Kirby - Q3 2018
October 26, 2018
Transcript
Operator (participant)
Good morning, and welcome to the Kirby Corporation 2018 Third Quarter Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. We ask that you limit your questions to one question and one follow-up. To ask a question, you may press Star then one on your touchtone phone. To withdraw your question, please press Star, then two. Please note, this event is being recorded. I'd 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 yesterday afternoon, can be found on our website at investors.kirbycorp.com. 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 included in our earnings press release and is 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 31, 2017, as well as in the subsequent filing on Form 10-Q for the quarter ended June 30, 2018. I'll now turn the call over to David.
David Grzebinski (CEO)
Thank you, Eric, and good morning, everyone. I'll start my comments today with a summary of the third quarter results, and then turn the call over to Bill to walk through the segment financials. Following Bill's comments, I'll discuss our fourth quarter and updated full year guidance before turning the call over for question and answers. Yesterday afternoon, we announced 2018 third quarter earnings of $0.70 per share. This compares to our guidance range of $0.50-$0.70 per share and represents a 35% increase compared to the 2017 third quarter earnings of $0.52 per share. In the third quarter, our inland marine transportation business continued its recovery from the downturn and experienced a steady increase in activity, increasing volumes from petrochemical and black oil customers, refinery turnarounds, and some major lock infrastructure projects all helped to drive up tank barge utilization.
At the end of the third quarter, Kirby's inland fleet utilization was in the mid-90% range. As a result of these tight market conditions, spot market rates increased between 3% and 5% compared to the second quarter. Furthermore, as anticipated, term contracts renewing in the third quarter repriced higher in the mid-single-digit on average. All of these factors, together with lower operating costs, reduced maintenance expenses, and efficiencies realized from favorable summer weather conditions, helped to boost inland operating margins. In the coastal sector, market fundamentals showed signs of improvement, with favorable activity levels across the entire network, driven in part due to some refinery turnaround, summer storm disruption, and good operating conditions on the West Coast. With respect to pricing, while spot rates were generally unchanged during the quarter, we renewed several term contracts modestly higher.
Looking at the broader market, the widening of the Brent-WTI spread has increased the number of crude oil shipments from the Gulf Coast to the East Coast refineries. While not directly impacting our fleet thus far, these incremental shipments in the coast-wise trade are generating more activity for MR tankers and larger ATBs that have been working in our fleet's trade lanes since the downturn, most notably in refined products. Provided the spread remains widened, we believe that our fleet could benefit as the larger vessels shift their focus to crude, thereby increasing our activity and utilization in the future. As anticipated, the distribution and services segment reported a sequential decline in revenue and operating income following strong results in the second quarter. Vendor supply chain issues, which were highlighted in our last earnings call, delayed the completion of many pressure pumping units under construction.
Additionally, the well-publicized Permian pipeline takeaway capacity issues reduced pricing for pressure pumping operators, and logistical challenges in the oil field resulted in lower activity for some of our major customers during the third quarter. This temporary softening of activity drove a slight sequential reduction of new orders for oil field equipment, including pressure pumping equipment and new transmissions and overhaul transmission and parts. Despite these reductions, compared to the second quarter, demand for pressure pumping unit remanufacturing and service remained strong throughout the third quarter. In our commercial and industrial market, compared to the second quarter, we experienced increased utilization in our specialty equipment rental business, most notably with generators and compressors dispatched during the peak hurricane season. Results in the commercial marine business, although significantly improved year-over-year, were largely unchanged sequentially.
Reductions in inland towboat service during the dry cargo harvest season were offset by higher sales of new marine diesel engines. In summary, although results in distribution and services sequentially declined as expected, the pause due to the Permian has an end in sight in 2019. Further, some of our customers are ramping up maintenance and beginning to order equipment in anticipation of the 2019 rebound. In marine transportation, things continue to move in the right direction. Inland pricing has inflected higher, barge utilization is nearly at capacity, and operating margins moved meaningfully higher. Coastal is showing signs of life again with increased revenue, some contracts renewing higher, and operating margins improving earlier than anticipated. In a few moments, I'll talk more about our outlook for the fourth quarter and the remainder of the year.
Before I do, I'll turn the call over to Bill to discuss our third quarter segment results and the balance sheet.
Bill Harvey (EVP and CFO)
Thank you, David, and good morning, everyone. In the 2018 third quarter, our marine transportation segment revenues were $382 million, with an operating income of $48.5 million and an operating margin of 12.7%. Compared to the same quarter in 2017, this represents a 20% increase in revenue and a 36% increase in operating income. Compared to the second quarter, revenues increased $3.8 million, operating income increased $10.3 million, and operating margin increased 2.6%. The significant improvement of profitability is attributable to improved pricing, enhanced operating efficiencies for the inland fleet, reduced operating and maintenance costs, especially related to the Higman fleet, and higher demand in coastal.
In the inland market, revenues were approximately 30% higher than the third quarter of 2017 due to the Higman acquisition, increased demand and utilization, additions to our pressure barge fleet, and improved pricing. During the quarter, the inland sector contributed approximately 75% of marine transportation revenue, which is unchanged sequentially. Long-term inland marine transportation contracts, or those contracts with a term of one year or longer, contributed approximately 65% of revenue, with 58% attributable to time charters and 42% from contracts of affreightment. Term contracts that renewed during the third quarter were higher in the mid-single digits. Spot market rates increased 3%-5% and were 20%-25% higher year-on-year. During the third quarter, the operating margin in the inland business improved to the mid to high teens.
In the coastal marine market, third quarter revenues declined approximately 5% year over year, primarily due to barge retirements completed at the end of 2017, which reduced the total volumes transported. These reductions were partially offset by barge utilization, improving to the 80% range. Although pricing is contingent on various factors such as geographic location, vessel size, vessel capabilities, and the products being transported, in general, average spot market rates were unchanged compared to the 2017 third quarter. However, during the quarter, we did see a number of term contract renewals reprice higher. During the third quarter, the percentage of coastal revenues under term contracts remained at approximately 80%, of which approximately 85% were time charters. The coastal business operating margin improved to breakeven during the quarter.
