Kirby Corp (KEX) 2017 Q3 法說會逐字稿

Good morning, and welcome to the Kirby Corporation 2017 Third Quarter Earnings Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. Brian Carey, Kirby's Manager of Investor Relations and Corporate Finance. Please go ahead, sir.

Thank you and good morning, everyone, and we appreciate you joining us today. With me today are Joe Pyne, our Chairman; and David Grzebinski, Kirby's President and Chief Executive Officer.

During this 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 third quarter earnings press release and is available on our website at kirbycorp.com, in the Investor Relations section under Financial Highlights.

Statements contained in this conference call with respect to the future are forward-looking statements. These statements reflect management's reasonable judgment with respect to future events. Forward-looking statements involve risks and uncertainties.

Our actual results could differ materially from those anticipated as a result of various factors. A list of these risk factors can be found in Kirby's Form 10-K for the year ended December 31, 2016, filed with the SEC.

I'll now turn the call over to Joe.

Okay. Thank you, Brian, and good morning. Yesterday afternoon, we announced 2017 third quarter earnings of $0.52 per share, including a net $0.03 per share of lost revenue and costs from the hurricanes we experienced in the quarter. Stewart & Stevenson, acquired on September 13, contributed $0.03 per share for the quarter, as it saw elevated demand for rental generators in response to the storm and some pent-up demand for service works once facilities reopened.

The third quarter results of $0.52 per share are within our guidance range of $0.40 to $0.55 per share. The 2016 third quarter results were $0.59 per share. After considering the impact of the storm and the addition of Stewart & Stevenson, the results in the quarter mirrored the underlying fundamentals we observed in the first half of this year. The inland marine tank barge market experienced an uptick in demand after Hurricane Harvey as refineries and petrochemical plants returned to services -- into service, increasing inland barge utilization into the fourth quarter. It is too early to determine the duration of this recent increase, but it is continuing.

The coastal markets continue to be challenging as the market has absorbed newbuilds and the crude oil moves planned for these newbuilds have not materialized. We do believe that pricing at current levels, maintenance decisions and ballast water treatment decisions will force a rationalization in this fleet. The land-based distribution and service business experienced consistently strong service demand. We are seeing modest orders for new pressure pumping equipment and new products. We believe this cycle will be more ratable, helped by better capital discipline, which forces much more rebuilding than just replacing.

U.S. rig count stayed relatively flat during the quarter as E&P companies are showing a preference for returns over just growth. Profitability of our customer base is improving, and as demand for pressure pumping services remain tight from the backlog of completion activity, Stewart & Stevenson has quickly shown encouraging results in our brief period of ownership during the third quarter, as they mobilize their rental equipment fleet in response to hurricanes and have healthy demand for service work, part sales and the manufacture of pressure-pumping equipment.

In summary, our marine transportation markets continue to be challenging, but our ability to contain costs is helping hold profitability steady. Post-Stewart & Stevenson, our balance sheet remains available for marine consolidation opportunities as many industry participants are experiencing significant distress.

Our land-based distribution and service businesses maintain the momentum built since the green shoots of recovery, which appeared third quarter of last year. With Stewart & Stevenson in the fold, we are seeing early benefits of its scale and scope of product offering to our distribution and services segment.

I'll now turn the call over to David.

All right. Thank you, Joe, and good morning, everyone. Thank you for joining us today. I'd like to start by commending the Kirby team, our customers and the communities affected by Hurricanes Harvey, Irma and Maria, for their tremendous resiliency and generous spirit in the face of these major storms.

Hurricane Harvey was particularly devastating to many communities where we live and work as the storm landed in the Corpus Christi area and moved east to Houston all the way through to Louisiana. It caused significant damage to western parts of Intracoastal Waterway system and shut down many of our petrochemical and refining customers' facilities. Many of our employees were personally impacted by high floodwaters and property damage.

Hurricanes Irma and Maria had a lesser impact than Harvey but still disrupted our coastal marine operations and distribution and services businesses along the East Coast. Through it all, our operations and commercial teams operated safely and worked diligently and creatively to meet our customers' needs, as customers managed the disruption to their supply chains and brought their plants and refineries and facilities back online. So thank you to all those involved in the recovery and response of the hurricanes.

Let me now move on to a recap of our third quarter results. I'll conclude with an update on our guidance, and then we'll go to Q&A.

In the 2017 third quarter, marine transportation segment revenue declined $40 million or approximately 11%, and operating income declined $19.4 million or 35%, as compared with the 2016 third quarter. The declines were mainly due to continued lower pricing in both marine markets and lower coastal marine utilization.

The marine transportation segment's operating margin in the quarter was 11% -- 11.3% compared to 15.4% in the 2016 third quarter. In the inland marine transportation market, the third quarter operating conditions deteriorated significantly after Hurricane Harvey made landfall on the Gulf Coast at the end of August. Unrelated and coinciding upriver infrastructure repairs further decreased the operating efficiency in September. So delay days in the third quarter were just under 2,000 days, roughly double from a year ago level.

