Jul 26, 2012
Executives
Stephen Holcomb – VP, IR Joe Pyne – Chairman and CEO Greg Binion – President and COO David Grzebinski – EVP and CFO
Analysts
Jon Chappell – Evercore Partners Jack Atkins – Stephens Alex Brand – SunTrust Anthony Segoya – Credit Suisse John Barnes – RBC Capital Ken Hoexter – Merrill Lynch Kevin Sterling – BB&T Capital Markets Jimmy Gilbert – Iberia Capital Chaz Jones – Wunderlich David Beard – Iberia Steve O’Hara – Sidoti
Operator
Welcome to the Kirby Corporation 2012 Second Quarter Conference Call. My name is Trish and I will be your operator for today’s call.
(Operator Instructions) Later we will conduct a question-and-answer session. Please note that this conference is being recorded.
I would now like to turn the call over to your host, Stephen Holcomb. Stephen?
You may begin.
Stephen Holcomb
Good morning. Thank you for joining us.
With me today are Joe Pyne, Kirby’s Chairman and Chief Executive Officer; Greg Binion, Kirby’s President and Chief Operating Officer; and David Grzebinski, our Executive Vice President and Chief Financial Officer. During this conference call we may refer to certain non-GAAP or adjusted financial measures.
A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures is available on our website at KirbyCorp.com in the Investor Relations section under non-GAAP financial data. Statements contained in this conference call with respect to the future are forward-looking statements.
These statements reflect management’s reasonable judgment with respect to future events. Forward-looking statements involve risks and uncertainties.
Our actual results could differ materially from those anticipated as a result of various factors. A list of these risk factors can be found in Kirby’s annual report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission.
I will now turn the call over to Joe.
Joe Pyne
Thank you, Stephen and good morning. Our second quarter earnings of $0.85 per share came in at the high end of our revised $0.80 to $0.85 per share guidance range.
With respect to our Inland Tank Barge business it continued to perform well and operating results were above the 2011 second quarter results despite some temporarily lower petrochemical volumes from one major customer principally due to plant maintenance outages as well as low water levels on the Mississippi river which led to light loading tank barges since mid-May and throughout June. Our legacy Diesel Engine Service Marine business operating results were also above the 2011 second quarter results principally due to improvements in the Gulf of Mexico oil service market.
Demand for our coastal tank barge equipment was about as expected except for the New York Harbor market which was a little softer. Higher maintenance and repair related issues and lower revenues caused by delays, plants and shipyards addressing this maintenance negatively impacted the second quarter.
For our land-based diesel engine service market with the current low price of natural gas the incentive to drill for natural gas has been sharply curtailed. But the incentive to find crude oil remains positive.
As a result orders for manufacturing frac spreads have been curtailed but demand for remanufacturing existing equipment has improved. I’ll come back at the end of our prepared remarks and talk about the third quarter and the full year outlook.
I’m now going to turn the call over to Greg Binion who will discuss our Inland Tank Barge and Diesel Engine Service markets. And then to David who will discuss the Coastal Tank Barge market and give you our financial update.
Greg Binion
Thank you, Joe, and good morning to all. For the second quarter our Inland Marine Transportation sector continued its overall strong performance with high equipment utilization in the 90% and 95% range and higher term in spot contract pricing.
In mid-May we started to experience low water conditions on the Mississippi river system and reduced operating drafts. Those conditions persist today.
During the second quarter we also were affected by some scheduled and unscheduled maintenance at a major Petrochemicals customer facilities. These facilities are now back in service.
Black oil demand remains strong driven by continued stable refinery output and the continued exportation of heavy fuel oil. Also the movement of crude oil along both the river and the Gulf Intracoastal Waterway continues to be brisk.
I’d also note that we did load our first Balken crude cargo out of St. Louis over the weekend.
Refined product demand remains positive benefiting from additional volumes from major customers. In our Agricultural Chemicals demand driven by low inventory levels and high corn prices remains strong in April and May but it declined sharply in June as expected.
Revenues from our long-term contracts, that is one year or longer in duration, remained at 75% and the mix of time charter and the freightment business continue to be about 55% and 45% respectively. Turning to the Inland Marine Transportation pricing, term contracts during the second quarter continue to be renewed in the mid-single digit level with some cases slightly higher pricing when compared to the 2011 second quarter.
