Kirby - Q2 2019

Transcript

Operator (participant)

Good morning, and Welcome to the Kirby Corporation 2019 second quarter earnings conference call. All participants will be in a 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 touch-tone 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 VP 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 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 call, we may refer to certain non-GAAP or adjusted financial measures. Reconciliations of the non-GAAP financial measures to the most 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 (President and CEO)

Thank you, Eric, and good morning, everyone. Earlier today, we announced second quarter revenue of $771 million and earnings of $0.79 per share. This compares to 2018 second quarter revenue of $803 million and adjusted earnings of $0.78 per share. Although revenues were down 4% year-on-year, adjusted earnings per share were flat, with a nearly 40% increase in marine transportation operating income, offsetting the impact of reduced distribution and services results. We'll discuss the second quarter in more detail in a moment, but before we do, I want to first discuss our announcement that we are lowering our 2019 earnings guidance range to $2.80-$3.20 per share.

Although we believe we have strong momentum in marine transportation, reduced expectations for the second half in our oil and gas distribution and services businesses and the extensive delay days in inland marine throughout 2019 will impact our full year. In distribution and services, although our previous guidance range contemplated some downside in the second half of 2019, the pace of new orders, maintenance activities, and parts sales have slowed considerably. Discussions for new and remanufactured pressure pumping equipment orders continue. However, it is clear that many of our customers are intensely focused on free cash flow and returns, and as such, are operating at very reduced levels of spending. While this is not good news for 2019, we do believe this level of spending will ultimately create a more ratable market and less volatility in 2020 and beyond.

Additionally, with limited new builds, remanufacturing, and maintenance activities ongoing today, we believe this lull in activity is creating pent-up demand. While completions activity has slowed in 2019, our customers continue to work their equipment incredibly hard. With minimal investment and maintenance being performed today, this should benefit our manufacturing and remanufacturing businesses in the future. Despite improved performance in our marine transportation businesses year to date, the financial impact from poor weather, high water conditions, and closures of key waterways in 2019 has been significant. This year, we have experienced extensive periods of ice and fog, and we are currently in the midst of the most prolonged period of flooding and high water conditions on the Mississippi River and her tributaries in modern history.

Further, lock maintenance and infrastructure projects throughout our network have significantly slowed operations, and the Houston Ship Channel, which is important to our operations, has experienced extended periods of delays and closures. Year to date, through June, we have incurred more than 7,900 delay days, which represents an 86% increase compared to the first six months of 2018. We estimate that these conditions and incremental delays have cost inland marine about $0.10 per share thus far in 2019. And although the high water conditions are improving, we expect the high water will continue into mid-August. So the guidance reduction is primarily due to what we are experiencing in the oil and gas markets, but there is also a component related to the marine operating environment.

Moving back to the second quarter, in inland marine, we experienced a solid rebound in financial performance following a slow start in the first quarter. Strong customer demand, improved pricing, and consistent barge utilization rates in the mid-90% range all contributed to more than a 30% improvement in operating income compared to the first quarter. As previously discussed, our inland operations, particularly our contracts of affreightment, were heavily affected by significant delays in this quarter, which were nearly double the second quarter of 2018. The impact is evident in our ton miles, which declined 5% year-over-year, despite an 8% increase in barges and a 9% increase in barrel capacity. In addition to the effects from high water and lock issues, we were also delayed and impacted by a temporary closure of the Houston Ship Channel due to a storage fire, a storage facility fire.

Ultimately, we estimate that the poor operating conditions and extensive delays negatively impacted inland second quarter earnings by approximately $0.05 per share. In coastal, we reported sequential financial improvement, with an 11% increase in revenues and reduced shipyard maintenance contributing to positive operating income. During the quarter, we experienced good customer demand and a tighter market for larger capacity vessels. Overall, our barge utilization levels increased into the mid-80% range, with higher usage on our equipment working in the spot market. Spot market pricing was flat compared to the first quarter, but we did experience mid-single-digit pricing increases on term contract renewals. In distribution and services, as we indicated, results were challenged by widespread reductions in customer spending within the oil and gas sector, with only a few new orders booked, minimal maintenance and service activities performed, and reduced part sales.

We implemented cost reduction initiatives during the quarter, and we will continue to adjust our business as needed to limit the impact. In commercial and industrial, we experienced a sequential increase in revenue and operating income, primarily due to additional deliveries of backup power systems in our power generation business. The marine sector was stable during the quarter. In summary, marine transportation had a good quarter. Strong sequential gains were realized in inland, despite extensive delays and challenging operating conditions, and coastal returned to profitability. Although distribution and services executed well on its backlog, slowing activity and the pace of new orders were worse than anticipated, and we have revised our full year guidance down as a result.

In a few more moments, I'll provide more details about our outlook, but before I do, I'll turn the call over to Bill to discuss our second quarter segment results and the balance sheet.

Bill Harvey (EVP and CFO)

Thank you, David, and good morning. In our marine transportation segment, second quarter revenues were $404.3 million, with an operating income of $53.2 million and an operating margin of 13.2%. Compared to the same quarter of 2018, this represents a 7% increase in revenue and a 39% increase in operating income. Compared to the first quarter, revenues increased $36.2 million, or 10%, and operating income increased by $17.8 million, or 50%. In the inland business, revenues increased 8% year-on-year due to increased customer demand, improved barge utilization, increased pricing, and the contribution from acquisitions. These were partially offset, however, by the impact of a 92% increase in delay days compared to the 2018 second quarter.

