Kirby Corporation (KEX) Q1 2017 Earnings Report, Transcript and Summary

Good morning, and welcome to the Kirby Corporation First Quarter 2017 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. [Operator Instructions] Please note, this event is being recorded. I’d now like to turn the conference over to Brian Carey. Please go ahead.

Thank you very much and good morning. With me today are Joe Pyne, Kirby’s Chairman; David Grzebinski, Kirby’s President and Chief Executive Officer; and Andy Smith, Kirby’s Executive Vice President and Chief Financial Officer. During this conference call, we may refer to certain non-GAAP or adjusted financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures is included in our first quarter earning press release and is available on our website 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, 2016, filed with the Securities and Exchange Commission. I’d now turn the call over to Joe.

Okay. Thank you, Brian, and good morning. Yesterday afternoon, we announced 2017 first quarter earnings of $0.51 per share versus our guidance range of $0.40 to $0.55 per share. That compares with $0.71 per share reported in the 2016 first quarter. In the marine tank barge utilization during the first quarter, it was improved relative to recent quarters. This was in part due to operating restrictions caused by the usual poor, but seasonally normal weather along the Gulf Coast and also stronger utilization in our black oil fleet driven by refinery turnarounds. We do believe that we are continuing to move slowly towards supply and demand balance in the inland market. In the coastal market, tank barge utilization was in the mid-70s to low-80% range. Utilization continues to be impacted by a large number of vessels trading in the spot market, which adds exposure idle time on these vessels. Barge oversupply continues to weigh on utilization and pricing in the coastal market. As a result, we took significant cost-cutting measures during the quarter, which David will discuss in more detail later in the call. In our land-based diesel engine services business, we saw strong service demand, particularly for pressure pumping unit remanufacturing and transmission overhauls. The U.S. rig count continues to rise steadily during the quarter, and our customers show healthier balance sheets as oil prices have mostly stabilized and capital is starting to come back into the oil service industry. We plan to continue to take a cautious approach to this business and are focused on operational improvements and sound inventory management. We expect service demand to remain steady for the remainder of the year with a potential upside if sales of new equipment continue. Summarizing the first quarter, it unfolded mostly as we expected with coastal – the coastal marine business performing worse and the land-based engine business performing better than we anticipated. I’d now call – turn the call over to David.

Thank you, Joe. Good morning, everyone, and thank you for joining us today. I’ll start my comments with a summary of the first quarter results in each of our markets, and then turn the call over to Andy to walk through the financials in more detail. Following Andy’s comments, I’ll provide an update on our second quarter and full-year guidance and then we’ll open up the call to Q&A. In the inland marine transportation market, our utilization ranged from high-80% to low-90% level during the first quarter, as weather-related delays from high winds and fog were a factor along the Gulf Coast. Utilization was fairly stable throughout the quarter, boosted in part by a refinery turnaround season that was busy. We also continued our retirement plan for older barges, which helped utilization. Pricing on term contracts that renewed during the first quarter was down in the mid single digits compared to the 2016 first quarter. However, spot rates were flat compared to the 2016 fourth quarter. In our coastal marine transportation sector, demand for the coastwise transportation of black oil and petrochemicals was relatively stable compared to the 2016 fourth quarter, and the refined petroleum products market demand was lower sequentially and year-over-year. The coastal market continues to be negatively affected by the oversupply of tank barges in the industry. While we expect the supply of barges and barrel capacity in the coastal industry fleet to eventually balance with demand, we don’t anticipate it will happen this year without a significant improvement in demand. As a result, we’ve made the decision to release chartered-in tugboats, idle some own boats and barges and reduced headcount accordingly. These moves will allow us to reduce cost until such time as the coastal market improves. Including temporarily laid-up barges, coastal tank barge utilization was in the mid-70% to low-80% range during the first quarter. With respect to coastal market pricing, generally spot rates were below contract rates, but the magnitude varies by geography, vessel size, vessel capabilities and the products being moved. As an indication of where spot pricing is, spot rates for vessels in the 80,000 to 100,000 barrel range in clean service are approximately 20% to 25% below year-ago levels. In our diesel engine services segment, our marine diesel engine business saw no improvement in the Gulf of Mexico oilfield services market, which remains at a very depressed level. Service activity and parts demand in the power generation market remained relatively consistent with the 2016 first quarter. Performance in the marine diesel engine services business reflected seasonal improvement over the 2016 fourth quarter, but revenues were lower compared to 2016 first quarter due to customer’s deferring major overhauls, particularly in the Midwest. However, the cost-cutting measures implemented in 2016 are showing results, as operating profit for the quarter was higher year-over-year. In our land-based diesel engine services market, demand for pressure pumping unit remanufacturing maintained its momentum from the 2016 fourth quarter, as the number of units on-premise awaiting remanufacture stayed above 120 throughout the quarter. We have seen a small increase in parts sales as part of the remanufacturing work, and believe this indicates that customers are beginning to deplete their inventories of spare parts and equipment. In terms of new equipment manufacturing, we completed the majority of one frac spread for a customer, the remainder of which will ship in the second quarter. One frac spread generally consists of 20 to 28 pieces of new equipment, made up primarily of pressure pumping units, but also some ancillary support equipment. We continue to receive strong customer interest in new frac spreads, but firm orders have been slow to materialize. The sale of engines, parts and transmissions remained relatively flat compared to the prior quarter, although we did experience a significant pickup in demand for rebuilt transmissions, which we anticipated at the beginning of the year and had factored into our guidance. I’ll now turn over the call to Andy, and then I’ll come back for discussion on guidance and outlook.

