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

Q2 2019 Kirby Corp Earnings Call

HOUSTON Jul 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Kirby Corp earnings conference call or presentation Thursday, July 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

* Kenneth Scott Hoexter

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

* Michael Webber

Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst

* Randall Giveans

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good morning and welcome to the Kirby Corporation 2019 Second 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 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 second quarter revenue of $771 million and earnings of $0.79 per share. This compares to 2018 second quarter revenue of $803 million and adjusted earnings of $0.78 per share. Although revenues were down 4% year-on-year, adjusted earnings per share were flat with a nearly 40% increase in marine transportation operating income, offsetting the impact of reduced distribution and services results. We'll discuss the second quarter in more detail in a moment, but before we do, I want to first discuss our announcement that we are lowering our 2019 earnings guidance range to $2.80 to $3.20 per share.

Although we believe we have strong momentum in marine transportation, reduced expectations for the second half in our oil and gas distribution and services businesses and the extensive delay days in inland marine throughout 2019 will impact our full year. In distribution and services, although our previous guidance range contemplated some downside in the second half of 2019, the pace of new orders, maintenance activities and part sales have slowed considerably. Discussions for new and remanufactured pressure pumping equipment orders continue, however, it is clear that many of our customers are intensely focused on free cash flow and returns and as such, are operating at very reduced levels of spending.

While this is not a good news for 2019, we do believe this level of spending will ultimately create a more ratable market and less volatility in 2020 and beyond. Additionally, with limited new bills, remanufacturing and maintenance activities ongoing today, we believe this low on activity is creating pent-up demand.

While completions activity has slowed in 2019, our customers continue to work their equipment incredibly hard. With minimal investment and maintenance being performed today, this should benefit our manufacturing and remanufacturing businesses in the future.

Despite improved performance in our marine transportation businesses year-to-date, the financial impact from poor weather, high water conditions and closures of key waterways in 2019 has been significant. This year, we have experienced extensive periods of ice and fog and we are currently in the midst of the most prolonged period of flooding and high water conditions on the Mississippi River and her tributaries in modern history. Further, the lock maintenance and infrastructure projects throughout our network have significantly slowed operations and the Houston ship channel, which is important to our operations has experienced extended periods of delays and closures. Year-to-date, through June, we've incurred more than 7,900 delay days, which represents an 86% increase compared to the first 6 months of 2018.

We estimate that these conditions and incremental delays have cost inland marine about $0.10 per share thus far in 2019. And although the high water conditions are improving, we expect the high water will continue into mid-August. So the guidance reduction is primarily due to what we are experiencing in the oil and gas markets, but there is also a component related to the marine operating environment.

Moving back to the second quarter, in inland marine, we experienced a solid rebound in financial performance following a slow start in the first quarter. Strong customer demand, improved pricing and consistent barge utilization rates in the mid-90% range, all contributed to more than a 30% improvement in operating income compared to the first quarter.

As previously discussed, our inland operations, particularly our contracts of affreightment were heavily affected by significant delays in this quarter, which were nearly double the second quarter of 2018. The impact is evident in our ton-miles, which declined 5% year-over-year despite an 8% increase in barges and a 9% increase in barrel capacity.

In addition to the effects from high water and lock issues, we were also delayed and impacted by a temporary closure of the Houston ship channel due to a storage fire -- a storage facility fire.

Ultimately we estimate that the poor operating conditions and extensive delays negatively impacted inland second quarter earnings by approximately $0.05 per share.

In coastal, we reported sequential financial improvement with an 11% increase in revenues and reduced shipyard maintenance contributing to positive operating income. During the quarter, we experienced good customer demand and a tighter market for larger capacity vessels.

Overall, our barge utilization levels increased into the mid-80% range, with higher usage on our equipment working in the spot market. Spot market pricing was flat compared to the first quarter, but we did experience mid-single-digit pricing increases on term contract renewals.

In distribution and services, as we indicated, results were challenged by widespread reductions in customer spending within the oil and gas sector, with only a few new orders booked, minimal maintenance and service activities performed and reduced part sales.

We implemented cost reduction initiatives during the quarter and we will continue to adjust our business as needed to limit the impact.

In commercial and industrial, we experienced a sequential increase in revenue and operating income, primarily due to additional deliveries of backup power systems in our power generation business. The Marine sector was stable during the quarter.

In summary, marine transportation had a good quarter. Strong sequential gains were realized in inland despite extensive delays and challenging operating conditions and coastal returned to profitability.

Although distribution and services executed well on its backlog, slowing activity in the pace of new orders were worse than anticipated and we have revised our full year guidance down as a result.

In a few more moments, I'll provide more details about our outlook, but before I do, I'll turn the call over to Bill to discuss our second 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. In our marine transportation segment, second quarter revenues were $404.3 million with an operating income of $53.2 million and an operating margin of 13.2%, compared to the same quarter of 2018, this represents a 7% increase in revenue and a 39% increase in operating income. Compared to the first quarter, revenues increased $36.2 million or 10% and operating income increased by $17.8 million or 50%.

