Kirby Corp Q1 FY2021 Earnings Call

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, which 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 including the impact of the COVID-19 pandemic and the related response of governments on global and regional market conditions and the company's business. A list of these risk factors can be found in Kirby's Form 10-K for the year ended December 31st, 2020. I will now turn the call over to David.

Thank you, Eric and good morning everyone. Earlier today, we announced a net loss of $0.06 a share for the 2021 first quarter. The quarter's results were heavily impacted by the continuing effects of the COVID-19 pandemic and winter storm Uri, which brought extreme cold temperatures to the Gulf Coast during February and virtually shut down the Gulf Coast refining and petrochemical industry for the balance of the quarter. I'd like to start by talking specifically about the major winter storm and the significant impact it had on Kirby and our customers. It has essentially pushed back our recovery a full quarter. The storm descended into Texas and Louisiana in mid-February bringing with it a severe cold wave. During the storm, the Texas electric grid collapsed, plant infrastructure and pipelines froze, and business came to an abrupt halt. Our customers' facilities were forced into hard emergency shutdowns which contributed to unit damage even beyond what typically happens with events like hurricanes where an orderly shutdown can be planned and implemented. As a result, refinery and chemical plant utilization and production levels plummeted for an extended period. In the refining complex, utilization in PADD 3 which is the Gulf Coast declined to 41%. This represents the lowest level on record in EIA's published data. It did not fully recover back above 80% until the end of March. In petrochemicals, the impact was also extensive, stretching across the entire Gulf Coast petrochemical complex and impacting our major customers. Operating rates at nameplate ethylene plants in Texas declined from 86% in January to just 40% in February and March corresponding to the 51% decline in production and feedstock consumption. At the height of the storm, the majority of capacity and production was offline including 75% of US ethylene capacity, more than 80% of US olefins capacity, 90% of ethylene glycol production, more than 80% of polypropylene production, 65% of propylene production and over 60% of epoxy resins production. Overall, the damage was so widespread and severe that some of our largest customers have just recently restarted their plants and are not yet back to full production levels. With this impact on our customers, it goes without saying that Kirby's businesses were also significantly impacted, particularly in inland where demand and overall volumes materially declined in February and through a large portion of March. As you would expect, this had a negative impact on pricing, which had stabilized prior to the storm. Distribution and services were also impacted by the storm with most of our locations in Texas, Oklahoma, and Louisiana closed for several days contributing to reduced activity, lower revenue, and project delays. Overall, we estimate the winter storm directly contributed to losses totaling approximately $0.09 per share during the first quarter. Looking at our segments, in Marine Transportation the inland market started the quarter with gradually improving demand as economic activity was improving and refinery utilization had returned to levels not seen since the summer of 2020. However, this upward momentum sharply reversed as the winter storm set in and refineries and chemical plants along the Gulf Coast abruptly shut down. These weak market conditions contributed to continued pricing pressure in the quarter, with further reductions in both average term and spot pricing. However, towards the end of the quarter refinery utilization recovered to over 80% and most chemical plants came back online. As a result, our barge utilization recovered late in the quarter and by early April, it was over 80%. Importantly, this improvement contributed to stabilization and modest gains in spot market pricing in the last few weeks. In coastal for the quarter, market dynamics were largely unchanged sequentially, with continued low demand for refined products and black oil transportation. This contributed to minimal spot requirements and low barge utilization. In Distribution & Services, we experienced improved demand throughout much of the segment, which contributed to sequentially higher revenues and a return to positive operating income. The most significant improvement came from our oil and gas businesses, which experienced increased demand as US rig counts and frac activity continued to recover from lows seen in the pandemic. In manufacturing, incremental orders and deliveries of new environmentally friendly and remanufactured pressure pumping equipment as well as some seismic equipment contributed to the quarter's results. There was also increased demand for new transmission parts and service in our oil and gas distribution business from major oilfield customers. In commercial and industrial, the continued recovery resulted in sequential improved demand levels in our on-highway and power generation businesses. Marine repair activity also increased with higher demand for major overhauls following the dry cargo harvest season in the fourth quarter. These gains, however, were offset by reduced product sales in Thermo-King as a result of supply chain delays and lower new engine sales in Marine repair. When combined with closures and lower activity associated with the storm, there was an overall sequential reduction in commercial and industrial revenues. In summary, the first quarter was tough and the freeze ultimately pushed back our recovery. In a few moments, I'll talk about the remainder of 2021, including our more favorable outlook in the second half of the year.