This led to a marked increase in inland tank barge utilization post-Harvey with utilization going from the mid-80% range to the mid-90% range during the third quarter. Initial net loss revenues and higher costs from the hurricane totaled approximately $0.07 per share for the quarter. However, as the quarter concluded, approximately $0.04 per share was offset as a result of cost recoveries from marine customers for delays and increase in utilization in our inland business due to pent-up demand and higher demand as pricing for our customers' products improved and drove natural demand.

Demand for transportation by inland tank barge in the quarter was higher than in the third quarter of 2016. The inland sector contributed slightly more than 2/3 of marine transportation revenue during the 2017 third quarter. Long-term inland marine transportation contracts, those contracts with a term of 1 year or longer in duration, contributed approximately 75% of the revenue with 48% attributable to time charters and 52% attributable to affreightment contracts.

Pricing on term contracts continued to deteriorate due to the excess capacity in the system. Contracts that renewed during the third quarter were down in the mid- to high single digits compared to the 2016 third quarter. As we've discussed before, term contract renewals can have a lag effect on earnings as it takes a year to see the full impact to Kirby's earnings. Spot contracts were consistent with the first 6 months of 2017.

The inland sector generated an operating margin in the mid- to high teens for the quarter.

In our coastal marine transportation sector, the oversupply of barrel capacity in the market was exacerbated by -- in the third quarter by new equipment entering service. Including temporary laid-up barges, Kirby's coastal tank barge utilization was in the low to mid-60% range during the quarter. Revenues from the coastwise transportation of refined petroleum products and black oil were lower compared to the 2016 third quarter, while revenues for the transportation of petrochemicals were stable.

We continue to evaluate the commercial viability of each piece of coastal equipment if it moves from a term contract into the spot market, and we temporarily lay-up equipment when it makes commercial sense.

Our aggressive actions to manage costs starting in the first quarter of 2017 have somewhat stabilized margins in the face of this deteriorating utilization.

Regarding coastal market pricing, generally, spot contract rates remain below term contract rates. The degree of which varies based on geography, vessel size, vessel capabilities and the product being transported. As an example of where spot pricing was in the third quarter, spot rates for vessels in the 80,000 to 100,000-barrel range including service were approximately 15% lower than the third quarter 2016. However, pricing on both term and spot contracts was stable compared to the 2017 second quarter. The percentage of coastal revenue under term contracts was consistent with the 2017 first 6 months at approximately 80%, mainly as a result of lower revenue for spot equipment. The third quarter negative operating margin for the coastal sector was in the mid-single digits.

In regards to our marine construction and retirement plans, we took delivery of 2 30,000-barrel inland tank barges and retired 16 over the course of the third quarter. After folding in the 13 barges from the asset acquisition that closed early in the quarter, the net result was a decrease of one tank barge in our inland tank barge fleet for a total reduction of approximately 15,000 barrels of capacity.

For the remainder of the year, we expect to take delivery of one additional 30,000-barrel inland tank barge and retire 4 more barges with approximately 57,000 barrels of capacity. Net, we expect to end 2017 with a total of 845 barges, representing 17.3 million barrels of capacity.

In the coastwise transportation sector, we took delivery of one 155,000-barrel ATB unit, our final new addition to the coastal fleet, and we scrapped one 45,000-barrel barge during the quarter, ending the quarter with approximately 6.2 million barrels of capacity.

Moving on to our distribution and services segment. Revenue for the 2017 third quarter increased 194% from the 2016 third quarter, and operating income for the quarter was $22 million as compared with operating income of $4.6 million in the 2016 third quarter. The segment's operating margin was 9.9% compared with 6.1% for the 2016 third quarter.

Our land-based operations, including S&S, made up approximately 80% of the distribution and services segment's revenue in the third quarter with an operating margin in the high single digits. The revenue and the margin composition of the legacy business for the third quarter was largely similar to the first 2 quarters of 2017.

Pressure-pumping unit remanufacturing remains strong as the number of units on premises from remanufacture was comparable to the first half of 2017 and the fourth quarter of 2016. In terms of new equipment manufacturing, we continue to build and deliver new frac equipment throughout the quarter. Demand for rebuilt transfer transmissions remained elevated in the third quarter, surpassing our all-time high set in the second quarter. We also saw increased demand for the sale of new transmissions in the third quarter as customers have started depleting their stocks of transmission as this expansion matures.

At S&S, rental revenues from standby generation demand were elevated as the result of hurricane-related demand in both Texas and in Florida. The remainder of S&S distribution and services revenues were in line with our expectations based on pre-closing forecasts that we received. In our marine distribution and services business, performance was slightly weaker year-over-year and sequentially primarily due to increased deferrals of major overhaul projects consistent with continued weak demand in the inland tank and dry cargo barge markets in the coastal marine markets and in the offshore oil and gas services markets.