Compared to the first quarter, inland revenues increased 10%, primarily due to the Cenac acquisition and higher pricing. During the quarter, the inland business contributed 77% of marine transportation revenue, and the average barge utilization rate was in the mid-90s. Long-term inland marine transportation contracts, or those contracts with a term of one year or longer, contributed approximately 65% of revenue, with 63% attributable to time charters and 37% from contracts of affreightment. Term contracts that renewed during the second quarter were, on average, higher in mid- to high single-digits. Spot market rates increased sequentially in the low- to mid-single-digit range. Compared to the prior year, spot market rates were approximately 15% higher on average.

During the second quarter, the operating margin in the inland business was in the mid-teens, although it was adversely impacted by the impacts of the high delay days on our contracts of affreightment. In the coastal business, second quarter revenues increased 3% year-over-year, driven by improved barge utilization and higher pricing. Compared to the first quarter, revenues improved 11%, primarily due to seasonal activity in Alaska, higher barge utilization, and reduced shipyard maintenance on several large vessels. Our barge utilization improved into the mid-80s. With regards to pricing, although rates are contingent on various factors, such as geographic location, vessel size, vessel capabilities and the products being transported, in general, term contracts renewed higher in the mid-single-digits, and average spot market rates improved 10%-15% year-over-year.

During the quarter, the percentage of coastal revenue under term contracts was approximately 80%, of which approximately 85% were time charters. Coastal's operating margin in the second quarter was slightly positive. With respect to our tank barge fleet, at the end of the second quarter, the inland fleet had 1,067 barges, representing 23.7 million bbl of capacity. We expected to end the year with 1,063 inland barges, representing 23.7 million bbl of capacity. In the coastal marine market, during the quarter, we sold one barge and returned one small charter barge with a combined capacity of 165,000 bbl. At the end of the quarter, we had 49 coastal barges with 4.7 million bbl of capacity. We do not expect further changes to the coastal barge fleet during the remainder of 2019.

Looking at our distribution and services segment, revenues for the 2019 second quarter were $366.7 million, with an operating income of $23.1 million. Compared to the 2018 second quarter, revenues declined approximately 14%, primarily due to lower activity in our oil and gas-related businesses. This was partially offset by higher sales and power generation. Compared to the 2019 first quarter, revenues declined 3%, and operating income declined $14.5 million, again, primarily as a result of reduced activity in the oil and gas-related businesses. These declines were partially offset by higher revenues and power generation. During the second quarter, the segment's operating margin was 6.3% and was unfavorably impacted by the reduction of higher margin oil field-related revenues and increased sales of lower margin power generation equipment.

In our oil and gas market, revenue and operating income were down compared to the 2018 second quarter due to softening of activity levels, which resulted in lower demand for nearly all our products and services, including new and overhauled transmissions, engines and parts, as well as new and remanufactured pressure pumping units. Similarly, compared to the 2019 first quarter, revenue and operating income declined with reduced demand for overhauled transmissions, parts, and pressure pumping unit manufacturing. In the second quarter, the oil and gas-related businesses represented approximately 55% of distribution and services revenue and had an operating margin in the mid-single-digits. In our commercial and industrial market, compared to the 2018 second and 2019 first quarters, revenue and operating income increased primarily due to growth in our power generation business.

In the second quarter, the commercial and industrial businesses represented approximately 45% of distribution and services revenue and had an operating margin in the mid-single-digits. Turning to the balance sheet. As of June 30th, total debt was $1.59 billion, and our debt-to-cap ratio was 32.4%. During the quarter, we paid down approximately $73 million in debt. We remain focused on repayment of debt for the remainder of 2019. As of this week, our debt balance was $1.55 billion. I'll now turn the call back over to David to provide additional details about our outlook.

David Grzebinski (President and CEO)

Thank you, Bill. As previously discussed, we have reduced our 2019 earnings guidance to $2.20-$3.20 a share. This represents a $0.50 per share reduction to the midpoint of our previous guidance range. We did reaffirm our capital spending guidance to $225 million-$245 million in the press release earlier today. Looking at our segments in marine transportation, we expect the inland market will remain tight with our barge utilization rates in the mid-90% range. With solid customer demand, modest increases in GDP, additional petrochemical capacity scheduled to come online, and new Permian crude pipelines bringing additional volumes to the Gulf Coast, we believe activity should remain strong for the balance of this year and through 2020.

In the third quarter, our inland marine operations will continue to be challenged by near-term delays associated with high water conditions on the Mississippi River. As well, we experienced a recent hurricane along the Gulf Coast earlier in the third quarter. However, improved efficiencies generated by better weather and increased pricing should yield modest sequential improvement in revenue and operating margin for our inland business in the third quarter. In the coastal market, we expect utilization will remain in the low- to mid-80% range for the remainder of 2019, with revenues and operating margins in the third quarter expected to be similar to the second quarter. In the fourth quarter, however, increased shipyard activity on several large vessels and the seasonal end to activity in Alaska will result in reduced revenue and operating income.

Overall, in marine transportation for 2019, we now expect revenues to increase in the mid- to high-single-digits year-on-year, with operating margins in the low-double-digits to mid-teens range. For our distribution and services segment, I've already largely covered the second half outlook for the oil and gas sector. In our commercial and industrial markets, we expect revenues to decline in the third quarter, primarily due to reduced large power generation system installations. Additionally, as water conditions on the inland waterways improve, we expect reduced service activity in our marine repair business. It is likely that much of the available towboat horsepower will be needed in the dry cargo area to catch up from months of delays. These reductions should be partially offset by higher utilization in our power generation rental fleet during the summer storm season along the Gulf Coast.

In total, for distribution and services, we expect third quarter revenue to decline in the mid-teens % range compared to the second quarter, with reduced deliveries of pressure pumping and backup power generation equipment being the main drivers. Operating margins are expected to be slightly down sequentially, with ongoing cost reductions keeping margins relatively stable. For the full year, we expect revenues to decline in the high single-digits year-on-year. The revenue composition for the full year is expected to be approximately 55% oil and gas related and 45% commercial and industrial related. Operating margins are expected to be in the lower end of the mid- to high single-digit range.