Thank you, David, and good morning. In the 2017 first quarter, marine transportation segment revenue declined $34.7 million, or 9.2%, and operating income declined $34.5 million, or 49.5%, as compared with the 2016 first quarter. The decline in revenue in the first quarter as compared to the prior year quarter was primarily due to continued lower inland marine pricing and lower coastal marine utilization. The decline in operating income was driven by these same factors. Modest savings from the cost-cutting measures David mentioned were realized during the quarter and the full benefit of these reductions will positively influence results for the rest of 2017. The marine transportation segment’s operating margin was 10.3% compared with 18.4% for the 2016 first quarter. The inland sector contributed slightly more than two-thirds of marine transportation revenue during the 2017 first quarter. Long-term inland marine transportation contracts, those contracts with a term of one year or longer in duration contributed approximately 75% of revenue with 48% attributable to time charters and 52% from affreightment contracts. The inland sector generated an operating margin in the mid-teens for the quarter. In the coastal sector, the trend of customers electing to source coastal equipment from the spot market over renewing existing term contracts continued. However, the percentage of coastal revenue under term contracts was consistent with the 2016 fourth quarter at approximately 78%, as a result of lower utilization and revenue for spot equipment. The first quarter negative operating margin for the coastal sector was in the mid single digits. Turning now to our marine construction and retirement plans. Over the course of the first quarter, we took delivery of one 30,000 barrel inland tank barge and retired 17. After accounting for temporary charters, the net result was a decrease of 12 tank barges in our inland tank barge fleet for a total reduction of approximately 230,000 barrels of capacity. For the remaining nine months of the year, we expect to take delivery of four additional 30,000 barrel inland tank barges and retired 19 additional barges with approximately 333,000 barrels of capacity, and we expect to end 2017 with a total of 849 barges, representing 17.4 million barrels of capacity. In the coastwise transportation sector, there were no new additions to the fleet. We did sell one 55,000 barrel barge during the quarter, ending the quarter with approximately 6.1 million barrels of capacity. In terms of coastal fleet additions, we now have just one remaining barge on order, and we expect to take delivery of that 155,000 barrel ATB sometime in the third quarter. Moving on to our diesel engine services segment, revenue for the 2017 first quarter increased 84% from the 2016 first quarter, and operating income for the quarter was $13.7 million, as compared with an operating loss of $806,000 in the 2016 first quarter. The segment’s operating margin was 9.3% compared with negative 1% for the 2016 first quarter. The marine and power generation operations contributed approximately 30% of the diesel engine services revenue in the first quarter, with an operating margin in the mid-teens. Our land-based operations contributed approximately 70% of the diesel engine services segment’s revenue in the first quarter, with an operating margin in the mid single digits. On the corporate side of things, our capital spending guidance for 2017 remains unchanged at $165 million to $185 million. Our guidance includes approximately $50 million in progress payments on new coastal equipment, including one 155,000 barrel coastal ATB, two 4900 horsepower and six 5000 horsepower coastal tugboats, and final cost for the new coastal petrochemical tank barge that we took delivery of at the very end of last year. The balance of $115 million to $135 million is primarily for five inland tank barges and capital upgrades and improvements to existing equipment and facilities. As I discussed in last quarter’s call, included in the capital guidance I just provided is a three-year build plan for the construction of six 5000 horsepower coastal tugboats to replace older boats in our fleet. We expect the first of these tugboats to deliver in the second quarter of 2018, and the last tugs deliver in mid to late 2019, with a total expected cost over the three years of approximately $75 million to $80 million. There is no change to the expected quarterly tax rates we announced last quarter as a result of the FASB rule change on accounting for equity-based compensation. Our guidance assumes a rate of approximately 40% for the second and third quarters and approximately 38% for the fourth quarter. For the year, we do not expect any significant change in our tax rate with our guidance based on a full-year rate of 38%. Turning to our balance sheet, total debt as of March 31, 2017 was $674.6 million, a $48.3 million decrease from December 31, 2016, and our debt to cap ratio at March 31, 2017 was 21.7%. As of today, our debt stands at $660 million. I’ll now turn the call back over to David.