Service activity and parts demand in the power generation market was slightly lower than the 2017 second quarter and 2016 third quarter, due primarily to the timing of major projects and a lack of new engine sales. Operating margins for the marine distribution and services business were slightly lower sequentially and year-over-year.

On the corporate side of things, we incurred approximately $0.01 per share in acquisition-related charges in the third quarter for S&S acquisition. This amount is included in the $0.03 per share contribution for S&S in the third quarter.

Our capital spending guidance for 2017 is updated to $175 million to $185 million compared to prior guidance of $165 million to $185 million. We do not expect any changes to our tax rate. Our guidance uses a rate of approximately 38% for both the fourth quarter and the full year of 2017.

As of September 30, 2017, total debt on our balance sheet was $1 billion, a $300 million increase from December 31, 2016, mainly as a result of the S&S acquisition. Our debt-to-total cap ratio at the end of the third quarter was 26.4%, a 3.3% increase from December 31, 2016. And as of today, our debt stands at $1,020,000,000.

So I will now move on to our fourth quarter outlook.

In our press release last night, we announced our 2017 fourth quarter guidance of $0.40 to $0.55 per share and updated our full year 2017 guidance to $1.90 to $2.05 per share from $1.80 to $2.10 per share. You will recall, our fourth quarter is almost always seasonally our weakest quarter. So this guidance includes approximately $0.03 to $0.05 per share impact from S&S for the fourth quarter and considers the impact of increased interest expense and a higher average shares outstanding due to the share issuance in the S&S acquisition.

In the marine inland transportation market, we expect utilization in the mid-80% to the mid-90% range for the fourth quarter, a range that assumes stable demand across the inland fleet. We look for delay days in the fourth quarter to be comparable to the third quarter as operating conditions reflect normal winter weather seasonal patterns and mirror the effect of operating conditions caused by hurricanes in the third quarter.

Our updated guidance contemplates a similar pricing environment to what we have experienced throughout 2017. The pain inflicted on the inland barge industry as a result of excess industry capacity grows more acute the longer it persists as pricing remains unsustainably low. We continue to assess opportunities to grow our inland marine franchise, and we fully expect to emerge from this cycle larger and stronger.

In the coastal market, our guidance range contemplates utilization, including temporary laid-up equipment in the low to mid-60% range for the quarter. We assume flat pricing on term and spot contracts and that renewing contracts repriced at spot levels. We are guiding to a full year mid-single-digit negative operating margin for the coastal business.

We do maintain an aggressive focus on costs and optimizing the equipment available and marketed commercially in this coastal business. For our distribution and services segment in our legacy land-based sector, we expect service work from pressure-pumping unit remanufacturing and new manufacturing of frac equipment in the fourth quarter to remain consistent with recent trends. We expect demand for transmission overhauls to lower slightly as sales of new transmissions replace some overhauls. We anticipate we will see some incremental demand for the sale of new engines and parts in the fourth quarter.

Regarding S&S, we are guiding to $0.03 to $0.05 per share for the fourth quarter, up from our prior guidance of $0.02 to $0.04 per share. While we anticipate demand for rental equipment will return to normalized levels, we expect demand levels for its distribution and services offerings will maintain current levels in the fourth quarter.

Though there remains much integration work to do, we are encouraged by the early signs of the potential for the combined land-based distribution and services business and have already started improving our ability to meet our customer needs by optimizing available capacity to improve delivery times on some customer orders.

In our marine distribution and services market, we expect a seasonal decline in revenue and continued deferrals by our customers. In the power generation market, we expect results that are slightly lower than the 2016 fourth quarter though slightly higher sequentially due to the timing of major projects. In summary, the fourth quarter 2017 should generally mirror trends seen over the last 3 quarters in all of our markets. The inland marine business is maintaining profitability in an oversupplied capacity market while safely meeting our customer needs. The coastal marine business has demonstrated resilience in its performance by aggressively managing costs and optimizing equipment in the face of very sloppy market fundamentals.

The land-based distribution and services business continues to execute well in an oil services cycle that so far has been more ratable and tempered than prior cycles. The addition of S&S to the mix has already provided encouraging evidence of the benefits of its scale, scope of product offerings and geographic breadth.

In conclusion, our financial position is strong with free cash flow excluding acquisitions expected to be comparable to 2016. We have a clean balance sheet that affords us plenty of dry powder for consolidating acquisitions. Our debt-to-cap ratio of 26% remains low even after the S&S acquisition. And we are committed to our established strategy of building out our inland marine franchise through acquisitions. And we are in a prime position and an environment to do so. So with that, operator, that concludes our prepared remarks. We are now ready to take questions.

(Operator Instructions) The first question comes from Jon Chappell of Evercore.