In the inland business, revenues increased 8% year-on-year due to increased customer demand, improved barge utilization, increased pricing and the contribution from acquisitions. These were partially offset, however, by the impact of a 92% increase in delay days compared to the 2018 second quarter. Compared to the first quarter, inland revenues increased 10%, primarily due to the Cenac acquisition and higher pricing.

During the quarter, the inland business contributed 77% of marine transportation revenue and the average barge utilization rate was in the mid-90s. Long-term inland marine transportation contracts or those contracts with the term of 1 year or longer contributed approximately 65% of revenue, with 63% attributable to time charters and 37% from contracts of affreightment.

Term contracts that renewed during the second quarter were on average higher in mid- to high-single digits. Spot market rates increased sequentially in the low to mid-single-digit range. Compared to the prior year, spot market rates were approximately 15% higher on average. During the second quarter, the operating margin in the inland business was in the mid-teens, although it was adversely impacted by the impacts of the high delay days on our contracts of affreightment.

In the coastal business, second quarter revenues increased 3% year-over-year, driven by improved barge utilization and higher pricing. Compared to the first quarter, revenues improved 11%, primarily due to seasonal activity in Alaska, higher barge utilization and reduced shipyard maintenance on several large vessels.

Our barge utilization improved into the mid-80s. 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 average spot market rates improved 10% to 15% year-on-year.

During the 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 second quarter was slightly positive.

With respect to our tank barge fleet, at the end of the second quarter, the inland fleet had 1,067 barges representing 23.7 million barrels of capacity. We expected in the year with 1,063 inland barges, representing 23.7 million barrels of capacity.

In the coastal marine market, during the quarter, we sold one barge and returned one small charter barge with a combined capacity of 165,000 barrels.

At the end of the quarter, we had 49 coastal 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 second quarter were $366.7 million with an operating income of $23.1 million. Compared to the 2018 second quarter, revenues declined approximately 14%, primarily due to lower activity in our oil and gas related businesses. This was partially offset by higher sales in power generation. Compared to the 2019 first quarter, revenues declined 3% and operating income declined $14.5 million, again, primarily as a result of reduced activity in the oil and gas related businesses. These declines were partially offset by higher revenues in power generation. During the second quarter, the segment's operating margin was 6.3% and was unfavorably impacted by the reduction of higher-margin oil field related revenues and increased sale -- sales of lower margin power generation equipment.

In our oil and gas market, revenue and operating income were down compared to 2018 second quarter due to softening of activity levels, which resulted in lower demand for nearly all our products and services, including new and overhaul transmissions, engines and parts as well as new and remanufactured pressure pumping units. Similarly, compared to the 2019 first quarter, revenue and operating income declined with reduced demand for overhaul transmissions, parts and pressure pumping unit manufacturing.

In the second quarter, the oil and gas related businesses represented approximately 55% of distribution and services revenue and had an operating margin in the mid-single digits.

In our commercial and industrial market, compared to the 2018 second and 2019 first quarters, revenue and operating income increased primarily due to growth in our power generation business. In the second quarter, the commercial and industrial businesses represented approximately 45% of distribution and services revenue and had an operating margin in the mid-single digits.

Turning to the balance sheet. As of June 30, total debt was $1.59 billion and our debt-to-cap ratio was 32.4%. During the quarter, we paid down approximately $73 million in debt. We remain focused on repayment of debt for the remainder of 2019. As of this week, our debt balance was $1.55 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. As previously discussed, we have reduced our 2019 earnings guidance to $2.80 to $3.20 a share. This represents a $0.50 per share reduction to the midpoint of our previous guidance range. We did reaffirm our capital spending guidance of $225 million to $245 million in the press release earlier today.

Looking at our segments, in marine transportation, we expect the inland market will remain tight with our barge utilization rates in the mid-90% range. With solid customer demand, modest increases in GDP, additional petrochemical capacity scheduled to come online and new Permian crude pipelines bringing additional volumes to the Gulf Coast, we believe activity should remain strong for the balance of this year and through 2020.

In the third quarter, our inland marine operations will continue to be challenged by near-term delays associated with high water conditions on the Mississippi River, as well we experienced a recent hurricane along the Gulf Coast earlier in the third quarter. However, improved efficiencies generated by better weather and increased pricing should yield modest sequential improvement in revenue and operating margin for our inland business in the third quarter.

In the coastal market, we expect utilization will remain in the low to mid-80% range for the remainder of 2019, with revenues and operating margins in the third quarter expected to be similar to the second quarter.

In the fourth quarter, however, increased shipyard activity on several large vessels and the seasonal end to activity in Alaska will result in reduced revenue and operating income.

Overall, in marine transportation for 2019, we now expect revenues to increase in the mid-to-high single digits year-on-year with operating margins in the low double digits to mid-teens range.

