of America Merrill Lynch.

Ken Hoexter (Managing Director)

Good morning.

Hey, good morning,Dave, and Bill. Just on—let me just follow up real quick on the Cenac stuff, just to knock that one off. But, you noted rates have improved, I guess, so much. I just want to understand, are you saying that, you know, even though it's only closed in March, when you said the upper end of your outlook is because Cenac could move to the upside, is that rates are moving even faster in the near term than you thought, even just, you know, a month or two ago?

David Grzebinski (CEO)

Yeah, I'd say that's part of it. You know, it's also the integration. You know, when we think about Cenac, we've got to integrate it. We've got to put our safety management system on board. We have to put our computer systems. I know it's kind of mundane stuff, but you know, that adds cost. It takes time until all that's done. You know, the integration and our ability to capture upside is limited. We have to get them fully integrated, and we have to rationalize some costs as we put the teams together. So, you know, that's part of it. But I would say that rate momentum could improve, you know, given how tight we are, but it's pretty good right now.

You know, as we said, and as Bill said in his prepared comments, they've moved year over year and sequentially, and that's good. Yeah, the upper end of our guidance really is more about integrating Cenac and, you know, getting those contracts successfully rolled over at higher rates. I wouldn't say it's about increased momentum as much as those two things.

Ken Hoexter (Managing Director)

All right. That's helpful. And then you've talked a lot about inland, and even a little bit on D&S, but coastal has kind of been left behind. You talked about expecting margins to kind of get back to break even in the second quarter. Where do you stand on the rates there going forward? Are we seeing kind of an acceleration there like you are on the inland, and is this just, you know, a period of rebound on the margins there as well?

David Grzebinski (CEO)

Yeah, it's not as—that market's not as tight as inland, is the way I would say it. We did see mid-single-digit price increase, mid- to high-single-digit price increases on both term and spot contracts. That's certainly headed in the right direction. You know, we retired some equipment, some others have retired some equipment. We've seen a little tick up in volumes. So the market's getting closer to balance. But again, we're only in the low 80% utilization range. I would say to get some true price momentum, we need to be in that high 80%. So we still need some capacity rationalization or some more robust demand growth, before we kind of get to the inland pace of things.

You know, we're just encouraged that it's starting to head in the right direction. We're also encouraged that, you know, we could get to back to break even here in the second quarter. Things are marching in the right direction.

Ken Hoexter (Managing Director)

Is there seasonality to that as well? Does that fall off in that fourth quarter? Or, you know, once you get to break even, that's just given where rates are, you stay at that level.

David Grzebinski (CEO)

No, there is some seasonality, absolutely. We do a bit of work in the Pacific Northwest, up into Alaska. That comes off in the fourth quarter. In the first quarter, it takes a while. Kind of the end of the first quarter, you start to deploy some equipment northbound. So there is some seasonality. It's similar to the seasonality we see in the inland side, where fourth and first quarter are weaker.

Ken Hoexter (Managing Director)

All right, great. Great, Bill. Thanks for the time.

David Grzebinski (CEO)

Yeah, thanks again.

Operator (participant)

The next question comes from Randy Givens with Jefferies.

Randy Giveans (SVP of Equity Research)

Howdy, gentlemen. How are you?

David Grzebinski (CEO)

Uh, good.

Randy Giveans (SVP of Equity Research)

Good. So on the fourth Q eighteen call in January, your legacy, I guess, DES backlog was, as you mentioned, through May or June. So I was curious how that backlog has developed in recent months in terms of deliveries, made versus new orders placed. Basically, is that backlog larger or smaller than three months ago, and does it now stretch into August or September?

David Grzebinski (CEO)

Yeah, the backlog, we have eaten into our backlog. You know, our book-to-bill was less than one. But we have taken on some new orders, and we've got backlog that will take us into the third quarter. But we have... It is at a relatively lower, a lower point than it was last quarter. But, yeah, this is not unexpected. It's kind of what we expected when we gave our guidance. We'll see. You know, the really good news is we've seen a pickup in some international activity. You know, we've started to see that. That's good. We do seismic units and other things, and also Rail King's been marginally better as well.

Randy Giveans (SVP of Equity Research)

Perfect. And then following the Cenac acquisition and the amended credit agreement, just trying to get a sense for your current financial capacity for acquisitions, if there were large ones that opened up. Is inland marine still the primary or only focus for acquisitions at this time?

