Kirby - Q3 2016
October 27, 2016
Transcript
Operator (participant)
Good morning, and welcome to the Kirby Corporation Third Quarter 2016 Results 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. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Sterling Adlakha. Please go ahead.
Sterling Adlakha (Head of Investor Relations)
Thank you, Andrew. Thank you, everyone, for joining us this morning. With me today are Joe Pyne, Kirby's Chairman; David Grzebinski, Kirby's President and Chief Executive Officer; and Andy Smith, Kirby's Executive Vice President and Chief Financial Officer. During this conference call, we may refer to certain non-GAAP or adjusted financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures is available on our website at kirbycorp.com in the Investor Relations section under Financial Highlights. 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. Our actual results could differ materially from those anticipated as a result of various factors.
A list of these factors can be found in Kirby's Form 10-K for the year ended December 31st, 2015, filed with the Securities and Exchange Commission. I will now turn the call over to Joe.
Joseph H. Pyne (Chairman)
Thanks, Sterling, and good morning to everyone. Yesterday afternoon, we announced third quarter earnings of $0.59 per share, versus our guidance range of $0.50-$0.65 per share. That compares to $1.04 per share reported for the 2015 third quarter. Inland marine tank barge utilization during this quarter was in the low-to-mid 80% range. The weaker levels of utilization that first materialized in July, which we discussed on last quarter's call, persisted throughout the third quarter, with some incremental improvement due to weather and some modest volume increases driven by a series of customer supply chain disruptions, occurred. Pricing remains at depressed levels. In the coastal market, barge utilization was also in the low-to-mid 80% range.
Utilization continues to be impacted by the amount of equipment trading in the spot market, which adds some idle time exposure. Our outlook for this market remains cautious as the industry fleet contends with additional supply that's coming online over the next year, and as it rationalizes older, less commercially viable equipment. In our land-based diesel engine service business, our service activity levels have improved in the remanufacturing area, and we think this new level of activity is providing a signal for market improvement next year. However, currently, demand for parts and components remains depressed. With low part volumes, we are not yet able to cover all our fixed costs, though we have reduced the loss run-rate from earlier this year. We have also not received any orders for new pressure pumping equipment, although we are beginning to have inquiries.
The market recovery is still in its infancy, but we believe that it has begun. In our marine and power generation diesel engine business, the oil service market along the Gulf of Mexico remains depressed as customers continue to defer maintenance. We did see business improvements in the Midwest and in our power generation market. In summary, as our guidance implies, the fourth quarter will be another challenging quarter for Kirby. It is, however, encouraging that there are some signs of stability in the marine transportation market and across our diesel engine service markets. It frankly, it's hard to see how pricing in the inland market could get much worse. In the case of our land-based diesel engine business, an upturn in service activity has caused us to begin to add employees to meet the demand for remanufacturing frac spreads.
In our marine diesel engine market, the markets we service may not get much better soon, but they're also not gonna get much worse. And finally, in our coastal marine transportation business, we continue to look for opportunities to take out cost and improve operating efficiencies as the market adjusts to the additional tonnage and lower crude oil volumes. I'll now turn the call over to David.
David Grzebinski (President and CEO)
Thank you, Joe, and good morning to those on the call. I'll begin today with a summary of quarterly results in each of our markets, then turn the call over to Andy to walk through the financials. Following Andy's remarks, I'll address our guidance range before turning the call over to question and answers. In the inland transportation market, our utilization was in the low- to mid-80% range during the quarter. The relatively sharp drop in utilization that we first experienced in July continued through most of the third quarter, with some periods a better utilization when weather conditions were less favorable, and for a brief period during product supply disruptions, including the brief outage that occurred on a portion of the Colonial Pipeline.
In response to the lower utilization, we reduced our average towboat count by approximately 6% in the third quarter. For the industry overall, weak utilization increases the likelihood that we will see a more rapid number of retirements and a decline in new equipment construction across the industry. This will facilitate an overall rebalancing in the market. Additionally, many of the temporary factors contributing to weak utilization are likely to subside over the next few months. Moving on to pricing. Pricing on term contracts that renewed during the third quarter was down in the mid- to high-single digits. Spot rates fell sequentially and were at or below term contract rates during the quarter.
However, spot rates have flattened out, particularly towards the end of the quarter, and have remained flat into the first part of the fourth quarter. Operating conditions during the quarter were seasonally normal. However, it's worth noting that historical levels of flooding in Louisiana drove a brief period of operating disruptions along the Gulf Coast. The impact from the flooding to our operations was minimal. In our coastal marine transportation sector, demand for coastwise transportation of black oil and petrochemicals was relatively stable, while refined products demand was weaker, due primarily to weak demand in the Northeast, despite a very brief improvement during the Colonial Pipeline outage. Coastal tank barge utilization continued to decline, primarily due to the ongoing trend of equipment moving off of term contracts to trade in the spot market. Utilization was in the low- to mid-80% range during the quarter.
Coastal market operations were briefly interrupted along the Gulf Coast and East Coast due to disruptions from Hurricane Hermine. With respect to coastal market pricing, term contracts that renewed during the third quarter increased very slightly, low single digits. However, it was only a very few older contracts that renewed in the quarter. Spot pricing did fall below contract pricing during the quarter. In our diesel engine services segment, as has been the case all year, in our marine diesel engine business, the Gulf of Mexico oil services market remained at historically depressed levels. We also continued to experience major maintenance deferrals by our customers in many regions of the country. The Midwest marine market was an exception, as maintenance demand improved there. Additionally, demand in the power generation market was strong during the quarter.