For our Distribution and Services segment, I've already largely covered the second half outlook for the oil and gas sector. In our commercial and industrial markets, we expect revenues to decline in the third quarter, primarily due to reduced large power generation system installations. Additionally as water conditions on the inland waterways improve, we expect reduced service activity in our marine repair business. It is likely that much of the available towboat horsepower will be needed in the dry cargo area to catch up from months of delays. These reductions should be partially offset by higher utilization in our power generation rental fleet during the summer storm season along the Gulf Coast.

In total, for distribution and services, we expect third quarter revenue to decline in the mid-teens percentage range compared to the second quarter, with reduced deliveries of pressure pumping and backup power generation equipment being the main drivers.

Operating margins are expected to be slightly down sequentially, with ongoing cost reductions keeping margins relatively stable.

For the full year, we expect revenues to decline in the high single digits year-on-year. The revenue composition for the full year is expected to be approximately 55% oil and gas related and 45% commercial and industrial related.

Operating margins are expected to be in the lower end of the mid- to high-single-digit range. Overall, for our full year guidance, the lower end assumes further weakness in the distribution and services, oil and gas market, including limited demand for engines, transmissions and parts, reduced volumes of transmission overhauls and minimal orders for new and remanufactured pressure pumping equipment. The high end assumes meaningful improvement in inland marine operating conditions and further pricing momentum.

It also assumes some improved contribution from the distribution and services, oil and gas related businesses, including incremental orders for pressure pumping equipment and remanufacturing as well as greater volumes of transmission overhauls and equipment and part sales.

Now to sum things up, overall, we had a good second quarter. Inland marine bounced back nicely, following a challenging first quarter, despite increased delay days. In coastal, we generated a profit, utilization rates improved and term contracts continue to renew higher. As we look forward, despite near-term spending cuts and uncertainty in the oil field, we remain excited about Kirby's long-term outlook and earnings potential. In inland marine, we put our strong balance sheet to work during the downturn, successfully completing and integrating several key acquisitions, which have well positioned Kirby to capitalize on the upcycle. Today our fleet is nearly 30% larger in barrel capacity than it was at the bottom of the cycle in 2017. We have the largest, youngest and most efficient fleet in our history and our results are starting to show the benefits.

With continued strong demand on the horizon and current pricing momentum, inland marine is positioned to continue to deliver increases in revenue and earnings as the market recovery continues.

In coastal, our actions to rightsize the fleet, improve horsepower efficiency and reduce our cost structure have paid off as evidenced by the return to profitability in the second quarter. In the fourth quarter, we will have several vessels in the shipyard for majors, some of which are being brought forward to ready the equipment for new contracts into 2020, with most of our large capacity major shipyards behind us by the end of this year, we anticipate higher term contract renewals in the coming quarters and coastal should be in a position to be more consistently delivering positive earnings in 2020.

In distribution and services, while the U.S. oil field will present some temporary challenges and reduced returns in the near future, we remain optimistic for the long-term outlook for our oil and gas related businesses.

Shale oil and gas are a significant contributor to the world's energy supply and we believe it will be so for the next few decades. The near-term minimal levels of investment and maintenance activities on existing equipment is unsustainable and this trend will reverse at some point. Additionally, there continues to be significant customer interest in new horsepower capacity to improve fleet operating efficiencies and reduce environmental footprints.

Pipelines from the Permian are expected to start coming online soon and when they do, completion activity should ramp up. Kirby is well positioned to capitalize on these opportunities.

Today, we're the largest non-captive new and remanufactured pressure pumping equipment provider in the world. We have leading capabilities and experience in high-efficiency electric and noise reducing fracturing equipment. Furthermore, our wide OEM distribution territory covers the majority of the U.S. oilfield. This places us in a firm position to capitalize on increased sales and service of engines and transmission and parts. While the near-term may be challenging, I firmly believe that our shareholders will be rewarded nicely in the coming years. Operator, that concludes our prepared remarks. We are now ready to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Ben Nolan with Stifel.

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Benjamin Joel Nolan, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [2]

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My first question relates to the D&S side of the business. And I think we -- and the market has expected there to be a slowdown coming there given what's going on in the oil patch. My question though relates to sort of how are you thinking about that business strategically right here, is it, given that it's a little slower now but you expect it to get better or you're just kind of battening down the hatches and waiting for the storm to blow over? Is there a shift maybe to a little bit more international business or something like that? Is this something where you might look to be opportunistic, like you do in the barge business and find somebody that is a potential acquisition target that can't weather the storm to the same extent that you can? Just curious, how you are thinking about it, I guess?

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

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Yes. Good set of questions, Ben. Look, we believe, as I said in our prepared remarks, that this shale phenomena, if you will, is going to last for a few more decades and we are positioned strategically

pretty strong in that business. So it's really at this point, it's battening down the hatches, as you said. We're cutting cost as you would expect, eliminating discretionary spending. We've reduced headcount in the manufacturing areas in our in and around pressure pumping by about 22% so far year-to-date. We're going to batten down the hatches. Keep this business as profitable as we can.