Overall, for our full-year guidance, the lower end assumes further weakness in the distribution and services oil and gas market, including limited demand for engines, transmissions, and parts, reduced volumes of transmission overhauls, and minimal orders for new and remanufactured pressure pumping equipment. The high end assumes meaningful improvement in inland marine operating conditions and further pricing momentum. It also assumes some improved contribution from the distribution and services, oil and gas related businesses, including incremental orders for pressure pumping equipment and remanufacturing, as well as greater volumes of transmission overhauls and equipment and parts sales. Now, to sum things up, overall, we had a good second quarter. Inland marine bounced back nicely following a challenging first quarter, despite increased delay days. In coastal, we generated a profit, utilization rates improved, and term contracts continued to renew higher.

As we look forward, despite near-term spending cuts and uncertainty in the oil field, we remain excited about Kirby's long-term outlook and earnings potential. In inland marine, we put our strong balance sheet to work during the downturn, successfully completing and integrating several key acquisitions, which have well-positioned Kirby to capitalize on the upcycle. Today, our fleet is nearly 30% larger in barrel capacity than it was at the bottom of the cycle in 2017. We have the largest, youngest and most efficient fleet in our history, and our results are starting to show the benefits. With continued strong demand on the horizon and current pricing momentum, inland marine is positioned to continue to deliver increases in revenue and earnings as the market recovery continues.

In coastal, our actions to rightsize the fleet, improve horsepower efficiency, and reduce our cost structure, have paid off, as evidenced by the return to profitability in the second quarter. In the fourth quarter, we will have several vessels in the shipyard for majors, some of which are being brought forward to ready the equipment for new contracts into 2020. With most of our large capacity major shipyards behind us by the end of this year, we anticipate higher-term contract renewals in the coming quarters, and coastal should be in a position to be more consistently delivering positive earnings in 2020. In distribution and services, while the oil, the U.S. oil field will present some temporary challenges and reduce returns in the near future, we remain optimistic for the long-term outlook for our oil and gas-related businesses.

Shale, oil, and gas are a significant contributor to the world's energy supply, and we believe it will be so for the next few decades. The near-term minimal levels of investment and maintenance activities on existing equipment is unsustainable, and this trend will reverse at some point. Additionally, there continues to be significant customer interest in new horsepower capacity to improve fleet operating efficiencies and reduce environmental footprints. Pipelines from the Permian are expected to start coming online soon, and when they do, completion activities should ramp up. Kirby is well positioned to capitalize on these opportunities. Today, we're the largest non-captive, new and remanufactured pressure pumping equipment provider in the world. We have leading capabilities and experience in high efficiency, electric and noise-reducing fracturing equipment. Furthermore, our wide OEM distribution territory covers the majority of the U.S. oil field.

This places us in a firm position to capitalize on increased sales and service of engines and transmission and parts. While the near, near term may be challenging, I firmly believe that our shareholders will be rewarded nicely in the coming years. Operator, that concludes our prepared remarks. We're 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 Ben Nolan with Stifel. Your line is now open.

Ben Nolan (Managing Director of Research)

Great. Thank you, operator. Good morning, David, Bill, and Eric.

David Grzebinski (President and CEO)

Morning.

Ben Nolan (Managing Director of Research)

My first question relates to the D&S side of the business, and I think we and the market has expected there to be a slowdown coming there, given what's going on in the oil patch. My question, though, relates to sort of how are you thinking about that business strategically right here? Is it, given that it's a little slower now, but you expect it to get better, are you just kind of battening down the hatches and waiting for the storm to blow over? Is there a shift to maybe do a little bit more international business or something like that?

is this something where you might look to be opportunistic, like, like you do in the barge business and, and find somebody that is, you know, a potential acquisition target that, that can't weather the storm to the same extent that you can? Just curious how you're thinking about it, I guess.

David Grzebinski (President and CEO)

Yeah, a good, good, good set of questions, Ben. Look, we believe, as I said in our prepared remarks, that this shale phenomena, if you will, is gonna last for a few more decades, and we are positioned strategically pretty strong in that business. So it's really at this point, it's battening down the hatches, as you said. We're cutting costs, as you would expect, eliminating discretionary spending. We've reduced headcount in the manufacturing areas in and around pressure pumping by about 22%, so far year to date. We're gonna batten down the hatches, keep this business as profitable as we can. And to your other part of your question, we continue to grow our commercial and industrial sides of the business.

Backup power generation continues to grow. It's got a nice, healthy, healthy growth profile. As the world becomes more and more data intensive, backup power becomes more and more important. So we're, we're investing manpower into those, those areas around commercial and industrial. So, you know, we're, we're kind of happy with the, the portfolio as it is. You may see us look for a tuck-in acquisition that beefs up some part of, of that business, maybe in the commercial and industrial area. In terms of, of buying more pressure pumping capabilities kind of in this downturn, which would be more of our playbook, I would say we don't need to. We, we've already got you know, the, the largest non-captive manufacturing capability in the industry. We're where we need to be.

Our two manufacturing facilities, one's in Oklahoma and one's in Texas. You know, our reman capabilities and our sites around the U.S. are strategically positioned. So, I think what we have to do is weather this storm, watch our cash flow, make the appropriate business adjustments, and be ready for the inevitable rebound. And we do think that's coming. You can look at the Permian pipeline situation. There's a number of pipelines coming on at the end of the year. I think two at the end of the year, maybe a third and third in the first quarter of next year or the first half of next year. Plus, there's a couple natural gas pipelines coming on.

