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Edited Transcript of KEX earnings conference call or presentation 25-Oct-19 12:30pm GMT

Q3 2019 Kirby Corp Earnings Call

HOUSTON Nov 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Kirby Corp earnings conference call or presentation Friday, October 25, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David W. Grzebinski

Kirby Corporation - President, CEO & Director

* Eric S. Holcomb

Kirby Corporation - VP of IR

* William G. Harvey

Kirby Corporation - Executive VP & CFO

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Conference Call Participants

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* Benjamin Joel Nolan

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Gregory Robert Lewis

BTIG, LLC, Research Division - MD and Energy & Shipping Analyst

* Jack Lawrence Atkins

Stephens Inc., Research Division - MD & Analyst

* Jonathan B. Chappell

Evercore ISI Institutional Equities, Research Division - Senior MD

* Justin Laurence Bergner

G. Research, LLC - VP

* Kenneth Scott Hoexter

BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials

* Kevin Wallace Sterling

Seaport Global Securities LLC, Research Division - MD & Senior Analyst

* Michael Webber;Webber Research;Founder

* Randall Giveans

Jefferies LLC, Research Division - VP,Senior Analyst & Group Head of Energy Maritime Shipping

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Presentation

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Operator [1]

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Good morning, and welcome to the Kirby Corporation 2019 Third Quarter Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. Eric Holcomb, Kirby's VP of Investor Relations. Please go ahead.

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Eric S. Holcomb, Kirby Corporation - VP of IR [2]

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Good morning, and thank you for joining us. With me today are David Grzebinski, Kirby's President and Chief Executive Officer; and Bill Harvey, Kirby's Executive Vice President and Chief Financial Officer. A slide presentation for today's conference call as well as the earnings release that was issued earlier today can be found on our website at kirbycorp.com. During this conference call, we may refer to certain non-GAAP or adjusted financial measures. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings press release and are also available on our website in the Investor Relations section under Financials.

As a reminder, statements contained in this conference call with respect to the future are forward-looking statements. These statements reflect management's reasonable judgment with respect to future events. Forward-looking statements involve risks and uncertainties and our actual results could differ materially from those anticipated as a result of various factors. A list of these risk factors can be found in Kirby's Form 10-K for the year ended December 31, 2018. I will now turn the call over to David.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [3]

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Thank you, Eric, and good morning, everyone. Earlier today, we announced third quarter revenue of $667 million and earnings of $0.80 per share. This compares to the 2018 third quarter revenue of $705 million and earnings of $0.70 per share. Although revenues were down 5% year-on-year, earnings per share increased 14% driven largely by significant revenue and earnings growth in marine transportation. The addition of Cenac and the continued improvement in marine more than offset reduced oilfield activity in distribution and services.

In inland marine, operating conditions improved significantly during the quarter with floodwaters on the Mississippi River receding at the beginning of August and favorable summer weather contributing to a 31% sequential reduction in the delay days. These conditions drove significant improvement in operating efficiencies for much of the quarter, particularly on our contracts of affreightment. Additionally, the -- with floodwaters subsiding, we were able to reduce operating expenses that had been elevated for much of the year as a result of high water conditions.

In the inland market, overall customer demand was stable, but with better weather in the quarter, we saw modest increases in industry barge availability. This led to a temporary pause in the upward momentum of spot pricing during the quarter. Pricing on expiring term contracts, however, renewed higher in the low to mid-single digits. Overall, with improved weather, increased pricing and lower cost, inland margins touched 20% in the third quarter. In coastal, we reported a significant improvement in profitability with operating margins approaching 10%.

During the third quarter, market conditions were favorable with improving customer demand and continued tight supply for large capacity vessels. Overall, our barge utilization was in the mid-80% range, and pricing on expiring term contracts continued to renew higher. In distribution and services, although we anticipated the slowdown in oilfield spending and that would have a negative impact on our third quarter results, the magnitude of the decline was significant. Our oil and gas related businesses reported sequential reductions in revenue and operating income with many of our customers further scaling back their maintenance activities and equipment and parts spending. In manufacturing, while deliveries of new pressure pumping equipment were in line with our expectations, remanufacturing activities were lower than anticipated.

In distribution, volumes of new transmissions sold and overhauls performed also declined. Although we believe there is growing pent-up demand as a result of this limited spending, the timing of recovery remains unclear. As a result, we have implemented additional cost reduction initiatives during the third quarter, including further reductions in force as well as reduced work schedules.

In summary, marine transportation had a very good quarter. Steady demand, favorable operating conditions and reduced cost led to strong sequential gains in operating margins for both inland and coastal. In distribution and services, the impact of reduced spending in the oilfield was felt across our oil and gas businesses.

In a few moments, I'll provide details about our outlook. But before I do, I'll turn the call over to Bill to discuss our third quarter segment results and the balance sheet.

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William G. Harvey, Kirby Corporation - Executive VP & CFO [4]

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Thank you, David, and good morning, everyone. In our marine transportation segment, third quarter revenues were $412.7 million with an operating income of $72.7 million and an operating margin of 17.6%. Compared to the same quarter in 2018, this represented an 8% increase in revenue and a 50% increase in operating income. The increase from revenue is largely attributable to higher pricing and the inland marine acquisitions of Cenac and CGBM. Compared to the second quarter, revenues increased $8.4 million or 2% and operating income increased by $19.5 million or 37%. These increases are primarily due to reduced delay days and improved operating efficiencies in inland and overall lower cost. In the inland business, revenues increased 10% year-on-year due to improved customer demand, higher barge utilization, increased pricing and the contribution from recent acquisitions.