And to your other part of your question, we continue to grow our commercial and industrial sides of the business. Backup power generation continues to grow. It's got a nice healthy growth profile. As the world becomes more and more data intensive, backup power becomes more and more important. So we're investing manpower into those areas around commercial and industrial. So we're kind of happy with the portfolio as it is. You may see us look for a tuck-in acquisition that beefs up some part of that business, maybe in the commercial and industrial area.

In terms of buying more pressure pumping capabilities in this downturn which would be more of our playbook, I would say we don't need to. We've already got the largest non-captive manufacturing capability in the industry. We're where we need to be. Our 2 manufacturing facilities, one's in Oklahoma and one's in the Texas. Our remanned capabilities and our sites around the U.S. are strategically positioned.

So I think what we have to do is weather the storm, watch our cash flow, make the appropriate business adjustments and be ready for the inevitable rebound. And we do think that's coming. You can look at the Permian pipeline situation. There's a number of pipelines coming on at the end of the year. I think 2 at the end of the year, maybe a third in the first quarter of next year or the first half of next year. Plus there's a couple of natural gas pipelines coming on.

So if you assume a flat oil price, which is a dangerous assumption, I understand, all things being equal, Permian profitability should get better because the takeaway infrastructure is going to be there and that's going to reduce their cost profile and improve their netbacks.

So given where we are and world oil situation, I think it should be better, if not in '20, certainly, somewhere in and around there. So we're pretty happy with the portfolio as it is, is the short answer.

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Benjamin Joel Nolan, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [4]

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Okay. And then real quick, just as my follow-up. As it relates to the weather-related things, both in the first quarter and now in the second quarter, and even a little bit in the third quarter, just curious, for all of your chemical customers and everybody else, is there some degree of pent-up inventory or something else that needs to move that as things normalize, you could actually see a little bit of a spike in activity or something like that? Or is this simply finding maybe an alternative, more expensive means of transportation and there shouldn't be any outsized level of sort of short-term recovery activity or something like that.

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

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There may be a little. There is some pent-up demand, but we're working with our customers to meet their plant feedstock needs and their plant takeaway needs. That is -- the weather has helped the utilization in the industry, probably 2% to 3%. So post the pent-up demand work off, you could see utilization dip a little. But I will say this, the industry is basically fully utilized. There is almost no spare capacity out there. So we do need a little relief on that. It's been very, very tight.

But look, this weather will pass. We're hearing mid- maybe even late August when the high water situation will come down and will get back to more normal weather. This has just been an abnormal year.

The good news in my mind is that the demand-side is solid. Our customers have invested billions in new plants and new facilities and expansions. The feedstock situation that they have is fuel sustainable. They're getting low-price natural gas that helps run their plants and converts into some of the petrochemicals. Clearly, the light crude coming out of the shale is also a good feedstock source.

So when you look at the demand-side of our barge picture, it's pretty robust. We've got good feedstock position for our customers, they've been investing a lot and it should be good for a while.

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Operator [6]

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And 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 [7]

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David, I mean, you touched on it a little bit in terms of industrial distribution and services doing okay. Just kind of curious, as we think about D&S, beyond the oil and gas side of the business, you have different types of power generation, you have pleasure marine. I mean, I was reading that the pleasure marine business has been kind of soft here. And just thinking about that those businesses are tied to GDP. Are you seeing anything or how are those businesses sort of in D&S, the non-oil and gas business is holding up? And as we think about the revised guidance, did those -- any of those businesses have any impact to the guidance?

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

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No. They're pretty steady. Their GDP, I would say, let's take them in a couple of pieces here. I would say, in backup power generation that continues to grow, that's growing faster than GDP. It's been -- it's all about the data centers and the need for 24/7 power.

When you look at the marine repair business, the marine engine repair business that's actually been stronger year-over-year. Now when we go into the third quarter on the marine business, what's going to happen is because the dry cargo business has been impacted greatly by this high water situation, when we get a little better river conditions, they're going to put their -- all their horsepower to work moving grain and other commodities on the river system.

So we forecast a little bit in the third quarter, a decline in our marine engine repair business, just because we know our customers and they're telling us that they're going to work hard to catch up. There is a lot of pent-up demand on dry cargo movements.

So that's a little bit of the impact in our diesel marine business, but that's more short-term. As you look at the strength in the inland barge market and also the offshore barge market and offshore -- we're seeing a little bit on the offshore oil and gas too. The diesel marine business is probably going to continue to grow at GDP, maybe plus a little bit.

I think mining, which is part of our commercial and industrial that's down a little bit with the global economic concerns. Pleasure craft has actually been pretty stable for us. These are high net worth individuals as you know and so far it's been stable.

I would worry about that a little bit than economic downturn. So it's pretty much GDP plus maybe a little bit in that commercial and industrial sector.

