Kirby Corporation (KEX) Q2 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the Kirby Corporation 2016 Second Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. 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. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Sterling Adlakha. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us today. 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 Web site at www.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 risk factors can be found in Kirby’s Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission. I’ll now turn the call over to Joe.

Thank you, Sterling. Yesterday afternoon, we announced second quarter earnings of $0.72 per share versus our guidance range of $0.65 to $0.75 per share. That compares to a $1.04 per share reported for the 2015 second quarter. In the marine tank barge utilization during the second quarter was in the high-80% to low-90% range. The market continues to adjust in response to excess barge supply that has influenced the market over the past 12 to 18 months. Although a combination of retirements and volume will help bring the market back into balance, the transition has not been as smooth as we hoped it would be. As mentioned in our press release last night, inland utilization in July fell significantly and we have seen aggressive pricing from several carriers at levels at what we believe is after full cost or in some cases cash cost. Such pricing in the market is historically unusual given the market fundamentals have not fundamentally changed that much since the start of the year and summer almost always sees a decline in utilization. Pricing at these levels we believe is unsustainable and if it persists will lead to destructive pressure on some less well-capitalized carriers. In the coastal market, tank barge utilization was in the mid-80% range and utilization continues to be impacted by the amount of equipment trading on the spot market, which adds idle time exposure. We continue to maintain a cautious outlook for this market as it absorbs new supply that is coming online through the first half of 2018. Remember that there is a lot older tonnage shipped in the coastal market. In the land-based diesel engine service business, market conditions remained depressed. Sales from the distribution of OEM engines, transmissions and parts, which have been relatively stable in prior industry cycles, were at historically low levels. Additionally, orders for new pressure pumping units have not yet materialized. The remanufacturing and service side of the business is more positive and we have seen an increase in inquiries during the quarter, as well as a number of firm orders. While such limited of activity does not lend itself to a materially better earnings outlook yet, our hope it does represent the first green shoots in the market and the conditions will improve in the coming months. In the marine and power generation diesel engine service businesses, the oilfield market along the Gulf Coast remains depressed while in the rest of our market, service activity is relatively stable. In summary, we continue to face an excess supply of equipment in marine markets and a severe cyclical depression in the oilfield market. As we confront these challenges, we will continue to focus on safety, customer service, costs, and capital discipline. In the inland market, we expect the market will get better later this year and benefit from additional retirements of maintenance deferrals, consolidation, as well as volumes from new chemical plants. For Kirby’s part, we will aggressively pursue our costs, aggressively service our customers, and look for opportunities to prudently apply our balance sheet. I'll now turn the call over to David.

All right. Thank you, Joe. Good morning to everyone on the call. I’ll begin today with a summary of quarterly results in each of our markets, then I'll turn the call over to Andy to walk through the financials in more detail. After he finishes, I’ll conclude with an explanation of our outlook and our guidance. In the inland marine transportation market, after a strong start to the second quarter in April, we experienced a modest decline in tank barge utilization into the high-80% range. The modest decline in utilization was largely attributable to a shortened spring season for ag products and soft demand and trading in refinery volumes, which we believe was largely related to high inventory levels. Pricing on term contracts that renewed during the second quarter was down in the mid- to high-single digits on average. Spot rates were at or below term contract rates during the quarter. Operating conditions during quarter were seasonally normal, although high cross-currents at floodgates and river crossings on the Gulf Intracoastal Waterway lead to congestion and added delays at certain points along the Gulf Coast. In our coastal marine transportation sector, demand for the coastal transportation of black oil and petrochemicals remained consistent with the 2016 first quarter, while refined products demand was weaker due primarily to lower demand in the Northeast. Relative to the first quarter, tank barge utilization declined slightly to the mid-80% range, a result of the continued trend of more equipment moving off of term contracts and trading in the spot market. As a reminder, most coastal barge term contracts are time charters which have 100% utilization and when equipment moves from time charter to spot, even when it is highly utilized, the average utilization drops. With respect to pricing, term contracts that renewed during the second quarter increased by a low-single-digit percentage on average, as several older contracts renewed in the quarter. However, term contracts that were signed a year ago and renewed during the quarter were at modestly lower rates. In our diesel engine services segment and our marine diesel and power generation markets, we continue to see deferrals of major overhaul projects. As has been the case, the Gulf of Mexico oilfield service market remained at depressed levels. In our land-based diesel engine services market, the sale of engines, transmissions, and parts in our distribution business remained at very depressed levels and have yet to show signs of improvement. Likewise, we have not had orders to manufacture new pressure pumping units. On a more positive note, we did see incremental improvement in order activity for pressure pumping, unit service and remanufacturing. The number of units serviced during the quarter was small but we did have an uptick in labor and facility utilization, particularly late in the quarter and that continues into the early part of this quarter, the third quarter. It remains too early to call this activity a trend but it does seem that we have at least seen the worst of the market in this cycle. I’ll now turn the call over to Andy to provide some detailed financial information before I come back and discuss our outlook.