So if you assume a flat oil price, which is a dangerous assumption, I understand, all things being equal, Permian profitability should get better because the takeaway infrastructure is gonna be there, and that's gonna reduce their cost profile and improve their netback. So, given where we are and world oil situation, I think it should be better, if not in 2020, certainly somewhere in and around there. So we're pretty happy with the portfolio as it is, is the short answer.

Ben Nolan (Managing Director of Research)

Okay, thanks. And then real quick, just as my follow-up. As it relates to the weather-related things, both in the first quarter and now in the second quarter, even a little bit in the third quarter, just curious, for all of your chemical customers and everybody else, is there some degree of pent-up inventory or something else that needs to move, that as things normalize, you could actually see a little bit of a spike in activity or something like that? Or is this simply them finding maybe an alternative, more expensive means of transportation and, you know, and there shouldn't be any outsized level of sort of short-term recovery activity or something like that?

David Grzebinski (President and CEO)

There may be a little. There is some pent-up demand. But you know, we're working with our customers to meet their plant feedstock needs and their plant takeaway needs. You know, that is, the weather has helped the utilization in the industry, probably 2%-3%. So yeah, post the pent-up demand work off, you could see utilization dip a little. But I will say this, you know, the industry is basically fully utilized. There's almost no spare capacity out there. So we do need a little relief on that. It's been very, very tight. But look, this weather will pass. You know, we're hearing mid, maybe even late August, when the high water situation will come down.

And we'll get back to more normal weather. This has just been an abnormal year. The good news in my mind is that the demand side is solid. You know, our customers have invested billions in new plants and new facilities and expansions. The feedstock situation that they have is feel sustainable. They're getting low-price natural gas that helps run their plants and converts into some of the petrochemicals. Clearly, the light crude coming out of the shale is also a good feedstock source. So when you look at the demand side of our barge picture, it's pretty robust. We've got, you know, good feedstock position for our customers. They've been investing a lot, and it should be good for a while.

Ben Nolan (Managing Director of Research)

Great. I appreciate it. Thanks, David.

David Grzebinski (President and CEO)

Thanks, Ben.

Operator (participant)

Thank you. Our next question comes from Greg Lewis with BTIG. Your line is now open.

Greg Lewis (Managing Director and Energy and Infrastructure Analyst)

Yes, thank you. Good morning, everybody.

David Grzebinski (President and CEO)

Hey, good morning, Greg.

Greg Lewis (Managing Director and Energy and Infrastructure Analyst)

Hi, David. I mean, you, you touched on it a little bit, in terms of, you know, industrial, distribution and services doing okay. Just kind of curious, as we think about D&S, beyond the oil and gas side of the business, you know, you have, you know, different types of power generation, you have pleasure marine. I mean, I was reading that the pleasure marine business has been kind of soft here. And just thinking about that those businesses are tied to, you know, tied to GDP, are you seeing anything or how are those businesses sort of in D&S, the non-oil and gas businesses holding up? And as we think about, you know, the revised guidance, did those any of those businesses have any impact to the guidance?

David Grzebinski (President and CEO)

No, they're pretty steady. They're you know, GDP, I would say, let's take them in a couple pieces here. I would say in backup power generation, that continues to grow. That's growing faster than GDP. It's been you know, it's all about the data centers and the need for 24/7 power. When you look at the marine repair business, the marine engine repair business, that's actually been stronger year-over-year. Now, when we go into the third quarter on the marine business, what's going to happen is, because the dry cargo business has been so impacted greatly by this high water situation, you know, when we get a little better river conditions, they're going to put all their horsepower to work moving grain and other commodities on the river system.

So we forecast a little bit in the third quarter, a decline in our marine engine repair business, just because we know our customers, and they're telling us that they're gonna work hard to catch up. There is a lot of pent-up demand on dry cargo movements. So that's a little bit of the impact in our diesel marine business, but that's more short term. As you look at the strength in the inland barge market, and also the offshore barge market and offshore, we're seeing a little bit on the offshore oil and gas, too. You know, the diesel marine business is probably going to continue to grow at GDP, maybe plus a little bit.

I think mining, which is part of our commercial industrial, that's down a little bit with the global economic concerns. Pleasure craft has actually been pretty stable for us. These are high net worth individuals, as you know, and so far it's been stable. You know, I would worry about that a little bit in an economic downturn. So, you know, it's pretty much GDP plus maybe a little bit in that commercial and industrial sector.

Greg Lewis (Managing Director and Energy and Infrastructure Analyst)

Okay, great. And then just one more for me on the D&S as it pertains to oil and gas. And you touched on it in your prepared remarks, so I guess that's why I'm going to talk about it a little bit. But you mentioned, you know, e-frac, and clearly, you guys have benefited from that, you know, in 2019. How should we—I mean, how, or at least should I say, how are you thinking about the absorption of these units? And then bigger—and then, I mean, it might be still early in the game to understand this fully, but how are you thinking about the life cycle for revenue for the D- for Stewart & Stevenson or United?

How are you thinking about that life cycle for the e-frac units versus, say, a conventional unit? Like, how should we be thinking about that or trying to model that?

David Grzebinski (President and CEO)

Yeah. A good, very good question. So e-frac is getting a lot of attention right now. And look, it's good technology. It saves the E&P company some diesel costs because natural gas is so cheap, so there's some attractiveness there. And it does have a lighter maintenance profile, right? I mean, big diesel engines have a heavier maintenance cycle than a big gas turbine. Now, that said, if a gas turbine goes down, it's a very expensive proposition. But let me put e-frac in context. You know, there's probably about 440 frac spreads out in the industry right now, roughly, you know, call it 400-450 frac in that ZIP code.