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Gregory Robert Lewis, BTIG, LLC, Research Division - MD and Energy & Shipping Analyst [9]

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Okay. Great. And then just one more for me on the D&S as it pertains to oil and gas. And then you touched on it in you're prepared remarks, I guess that's why I'm going to talk about it a little bit. But you mentioned you frac and clearly you guys have benefited from that in 2019. How should we -- I mean how -- or at least -- or shall I say, how are you thinking about the absorption of this -- of these units? And then bigger -- and then -- I mean it might be still early in the game to understand this fully, but how are you thinking about the life cycle for revenue for Stewart & Stevenson and/or United? How are you thinking about that life cycle for the eFrac units versus say a conventional unit? Like how should we be thinking about that or trying to model that?

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

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Yes. A very good question. So eFrac is gaining a lot of attention right now and look, it's good technology. It saves the E&P company some diesel cost because natural gas is so cheap. So there's some attractiveness there. And it does have a lighter maintenance profile, right? I mean big diesel engines have a heavier maintenance cycle than a big gas turbine. Now that said, if a gas turbine goes down, it's a very expensive proposition.

But let me put eFrac in context. There's probably about 440 frac spreads out in the industry, right now, roughly, call it 400 to 450 in that ZIP Code. And I would say there are 13 to 15 eFrac spreads out there. So it's still a relatively small number. I do see it growing, but it probably in the next 10 years, it could get to 10% to 20% of the market. But I think that's going to take some time. There is also new tech -- other new technologies out there where they're doing gas blending with diesel and making some pretty good progress. There's a lot of different technologies out there that are working every day to lower the cost profile for our pressure pumping customers and their customers, the E&P customers.

So in that context eFrac is important. We're heavily involved as you know, with one of the key participants. We jointly develop equipment together and it's been pretty good for us. But remember, it's probably, it's less than 5% of the equipment out there now and it still got a long way to go before it's meaningful.

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Operator [11]

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And our next question comes from Michael Webber with Wells Fargo.

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Michael Webber, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [12]

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David, I wanted to follow up a bit on D&S. And so I guess one around expectations -- if I kind of dovetail growth questions on eFrac with the guide, it seems a bit like you're going to through in the towel for back half expectations. And if I think about the past 12 to 18 months, in other words -- a couple of larger eFrac orders that kind of came in that insulated your backlog a bit more than the market would've expected. And I think you mentioned there are 13 to 15 eFrac spreads out there, I believe about half of them are yours. And so I'm just trying to think about -- I guess it may be the follow-up to kind of growth question in terms of that business and how it evolves. Do you think you can develop a position within that eFrac market to where it provides a degree of insulation within your OFS business going forward? Or is that too optimistic? There could be -- if you're talking 10% to 20% of the market in 5 to 10 years and you're still clipping half of that, that could be a nice differentiator to your D&S business, but I don't know if that's sustainable.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [13]

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Yes. I don't -- look, we'll participate. We're clearly one of the key providers in the eFrac space. Does it insulate us from some like this big guide down? Maybe a little bit. I mean it certainly helped us a little bit this year with the eFrac orders. But I don't know that it's a game changer. We -- look, frankly, we were surprised by the level of the spending cuts by our customers and it's never good to be surprised. But look, we took action and it became increasingly obvious and we have cut cost. But i would say this, it's not like 2015 and 2016 where everything stop. I mean the rig count still relatively high to where it was back in '15 and '16. We know our customers are working the equipment and we're hearing that many of them are like "Boy, we're wearing out our equipment" and we also heard from a number of the bellwethers that equipment is trading out very quickly right now.

So I think this is more of a pause rather than a big '15 or '16 downturn. And particularly if these -- when these pipelines come back, if the oil price doesn't collapse, the profitability of the Permian has got to go up just because the takeaway capacity reduces the cost to get the product to market.

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Michael Webber, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [14]

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Got you. All right. That's helpful. Can see how it develops over the next couple of quarters and next few years. As it pertains to inlands, the inland market and your business in particular it's going to fought through, seems 2 or 3 quarters now in a row with kind of historic -- water issues. Pricing is at a pretty -- is at a very firm level, but it's going to -- it's still improving. It seems like a kind of linear eclipse and we would expect the second half of that March to peak level pricing, you'd start to see spot pricings to gapping higher particularly given the supply dynamics that seem pretty favorable in inland market for the next couple of years. I'm just curious when -- or do you think that's a fair characterization of how you would expect spot pricing to potentially move towards kind of really kind of peak levels? Or do you think it'll be a bit more orderly as well and is that something you would -- you think it's feasible for 2020?

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

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Yes. I think it'll be more ratable. I don't think we'll see spikes. I would say this, you say peak pricing, but the cost of doing business has gone up and it continues to rise. You know this, Michael, the cost of new barges is up. Part of that's the steel price. We're seeing labor pressure as it is most of the United States, right? We're pretty much in full employment. We're having to give some pretty healthy wage increases. And then there's the cost of compliance, as you are aware, there's Subchapter M which is inspected towboats and that adds a whole another layer of cost to the industry.

So we are getting the prices on a relative basis to prior cycles are moving up. But they need to move up in order to get even higher to get to justify new builds. Frankly, there is some new building now, but the current prices you can't get that return on capital. It needs to move probably another 20% to 30% higher to justify a return on capital on new equipment.