Thanks, David, and good morning. In the 2016 second quarter, marine transportation segment revenue declined 11% and operating income declined 25% as compared with the 2015 second quarter. The decline in revenue in the second quarter as compared to the prior year quarter was primarily due to a 33% decline in the average cost of marine diesel fuel, lower inland marine contract pricing, and an increase in available spot market days for our offshore marine equipment. The marine transportation segment's operating margin was 19.2% compared with 22.8% for the 2015 second quarter. The inland sector contributed approximately two-thirds of marine transportation revenue during the 2016 second 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 51% of those contracts attributable to time charters and 49% from affreightment contracts. The inland sector generated an operating margin in the low-20% range 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 quarter at approximately 78%, partly as a result of lower utilization and revenue for spot equipment. The second quarter operating margin for the coastal sector was in the low-double digits. Turning now to our marine construction and retirement plans. During the 2016 first half, we received 27 barges from the acquisition of SEACOR inland tank barge fleet, took delivery of three barges, transferred one 30,000 barrel barge from coastal to inland service, and retired a total of 28 barges. The net result was an increase of three tank barges to our inland tank barge fleet, which totaled approximately 345,000 barrels of capacity. For the second half of the year, we expect to take delivery of four 30,000 barrel inland tank barges and to retire or return to charters an additional 11 barges with 135,000 barrels of capacity. On a net basis, we expect to end 2016 with approximately 18.2 million barrels of capacity or roughly the same level we finished the second quarter, an increase of approximately 325,000 barrels from the end of 2015. In the coastwise transportation sector, our second new 185,000 barrel ATB began operating under a long-term customer contract in mid-June. The first of two new 155,000 barrel ATB should deliver in late 2016 and our second 155,000 barrel ATB in a coastal chemical barge are both expected to be completed in early 2017. Also during the second quarter of this year, we retired an 80,000 barrel barge and transferred a 30,000 barrel coastal barge to our inland fleet ending the quarter with approximately 6.1 million barrels of capacity. In our press release last night, we also announced that we purchased four coastal tugboats during the second quarter for $26.5 million. The total transitioned into service with existing barges in our fleet. The addition of these boats will help lower the age of our tug fleet, better align the age of our boats and barges, and improve our operating performance. The average age of the boats we purchased is eight years and the average age of boats they’re replacing is close to 40 years. Moving on to our diesel engine services segment, revenue for the 2016 second quarter declined 46% from the 2015 second quarter and we had an operating loss in the segment of approximately $2 million. The segment's operating margin was negative 3.1% compared with 4.2% for the 2015 second quarter. The marine and power generation operations contributed approximately 65% of the diesel engine services revenue in the second quarter with an operating margin in the low-double digits. Our land-based operations contributed roughly 35% of the diesel engine services segment's revenue in the second quarter with a double-digit negative operating margin. On the corporate side of things, our 2016 capital spending guidance remains in a range of $230 million to $250 million, including approximately $10 million for construction of seven inland tank barges to be delivered in 2016, approximately 100 million in progress payments on new coastal equipment, including one 185,000 barrel coastal ATB, two 155,000 barrel coastal ATBs, two 4,900 horsepower coastal tugboats and a new coastal petrochemical tank barge. The balance of $120 million to $140 million is primarily for capital upgrades and improvements to existing inland and coastal marine equipment and facilities, as well as diesel engine services facilities. In addition to our capital spending guidance, we spent $81 million on the acquisition of the SECOR inland tank barge fleet with an additional $4 million [ph] paid in July for a tugboat which was under construction. We also spent $13.5 million to acquire a leased coastal barge from the lessor and 26.5 million to purchase four coastal tugboats. Total debt as of June 30, 2016 was $799 million, a $24 million increase from December 31, 2015. Our debt to cap ratio at June 30, 2016 was 25.4%, unchanged from December 31, 2015. As of today, our debt stands at $786 million. I'll now turn the call back over to David.