With respect to our tank barge fleet, in the inland sector during the quarter, we retired 9 barges with a total capacity of approximately 141,000 barrels. At the end of the 2018 third quarter, the inland fleet had 981 barges, representing 21.6 million barrels of capacity. During the fourth quarter, we expect to take delivery of one additional 24,000-barrel specialty barge that was acquired through the Higman acquisition, and we also plan to retire 3 additional barges with approximately 40,000 barrels of capacity. On a net basis, we currently expect to end 2018 with a total of 979 inland barges, representing 21.6 million barrels of capacity. In the coastal marine market, we returned one charter barge with a capacity of 77,000 barrels during the quarter.
As mentioned last quarter, we expect to take delivery of a new 155,000-barrel ATB in the fourth quarter. However, we intend to retire an older vessel with a similar barrel capacity currently operating in our fleet. We also intend to return one additional charter barge with a total capacity of 58,000 barrels in the fourth quarter. On a net basis, we currently expect to end 2018 with 53 coastal barges with 5 million barrels of capacity. Moving on to our distribution and services segment. Revenues for the 2018 third quarter were $322.8 million, with an operating income of $23.9 million. Compared to the 2017 third quarter, revenues increased $100.3 million, primarily due to the incremental contribution from S&S and the improved market conditions in the commercial marine diesel engine repair business.
Compared to the 2018 second quarter, revenues declined 24% or $101.7 million, and operating income declined $16.3 million, primarily due to reduced deliveries of pressure pumping units in our oil and gas business. During the third quarter, the segment's operating margin was 7.4%. In our oil and gas market, revenues and operating income were up year-on-year due to the acquisition of S&S occurring late in the 2017 third quarter. Additionally, increased orders and deliveries of new pressure pumping equipment this year were offset by lower pressure pumping remanufacturing activity, as well as reduced demand for new and overhauled transmissions. Compared to the second quarter, the reduction in revenue and operating income was due to the timing of new pressure pumping unit deliveries, which were delayed as a result of ongoing vendor supply chain issues.
Recent softening of activity in the oil field, which impacted some of our key oil and gas customers, also contributed to reduced demand for new transmissions and parts, as well as transmission overhauls during the quarter. For the third quarter, the oil and gas business represented approximately 60% of distribution and service revenue and had an operating margin in the mid to high single digits. In our commercial and industrial market, compared to the 2017 third quarter, revenues and operating income increased primarily due to the acquisition of S&S. We also experienced year-over-year increases in demands for overhauls and service on marine diesel engines, particularly related to the inland towboat market and the high-speed offshore market along the Gulf Coast.
Compared to the second quarter, revenues in our commercial marine business were stable, with reduced inland service due to the harvest season in the dry cargo markets being offset by the sale of several new large diesel engine packages in the Northeast. Activity in the power generation market was unchanged year-on-year, but higher compared to the second quarter due to seasonal increases in rentals of standby power generators and compressors. For the third quarter, the commercial and industrial businesses represented approximately 40% of distribution and services revenue and had an operating margin in the mid to high single digits. Turning to the balance sheet. As of September thirtieth, total debt was $1.4 billion. Compared to the end of the second quarter, total debt declined $43 million. Our debt-to-cap ratio at the end of the third quarter was 30.2%.
During the quarter, the delayed deliveries of Pressure Pumping Units resulted in a meaningful sequential increase in working capital. I expect as these units are delivered in the coming months, we'll benefit as we draw down working capital. As of this week, our debt balances had further reduced to $1.38 billion. I'll now turn the call back over to David to discuss our guidance for the fourth quarter and the remainder of the year.
David Grzebinski (CEO)
Thank you, Bill. In our press release yesterday afternoon, we announced our 2018 fourth quarter guidance of $0.55-$0.75 per share. This range implies a 2018 full year GAAP guidance range of $2.27-$2.47 per share, $2.47 per share, which contains several one-time items disclosed in the first and second quarters, including $0.04 per share for Higman Marine acquisition fees and expenses, $0.04 per share for severance, $0.05 per share for expenses related to an amendment to an employee stock plan, and $0.30 per share for expenses related to Kirby's Executive Chairman's retirement.
Looking at our segments, in marine transportation, we expect inland barge utilization for the fourth quarter will be in the low- to mid-90% range and will be strong because of demand, continued lock closures, and seasonal weather, weather impacts. As a result, we expect that inland pricing will continue to move higher. Overall, we expect inland revenue and operating income will be flat to up slightly compared to the third quarter, with the benefits of the higher pricing offset by reduced efficiencies on contracts of affreightment as deteriorating seasonal weather conditions add to higher delay days. In the coastal market, we expect stable pricing and overall utilization around 80% for the remainder of this year. During the fourth quarter, we have scheduled shipyard for several of our large capacity vessels, which will have a negative impact on revenue and operating income.
As a result, we expect coastal operating margins to be in the negative low to mid-single digit range for the fourth quarter. For our distribution and services segment, we anticipate that revenue and operating income in the fourth quarter will be similar to the third quarter. In our oil and gas manufacturing business, we expect that pressure pumping remanufacturing activity will remain robust as our customers ready their fleets for the increased oil field activity anticipated in 2019. With respect to new pressure pumping equipment, we expect to deliver many of the units currently under construction, some of which have been delayed during the third quarter by vendor supply chain issues. The current build schedule, however, reflects many of the more recently ordered units to deliver late in the fourth quarter.
Together, with the timing of OEM deliveries, it is possible that the completion of some units could be delayed into the first quarter of 2019, and therefore, have an adverse impact on our revenue and profit for the fourth quarter. In our oil and gas distribution business, the current slowdown in activity for our key customers is expected to persist through the fourth quarter and result in lower transmission sales and overhauls. In our commercial and industrial markets, we expect the fourth quarter to be modestly down sequentially, primarily driven by seasonal declines in demand for standby power generation and other specialty equipment rentals, as well as reduction in sales of Thermo King refrigeration units following the summer peak. Now, to wrap things up, our third quarter results were strong despite some short-term challenges in our distribution and services segment.