So I would factor that in and the thinking that you know the peak pricing has to go higher just because the absolute cost of doing businesses has risen for all the reasons I just discussed.

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Operator [16]

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And our next question comes from Ken Hoexter with Bank of America Merrill Lynch.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [17]

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If I could just kind of dovetail on Mike's question there. Just to what -- I mean the setup is great on the margin side, you're best in years it sounds like, noted mid-90s utilization pricing going up. I just want to understand though, David, you're saying that you don't see the industry now committing more capital to build assets, even with the direction that we're heading in?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [18]

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Yes. No, no. Yes. Let me clarify, good question -- good follow-up question, Ken, because we are -- the build book is probably 175 to 200 barges that are expected to be delivered this year. We know that probably the majority, well over a 100 of those are for replacement, not really new incremental growth. Think of it this way, we've been in a downturn for 4 years and we're just starting to get some positive free cash flow -- positive cash flow and many of our competitors need to build some replacement equipment.

We know, it's not appropriate for me to give you the list of competitors that are building replacement equipment, but that's a big part of the build and when you look out beyond this year, it's basically drying up. We're not hearing much of an order book beyond -- there's some that'll deliver in 2020, but when you start looking out to late '20 and into '21, the order book is pretty minimal. And that's because the pricing still needs to go higher to justify incremental new capital for growth. I do think the replacements, kind of, you have to do it. They are working the equipment and have got stuff retiring and they're going to have to replace it. And that's a big part of this year's order book in my mind.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [19]

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Great. So you gave a lot of great detail upfront in terms of what's going on, on the inland and coast-wise. Maybe just talk a little bit more about the coast-wise you talked about rates kind of coming up -- oh, I'm sorry margins finally turning positive here, it bounce up in the third quarter, but it sounds like a pullback in the fourth quarter given some of the maintenance that you saw. Maybe talk how are rates doing in light of that? And then maybe the outlook into '20 as we now have fixed, I guess, some of the overcapacity?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [20]

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Yes. Well, that overcapacity has been correcting itself, as you've heard us say. People are retiring equipment. We're seeing more of that. Ballast water treatment is impacting that a little bit. So it's gotten tighter particularly in the larger capacity vessels, 150,000-barrel up. Capacity vessels are actually pretty tight right now. In the 80,000 to 100,000 barrels or even the 50,000, it's still a little loose. But what we are seeing is more utilization. Demand continues to grow. Supply has been contracting. We saw a sequential spot. Pricing was flat. But year-over-year, it's up 10% to 15%. And then more importantly is term pricing. It's been up mid-single digits year-over-year. So we're hoping that cadence grows. We are seeing a pretty tight larger barge market. So as we look into 2020, as we said in the prepared remarks, we've got these shipyards at the end of this year, but we'll have all the bigger units done by the end of this year and '20 should be a little better because we won't have some big shipyards.

We did pull a couple forward to help with the customer contract as you would expect us to do. So I would just say it's much more constructive than it's been in probably 3 to 4 years. So we're really pleased with the direction it's heading.

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Operator [21]

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And our next question comes from Randy Giveans with Jefferies.

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Randall Giveans, Jefferies LLC, Research Division - Equity Analyst [22]

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Two quick questions for me. So in recent years, your full year guidance range has been around $0.30 following the 2Q results. Obviously, this year it's $0.40. So if you can kind of touch on why that wider range than normal? Also can you break out the range by inland versus coastal versus D&S? Meaning is the vast majority of the range based on uncertainty in the D&S business?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [23]

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Yes. Well, I think last year at this time, we were about 40% gap high to low too. But I hear you -- now look, our portfolio is just more diverse, so there's just more moving parts. So in the last several years we've kind of widened that a bit. The inland barge market has always been pretty ratable and adding coastal, it's got a little more variability adding the D&S businesses again and growing those, get a little bit more variability. So we felt we had to widen our range a little bit. We did narrow it. We were at $0.50 range, we've narrowed it to $0.40 this quarter.

I wouldn't read too much into that, Randy. And then in terms of the guidance, clearly, the D&S oil and gas business where these big frac spread orders can move the needle is part of that variability. There's also a big spare parts piece that's kind of the book and ship that happens when our customers are spending on quick repairs and maintenance. So that variability is a little more than we've had historically.

I think we said this earlier, they are so focused on cash flow right now. We've just seen a dearth of -- well, a lack of orders. Now that's not really sustainable. Sooner or later they're going to run out of other equipment to cannibalize. And they're also going to have to repair some stuff and replace it.

The other thing I would add is the revenue recognition, new standards, has added volatility. Think of it this way, under the new rev rec rules, if we ship a frac spread the last week of a quarter or if it slips into the first week of the next quarter, we just -- that's a pretty big swing in terms of our earnings and rev rec. So I like to beat up our accountants here internally. The accountants have made it harder and not easier to explain the business.

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Randall Giveans, Jefferies LLC, Research Division - Equity Analyst [24]

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Sure. That's fair. So what do you say, maybe $0.30 of the $0.40 is D&S?