I would say there are 13-15 e-frac spreads out there, so it's still a relatively small number. I do see it growing, but I, you know, probably in the next 10 years, it could get to 10%-20% of the market, but that, I think that's gonna take some time. There's also other new technologies out there, where they're doing gas blending with diesel and making some pretty good progress. There's a lot of different technologies out there that are working every day to lower the cost profile for our pressure pumping customers and their customers, the end customers. So, you know, in that context, e-frac's important. We're heavily involved, as you know, with one of the key participants.

We jointly develop equipment together, and it's been pretty good for us. But remember, it's probably, you know, it's less than 5% of the equipment out there now, and it's still got a long way to go before it's meaningful.

Greg Lewis (Managing Director and Energy and Infrastructure Analyst)

Perfect. Okay, guys. Hey, thank you very much for the time.

David Grzebinski (President and CEO)

All right. Thanks, Greg.

Operator (participant)

Thank you. Our next question comes from Michael Webber with Wells Fargo. Your line is now open.

Michael Webber (Managing Director)

Hey, good morning, guys. How are you?

David Grzebinski (President and CEO)

Morning.

Bill Harvey (EVP and CFO)

Good morning.

Michael Webber (Managing Director)

Hey, David, I wanted to follow up a bit on D&S. So I guess one around expectations. If I kind of dovetail Greg's questions on e-frac with the guide, it seems a bit like you're kind of thrown in the towel for back half expectations. And if I think about the past 12-18 months, you know, I know there were a couple larger e-frac orders that kind of came in that insulated your backlog a bit more than the market would have expected. I think you mentioned there are 13-15 e-frac spreads out there. I believe about half of them are yours. And so I'm just trying to think about...

I guess, maybe this follows to kind of Greg's question in terms of, in terms of that business and how it evolves. You know, do you think you can develop a, you know, a position within that e-frac market to where it provides a degree of insulation within your OFS business going forward, or is that too optimistic? It could be, you know, if you're talking, you know, 10%-20% of the market in five-10 years, and you're still clipping half of that, that could, that could be a nice differentiator to your D&S business, but I don't know if that's sustainable.

David Grzebinski (President and CEO)

Yeah, I don't... Look, we'll participate. You know, we're clearly one of the key providers in the e-frac space. Does it insulate us from some, like, this big guide down? Maybe a little bit. It certainly helped us a little bit this year with the e-frac orders. But I don't know that it's a game changer. You know, we-- Look, frankly, we were surprised by the level of the spending cuts by our customers, and it's never good to be surprised. But look, we took action, you know, and it became increasingly obvious, and we've cut costs. But I would say this: It's not like 2015 and 2016, where everything stopped.

I mean, the rig count's still relatively high to where it was back in 2015 and 2016. We know our customers are working the equipment, and we're hearing that many of them are like, "Boy, you know, we're wearing out our equipment." And we also heard from a number of the bellwethers that equipment is attriting out very quickly right now. So yeah, I think this is more of a pause rather than a big 2015 or 2016 downturn. And particularly if, when these pipelines come back, if the oil price doesn't collapse, you know, the profitability of the Permian's got to go up just because the takeaway capacity reduces the cost to get the product to market.

Michael Webber (Managing Director)

Gotcha. All right. That's helpful. Can see how it develops in the next couple quarters, next couple years. As it pertains to inlands, you know, the inland market and your business, in particular, is gonna fall through, seems two or three quarters now in a row of kind of historic water issues. Pricing's at a very firm level, but it's kind of, it's still improving. It seems like kind of a linear cliff, and we would expect kind of the second half of that march to peak level pricing, you'd start to see spot pricing, you know, gapping higher, particularly given the supply dynamics that seem pretty favorable in inland markets the next couple years.

I'm just curious, one, do you think that's a fair characterization of how you would expect spot pricing to potentially, you know, move towards kind of, really kind of peak levels? Or do you think it'll be a bit more orderly as well, and is that something you would you think is feasible for 2020?

David Grzebinski (President and CEO)

Yeah, I think it'll be more ratable. I don't think we'll see spikes. I would say this, you know, you say peak pricing, but the cost of doing business has gone up, and it continues to rise. You know this, Michael, the cost of new barges is up. Part of that's the steel price. We're seeing labor pressure, as it is most of the United States, right?

Michael Webber (Managing Director)

Mm-hmm.

David Grzebinski (President and CEO)

We're pretty much in full employment. We're having to give some pretty healthy wage increases. You know, and then there's the cost of compliance. As you're aware, there's Subchapter M, which is inspected towboats, and that adds a whole another layer of cost to the industry. So, you know, we are getting, you know, the prices on a relative basis to prior cycles are moving up, but they need to move up in order to get even higher to justify new builds. Frankly, there is some new building now, but the current prices you can't get that return on capital. It needs to move probably another 20%-30% higher to justify a return on capital on new equipment.

So I would factor that in the thinking. You know, the peak pricing has to go higher just because the absolute cost of doing business has risen.

Michael Webber (Managing Director)

Sure.

David Grzebinski (President and CEO)

for all the reasons I just discussed.

Michael Webber (Managing Director)

Gotcha. So think of it almost like a revenue yield, effectively.

David Grzebinski (President and CEO)

Yeah.

Michael Webber (Managing Director)

Okay. All right, that's helpful. I'll turn it over. Thanks, guys.

David Grzebinski (President and CEO)

Hey, thanks, Mike.

Operator (participant)

Thank you. Our next question comes from Ken Hoexter with Bank of America Merrill Lynch. Your line is now open.