Compared to the second quarter, inland revenues increased 2%, primarily due to the reduced delay days, improved operating conditions and increases in term contract pricing more than offsetting the impact of slightly lower barge utilization. During the quarter, the inland business contributed 77% of the marine transportation revenue and the average barge utilization rate was in the low 90s. Long-term inland marine transportation contracts are those contracts with terms of 1 year or longer, contributed approximately 65% of revenue, with 61% attributable to time charters and 39% from contracts of affreightment. Term contracts that renewed during the third quarter were higher in the low to mid-single digits on average and spot market rates were approximately 15% higher year-on-year.

During the third quarter, the operating margin in the inland business was approximately 20%. In the coastal business, third quarter revenues increased 3% year-over-year primarily driven by improved barge utilization and higher pricing. Compared to the second quarter, coastal revenues also increased 3% primarily as a result of higher refined products demand. Overall, coastal's barge utilization was in the mid-80s range during the quarter. With regards to pricing, although rates are contingent on various factors such as geographic location, vessel size, vessel capabilities and the products being transported, in general, term contracts renewed higher in the mid-single digits and the average spot market rates improved approximately 20% year-on-year.

During the third quarter, the percentage of coastal revenue under term contracts was approximately 80%, of which approximately 85% were time charters. Coastal's operating margin in the third quarter was in the high single digits. With respect to our tank barge fleet, at the end of the third quarter, the inland fleet was largely unchanged and had 1,065 barges, representing 23.7 million barrels of capacity. We expect to end the year with 1,060 barges, representing 23.6 million barrels of capacity. In the coastal marine market, the barge count was unchanged at 49 barges with 4.7 million barrels of capacity. We do not expect further changes to the coastal barge fleet during the remainder of 2019.

Looking at our distribution and services segment. Revenues for the 2019 third quarter were $254.1 million with operating income of $9.1 million. Compared to the 2018 third quarter, revenues declined approximately 21%, primarily due to lower activity in our oil and gas related businesses. This was partially offset by higher sales of power generation and increased service levels in the marine repair business. Sequentially, revenues declined 31% with operating income down $14 million as a result of limited activity in the oil and gas sector, lower backup power system on installations and reduced demand for new marine engines and repair services.

During the third quarter, the segment's operating margin was 3.6%. In our oil and gas market, revenue and operating income were down due to softening of activity levels, which resulted in low demand for new and remanufactured pressured pumping units, new and overhauled transmissions and engines as well as parts. In the third quarter, the oil and gas related businesses represented approximately 45% of distribution and services revenue and had an operating margin in the negative low single digits.

In our commercial and industrial market compared to the 2018 third quarter, revenue and operating income increased, primarily due to higher service levels in the marine repair business as well as growth in our power generation business. Compared to the 2019 second quarter, revenues declined as a result of reduced installations of large backup power systems at low single-digit operating margins. Operating income was stable, however, as this reduction was offset by lower costs. In the marine repair business, results declined as our customers were very busy following many months of disruption due to high water conditions as well as lower new marine engine sales.

In the third quarter, the commercial and industrial businesses represented approximately 55% of distribution and services revenue and had an operating margin in the high single digits as we benefited from lower costs.

Turning to the balance sheet. As of September 30, total debt was $1.43 billion and our debt to cap was 29.8%. During the quarter, we paid down more than $160 million in debt, and we remain focused on the repayment of debt. As of this week, our debt balance was $1.39 billion.

I'll now turn the call back over to David to provide additional details about our outlook.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [5]

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Thank you, Bill. I will now discuss our updated 2019 guidance, which has been narrowed to $2.80 to $3 per share. Looking at our segments, in marine transportation, we expect customer demand will be stable during the fourth quarter with some potential upside from continued growth in petrochemical moves as new Gulf Coast plants come online. Operating conditions are expected to seasonally deteriorate in the fourth quarter with the onset of winter weather and some temporary disruptions from lock closures along the Gulf Coast -- the Gulf Intracoastal Waterway and on the Illinois River.

Overall, we anticipate the inland market will remain tight with our barge utilization in the low 90% range. With respect to cost, we anticipate sequentially higher operating expenses as a significant number of barges acquired in recent acquisitions are scheduled for maintenance during the fourth quarter.

Overall, during the fourth quarter, we expect inland revenues will be relatively stable as compared to the third quarter with operating margins in the high teens. In the coastal market, we expect stable demand and barge utilization in the mid-80s for the fourth quarter.

As highlighted last quarter, we will have a significant amount of major shipyard activity in the fourth quarter with 7 vessels scheduled, of which 6 are large capacity vessels. This will have a negative impact on revenue and operating income during the fourth quarter. Together, with the seasonal reduction in Alaska activity, coastal revenue is expected to sequentially decline 5% to 10% with operating margins in the negative low single-digit range.

For our distribution and services segment, the fourth quarter is expected to remain challenging. In the oil and gas market, we expect our customers will remain intensely focused on limiting spending through the end of the year. With that in mind, we expect minimal new orders for new manufactured -- new remanufactured pressure pumping equipment. However, we continue to work on existing orders which are expected to deliver in the back half of the quarter. Given this time line, there is risk that some of these units could be delayed into the 2020 first quarter. The impact of a potential delay is factored into our low end of our guidance range.