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William G. Harvey, Kirby Corporation - Executive VP & CFO [25]

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We don't really look at it that way, Randy. We look at the whole business. So I wouldn't want to point to any one particular area of the business.

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Randall Giveans, Jefferies LLC, Research Division - Equity Analyst [26]

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All right. That's fair. So it's certainly some near-term headwinds, or possibly longer-term tailwinds on that side. All right, switching gears to inland. How has that integration of the Cenac acquisition been progressing? And as those barges roll off contracts from maybe 1 or 2 years ago, how much have the new spot or even term rates on those barges improved? And your expiration kind of for future expiration repricing here in the coming months?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [27]

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Yes. That's a good question. The physical integration has gone extremely well. One, we've been delighted with the quality of the equipment and more importantly, the quality of the mariners and the team that joined us from Cenac. We got top-notch salespeople, top-notch operations people, top-notch mariners. It's been a great addition to Kirby and the integration has gone extremely well.

Now to your contract question, they did have a big -- they were pretty heavily contracted and they had a number of multiyear contracts. And you can imagine, not their fault, but at the time they put those contracts into place, they were at much lower levels. And it's just going to take a while to roll off. Unlike Higman -- Higman rolled off quickly. They were much shorter-term contracts. Cenac has got longer-term contracts. So you've heard us say when we got Cenac that it wouldn't be accretive to this year and that's still pretty much true.

But getting into 2020, some of those contracts roll off and it should get more constructive. But that's not to detract from the acquisition. It's been a tremendous acquisition and again, we couldn't be happier with the quality of people and assets we got there. The assets are in really good shape and we've been delighted.

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Operator [28]

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(Operator Instructions) Our next question comes from Jon Chappell with Evercore.

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Jonathan B. Chappell, Evercore ISI Institutional Equities, Research Division - Senior MD [29]

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David, just want to follow-up a bit on inland first. You mentioned the postulates of pricing, spot pricing is up 15% year-over-year. So if we kind of aggregate that from the trough, how far we're up from kind of trough level pricing? How much of that is transitioned then into terms? So maybe kind of what inning are you in transitioning the spot uplift into marking term to market?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [30]

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Yes. We still have a -- let me answer the second question first. We still have a pretty big, as you heard in Bill's number, we still have a lot of spot equipment and as the market tightens, we'll start to see the customers look to term things up as they worry about unavailability. We're starting to feel that now. But there's still a fair, as you heard in our numbers, a fair amount of equipment that's a large percentage is in spot. But we are seeing more and more term demand.

That said, your first question, spot pricing is probably up. If you do a quick math here, up 20% plus from the trough, maybe 25%. If you just take a unit toe, for example, it's up more, but some of those trough unit toe prices were just really, really low. The lowest of low were probably up 30% from the lowest of the low. But on average, probably up 20%, maybe 25% from the average low on spot.

Term is just starting to move, we have seen that. It didn't go as low as the trough and the spot, so it's just started to rise. As you know, you need spot pricing above term for a while for those term prices to start moving. And as you heard, we're -- our term pricing on the inland side is up mid- to high-single digits and that's continuing to march forward as is term contract for a while.

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Jonathan B. Chappell, Evercore ISI Institutional Equities, Research Division - Senior MD [31]

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Okay. So that probably then transitions to the second question, which is the margin. Still in the mid and maybe the high teens, which is just off the bottom, but if we go back and look historically, the majority of the years or the last 2 decades, you've been well under the 20% range. So you need that term pricing then to really get the margin moving significantly? Is there something else that's required to move the margin significantly? And then maybe just the third part as a follow-up to one of your answers before, the labor tightness that you talked about, does that maybe put a ceiling on the potential margin upside to inland in this recovery?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [32]

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Yes. Look. I think if you adjust for high water and some other things, we were probably in the high teens this quarter in margins. And we would definitely get back to the 20s. We are seeing labor pressure, but we see that kind of every cycle, to be honest. Now the other cost, Subchapter M and some of those other costs will have to -- in order to keep the margins profile as in past cycles, we will have to have higher highs, so to speak. But you're precisely right when -- in order to get those margins really moving, we've got to get term pricing up and that's starting to move. If you think about our book of business over 60%, almost 65%, almost 70% of what we've got is term.

So those term contracts have to roll to get up into that 20% range. I fully believe we'll get there and I fully think -- I do believe we'll get to higher highs this cycle, just because, one, when we look at the leverage points of what we have in the cost savings, given our fleet size, we'll be able to transfer that into higher margins.

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William G. Harvey, Kirby Corporation - Executive VP & CFO [33]

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I think truly, when these are factor in, is just a fact these acquisitions have a lot of synergies in them.

And you look at our SG&A in that group and how it's been spread over more units, we have some cost pressures, but it's being -- for at least for us some of it's being offset by the economies of scale.