The marine transportation segment definitely exceeded expectations and delivered solid operating margin improvement. As we look forward, we remain very positive on Kirby's near-term and long-term potential. The inland marine business is gaining momentum. Utilization rates are high, contract prices are increasing, and operating margins are improving. Higman contracts are rolling off and being repriced at current rates. This acquisition, as well as recent pressure barge acquisitions, are fully integrated and yielding positive returns to our fleet. With incremental volumes expected in 2019 from new petrochemical plants and crude pipeline, low tank barge construction, and ongoing lock infrastructure issues, we expect that our inland business will continue to improve. The coastal market is showing initial signs of recovery, and operating margins returned to breakeven levels during the third quarter.
While the fourth quarter is expected to be negatively impacted by scheduled maintenance activities on some of our larger vessels, I do feel more confident that we are seeing improvement in this business. We recently made some significant investments to improve the efficiency of our fleet, including six new state-of-the-art tugboats and a new 155,000-barrel ATB. These investments, combined with anticipated industry retirements and improving market conditions, should yield better operating margins next year. Distribution and Services, while challenging in the near term, has significant runway ahead of it. All signs point to a strong year in 2019 as Permian pipeline infrastructure issues are resolved and our customers are making plans for increased activity. As a result, we've received new orders, and our customers are planning for new pressure pumping equipment to be delivered in 2019.
Our market-leading remanufacturing and services business, including our fully operational facility in the Permian, is expected to remain very busy as customers seek economic opportunities to remanufacture fleets currently working in the field today. Beyond the oil field, demand for power generation is increasing, inland marine has recovered, and offshore commercial marine is seeing signs of life. These improvements, combined with the continued realization of synergies, should generate opportunities for some operating margin expansion in 2019. Finally, our balance sheet remains strong. Debt reduction remains our top priority in the near term. However, we will continue to take advantage of any attractive acquisition opportunities to grow in our core businesses and deliver incremental returns to our shareholders. Operator, this concludes our prepared remarks. We are now ready to take questions.
Operator (participant)
Thank you. 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. As a reminder, we ask that you please limit your questions to one question and to one follow-up. At this time, we will pause momentarily to assemble the roster. The first question comes from John Chappell with Evercore.
John Chappell (Analyst)
Thank you. Good morning, guys.
David Grzebinski (CEO)
Hey, good morning, John.
John Chappell (Analyst)
David, I was going to start with inland, but actually, your last couple of comments on D&S were pretty interesting. So you sound more optimistic on 2019 than maybe the narrative in the market right now. So what's the timing on kind of ramp in your mind? I know you haven't budgeted 2019 yet, but when do you thought things start returning to "normal"? And in the meantime, can you just give a little bit of color about your backlog as it sits right now and, and the potential for that to kind of cushion any near-term headwinds?
David Grzebinski (CEO)
Yeah, sure. Let me start actually with the backlog because I think it is interesting. If you go back to our last call and you compare the backlog then to what it is now, it, the backlog is about the same. So in other words, we booked about the same amount that we shipped in the third quarter. So backlog is staying high. What we are doing now is receiving orders for delivery into 2019, so that's why we're getting more excited. In fact, Joe Reniers, who runs that business for us, is out there trying to hire 50 to 100 techs right now. So we're very busy.
A lot of it is some maintenance that's happening on the front end as people try and prepare. Others are looking for equipment deliveries in the first part of 2019. I think it's in anticipation of a recovery next year. I say recovery, it's not really a recovery, it's a resumption of growth. If you look at the Permian, it's still producing quite a bit, and they're still fracking out there, so there's a lot of equipment being used. And as you know, the operating conditions and how hard they run this, it tears up the equipment, and some of the older stuff needs to be replaced. Some of the new stuff can be remanufactured or just simply some simple maintenance.
So, yeah, you know, as we look at it and listen to our customers, you know, they're anticipating a pretty good 2019 as some of these pipelines come on in the Permian. And, let's not lose track that they're still operating this equipment. It's not growing as much as it had been, but it's still being operated. So that actually plays to us because there's a huge maintenance component, and then there's a replacement component as well. All that said, there are other things that are happening in the industry. You know, technology keeps moving forward. If you go back 5 years, and I think, you know, OPEC kind of underestimated the resiliency of the U.S. land market and the technology advances that our customers make.
So that's a long way of saying that technology keeps increasing. You know, we're doing more stuff, bigger engines now on frack units. They're adding sound enclosures to make them more environmentally and sound friendly. They're adding dual fuel options, looking at electric fracks. So technology keeps improving as well. So pump technology improves. So all of our customers keep moving the ball forward and take out old fleets and bring in new fleets or repair the ones that they think have some good life. So when we look at 2019 and my comments, prepared comments, we've tried to reflect that because that's what we're seeing.
John Chappell (Analyst)
Okay, that's very useful. And then for my follow-up, if I can switch back to marine. Clearly, it's shown that it's moving in the right direction, I think, faster and more meaningfully than anyone really expected. Are you seeing anything that gives you reason for pause that the pricing momentum or the margin momentum may slow, whether that's macro or whether it's kind of speculative ordering now for new equipment? Any reason to believe that 2019 shouldn't be sustainably better than 2018, you know, especially as you kind of recontract pricing?
David Grzebinski (CEO)
Yeah, the short answer is we think it'll continue. That's the short answer. Let me give you some color around that. Utilization across the industry is quite robust, right? You know, I think the industry is in the 90%-95% utilization range, which essentially, as you know, at 95%, that's pretty much full utilization. We're coming off of three years of bad times, where last year, cash pricing, or excuse me, spot pricing was below cash cost. So there's a needed recovery. Many of our competitors, you know, got close to the brink of bankruptcy. And so there's a need to get pricing up and recover. From the depths of last year, spot pricing's up about 20%, but that just gets it back to kind of P&L breakeven.