Bill Harvey (EVP and CFO)

I'll cover the credit agreement, Randy. So yeah, our liquidity post the credit agreement was over $700 million. Now, that includes, does not include the fact we have a private placement note coming due next February of $150 million, which we factored into that size. So over $700 million, and we pre-financed the repayment in February of the $150 million. Again, we expect strong cash generation for the balance of the year.

Yeah, no, so said another way, we do have some capacity that, you know, we could probably do, you know, a $400 million acquisition with our liquidity if we wanted to. But what we would like to do is pay down some debt now. Clearly, you know us, we take acquisitions when they come and when they make sense. I would say our preference right now is to delever. That said, if a small strategic acquisition or a really good acquisition came along, we'd have to look at it, and we would. You know, our preference right now is inland. We still, you know, the consolidation play there is good. We're still coming off the bottom, so to speak, on inland, so that's attractive.

David Grzebinski (CEO)

But there could be some nice little niche acquisitions, very small, in terms of size, that might fit within our DNS business as well. But, you know, we're, as you know, disciplined, and we're gonna remain disciplined. We would like to delever, though, some. And based on, you know, Bill's comments here about free cash flow, we should generate some pretty, pretty good free cash flow this year. So, that should help our delevering goals.

Randy Giveans (SVP of Equity Research)

Sure. All right, well, hey, that's it for me. Thank you very much.

Bill Harvey (EVP and CFO)

Hey, thanks, Randy.

Operator (participant)

The next question comes from Jack Atkins with Stephens.

Jack Atkins (Research Analyst)

Guys, good morning, congratulations on a good quarter.

David Grzebinski (CEO)

Thanks, Jack.

Bill Harvey (EVP and CFO)

Thanks, Jack.

Jack Atkins (Research Analyst)

So David, let me, let me start with you, just going back to inland for, for a minute. You know, it, it certainly feels like things are, are moving in the right direction there and have been a pretty meaningful way. But I guess, as you think about—I would just be curious to get your thoughts on, sort of how you view underlying market demand growth, this year and into next year. You know, just in terms of all the incremental capacity, chemical capacity that's been coming online all around the Gulf Coast, what's that doing to sort of underlying volume for that, for your core inland business? If you could just sort of talk about that for a moment.

Then just sort of an extension of that, you know, how are your customers thinking about securing capacity over the next, you know, 12-18 months, given the industry's running at tight levels of utilization now? Are you getting calls from customers who are sort of increasingly worried about not being able to get capacity, as you look out over the next several quarters?

David Grzebinski (CEO)

Yeah. No, let me take the second one first, and then I'll come back to the first. Yes, is the short answer. We are seeing a move, a gentle move from spot to more contract. As the customers are starting to worry about availability a bit, we're seeing them look for more contract positions. As you know, during when it was pretty sloppy the last four years, as you know, we had too much capacity. They got used to the spot market being readily available. That's tightened up now, so we are seeing kind of that gradual and normal shift to desire for more contract equipment. But when you look at demand, you know, let's just run through it. You know some of these projects, Jack.

There are six ethylene projects that are going to start up in 2019: Formosa, Shintech, Indorama, Sasol, Lyondell, and then Lake Charles. I think it's Lake Charles. So we've got, you know, that coming at us, and all those ethylene plants will feed something. Now, some of it will be a good portion of it will be for polyethylene, but there are derivatives downstream, as we've talked about before. There's also two new methanol projects starting up in 2019. Maybe one of them slips into 2020. There's two MEG plants expected to start up this year, MEGlobal, and another one. So it's all good. I would characterize it as, you know, our volumes usually go up with GDP. Now we're probably GDP plus, you know, 2%-5%.

Hard to translate that to actual barges, but we're seeing some good volume growth, and that's adding some tightness to the market, which is all good.

Jack Atkins (Research Analyst)

Well, that's encouraging to hear. And then for my follow-up question, and I know you guys have talked about IMO 2020 in the past, but you know, for sort of coming at us like a freight train in terms of the end of the year. Just curious if there are any updated thoughts on how this could impact your business in terms of potential increased volume moves by either your inland or your coastal refining customers? Yeah, I know it's not gonna be an issue for you guys from a cost perspective. Just trying to think about, you know, is this potentially gonna drive incremental demand, given we may have refined products that may need to move between markets on the Gulf or the East Coast?