Ken Hoexter (Managing Director)

Hey, good morning. If I could just kind of dovetail on Mike's question there, just so it... I mean, the setup is great on the margin side, your best in years, it sounds like. Noted mid-90s utilization, pricing going up. I just want to understand, though, Dave, you're saying that you don't see the industry now committing more capital to build assets even with the direction that we're heading in?

David Grzebinski (President and CEO)

Yeah, no, no. Yeah, let me clarify. Good follow-up question, Ken, because we are, you know, the build book is probably 175-200 barges that are expected to be delivered this year. We know that probably the majority, well over 100 barges of those are for replacement, not really new incremental growth. Think of it this way, we've been in a downturn for four years, and we're just starting to get some positive free cash flow and, or positive cash flow. And many of our competitors, you know, need to build some replacement equipment. We know, you know, it's not appropriate for me to give you a list of competitors that are building replacement equipment, but that's a big part of the build.

When you look out beyond this year, it's basically drying up. We're not hearing much of an order book beyond. You know, there's some that'll deliver in 2020, but when you start looking out into late 2020 and into 2021, the order book is pretty minimal. And that's because the pricing still needs to go higher to justify incremental new capital for growth. I do think that the replacements kind of you have to do it. You know, they're working the equipment, and they've got stuff retiring, and they're going to have to replace it. And that's a big part of this year's order book, in my mind.

Ken Hoexter (Managing Director)

Great. So you gave a lot of great detail up front in terms of what's going on in the inland and coastwise. Maybe just talk a little bit more about the coastwise. You talked about rates kind of coming up, or I'm sorry, margins finally turning positive here, it bounced up in the third quarter, but it sounds like a pullback in the fourth quarter, given some of the maintenance that you saw. Maybe talk how are rates doing in light of that? And then maybe the outlook into 2020 as we now have fixed, I guess, some of the overcapacity.

David Grzebinski (President and CEO)

Yeah. Well, yeah, that overcapacity has been correcting itself. As you've heard us say, you know, people are retiring equipment. We're seeing more of that. Ballast water treatment is impacting that a little bit. So it's gotten tighter, particularly in the larger capacity vessels, 150,000-bbl and up capacity vessels are actually pretty tight right now. You know, in the 80,000 bbl-100,000 bbl or even the 50,000 bbl, it's still a little loose. But what we are seeing is more utilization. You know, demand continues to grow, supply has been contracting. We saw a sequential spot pricing was flat, but year-over-year, it's up 10%-15%. And then more importantly, is term pricing. It's been up mid-single-digits year-over-year.

So we're hoping that cadence grows. We are seeing a pretty tight, larger barge market. So, as we look into 2020, as we said in the prepared remarks, we've got these shipyards at the end of this year, but we'll have all the big, bigger units done by the end of this year, and 2020 should be a little better because we won't have some big shipyards. We did pull a couple forward to help with the customer contract, as you would expect us to do. So, you know, I would just say it's much more constructive than it's been in probably three to four years. So we're really pleased with the direction it's heading.

Ken Hoexter (Managing Director)

Great. Appreciate the time to talk. Thanks, Dave.

David Grzebinski (President and CEO)

Thanks, Ken.

Bill Harvey (EVP and CFO)

Thanks, Ken.

Operator (participant)

Thank you. Our next question comes from Randy Giveans with Jefferies. Your line is now open.

Randy Giveans (SVP of Equity Research)

How are you, gentlemen? How's it going?

David Grzebinski (President and CEO)

All right, Randy, how are you?

Randy Giveans (SVP of Equity Research)

Good, good. All right, two quick questions for me. In recent years, you know, your full year guidance range has been around $0.30, following the 2Q results. Obviously, this year, it's $0.40. If you can kind of touch on, on why that's kind of a wider range than normal. Also, can you break out the range by inland versus coastal versus D&S? Meaning, is the vast majority of the range based on uncertainty in the D&S business?

David Grzebinski (President and CEO)

Yeah, well, I think last year at this time, we were about a 40% gap, high to low, too. I hear you. Now, look, our portfolio is just more diverse, so there's just more moving parts. In the last several years, we've kind of widened that a bit. You know, the inland barge market has always been pretty ratable, and, you know, adding coastal, it's got a little more variability. You know, adding the D&S businesses again and growing those get a little more variability. We felt we had to widen our range a little bit. We did narrow it. We were $0.50 range. We narrowed it to $0.40 this quarter. Yeah, I wouldn't read too much into that, Randy.

In terms of the guidance, you know, clearly, the D&S oil and gas business, where these big frac spread orders can move the needle, is part of that variability. There's also a big spare parts piece that, you know, kind of the book and ship that happens, when our customers are spending on quick repairs and maintenance. So that variability is a little more than we've had historically. I think, you know, we said this earlier, they are so focused on cash flow right now. We've just seen a dearth of, well, a lack of orders. Now, that's not really sustainable.

Sooner or later, they're gonna run out of other equipment to cannibalize, and they're also going to, you know, have to repair some stuff and replace it. The other thing I would add is the revenue recognition new standards has added volatility. Think of it this way, you know, under the new rev rec rules, if we ship a frac spread, you know, the last week of a quarter, or if it slips into the first week of the next quarter, we just, you know, that's a pretty big swing in terms of earnings and rev rec. So, I like to beat up our accountants here internally. You know, the accountants have made it harder, not easier to explain the business.

Randy Giveans (SVP of Equity Research)

Sure, that's fair. So would you say maybe $0.30 of the $0.40 is D&S?

Bill Harvey (EVP and CFO)

We don't really look at it that way, Randy. We look at the whole business, so I—I wouldn't want to point to any one particular area of the business.