Depending on their debt levels and their interest carry or interest costs, you know, it still needs to go meaningfully higher. With the utilization where it's at, everything's set up to continue the price increases. Now, I would say this on new builds: We think new builds in 2018 are about 60, well, mid-60s in terms of new equipment. Of course, retirements outstripped that in 2018. I think we retired 40-45 barges this year, so we retired pretty much the bulk of what was built this year, and others retired. Next year, we're hearing the order book's about 120 or so barges right now. We think retirements will be around that, ± a little.
So net new adds are probably very little. I mean, we know for a fact on that 120 order book, you know, the vast majority of them are for replacement. We've heard that in the market. So when you put all that together with the demand increasing from these new petrochemical plants, the refinery expansions, the new crude that's gonna be hitting the Gulf Coast coming out of Permian when the pipelines come on, that should all be good for the demand. So supply and demand are tight now. I think demand's gonna continue to grow. Supply is not growing. It's probably flattish, maybe up a tiny bit. So, yeah, all that portends for a continuation of what we've seen on pricing and utilization.
John Chappell (Analyst)
Great. Very helpful. Thank you, David.
David Grzebinski (CEO)
Thanks, John.
Operator (participant)
Thank you. And the next question comes from Justin Barker with Gabelli & Company.
Justin Barker (Analyst)
Oh, thank you, and good morning.
David Grzebinski (CEO)
Good morning, Justin.
Justin Barker (Analyst)
I was curious about the improvement in the coastal market. The factors that helped in the third quarter, do you see those persisting into 2019? Do you think that business has the potential to be profitable in 2019, where things stand today?
David Grzebinski (CEO)
Short answer is yes. We're, you know, this year, we probably averaged a margin of minus 5% for the year. Yeah, we broke even in the third quarter. We know the fourth quarter is gonna be back down because we've got five of our larger units for scheduled shipyards, so we know that's gonna impact the fourth quarter. But once that's behind us... and given the cost that we've taken out of that business and the signs of life, both increased demand, slight increase in demand, retirement of older equipment, the new ballast water treatment regulations are gonna accelerate some of the retirements that have to happen. So when we look at supply and demand in that business, it's gonna get tighter.
So I definitely think we could see profitability next year or break even. You know, the spread between WTI and Brent is also helping. As long as that persists, the MR tankers will be used to move crude oil out of the Gulf Coast up to the East Coast, which keeps those larger units out of our trade lanes. They dip down occasionally in our trade lanes and displace some of our equipment. But that's also a positive. I don't see that spread tightening because of all the crude that's gonna come out of West Texas. So I... That's the long answer.
The short answer, again, is we definitely think we could get to breakeven, or maybe profitable next year if things continue the way we're seeing them now, which we believe they will.
Justin Barker (Analyst)
Okay, great. And then just one quick clarification question on guidance. I think last quarter, you'd called out the $0.05 for the amended employee stock plan, $0.30 for the executive chairman's retirement, the $0.04 for Higman acquisition fees, and the $0.04 per share for severance. Those were also anticipated in your earlier guide, correct? You're just sort of clarifying the magnitude here.
David Grzebinski (CEO)
Yeah. Yeah, no, we just wanted to make, we just, I know you guys have a job to put out your, the, to compare to our guidance. We just wanted to put all the special items for the year in one place, so that's what we did.
Justin Barker (Analyst)
Okay, so none of those, hopefully, would repeat next year, including the $0.04 and the $0.04.
David Grzebinski (CEO)
Oh, definitely, none of those would repeat next year.
Justin Barker (Analyst)
Okay. Thank you.
Operator (participant)
Thank you. The next question comes from Michael Webber with Wells Fargo.
Michael Webber (Analyst)
Hey, good morning, guys. How are you?
David Grzebinski (CEO)
Hey, Michael. How are you?
Michael Webber (Analyst)
Good. David, just on the inland market, you know, you guys talked to, I think it was 3%-5% spot improvement this quarter, and about 25% off of trough levels. You also mentioned term pricing this quarter finally starting to move. I think you mentioned mid-single digits. Is the right way to look at that, that we're starting to see term pricing improve at a slightly healthier clip than spot? And if so, is that something that you think is accelerated as we move into Q4? Or, you know, just kind of a further indication of that market getting a bit healthier. I'm just curious how those different paces have trended so far.
David Grzebinski (CEO)
Yeah, no, spot pricing has moved quicker than contract, but that's kind of normal. You need spot pricing above contract to get the contract pricing to move higher, and that's been happening. I would say spot pricing's 5-10, maybe even greater than 10% above contract. So that's good. We needed that to happen in order to get the contract pricing to start rolling higher. This is kind of the first quarter, third quarter is where we started to see contracts renewing higher. I expect that trend will continue. Equipment's tight, and as equipment gets tighter, as you might expect, our customers start worrying about barge availability, and so that pushes them more towards contracts, which should start to accelerate contract pricing, pricing gains.
Michael Webber (Analyst)
Gotcha. So is we're at a point where that, the acceleration in term pricing should start to kind of outpace that, that early spot move?
David Grzebinski (CEO)
Yeah, I don't know. I don't know if it'll outpace spot moves. You know, hopefully, they both continue to march up.
Michael Webber (Analyst)
Sure.
David Grzebinski (CEO)
I like the spot being a little higher than contract because that just puts the emphasis on securing those contract prices higher.
Michael Webber (Analyst)
Yeah. Okay. So then just, as a follow-up, just to try and kind of tie together, you know, the inland market with kind of some of the dynamics we're seeing in, in D&S. Just from an inland ton mile perspective, can you kind of, if we, if we fast-forward to 2020, and we kind of debottleneck the Permian, can you talk about what your ton mile mix looks like in that scenario, where you've got more crude hitting the Gulf? Does that cannibalize, you know, some of that longer haul business with Bakken or elsewhere? Can you just kind of talk about what you think that ton mile mix looks like over the next couple of years as you tie together some of those segments?