In our land-based diesel engine services market, the sale of engines, transmissions, and parts in our distribution business remained at very low levels. Likewise, we have not had orders to manufacture new pressure pumping units. However, we did see a material increase in order activity for pressure pumping service and remanufacturing. Before I turn the call over to Andy, let me briefly address an incident involving a Kirby vessel that occurred earlier this month. On October 13th, the tugboat Nathan E. Stewart was pushing the DBL 55, an empty 55,000-barrel ATB, and it went aground on the Inside Passage, on the West Coast of Canada. The tugboat is submerged, and some of her fuel tanks were compromised. We have responded to the fuel spill. The cleanup is essentially complete, and we are commencing the salvage operation on the tug now.
This incident is very unfortunate, but it is insured, and we expect only to incur the incident deductible. I'll now turn the call over to Andy to provide some detailed financial information before I finish with a discussion on the outlook.
Andrew Smith (EVP and CFO)
Thank you, David, and good morning. In the 2016 third quarter, marine transportation segment revenue declined $59 million or 14%, and operating income declined $38 million or 41% as compared with the 2015 third quarter. The decline in revenue in the third quarter, as compared to the prior year quarter, was primarily due to lower inland marine pricing and utilization, lower coastal marine utilization, and a 17% decline in diesel fuel prices. The decline in operating income was driven by these same factors, partially offset by a reduction in inland towboats and savings from a reduction in force earlier in the year. The marine transportation segment's operating margin was 15.4%, compared with 22.4% for the 2015 third quarter. The inland sector contributed approximately two-thirds of marine transportation revenue during the 2016 third quarter.
Long-term inland marine transportation contracts, those contracts with a term of one year or longer in duration, contributed approximately 80% of revenue, with 52% attributable to time charters and 48% from the freight contracts. The inland sector generated an operating margin in the high teens for the quarter. In the coastal sector, the trend of customers electing to source coastal equipment from the spot market over renewing existing contracts continued. However, the percentage of coastal revenue under term contracts was consistent with the first nine months of the year at approximately 78%, as a result of lower utilization and revenue for spot equipment. The third quarter operating margin for the coastal sector was in the high single digits. Turning now to our marine construction and retirement plans.
During the 2016 first nine months, we received 27 barges from the acquisition of SEACOR's inland tank barge fleet, took delivery of 3 new build barges, transferred one 30,000-barrel barge from coastal service to inland service, and retired or returned to charterers a total of 48 barges. The net result was a decrease of 17 tank barges in our inland tank barge fleet for a total reduction of approximately 21,000 barrels of capacity. In the fourth quarter, we expect to take delivery of two 30,000-barrel inland tank barges, with two additional 30,000-barrel tank barge deliveries shifting into 2017. Also, in the fourth quarter, we expect to retire or return to charterers an additional 6 barges with 77,000 barrels of capacity.
On a net basis, we expect to end 2016 with 877 barges with approximately 17.9 million barrels of capacity, or roughly the same level we finished the third quarter and down slightly from our barrel capacity at the end of 2015. In the coastwise transportation sector, during the third quarter, we retired a small 9,000-barrel harbor barge and ended the quarter with approximately 6 million barrels of capacity. In the fourth quarter, we expect to take delivery of the first of two new 155,000-barrel ATBs, with the second 155,000-barrel ATB and a coastal chemical barge, both expected to be completed in early to mid 2017. Moving on to our diesel engine services segment.
Revenue for the 2016 third quarter declined 34% from the 2015 third quarter, and operating income declined 17%. The segment's operating margin was 6.1%, compared with 4.9% for the 2015 third quarter. The marine and power generation operations contributed approximately 46% of the diesel engine services revenue in the third quarter, with an operating margin in the mid-teens. Our land-based operations contributed approximately 54% of the diesel engine services segment's revenue in the third quarter, with a modest operating loss.
On the corporate side of things, our 2016 capital spending guidance remains in a range of $230 million-$250 million, including approximately $10 million for the construction of seven inland tank barges, five of which are to be delivered in 2016. Approximately $100 million in progress payments on new coastal equipment under construction, including our new coastal ATBs, two 4,900-horsepower coastal tugboats, and a new coastal petrochemical tank barge. The balance of $120 million-$140 million is primarily for capital upgrades and improvements to existing facilities and equipment.
In addition to our capital spending guidance, during the first half of 2016, we spent $85.5 million on the acquisition of the SEACOR inland tank barge fleet, $13.6 million to acquire a leased coastal barge from the lessor, and $26.5 million to purchase four coastal tugboats. Total debt as of September 30, 2016, was $726 million, a $49 million decrease from December 31, 2015. Our debt-to-cap ratio at September 30 was 23.3%, a 2.1-point decline from December 31, 2015. As of today, our debt stands at $740 million. I'll now turn the call back over to David.
David Grzebinski (President and CEO)
Thank you, Andy. In our press release, we announced our 2016 fourth quarter guidance of $0.45-$0.60 per share, which translates to a narrower full year 2016 guidance range of $2.47-$2.62 per share. In the inland marine transportation business, we expect utilization in the low-to-mid 80% range at the low end of our guidance range, and mid-to-high 80% range at the high end. During the quarter, we saw very few delays throughout the system, and also a decline in refinery operating rates. However, we did experience some short periods of tank barge utilization improvement from weather events and customer supply disruptions. We think that provides some support for our view that some of the utilization decline since July, July is temporary.
However, we have yet to see any consistent utilization strength, although we are seeing spot market pricing that has flattened out. Spot rates are no longer declining, and we believe they are at levels that are at or below cash breakeven for much of the market. Frankly, these rates are unsustainable and will go up. In the coastal market, on the low end, our guidance range contemplates utilization in the low 80% range. On the high end of guidance, we are expecting flat pricing on contract renewals and utilization in the mid 80% range. Additionally, Hurricane Matthew impacted our operations for 2 weeks in October and caused us to shut down operations for a short period of time along the Eastern Seaboard.