Thanks, Andy. In our press release, we announced our 2016 third quarter guidance of $0.50 to $0.65 per share and we lowered our full year 2016 guidance to a range of $2.40 to $2.70 per share. Let me take a moment and provide a general overview of our approach to guidance this quarter. In the second quarter, we saw strong utilization and firming pricing in the inland market in April with the rest of the quarter playing out around our expectations, as you saw with our second quarter results which go within our guidance range. However, in July, we've seen our inland utilization fall into the low-80% range. Given the lower inland marine utilization, we are seeing a very competitive pricing environment. We are lowering guidance to reflect these conditions and on the low-end of the range, we are factoring in a continuation of this environment through the remainder of the year. In terms of inland marine utilization, tank barge utilization does typically fall slightly in the summer when good operating conditions reduce congestion and improve efficiency throughout the waterways. However, so far this quarter, utilization has remained in the low-80% range, lower than we would expect. We do think that weaker utilization levels are partly related to factors that are temporary in nature, including high refinery and terminal inventory levels and reduced trading activity in the black oil markets. As it remains unclear how long these utilization levels will persist, we have lowered our guidance. In terms of pricing, we expect spot and contract renewal pricing to continue to be under pressure during the quarter. As Joe mentioned, we believe spot pricing in the inland market has reached unsustainable levels and that spot rates now reflect pricing that is below cash breakeven for some carriers. If this pricing persist, we believe potential sellers will materialize either through choice or distress. We will deploy our capital appropriately should that occur. In the coastal market on the low-end, our guidance range contemplates pricing declines on contract renewals in the low-single digit percent range and utilization in the low- to mid-80% range. On the high-end of guidance, we are expecting flat pricing on contract renewals and utilization in the high-80% range. For our diesel engine service segment and our land-based sector, we expect to incur quarterly operating losses of a similar magnitude as in the first half of the year. However, our results may improve its service activities which picked up in late June continue to improve. In our marine diesel markets, we do not expect any improvement in the Gulf of Mexico oil service market this year, and the power generation market and in our other marine diesel engine services market we expect results to be largely consistent with the 2016 second quarter. In closing, our financial position is strong. We have a strong balance sheet, a young well-maintained fleet and healthy free cash flow. As both our marine transportation and diesel engine services markets undergo difficult times, we will focus on safe operation, customer service, and cost containment while looking to deploy cash flow where we can find high return projects in a discipline and accretive manner. As we look beyond this year, we are much more constructive on the outlook across our markets. In the past few days, many large oilfield operators have stated their belief that the worst of the energy market collapse is behind us. We believe that is the case as well. By the second half of next year, if not earlier, we expect to see volumes increase in our land-based diesel engine business. Similarly, in our marine transportation markets, the worst of the correction which arose from overbuilding into the crude market is likely behind us. While the aggressive pricing in the market this quarter is troubling, it likely yields opportunities that would not otherwise be there or at a minimum should force capacity discipline on some operators who have not shown much discipline lately. A rationalization of supply this year provides a better environment for growth next year, particularly in the chemical markets where we expect growth to accelerate through next year. Operator; that concludes our prepared remarks and we’re now ready to take questions.

We will now begin the question-and-answer session. [Operator Instructions]. Our first question will come from Jon Chappell of Evercore ISI.

Thank you. Good morning, guys.

Good morning, Jon.

David, if I just put some of your last comments together and try to figure out the duration of maybe this pricing pressure, if you said in the guidance that you’re expecting spot to remain under pressure for the remainder of this but then also that the recurring rates in many cases are below cash breakeven and unsustainable. I don’t want to put words in your mouth, but is that kind of like a worst-case scenario that’s more likely to play out in a shorter period of time than a longer period of time?

Yes, that is the worst-case scenario. What I said was that was related to our low-end of guidance. We actually do think that some of this disruption we’ve seen, particularly as it relates to high product inventories across the system now, we think that's pretty temporary in nature. And we should get utilization back as the year progress. But in the low end of our guidance we wanted to kind of just say, okay, what if it doesn't come back? And that's how we got to the low end.