Spot contract pricing, which includes the price of fuel saw rates increase modestly when compared to the 2012 first quarter. We continue to invest in our Inland fleet both in terms of new construction and upgrading existing barges.
This reduces maintenance cost and out of service days and improves the reliability of the fleet and our customer service. During the 2012 first six months we took delivery of 20 new 30,000-barrel tank barges and eight new 10,000-barrel tank barges totaling approximately 650,000 barrels of capacity.
We retired 27 tank barges and returned three chartered tank barges, reducing capacity by about 470,000 barrels. So net, net during the 2012 first six months our inland tank barge fleet decreased by one but our capacity increased by approximately 180,000 barrels.
As of June 30 we operated 818 tank barges with a capacity of 16.4 million barrels. We also took delivery of two 2,000-horsepower inland towboats in the 2012 second half.
In May of 2012 we signed contracts for the construction of 36 new 30,000-barrel inland tank barges and 20 new 10,000-barrel tank barges all totaling approximately 1.2 million barrels of capacity. Three of the 30,000-barrel tank barges are currently planned for delivery in late 2012 and the balance of these barges will be delivered throughout 2013.
At the present time many of these new tank barges are anticipated to be replacements for older barges removed from service. For the second half of 2012 our construction program will consist of eight new 30,000-barrel inland tank barges and 22 10,000-barrel inland tank barges with a total capacity of approximately 450,000 barrels.
We will also take delivery of three additional canal towboats. The cost of the new inland tank barges and towboats during 2012 and progress payments made on barges and towboats delivered in 2013 will be about $130 million.
We also continue to retire older barges during the 2012 second half, and at the present time we anticipate that our 2012 year-end capacity will be approximately 16.5 million barrels or 350,000 barrels above the 16.2 million that we had at the beginning of the year. In the 2012 fourth quarter we will take delivery of two new offshore dry bulk barge tug units for the use under long-term contracts.
The cost is about $52 million for each of these units. During 2011 and the first half of 2012 we made progress payments on these units totaling approximately $65 million, and the balance will be paid during the 2012 second half.
Turning to our Diesel Engine Service segment. United, a land-based service provider as anticipated saw revenues and operating income decline, the result of order cancellation and postponement for the manufacturing of fracturing units, as well as modest declines in the service of land-based diesel engines and the sale of engines, transmissions and parts, all associated with the low price of natural gas and resulting declines in drilling for natural gas in the North American shale formations.
Partially offsetting the decline in manufacturing of fracturing units was the demand for remanufacturing of such units. However, it will take us several quarters for United to obtain its optimal efficiency level for the process of remanufacturing these units.
Currently United has 29 units in its facilities either in the process of being remanufactured or in the queue to start the process with commitments from our customers to send more units to be remanufactured as capacity becomes available in a reman facility. We said since we announced the acquisition of United that our vision was to move the majority of United’s business to service, including the reman of all service equipment along with parts and distribution as a means to establish a more stable revenue and earnings stream while preserving the ability to layer in manufacturing as the market present the opportunity to do so.
We are on the path towards achieving this business model. Our legacy Diesel Engine Service Marine business reported higher operating results benefiting from an improved oil service activity levels in the Gulf of Mexico as well as from international customers.
Business was also brisk for major overhauls and gear work for inland tank barge and dry cargo operators as well as coastal operators. The power gen market benefited from strong part sales and continued favorable engine generator set-up grades during the second quarter.
I’ll now turn the call over to David.
David Grzebinski
Thank you, Greg, and good morning. Let me start with Kirby Offshore Marine.
Overall equipment utilization was in the 75% range for Kirby Offshore Marine. The Pacific, Alaska and Hawaiian markets reported higher utilization levels, however the New York market, the New York Harbor market in particular, saw lower equipment utilization levels and corresponding competitive bidding for available movements.
During the second quarter we had an additional $500,000 in severance charges associated with the integration of Kirby Offshore Marine into Kirby. We had the negative impact of maintenance and repair-related equipment unavailability issues that negatively impacted results as well.