This hurricane is expected to have only a modest fourth quarter earnings impact on our coastal results. For our diesel engine services segment in our land-based sector, we expect to incur a small operating loss for the fourth quarter at the midpoint of our guidance range, and to breakeven in the land-based market at the high end of our guidance range. This market continues to improve, and service volumes continue to grow, with some new inquiries for new equipment. In our marine diesel markets, we do not expect any improvement in the Gulf of Mexico oil service market this year. In the power generation market and in our other marine diesel engine services market, we expect fourth quarter results to reflect a normal quarter-over-quarter seasonal decline, which generally leads to an operating margin in the low double digits.
In closing, we entered the last quarter of the year with a strong financial position. Despite the market challenges that we are dealing with and the investments we have made in upgrading and expanding both our inland and coastal fleet, Kirby's debt-to-capital ratio is the lowest it has been in two years. While the exact timing of recoveries in our markets is still unclear, we do believe the inland market will come into supply and demand balance sometime in 2017, and pricing will inflect. Also, we believe the land-based diesel business has bottomed and will begin to recover in 2017. Finally, we have the financial strength to not only weather the cycles, but to grow and improve our market position throughout them. Operator, that concludes our prepared 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 star, then two. Please limit yourself to one question and a single follow-up. At this time, we will pause momentarily to assemble our roster. The first question comes from Jon Chappell of Evercore ISI. Please go ahead.
Jonathan Chappell (Senior Managing Director)
Thank you. Good morning, guys.
David Grzebinski (President and CEO)
Hey, good morning, Jon.
Jonathan Chappell (Senior Managing Director)
David, a lot of commentary about, you know, unsustainably low pricing, pricing is about to bottom in inland. To the extent that you can, can you just lay out a little bit how you're looking at the supply-demand balance for next year? Like, how many barges are on order relative to, you know, typical years? What the outlook is for scrapping? Is demand, you know, GDP or GDP plus or minus for any reason? And then also, as part of that, can you just explain a little bit how the pricing kind of filters through the P&L? If pricing were to bottom in one Q, how long does it take to actually filter through all your term contracts and have the final impact on the P&L statement?
David Grzebinski (President and CEO)
Yeah, sure. Let me start with supply. You know, as you know, it—when spot rates are at or close to break cash flow breakeven, it's pretty painful. And what you see in that environment is companies start to accelerate their retirements. You know, they look at some of their older equipment, and it's coming up for a shipyard, and they say, "You know, goodness, there's no way we're gonna spend the cash to extend that life for another five-year period." So they begin to retire it, and we're starting to see some aggressive retirements. I think, you know, the last time we talked, we were talking about Kirby's retirements around 39 barges this year.
I think we'll probably end up with about 54 retired this year. So you know, we're retiring more barges, the industry is retiring more barges, and it's just a matter of good economic discipline and stewardship. Some of our competitors, you know, don't have the economic wherewithal to actually make the investment to extend the life, so they're almost forced to retire. So we think we'll see a good number of retirements, you know, this year, and that's happening now, and it should carry into next year. I think the order of magnitude, I think in past histories, we've seen, you know, up to 150 to 200 barges retired in any one year.
If you think about, you know, our utilization being somewhere right now between 80% and 85%, maybe closer to 85%, you're 5% from kind of the high 80s, where you need price increases. So 5% of the industry is, you know, probably around a little less than 300 barges, and, you know, maybe 250. And, you know, if you get some retirements, that'll get the utilization up without any demand growth. Now, we do have demand growth, which I'll come back to in a minute. On the shipyard side and new construction, you know, basically, it's nonexistent. There may be a handful of barges. As you heard Andy's prepared comments, we shifted some barges that we're gonna deliver this year into next year.
So I think, you know, it's probably a handful of barges that get built next year, maybe two handfuls. But, so, you know, from a supply standpoint, it looks pretty good. On the demand standpoint, we still have, you know, pretty good market outside of crude oil. If you look at, you know, chemicals, everybody knows, you know, those chemicals continue to increase, albeit the, you know, the construction of all the new plants is probably a bigger impact in 2018, because those projects tend to slip to the right, as you know. But then in refined products, black oil, all those, the, you know, the macroeconomic trends are fairly positive. You can look at vehicle miles driven. They continue to grow, albeit at a slower pace here of late.
But, you know, the general demand picture is pretty good. So I think demand will also, you know, require some more barges. I think utilization in the industry is maybe a little low because we've had some inventory disruptions and some bloated inventories. And frankly, we've had really good weather. You can look at our delay days and see that they're very, very much lower than normal. So you know, from a supply/demand standpoint, I think you know, things should come into balance in 2017, and that will drive pricing. These spot contracts are pretty, pretty brutal right now, and frankly, they're unsustainably low.
Now, with respect to earnings, I mean, you've heard us say this before, you know, we have contracts that roll over kind of ratably through the year. And as they roll over at lower prices, that has a full year effect in the next year. So that will be an impact. As the contracts have essentially renewed lower this year, there will be a full year effect next year. I don't think that's a surprise to anybody, but it's just a matter of math. I don't know if that answered your question, but.
Jonathan Chappell (Senior Managing Director)
No, very.
David Grzebinski (President and CEO)
Or if I missed one.
Jonathan Chappell (Senior Managing Director)
No, incredibly thorough. Thank you. So that sounds like the opportunity. And then just for my follow-up, on the risk side with coastal, you know, what's the potential or how much more could potentially move, to spot? What's the risk from, I guess, a very precipitous decline, in the MR market to kind of cannibalize your cargoes? And then, you know, how can you--how much more can you rightsize the cost structure, in the coastal business if the demand side were to be pressured next year?