Thank you, David, and good morning, everyone. In the 2021 first quarter, marine transportation revenues were $301 million with an operating income of $1.9 million and an operating margin of 0.6%. Compared to the 2020 first quarter, marine revenues declined $102.3 million or 25%, and operating income declined $48.8 million. The reductions are primarily due to lower inland and coastal barge utilization and significantly reduced pricing in inland due to the impact of the winter storm. These reductions were partially offset by the acquisition in the Marine asset acquisition, which closed on April 1, 2020. Compared to the 2020 fourth quarter, revenues increased slightly by $1.5 billion, inclusive of increased rebuilds related to higher fuel prices, partially offset by a reduction in freight revenue. The reduction of freight revenue included lower pricing and volume reductions as a result of the winter storm. These were partially offset by a modest sequential increase in overall barge utilization. Operating income declined $27.2 million, largely due to the impact of significant disruptions and winter storm related volume reductions, particularly as it related to contracts of affreightment as well as lower term and spot pricing in inland, also contributing were seasonal wind and fog along the Gulf Coast, flooding on the Mississippi River and ice on the Illinois River. Additionally, we did incur increased maintenance employee costs in the quarter's results as we began to ramp up our operations in anticipation of increased activity levels. This will continue in the second quarter. During the quarter, the inland business contributed approximately 75% of segment revenue. Average barge utilization was in the mid-70s range, representing a significant reduction as compared to the low to mid-90s range in the 2020 first quarter, but was up from the high 60s range in the 2020 fourth quarter. Barge utilization continued to be impacted by the effects of COVID-19 as well as reduced refinery and chemical plant volumes as a result of the winter storm. Long-term inland marine transportation contracts are those contracts with a term of one year or longer contributed approximately 65% of revenue with 61% from time charters and 39% from contracts of affreightment. Term contracts that renewed during the first quarter were down in the high single digits on average. Average spot market rates declined approximately 5% sequentially and 25% to 30% year-on-year. However, late in the first quarter, rates stabilized and started to move off the bottom. During the first quarter, the operating margin in the inland business was in the low to mid-single digits. In coastal, our business continued to be challenged by significantly reduced demand for refined products in black oil as well as weak spot market dynamics. During the quarter, coastal barge utilization was in the mid-70s range, which was unchanged sequentially, but down from the low to mid-80s range in the 2020 first quarter. Average spot market rates and renewals of term contracts were generally stable. During the first 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 first quarter was in the negative mid-single digits. With respect to our tank barge fleet, a reconciliation of the changes in the first quarter as well as projections for the remainder of 2021 are included in our earnings call presentation posted on our website. Moving to Distribution and Services. Revenues for the 2021 first quarter were $195.9 million with an operating income of $2.9 million and an operating margin of 1.5%. Compared to the 2020 first quarter, Distribution and Services revenues declined $44.8 million or 19%, and operating income declined $0.8 million. These reductions are primarily due to the pandemic, lower oilfield activity and the winter storm, with the impact to operating margins mitigated by significant cost reductions throughout 2020. Compared to the 2020 fourth quarter, overall demand for our products and services steadily improved, with revenues increasing $5.6 million or 3% and operating income increasing $5.8 million. Favorable sales mix contributed to the increase in operating income. In commercial and industrial, increased economic activity results in improved demands for parts and services in the on-highway, power generation and marine repair businesses. However, lower sales of Thermo-King products, reduced deliveries of new marine engines and closures associated with the winter storm resulted in an overall sequential reduction in commercial and industrial revenues. During the first quarter, the commercial and industrial businesses represented approximately 68% of segment revenue. Operating margin was in the mid-single digits and benefited from favorable sales mix. In oil and gas, improving market dynamics in the oilfield contributed to a sequential increase in revenues and operating income during the first quarter. Our manufacturing businesses experienced sequential improvement with increased orders of new and environmentally friendly and remanufactured pressure pumping equipment for domestic markets and seismic units for international markets. Our oil and gas distribution businesses also improved sequentially with improved demand for new transmissions, parts and services by major oilfield customers but was partially offset by facility closures during the winter storm. For the first quarter, the oil and gas-related businesses represented approximately 32% of segment revenue and had a negative operating margin in the mid-single digits. Turning to the balance sheet. As of March 31, we had $52 million of cash and total debt of $1.35 billion with a debt-to-cap ratio of 30.4%. During the quarter, cash flow from operations was $103 million, which included a tax refund of $117 million. In the quarter, we repaid $120 million of debt and used cash flow and cash on hand to fund capital expenditures of $14 million. At the end of the quarter, we had total available liquidity of $776 million. Looking forward, capital spending in 2021 is expected to be approximately $125 million to $145 million, which represents nearly a 10% reduction compared to 2020 and is primarily composed of free cash flow of $230 million to $310 million in 2021. I'll now turn the call back over to David.