Is there any way to quantify what part of the precipitous drop in July is tied to inventories alone, and I guess therefore the inability to move cargoes?

It’s difficult to quantify because there are other things. As we mentioned, just the better summer weather we usually get some increased efficiencies which drops utilization. But we've also – in the black oil markets, feedstock prices have moved around and we've seen sometimes the arbitrage closes and sometimes it opens back up. And so the black oil fleet utilization moves around a bit with that. So it's not just the inventory levels. Then also you’ve got the strong dollar which can affect imports and exports for that matter, and that can move things around there. So the short answer is hard to quantify it and how much of it’s related to inventories. But I would say a good portion of it – I couldn't put a percentage on it but it is a decent percentage of it.

Just for clarification, and I’m sorry one last super quick, when we think about the term versus spot, when would you say that the term pressure really started? As we think about kind of anniversarying earlier comps, did it start middle of last year so that this back half of '16 should have an easier comp relative to last year, or did it really start to intensify early this year where you’d see kind of an easier comp starting in '17?

No, we did see it come mid last year with pressure on term contract renewals.

Okay. Perfect. Thanks a lot, David.

The next question will come from Kelly Dougherty of Macquarie.

Good morning, guys. Thanks for taking the question. Just a quick housekeeping one to start with. Just wondering why you didn’t buy back any stock in the second quarter? And how we should think about the buyback plans relative to your expected free cash flow for the rest of the year?

Yes, good question, Kelly. As you know, there’s times when you're precluded from being in the market and times when you can be in the market. It's difficult to say but if you're working on acquisitions or you have some other information that you’re working on or looking at, it can preclude you from being in the market. I don’t want to get too specific there. But you know us, we’ll look at our opportunity set of whether it's acquisitions, buying back stock or whatnot with our cash flow. And we look at that the same way always and we’ll be prudent with the deployment of our excess cash flow.

Just a quick follow up on that one. Do you have an expected free cash flow number for the year? I think you had kind of put out 250 plus previously but now with a lower guidance, is that still a good number?

Lower free cash flow, yes, it’s probably going to be sort of between 210 to maybe 235 kind of given where we are depending upon some working capital changes.

Okay, great. Thanks. And just kind of bigger picture question. Can you help us think about the margin outlook in both the inland and coastal business? Should these current conditions persist in the back half of the year? And then specifically I’m trying to get my head around the operating margin impact of more customers opting for spot versus contract renewals on the coastal side?

Well, look, clearly pricing has an impact on margins and you would think – and they will go down. And that's part of what's in our guidance for the third and fourth quarter. Now as utilization starts to come back, we do get a pickup from that. So we think utilization will come back and most of this is temporary. So it’s a balance but clearly we – look at third and fourth quarter, the margin impact is in our guidance. Now in terms of spot versus contract, the move to more spot actually gives you some leverage when things start coming back, because you're not locked into lower pricing. A lot of what you're seeing in this pricing environment has just been in the spot market. Some very few contracts are being signed up at these low levels.

But more – the spot on the coastal side though, how do we think about because you’re basically going to have fewer revenue days and if I’m correct very similar operating costs. And if it’s in a low-double digit range now, does that go to a single digit range on the coastal side if more customers move over to spot?

It could potentially, yes. We’re in low-double digits now and clearly as the spot – the more spot you have on the coastal side, you just don't get the continuous voyages. So, yes, you don't shed the cost but you don't have as much revenue. So you're correct. It could go into the high-single digits.

Okay, great. Thanks, guys.

Kelly, real quick just to clarify on my free cash flow number. I want to make sure you understood that. That does not include the acquisition spend. That’s incremental to that.

Okay. Thank you.

Our next question will come from Jack Atkins with Stephens.

Hi, guys. Good morning. Thank you for the time.

Hi. Good morning, Jack.

So I guess, David, just to kind of think about the pricing dynamics on the inland side a little bit, you talked about unsustainably low spot pricing which sort of at or below the breakeven price for some players in the market. Could you give us a sense for really where spot rates and contractual rates are today relative to both the prior peak in '14 and then the trough during the recession in '09? So where are we in that continuum with both of those type of rates?