David Grzebinski (President and CEO)
Yeah. Well, you know, in the coastal market, it is, as we've been saying, we've got a situation where you've got new tonnage coming in. I think there's about 14 new units that will be delivered, in the next 18 months or so. You know, brand-new ATB barge units coming into the market. And, there are, probably around 40 older barges that are at retirement age or be actually probably been extended longer than they should, that need to come out of the market. But, but as you know, you, you'll work older tonnage as long as you can until, until you can't. So there has to be a, a little pain to drive, to drive that older tonnage out. I think that's starting to happen.
I think it'll happen, and it may take a couple of years to play out as that excess or the new equipment is absorbed, and the older tonnage comes out. You know, we've seen because of the excess coming in that customers are not too worried about having availability, so there's been a drift towards taking the chance in the spot market. Clearly, the spot market is more difficult for us. You know, we get periods of lower utilization because of it. Repositioning barges is on our nickel in that case. And so it's a bit painful. You see that. You saw our Andy's comments on our margins there.
But I think, you know, the longer term is it will come back into balance because that old tonnage has to come out and will come out as you come into a shipyard. As you know, the shipyards for these coastal units are very much more expensive than the inland ones, There's a natural tension that should encourage retirement.
Jonathan Chappell (Senior Managing Director)
Right. Right. All right. That's very helpful. Thanks so much, David.
David Grzebinski (President and CEO)
Yeah. Thank you, Jon.
Operator (participant)
The next question comes from Gregory Lewis of Credit Suisse. Please go ahead.
Gregory Lewis (Oil Service Analyst)
Yes, thank you, and good morning, gentlemen.
David Grzebinski (President and CEO)
Hey, Greg.
Joseph H. Pyne (Chairman)
Morning, Greg.
Gregory Lewis (Oil Service Analyst)
Yeah, I guess I'll open this up to either David or Joe. And really, my question is, you know, clearly, Kirby's always, you know, in the market looking at M&A transactions. But just as we've looked through previous periods of time, I mean, you guys have alluded to the fact that, you know, the market is kind of at the bottom. Do we need to see the market start to improve before maybe we can see a pickup in M&A, or can we see sort of, you know, down cycle-ish type acquisitions?
David Grzebinski (President and CEO)
Yeah, let me give a quick comment, and I'll turn it over to Joe to give his comments. You know, people, nobody wants to sell at the bottom, right, Greg? I mean, you don't want to sell at the bottom. You want to maximize your price if you're a seller. And you know, that's normal. I think there are some people in the market that in this environment, if you had levered up at 4 times EBITDA when things were really good back in 2012, 2013, and we've you see this kind of pronounced downturn that we've had, you know, those debt-to-EBITDA multiples get really stretched, and there may be some people in trouble. Hard to say.
We don't have insight to their financials because a good many of them are private. But you know, by and large, I would say that nobody wants to sell at the bottom, but some people maybe feel like that it's still time to sell. I'll turn it over to Joe. He's got a lot more history on how these cycles play out.
Joseph H. Pyne (Chairman)
Yeah, no, I think David has it about right. The kind of sales that you would see here is, you know, either a company that owns a barging business in addition to something else that just says that we want to deploy capital, so let's sell the barge operation. You saw that with respect to SEACOR recently, and you may see some of that at, you know, in the next year. The forced sales are typically bank driven, and it. You know, we'll just have to wait and see if any of that happens. What David is talking about are really operators that you know go through the cycle. It's painful.
They realize that they're vulnerable. They're getting to the point in their lives that they're thinking about doing other things, and they're just looking for an opportunity to capture some additional value that may not be there at the bottom of the cycle. So if you look at Kirby's historical acquisitions, they typically occurred as we came out of a recession, not in the middle of it.
Gregory Lewis (Oil Service Analyst)
Okay, great. And then just David, on your comments about diesel engine services, you know, he kind of gave some guidance. You know, when could we see, and I guess what needs to happen for diesel engine services on the land side to get back to breakeven? It seems like we're kind of in that period of where we're getting there. I mean, it sounds, I mean, any sort of guidance you could give around that?
David Grzebinski (President and CEO)
Sure. We're getting closer every day. Let me characterize it this way, Greg. You know, our customers and the number of remans that we have in the shop for service are growing every day. You know, it's a bigger number, but the initial wave of remans, if you will, are customers that are coming with kind of their better fleets that just need some maintenance, or they think it's easy to fix to get it running again.
And they say, "Okay, bring." They bring it in, and they'll say, "Let's just get it running, and, oh, by the way, if you have any major components that need to be replaced or some parts that need to be replaced, please use our inventory first," or they demand that we use their inventory first. They have extra spares and stuff. So even though we're getting an increasing amount of remans, the parts and rebuild componentry that goes with normal remans is still developing as our customers work off their own inventories first. But, you know, every day, we're getting closer to working that off, and I think you'll start to see us get parts and major component flow through, which will add to our ability to absorb fixed costs and be above breakeven.
We're getting closer every day, and the signs are very encouraging from what we're seeing. Our customers are coming to us with very large fleets, trying to get them back into service. They are, of course, you know, still coming out of the bottom, so they, you know, they're trying to minimize their spend at this point. We're working with our customers to help them do that, get their service going, and build and build a long-term supply chain maintenance partnership. And, I, you know, that's happening very, very well. We're pretty excited about how that's headed.
Gregory Lewis (Oil Service Analyst)
Okay, guys. Hey, thank you very much for the time.