David Grzebinski (CEO)
Yeah, hard to predict, but I would say, you know, most of the long crude moves are Canadian, are coming down from Canada, and that's at a very big, steep discount to WTI. I would think that would persist. I think the crude coming out of the Permian, going to either Corpus or Houston, some of it will go direct to export. We know there's a group trying to build another loop, if you will, an offshore loading facility for VLCCs. So some of it will go direct for export. I think the pipelines into Houston will go into some of the refineries.
We heard rumors of one of our major customers maybe building another refinery in the Houston area, or at least buying an old one and upgrading it. So, you know, I do think we'll see some volumes as that crude gets processed on the Gulf Coast increase. So from a ton mile standpoint, we may see less miles, but more moves because of a lot of that stays in the Gulf Coast. The moves are shorter, but you still get paid for short moves, and sometimes our most profitable moves can be, kind, can be Houston cross-channel, if you will. Short ton miles, but you get paid for using the barge and supplying the customer.
So it -- you know, the ton-mile mix is a little hard to gauge, but in general, maybe the ton-miles come down a little bit to your point. But I don't think the Canadian crude moves disappear because it's one, the U.S. refineries or Gulf Coast refineries like that heavy crude; they're set up to crack heavy crude. And two, it's just a big discount, so there's a pretty good arbitrage move for the refiners to use it.
Michael Webber (Analyst)
Gotcha. Okay. That's helpful. Appreciate the time, guys. Thank you.
David Grzebinski (CEO)
Thanks, Michael.
Operator (participant)
Thank you. The next question comes from Randy Givens with Jefferies.
Randy Givens (Analyst)
Hey, thanks, guys. Looks like-
David Grzebinski (CEO)
Hey, Randy.
Randy Givens (Analyst)
How are you all?
David Grzebinski (CEO)
Good.
Operator (participant)
Very good.
Randy Givens (Analyst)
Good, good. Quick question. So it looks like your marine transportation revenues were up slightly, and your operating maintenance costs were down even more significantly, kind of from 2Q levels. So what exactly drove those cost reductions on the marine side? And do you expect 4Q 2018 costs to decrease further or kind of go back to those 2Q levels?
David Grzebinski (CEO)
Well, 2Q was elevated because of the Higman fleet. Remember, we got the Higman fleet mid-February, late February, and there was a lot of catch-up maintenance. So Q2 was probably elevated. Q3, you know, we integrated, had caught up on some of that maintenance. But yeah, maintenance should be around the level in Q3. And going forward, yeah, it depends on the shipyard cycle. Obviously, we called out the coastal shipyard business and planned maintenance that we have there will be elevated in the fourth quarter. But I would say it's probably closer to what we saw in the third quarter, maybe go up a little bit from where it was in the third quarter.
But it's gonna be in that range because the bulk of the catch-up maintenance that we knew about for Higman Fleet is done.
Randy Givens (Analyst)
Sure, sure. All right, that's helpful. And then, one more question for David. You commented that power generation demand is increasing. So is that business something you're focused on growing? And if so, kind of, how do you expect to do that? And then how much in annual EBITDA does that business contribute?
David Grzebinski (CEO)
Yeah, so power generation, as you know, there are a lot of these data centers and whatnot around the United States, and they're growing. And even financial institutions and companies, corporates want to have backup power generation, particularly along the Gulf Coast, where we get hammered by hurricanes occasionally. So we, through our Stewart & Stevenson acquisition, do a lot of backup power generation, and particularly on the rental side. For example, a big retailer, we provide backup power generation that's on basically semi-trailers that goes into hurricane-impacted areas for a large retailer, and essentially, you plug in the trailer, and it gets the store back up and running, and they're able to service the customers, which, you know, are desperate to get the supplies out of the store, too.
So when you add data centers, hurricane, and retail backup power, it's becoming a growth area for us. We're excited about it. In terms of, you know, volume and EBITDA, I'm not prepared to answer that. We can in our Analyst Day, we kind of outlined kind of the percent revenue. I would say the operating income margins are similar to the average for that group, but I don't have that off the top of my head, Randy, but we could-
Randy Givens (Analyst)
Sure.
David Grzebinski (CEO)
We could probably... Eric can probably help give you a feel for that. But I do believe it is a growth area, and, you know, frankly, it, it's part of that, you know, diversification we talked about because it has a little different cycle and a little different end use. And, and frankly, it's growing because of the way the world uses computers now and needs, you know, instant access to data. So, we're pretty optimistic about growing that market.
Randy Givens (Analyst)
Got it. Well, makes sense. Thanks again.
David Grzebinski (CEO)
Thanks, Randy.
Operator (participant)
Thank you. The next question comes from Kevin Sterling with Seaport Global.
Kevin Sterling (Analyst)
Thank you. Good morning, gentlemen.
David Grzebinski (CEO)
Hey, good morning.
Operator (participant)
Morning.
Kevin Sterling (Analyst)
Yeah, sorry about your Astros not making the World Series this year, but they had a good run. They had a good run. So David, you mentioned some of the Higman fleet contracts rolling off in 2019. How much of that business should we be thinking about in 2019 that could be rolling over, that you guys have the opportunity to re-reprice?
David Grzebinski (CEO)
Yeah, well, it's hard to quantify. Let's see, let me back into it a little bit. When we bought Higman, they were about 60% contracted, 40% spot. You know, I'd say that's up now. We're probably 65% contracted on average, because we've integrated it fully into our fleet. You know, at, on average, these contracts reprice—probably 2/3 of them reprice in a year, the other are multi-year. So, you know, I would say it would still reprice through 2019, but, the big impact's happening now.
Kevin Sterling (Analyst)
Mm-hmm.
David Grzebinski (CEO)
Yeah, they, because of where they were financially, you know, they had to take jobs they could get just to keep, you know, cash flow and paying their crews. So they were, some of their contracts were, you know, paper thin in terms of margins, if not at a loss. And so we're happy to see them repricing back to kind of the market now. You know, it's still got a ways to go, but you know, I think by kind of mid-2019, the bulk of them will be repriced.