In oil and gas related distribution, we expect sales of new equipment, including engines, transmissions and parts as well as service and overhauls will continue to be soft and down sequentially. In our commercial and industrial markets, we expect revenues to sequentially decline in the fourth quarter, primarily due to low utilization in our power generation rental fleet as the summer storm season along the Gulf Coast ends. The marine repair business is expected to be relatively stable.

In total for distribution and services, we expect fourth quarter revenue to be flat to modestly down compared to the third quarter with a challenging oilfield and reduced utilization of power generation rental equipment being the major drivers. Operating margins are expected to be breakeven to slightly positive in the low single-digit range.

Overall, for our full year guidance range, the lower end assumes possible additional weakness in the distribution and services oil and gas businesses. This includes some potential delivery delays of new pressure pumping equipment into 2020, very limited orders for remanufacturing and minimal demand for engines, transmission and parts. The high end assumes continued good operating conditions in marine and inland barge utilization into the mid-90% range. The high end also assumes some improvement in contribution from the distribution and services oil and gas related businesses.

Now to sum things up. Overall, we had a good third quarter despite challenges in our distribution and services segment. Inland and coastal both executed well, delivering significant year-on-year and sequential improvement in earnings. In the fourth quarter, we will have increased maintenance in marine transportation as well as continued oilfield weakness in distribution and services. However, we remained very positive about Kirby's long-term outlook and earnings potential. In inland marine, we have successfully completed and integrated several key acquisitions during the last 2 years, adding over 30% more barrel capacity to our fleet. These have made a significant contribution, and we expect the inland market to continue to be strong.

With improved demand as the result of new petrochemical capacity under construction, inland marine is well positioned for the coming years. In coastal, our strategy to invest in modern equipment, rightsize the fleet and reduce our cost structure has begun to pay off. In recent months, we've witnessed a growing desire by customers to extend contracts or term up spot equipment at improved rates, giving us increased confidence that this market is trending upward. With a number of industry vessels expected to retire in the coming years, including a few of ours in 2020, and limited new capacity under construction, we believe the coastal business is set to see multiple years of a continued improvement. In distribution and services, although the oilfield presents challenges in the near future, we remain optimistic about the long-term outlook for our oil and gas related businesses. The current lack of investment in maintenance activities on existing equipment is unsustainable, and we believe this activity will rebound.

Additionally, although the industry does not currently need new pressure pumping capacity, there is a need for replacement horsepower, which will improve operating efficiencies and reduce environmental footprints. With the major oil -- the major integrated oil companies continuing to invest in shale, we expect shale to play a key role in world energy supply for the foreseeable future. With steep decline curves and new pipelines from the Permian coming online, completion activities will cycle back up. Kirby is well positioned to capitalize on these opportunities when they arise. In the meantime, we will continue to make adjustments as needed to align our operations with the market conditions.

Elsewhere in distribution and services, the nonoilfield commercial and industrial businesses have grown significantly and have provided a solid margin contribution for the segment. As we look forward, these businesses are expected to continue to grow with increasing demand for backup power generation equipment as well as some growth in our marine and industrial distribution businesses.

And finally, we've taken significant steps to improve our balance sheet. Earlier in the year, we put in place new bank lines that enhanced our liquidity for the coming years, and we've paid down more than $260 million in debt since March. This is the equivalent of paying for the Cenac acquisition in less than 6 months.

With continued strength in inland and improvement in coastal, we expect to generate significant free cash flow in the coming year, positioning us well for additional debt reduction and giving us more financial flexibility to take advantage of any additional acquisition opportunities that may arise.

Operator, this concludes our prepared remarks. We're now ready to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ken Hoexter with Bank of America.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [2]

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Dave, just great detail on the fourth quarter and nice job on the quarter at marine. But maybe just -- you kind of just started to, at the end there, take a step back and look into 2020. Maybe talk about the market structure for inland. Now that you've consolidated, as you mentioned, a couple of additional carriers and you're coming out of the downturn, are you seeing peers building assets again? Are you seeing new -- maybe talk about the timing of the new facilities you just mentioned coming online in the Gulf to kind of see the scale of that ramp as we look into 2020 after the -- maybe a little bit of step back here in the fourth quarter?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [3]

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Yes. Sure. Let me start with supply and demand outlook. Essentially, in a real quick word, it continues to look good. There's not a lot of new supply coming on. For 2019, I think last quarter, we said there were about 200 we expected delivery in for 2019. The current number is actually 150. There has been delays in delivering that equipment because the shipyards have had a lot of rain and winter-type weather that's pushed it out. So 50 of the barges we expected to hit in 2019 are moved out to 2020. And then when you look at retirements, we think at least half of those 150 that'll deliver this year will be for replacement. So from a supply and demand standpoint, we're pretty positive because the demand is growing faster than supply. Of course you've got the risk of a recession next year, but if you exclude that, things are looking pretty good. And even with the recession, all these new chemical plants, to your point, are coming along.