Congratulations on the [Asterisk]. Great series. It's good for the community down there too, I'm sure. First question, on the inland side. So it's kind of a 2-parter. Last quarter, I think Joe was talking about the pain threshold kind of getting there, where some of the maybe less well-capitalized companies were starting to bend a little bit. So the first part is, this little boost in utilization to the mid-90s, is that kind of giving a reprieve to some of these guys and helping them to hold on, and maybe pushing back some of the opportunities that you see there? And then also, speaking of pushing back, it seems that some of the petrochemical capacity that's supposed to come on line is continuing to shift to the right, whether that was Harvey-related or just kind of delays in that, and you spoke about the kind of lagged impact of pricing on the bottom line. Does this seem like that's more of a '19 recovery as opposed to a mid-'18 recovery now?

Yes. So let me take those in order, and I'll have Joe chime in on the pain threshold in particular and what we've seen in past cycles. The pain threshold continues because spot pricing is basically down near cash breakeven. So we may be busier but pricing is still low, and for some carriers, it's unsustainably low. We have heard anecdotes of companies in trouble. We heard of a repossession of some equipment from one of our smaller competitors here recently. So even though we're a little busier, it's still very painful. However, that said, if this demand continues and the market believes that it's going to be sustained there, it sure gets us a lot closer to the inflection point on pricing, because, as you know, you've got to have a higher utilization and the belief that there is going to be sustained demand, and then we'll be able to push pricing. So there's still a lot of pain out there, and even though we're a little busier, it hasn't helped the whole lot for some of the competitors. But the encouraging thing is, if the demand stays up, it leads us to a better pricing environment sooner rather than later. I'll come back to the petrochemical shift and another question, but I'll ask Joe if he's got any comments on the -- kind of the history.

I think you've answered Jon's question well. One little market turn, while the market will turn as we come into balance, and certainly the higher utilization after the storm and its prolonged utilization rates into the fourth quarter are encouraging, but you need that -- the market will need to have the sense that the business is indeed going to get better, and these utilization rates are going to be maintained before, I think, you shouldn't see any inflection in pricing.

Yes, Jon, I'll come back to your petrochemical shift question. And yes, what I'm hearing from our customers is still a lot of excitement about the build-out. I think what we're seeing -- well the hurricane didn't help at all, to be clear, it disrupted not only the normal operations but the construction of a lot of plants and shut down a lot of things as you would expect. But what I think we're seeing is kind of that normal shift to the right in projects. They just tend to take longer than everyone's ambitioned plans -- ambitious plans. I will say this, I recently had been with the CEO of a major chemical company, and there is a tremendous amount of excitement to continue these projects, and in fact, even looking at adding some projects. So I think we have seen more projects added and almost none canceled. We are seeing them pushed out. I think that's all positive because as we talk about coming back in the balance here, our volumes typically grow with GDP. And GDP is doing okay, and if you add a little bit more for chemicals, I think that helps soak up capacity as we move forward, so we could have 2% to 5% kind of volume growth as we go forward into '18, and then if you get supply contraction, which I fully expect, we haven't heard of any new building announced for 2018 thus far. And we know a lot of us are retiring. Inland capacity, in particular, I think, our forecast right now is that we'll retire by the end of the year 49 barges in total. I think we're actually in the high 40s right now than what we've require -- retired through the third quarter. So with supply contraction, little demand input pickup and this utilization trend kind of stays where it's at, we could be a lot closer to that inflection point. That said, it's still very, very painful out there at these price levels.

Right. That's super helpful. Hopefully, my follow-up's a lot quicker than that, but I appreciate that insight. On the coastal side, as you mentioned in your comments, David, you've been able kind of maintain this margin kind of negative mid-single digits and it seems like kind of temporary things like laying up equipment, et cetera. If this market deteriorates further, most likely because of the continued onslaught of new capacity, is mid-negative single digits is still kind of the right way to think about it? Or potentially kind of get worse? Or if you kind of make a shift to more kind of fixed cost removal, could that even improve in the same type of utilization or even a leap on a lower utilization environment?

Yes. I mean, the short answer, the margin will probably going to be in this range. It could go up and down. But let me just comment a little bit about the coastal market and kind of the trends. There are only, I think in our mind, about 5 pieces of equipment, new pieces of equipment to come into the market left. The bulk of the equipment's been delivered. We could be off 1 or 2 there, but the bulk of the new equipment has delivered. There's a few left to come in, and scrapping is starting. We -- so far this year, we'll have basically sold -- mostly just scrapped 4 barges. So we're taking out our capacity. I think other people are in the process of doing it. And as Joe mentioned in his opening comments, this ballast water treatment process that we're going to have to go through is going to require a lot of capital. And that's going to actually help accelerate some retirements, including for Kirby. So yes, I think, the supply and demand situation is not going to get a lot worse from this point. We should see some demand growth just with GDP. On the -- what we can control or we continue to look at cost and take it out, I wouldn't expect the utilization to get any worse than where we're at now, if anything as we move into '18, it could start getting a little better. But your assumption of margins in this range is probably a good one for the near-term, at least.

The next question comes from Jack Atkins with Stephens.