Yes, we are – I’m saying from the peak in '14, we’re probably down 20%, maybe even 25%. And then from the last downturn, say, '09, spot prices are little below that. Part of that is frankly we’ve got some undisciplined players in the market that have impacted it below what we saw in the last cycle. But, yes, that’s why we think we’re close to the bottom here because it’s hard to envision a longer term pricing environment where you’re at or below cash cost, it’s not sustainable.

Okay, that’s helpful. And then shifting gears over to the diesel engine side, I know a lot of work has been done there to remove excess operating expenses there just given the type of cycle we’ve seen in the oilfield services market. But as you think about that business potentially recovering in '17, perhaps the second half of '17, I’m curious what you think the land-based diesel engine services segment could look like over the course of the next cycle? I know typically it’s been high-single digits. With all the cost actions and rationalization in that business for you guys, how should we think about that business looing from a profitability perspective coming out of this?

Jack, this is Andy. With some of the cost initiatives that we’ve taken on and some of the improvements that was made in our processes in that business, we think that we can probably easily add an additional 300 to 400 basis points of margin to that business over the next cycle.

Okay, that’s helpful, Andy. Thank you very much.

The next question will come from Gregory Lewis of Credit Suisse.

Thank you and good morning, guys.

Good morning, Greg.

I guess my first question will be on the inland and the coastal side. Joe mentioned that you guys retired an 80,000 barrel coastal barge earlier this year. As we look at both those markets sort of over the next 12 months in terms of what visibility you have, exclusive of retirements, what type of fleet growth do you expect to see in inland and do you expect to see in coastal?

Well, I think – let me take inland first. Clearly, we’re in an oversupplied market right now. We’ve got too much equipment. And in this kind of market with these kind of prices, as maintenance decisions come up, certainly nobody would want to build into this market right now. No rational player would want to add capacity in this environment. And I think as you look at maintenance decisions that come up on, say, a 25-year-old or a 30-year-old barge, you probably tie it up at best and maybe you just retire it and cut it up and sell for scrap, because at this market those kind of decisions become easier. And this is why we see in these kind of environments the number of retirements go up and the building go down. As we look at the 2017 order book, we’re not hearing much at all being led in terms of contracts. So in terms of inland fleet growth, I don’t think there will be much, if any at all, and with retirements it should contract. On the coastwise side, it’s a little more balanced in that you’ve got some new capacity coming in, including some of ours, over the next 12 to 18 months. I think in total it’s the ones that haven’t delivered, maybe it’s 14 units. But there are still over 40 units that are 30 years or older in the coastwise business and they need to come out. The betting requirements from our customers are getting tougher and in the offshore environment, they’re even tougher than there are in the inland side. And age is a factor there. So I think you’ll see more retirements on the coastwise side. The question is, is the balance between the new additions and the retirements and how that plays out? But I don’t think you’ll see overall capacity growth, volume growth on the coastwise side in the barges that are 200,000 and less.

Okay, great. And then just one other from me since the focus it seems like it’s going to be on margins. You mentioned the four tug barges that you bought for, I don’t know, $24 million, $25 million and they’re replacing four older barges. I’m assuming that that would be margin accretive. Is there any way to sort of – whether it’s more fuel efficient, whether they break down less, whether they require more maintenance, is that enough to sort of move coastal margins a couple – some basis points or is that more just like not really going to have much of an impact?

It’s probably positive but I’m not sure it’s going to move the needle. If you think about it and let me clarify. For tugs not barges --

Sure.

For 40-year-old boats and replacing them with much younger. So what happens is you get a little more depreciation but the offset of that is you get higher reliability, lower maintenance costs and just better utilization out of them because there’s fewer maintenance days, fewer down days. And clearly the younger fleet is more attractive for term customers as well. Now to quantify that in terms of margin, I don’t think I can quantify that and I’m not sure it would be that material. But it certainly is a positive.

Okay, guys. Thank you very much for the time.

Thanks, Greg.

Thanks, Greg.

Our next question will come from Ken Hoexter of Merrill Lynch.

Great. Good morning. So, Dave or Andy, when you guys talked about the pricing before in terms of the great recession, how about utilization? You talked about it dropping it to the low- to mid-80s. Where did you see utilization getting to – how low can this go? And then I guess in that utilization concept, you didn’t talk much about the remaining crude barges. Is there anything left on that side to still come in, is that what’s creating some of this excess capacity? Are they now all in petrochem? And I guess sticking with that, a lot of discussion on pricing, but I think on the demand side, anything happen with the new plants? Is there something that’s coming on line that you look out and you see it turn that can drive this? Thanks for the thoughts there.