Kevin Sterling (Analyst)
Yeah. Okay, awesome. And kind of just keeping on the pricing thing there, you know, obviously, you were seeing better pricing in inland and, you know, a better demand supply equation. But is there any way to tell, you know, part of this pricing narrative, how much could be attributed to some of the bad actors, if you will, the past couple of years, who have found their religion regarding pricing and, you know, are now acting more rational, if you will, in addition to just kind of regular markets, demand, supply, dynamic? Does that make sense?
David Grzebinski (CEO)
Yeah, you know, and I don't know if I'd call it bad actors. I think, look, it was a long, painful three years, and, and, people got to the point where they had to bring up pricing. It just was unsustainable, as we talked about. You know, some of the, some of the, kind of the lower, I don't want to call them lower tier, because that implies something different. But the guys that were at the lower end of the pricing have booked up much of their fleet and are busy now. And, you know, they're seeing that the incremental pricing can get them back to profitability. So, you know, some of it is happening where some of those lower bottom pricers are coming up.
You know, I don't know if you'd call that religion or not yet, but it's certainly they're more constructive about it. You know, that's a positive.
Kevin Sterling (Analyst)
Yep, and obviously, you guys, you're doing the same thing with Higman, where you're repricing that book of business.
David Grzebinski (CEO)
Exactly right. Exactly right.
Kevin Sterling (Analyst)
Okay, well, that's all I had. Thanks for your time this morning.
David Grzebinski (CEO)
All right. Thanks, Ken.
Operator (participant)
Thank you. The next question is from Jack Atkins with Stephens.
Jack JAtkins (Analyst)
Hey, good morning, guys. Thanks for taking my question.
David Grzebinski (CEO)
Hey, Jack.
Bill Harvey (EVP and CFO)
Hey, Jack.
Jack JAtkins (Analyst)
Hey, David. Hey, Bill. So I guess, let me start off with distribution and services for a moment. I guess my sort of question is sort of thinking about what the go-forward run rate is there from a revenue level? I mean, you know, it certainly seems like we're pushing some revenue out, right, out of the third quarter into the fourth quarter, because of the vendor bottleneck issues, but there's still new orders there.
So I guess, what I'm trying to understand is, you know, kind of as we look forward, is this business, you know, as you think about it, generating $300-$350 million in revenue a quarter, or is this more of the $400-$425 million revenue quarter that we saw sort of in the first half of the year? Just trying to figure out the trajectory of this business as we go into 2019 from a revenue perspective.
Bill Harvey (EVP and CFO)
Jack, one thing, one thing to look at is, as David talked about, activity. We, we were very active at the sites, and we talked about in the press release about an inventory going up, and a lot of that was work in progress, about $40 million, and that's just quarter to quarter. That's work in progress and some of that's been offset by deferred revenue because we're getting progress payments, but that's just in the quarter to quarter buildup is $40 million, and that's not including any profit. And as you know, with the revenue recognition, we don't get any profit, and it doesn't go through our income statement until you deliver.
So the base, actually, activity level, which was frankly closer to the second quarter than it was to the, to what you see, and I mean, second quarter revenues, than, than you would have seen, in the third quarter numbers.
Jack JAtkins (Analyst)
Okay, so the expectation is when we get through these bottleneck issues early in 2019, I would guess, that we'll return back to something closer to that $400 million level.
Bill Harvey (EVP and CFO)
Yeah.
Jack JAtkins (Analyst)
Is that the way we should interpret all that?
Bill Harvey (EVP and CFO)
Yeah, I mean, the second quarter was a very good quarter with a lot of good business. It was about, revenue there was $424 million for the second quarter, so we don't, the numbers don't point to getting right back there right away. But what it, the message really is the activity and what's going on right now is you're not seeing that activity in the third quarter revenues.
Jack JAtkins (Analyst)
Okay.
Bill Harvey (EVP and CFO)
that you will see the revenues in the third, in the fourth quarter. Some of it may spill over to the first quarter, but these are, these are, this is inventory, that work in progress that is going to be shipped.
Jack JAtkins (Analyst)
Gotcha. All right. And then as a follow-up question on the marine side of the business, you know, David, could you talk about IMO 2020, and sort of as that maritime regulation is implemented, obviously, it doesn't have an impact on what you're paying for fuel because you're already compliant. I'm not asking about that. I'm more curious, what does it do to product flows and the demand for distillates and maybe distillate moves by barge that you guys could anticipate on, either on the inland side or on the coastal side? Would you expect that to have any impact on the business? And if so, when should we think about that maybe showing up?
David Grzebinski (CEO)
Yeah, I don't think it'll materially change our business. You know, we'll bunker, we bunker now, we bunker ships now. You know, we bunker with heavy fuel oil in some cases, and as it shifts to, you know, ultra-low sulfur diesel, you know, we'll bunker that as well. Maybe you see a little more volume here locally because, you know, we've got that coming out of the refineries here. But it's hard to say that it's gonna be materially different. We'll see. I mean, one of the things we wanna figure out and watch our customers is, you know, what happens to their profitability? Because clearly, you know, the more profitable our customers are, the better.
There could be an increase in blending, which might help us, right? They blend the different grades and that might lead to more barge moves to reposition, to position for blending. We'll see. It's really hard to predict for us right now, but I would say it's probably neutral to maybe slightly positive if there's a lot of blending going on.
Jack JAtkins (Analyst)
Okay, great. Thank you again for the time.
David Grzebinski (CEO)
Hey, thanks, Jack.
Operator (participant)
Thank you. The next question comes from David Beard with Coker & Palmer.
Hey, good morning, gentlemen.
David Grzebinski (CEO)
Hey, good morning, David.
Bill Harvey (EVP and CFO)
Good morning.
David Beard (Analyst)
A question on inland pricing. I think you mentioned it moved up about 20%, but it's still at P&L breakeven. How much further would pricing need to move to justify a new build? And do you think the industry would put new build orders in based on spot prices, or would they wanna see contract prices moving higher to justify a new build? Thanks.