David, I guess, just a follow-up on the inland commentary, and I appreciate all of that detail that you've provided with Jon's question. But, I guess, just sort of thinking about how, I guess, returning -- going into 2018, with pricing renewing in the third quarter, you're down in the mid- to high single digits on the inland side, and you referenced the sort of the lag effect given the contractual nature of that business, yes, I guess, can you kind of -- without providing 2018 guidance, obviously, can you kind of help us think through how we should be framing up the profitability trajectory of the marine segment kind of going into 2018? Because I would think that as we push out that pricing recovery, we're really sort of probably pushing out any sort of recovery in underlying profitability of that segment. But I want to just -- would like to sort of get your take on how you guys are thinking about that going into next year?

Yes. No, it's a great question, Jack, because as you know and we called it out in the script here. We didn't get the full year effect, right? We're renewing. As you heard in our comments, contracts are down year-over-year and then that translates into a full year effect in '18. So that is math, right? I think everybody kind of gets that math. With that said, what we don't know is when the inflection will happen and the magnitude of it. The earlier in the year it happens, the better. We still have significant spot exposure and then the contracts due to renew throughout '18. But your premise is spot on. We do have that full year effect, and it's just -- it's the mathematics of these contract renewals.

Yes. Jack, also remember that 60% to 70% of our business is exposed to rate increases or decreases of a given year. Contracts were renewed through the year, but you also have your spot exposure that reprices strip by [credit]. So depending on -- as David suggested, depending on when the turn is, it could offset some of the deterioration that is occurring in 2017.

Okay. Okay, that's helpful. Maybe then, I guess, just my follow-up with the distribution segment. Now that you have S&S in the fold, could you kind of give us just sort of some framework right how we should be thinking about the revenue run rate of that segment sort of going forward with Stewart & Stevenson and the legacy businesses combined now?

Yes. And it's unfortunate, Jack, I'm not prepared to give you the revenue guidance. I think what we've seen so far has just been very encouraging. And that's all I can really -- we're just not prepared to give you revenue guidance or margin guidance. But the early indications are this is going to be what we expected. There's -- we're seeing great synergies as we put the organizations together, and again there's -- we had a great customer win here recently by being able to collaborate between the 2 organizations and now become one, and we're able to meet some customer needs that either organization couldn't have done on its own. So we're very excited about the potential of the distribution services business, as we continue to integrate it. And you saw, we get -- there's some pleasant upside, I think. We all did not like the hurricanes at all, but if there is a silver lining that rental fleet that they have, it was a nice addition. So it's a long way of saying, "I'm not giving you an answer, but we like what we see so far."

The next question comes from Greg Lewis with Crédit Suisse.

Could you talk a little bit about -- I mean, clearly, we've seen Kirby's utilization was -- pre-hurricane, it looked like it was firming. Out of the hurricane, it got even firmer. Is part of the issue with the ability to push pricing and the fact that while Kirby's utilization is in that 90-plus sweet spot that the rest of the industry just is that far behind?

Yes, I think that's part of it. We don't know exactly where everybody's utilization is. Our sense is that it may be anywhere from a couple of points lower. Maybe in some cases, 5-plus percent. But that is absolutely part of it, Greg. But their utilization in general should be up like ours is in terms of relative moves. If we are up about 5% utilization, I would think their relative utilization is up about 5%. So it's a very encouraging. I think part of the demand utilization or the demand that we are seeing is crude prices are a little higher. Some of the end product pricing is a little higher, so there is a little more profitability out there for our customer base. And the traders are making a little more money. We've got kind of a spread between WTI and Brent now that's actually helping some of the arbitrage plays out there. So we'll see how long this demand holds. It's been encouraging so far. Clearly, some of it is temporary because there was a -- with all the refineries down and some of the chemical plants down and certain maintenance activities that had to happen or recovery activities that had to happen, we had a pent-up demand. But we're seeing a little more than just a hurricane fallout now. We're encouraged by it. I don't know if it will hold, but we remain hopeful. If it does hold, it certainly gets us into a better possibility to raise prices.

Okay, great. And then you actually lead it to my second question. It was around the Brent-WTI spread, it doesn't look like there's any benefit that is happening in the coastal market based on your commentary. But is there any benefit that we are seeing on the inland side, at least?

Yes, we've seen a little pickup in crude moves particularly out of the upriver locations, Utica and Marcellus. We have seen a nice little pickup, but it's not meaningful yet. But, yes, we were getting down at one point to a handful of barges, and now it's gone the other way. So we have seen it, and I think that part of that is a higher absolute level. And then there is -- with some of the by-products, I think there is an arbitrage going on with between WTI and Brent. Now on the coastal market, at some point, if that differential maintains itself, I would imagine on the East Coast that price differential plus transportation ought to start backing out some Brent. But to your point, we haven't really seen that yet, but you would expect that it may come if the differential holds for a while.

The next question comes from Kevin Sterling with Seaport Global Securities.