Yes, sure. Let me take those – try to do them in order. In '09 I think there was a quarter we dipped into the high-70s but it was – I think it was just one quarter. It’s not as bad as that but – low-80s is a pretty difficult environment in terms of utilization. In terms of crude barges, I think last quarter we said we estimated there were about 175 or so barges still moving crude and that was down from 550. Our latest poll indicates it’s probably around 140 barges. So sure, that did have some impact. It went from 175 down to 140. It’s interesting you’ll see – you read some of the snippets that people in Utica are going to start drilling again. So who knows if we’ve hit bottom on the crude barges but clearly the barges that have come out of crude have been cleaned up and put into clean service by and large, which has impacted utilization for sure. Now to your broader question about demand, if we look across all of our products that we carry, outside of crude everything’s pretty good. Crude’s down for sure but if you look at the chemicals, they’re okay. And we do see continued building. I think one of our customers just announced a new joint venture. They’re going to build a new facility on the Gulf Coast. There has been one or two delays but by and large most of the chemical facilities that have been announced and they’ve started construction are still going on. So that’s a positive. Refined products outside of this product glut that we’re in now that’s impacting kind of some movements, if you look at vehicle miles driven, they’re up in refined products. Demand is still growing and I don’t think the production has outpaced it here recently and that’s caused this kind of disruption or product glut, if you will. And then you look at some of the other products. Outside of crude, everything is okay and fairly healthy. It’s just we’ve got a little dislocation now where things have to come back into balance.

Great, I appreciate that. If I can follow up on your comment on particularly players that are more aggressive, I just want to understand. In that phase when you’re going through this, your take-or-pay contracts, which is kind of your basis I guess stability or kind of some stability there, what happens to those contracts as they come up for renewal? Do they tend to be higher than average contract pricing and so that’s why you see maybe a little bit more volatility or is it just anything that gets touched is just coming down to the current spot levels?

Yes. Well, what you’re seeing because there’s equipment availability, some of the term contracts, and this is across the industry not Kirby specific, but some term contracts aren’t getting renewed and they’re just going to the spot market for a while. I don’t want to overstate that. That’s not a huge number. But there are a number of term contracts that are going to the spot market because the availability is there. And the shippers aren’t as concerned about availability. Now as things start tightening up, that will reverse itself and we would expect that to start happening again later this year.

Great. David, I appreciate the insight. Thanks.

Thanks, Ken.

The next question comes from Michael Webber of Wells Fargo.

Hi. Good morning, guys. How are you?

Good morning, Michael.

Just wanted to go back to some of the, I guess the pricing pressure conversations you were having a bit earlier and maybe kind of backing away from kind of the natural inclination the market seems to have with trying to find a floor for pricing or kind of setting a bottom. But if we kind of frame this up within the context of the past couple cycles, you mentioned some of the pricing is unsustainable and also competitive. We’re hearing about cash conversion cycles starting to contract as guys are looking to preserve liquidity. So I guess maybe within the context of those past cycles, how long does it take for the market to really clear that capacity and for those irrational actors [ph] to actually get removed kind of beyond just the idea of scrapping individual assets? Is that something that’s typically measured in quarters or in years when you guys go back and look it over the past two or three or four cycles you’ve been a part of?

David, do you want me to take that?

Yes, Joe, go ahead as it’s a long-term context here.

Having lived through many cycles.

Perfect. Thanks, Joe.