Joseph H. Pyne (Chairman)
Thanks, Greg.
Operator (participant)
The next question comes from Jack Atkins of Stephens. Please go ahead.
Jack Atkins (Research Analyst)
Hey, guys. Good morning. Thanks for the time.
David Grzebinski (President and CEO)
Hey, Jack.
Joseph H. Pyne (Chairman)
Hey, Jack.
Jack Atkins (Research Analyst)
So just kind of going back to an earlier question, I think, I think it was John's question around, you know, sort of the how, you know, how we think about these inland contracts repricing and sort of how that flows to the P&L. Is there a way to think about sort of, you know, how those contracts are dispersed throughout the year? Is it sort of, do they renew sort of ratably when you think about your, your contractual book of business, or are they sort of, levered to more one, you know, one part of the calendar or the other? Is there a way to kind of think about that?
Andrew Smith (EVP and CFO)
Yeah, Jack, this is Andy. So, you know, in any given year, about 70% of our book of business reprices, and splitting that down, about 50% of it is term contracts and 20% of it's spot. So spot obviously is pretty quick, and it sort of is ratable throughout the year. And the term contracts, I would say, for the most part, in any given year, are pretty ratable as well. You know, I wouldn't say that we favor one quarter to another in terms of what reprices.
Jack Atkins (Research Analyst)
Okay. Okay, that's helpful, Andy. And then, Andy, I guess this one's for you as well. But when you think about initial CapEx plans, I understand you're still in your, in your budgeting process. But just sort of think about, you know, we're just, we're just trying to think about how we should be looking at maybe CapEx expectations for next year. If you could sort of give us some insight on that, I think that'd be helpful.
Andrew Smith (EVP and CFO)
Yeah, again, again, we're still going through our budget, as you said, and without really sort of holding ourselves to a guidance number, I would say that typically, our maintenance capital, and next year looks like it's probably a maintenance capital type year, is in the $150-$175 type number.
Jack Atkins (Research Analyst)
Okay. Okay, great. Thank you.
David Grzebinski (President and CEO)
Thanks, Jack.
Operator (participant)
The next question comes from John Humphreys at Bank of America Merrill Lynch. Please go ahead.
Speaker 11
Good morning, gentlemen. Thanks for taking my question. I just kind of wanted to get into the calculation of utilization and margin, obviously eroded pretty far this quarter. If you could just sort of walk me through, I saw some of your commentary around spot activity increased idle time. To just, if I can get sort of an understanding of the mechanics that really pressured margins, and is it solely tied to utilization, and then kind of what we can look for to see margins return to levels we've seen in the recent past? Thanks.
David Grzebinski (President and CEO)
Yeah, John, I'll start, and I'm gonna turn it over to Andy, maybe he can put some quantity, quantify it a bit. But as you know, pricing is almost a direct hit to margin, right? I mean, as pricing falls, it does hit impact margin pretty quickly, right away on spot, and then, you know, in the contracts, it takes a while to roll through from a full year effect. But utilization also has a pretty big impact. You can see if you look at our second quarter of this year and third quarter, you know, we had a decline across the board in utilization on the inland side that, you know, was on the order of 5%-10%.
And, I mean, you can see, if you look at, the quarter, the sequential, decline from second quarter to third quarter, how that utilization, has a pretty big drive, in terms of earnings, in terms of earnings power. Andy, anything.
Andrew Smith (EVP and CFO)
Yeah, John, well, I would split that—I would split my answer up into the inland side and the coastal side. And on the inland side, I would say that when you see utilization fall, because of the way that we manage our horsepower, we do have some levers we can pull, and we did in the third quarter. Now, they're not immediate, but over time, we were able to get rid of some charter boats and some costs. So that as you saw margins fall on the inland side, they don't fall necessarily, sort of dollar for dollar with the fall in utilization, the revenue impact of the fall in utilization.
On the coastwise side, as you see pieces of equipment move from term contract to spot business, where they are less well utilized, that utilization, because generally you're talking about one piece of horsepower to one barge, that utilization kind of falls pretty dramatically to the bottom line. So you can see the impact of utilization on the coastwise side being a little bit more significant in your margin than you see it on the inland side.
Speaker 11
Great. Thank you. That's, that's very helpful. And then, just sort of a, a follow-up to on that utilization is, with the sort of increased capacity, in the Corn Belt, I think you referred to this, being more of a 2018 factor. We've heard some commentary that a lot of the new, capacity additions in nitrogen fertilizer coming online, is aimed at displacing imports. Any, any commentary there around, you know, how that, how that would impact your business?
David Grzebinski (President and CEO)
Yeah, no, not really. I'm not sure it would be a big impact. You know, we're pulling up some information here for a second. But you know, on the ag side of things, it's pretty low for our inland business. You know, it's less than 5%. And you know, we move ammonia up and down the river. I think that probably won't be impacted much by any of that, the import changes. So I would say, you know, we can do some more research on it, but I don't think it's gonna be of a material impact to us, John. Well, it still needs to be moved. I mean, if it's imported, it needs to be moved. If it's made domestically, it needs to be moved.
Speaker 11
Great, yeah, and I saw that it is a small piece. It's just there's some recent commentary we had with some people out in the region. That's that for me. I really appreciate, gentlemen.
Andrew Smith (EVP and CFO)
Great.
David Grzebinski (President and CEO)
Thanks, John.
Operator (participant)
The next question comes from Doug Mavrinac of Jefferies. Please go ahead.
Douglas Mavrinac (Managing Director Investment Banking)
Thank you, operator. Good morning, guys. How are you all?
David Grzebinski (President and CEO)
How you doing?
Joseph H. Pyne (Chairman)
Hi, Doug.