And David, as a coastal business, do you think it's deteriorated a little more than you thought, kind of utilization of low 60s and just all of moods we are seeing more of the spot market versus contract? And I haven't seen it this bad. I'm just curious, have you seen it this bad before? I'd love your thoughts around it.

Yes, it has deteriorated more than we expected. And if you go back and you look back into the K-Sea time frame, you go back at this below what they saw then. Yes, I think they got the low 70s. There was a high 60s for one quarter, I think, back in K-Sea's public days. So this is pretty bad. I think -- well you know what happened, Kevin. It was a lot of newbuilds. A lot of the newbuilds were in anticipation of crude moves and crude projects on the coasts that didn't materialize. There was supposed to be some crude by rail going to terminals on the water, and that was going to drive a number of coastwise moves. And a lot of those projects, I think, our team, Chris and Bill have seen a list of about 6 or 8 projects that were canceled that had significant crude volumes being moved by water. That's unfortunate so we had -- demand didn't materialize as expected, and the capacity came on. So that has led to probably one of the worst markets in the coastwise business that I'm aware of. But I would say this, there's still a lot of old equipment out there. I think we're tracking over 30 barges that are over 30 years old and it will come out. In this market, it's starting to get very painful. And ballast water treatment, we're all going through our fleets and looking at our fleets and saying, "Okay, is this barge worth putting a ballast water treatment system on it?" and as you can imagine, the older the barges, the more likely the answer is, it's not worth it.

So in the coastal market, I hear you on scrapping and obviously, if we get accelerated levels of scrapping that will help. But do we need consolidation as well to really kind of get this market moving higher? Or do you think if we get meaningful scrapping that, that will really kind of help turn the tide?

Well, I think, it's really about scrapping, because even if you get consolidation, you got to take the capacity out. So it's more about the scrapping of the older equipment. Consolidation always helps, but it's a pretty painful market. And as you've heard us say time and again that we almost have to be coming out of the market to get the consolidation done. It rarely happens, it's kind of at the bottom. So...

Yes. And last question here, David. You mentioned, and I've heard kind of similar anecdotes, that some of the inland players are obviously really struggling and things like that. You mentioned repossession of some equipment on the inland side. Do you know if that equipment was sold back into in the market? Or was it scrapped, kind of keeping on the scrapping theme?

Yes. They'll know the details of where the equipment ended up, but, yes, it may have been sold to -- somebody may try and put it to work but it probably landed a very low value, and some of it may end up being scrapped anyway. And look, it's tough, it's tough on the whole industry. I mean, there is some wage cuts going on out there. There's certainly layoffs in the industry. And these prices are just unsustainable. There are, in some cases, some deals are being done at below cash cost which is, as you know, not a good plan for a long-run business. So the pain continues, and out of all this, there should be some opportunities for Kirby to be sure.

The low value of equipment, is that just keeping banks from maybe taking repossession of that equipment just because they'd have to take such a huge write-down on their loans? You think that's part of the issue?

I absolutely believe that's part of the issue that the banks don't really want the equipment either, right? So -- and when you got a bunch of equipment out, what are the banks going to do with it? Yes, I'd say it's just sloppy.

Yes, I think, some of this is getting sorted out now. We're at the part of the cycle that the banks and operators are making decisions with respect to their sustainability. So I think you need to give it another 6 months before we truly understand what's going to happen.

The next question comes from Kenneth Hoexter with Merrill Lynch.

I just want to revisit the contract pricing for a quick second, just to understand your -- I guess, your more immediacy. I think the last 2 quarters we've actually seen margins maybe tick up slightly on the inland or fairly stable but is this kind of an acceleration of the pricing decline on the contract side that you're talking about? Because I want to understand as you look to fourth quarter, I know you said seasonally typically the weakest but I want to understand what kind of the magnitude maybe nearer term in terms of how quickly we should expect maybe some pressure on those margins or is this just kind of what you are talking about into '18?

Yes. No, the margin comments were really about into '18 as we get the full year effect. I would say our margins didn't tick up a little bit in the third quarter on the inland side, principally because we got some cost recoveries there that when we're not moving and we get the cost recoveries, the revenue's a little lower but the recovery still happens. So that helps the margins a little bit. I think what we're talking about mostly here is, as these contracts have rolled over, as you heard, down quite a bit from a year ago, you get the full year effect of that going into '18. That was principally our comment, Ken.

Okay. On the S&S deal, I guess, 2 parts to the question. But one, can you -- I know you said you can't talk about revenue growth for '18, but can you talk about the seasonality in the business? How we should think about that as you look into the fourth quarter? And maybe within that, can you talk about the rationale? How do you want investors to focus on you now that you've acquired S&S and integrated it? Is it one consolidated kind of entity? Or are they -- are you an oil -- are you moving more toward oil services? Or is it transportation? Just how should we kind of look at what the service target is?