I think the big Sasol unit in Lake Charles is expected to be completed by the first quarter of 2020 with 3 of their 7 units starting up now. So we're pretty excited about that. Formosa has a cracker that's starting up here the second half. And there is probably about 6 others that are going to come online here in the second half or the first part of 2020. So that bodes well for demand. So the way we think about it is GDP plus something demand, maybe that plus is 2% to 5%. So even with a little supply growth, we feel pretty good. The other thing I'd say about supply growth is they are building this equipment at pretty heavy prices for new barges. So they need higher rates to justify -- higher barge rates to justify the cost of that new equipment. So when we look at that and put it all together, I think 2020 should be pretty good. We hit -- we've just hit 20% margins this quarter. We'll have a little pullback in the winter weather months -- winter weather quarters here both in fourth and first. But we're on track for continued improvements in marine next year on the inland side for sure.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [4]

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Got it. Sounds great. And then I guess maybe to do the same thing on the oil and gas part of D&S. As you talk to your main customers, are they beyond just their discussions of a rebound? Or are they kind of timing of contracts? Maybe your thoughts on how that's panned out over the past in terms of timing.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [5]

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Yes. No, good question. I think couple of thoughts here. I'm sure you saw a bunch of the announcements this week, many of our pressure pumping customers are laying up and cutting up and impairing old capacity. I think just our estimate this week alone, they've announced about 1.5 million of horsepower that's being cut up and impaired. That's great news for that industry. That brings the supply and demand back into balance. Couple of the major -- the largest pressure pumping companies said they expected the first quarter activity to tick up. I think nobody is really expecting a lot of activity in the fourth quarter. And in fact, we think it'll decline. But look, there is pent-up demand that pent-up demand is growing not shrinking. As we look at maintenance activities, you can only cut back on maintenance for so long. We saw our remans go way down this quarter and what we're hearing from them next quarter, they'll be down. But that's unsustainable. It absolutely has to come back. And the great thing about new equipment, it's more efficient. And we're hearing the majors continue to want to invest. In fact, one of the major big integrated oil companies said that they saw decades of growth in shale for them. They said that this week. So when we look at the activity and talk to the customers, I think you'll see a rebound next year. It's hard to predict which quarter that rebound will come, but couple of our customers said, first quarter, the activity level will go back up. I don't know how far it goes up, but it's going to be better than it's been in the fourth quarter and the third quarter for sure.

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Operator [6]

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Our next question comes from Jack Atkins with Stephens.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [7]

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So I guess, if we could start with D&S for a moment. David, in the press release and your prepared comments you talked about a workforce reduction there. Do you expect to sort of fully see the benefit of that in the fourth quarter? Or if not, sort of what's the timing of that in terms of helping out some of the profitability there? And then are there opportunities as you look at your just broader cost structure D&S outside of a workforce reduction to maybe find some other cost levers to pull in 2020 that could help support profitability there above the -- sort of the fourth quarter run rate level?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [8]

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Yes. No, look, workforce reductions, as you know, are tough. But when we look at what we've done year-to-date, in the oil and gas business, we've reduced probably 35% to 40% of the workforce. We also, this quarter, added reduced work schedules, cutting back from the 40-hour weeks. That's helping. But look, when we look at third quarter and we gave guidance and talked about -- we didn't give quarterly guidance, but we talked about what we thought would happen in the third quarter. We had said, we thought sequentially, revenue would be down about 15%, while in actuality, it was down about 30%. So when we look at the fourth quarter, we know activity is going to be less than it was in the third quarter, budget exhaustion and other things, you've heard those phrases. So we know that's happening. So that's part of our -- kind of our fourth quarter discussion. But when you start going into next year, these lower cost structures should start to pay off. The problem we've got really in the fourth quarter is there's just not of a lot of activity, but we're taking the right measures.

I think there are some other stuff we're working on. You've heard us talk about putting all of our ERP systems on one system. We're well underway on that and that should complete kind of mid next year. And there's going to be a lot of savings with that, a lot of cost savings. Think about it this way, we'll be able to share inventory between all our locations because it'll be on one system. So we'll be able to take more cost out just on that kind of stuff, inventory, shifting manufacturing around when you've got the available capacity. So we're pretty excited about that, particularly as activity and this pent-up demand starts to come back.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [9]

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Got you. So it sounds like there is maybe more to come on the cost side and that will add to the operating leverage on the up cycle. Okay. Got you.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [10]

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Yes. No.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [11]

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Shifting gears to the coastal market for a moment for my follow-up question. Can you talk about supply/demand dynamics there? I think it's very interesting, customers are coming to you looking to term up business now. As you look out to 2020, I know you're going to wait to give guidance in January, but we're operating in the third quarter at a high single-digit operating margin at coastal. Things are obviously recovering very quickly there. What's realistic to sort of think about in terms of broad strokes for 2020 if we're already at a high single-digit level in terms of the third quarter?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [12]

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Yes. Well, the third quarter was a good quarter for coastal for sure. But as you heard, we've got some major shipyards starting in the fourth quarter. That's going to take us back to a loss in coastal. Some of those shipyards will carry into the first quarter. But then they'll be over. So that's a positive. I said kind of the negative side, we do have some retirements next year, but that's a short-term negative, it's a long-term positive. We're going to -- we will retire, I think, 3 vessels next year and that'll hurt a little bit from a revenue and operating income standpoint. But it will help in terms of supply and demand because we're seeing supply and demand tight right now. And as we pull those units out and others do that, there are some other of our competitors retiring equipment, as that happens, the market is going to get tighter. So it's hard to predict, we're not prepared to give guidance yet. But we'll lose a little revenue from the retirements we have. But the market structure is getting tighter and we're terming up stuff. So it's a little too early to call next year, but it's looking pretty constructive. We like what we see.

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Operator [13]

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Our next question comes from Jon Chappell with Evercore.