All right. Thank you, Andy. In our press release last night, we announced our 2017 second quarter guidance of $0.40 to $0.55 per share, and our full-year guidance remains unchanged at $1.70 to $2.20 per share. In the inland marine transportation market, we expect utilization in the mid-80% to low-90% range for the second quarter and the full-year. This range assumes the first quarter’s increased demand for black oil barges returns to expected lower levels this quarter and stable demand across the rest of the inland fleet. We also look for weather-related delays to taper off in the second quarter, as weather conditions typically improve. Our guidance also factors in the full-year effect of pricing declines experienced in 2016. At the middle to high-end of our annual guidance range, we factor in modesty better pricing at some point in the second-half of the year, as the industry continues nearing supply-demand balance. In the coastal market on the low-end, our guidance range contemplates utilization in the mid-70% range, both for the second quarter and full-year 2017. On the high-end of guidance, we’re contemplating utilization in the mid-80% range. As I mentioned earlier in my remarks, spot rates in the coastal market for units in the 80,000 to 100,000 barrel size range in clean service are approximately down 20% to 25% from a year ago. Additionally, spot pricing is below contract rates. Our guidance assumes these rates persist through the end of the year, and that renewing contracts reprice at spot levels. After the cost-cutting measures we took in the first quarter, we expect to be able to maintain quarterly performance ranging from a small operating loss to a break-even operating profit through the end of the year. For our diesel engine services segment, in our land-based sector, we expect service work from pressure pumping unit remanufacturing and transmission overhauls in the second quarter to maintain levels consistent with levels seen in the first quarter and remain healthy through the remainder of the year. The remaining new pressure pumping units from the frac spread ordered in the first quarter are expected to ship in the second quarter. We expect inquiries regarding sales of new additional pressure pumping equipment to result in at least one additional frac spread order. While the first quarter results were strong, risk does remain should oil prices dip unexpectedly lower and current drilling activity trends and demands for pressure pumping horsepower reverse. In our marine diesel markets, we do not expect any revenue improvement relative to the 2016 second quarter. In the power generation market, we expect results that are relatively consistent with 2016. So in closing, our first quarter 2017 results largely met expectations. We remain in a strong financial position with a debt to cap ratio that continues to move lower and an expectation that 2017 free cash flow exclusive of any potential acquisitions will be comparable to 2016. he inland marine business is well-positioned for the eventual return to supply demand balance. And although, the coastal market is difficult, we believe our cost structure has been adjusted in the short-term to weather a downturn through the remainder of the year. The land-based diesel engine business has hit its stride and shows positive signs of maintaining that momentum. And finally, we remain able to put our balance sheet to work on acquisitions, but we are staying with our disciplined approach. Operator, that concludes our prepared remarks. We are now ready to take questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Jon Chappell with Evercore. Please go ahead.

Thank you. Good morning, guys.

Hey, good morning, Jon.

David, I wanted to just focus on my two questions on the inland business. I know that you mentioned in the press release that the black oil recovery, which I know is a bit of a higher-margin business was more the result of kind of seasonal factors and stuff going on in the Gulf. But it got me thinking, especially as we kind of put it up to what’s going on with the land-based diesel engine services with rising U.S. production, is there any thought whether it’s kind of realistic or maybe just hopeful that there will be a return of the kind of a crude oil business in the inland barge business that can start to absorb some of the overcapacity and maybe accelerate the return to supply demand balance in that business?

Yes. That’s a good question. We’ve gone on record for years saying that, crude is best moved in pipelines. But as the shale industry starts producing at higher levels, there will be transitory times where it won’t be in pipeline, because the pipelines are still being built or may actually get overused, and then they’ll have to go to crude by barge. But I – we are not counting on that. If there is a little bit there, we’d be okay. What we don’t want to happen is a significant ramp up and building again because of that, because those tend – those crude volumes tend to be transitory. Now, as it pertains to black oil movements in the Gulf Coast and around our system, I think heavy crude coming down from Canada is good. There is more byproducts. It tends to lead – the byproducts tend to lead to barge moves for us. And frankly, the feedstock flexibility is good for our customers and that’s helpful as well. Yes, we are – we did see, as you mentioned, a temporary pickup in black oil in the quarter. A lot of that was refinery driven. But hopefully, some longer-term crude supplies in the Gulf Coast that could bolster that black oil business would be good.