Yes, good question, Ken. I would say this, I don't think there's a lot of seasonality in the distribution and services business. Yes, there may be a little bit. We do take care of some pleasure crafts in Florida, for example, and there may be some seasonality there. But when you put it all together, I don't think there's much at all seasonality for the distribution and services business. But, as you know, about 80% of the revenues are land-based in that business. So a good portion of that is oilfield service-related. But there is also an on-highway portion and the rental portion and other ancillary industrial equipment, whether it's a standby generation power, et cetera. We service, as I just mentioned, the pleasure boat market in Florida. That's a big part of it. That's a $100 million business there. We do -- up in the Northeast, we do -- we have kind of an on-highway service business there. So there -- it's not just oil service to be clear, but certainly, there is significant exposure to the oil service, as you could hear frac spreads and remanufacturing's a healthy part of the growth that we've seen in the rebound. You had seen that with United before, obviously. I would say we're going to treat this as just one business. It's a -- we'll talk about it as one single business because we're integrating everything, as you might imagine. There's some branch integration that we've got to do. Certainly back-office integration. The sales team is already working very well together and trying to jointly attack opportunities out in the marketplace and service the customers where -- because the joint capability of Kirby now is stronger, so we're able to take bigger orders and meet shorter time delivery requirements. So it's very encouraging. In terms of how to think about it with respect to Kirby, look, it's going to be a big business. It's a $1.5 billion probably revenue business and the marine business is probably in that same order of magnitude. As you know, the marine business tends to have better margins over time through the cycle, but we'll try and give you as we can in our calls and our commentaries and our guidance, how best we think about those businesses. But they're both going to be significant going forward.

That's great insight. If I could just get a quick softball for you, though. You bought a bunch of vessels and then you retired a bunch of inland vessels, and it seemed like you've netted out the one change. Presuming this was a younger more profitable fleet, I guess, is that an ample answer as to why?

Yes, some of it. There were 4 very young 30,000-barrel barges in that, but there were some pressure equipment. So we retired kind of the equipment that was surplus, which is older 30,000-barrel barges and some older 10s. And we bought some young, 4 young 30,000-barrel barges, and then we bought -- the rest of the purchase was pressure equipment, which is very, very specialized. And the pressure market is kind of its own submarket, if you will, which with these chemical plants coming on and particularly, there's things like butane and butadiene moves and other pressure cargoes, propylene and whatnot, that our customers are already starting to talk to us about making sure they have pressure barges for those moves. Also with that transaction, we've got 3 new boats, which were kind of younger, which are good to put in our fleet.

The next question comes from David Beard with Coker Palmer.

A bigger-picture question on capital allocation. Just what absolute level of debt would you target? I mean, I know your metrics are good. But would you want to bring the $1 billion down to a certain number or some color there? That is my first question on capital allocation.

Sure. Look, we tend to take acquisitions and build when it makes sense. I think, as you've seen us do in the past, if and when we get some consolidation opportunities, and we think on the inland side they're sooner rather than later, we'll use our balance sheet and we'll lever up. I think we'd be comfortable getting up into the 40, high 40s and maybe for the right acquisition into the 50s. And then as we've done, we'll use our debt -- our cash flow generation to pay down our debt quickly to get the balance sheet back into shape for the next opportunities. There's never an absolute target. I guess, theoretically, if you do that weighted average cost of capital, you'd want a 40% to 45% debt-to-total capital but that's really not the way we think about it. The way we think about it is having balance sheet dry powder. So when the opportunities exist, we can move and we can move quickly. And at 26% debt-to-total cap, we've got some dry powder, and we remain hopeful to put that to work in the near term.

I would -- just to add that the other thing that's important is to maintain our investment-grade rating, because cost to debt is a competitive advantage. We have been as high as 60% after the Hollywood Marine acquisition, not suggesting that we go to that level, but we did that and still maintained the investment-grade rating. So there's plenty of capacity, 26% debt-to-total cap is very reasonable. And the balance sheet can support more debt if there's a good opportunity to kind of add value in the future.

Okay, good. And as a follow-up, would it -- should we be even thinking that coastwise acquisitions make sense relative to incremental return on capital? Or is -- or do you feel that business might not offer a full-cycle return relative to making acquisitions in inland?

Yes. No, look, our first priority will probably be inland. It's about to come out of the cycle, that would be -- the timing makes sense. I think as we've talked about, the coastwise business is probably in a little longer-term downturn, but it all depends on what the opportunity is. But I would say our preference right at the moment is to consolidate the inland side. Yes, I think that's where the real opportunities are in the near term.

The next question comes from Bill Baldwin with Baldwin Anthony Securities.

Couple things here, gentlemen. Can you bring us up to date on your CFO search, David? Kind of where that stands?

Sure. Yes, as you know, it takes a while. The hurricanes didn't help our search process. We've got a number of good candidates, a handful of good candidates that we've been interviewing. And we continue to narrow that field. And I'm hopeful that certainly by the end of the year, I'd like to have somebody on board.