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Jonathan B. Chappell, Evercore ISI Institutional Equities, Research Division - Senior MD [34]

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Okay. So then just to be clear though. So weather normalizes, knock on wood. You're seeing the action in the term. You said, you're fully confident you'll get there. Is 20% margin handle early next year, sometime in 2020, kind of average till 2020 or are we still kind of too early in the innings to think about down the near-term ride?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [35]

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Yes, yes. I don't want to give guidance for next year is the problem here. I would say we're marching towards having that level of margin through most of the next year. But it -- I would -- the timing could be mid-2020s or -- but when you think at average, we're not prepared to give that yet. We just -- we need to look at how our contracts are going to roll off. I'm not trying to be too cute here. It's just -- we got to look at the contracts that are going to roll off in the next 12 months and how they pencil out. But I think directionally what you said is correct that we're getting closer and closer to that 20% plus margin. And I think all things being equal, we should be on the path to get there next year.

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William G. Harvey, Kirby Corporation - Executive VP & CFO [36]

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I'd well say Jonathan, your wording was correct. It's not too early to think about it. We just haven't -- we're just not -- it's just too early to put it into guidance for next year.

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Eric S. Holcomb, Kirby Corporation - VP of IR [37]

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All right, Jewel, we'll take one more caller.

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Operator [38]

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And our final question comes from Jack Atkins with Stephens.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [39]

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Just to follow-up on Jon's question there on marine margins for a moment. David, or Bill, if you care to chime in as well. I guess can you help us think through incremental margins at inland marine? When I think about the revenue growth looking forward, it seems to me, most of that's going to be price-driven because your utilization level is pretty high. How should we think about incremental margins on price? I guess that you got some inflationary costs, but I would imagine it would be fairly high. It look like it was close to 45% or 50% in the second quarter despite the high water issue. So if you could just kind of help us think through incremental margins at inland marine, that would be helpful.

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William G. Harvey, Kirby Corporation - Executive VP & CFO [40]

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I think your point is price will flow right through. We do have some pressures on inflation and there is inflation pressures, but again, that's a piece of it -- that's a piece of the puzzle. We are offsetting, as I just mentioned. When we look at ourselves, we look at ourselves and we look at our SG&A as a percentage of revenue, et cetera, it's pretty well controllable. What isn't controllable are actually going down. In relative terms for inland marine, what we -- what the factor that we can't control is some additional cost that you get with compliance and other things in operations. But the price flows almost directly through, Jack.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [41]

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But Bill is it safe to assume that the incremental margin level that you saw in the second quarter, even though it was hampered by high water issues, I mean that's kind of how we should be thinking about it going forward through the cycle?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [42]

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Yes -- now, be careful. You're looking at it sequentially.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [43]

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No. I'm looking at year-over-year incrementals.

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [44]

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Oh, year-over-year incrementals. Oh, okay. I thought -- because sequentially it is about 50% incremental margins. I don't know what they are year-over-year. But the pricing is as you know, Jack, is very high incremental margins, right? I mean it's in the high 70%, 80%, just pricing when you get that. So the only offsets really are kind of the operations cost and pricing, it's just -- it almost falls straight to the bottom line.

But let us do some work, maybe Eric can get back to you on some -- better thoughts on incremental?

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William G. Harvey, Kirby Corporation - Executive VP & CFO [45]

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I wasn't really thinking year-over-year, Jack, but -- so that's a different perspective. I think on the SG&A side, I know what went down year-over-year, but we tend to focus more on discrete cost elements than overall but it's a good question.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [46]

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Okay. That's helpful, Bill and David. Thank you and then just the last one for me. I would be curious to get your take, David, I know you talked a little about M&A on the D&S side, but what's your appetite for M&A on the inland side of the house? I know that there is at least one of your larger competitors that still are under a lot of pressure financially. I'm just being curious to get your take on -- you guys have done a number of larger deals here over the last several years. Do you still have an appetite for further consolidation in the inland market, if an opportunity or two were to become available in the next 12 to 18 months?

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David W. Grzebinski, Kirby Corporation - President, CEO & Director [47]

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Short answer is yes. I mean you know us. We like inland assets. It's probably when we do acquisitions, it's probably the easiest one for us to integrate. So we're always looking, always interested.

I will say this, our debts, as Bill said, 32.4% debt to total cap, that's a little higher than we'd like. We are paying down debt rapidly and we'll continue to pay it down until we get an opportunity. But if we had a big opportunity or an opportunity in the near term, there probably have to be some equity involved.

As you know, Jack, we covered our investment-grade rating, but we also love buying inland assets. So it'd be a balance, but as you know, it's also very hard to predict acquisitions and we are always disciplined about how we go about valuing them.

So it's a long way of saying, of course, we'd look at further consolidation for us. It just makes sense for us, but our balance sheet would be very thoughtful about how we deploy that.

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Eric S. Holcomb, Kirby Corporation - VP of IR [48]

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All right. Thanks, Jack, and thank you, everyone, for participating in our call today. If you have any additional questions or comments, you can reach me today at (713) 435-1545. Thanks, everyone, and have a good day.

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Operator [49]

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