So the pipelines are actually beneficial to you, maybe not necessarily as competitive. The second question I want to ask is, just a broader-picture update on petrochemical build-out. I mean, I know it’s something that’s been a major focus and even a source of controversy dependent – depending on who you talked to over the last couple of years. Can you give an update on the timing of kind of ramp up of some of those facilities that have been pushed to the right a little bit? And also any update that you could possibly give on kind of the output from that, whether that’s liquids or pellets? And just kind of what your customers are saying to you, as they kind of reach out for capacity a little bit ahead of startup?

Yes, no. Yes, the pet chem build-out, if you look at ethylene as the proxy for all of the pet chem build-out, the big bulk of the pet – of ethylene plants coming online is now scheduled for 2018. And then there is a reasonable amount that come on in 2019 and 2020. But the big spike in ethylene output comes in 2018. Now to your question, does that lead to barge moves and how much of it’s pellets? We’ve seen studies that about 60% of the ethylene will go to downstream products and about 40%, excuse me, I’m reversing that. 40% will be downstream products and 60% will be pellets. So even if it’s that much in terms of plastic pellets, that’s still a big number. 40% of all this new ethylene capacity going to some downstream chemical product, which is – makes it more likely that there will be barge moves that we’ll see throughout that. And even in a – even if it’s an ethylene plant with petro -- going straight to polyethylene pellets, there are feedstocks that will come into the plant, but will come in on barges. So that doesn’t mean that just because it’s polyethylene, we won’t see any barge moves. But back to the core essence of your question, it’s 2018 before you see significant volumes coming online.

And is it still too early for the customers to be kind of reaching out for capacity? Is that like a quarter or two away?

Yes. There – customers kind of assume the capacity will be there. Now that said, we’ve had detailed conversations with a number of customers about their needs and clearly are working with them to plan how to handle their needs.

Okay, very helpful. Thanks so much, David.

Yes. Thanks, Jon.

Our next question is from Douglas Mavrinac with Jefferies. Please go ahead.

Great. Thank you, operator. Good morning, guys. I Just had..

Good morning.

I just had a few follow-ups for you guys this morning, actually a couple. With the first being on the diesel engine services side, because out of everything that came out of your report this morning, one thing that jumped out at me was just how well the engine services business has done, particularly the land-based. And if I’m not mistaken it looks this is your best quarterly revenue performance since 1Q of 2015. So when we look at kind of what’s happening there and we know why it’s happening, and we think about kind of maybe modeling going forward, this is a harder business, I think, to model than the inland or the coastal. So how should we think about margin contribution from remanufacturing your pressure pumping units versus the sale of new pressure pumping units? And then also, just kind of when you think about your guidance more quantitatively, how should we think about ranges of revenue growth potential for this business throughout the balance of this year?

Yes, let – Doug, let Andy and I tag team. Let me give you some context about ranges here, and then Andy can get into the margin question in more detail. This is an interesting time. The – our pressure pumping customers have gone through a very severe downturn probably one of the worst they’ve ever seen. And the stronger ones have survived and there has been some consolidation. And also they’ve been very smart and they’re recapitalizing. A number of them are reemerging, issuing some equity, and coming to market basically debt free, or with very low levels of debt. So which is great news to us. It’s a much more sustainable model for them. And so far, they’ve been very disciplined in terms of their capital deployment with remans leading the way and then we do believe we’ll see some new equipment orders. But they are being very cautious and very disciplined, which is good, and they are starting from a very strong capital position, which is good, and it’s more consolidated. So that’s all positive and probably more sustainable. I – we don’t think you’ll see the big spiky ramp-ups in volumes like we did back in 2011. We are hoping it’s more ratable. What we’ve seen so far is, they’re being very disciplined and cautious. But Andy can give you some more specific revenue kind of guidance and margin guidance.

Yes, Doug, I want to kind of focus on new frac spread construction. In our guidance, we’ve assumed one new spread. Now, we had one spread in the first quarter most of which was recognized in the revenue in the first quarter. And so if you look at our first quarter revenue at about $100 million, that’s what our revenue will look like with one spread per quarter. Our guidance only assumes one more for the year and we don’t have a firm order for that. But we’ve been talking to our customers and our conversations have been very constructive. So at the low-end of our quarterly guidance range for this business, I would say that, assuming no frac spread, you probably look like you are doing $65 million, $70 million of revenue at maybe a low to mid single-digit margin, and at the high-end you’re doing closer to $100 million at a sort of a mid to high single-digit margin. And so if you add all that up for the year, what we’re giving is guidance for the full-year now has been raised to $290 million on the low-end at a – at the low-end at a low single-digit margin to $340 million on the high-end at a high single-digit margin with one new fleet in it. So that’s kind of where we’re bracketing right now. It’s a relatively cautious approach, but until we start seeing those firm orders, we think that’s the right way to go.