Well, I think firstly you need to separate what drove some of the cycles in the past and what’s driving this one. Cycles in the past have been principally driven by recessions where volumes have declined and you really needed to have kind of a cleansing of the industry. You needed – you want the economy to recover, volumes to improve and some equipment to come out. This particular downturn is not economically driven. It really is affected by a couple of things. It’s affected by building barges for a market, the crude oil market that then collapsed as crude oil collapsed. And it’s affected by what I think is an anomaly, which is high inventories and the market adjusting to those inventories. We saw something similar to that in end of 2008 and the beginning of 2009 where you did have an economic collapse but you also had an enormous adjustment in inventories. And that was relatively short. Now there’s some other things that are going on I think during this particular period. You have the summer weather effect that David talked about and that’s something that we really haven’t seen in the last three or four years because the market’s been so tight. There hasn’t been enough equipment. But if you go back for the last 30 years before that, you always had utilization trail down in the summer as the system got more efficient and there was more equipment on the market. Come fall, that tightens up again. I think what’s happened here is that you had some operators that are already worried about crude oil equipment they build that doesn’t have a home for it. And then you had this summer doldrums that has been traditionally seen in the business and they panicked and they lower prices just to book equipment, which has brought the whole market down. As you get some adjustments in inventory, as you go into the fall where the system isn’t as efficient, it gets a little less efficient, you’ll see utilization get better and I think pricing will follow it. How long it takes to absorb the crude oil overhang will really be driven by two things. One, equipment going out of the market and some of that’s happening now. You’re already getting maintenance deferrals, so you’re going to see less available equipment going forward in the year. And then the volumes that David talked about, you got strong refined products markets, record miles driven in the U.S. and I think people are predicting that that’s going to continue given the low gasoline prices. And then you have these volumes that are coming from the chemical business. So it’s going to correct itself. I think you’ll begin to see it towards the end of the year and 2017 barring any economic issues should see continued correction, higher utilization, and more normalcy in pricing.

Fair enough. And just a follow up on that, Joe. You mentioned kind of a petchem cycle potentially starting some point in kind of '17, '18. But when you think about the enhanced focus around ethylene and kind of away from [indiscernible] and then some of the cargoes, when you think about barge market share of overall petchem production kind of relative to rail and the pipeline, when you think about what that mix looks like going forward and yields look like going forward from the petchem space, do you think that barge market share technically grows or contracts just given what we’re likely to be selling off?

Yes, it should grow. Pipelines aren’t conducive to the kinds of chemicals that we carry. Barging is much more flexible because you can source it from different plants, you can move it into different markets. A pipeline is – you put it in the pipeline and it comes out where the pipeline ends. And it also requires steady volumes of some significant nature. That’s really not the chemical business. Barging has been really the principally way of moving chemicals around because of their flexibility and because of the volumes that you typically see. Railroads are competitive depending on where you’re moving the chemicals and how much you’re moving. Remember that our – the smallest barge that we operate is equal to I think 16 railcars. So if you’ve got less than a barge load, then rail makes a lot of sense. If you’re taking it to a place that barging doesn’t service and rail makes a lot of sense. But typically on most movements, rail is not a competitive factor. So I would think that we’re going to get more than our share.

Fair enough. Thanks, guys.

Thank you, Mike.

Our next question comes from David Beard of Coker Palmer.

Good morning, gentlemen.

Hi, David.

Good morning, David.

Given the rather sharp downturn, how do you guys prioritize share buyback versus acquisitions? And should we expect to lean more towards acquisitions in the time of stress?

Yes, it’s a moving target; obviously right. It depends on the share price. But clearly we like to do consolidating acquisitions that set you up for growth long term and allows us to further leverage our cost structure if we’re able to get a good consolidating acquisition. So, yes, on the margin we do like the acquisitions but there’s a price obviously that our peers are very attractive as well. So it’s a balance.

Okay, good. And just sort of a clarification on the history lesson of barge pricing and the utilization. I don’t know if we can rattle off the times we’ve seen utilization at the low 80s and prices below cash breakeven for some operators. I think you mentioned briefly in '09. If there have been some other periods of time you can recall that happening?

No. You have to almost go back to the '80s where you saw this kind of predatory pricing. And 2001 through 2003 we saw some low prices but I don’t recall them being at cash prices.

I think, David, we have to clarify that not every deal is done this way. It’s just that you have several operators that I think have gotten way more nervous than they should be based on some decisions they made with respect to building equipment. And then this inventory problem coupled with seasonality that we talked about just panicked. I can’t imagine that they’re going to carry this forward. Once I see the market improve a little bit, which it really should do just driven by the fact that we’re going to be less efficient going into the fall and the winter.

No, that’s very helpful. I appreciate the clarifications. Thank you.

Thanks, David.

[Operator Instructions]. Our next question will come from John Barnes of RBC Capital Markets.