Thank you, Bill. Although the first quarter was very challenging, many of Kirby's businesses are seeing more favorable market conditions and improving levels of demand. I'll talk more about the anticipated recovery in each of our major businesses in a moment. But overall, we expect a sequential increase in revenues and a return to profitability in the second quarter. That said, the improvement in the second quarter will be muted due to the effect of lower pricing on contracts renewed in recent quarters, as well as increased spending in anticipation of a much busier second half. We anticipate improvement in the third and fourth quarters, as the economy continues to recover, refinery and chemical plant production continues to grow, and our barge utilization improves above the 82% to 84% we have seen in April. In the inland market, with our barge utilization starting in the second quarter over 80%, most refineries and chemical plants back online and improving weather conditions, we expect better results going forward. From a macro viewpoint, the economy is steadily improving and pent-up demand is significant. The winter storm reduced product inventories. And with higher commodity and product prices and increasing crack spreads, the economics for our customers are becoming increasingly more favorable. We believe this will drive increased production in the coming months, which should bode well for the inland market. With little construction of new barges and retirement of barges occurring across the industry, we expect an improvement in the spot market and our barge utilization to move up into the high 80% to low 90% range in the second half of the year. Market conditions are looking more favorable and spot market pricing appears to have bottomed, as we are now seeing some positive momentum. However, we expect it to take some time for reduced pricing on term contracts, which were renewed lower last year and during the first quarter to reset. Overall, in the second quarter, we expect revenues and operating income will sequentially improve due to higher barge utilization, improved weather and more favorable operating conditions. However, as mentioned, certain costs, including maintenance, horsepower and labor are expected to increase in the second quarter, as operations ramp up. Beyond the second quarter, we do expect third and fourth quarter revenues and operating income to meaningfully improve with better spot market dynamics. On a full year basis, as compared to 2020, given the tough first quarter and anticipated second quarter, we continue to expect revenues and operating income will be down year-over-year. The lower average barge utilization, reduced term contract pricing and the impact from the recent storm are the main drivers for the anticipated year-over-year decline. In coastal, our outlook has not materially changed. We expect coastal second quarter revenues and operating margin will be similar to the first quarter. However, we do expect coastal market conditions will begin to improve in the second half of the year, as demand for refined products and black oil increases, resulting in higher barge utilization and reduced operating losses in the second half of the year. Looking at Distribution and Services, we expect further growth in the second quarter and the remainder of 2021 driven by a more robust economy and increased activity in the oilfield. In commercial and industrial, we anticipate continued improvement in on-highway, with increasing truck fleet miles, some recovery in bus repair and increased parts sales, as a result of our new online sales platform. We also expect increased Thermo King product sales. In power generation, demand for new equipment parts and services is expected to grow as the need for 24/7 power becomes increasingly important. In marine repair, although activities remain strong, we do expect a year-on-year reduction in revenues, primarily due to reduced new engine sales. In oil and gas, we believe current oil prices will contribute to increased rig count and well completions as 2021 progresses. As a result, we expect to see higher demand for new engines and transmissions, parts and service and distribution as well as increased remanufacturing activities on existing pressure pumping equipment in the coming quarters. With respect to manufacturing of new equipment, an intensifying focus on sustainability and the desire of many of our customers to reduce their carbon footprint will likely result in increased demand for Kirby's portfolio of environmentally friendly equipment during the remainder of the year. Currently, we anticipate increased sales of new electric and dual-fuel pressure pumping equipment as well as natural gas power generation equipment. For Distribution & Services in the second quarter, we expect the economic growth anticipated manufacturing deliveries and increased Thermo-King product sales will drive sequential improvements in segment revenues and operating income with margins rising into the low to mid-single digits. For the full year, our expectations have not materially changed. We anticipate significant year-over-year growth in revenues and operating income with commercial and industrial representing approximately 70% of segment revenues; and oil and gas representing the balance of 30%. We expect D&S margins will be in the low to mid-single digits for the full year with the first quarter being the lowest and the third quarter being the highest, with the expectation that normal seasonality will likely result in some reduction in operating margins in the fourth quarter. In conclusion, the first quarter's results were disappointing. Although we expected lower pricing and winter weather to contribute to a sequential reduction in first quarter revenues and earnings, the winter storm threw us and many of our customers a curveball. Ultimately, the storm was a disaster for the State of Texas and created significant disruptions across the industry supply chain that will likely be felt for many months to come. We do anticipate improving markets as the pandemic eases and demand continues to rise, especially since product inventories for certain refined products and chemicals have fallen significantly in a very short period of time. Also, prices for many finished goods, including refined products, plastics and other consumer products are escalating at rapid rates. As a result, many of our customers are working hard to ramp up production, which will ultimately be positive for our outlook. So while the winter storm pushed back our recovery, looking forward, the underlying economic outlook remains strong. As a result, we firmly believe we will see improving results for the balance of the year. Operator, this concludes our prepared remarks. We're now ready to take questions.

Thank you. Our first question comes from Jack Atkins from Stephens. Your line is now open.

Okay. Great. Thank you for taking my questions. Good morning, everyone.

Hey, good morning, Jack. How are you?