Right. That is super, super helpful. Thank you, Andy, for that. And then just my follow-up, and it’s kind of along the same theme as what Jon was asking on the inland side. Focusing on the two sectors, land-based engine services and inland on the marine side, that we’ve seen inflection points or seemingly seen inflection points. And my question is – my follow-up is, when you look at that sector seemingly having put in a bottom, utilization levels now starting to firm, pricing stabilizing sequentially. At what levels do you guys expect to see utilization levels cross to where you start seeing pricing power again? And even though shale volumes maybe transitory and not permanent could that maybe help flip you over that utilization threshold to where you start seeing decent pricing power at some point in the coming quarters?

Yes. So utilization, as you know, ticks up in bad weather and that’s not necessarily good utilization.

Right.

So that was part of the first quarter’s tick up in utilization and then we had the black oil, which we talked about. But utilization has been fairly good across the industry, and typically this is the type of utilization where you might start seeing pricing. I think we are inching ever closer to supply demand balance. The number of new builds coming out or planned for this year are very low. There is – we continue to retire old capacity and older barges. Yes, I think we’ve got, this year 38 scheduled to be retired. I think we did 17 in the first quarter. I think others will be looking at retiring and if not already retiring. And if they don’t have candidates for retirement, they are probably tying up some of their older barges on the bank, which essentially retires them, because they will have a big maintenance catch-up at some point. But we are seeing supply and demand come together a little bit. It’s still not there. I think you heard the high-end of our guidance, we’ve got in the back-half of the year at some point some better pricing. We’ll see, I think, the incremental chemical demand, which comes on in 2018 should certainly help with the overall demand picture. But right now, supply is in check, I think, and demand is inching up. The U.S. economy is a little better and that’s certainly positive for our business. Over the years, you’ve heard us say that, our volume demand kind of grows with GDP. And as GDP picks up a little bit, the overall volumes grow. Now we’ve got this tailwind with the chemicals coming. So the outlook is pretty bright. It’s just – it’s painful for right now, because spot pricing is kind of at break – cash flow break-even. But I’ll say this, that spot pricing has kind of been flat for three quarters now.

All right.

So it’s stopped going down. I think we are getting poised to be back into supply and demand balance. And hopefully, that happens and we’ll get an inflection in pricing sometime this year. It could go into next year, but we’re marching very much towards being in balance?

Gotcha. Very helpful, guys, and thank for the time.

Thanks, Doug.

Thanks, Doug.

Our next question is from Gregory Lewis with Credit Suisse. Please go ahead.

Yes, hi. Thank you and good morning.

Hey, good morning, Greg.

Hey, David, just looking at coastal. I mean, that was a tough quarter for coastal. I guess, we now have EBIT margins negative. I don’t think there is – it doesn’t sound like it caught you by surprise, given that you’ve kind of – it sounds like you’ve been quick to respond. When you think about moving back towards a slightly negative break-even EBIT margin, is any of that based on some seasonal weakness that we saw in the first quarter returning back in the market, or is that more of we’ve kind of rightsized the fleet and [Multiple Speakers]?

Yes, a little bit of it is seasonal. The Alaska business is seasonal obviously, and that impacted, but it’s pretty small. We did have some shipyard work that was in the first quarter, bigger units that impacted us a little bit, so that’s also a part of it. But cost savings is a significant piece of it. Laying off some charter boats and idling some of our own equipment was painful, because it involved headcount cuts. But it was meaningful and we needed to do it and respond quickly, and I think we did. And we’ll continue to monitor the market and adjust as we need to. But yes, putting all those factors together is what really got us kind of back to the – closer to the break-even from what we saw in the first quarter.

Okay. And then before I transition over to diesel engine services, you mentioned that a coastal barge got sold. Is that getting sold from more active trading?

Now with a one-off barge that we’ve had in the market that one of our customers needed and it made more sense for us to sell it than keep it. It’s just a one-off barge.

But – so that vessel is going to still trade?

Yes, it will still trade…

Okay.

…but directly – the customer will directly own the barge.

Okay, great. And then just switching over to diesel engine services. As we think about, just following-up on Doug’s question, clearly, it looked like the overall industry for pressure pumping maybe got caught a little bit flat-footed, given the strength of the recovery. As you think about your capacity, your utilization of your staff, of your Oklahoma facility, are we kind of fully ramped up, or – and if you think about where we are maybe in baseball terminologies, is United Group in sort of the middle innings of where it needs to be to service your customers, or could we still – and what I’m trying to get at is, are we still going to be spending money to get United, where it needs to be for this cycle?