Hi. Thanks for taking my questions. A couple of things here. You mentioned there may be a little bit of equipment that’s moving from a contractual environment to the spot environment. For Kirby, can you provide us with what that mix is today and kind of where it has gone from, say, the peak or most recent peak, something like that?

I think we’re right about, what is it, 81% term contract, 80% net and then probably down from about 85%.

Okay, all right. And then I guess you’ve got this petchem cycle that’s kind of developing, my question would be is the current downshift in the cycles severe enough that it hampers or harms the ability to rate benefit from that petchem boom? Is it going to be destructive enough to price that it really mutes any uptick, or is the industry going to under build for a couple of years to where – as that cycle really begins to gain some traction, we can back into a much tighter capacity situation? And then we’re seeing – maybe experienced the same type of pricing power we’ve seen in other cycles. How do you feel about having gone through this a couple of times?

Yes, I don’t think it mutes the chemical cycle. If anything I think what ends up happening is we get some capacity rationalization out of this. And certainly it should dampen any enthusiasm to build, and I think that’s a positive. I think for some operators that are more highly levered, it really puts them in a tough way which makes them less likely to go do something like build new capacities. So, if anything, I don’t think this down cycle mutes the benefit from petchem and if anything, it helps because it is so stinging right now brings some discipline into the market.

Let me just add one more thing. And John, I think this is worthy to note. We’re down on crude oil because crude oil prices are such that there are some significant restraints to growing for oil in the U.S. And we tend to think that that’s going to go on forever, and it’s not. The world’s demand for crude oil in the U.S. position, barring some regulations that I don’t think we’re going to see, is very important to the world of oil supply. And we have said this in the past and I think it’s worth saying it again is that barging is going to be one of the ways that you’re going to move crude oil to the market. And when the volumes come back, you’re going to move more volumes of crude oil. And that’s also going to have a stabilizing effect on the fleet. I think that Halliburton said the other day in their earnings call that by 2021, the world needed close to 18 million more barrels of oil. That’s an enormous amount of oil and some of that is going to have to come from the U.S. shale effort and we’re going to get some of those volumes.

Yes, I will acknowledge [ph]. We went from an environment where it was all crude oil at the time to now it’s never coming back. I think we’ve seen in cycles. This stuff never goes away permanently but obviously there was some overbuilding for a while I guess. My last question for you, David, is your comments around the land-based side, diesel engine. When do you think that the inquiries and all on service and reman work starts to result in quantities and orders for new equipment? The rig count is up. We’ve heard that some of the producers are still kind of basically cannibalizing parts and everything from other existing equipment or whatever, but when do you think that really begins to materialize in real orders?

Yes, it’s interesting, John. I think because it’s been so painful in the pressure pumping business, I think capital there is not as plentiful. And what you’re seeing and what we’re seeing from our customer base is a lot more reman in service, almost no discussion about any new capacity. So it’s kind of the reason we said we’d get into this business, we thought there would be a lot of reman business just because capital discipline would work. And I think we’re starting to see that play out where we get a lot of the inquiries about repairing equipment and remanufacturing equipment. Now there’s some interesting things going on. We’ve heard in some of the oil service commentary that you don’t need 1,800 rigs to absorb the pressure pumping fleet. They think it’s closer to 900. So that service intensity plus the attrition that’s happened in the fleets. So I think on the pressure pumping side you’re going to see that market tighten up pretty quickly, and they need it. Our pressure pumping customers have been cash constrained. So I don’t think that’s a long way of saying we’re not seeing new equipment orders. I don’t think – and they will reemerge. But right now, the demand for reman is growing and to us that’s very encouraging.

Okay, all right. Is the margin on that business still as good as – is the spread between reman, service work and new equipment, that margin spread still like it was when you first bought the business or was there enough [ph] of that service capacity that it beats a little bit of that?

We still have a volume problem. You got to have enough volume to absorb all your fixed costs, but in general service margins are usually kind of double digit whereas new equipment is more high-single digits. So, yes, service margin should be higher. The issue is we’ve got the volume where we’re absorbing all of our fixed costs and then the margins will really start to improve.

Okay, all right. I know I went over my allotted one follow up months ago but thanks for taking the question.

Thanks, John.

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

Thank you, Laura. We appreciate your interest in Kirby Corporation and for participating in our call. If you have additional questions or comments, you can reach me directly at 713-435-1101. Thank you all and have a nice day.

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