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Jonathan B. Chappell, Evercore ISI Institutional Equities, Research Division - Senior MD [14]

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David, if I can start with inland. Hitting 20% margin in the third quarter was -- I think we talked about in the last conference call, we were kind of hopeful for maybe second half of next year, so much earlier than expected. Trying to get a sense of how temporary some of these fourth quarter issues are, whether it be the higher-than-expected maintenance on your own fleet or the maintenance on the locks. Sequentially, things moving down somewhat is expected but are these -- should we kind of view these as onetime events and having the fleet kind of primed and positioned for continued recovery in 2020? Or is there some carryover into early next year on both of those?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [15]

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Yes. Well, I think it's more the latter where not carryover, it's the seasonality. Most of this is temporary. Maintenance cycles based on when it was built and when the annual shipyards are -- or excuse me, the regulatory shipyards. And with the acquisitions we've done, there's pretty big hit here in the fourth quarter, a little bit carrying over into the first quarter just because of the timing of when the acquired companies built that equipment. The other thing is the seasonality. Fourth quarter, weather starts getting rough and then the first quarter is usually the worst in terms of the weather. When we look at our third quarter, the weather was really good after we got past the high water. We took out a lot of cost, extra horsepower costs, if you will, and that really helps the margins. And I would say that will continue next year but for the seasonality. So I think it's more what you said early in your question that it's mostly temporary, normal seasonality and a little bit of it is just the timing of regulatory shipyards. So the structure of the inland markets is very good right now. Our utilization is in the 90% range right now. We were in the mid-90s in the third quarter and in the fourth quarter it'll drop down a little bit maybe -- or excuse me, in the end of the third quarter it dropped down a little bit but that's because of the weather. Fourth quarter it'll go back up probably as the weather chews up some of the utilization.

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Jonathan B. Chappell, Evercore ISI Institutional Equities, Research Division - Senior MD [16]

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So then just to be clear, I mean taking all seasonality out of it and obviously it tends to peak in the first quarter, the impact of seasonality that is, there is no reason to think that 2Q '20 wouldn't look similar to, if not better, than the 3Q of '19?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [17]

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Third quarter is always the best quarter, it's when the weather is the best. But I would say, if you look at third quarter this year and third quarter next year, I'd be -- I would expect third quarter next year, given pricing and everything we're seeing in the market, it should be better than this third quarter. So just year-over-year and the way things are progressing, the tightness in the market, pricing should continue to increase. And the price increases that we've gotten throughout this year will carry into a full year next year. So it looks pretty favorable from where we're sitting right now.

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Jonathan B. Chappell, Evercore ISI Institutional Equities, Research Division - Senior MD [18]

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Great. And then the second question, maybe a different way to ask Jack's first question, which I think is very important. I think you message to that question was that you're improving the cost structure so that you're primed really well in the D&S recovery when that eventually comes. But maybe to think about it another way, let's say it doesn't eventually come or at least not on the near-term horizon. Is there a path to profitability even if the demand doesn't pick up in the next 6 to 12 months? Is there more cost, what you've done so far, has that -- does that take some time to filter in? Just trying to think about the ability to keep some positive margin if the narrative continues to be very poor.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [19]

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Yes. No, I think absolutely. Let me put distribution and services kind of in a little context here. About 45% of our revenue is in commercial and industrial, which is nonoilfield related, so 55% is oilfield related. But when you take distribution and services year to date, we've generated over $100 million of free cash flow. This business is different than our pressure pumping customers and E&P customers business, right? Their business is very capital intensive, ours isn't. We're in the equipment supply and equipment repair business in the oil and gas. So when you look at the structure of that, what it means is, our CapEx, year to date, in distribution and services was $12 million. So when you generate operating cash flow of over -- almost $120 million, it -- that all flows to the bottom line and we get free cash flow. So it's noisy, right, because of what's going on in the oilfield. But remember, our capital requirements are pretty small. So we do generate free cash flow. To the earnings side, yes, we think with the base of commercial and industrial, we should be positive earnings next year, even in the -- even in this oil and gas market and if it were to continue into next year.

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Operator [20]

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Our next question comes from Mike Webber with Webber Research.

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Michael Webber;Webber Research;Founder, [21]

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David, I wanted to zero in first on -- just kind of follow up on the -- my question is on inland pricing. I had -- there are a lot of factors that kind of go into the Q4 guide and give a bunch of color of it -- on it already. But if we just look at how spot inland pricing trended during the quarter and then I guess the impact of where that spot momentum is on the Q4 guide? I know there's some seasonal weakness in that guide.

(technical difficulty)

weakness, probably would've been baked in to begin with (inaudible) going to be reflective to how you were setting that guidance at the beginning of the year. I'm just curious how you've seen inland pricing trend throughout the quarter on a spot basis? And then how the competitive dynamics are set up right now in terms of capacity coming back into the market kind of following the seasonal weather patterns from H1, whether that's been a little bit sloppy that's kind of contributed to kind of the Q4 weakness on the market end?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [22]

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Yes. Spot pricing was flattish in the third quarter, but contract prices were renewing up. When I say spot pricing, I mean sequentially it was flat. Year-over-year, it was up kind of 15%. But frankly, that's pretty normal in a good weather quarter like we had in the third quarter. You have heard us say this before, Mike, we usually lose as an industry about 2% to 3% utilization when the weather is really good, and that's what happened. You heard our utilization was in the mid-90s, fell to the low 90s. That's all about weather. So when you're trying to push price increases and you get a good weather quarter, it's tough because you've got little more barge availability. So the impetus or the tailwinds to get those price increases slow down. But as weather comes on that utilization will tighten up, and we believe spot pricing will continue. It's kind of the trend that we've had all year long. But that's a good question. I don't think it's new capacity coming on. This was just better weather, things moving better. There was a little more barge availability. So the upward price momentum on spot kind of slowed and flattened out. I think it'll come back as we get tighter here in the fourth and first quarters.