David Grzebinski (CEO)

Yeah. Well, let me go to your point on the cost. Look, we're already on all our towboats and tugboats, we're already using ultra-low sulfur diesel.

Jack Atkins (Research Analyst)

Right.

David Grzebinski (CEO)

So it won't impact us there. Now, what you could see is a spike in diesel prices, so we'll have to watch that. We generally have pass-through or indexes within our contracts to, you know, prevent price spikes from hurting us, but there can sometimes be lags there. So that's not the—I don't want to think we're completely immune. If we get a price spike and there's a lot of volatility, we could get pencil-whipped a little bit with our contract catch-up calculations on diesel prices. But that said, we should be pretty immune from any real big impact on IMO on our cost side.

Now, on the demand side, you know, clearly, we bunker a lot of, of ships, you know, Houston, Miami, and other places. You know, we'll, we'll make the switch over. They'll still have to, to use barges to, to bunker that. You know, there, there'll be some cut-over challenges, but we think that part of our business, bunkering part of our business, should be okay, and maybe a little positive there, depending on, availability of, of other people's equipment. I guess the potential upside is blending. There could be some blending that happens, and that could lead to a few more moves. So all in all, we, we think it's a neutral to maybe a slight positive, but we wouldn't get too aggressive on the positive side.

Jack Atkins (Research Analyst)

Okay, makes sense. David, Bill, Eric, thanks again for the time.

David Grzebinski (CEO)

All right. Thanks, Jack.

Eric Holcomb (VP of Investor Relations)

All right, Shannon. We're running up on time, so we have time for one more, one more question.

Operator (participant)

Our next question comes from Justin Bergner with G.research.

Justin Bergner (Research Analyst)

Oh, good morning, and thank you for fitting me in on today's call.

David Grzebinski (CEO)

Great. Thanks, Justin.

Justin Bergner (Research Analyst)

In regards to the inland barge utilization, if there weren't the weather and other related disruptions on the supply side, do you still think that the industry would maintain a mid-90s utilization rate, going forward?

David Grzebinski (CEO)

Yeah, I would say between lock and the lock delays and weather, there's probably 2%-3% extra utilization. That's typical what we see in the winter months. We see 2%-3%, so maybe it's on the high end of that range now because the weather's been so bad. But we'd still be in the 90s in terms of utilization, which is, which is pretty, pretty strong.

Justin Bergner (Research Analyst)

Okay, great. And then, the second question I had was, in your press release and in your comments, you talked about, good demand for pressure pumping units, in the oil field equipment space, but then lower sequential sales of new engines, transmissions, and parts to oil field customers. Could you maybe just clarify that dichotomy? Is that because the pressure pumping units were in backlog coming into the year, and the engines and transmissions and parts were not, and that sort of dichotomy is gonna narrow, or are there other factors behind it?

David Grzebinski (CEO)

No, you got it exactly right. Much of our pressure pumping equipment was in backlog. We did get some new orders, but the pieces and parts, if you will, are more book and ship type business, and, you know, that got, that declined in the quarter. So no, you have it precisely correct.

Justin Bergner (Research Analyst)

So going forward, we should expect not two dissimilar results across the different parts of your oil field equipment?

David Grzebinski (CEO)

Yeah, I would agree with that. You know, the question is, what happens in the second half? Do we see, you know, activity start to pick up? Or said another way, do we see, you know, some more maintenance, more new orders in the second half, given the equipment's being worn out, given that Permian's getting more sporty, particularly with takeaway capacity coming out of the Permian on a pipeline basis, coming online. So we could actually see those trends kind of reverse themselves in the second half.

Justin Bergner (Research Analyst)

Okay, great. Thanks.

David Grzebinski (CEO)

All right. Thanks, Justin.

Bill Harvey (EVP and CFO)

Thanks, Justin.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Mr. Eric Holcomb for any closing remarks.

Eric Holcomb (VP of Investor Relations)

All right. Thank you, Shannon, and thank you everyone for your interest in Kirby, and participating in our call today. If you have any additional questions or comments, you can reach me directly at 713-435-1545. Thanks, everyone, and have a great day.

Operator (participant)

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.