No. Actually, we are quite excited, because we – during the downturn in 2016, we spent a lot of money consolidating the facilities, investing in our facilities, in our supply chain, processes. So the way I like to think about it, the cycles have been pretty robust up and down in this industry, but our ability to respond is much better. And if we go back to the prior cycle peaks, I would expect our margins to be considerably better, perhaps 20% better in terms – so in other words, if we were doing at the past kind of a 10% margin, we should be well north of that going forward, just because of the consolidation and streamlining we’ve done. And also that supply chain – the moves we made in our supply chain should help inventory management, which is where all the capital is in this business.

Greg, I would add something to that. If you look at this business relative to prior cycles, right now our mix is much different than it has been in the past. We’ve got a lot more remanufacturing, which if you recall, the original thesis for getting into the business was the remanufacturing and the service work. But we also haven’t seen the product pull-through yet. It’s still lagging a little bit behind. And so, as that comes through, I think you will – to David’s point, you will really see the thing ramp-up and draw us a little bit more profitability.

Great. And just one final. Are you guys still hiring at United?

Yes.

Okay. Hey, thanks very much for your time, guys.

Our next question is from Jack Atkins with Stephens. Please go ahead.

Hey, thanks. This is actually Andrew Hall on for Jack. Just a couple of questions from us. David, as you think about pricing beginning to recover on the inland side, hopefully, that’s later this year. I think we typically think of your – Kirby in the broader market would see a fairly robust pricing coming out of a downturn, somewhere in the high single-digit range? Is that how should be thinking about the potential recovery this cycle, or is it – because this is more a supply-driven recovery, you think that pricing power could be a bit more muted?

Yes, it may be a little more muted. But coming out of the bottom of the cycle, it can get sporting. But I think, because this has been particularly painful with respect to overbuilding, it could be a little more muted coming out of the cycle.

Okay, perfect. And then as a follow-up, if you look at your utilization levels on the inland side, do you think that’s indicative of the broader market?

Yes.

And then, I guess, as a follow-up, given where your utilization is, have you guys had to bring back any lease-in towboats to better service your customers?

Yes. Let me take that by each question. We have ramped up and ramped down our chartered-in towboats. We – as you know, we use that as a way to variabilize some of our costs, and we have added towboats at times and taken them out at times. And we will continue to do that. And it feels like, we’ve got plenty of capacity to do that. Now, in terms of the industry utilization, Kirby may be a couple of percent better than the industry average. But we are hearing that the industry is pretty similar in terms of utilization. There may be a customer – or a competitor or two that’s a little lower. But on average, we think they are pretty close to us, which is good. That means, the whole industry is starting to tighten up. But it’s still probably early to say that. Again, we had the weather and the turnaround season. I think we’ve got to see how it plays out through the summer, as weather get better and see how that transpires.

Perfect. Thank you.

Thanks, Andrew.

Our next question is from Kevin Sterling with Seaport Global Securities. Please go ahead.

Thank you. Good morning, gentlemen.

Hey, good morning, Kevin.

Good morning.

Hi, your marine margins took a step back this quarter. And is all of that coastal, or is there some inland deterioration in there for that reduction in your marine operating margins?

Yes, Kevin, I’ll take that. Most of it’s coastal, and coastal is slipping into a sort of a mid single-digit loss. Certainly, it had an effect, dragging on the overall marine. But a little of it is still inland. If you look, we certainly – we came down a little bit from the fourth quarter. But if you can go back to the third quarter, we are probably off a couple of hundred basis points on the inland side, but most of it was coastal.

Gotcha. Okay, that sounds fair. And then maybe along those lines, David, and you guys are seeing a little bit of that deterioration in inland, but it seems to me, there is still some squirrely pricing in the inland market, particularly in the 30,000 barrel segment by a handful of players. And they may be operating at or below cash break-even, and in my simple world that just doesn’t make sense to me or seems reasonable to me. So at some point, someone [indiscernible], they kind of – you’ve got to get over that. And so my question to you is in past cycles when you’ve seen gutter-type pricing, how long does it typically last before you throw in the towel and pricing moves higher?