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Michael Webber;Webber Research;Founder, [23]

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Okay. That's helpful. And then I guess the follow-up, kind of along those lines. You got a couple of competitors, and one large one in particular, that are in varying degrees of distress. And some of that might be coming to a head over the next couple of quarters. How should we think about the utilization of those kind of -- those chunks of capacity and whether or not those are full utilized today or not what have -- would be the primary driver whether that's capacity entering the market or exiting the markets if there was some sort of -- say, some sort of restructuring or some sort of bigger event at one of those entities? I'm just curious, how do you think about market dynamics within that context of capacity ever entering or leaving with a major competitor restructuring?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [24]

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Yes. A lot depends on the restructuring and what happens, right? If it's a liquidation, it could -- the capacity could actually come out. But most of the time, reorganization, they want to keep everything running. So I think their equipment or most of the industries' equipment is that -- at roughly the same utilization as we have. So I don't see that really changing, to be honest. I think any kind of reorganization, the bankruptcy courts are usually trying to keep your business going. So I don't really see any change there. I mean if it got really bad and there was a forced liquidation that might actually help. But I don't think that would happen. It's not good to talk specifics, but everybody's trying to do the best they can to keep their entities going.

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Michael Webber;Webber Research;Founder, [25]

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Got you.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [26]

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And I don't think it will change the utilization is the short answer. Who knows what happens. And I'm talking broadly across our competitors. There are still possibilities for acquisitions. But given then the markets a little better, right, we've got -- seen pricing come up, price expectations tend to go up when that happens. But as Bill told you, we've paid down a lot of debt and if you look at our revolver right now, it's undrawn, it's an $850 million revolver that's totally available for us. So if there is some acquisition possibilities out there, you know us, if it makes sense for Kirby, we do it. But I'm not predicting one at all right now because the market is much better. And typically, when we see a better market, the price expectations for acquisitions goes up.

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Operator [27]

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Our next question comes from Randy Giveans with Jefferies.

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Randall Giveans, Jefferies LLC, Research Division - VP,Senior Analyst & Group Head of Energy Maritime Shipping [28]

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All right. So yes, following the cost cutting, the head count reduction, facility consolidation, what is the current utilization for your oil and gas manufacturing? And then it sounds like there isn't much backlog remaining for new [building] equipment, but how does the service contract backlog last? Is that 6 months, a year, 3 years, 5 years?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [29]

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Yes. Let me take that in pieces, right? Look, oil and gas utilization is pretty low. It's probably in the 60s to 70s. We typically like to run a lot higher than that, as you would expect. What we are working on is maintenance and we've got some old orders that we're still working through, keeping those guys busy. But when you look at how much of it's maintenance, it's probably 50-50 now if I had to put a number on it. But I'll tell you, we expected more reman activity in the third quarter, and it was about 50% to 75% -- maybe even greater than 75% lower than we anticipated in the quarter. They've cut back on the reman and their maintenance spending. I think there is an acute pressure on them to show free cash flow. But as we talked about, I don't think that's sustainable. There is a lot of pent-up demand being built right now.

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William G. Harvey, Kirby Corporation - Executive VP & CFO [30]

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Yes, Randall, you should think about business as highly variable cost, so utilization is little less important. From our point of view, the 39% workforce reduction in manufacturing lines it -- we're trying to line up the variable cost to what activity we have. And we do have fixed cost, don't get me wrong, but it's much different than some other industries.

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Randall Giveans, Jefferies LLC, Research Division - VP,Senior Analyst & Group Head of Energy Maritime Shipping [31]

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Sure. And then in terms of the kind of service contracts, do some of those extend into 2021 and beyond?

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William G. Harvey, Kirby Corporation - Executive VP & CFO [32]

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We have service contracts. I don't know if they go into 2021, but there's always service contracts in place.

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Randall Giveans, Jefferies LLC, Research Division - VP,Senior Analyst & Group Head of Energy Maritime Shipping [33]

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All right. And then I guess for my second question, following up on possible acquisitions, are you solely focused on inland or is there any appetite for coastal or maybe even a bolt-on D&S acquisition?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [34]

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Yes. The short answer is, yes, we look at everything. In terms of the ones that we get the more synergies from, it's inland first, obviously. We're pretty good at inland acquisitions. We always like them because it's -- they're very easy to integrate. I think very easy -- our operations guys work very hard to integrate them from a crewing standpoint and the quality of equipment. But we always tend to prefer inland. But that said, we'll look at any acquisition in our space. I would say, on the oil and gas side, we're happy with our platform the way it is. We wouldn't -- unless it's just like an incredible deal, we wouldn't go anywhere. We don't need to add anything on oil and gas. You might see us add a little bit on commercial and industrial. But in terms of priority, as Bill said, we've been focused on paying down debt, getting ready to -- so for the -- for a potential recession. But if an acquisition comes along, we'd love an inland one. Certainly look at a coastal one and -- or maybe a commercial and industrial one, not likely to look at an oil and gas type one, we're happy with that platform now. And frankly, it's pretty ugly in that business right now anyway. But predicting acquisitions, Randy, as you know, is difficult. All I can tell you is, we've got the financial capability to do up to a sizable acquisition, and we'll stay price disciplined as we always do.