Randy Giveans (SVP of Equity Research)

All right, that's fair. So certainly some near-term headwinds, but possibly longer-term tailwinds on that side. All right, switching gears to inland, how has that integration of the Cenac acquisition been progressing? And as those barges roll off contracts from maybe one or two years ago, how much have the new spot or even term rates on those barges improved and your expiration kind of for future expiration repricings here in the coming months?

David Grzebinski (President and CEO)

Yeah, that's a good question. The physical integration has gone extremely well. We've been delighted with the quality of the equipment, and more importantly, the quality of the mariners and the team that joined us from Cenac. We got top-notch salespeople, top-notch operations people, top-notch mariners. It's been a great addition to Kirby, and the integration has gone extremely well. Now, to your contract question, they did have a big... They were pretty heavily contracted, and they had a number of multi-year contracts. And you can imagine, not their fault, but at the time when they put those contracts into place, they were at much lower levels, and it's just gonna take a while to roll off. Unlike Higman. Higman rolled off quickly.

They were much shorter-term contracts. Cenac's got longer-term contracts. So, you heard us say when we got Cenac, that it wouldn't be accretive to this year. And that's still pretty much true, but you know, getting into 2020, some of those contracts roll off, and it should get more constructive. But that's not to detract from the acquisition. It's been a tremendous acquisition, and again, we couldn't be happier with the quality of people and assets we got there. The assets are in really good shape, and we've been delighted.

Randy Giveans (SVP of Equity Research)

Sure. All right, well, that's it for me. Thank you all.

David Grzebinski (President and CEO)

Thanks, Randy.

Bill Harvey (EVP and CFO)

Thanks, Randy.

Operator (participant)

Thank you. Again, if you have a question, please press star, then one. Our next question comes from Jon Chappell with Evercore. Your line is now open.

Jon Chappell (Senior Managing Director)

Thank you. Morning, guys.

David Grzebinski (President and CEO)

Jon.

Jon Chappell (Senior Managing Director)

David, just want to follow up a bit on inland first. You mentioned the press release pricing. Spot pricing is up 15% year-over-year. So if we kind of aggregate that from the trough, how far are we up from kind of trough-level pricing? How much of that has transitioned then into terms? So maybe kind of what inning are you in transitioning the spot uplift into mark-to-market?

David Grzebinski (President and CEO)

Yeah, we still have a... Let me answer the second question first. We still have a pretty big, as you heard in Bill's number, we still have a lot of spot equipment. And as the market tightens, we'll start to see the customers look to term things up as they worry about availability. We're starting to feel that now. But there's still a fair, as you heard in our numbers, a fair amount of equipment that's a large percentage is in spot. But we are seeing more and more term demand. That said, you know, to your first question, spot pricing is probably up. Let me do a quick math here. Yeah, up 20%+, from the trough, maybe 25%.

You know, if you just take a unit tow, for example, it's up more, but some of those trough unit tow prices were just really, really low. The lowest of the low were probably up 30% from the lowest of the low, but on average, probably up 20%, maybe 25% from the average low on spot. Term is just starting to move. We have seen that. It didn't go as low as the trough in spot.

Jon Chappell (Senior Managing Director)

Right.

David Grzebinski (President and CEO)

So it, you know, it's just started to rise. As you know, it, you need spot pricing above term for a while, for those term prices to start moving. And as you heard, our term pricing on the inland side is up mid to high single-digits, and that's, you know, continuing to march forward as term contracts roll off.

Jon Chappell (Senior Managing Director)

Okay, so that probably then transitions to the second question, which is the margin. You know, still in the mid, maybe the high teens, which is off the bottom, but if you go back and look historically, you know, the majority of the years over the last two decades, you've been well into the 20% range. So do you need that term pricing then to really get the margin moving significantly? Is there something else that's required to move the margin significantly? And then maybe just the third part as a follow-up to one of your answers before, the labor tightness that you talked about, does that maybe put a ceiling on the potential margin upside to inland in this recovery?

David Grzebinski (President and CEO)

Yeah. Look, I think if you adjust for high water and some other things, you know, we were probably in the high teens this quarter in margins. You know, we would definitely get back to the twenties. We are seeing labor pressure, but we see that kind of every cycle, to be honest.

Jon Chappell (Senior Managing Director)

Mm-hmm.

David Grzebinski (President and CEO)

Now, the other costs, you know, Subchapter M and some of those other costs, will have to in order to keep the margins profile as in past cycles, we will have to have higher, higher highs, so to speak. But you're precisely right when in order to get those margins really moving, we've got to get term pricing up, and that's starting to move. If you think about our book of business, over 60%, almost 65%, almost 70% of what we've got is term. So those term contracts have to roll to get up into that 20% range. I fully believe we'll get there, and I fully think... I do believe we'll get to-

Jon Chappell (Senior Managing Director)

Mm-hmm

David Grzebinski (President and CEO)

... higher highs this cycle. Just because when we look at the leverage points that we have and the cost savings, given our fleet size, we'll be able to transfer that into higher margins.

Bill Harvey (EVP and CFO)

I think, too, what you should factor in is just the fact these acquisitions have a lot of synergies in them.

David Grzebinski (President and CEO)

Yeah.

Bill Harvey (EVP and CFO)

And you look at our SG&A in that group and how it's being spread over more units, we have some cost pressures, but it's being, or at least for us, some of it's being offset by the economies of scale.

Jon Chappell (Senior Managing Director)

Okay, so then just to be clear, though. So weather normalizes, knock on wood. You're seeing the action in the term. You said you're fully confident you'll get there. Is 20% margin handle, you know, early next year, sometime in 2020, kind of average till 2020? Or are we still kind of too early in the innings to think about it on the near-term horizon?