Doing great, David. Thank you. To start on inland, can you help us understand the timing of contract renewals throughout the year? It sounds like you're expecting significant improvements in the second half. Can you explain how those contract renewals are spread out over the next three or four quarters? Additionally, what level of utilization do you think is necessary before contract rates begin to increase sequentially and we see a more substantial improvement in spot rates?

Yeah. Well, let me take the last question first because we're there.

Okay.

As of this morning, we are over 85% utility. In recent weeks, we've noticed a slight improvement in spot market pricing. However, the first quarter was challenging, and we experienced a sequential decline in spot pricing of about 5%. Term contracts saw a decline in the high single digits. The first quarter was really tough, and we need to manage our term contract portfolio, with about 65% of our revenues coming from these contracts, two-thirds of which will roll over in about 12 months. We need contract pricing to start moving upward, and the first step is to get spot pricing on the rise, which is beginning to happen now. We are extremely busy, and there's a lot of positive news out there. Our customers are returning to profitability across the board. Refiners, integrators, chemical companies, and even pressure pumpers are showing improvement. Recently, refinery utility hit 89% in PADD 3, and some of our public refining customers are projecting low 90s in refinery utilization for the second quarter. Commodity prices and crack spreads are increasing, airlines are hiring pilots, and the CDC has indicated that cruise lines could start operating in July. With the recent increase in utility, we feel quite positive. Our activity is growing, and we expect things to pick up significantly. We have been hiring mariners and started our training school in January in anticipation of increased volumes. To summarize, utility is improving, and as it rises above the mid-80% mark, pricing tends to shift upwards. Given the outlook, I believe this trend will continue. However, price resets for term contracts will take some time since they roll off gradually over 12 months. The good news is that 35% of our portfolio is based on spot pricing, which will adjust more quickly.

Okay. That's all really encouraging to hear. You're right, the outlook is very positive. I guess my follow-up question David, I think as we look forward there's a substantial amount of earnings power within your three different business lines. There is inflation on the broader economy though. And it's been a tough 12 months. I mean how are you thinking about the long-term earnings power of the business? Has that really changed in your mind given what's happened over the last 12 months, or do you still feel like this is a business that over time can see margins in the 20s, if you can get multiple years of solid price increases?

Yes, we believe we have significant earnings potential and can achieve around a 20% margin. The second quarter will likely be subdued due to ongoing low pricing challenges. As utility operations ramp up, we will incur some expenses to restore utility and remove equipment from inactive status. Therefore, we expect second quarter margins to be better than the first quarter, but still challenging. However, we anticipate improvements in the third quarter, with inland margins likely reaching double digits in both the third and fourth quarters. While it's difficult to predict, there might be potential for margins in the mid-teens or higher in 2022, depending on how events unfold. As we know, economic conditions can shift quickly. I believe inflation is generally beneficial for us. While wage inflation poses a challenge, commodity inflation positively impacts our substantial fixed asset base, such as our barges, as the replacement costs increase. This, in turn, hinders new supply from entering the barge market, which is advantageous. Overall, inflation benefits us, barring wage-related challenges. We are experiencing some recruitment pressures, but we have commenced classes at our training facility, which is the only one authorized to issue Coast Guard licenses to our mariners. We began these classes in January to prepare for the demand we are beginning to see.

Jack, I might just add on the inland marine side for instance one thing that's happened over the last year has not just been hunkering down, but there were really huge strides in a lot of areas. Like for instance when you look at the acquisition of Savage there's less SG&A number just now than there was before Savage. So I think there's been a lot of steps taken there not just focusing on where we could just get better. So I really do think that the actual inland marine business is better now than it was a year ago.

Absolutely. That’s great to hear. Thanks again for the call guys.

Thanks.

Our next question comes from Randy Giveans from Jefferies. Your line is now open.

Howdy, gentlemen how’s it going?

All right, Randy. How are you?

Great. So I guess starting with D&S, nice to see that kind of back in profitability and you mentioned continued improvement throughout the year. So which business segments for the D&S will be kind of the main driver of this improvement? And also, D&S business, obviously smaller now than it's been in previous years. So what kind of income can it contribute maybe on a quarterly basis by the end of the year? Are we thinking $5 million, $10 million, $20 million?