Douglas Mavrinac (Managing Director Investment Banking)
Good, good, good. Yeah, so, so my question pertains to, I guess, 2017. And, and David, you know, in your commentary, you gave very good, you know, guidance and visibility as far as where current utilization levels are and why you expect them to increase into the mid-80% range heading into next year. And, and, you know, clearly, there's a lot of debate about, you know, the timing of the petchem ramp up next year, the order of magnitude of how much that, of that stuff makes its way into barge. So my question is, you know, trying to get visibility about the impact on utilization levels next year of that, which, you know, clearly, you know, that's a bit of a ways out.
But I would imagine you guys are having conversations at this point with some of your petrochemical customers about what some of their barge needs are for next year. So based on those conversations, and obviously, without getting too specific, can you help us frame how we should expect the, you know, the utilization levels to evolve next year if you're heading into 2017 in the mid-80% range? You know, how we should expect, you know, utilization levels to evolve and what might be type of levels we could possibly hit next year?
David Grzebinski (President and CEO)
Yeah, let me take that in pieces here. I think a big part of the, excuse me, the utilization drop-off we've seen in the third quarter has been temporary in nature. One, as we said, the delay days are very, very low. We had good weather. Dock delays have been down considerably. The number of locks and dams that were under repair and slowing things down was minimal. So that temporary type utilization will come back. I mean, we're gonna have bad weather in the fourth quarter. We always do. You know, we've had some refinery inventory issues. I think that's self-correcting now.
You know, we're in the refinery maintenance season, so inventories are gonna kind of right size, and things will get back into a more, normal flow of things. So some of those temporary utilization things will come back. You know, it's maybe into the fourth quarter and to the early part of 2017. I think the longer-term utilization growth will come as we talked about earlier, the supply coming out and no new supply coming in, the retirements. And then I think you get towards the end of 2017 and early 2018 before you start to see the chemical build-out and startup of plants having an impact. You know, we're in discussions with many of our customers about their needs.
They're, you know, it's still a ways out, but it's gonna start probably at towards the end of 2017. I wouldn't, you know, I wouldn't hazard a guess to the actual number of barges or the percent utilization. We do know. Look, if it's an ethane plant, ethane driven ethylene plant going to polyethylene, we know there's not a lot of barge moves. But if it goes from ethane to poly- to ethylene and then to some downstream derivatives, whether it's glycols or EDC or whatnot, there can be a significant number of barges. A lot of that's still being held closely to the vest by our customers, you know, for trade secret reasons. We're getting a feel for it. Some of them are talking to us, others are pretty quiet about it.
But again, I think that's, you know, late 2017, and the bulk of the new ethylene startups will be in 2018.
Douglas Mavrinac (Managing Director Investment Banking)
Gotcha. That's very helpful, David. And then my follow-up question, you know, in one of the earlier questions, when you were talking about your diesel engine services, and even in your commentary, when you talked about seeing, you know, the material increase in pressure pumping, remanufacturing, and service, you know, I would think that that wouldn't happen in a vacuum. I would think that, you know, some of that equipment is coming back to work, rig counts picking back up. Then at some point, you know, one would expect that to translate into additional volumes making their way onto a barge. You know, is that thinking correct?
I mean, it seems like, you know, that it's kind of an if then thing, that you know, if you know, some of the equipment comes back to work, it should make its way into a barge. So how should we think about, you know, what has been obviously a negative downdraft on barge volumes over the last couple of years, maybe, you know, starting to actually not hurt anymore, but maybe starting to help at some point in 2017 or 2018?
David Grzebinski (President and CEO)
Yeah, yeah, I think that's a possibility. We've always said this, that, you know, crude is best moved in a pipeline, and that's where it'll end up. I do think what we are seeing now portends that you'll see more crude volumes coming out of the shale plays. We know that's gonna happen, but ultimately, it'll end up in a pipeline. We could get some demand from these shale plays if things continue to improve. But, you know, it's not something that we think is that should be bet. You know, we wouldn't bet a bunch of equipment on. You know, if it helps tighten it up, that'd be great. I mean, we saw what it did 2012-2014.
But then, you know, that overhang is what we're dealing with now. I would say this, you know, the number of barges moving crude right now is roughly the same as it was last quarter, right around 140 barges, so it seems to have stabilized. But, you know, the long-term trend is crude should be moved in a pipeline. I think part of the problem with new pipelines coming on is they, they're gonna want 20-year offtake agreements. So there is a scenario where you could see some barge volume come back. It's not something that, we're betting on now.
Douglas Mavrinac (Managing Director Investment Banking)
Right. Okay, great. Very helpful. Thank you, David.
Operator (participant)
The next question comes from Mike Webber of Wells Fargo. Please go ahead.
Michael Webber (Managing Director)
Hey, good morning, guys. How are you?
David Grzebinski (President and CEO)
Mike.
Andrew Smith (EVP and CFO)
Mike.
Michael Webber (Managing Director)
David, just wanted to go back to a couple of your earlier comments. I guess one on supply rationalization, and then kind of following up on margin. But I think you mentioned, you know, 2017 being a potential inflection point and seeing some of the older capacity come out of the market and helping you to find balance in terms of pricing. I guess my question is: What degree of confidence do you have in 2017 being that period? If we look across most of the marine spaces and even maybe kind of even coastal as a comp, you know, we still see 45-year-old ATBs that are trading in the market that have gone through two or three cycles now.
So it seems like it tends to take a bit longer than kind of a 12-month rationalization period. So I'm curious how you think about that on the inland side, and then, you know, what degree of confidence you have in it being 2017 versus, you know, 2018 or 2019.