David Grzebinski (President and CEO)

Yeah, yeah, I don't want to give guidance for next year is the problem here. I, I would say, we're marching towards having, that level of margin, through most of next year. But, it, it... I would, you know, the timing could be mid-2020s or-

Jon Chappell (Senior Managing Director)

Mm-hmm.

David Grzebinski (President and CEO)

You know, when you think average, we're not prepared to give that yet. We just—we need to—

Bill Harvey (EVP and CFO)

Yeah

David Grzebinski (President and CEO)

... to look at how our contracts are going to roll off. I'm not trying to be too cute here. It's just, we got to look at the contracts that are going to roll off in the next 12 months and how they pencil out. But I think directionally, what you said is correct, that we're getting closer and closer to that 20%+ margin. You know, I think all things being equal, we should be on a path to get there next year.

Bill Harvey (EVP and CFO)

I will say, Jon, I think your wording was correct. It's not too early to think about it. We just haven't. We're just not. It's just too early to put it into guidance for next year.

Jon Chappell (Senior Managing Director)

Yeah, completely understand. Thanks, David. Thanks, Bill.

Eric Holcomb (VP of Investor Relations)

All right, Joel, we'll, we'll take one more, one more caller.

Operator (participant)

Thank you. Our final question comes from Jack Atkins with Stephens. Your line is now open.

Jack Atkins (Research Analyst)

Great. Good morning, guys. And Eric, thanks for squeezing me in here. Just to follow up on Jon's questions there on marine margins for a moment. You know, David, or Bill, if you'd care to chime in as well. I guess, can you help us think through incremental margins at Inland Marine? You know, when I think about the revenue growth looking forward, it seems to me most of that's gonna be price driven, because your utilization level is pretty high. You know, how should we think about incremental margins on price? I get that you've got some inflationary costs, but I would imagine it would be fairly high.

It looked like it was close to 45% or 50% in the second quarter, despite the high water issues. So if you could just kind of help us think through incremental margins at Inland Marine, that'd be helpful.

Bill Harvey (EVP and CFO)

I think your point is price will flow right through. We do have some pressures on inflation, and there is inflation pressures, but again, that's a piece of it. That's a piece of the puzzle. We are offsetting, as I mentioned. When we look at ourselves and we look at our SG&A as a percentage of revenue, et cetera, it's pretty well controllable. What isn't controllable are actually going down in relative terms for Inland Marine. The factor that we can't control is some additional costs that you get with compliance and other things in operations. But the price flows almost directly through, Jack.

Jack Atkins (Research Analyst)

But Bill, is it safe to assume that, you know, the incremental margin level that you saw in the second quarter, even though it was hampered by high water issues, I mean, that's kind of how we should be thinking about it, kind of going forward through the cycle?

David Grzebinski (President and CEO)

Yeah, now be careful. You know, you're looking at it sequentially.

Jack Atkins (Research Analyst)

Mm-hmm. No, I'm looking at year-over-year incrementals.

David Grzebinski (President and CEO)

Oh, year-over-year incrementals? Oh, okay. I thought... Yeah, because sequentially, it is about 50%, incremental margins. I don't know what they are year-over-year, but look, the pricing is, as you know, Jack, is very high incremental margins, right? I mean, it's, it's, you know, in the high, high, 70%-80% just, pricing-

Jack Atkins (Research Analyst)

Yep.

David Grzebinski (President and CEO)

When you get that. So, you know, the only offsets really are kind of the operations costs.

Jack Atkins (Research Analyst)

Mm-hmm.

David Grzebinski (President and CEO)

You know, pricing, it just, it almost falls straight to the bottom line. But, but let us do some work. Maybe Eric can get back to you on some-

Jack Atkins (Research Analyst)

Okay.

David Grzebinski (President and CEO)

Some better thoughts on incremental.

Bill Harvey (EVP and CFO)

Yeah. I wasn't really thinking year-over-year, Jack, but you know, so that's a different perspective. I think on the SG&A side, I know it went down year-over-year, but we tend to focus more on discrete cost elements than overall. But it's a good question.

Jack Atkins (Research Analyst)

Okay. That's, that's helpful, Bill and David. Thank you. And then just the last one for me. You know, I would be curious to get your take, David, I know you talked a little bit about M&A on the D&S side, but what's your appetite for M&A on the inland side of the house? You know, I know that there's at least one of your larger competitors that's, you know, still under a lot of pressure financially. Just be curious to get your take on... You know, you guys have done a number of larger deals here over the last, you know, several years. Do you still have an appetite for further consolidation in the inland market if an opportunity or two were to become available in the next, you know, 12-18 months?

David Grzebinski (President and CEO)

Short answer is yes. I mean, you know us, we like inland assets. It's probably when we do acquisitions, it's probably the easiest one for us to integrate. So we're always looking, always interested. I will say this, you know, our debts, as Bill said, 32.4% debt to total cap, that's a little higher than we'd like. We are paying down debt rapidly, and we'll continue to pay it down until we get an opportunity. But if we had a big opportunity or an opportunity in the near term, there'd probably have to be some equity involved. As you know, Jack, we covet our investment-grade rating, but we also love buying inland assets.

So it'd be a balance, but as you know, it's also very hard to predict acquisitions, and we are always disciplined about how we go about valuing them. So, it's a long way of saying, you know, of course, we'd look at further consolidation. For us, it makes sense for us, but our balance sheet, we'd be very thoughtful about how we deploy that.

Jack Atkins (Research Analyst)

Okay. Totally understand. Thanks again for the time this morning, guys.

Bill Harvey (EVP and CFO)

Thank you.

Eric Holcomb (VP of Investor Relations)

All right. Thanks, Jack, and thank you, everyone, for participating in our call today. If you have any additional questions or comments, you can reach me today at 713-435-1545. Thanks, everyone, and have a good day.

Operator (participant)

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