David Grzebinski (CEO)
Yeah, no, that's a great question, David. I would say, you know, spot prices being at peak P&L breakeven is a start, but prices would need to be 25% higher to get to where you'd start to consider good economics for new builds. Now, that said, some people aren't as disciplined about looking at returns on capital, and some people like to build on spec. I'm not sure we're seeing a lot of that. There may be, you know, of that 120 or so barges that are on order for 2019, maybe 20 or so, maybe a little more, might be on spec. But we're still a ways from the price that's needed to justify new buds.
And oh, by the way, as you're well aware, barge pricing's going up in part because steel prices are up. So, you know, the pricing needed to justify new builds is going higher because of steel pricing. And also, you may recall that, you know, Trinity bought Jeffboat and essentially shut down Jeffboat. Now, they're gonna open up. We understand they're gonna open up their Louisiana line, which didn't have the capacity of Jeffboat. Jeffboat was a huge shipyard, as you might imagine. But you know that having a consolidated barge-building industry you know is not helpful to low barge pricing. But you know, we're okay with that.
If it's more expensive to build barges, maybe barges don't get built as robustly as they have in past cycles. But I still think we're a long way away from justifying a new build, but that doesn't mean there aren't some speculative players.
David Beard (Analyst)
That does give you a lot of headroom. And just shifting over to DNS, would you be able to quantify in your guidance how much revenue you expected to slip into the first quarter of 2019, or, or a range or some color there would be helpful? Thanks.
Bill Harvey (EVP and CFO)
Well, we put our guidance for the fourth quarter, and it reflected a sort of a down scenario and an up scenario for how much it will flow through in the fourth quarter. So there could be some slippage. It's our guidance reflects everything, and that's, and we, but it's really tough for us to quantify that. There, because it's really the degree of guidance, the degree that could slip.
David Beard (Analyst)
Gotcha. And would the high end assume, you know, none of or very little, or there's still some slippage in that assumption?
Bill Harvey (EVP and CFO)
Well, the low end versus the high end means that most of it would slip, and we did not assume all of it, because we're far along on a lot of these shipments, so. But we did assume at the low end that a significant portion slip.
David Beard (Analyst)
Okay, good. That's helpful. Thanks for the time, gentlemen. I appreciate it.
Bill Harvey (EVP and CFO)
Thanks, Dave.
Operator (participant)
Thank you. The next question comes from Ken Hoexter with Bank of America Merrill Lynch.
Ken Hoexter (Analyst)
Hey, good morning. Dave, your up-
Bill Harvey (EVP and CFO)
Good morning.
Ken Hoexter (Analyst)
Hey, good morning, everyone, and Bill. Your operating margin for inland used to be in the mid- to upper twenties, now you're in the upper teens. As pricing comes up, I just wanna get your big picture thoughts on where it's possible to get back to. Just wanna understand, has anything, I guess, structurally changed, given either the acquisition, the product mix, or even on the other side, given your cost cutting, could it go even higher?
David Grzebinski (CEO)
Yeah, I would say, I fully expect us to be able to get back to our peak margins at some point in the cycle. As you'll recall, they were in the high 20s. We almost got to 30%, in terms of peak margins. We, that's a long way off, obviously. But, you know, I would say our normalized margin through the cycle is probably in the low-to-mid 20s. I fully expect us to get back there. I would say, given our fleet composition, we could go higher. You know, the level of synergies and integration that we're able to achieve, given our fleet size, I think we could get higher in terms of margins.
Ken Hoexter (Analyst)
And presume that's really just led by the pricing at this point, just to get back. Is that kind of your?
David Grzebinski (CEO)
Yeah, no.
Ken Hoexter (Analyst)
Okay.
David Grzebinski (CEO)
As you know, Ken, the pricing just kind of rolls right to the bottom line, so very high incremental margins, right?
Ken Hoexter (Analyst)
Okay. And then, a follow question would be your thoughts. You know, you talked about all the wave of petrochem plants that were opening, and you already mentioned a bunch of the crude and other opportunities. Now that we're closer to having some of those open, operating, flows have started to move or just still about to start and a couple others, what are your thoughts now in terms of the growth that is gonna? Are you seeing any of that? You know, before you were like, "Hey, we don't know if it's going to go international or stay domestic." Any update, thoughts on kind of what's shifting maybe toward your way or away?
David Grzebinski (CEO)
Yeah, I would say, you know, one of the things we've seen, and not to get too specific here, but, you know, pressure cargoes, we're seeing those increasing and shifting our ways. Things like methanol and some of the chemicals are shifting. I think crude, going forward, I think the refineries are using all the crude they want, so most of that will go for export or up to the East Coast. So, you know, ultimately, a lot of that's gonna be, as you know, polyethylene, and that polyethylene will go for export. But, as you know, there are also byproducts that come out of an ethylene plant. And that, that's part of why we're seeing an increase in pressure cargoes.
There's still pressure cargoes that come out, even, even in some of the, lighter feedstock-type ethylene plants. I know it, it's not very precise, Ken, so I apologize, but, we definitely are seeing some growth, because of these petrochemical expansions, and, it's GDP plus, you know, 2%-5% is kind of the way I'm thinking about it. It's really, really hard to quantify in terms of barge count, but, we're definitely seeing it.
Ken Hoexter (Analyst)
Yeah, I guess what I was just trying to get at from your thought there is, you just gave it with the GDP plus two to five. If there's some, you know, big shock to the system in demand, that's going to get ramped up in the next, you know, one, two years because of what's coming online, or if it's more gradual, that you kind of intimated there in terms of kind of leading pricing over time, but not any kind of quick fix rebound on pricing.
David Grzebinski (CEO)
Yeah, I think it's gradual. I don't, I don't think it'll be a shock. It's just the things come on too rapidly, you know? Not all the plants are starting up at the same time, and
Bill Harvey (EVP and CFO)
We are running at 95% utilization right now, so it's weird. All this is coming on in an environment where the industry is fairly tight.