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Operator [35]

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Our next question comes from Ben Nolan with Stifel.

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Benjamin Joel Nolan, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [36]

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So I have -- well, let me start with my first question and it does -- well, it relates to D&S and you've talked a little bit on some of the other questions about sort of the cost cutting and then cadence. What I want to try to understand a little bit is, if I'm looking back relative to the last time that, that business was pretty challenged, operating margins dipped to, I don't know, a loss of about 3% or something, but that was pre-S&S acquisition. Is there a low watermark? Do you think that going forward, come hell or high water, that you can keep those operating margins positive now with the way the business is structured currently?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [37]

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Yes. I would -- I think so. When you go back to those loss years, that -- the rig count got below 400. Right now the rig count is in 800 and they're still operating the equipment. And so we still are getting some maintenance and we're getting some replacement. When that rig count got below 400, everything kind of stopped. So they -- that was what drove the losses there. But back then, we didn't have this big commercial and industrial business. As I think Bill said in his prepared remarks, 45% of our revenue in the quarter was commercial and industrial and that continues to grow. We're seeing nice growth there. And that had -- I think in the third quarter, we had 9 -- well, excuse me, high single-digit margins and that margin profile is usually mid- to high single digits. So with growth and that kind of margin profile, we think commercial and industrial even in a very ugly oil and gas market keeps D&S profitable. And of course, we're not standing still. If the oil and gas market gets worse, we'll take more cost-cutting actions. But again, I think you're going to see some activity come back when you look at the very big pressure pumping comment -- pressure pumping company comments, they -- the 2 of the biggest ones said that they felt first quarter activity would be up from the levels we see now. So we're not overly negative about next year, and we do think we'll stay positive.

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William G. Harvey, Kirby Corporation - Executive VP & CFO [38]

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Yes. Put in perspective, year to date out of this -- out of the commercial and industrial side of the business, it's generated about $32 million of operating income. And if anything, it's not -- it's actually got a little better hopefully recently. So we expect that, that will be a good ballast, so to speak, on the business.

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Benjamin Joel Nolan, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [39]

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Okay. And then for my second question, on the coastal side of the business, obviously, those rates are getting better and I understand the guidance for 4Q. But as you look out going forward and you kind of back to profitability, it sounds like you expect rates to continue to improve in that business, to trend higher, is it exclusively or solely on the back of supply rationalization? Or is there any level of demand growth that you're seeing in that side of the business?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [40]

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Yes. I would say most of it is supply rationalization. We are seeing GDP-type growth in terms of demand. I mean look, what's GDP now? Call it 2%. It's not a huge number. So it's really on the back of supply contraction, which, again, we've been foreshadowing this with ballast water treatment and as this older equipment gets retired, I think there's still, what, 14-or-so pieces of offshore bluewater equipment that's 30 years old, 25 to 35 years old. So we know more is coming out, and as we talked about, we've got 3 units coming out next year. And as ballast water treatment continues to be implemented, I expect more of that 14 to be retired. So as we look at it, the supply is going to continue to contract. Even if somebody wanted to build a new unit now, it's a 2-year process. So it tends to take a long time for supply to come back there, which is a good thing. And absent a recession, I would think demand continues to build kind of in that 2% to 3% per year.

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Operator [41]

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Our next question comes from Greg Lewis with BTIG.

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Gregory Robert Lewis, BTIG, LLC, Research Division - MD and Energy & Shipping Analyst [42]

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David, I have a question for you. So I mean clearly, pricing in inland has been getting better sequentially year-over-year for a while now. Knowing that you guys don't -- you're limited on what you can disclose around pricing, is there any way you could kind of put some context around where we are in terms of pricing versus maybe where we were last cycle in terms of how much more upside or -- I mean could we see in pricing. Any kind of context around that I think would be helpful.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [43]

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Yes. I would say, in general, we've seen cycles last kind of 5 years, a long cycle might be 7 years. In that context, we're probably in the third inning, to use a baseball analogy. Yes, it's going to take a while, particularly take a while to get to peak pricing is what I mean. It'll be a longer cycle. And it needs to be a higher cycle just given the -- in terms of pricing, just given the cost of new equipment, the cost of compliance, rates still have a way to go -- ways to go.

Yes. I think what could derail it is probably the corollary question and that would be a recession. I don't know if we're heading into a recession. But even if we got into a recession, I think it would be short-lived because it's just -- the market structure just needs continued pricing. And I don't see -- I see the market getting more disciplined, not less disciplined as we look around at what's going on.