In D&S, we have our manufacturing business primarily focused on oilfield-related activities, along with our commercial and industrial business. We're beginning to see growth in the manufacturing sector, with labor utilization in the mid to high-90% range, and we are actively hiring. Our customers are increasingly concerned about their carbon footprint, leading to a rise in orders for environmentally friendly frac equipment, such as electric frac equipment and power generation systems that support electric operations. The demand has been steady. However, we rely on shipping for revenue recognition, so it may take some time to reflect in our financials. As previously mentioned, we expect the third quarter to show improvement; the first quarter was our weakest, and we anticipate the second quarter will be better, with the third quarter performing the best. Seasonal factors may affect the fourth quarter. Overall, we expect D&S revenue to increase year-over-year, initially projected around 30%, but it's now likely closer to 20% or perhaps even better due to strong interest in our eco-friendly equipment. In the commercial and industrial segment, we're seeing a rebound in the on-highway business and improving labor utilization, with hiring also taking place. Overall, D&S is progressing positively with a projected 20% revenue growth year-over-year. Margins this quarter are in the low single digits, but we expect to average around 5% for the year, and with our leaner cost structure, we anticipate high single-digit margins next year.

Wow, okay. And then looking on the inland side turning back to that, obviously, you're very positive on inland barge utilization right with your expectation for high 80s, low 90% later this year. That said, what are your thoughts on pricing right? When do you expect pricing to maybe reach those pre-COVID levels? And then when do you expect kind of customers to go back to term instead of just keep relying on spot pricing?

Yes, I believe spot pricing is beginning to rise. Recently, we’ve observed an upward trend in spot contracts. It may take some time for this to affect the pricing of term contract renewals, but it's approaching. We need spot pricing to surpass contract pricing, which is happening, and that will lead to changes in term contracts. The positive news is that when utility is in the mid-80% range, which seems stable right now and could even improve further, we can expect pricing to enhance significantly in the upcoming quarters. I'm not sure if that fully addresses your question, but everything is aligning for better conditions. However, I don't anticipate returning to the pricing levels we saw before the pandemic for several quarters. It's a slow process, much like turning an aircraft carrier; it takes time to roll over all these contracts. The average term contract lasts about 12 months, and while we do have some longer contracts, most are 12 months and renew gradually each quarter, so it requires patience. But it will happen. I can say we are quite optimistic about the current state of utility compared to years past.

And when we say contracts over 12 months' term those are typically long-term contracts where we add a lot of value and it's a strong relationship. And they haven't really been impacted with the volatility we've seen over the last year because of the pandemic; those are long-term good contracts and not drags on us.

Got it. Just to clarify, you mentioned that it could take several quarters to reach pre-COVID levels from our current spot prices. However, spot prices are increasing. Can you tell me how far we are from pre-COVID levels in terms of current spot pricing? Are we 20% below or 50% below?

Yes. I think spot prices have decreased by 25% to 35% compared to pre-COVID levels.

And Randy when you think of spot prices remember that spot for us occurs over a couple of months. So they're not built long, but it still takes time for voyages for trips to end and then new trips to begin and pricing. So that's why when we say we were muted in the second quarter it's simply because it takes a couple of months in order to start to transition.

Sure. Yes, these aren't five-day voyages. Yes. Thanks so much fellas.

Thank you. And our next question comes from Ken Hoexter from Bank of America. Your line is now open.

Great. Thanks.

Good morning, Ken.

Just to revisit the last question, when you mention that time utilization has increased to 85%, I want to clarify that it typically takes a few quarters for pricing to recover. Given that some pricing competitors have exited the market and we are seeing an acceleration, do you think the time frame remains the same as previously discussed? Or does the current tightness and rapid rebound affect that timeline, or is it still dependent on contract timing?

Yes, it's really a combination of factors. The speed of this situation has been unexpected. In the first quarter, we averaged around 75% utility, and now we’re at 85%. So, in just about a month, we’ve increased utility by 10%. I believe this momentum will continue. I don’t expect us to reach 95% next month, but things are looking promising. The faster utility rises, the quicker spot pricing will increase. Pricing might actually rise more rapidly than in previous cycles due to the strong recovery. However, there are no guarantees. Many factors affect pricing, but the current environment is favorable. Our industry's players are eager as it has been a challenging year and a half, impacting all of us, including our competitors. Additionally, new construction has been limited. This year, there are very few new orders, with reports indicating only about 36 barges scheduled for delivery, all of which were ordered over a year ago. With no new construction and a significant rebound in utility, there’s a lot of demand from operators who have been struggling. Everything is aligning well, but I wouldn’t predict a 25% increase in a quarter. Nonetheless, it should remain quite active.

Okay. So when you're looking at the inland market fundamentals, you're not seeing any, kind of, obviously you just mentioned the order book is really thin continued retirements so not seeing any. How about the cost side of the equation? Incremental costs as you mentioned tugs, new boats needed for the snapback to mute this. And any update from what you're hearing from the refineries?