We continued – with continued low equipment utilization and excess capacity in the New York Harbor market during the second quarter, we did reposition four tank barges and two tugboats to the Gulf Coast market; and the repositioning costs for these moves were included in our second quarter results. With respect to pricing, contracts that renewed for Kirby Offshore Marine during the quarter and spot-contract rates were basically flat.
Approximately 60% of Kirby Offshore Marine’s revenues were under term contracts with 40% being spot contracts. Time charter is represented approximately 90% of the revenues under term contracts during the second quarter.
Moving to Kirby general financial data, late yesterday as you know we announced net earnings for the second quarter of $0.85 per share compared with $0.77 per share from the second quarter last year. For comparison purposes, the 2011 second quarter results included about $0.07 negative impact from the record-setting high water and flood conditions we had last year.
A continued strong perform in our Inland Transportation sector and the acquisition of Kirby Offshore Marine, which was effective July 1 of last year, resulted with our Marine Transportation segment revenues being 28% above and operating income 23% above the 2011 second quarter. The Marine Transportation segment second quarter operating margin was 21% compared to 21.9% from last year.
As Greg noted, during the second quarter our inland-marine transportation fleets 90% to 95% equipment utilization continued along with favorable pricing. The Inland sector contributed about 80% of the second quarter’s Marine Transportation segment revenue.
We estimate that the low water levels on the Mississippi River and the maintenance issues at a major petrochemical customer’s facilities negatively impacted the second quarter by about $0.03 to $0.04 per share. Despite these temporary negative issues, our Inland Marine operations maintained an operating margin in the mid-20% range for the second quarter.
Kirby Offshore Marine contributed about 20% of the second quarter’s Marine Transportation revenues. With the maintenance and repair-related issues negatively impacting earnings and an additional $500,000 severance charge coupled with the weak New York harbor market and the re-positioning costs, the operating margin at Kirby Offshore Marine was in the low single-digit range.
Our Diesel Engine Services revenue for the 2012 second quarter was in line with 2011 second quarter, which both periods included United. However, last year United acquisition was completed on April 15.
Diesel Engine Services operating margin – operating income was 14% lower than the 2011 second quarter and the second – and the segment’s operating margin was 8.9% compared with 10.3% for the second quarter last year. The decline in operating margin and operating income was due to the lower results from United, that Greg noted.
United contributed approximately 70% of the Diesel Engine Services segment revenue during the second quarter. With the decline in manufacturing revenue, specifically fracturing units, and replaced to some degree with remanufacturing of fracturing units, United earned an operating margin in the mid- to high-single digit range for the second quarter.
The legacy marine and power generation operations contributed approximately 30% of Diesel Engine Services revenue during the second quarter and they benefited from improved Gulf Coast offshore service market and some large overhaul projects for the inland and coastal marine customers that they have. We continue to generate significant cash during the first just of 2012, with EBITDA of $243 million.
Our capital spending for the first half was $154 million and consisted of $70 million for new inland tank barges and tow boats, $32 million for progress payments on the two new offshore dry bulk barge and tug units and $52 million primarily for capital upgrades to the existing inland and coastal fleet, as well as some spending on the Diesel Engine Services facilities. We have raised our capital spending guidance for 2012 to $290 million to $300 million range, including $130 million for construction of new inland equipment, approximately $70 million in progress payments for the two offshore dry bulk units, with the balance attributable to upgrades for the inland and coastal fleets, as well as some progress payments on – for the inland tank barges ordered in 2012 for late 2012 and 2013 deliveries.
As of June 30, we had $106 million outstanding on our $250 million revolving credit facility, and as of this morning, our revolver’s outstanding balance was $91 million. With respect to United earn-out, during the fourth quarter of 2012, based on United’s earnings, we booked $4.2 million or $0.05 per share in expense as our estimate of the earn-out increased.
During this second quarter, with the decline in natural gas prices and the subsequent weaker market for manufacturing of fracturing units, we held the contingent liability flat making only a slight adjustment to reflect the time value of money. As of June 30, we have recorded an earn-out liability of $26.9 million.
As there are 18 months remaining for the earn-out period, you can understand that we may be required to make further adjustments, either up or down to this contingent liability. We have consequently excluded any future changes to the earn-out contingent liability from our guidance.
With that, I’ll turn the call back to Joe.
Joe Pyne
Okay. Thank you.