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Gregory Robert Lewis, BTIG, LLC, Research Division - MD and Energy & Shipping Analyst [44]

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Okay. Great. So I guess a lot more still to go. And then just one more -- just switching gears over to D&S. Realizing now going back to when you, pre-S&S, you had United, is there any kind of difference between what we're seeing in this down market versus what we've seen in previous down markets? I mean as you have conversations with customers, how they're thinking about it? I mean have there been lessons learned in kind of across the D&S value chain in terms of how companies are positioning themselves or is it kind of, "Yes, looks like just like the last down cycle"?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [45]

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No. I honestly believe in talking to customers, they really are a lot more focused on return on invested capital, returning capital. And I think that's healthy. So is it different this time? Those are horrible words, right? Always run from those words. But it does feel like there is a difference. Now they're very focused on this return on capital. And I think, frankly, it's because the financing, the easy money is requiring -- or has gone away and there is a required return now. So I think that's probably what's different is the financing of some of these independent E&P companies has gotten tougher. And also the financing for some of the smaller pressure pumping companies has gotten tougher. So that discipline of debt, so to speak, is driving a more intrinsic return on capital focus, which I think is very positive. We like seeing that because what will happen and what we're seen happen is, they want the newer equipment that's higher horsepower, more efficient, it's got more technical bells and whistles, and frankly, that plays into Kirby's strength. That's where we can play really well. So as I think about, is it different this time? Yes, a little bit because of what I just articulated. And it's -- sure it'll continue to cycle, but I don't think it'll be as violent going forward just because of this due discipline that's happening.

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Operator [46]

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Our next question comes from Justin Bergner with G. Research.

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Justin Laurence Bergner, G. Research, LLC - VP [47]

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First off, when you were talking about term contract pricing being higher, you were referring to year-on-year there or actually sequentially?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [48]

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Year-on-year.

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Justin Laurence Bergner, G. Research, LLC - VP [49]

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Okay. That's what I thought. And then I think you had talked about demand having the potential to grow GDP plus 2% to 5%, maybe on the inland side, if I heard you correctly. If so, is that sort of more of a post-2019 event? Because clearly, supply only grew about 2% this year with the 150 deliveries and the market seemed to stall in terms of tightening in the sort of second half of this year. Just any clarity there would be helpful.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [50]

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No. Yes, the growth is coming from all the new petrochemical plants in refinery expansions that are going on. I think you've seen us talk about the $150 billion of new plants. But I wouldn't say demand stalled at all. What happened here was spot pricing sequentially is just -- is a pause because we had better weather and there was more barge availability because of better weather. Usually in better weather, we get 2% to 3% drop in utility and that's what's happened. And whenever you get a little drop in utility, it's harder to push prices up. I think utility is going to tighten here as we get the kind of the cold front and the fourth quarter weather coming on. So I wouldn't say there is a pause, Justin. I would say -- I wouldn't say there is a slowdown, I would say it's just a pause.

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Justin Laurence Bergner, G. Research, LLC - VP [51]

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Okay. Great. And then just lastly, on the D&S side, are any of your competitors in the oil and gas side in financial distress? I mean did the current weak operating conditions present an opportunity to gain share or see a competitor have to exit part or all of its business?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [52]

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Yes. I think you're seeing a little bit of that. I think there is the haves and the have nots in that pressure pumping group. But I think there's a bunch of smaller players that will end up being consolidated. We did see one big consolidation. We've seen, I don't know, heard anecdotes of some people wanting to get out of the business. So I think you're going to see consolidation in the pressure pumping area. I think that's healthy and will lead to the better market dynamic. The bigger players will be able to invest more properly and for longer-term sustainability. So we think, again, the market structure is getting better here with this focus on return on invested capital.

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Operator [53]

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Our final question comes from Kevin Sterling with Seaport Global.

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Kevin Wallace Sterling, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [54]

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So David, can I dive into coastal a little bit more. I know you talked about supply rationalization there. But it seems like we're seeing a little bit of a pickup in demand. Is any of that related to IMO 2020? Are you seeing an increase in any bunkering activity? Is that -- could that draw potential demand in coastal?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [55]

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Yes. It could a little bit. But as we look at IMO 2020, it would probably help us in our bunkering business because you'll have more types of fuel that you bunker with. So we'll end up having to use more barges and the industry will have to use more barges as they do bunkering. But in terms of coastal, I'm not sure it's going to impact our coastal business much. Yes, we're still talking to customers and trying to figure out what's going to happen. Everybody is kind of worried about what will happen with diesel prices, what will happen with heavy fuel prices and what kind of dislocations will happen. Our refinery customers, I would say, are spending a lot of money on their turnarounds right now. It's a big turnaround season right now as they try and prepare for IMO. It's going to be interesting to watch. I'm not sure how much change there will be. And if there is change, my view is it will be temporary because if there becomes a price dislocation, more people will install scrubbers and that'll bring the price back into line. And my guess is, the realignment of that will be quicker rather than slower. Economic incentives work really well. So as we think about IMO from a coastal standpoint, we don't think it'll have much effect to our business.

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Kevin Wallace Sterling, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [56]

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Okay. And lastly on coastal. Can you remind us -- do you still have some equipment tied up in coastal? And if so, the coastal market continues to improve, would you untie that equipment? And I believe some of your competitors may have some of their equipment still tied up as well.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [57]

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Yes. We do have some tied up, not a lot. And I do believe that's true on our competitors, too. Look, there's a cost to bringing it back off the bank. And that could be an impediment for some of that tied up equipment to come back. But I don't think it's a meaningful amount. And because of -- you might imagine, most of that tied up equipment's on the older side. So in my view, it's more likely to be retired than it is brought back in service.

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Operator [58]

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Thank you. This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Eric Holcomb for any closing remarks.

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Eric S. Holcomb, Kirby Corporation - VP of IR [59]

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All right. Thank you, Daniel, and thank you, everyone, for joining us today. If you have any additional questions or comments, feel free to reach me at (713) 435-1545. Thank you, everyone, and have a good day.

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Operator [60]

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