The cost structure is rising, and we will experience some wage pressure. Our mariners will receive a raise this year, which they certainly deserve. We are seeing increased costs in food and energy, and fuel costs are up, along with supplies. Currently, I would estimate inflation at around 3% to 4%. Steel prices are a different story, but we are actually pleased that steel prices are increasing because it indicates a slowdown in construction. While we will face some inflationary pressure on costs, pricing should be able to manage that effectively. Regarding refineries, they have expressed optimism. Crack spreads have rebounded, and we are beginning to see a return of jet fuel demand. Leisure travel is significantly up, though business travel has not fully recovered yet. The refineries are eager for more jet fuel, and some airlines are hiring pilots in preparation for a stronger June. Our refinery customers are aiming for utility rates of around 90% to 94% in the second quarter as they get ready for the summer driving season. Overall, the sentiment from our customers is the most positive we've experienced in years.

That's really nice. So if I can just sneak one more in, in terms of your perception your historical perception, perspective I guess just with past recoveries. I mean, how do you view this, I don't know maybe go back to 2015, 2016 or anything even prior to the speed with which you're looking at on this recovery?

That's a great question. I believe it could happen faster since it declined quickly, so the recovery might follow suit. However, it's always risky to claim that it will return faster than in previous cycles. The phrase "it's different this time" is often misleading. Still, the decline was rapid, with a 10% decrease in one quarter being significant, which we haven't seen before. So, there's a possibility it might recover quickly. I just want to be cautious in saying that it's much different this time. Nonetheless, it did drop sharply, and hopefully, it will rebound soon.

One thing to note is that the market was recovering at the end of January when the deep freeze occurred, which caused PADD three to drop to historically low levels for the refineries. This situation created a nice recovery, but the deep freeze disrupted it and caused a decline. The rebound from this is significant as things have started to recover. The combination of these factors is unprecedented. If you look at our utility's performance over recent months, the upward trend has been quite steep, and when we compare that internally, we don't see similar patterns.

Very helpful. Thanks Dave. Appreciate the time. Thanks.

All right. Thank you. Take care.

Thank you. And our next question comes from Jon Chappell from Evercore ISI. Your line is now open.

Thank you. Good morning.

Good morning, Jon.

David, I want to revisit an answer to one of Jack's questions. I believe you said in one of the prior conference calls that your operating margin in inland was approaching 20% before the pandemic. But then you mentioned 2022, you might see mid to high teens margins despite all the positive commentary you've given both on the macro and from your customers. I'm just wondering has anything structurally changed with that business where peak or even mid-cycle margins may be lower going forward, or is it just a slower return to where you were early 2020 just given the depth and the duration of this downturn?

It's more of the latter. Nothing has structurally changed. In fact, our cost structure is likely the best it has been in recent years. We reached 20% on inland margins at one point pre-pandemic. While I would love to say we could return to 20% by the end of this year, it will take time to roll out these contracts, as it’s largely a mathematical issue. Approximately 20% of our contracts are renewed each quarter, with the fourth quarter typically being stronger. The overall portfolio's margins will take time to improve. The initial set of price increases will not be as impactful as the subsequent ones. I wish we could quickly return to those higher margins, but practically, it will take time for the entire contract portfolio to roll over.

It depends on how tight the spot market is and how sharply it increases, as we have 35% spot market exposure and another 15%. If we look at the average from the first quarter, there's an additional 25% that wasn't active. The implications of these figures are quite significant. It's unprecedented for the company to see such rapid increases if the market tightens significantly.

Yes. Understood. And then David, this frequently comes up, but maybe it's most relevant today than any time in the recent past. I know you're sitting with $776 million of liquidity. You just mentioned that the entire industry has gone through an incredible period of pain. And someone like you are seeing it and I have to imagine others are seeing it in a much worse manner. I feel like post some of your recent M&A you brought more power in-house, you've modernized your fleet, you've improved your cost structure. Have we seen enough kind of light at the end of the tunnel where maybe some potential sellers think, okay, we're through the worst of it and maybe it's time to roll this industry up a little more, or is it still you need to see margins improve greatly and maybe asset values improve greatly before there may be some natural sellers in the market?

Yes. I would say there are some opportunities even now, but I think our view would be to delever a little bit more. It's more about our comfort with leverage. And we're going to hurt our free cash flow estimates. We're going to delever a little more get our balance sheet a little stronger, let margins pick up a bit. But certainly, I think there's some consolidation opportunities out there. And yes, it's been another tough period for all of us competitors included. So maybe there's some potential transactions out there. But again, near-term, we want to delever the balance sheet a bit more.

When reviewing the balance sheet, it's clear that several key points are worth noting. One important aspect is that our acquisitions involved new equipment. Currently, we are allocating approximately 60% of our depreciation to capital expenditures. This isn't due to any restraint on our part or a lack of action; rather, it's simply that the new equipment has alleviated that pressure. As we assess the situation, we anticipate being able to reduce our debt very rapidly, and we are indeed making swift progress in that direction. We also expect our credit metrics to improve quickly, allowing us to feel very comfortable with our position soon.

Okay. Understood. Thanks, Bill. Thanks, David.

And thank you. And our next question comes from Greg Lewis from BTIG. Your line is now open.