Ken Hoexter (Analyst)
Yeah. No, sounds great. Appreciate the time, guys. Thanks for the thoughts.
David Grzebinski (CEO)
Thanks, Ken.
Bill Harvey (EVP and CFO)
Okay, Keith, we'll take one more question, please.
Operator (participant)
Okay, great. Now it comes from Bill Baldwin with Baldwin Anthony Securities.
Bill Baldwin (Analyst)
Hey, good morning.
Bill Harvey (EVP and CFO)
Hey, Bill.
David Grzebinski (CEO)
Good morning.
Bill Baldwin (Analyst)
I hope everybody is doing well.
David Grzebinski (CEO)
Yeah.
Bill Baldwin (Analyst)
On the DNS side, did the revenue in the third quarter come in pretty much in line with your expectations as far as, you know, the performance was concerned on the revenue side?
David Grzebinski (CEO)
Yeah, it did. It was pretty much exactly as we expected. You know, when you look year-over-year, you got to remember last year, we only had Stewart & Stevenson for three weeks or so. And so when you look year-over-year, it's still a pretty big revenue increase. But to your point, it was as expected. The third quarter revenue and operating income was essentially as expected for distribution and services. The surprise in the quarter, I say surprise, but you know, the upside from the quarter really was all about inland marine performing better and coastal marine performing a little better. When you look at year-over-year margin difference between third quarter last year and third quarter this year on DNS, that's all about mix.
You know, distribution and services at Stewart & Stevenson has more distribution, if you will, and so that's at a little lower margin. So when we added all the revenue from Stewart & Stevenson, that mix brought down essentially our average operating margin. But there was still huge contribution margin in there.
Bill Harvey (EVP and CFO)
One thing I should mention, Bill, when I mentioned the inventory and the sales that are being deferred, the actual, when you look at DNS, they actually lowered their SG&A cost compared to the second quarter, quite nicely, down, I mean, down $3 million. And because of how fixed cost absorption works, if they would have had the revenues of the work in progress build up, their margins would have been roughly the same as the second quarter. So it's really a question of timing.
Bill Baldwin (Analyst)
Joe's doing a good job over there.
David Grzebinski (CEO)
Yeah, he's not good enough, but he's doing a job.
Bill Harvey (EVP and CFO)
Doing a job.
Bill Baldwin (Analyst)
... On the reman side then, I know, you know, we can't get specifics, but on a relative basis, second quarter versus third, did, did reman hold up a lot better than the overall DNS? I mean, was that fairly steady demand for the remanufacturing business in the third quarter versus second?
David Grzebinski (CEO)
Yeah, yeah. Yeah, no, it was. Reman is, again, and that's right in our sweet spot.
Bill Baldwin (Analyst)
Right. And then 2 quick questions there. On the competitive environment, what—how would you describe the competitive environment, in the, you know, in the reman area? I mean, is it, is, is, is Kirby such a leader in that business that, that you're, that your first choice for, for your customer base is gonna be, Kirby reman, or-
David Grzebinski (CEO)
We certainly like-
Bill Baldwin (Analyst)
Do you run into much competition out there?
David Grzebinski (CEO)
Yeah, we'd certainly like to believe so, Bill. I think so. When we reman these units, they operate like new. We've got a reputation, a high-quality reputation on reman. You can get remans done cheaper, you know, by some of our other competitors. But as in any market, you've got people that care about quality and kind of want the high-end reman, and then there's the people that are very price sensitive. But I would say, you know, we've got a good market niche, and high market share, and I would say we're preferred certainly by the top tier or top two-thirds of the pressure pumping market.
We do quality work, and we like to believe, you know, we're the best at it, and we certainly think we have probably 60% market share in that space.
Bill Baldwin (Analyst)
That's, that's superb. I mean, that was the, the goal when you got into that business years ago. Is there opportunity to expand capacity in that business, you think, over time then? Is, is that market gonna, should grow and expand, or-
David Grzebinski (CEO)
Well, we have
Bill Baldwin (Analyst)
Do you take it to different basins? Can you go... Or I guess the business comes to you from basins all over, though, doesn't it?
David Grzebinski (CEO)
It does. Remember, these frack units are on trailers, and-
Bill Baldwin (Analyst)
Right, right.
David Grzebinski (CEO)
They can travel at 60 miles an hour. But that said, we have a facility in Midland, Odessa. We've just expanded it, added a lot of capability there. I've hired a lot of people, still trying to hire people in Midland, Odessa. So we have expanded it essentially in that area.
Bill Baldwin (Analyst)
My last question: Are you seeing some alleviation on the vendor supply situation, or-
David Grzebinski (CEO)
Yeah, but-
Bill Baldwin (Analyst)
Is that bottleneck beginning to clear up a little bit?
David Grzebinski (CEO)
Yeah. So the bottlenecks are clearing up. But look, part of this is, you know, supply chain issues. There's new technologies and, you know, look, we went from Tier 3 to Tier 4 engines, or Tier 2 engines to Tier 4 engines, from a, you know, an emission standpoint. So that's all new technology. There's new pumps being developed, so that's new technologies. With the new Tier standards and the new bigger engines, there, you know, there's new transmissions that are coming out. So the supply chain issues aren't just bottleneck delivery problems, but some of it's, you know, these are new designs and, with every new design, there's always kind of ramp-up issues and issues that our OEMs are dealing with.
I would say this: They're dealing with them, but they do have an impact.
Bill Baldwin (Analyst)
You see that continuing into 2019, David?
David Grzebinski (CEO)
No, you know, I'm hopeful, you know, by the end of this quarter, the bulk of them will be resolved.
Bill Baldwin (Analyst)
Okay. Well, thank you very much. Good job.
David Grzebinski (CEO)
All right. Hey, thanks, Bill.
Eric Holcomb (VP of Investor Relations)
All right. Thank you, Bill, and thank you, everyone, for participating in our call today. If you have any questions or comments, feel free to reach me directly at 713-435-1545. Thanks, everyone, and have a great day.
Operator (participant)
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your line.