Well, good luck to you on that. I know you'll get the kind of person you're looking for. Secondly, on the vessel personnel on your barges, particularly the inland barges as this business picks up and with all the construction activity on the rebuilds and so forth going on down there in the Gulf States area. Is that going to present any particular supply issues, do you think for personnel to work on your boats? Are you seeing anything or do you anticipate anything?

Yes. Not as of yet. It's -- well frankly, some of our competitors have been laying off. But as you know, the root of your question is when things start coming back how quickly we will get tight, is probably at the root of your question. We continue to use our training center. Our team has been training people, but we're running pretty tight on staffing. We don't want to have too many people because there's costs associated with that. But right now, I don't think there's an issue with staffing. As we rebound, I still think given the number of layoffs that occurred in the industry, I think, we'd have time before we get crunched for qualified people.

Yes. And Bill, as you know, we produce most of the people that we employ and...

Right, I know you do and I was just kind of getting around to the kind of the quality of the candidates you're seeing today versus a while back. I mean, are you still getting the folks in there that you'd like to have come into your training program?

Oh, yes. Yes, absolutely.

I'll tell you where you're getting the trouble is, after like an event like Katrina where you have so much infrastructure disruption and you're using marine equipment to repair it, and the market immediately tightens up, that did not happen in Harvey. Harvey was a more water issue than a kind of infrastructure disruption issue. So I think if you have more ratable demand, you can gear up your training efforts to produce the people that you need.

Are you seeing just the change quickly? Or -- but are you seeing the kind of labor force you need on the S&D side, on the work in your Stewart & Stevenson plants and Kirby plants as the demand ticks up for the fracking equipment and overhaul and so forth?

Yes, that's a good question, Bill. We have been -- we've ramped up several hundred people in our United organization, and we're ramping up a little on the S&S organization now even as we speak. So far it's been pretty good but it's starting to get tighter, is the short answer. And there's a little more competition. As the oilfield has been rebounding here, it's starting to get a little tighter.

The next question comes from Michael Webber with Wells Fargo.

David, just wanted to follow up on inland pricing. I know you've just said it a couple of times already but in the past, we've heard a fair amount about irrational pricing from certain players in the space. Curious to what degree you are still seeing that? And then specifically, to the extent that you can get color on it, is that -- has that been more on a spot or on a term basis? And specifically kind of thinking about if we do get some kind of bumped or the less-rational players are going to be a bit more termed out at that point?

Yes. Most of it's been in the spot market, to be honest. There's been a couple of deals that have been termed up at these really ridiculous rates. But we're hearing anecdotes that some of the low pricers are pretty much booked up now. But it's a fluid, fluid situation. But I would say most of that really low pricing is in the spot market, and there are very few long-term contracts being done at that level. It just doesn't make sense. There are a few that are getting done at that level, but you've got to wonder whether that's a good long-term business decision. Clearly, Kirby doesn't like it and wouldn't do that kind of thing.

At this point, all of the pricing is irrational.

I guess, given the nature of some of these businesses, I thought maybe they would be reaching for some term but it doesn't sound like it. The -- just as a follow-up on coastal, and I know you've touched on obviously the state of that market, and I think -- I believe that question is on ballast water treatment and I guess, scrapping. If you look though at the actual special survey dates of most of the older ATB tonnage, that's not -- most of them are '19 -- 2019, 2020. And as you guys know well, obviously, just because scrapping happens it makes sense at the time on paper there's usually a multiyear lag between when that actually happens versus when it starts making sense in a model. So, I guess, my question is, is there really, I mean, a realistic scenario? Or is it realistic to think that, that coastal market could improve without that ultra-old tonnage coming out of the market at that special survey date which is '19 and '20?

Yes. No, I think the capacity has got to come out. I do think it will come out probably ratably over the special survey dates, to be sure. But there are some older pieces that just can't even earn the cost of their cash cost right now, and that may force a retirement before the special survey. So it's not just the ballast water treatment situation, which will help drive it, because if you're going to bring it into a shipyard, you don't want to spend that additional money. But there are some decisions that you won't even bring it in for the special survey shipyard. You'll just retire it because it's older. Frankly, we've retired some very old equipment that we could have taken into the shipyard and extended its life. It just doesn't economic sense, and so we're not going to do it. Working it 50% in the spot market at prices that barely cover your cash cost, it becomes pretty easy if you're thinking about a shipyard or even still running the equipment. Does it make sense to keep a crew fully engaged on that piece of equipment? So I think you'll see equipment retired irrespective of the shipyard cycle. It'll just happen. There is 4.5 million to almost 5 million barrels of capacity that's well over 30 years old that's just got to come out. Kirby has one. It's a 180,000-barrel one that's going to have to come out soon. And we're not going to extend the life, and that's irrespective of the ballast water treatment.

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

Thank you very much for your interest today in Kirby Corporation and for participating in our call. If you have any additional questions or comments, please reach out to me at (713) 435-1413. Thank you, and have a great day.

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