Yes, I may get Joe to chime in here in a minute, given his long industry history and knowledge. But we are seeing several people that are pushing pricing down to the cash flow break-even level. But that really hasn’t changed in the last three quarters. It’s kind of been bouncing along there. We keep trying to push it up a little bit and we will continue that process. I think part of the issue with some of these players and they gets into whether they will sell at the bottom here or not, and nobody likes to sell at the bottom. But some of our competitors are pretty highly levered, and they are just looking for any incremental cash to help either debt service or cover fixed costs. And I think that has to work itself out. I think it is working itself out and that’s part of the dynamic here. Everybody is looking for a little incremental cash to help defray fixed costs and debt service. But I’m going to ask Joe to give us a longer-term perspective on that.

Well, I think the simple answer is that you can’t operate at levels that are below your cash flow break-even levels for very long. And I think where we are, are essentially at cash flow break-even levels. If there are operators are operating below, they probably have other business that, at least, gets them to the break-even level. I think the observation I’d make about pricing is that, there are two components of pricing. One is utilization. And as we look at utilization around the industry, frankly, it should support higher pricing levels. So what’s absent? Well, what’s absent is that – is the confidence that this utilization is going to continue, we think it will. And maybe secondly, that we’ve come off a three to four-year period, where the industry was essentially fully utilized. In fact, it was shorter barges and it was building barges to address that shortage. And the expectation was that there – you always stay fully utilized. Well, if you go back in history, that wasn’t the case. You always had swings, seasonally, where you had excess barges, typically, as the weather improved. And I think the threshold for modest price increases, we always thought was around kind of the mid-80% level, but the industry is above that. So you really need to go back to the standard that within anybody’s fleet, there is going to be idle equipment. And what’s important is that you have rate levels that support a sustainable business. And not to think that the experiences over the past several years where every barge is utilized is the – is normal. I think that’s going to happen. I think that there is a big incentive by everybody that’s operating in this business to see rate levels at a higher level. When it’s going to turn is, hard to say. But certainly, rates at these levels are not long-term sustainable. So the turn has to happen.

Right. Well, Joe, thank you very much. And, David, thank you. That was extremely helpful. I want to appreciate your insight. One last question. David, you mentioned M&A and obviously no one wants to sell at the bottom. Is there still – as you’re looking at potential acquisition opportunities, I’d imagine it’s probably still a pretty wide gap between seller’s expectations and buyer expectations like yourself. Is that a fair assessment?

I think that’s reasonably fair. A part of it again, is the debt. Some competitors have built equipment at levels that are pretty high in terms of price and what you can build new for now, and they financed that. And so there’s a bit of a gap between what’s – what we’d be willing to pay and what you can build new for, and what some of their book values and debt levels are for that equipment. So and that’s been slowly coming together. It’s just – it’s still a bit apart. And, of course, as you mentioned at – with your question, nobody wants to sell at the bottom.

Right. Okay. Thanks so much for your time this morning. I really appreciate those very helpful in giving the insight. Take care.

All right. Thanks, Kevin. Take care.

Our next question is from Mike Webber with Wells Fargo. Please go ahead.

Hey, good morning, guys. How are you?

Good, Mike. How are you?

Good. It’s been picked over quite a bit. But I want to try to make sense of, I guess, some of the inland talking points here. There seems to be a bit of a rush to put an inflection point around inland pricing. And I guess, I’m trying to make sense of the – I guess, Andy’s comment that inland margins, I guess, within the overall ocean trends were probably off a couple of hundred basis points, and most of that weakness is coastal. And then, David, your comments around kind of the irrational pricing within the space and Kirby trying to support that – kind of support firmer prices. But I guess, when I look at the numbers, right, you’ve got – Ocean Trans revenue is more or less flat, you’ve got the lowest operating margin in the last 10 years in that business by 500 basis points. And it just seems like there is a lot of kind of low to no-margin business that kind of got worked through the system there in Q1, which led to utilization actually being – inching higher. I assume some weather noise in there too. So I guess, my question is, how much of that low to no-margin business actually got worked through your inland book in Q1? Do you have an idea about how much of that book actually turned over and repriced during the quarter? And do you think it’s feasible we could see mid to high single-digit operating margins for that coastal business – for the Ocean Trans business into the back-half of the year?

Yes, Mike, I just want to make sure that you heard correctly. I was – the couple of hundred basis points of margin pressure I was talking about was specific to inland. It wasn’t the overall marine transportation business. Marine transportation has fallen further than that largely due to…

Yes.

Yes, okay. All right, I want to make sure [Multiple Speakers]

No, I’m with you. 500 or 200 basis point is still a decline, right? So I see revenue flat, utilization up, margins that low, and then talk about supporting pricing. I’m just trying to jibe that up and I had to make sure it makes sense. So I guess, how much of your book got repriced during the quarter? And could we see a single-digit operating margin for that unit into back-half of the year?