Yeah. Thank you. And good morning, everybody.

Hi. Good morning, Greg.

Bill or David, I was hoping you could explain the $0.09 charge. It seems to primarily stem from the cost side, but I'm curious how we should consider that $0.09 as we continue to refine our margins.

Yes. Most of it was due to marine activities and primarily related to inland issues. There were some repair costs because of damage amounting to roughly $1 million across the company, including some D&S. A significant part was tied to freight trips. We faced a deep freeze that prevented us from unloading and loading, which affected our contracts for affreightment. This accounted for about two-thirds of the issue. We couldn't reduce our horsepower because our customers were not active, leaving us with limited options. There were also other factors like harbor activities and boats outfitted but unable to operate due to shutdowns. We did not factor in the lost opportunity costs from low activity. Overall, it was mainly cost-driven, particularly because we couldn’t reduce horsepower.

Yes. Let me add a little bit on horsepower, Greg because it's an important thing. Look, we had probably 90 charter boats. And they're great guys and we cut all the way down to about 12 charter boats tried to keep as many on as we could to keep them working. They're a great part of what we do to deliver. And then we tied up probably 40 of our own boats. And it just takes time to bring all that equipment back in cost. And we weren't hiring people during that time. So attrition was working. So when you think about horsepower and everything that goes around it, it's taking time to ramp that up. And that's why we talked about muted second quarter that's putting that margin pressure. We've got to pull boats off the bank. We've got to rehire charter boats. We've got to train and hire new people. We've been running deckhand classes and mariner classes since the first of the year, which we did in anticipation of it. But my point is this, again, it's just like pricing it's going to take a while to get that up. We're going to have to expend some money. We're doing that, but it's all going in the right direction.

Okay. And it sounds like at this point that's pretty much wrapped up.

Yes. Not on the part David was talking about, but the storm element. But we're going to continue to be ramping up through the second quarter.

Okay. Perfect. I have another question about D&S. David, I'm interested in your perspective on the condition of the fleet. Is the pressure pumping frac fleet secured? There are clearly concerns about some cannibalization. You also mentioned in your opening comments the shift towards e-frac. How should we approach this as it develops throughout the year? You talked about improving margins. Should we expect that the significant advantages from this will materialize more in 2022 rather than in the second half of this year?

Yes, I believe we'll see some improvements in the second half, but 2022 is likely to be better overall. From what I understand, they're operating around 200 frac spreads currently. They are enhancing their capabilities and managing to perform more fracking with fewer resources. One of our major customers mentioned that approximately 10% to 12% of equipment is being retired annually, and any new additions are focusing on ESG considerations. They're replacing equipment with either electric options or dynamic gas blending to lower their carbon footprint. This trend is evident. For Kirby, the positive aspect is that we offer strong products, including both electric frac and electrification solutions for well site completions, which excites us. We are also starting to notice some remanufacturing pickup, although it will likely be a gradual process. There remains a strong focus on capital discipline, which is beneficial and healthy. Both exploration and production companies and pressure pumping firms are being very careful with their capital. Consequently, I don’t expect to see a significant spike like we witnessed in 2011 in the frac industry, where companies rushed to build as much as possible. Instead, the growth will be gradual, consistent, and more focused on ESG, and I believe this momentum will carry into 2022.

Perfect. Sounds good to me. Thanks guys.

Thank you.

Thank you. And our next question comes from Ben Nolan from Stifel. Your line is now open.

Good morning, everyone. I wanted to ask about the barge supply situation. I appreciate the information you provided earlier regarding the expected delivery of 36 barges this year. We often discuss the removal of barges, so an update on that would also be helpful. It seems that in weak markets, especially after what we saw in the first quarter, owners tend to store older equipment for a while. This usually affects the less desirable equipment first, and getting it back into service can be challenging. I'm interested to know if you believe this could be the case now, considering the industry's supply ramp-up might face difficulties due to stressed balance sheets and equipment that likely requires repairs. Any insights on that and the removals would be appreciated.

Yes, we don't know the exact numbers from last year, but this year we anticipate about 36 new builds based on feedback from our maintenance and operations teams. There might be some variance around that number, perhaps five or ten more or less. For retirements, we are currently planning 25 for 2021, specifically for Kirby, which offsets the 36 new builds. Other companies seem to be doing what you described, placing some of their older, less reliable equipment out of service. The industry is still experiencing very low prices, which may lead to reduced maintenance spending, and potentially scrap. With scrap steel prices rising somewhat, the economic factors might result in more retirements. I can't say definitively, but I wish I could predict 120 to 150 barges this year; I just don't have that information. When the market conditions change, it's surprising how much equipment can re-enter the market. However, bringing that equipment back can be challenging and costly, especially since older units, which tend to be the least reliable, are often the first to be sidelined. While they are idle, their condition worsens. Sorry for the lengthy response, but to summarize, we know there are 36 on order and we expect to retire 25, which we feel confident about. The wider question is how many units will be taken out across the industry; I believe it will definitely exceed our 25, possibly going over 100, but it's difficult to estimate at this moment.