Thank you, David. I’m going to talk about the outlook going forward.
Yesterday afternoon we announced our guidance for the third quarter of $0.87 to $0.97 per share. This compares with $0.94 per share earned in the 2011 third quarter.
The 2012 and 2011 third quarters are a direct comparison as the third quarter last year results included United purchased on April 15, 2011 as well as Kirby Offshore Marine, which was purchased July 1, 2011. For the year our guidance is $3.50 to $3.70 per share compared to the 2011 results of $3.33 per share.
As we stated earlier, our Inland Marine Transportation sector is doing well, favorable pricing trends and we anticipate that this is going to continue throughout the rest of this year and into next year. As I’m sure you’re aware, draught conditions in the Midwest have created low water conditions on the Illinois, Ohio and Mississippi rivers.
These low water conditions negatively impacted our second quarter as well as reducing drafts on our barges with destinations to up-river locations since about mid-May. That continues as we speak today and our third quarter guidance assumes that the water levels on this system will remain similar to where they are today.
We cannot predict rainfall in the Midwest any better than we can predict potential hurricanes, therefore we based our guidance on current weather conditions and water levels going forward, although we are beginning to see some rain in the Midwest, which is encouraging. Our third quarter guidance assumes our Coastal Marine Transportation business results should improve due to the seasonality of the refined products market as well as favorable operating conditions during the quarter.
Since we purchased our coastal fleet in July of 2011, we have said the Coastal market is not a next quarter or 2012 story but operating results should improve over the next couple of years as supply and demand becomes more balanced, leading to higher equipment utilization. And maintenance and repair expenditures should decline as we bring this fleet up to what we think are appropriate equipment standards.
Our maintenance strategy will improve this fleet’s performance as well as its profitability, and our long-term strategy for this business remains intact. Our guidance assumes our legacy Diesel Engine Service business will be similar to the second quarter results, reflecting continued good marine and power generation markets.
A more significant variable in the third quarter and the year guidance is United, with the decline of natural gas prices and its impact on manufacturing and remanufacturing pressure pumping equipment and service to the land-based oil and gas market. Even with this volatility, however, United remains profitable.
Its performance is consistent with our original acquisition pro forma and our initiative of focusing this business on the service side of the business will take out some of the future volatility. Operator, we’re now ready to open the call up for questions.
Operator
Thank you. (Operator Instructions) Our first question comes from Jon Chappell with Evercore Partners.
Please go ahead.
Jon Chappell – Evercore Partners
Thank you. Good morning, guys.
Greg or Joe, you mentioned at the very beginning the movement in crude oil in the intercoastal highway and along the river, I’ve been talking to a lot of oil traders and ship brokers about this potential market. I’m just trying to get a better understanding to what Kirby’s potential is to move excess crude from the Eagle Ford to the Texas region along the intercoastal highway and even your potential to potentially move it to the East Coast refineries where there may be a shortage.
Joe Pyne
Yeah. Jon, I’ll start answering and Great and David you can fill in the blanks.
There’s a lot of crude oil coming out of Eagle Ford which is South Texas. And that’s being moved by inland barge and in some instances coastal barge.
There’s also a gathering pipeline systems that are being installed in that market. And what we have said in the past is that we think that, that barge demand at some point is going to be capped.
We don’t think it’s going to go away, but we don’t think there’s going to be a lot of future growth coming out of South Texas. Now having said that the need to supply crude oil to east coast refineries is significant.
That’s going to be moved in larger vessels, these are the, you know typically ships in the 340,000 barrel range. KC’s biggest barge is 185,000.
That lends itself more to the refine products trade than actually moving crude oil. Where we do think there’s some offshore opportunity is the movement of some crude oil but also a lot of the condensate that’s coming out Eagle Ford to refineries that can use it by offshore equipment.
And that movement really is much better suited for barges that are in the KC range. How the east coast gets their crude oil is stills somewhat of a mystery.
There’s talk of bulk and crude coming into Albany by train. Some of that’s happening today.
We should have an opportunity to move some of that. I think we’ve already moved some of it.
You of course have the imported crude, which is expensive relative to U.S.-crude-based pricing. But I’m not sure that, that’s all been worked out yet.
You guys have anything to add to that?