David Grzebinski (President and CEO)
Yeah, I think your comments are generally correct. On the inland side, rationalization can happen a lot quicker. You know, it's pretty easy to take out a 10,000-barrel barge. You know, it's a lower capital amount. It's easier to tie them up or to cut them up, sell them for scrap. Your point is taken on the ATBs. These are bigger units. They're, there's a higher capital base, and if you can keep them working and they're long in the tooth, you know, they're fully depreciated, it's a pretty good deal. So it has to be painful in order to take them out.
And that's why I said on the coastal side, it could take, you know, a couple of years for that to play out as those 14 new ones come in and the 40 come out. Now, you know, on the inland side, as you've seen, we upped just in the last since our last call, from planned retirements on inland of 39 to 54 this year alone. So, you know, I think you'll see pretty hefty retirements in the inland side.
Andrew Smith (EVP and CFO)
Yeah, Mike, this is Andy. I would just add to that, you know, while we don't have perfect visibility into what other industry participants are retiring, we do have relatively good visibility into what's being built. And so this year, again, if you look at our net retirements of 49 barges, you know, the industry as a whole is only building just a little under 100, if you net our 5 out of it. So we're retiring, ourselves, almost half of what is being built this year. And then as you go into next year, we think the shipyard order book right now is less than 10. So, I think really, you know, supply and demand just through attrition and lack of new capital will be sort of a help to us over the next year or two.
Michael Webber (Managing Director)
Great. No, that's helpful. And just to follow up on operating margin and trying to kind of consolidate a couple of the comments. If I look at what you guys put up in Q3, I believe it's just looking at our model, the lowest consolidated operating margin since 2008. And when we go through and we look at that history, you know, you realize that that's, you know, you go back far enough, and that's pre-K-Sea, right? So that's not necessarily you're looking at kind of inland margin versus kind of a consolidated operating margin today.
Andrew Smith (EVP and CFO)
Right.
Michael Webber (Managing Director)
So at 15%, if I think about, you know, the inland market taking a major leg down in July, right? So you've got another 6-7 months or more of kind of rolling over that 80% of COA or time charter business onto a lower spot market on the inland side. And then mid-single digit market margins on the coastal business, with 72% of that market on time charter and yet to roll off and a considerable supply headwind still facing the coastal market. Would it stand to reason that your consolidated operating margins should remain under pressure through at least for the next 9-12 months?
David Grzebinski (President and CEO)
Yeah. No, I mean, you heard my earlier comments about the full year effect of pricing rolling over, putting pressure on margins. I think. Yeah, I would say, you know, Andy's comments said that the inland margins in the quarter were up in the high teens, you know, just below 20%. So, I mean, I don't disagree with what you're saying. We will have margin pressure for the next while, as these contracts have rolled over, and we get that full year effect. And, you know, the inflection point is in terms of pricing, and when does pricing inflect?
Michael Webber (Managing Director)
Right.
David Grzebinski (President and CEO)
And then it takes some time for that pricing to roll through, to come back into the margins, on a full year basis.
Michael Webber (Managing Director)
Right. Okay. No, that's helpful. I appreciate it, guys. Thanks for the time.
Andrew Smith (EVP and CFO)
Mike.
Operator (participant)
The next question comes from Kelly Dougherty of Macquarie. Please go ahead.
Speaker 12
Hey, guys, thanks for the time. Not to be too-
David Grzebinski (President and CEO)
Hey, Kelly.
Speaker 12
Hi. Not to be too skeptical, but have you actually started to see these accelerated retirements happening, or are we just assuming that, you know, even more difficult conditions will finally spur them? Because I kind of feel like we've been expecting that for a while. So you know, what, if you are seeing them happen, hopefully, you know, what do you think finally precipitated that? Or is it just a, you know, a certain number of quarters of the pain and people finally, you know, start to make a move? Or do you have any insights maybe into the industry's shipyard schedule, so we can kind of think, okay, you know, X% of the vessels have to come up to getting more money put into them, so that's a good proxy for how much should come out over the next few months?
David Grzebinski (President and CEO)
Yeah. Now, let me break your question. Is your question more about coastal, or is it on inland?
Speaker 12
More about inland.
David Grzebinski (President and CEO)
In inland.
Speaker 12
Yeah.
David Grzebinski (President and CEO)
Yeah, in inland, we have seen people retiring equipment. You know, you can fly around or drive around the Houston Ship Channel and see equipment is coming out. We are. You heard our accelerated retirement schedule. I think the same is happening in the coastwise business. It's just starting. I mean, I think both Vane and OSG have been public about retiring coastwise equipment. We're gonna retire some coastwise equipment. We have retired a couple bigger units. So I think it's happening, and it's. I don't think it's just us.
Speaker 12
Do you have any kind of sense of what the shipyard schedule might look like, or is there any way to figure that out, where we can kind of think of that as a good proxy of what might, you know, continue to come off over the next few months?
David Grzebinski (President and CEO)
Yeah. No, I think in the shipyard schedule, most of the 2016 deliveries have happened on the inland side. As Andy said, there's probably less than 10 contracted for delivery next year on the inland side. On the coastwise side, we know that there's 14 new builds. And actually, Sterling can give you that list if you want it. He knows what they are by unit. Yeah, I don't think any new contracts for new tonnage on the coastwise business have been let in the last quarter or so. And I, you know, I don't know of anybody really adding to the inland fleet. I had a conversation with an inland shipyard earlier this week, and he basically was moaning that he had no inbound orders at all. So.
Speaker 12
Yeah, no, I'm sorry. When I meant the shipyard schedule, I meant, you know, the vessels that have to go back in for the Coast Guard mandated.
David Grzebinski (President and CEO)
Oh, I misunderstood.