Ben, it's really about getting the equipment and the crew back, among other factors. The supply response to demand will be challenging. As demand increases, it's tough to perform maintenance, and it's also challenging to staff properly. This issue is not just limited to Kirby; it's something that affects everyone.

Sure, I appreciate that. I know it's difficult to represent all owners out there. My follow-up question relates to the coastal area. Last year, David mentioned that as the market looked toward recovery post-COVID, coastal might see the sharpest V-shaped rebound. I'm curious if you still believe that coastal has the most potential compared to other areas you are considering.

Well, as you know the elasticity of demand so to speak is sharp in the coastal business because just bigger units of capacity and smaller fleet, right there's probably less than 300 coastal hubs – or excuse me ATB barges in less than 200,000 barrels. So it's a much smaller market, so when things start to move and get sporty. It's just a longer process when you think about bringing new capacity in, right, because it takes a good pull-through years to build a whole new unit. So when that market starts to come back, it will snap back probably stronger and stay up longer. It's just a much longer cycle. All that said, as you heard, we're losing money in coastal, it's still a tough market. We're starting to see refined products come back. So that's getting better. With the infrastructure plan, that could be better because there could be a lot of asphalt. We move a lot of asphalt and black oil products offshore. That said, there's also the overhang of one of our competitors that just went through bankruptcy and we'll see what happens to that equipment. It's been tied up and under maintained. So it's going to cost a lot of money for to be enter the market. But that overhangs out there. We're watching it carefully. Long and short of it, I feel pretty good about the supply and demand situation in the coastal market because there's no new delivery scheduled and it takes two years to build new equipment. So I feel pretty good about the supply. And when I think about demand with refined products coming back, which is the bulk of it gets moved in the coastal business, I feel pretty good about that.

All right. I appreciate it. Thanks, guys.

Thank you.

Okay. Operator, we're going to run a little long here and take one more caller.

Thank you. The last question comes from Justin Bergner from G.Research. Your line is now open.

Thanks, David. Thanks, Bill, for fitting me in. Good morning.

Good morning.

Most of my questions have been answered. So, just a quick clarification question or two and then one bigger picture question. On the clarification side, when you were talking about D&S and high single-digit margins next year, were you referring to the whole segment, or were you just referring to the commercial and industrial side? And then a second part of that clarification question was, you're talking about 90%-plus utilization on the manufacturing and remanufacturing side. Is that just kind of given the current tight labor that you have and that would not be as tight once you brought back some labor? It just seemed like a high number both of those?

Yes, we were talking about the whole segment on the margin. And on the labor, we use a lot of variable labor there. So our job is to keep high utilization. So it doesn't – there is volatility a little, because orders come in bunches. We tend to run it over the last year as we realigned as they've done a great job of realigning the business and managing it differently. We tend to run at a pretty high utilization.

When we mention high single digits for next year, we're referring to the entire segment. The manufacturing side is a bit more unpredictable due to its focus on the oilfield, while the commercial and industrial sector is generally more stable. We're currently hiring in both areas. Additionally, we've introduced a new digital platform over a year ago that is gaining traction in the commercial and industrial space for the industrial equipment we sell for OEMs. This digital platform reduces costs, making us optimistic about the performance of our D&S segment. I believe we will return to high single digits in 2022.

Okay. And then just one last big picture question. Clearly, your balance sheet is still levered and you're focused on de-levering. But if you didn't have the leverage balance sheet that you had today, where would you be putting free cash flow to work? Would you be continuing to consolidate the inland industry, or would you be looking at other diversifying sources of acquisition, or would you be focusing on share repurchase? Just trying to get a sense as to where your capital allocation priorities lie once the balance sheet delevering is...

Yes. I would say, continued consolidation in inland is always pretty close to the top of our desire when our balance sheet is strong. But also buying back stock is something we've done over time. So it's one of those two things. I think continuing to consolidate the inland business is a good thing because that's just good for the whole industry structure. We've got 30 players in there, and I'd love to see it about 15. So we'll see, but yeah, I know that's probably another non-answer but it gives you a feel for how we think about it.

And Justin, when you look at the inland acquisitions you can see it in our numbers as I said earlier on the call, we make an acquisition like Savage, and that we have huge synergies. We end up having the SG&A to actually has come down year-over-year for inland, which even though we added that. So the synergies are very apparent there and generate a lot of value for us.

Okay. Thank you.

All right, Justin.

Thank you, Justin. Thanks everyone for joining us on the call today and for your interest in Kirby. If you have additional questions, you're welcome to reach out to me today. My number is 713-435-1545. Thanks everyone. Have a great day.

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