Yes. Well, if you think about it, spot pricing has been flat kind of three quarters in a row. So as things get repriced to that level or around there, there is less and less impact, because it’s kind of flattened out. And I would also say that nobody really wants – and this is throughout the industry, none of our competitors wants to term up anything at these low spot rates. And we are chief among that group of not wanting to term up at low rates. So there’s a bit of that going on, where we’re booking only the spot business that we have to and not – and trying to maintain our contract portfolio. Now in terms of repricing, I think – or contracts that renew, Andy has gone through those number before. But we – roughly, 35% of our business is long-term multi-year contracts. And then if you think about our whole contract portfolio, it’s roughly what 75% right now under contract. So it’s the spot business that is the most impacted. I don’t know if that helps you, but…

Yes, it does.

It’s – but we are still kind of mid-teens in operating margins for the inland business. And I would say and Andy can chime in here, but it may bounce around that up a little or down a little from there. But I think if you averaged our inland operating margins for how 2017 will probably play out, it’s probably going to be around the mid-teens level and that’s essentially what’s in our guidance.

Yes, I’d agree with.

Okay. It’s helpful. I guess, you mentioned the benchmark of 35%, was that lumpy at all during the quarter? I’m trying to get a sense that if we could see this kind of sequential margin decline. I know coastal played the big role in that. That – if it’s lumpy within Q1, all right, you can make the case that maybe we stabilize here. But if we’re only three quarters into this, right, in terms of this kind of flat pricing on the inland side getting more through the system, that would stand to reason we would have another big leg down in Q2. So I’m trying to get a sense of whether there is anything else going on within the quarter besides what you guys have mentioned that would have driven that kind of disparity between utilization up and margins that low?

No. It wasn’t – I wouldn’t say it was lumpy in the first quarter. I mean, we sort of – our contacts will renew relatively ratably throughout the year. But again, I think most of that stuff has renewed closer to spot pricing now over the last three quarters than say what you’re getting from 2015 into ‘2016. So you’ve seen the worst of it in terms of, I think, the effect on margins. And I would say that, as David mentioned, we are sort of bottoming out close to that sort of mid-teens type number.

Yes. Let me just come back to kind of a more of an overview here. Look, if you look historically, quarter one for our inland business is almost always our weakest quarter in terms of margin, particularly, if you compare it versus the second and third quarters. Fourth quarter is usually better than first quarter. And that’s a pattern that’s existed for years and a lot of that’s seasonal weather and just the way the trade works. So that that’s part of what you are seeing. Also, pricing is flat on spot, but we do have some inflationary pressures, whether it’s medical and pension and insurance-type costs. So that’s also rolling through. But if we come back to coastal, look, it was ugly. We’ve been talking about coastal getting worse, and it was pretty bad, but we reacted quickly. I think we’ve got that under control now. If we need to do more, we will. But right now, we think we’ve rightsized it. So in my mind, that’s kind of the big picture.

Gotcha. Okay. I appreciate all the color, guys. Thanks a lot.

Yep.

Our next question comes from David Beard with Coker Palmer. Please go ahead.

HI, gentlemen, thanks for the time, and good morning.

Good morning, David

Good morning, yes.

My question relates to your barge business, specifically in supply demand. I don’t know if you have any color relative to what you expect for deliveries and scrapping for the industry. And then specifically, a barge manufacturer mentioned, they were seeing some push-outs of deliveries. I wondered if that was related, if you pushed out any deliveries in to 2018, or if that was someone else in the industry? Thanks.

Yes, we’ve – this is a little dated. The last number I saw was an estimate of about 40 barges being built this year. Roughly half maybe, just a little less than half was for one captive MLP customer. So Marathon, in particular, that was building for their own use. So it feels like the supply is pretty muted right now, the new supply coming in. Andrew?

David, just – I mean, again, we are scrapping roughly 30, I think, this year net. So if the industry behaves as we hope they will and if they behave using us as a proxy, or if we are a proxy for the industry, then you would assume that you will see sort of that standard 100 to 150 come out this year or more.

And just on that comment on push-out in deliveries, any color there would be appreciated?

I don’t have any good data on that. David, I’m sorry, I don’t. Now maybe it’s dry cargo. I know the dry cargo market is in pretty much disarray. There is too many covered hoppers. And I would imagine that if there were covered hopper orders that – those would be getting pushed out. So maybe it’s dry cargo that’s being talked about.

Yes, that’s a good point. All right, gentlemen, thanks for your time.

All right. Thanks, David.

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

Thanks, everyone, for your interest in Kirby Corporation and for participating in our call. If you have any additional questions or comments, you can reach me or – and/or Sterling at 713-435-1413. Thank you, and have a great day.

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