Speaker 12
At the point where. Yeah, or you got to make a decision, "Hey, do I'm gonna put $200,000 more into this or just scrap it?
David Grzebinski (President and CEO)
Yeah. Yeah, it's a 30-month cycle, so, you know, but maybe the best way to think about it is, you know, every little less than every three years, every ship has to come, or every ATB or tug has to come in to the shipyard. You know, it's a 30-month cycle, so you can take the fleet. There's about 290 barges out there. You know, you would say 90 to 100 come into the yard, into the shipyard every year, as a rough. That's a rough proxy.
Speaker 12
Okay.
Joseph H. Pyne (Chairman)
Yes.
David Grzebinski (President and CEO)
You know, hey, we just add one thing, too, is we've got the ballast water treatment system that has to come in.
Speaker 12
Mm-hmm.
David Grzebinski (President and CEO)
And that's gonna be a capital cost of $1.5 million-$2.5 million for every in addition to every shipyard. So, you know, that's a pretty big headwind if you've got older tonnage.
Speaker 12
Okay.
Joseph H. Pyne (Chairman)
David, I think Kelly is also asking about inland equipment, which has the same cycle, inspected every 2.5 years, dry docked at least every 5 years. So you—if you do the math on the population of tank barges, you can get kind of the period where those decisions are gonna be made.
Speaker 12
Okay, great. Now, that, that's helpful. And, and then, is there just a way to think about, right, if spot utilization or spot, you know, moves on the coastal side, kind of stayed at 78%, do you have. And maybe this isn't, you know, the easiest question to answer, but any sense of what that might move to in 2017? I have to imagine there's a certain percentage of customers that's just not gonna operate in, in the spot market, even if, you know, capacity looks a little bit more readily available. But, but any way to kind of help us put some orders of magnitude around how much might actually translate into a spot move, potentially?
David Grzebinski (President and CEO)
Yeah, no, I'm sorry. How much of the coastal will, will translate into a spot move? How much.
Speaker 12
Yeah, I mean, I imagine that some of the coastal business is just, you know, probably going to be under contract just because it's the nature of that business. Is there. Or maybe I'm wrong, but, you know, how much do you think really might be at risk to move over to the spot market as we look into 2017?
David Grzebinski (President and CEO)
Yeah, that's hard to quantify. Yeah, I think it's a bit of a dance with the customers in that they will, you know, they'll try and term you up at a very low rate if they can. And if they can't, they'll say, "Well, let's just stay in the spot market." So it's, you know, we're reluctant too, to term up that at rates that are extremely low. So it's a bit of a give and take. So it's really hard for me to predict and be more quantitative than that.
Speaker 12
Okay. Thanks very much, guys.
David Grzebinski (President and CEO)
Thanks, Kelly.
Joseph H. Pyne (Chairman)
Thanks, Kelly.
Operator (participant)
Excuse me, this is the conference operator. I see that we're at the bottom of the hour now. Is there time for one more question?
David Grzebinski (President and CEO)
Yes, operator. We'll, we'll take one more.
Operator (participant)
Thank you. That question comes from David Beard of Coker Palmer Institutional. Please go ahead.
David Beard (Analyst)
Hey, it's David Beard. Thanks, guys, for fitting me in.
David Grzebinski (President and CEO)
Hey, David.
David Beard (Analyst)
You know, two, two questions, kind of big picture. The first, just on the mix of spot and contract. You know, is Kirby more sensitive now to an improving rate environment? You know, when it should improve relative to utilization of pricing, or are we really going to see utilization move first and then pricing lag?
David Grzebinski (President and CEO)
Yeah, utilization's got to move first before you can get the pricing. But it. You know, one of the things, having a larger spot exposure is kind of what you want when pricing is really low, so that as pricing comes up, you're able to get, you know, pricing back up for your book of business. But we do need, to your point, you do need the utilization to come before the pricing. And typically, on the inland side, if you're north of 85%, kind of in the high 80% range, and you know, the customers believe it's gonna be that way for a while, you get to an environment where you can get a little pricing momentum.
David Beard (Analyst)
Okay. No, that's helpful. And then just to go back, you know, to the capital allocation question and the acquisition. And I really want to sort of loop in the share buyback, and I know it's a little bit of a circular argument, but you know, you bought back stock at a higher level, business got worse. I can see you not wanting to buy back stock if you're going to make an acquisition. But then again, if business gets better next year, who's going to sell? So would you be buying back stock? So I know we're in a little bit of a circular argument, but I'd just like to kind of you know, walk us through how you're thinking about that capital allocation issue, especially as you're in maintenance mode next year and the free cash flow builds.
Yeah. Well, David, we certainly like our stock at these prices, and, you know, if we bought it at higher levels, you can imagine we like them at these lower levels. I would say this, though, you know, one of our first priorities in terms of capital deployment is a consolidating acquisition in our core businesses. You know, clearly, we like to do that. It sets the company up for long-term growth, so that tends to get the higher priority. You know, you can't be in the market buying back stock if you're looking at material acquisitions, and even if you don't know whether they're going to happen or not. I think that's understood.
David Grzebinski (President and CEO)
You know, there's times when you can be in the market and times when you can't. But, you know, we're glad we've got the balance sheet we do. We're, as you saw, we're down 23% debt to total cap. That's a good position to be in, in a market like this. We're, you know, this is where our capital discipline and our financial strength become, you know, a pretty good strategic tool.
David Beard (Analyst)
Now, that's very helpful. I appreciate it. Thanks for the time.
Joseph H. Pyne (Chairman)
Thanks, David.
David Grzebinski (President and CEO)
Operator, we're done with Q&A. You want to close out the call?
Operator (participant)
Yes, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.