Stephen Holcomb
No, not really.
Operator
Our next question comes from Jack Atkins from Stephens. Please go ahead.
Jack Atkins – Stephens
Good morning, guys. Thanks for taking my questions.
First, Joe, I was wondering if you could maybe just expand a little bit on your comments about the low-water issues on the Mississippi. Could you maybe talk about Kirby’s exposure to it?
Specifically whether this is more of an issue of the upper Mississippi River or are you guys seeing an impact of it as well down on the Gulf Coast Intracoastal Waterway?
Stephen Holcomb
No impact on the Gulf Coast Intracoastal because it’s open to the sea so if you lose fresh water you’ll gain salt water. With respect to the lower Mississippi, those drafts have been decreased to nine feet but frankly, since mid-May we’ve been loading the barges that we take up-river to that draft because the Illinois and the Ohio River were already there.
I think that in our contracts we do have low-water protection and we have minimum volume protection in most of the contracts. Where you may yet to be affected is if it continues to shoal, you’re going to see delays caused by dredging and you’re going to see some high-velocity currents as the river narrows.
You can anticipate that if we don’t get water but as I said in my remarks, you actually are getting a little water now. So let’s hope that the worst is behind us.
Operator
Our next question comes from Alex Brand from SunTrust. Please go ahead.
Alex Brand – SunTrust
Hey, good morning, guys.
Stephen Holcomb
Good morning.
Alex Brand – SunTrust
Just, Greg, when you had mentioned the spot pricing, I think you gave it sequentially. Can you just give what that was year-over-year as well?
Stephen Holcomb
Well, I think you gave it year-over-year.
Joe Pyne
The term was year-over-year.
Stephen Holcomb
Yeah, the term was year-over-year. The spot pricing was sequentially, so it was modestly better.
And so I – Alex, I think the way probably to think about that is that spot pricing has been about five to kind of – mid to high-single-digits above term pricing; term pricing’s moved up to that mid-single-digit range year-over-year. So I think that – think about it is it’s moved real – the spot pricing’s really moved in concert with term pricing over the last year.
Joe Pyne
Yeah. And Alex, just to add, as you know, fuel prices impact spot pricing.
It’s in there and year-over-year, this quarter the average fuel price was about $3.35 and last year it was about $3.25. So that adds a little bit to the spot pricing.
Stephen Holcomb
Yeah. I think what you’re really looking for is our spot pricing, because prices are continuing to rise and they are.
Yup. And they’re ahead of contracts.
Operator
Thank you. Our next question comes from Gregory Lewis with Credit Suisse.
Please go ahead.
Anthony Segoya – Credit Suisse
It’s actually Anthony Segoya for Greg this morning. Good morning, everyone.
I just had a quick follow-up on the low water level, in this situation, are – do you guys add barge capacity to kind of offset the like light loadings in this case?
Stephen Holcomb
Yeah, they’re – that’s a good question. And it would be around the margins, because you’re really talking about, in the summer, probably about 6 inches to 10 inches of cargo that you’re missing.
Anthony Segoya – Credit Suisse
Yup.
Stephen Holcomb
So it – but yes, I mean to service the demand there will be a little capacity added and they’ll also – you’ll also incur some delays, too, that will add a little capacity.
Anthony Segoya – Credit Suisse
Okay.
Stephen Holcomb
It’s more marginal than anything.
Anthony Segoya – Credit Suisse
All right. And then I guess just a quick question on United, or on the Diesel business, with – since kind of the manufacturing is a little bit, has been light or is expected to be light for the rest of the year, would you say that we should see kind of some margin improvement because of kind of the switch more to remanufacturing?
Is that kind of fair to say?
Stephen Holcomb
Well, Anthony, long term I think the answer is yes. Where we are in the process is we are still in the start-up phase of this.
It’s still really working through the process of improving the efficiency of the flow of remanufactured units through our facilities. So we’re not quite where we want to be in terms of margins in the reman area, but I think your assessment long term is a good one.
Operator
Our next question comes from John Barnes with RBC Capital. Please go ahead.
John Barnes – RBC Capital
Hey, guys. Good morning.
Could you talk a little bit about – and I hate to keep beating this to death on the drought side, but just with the light loadings and type of thing. Joe, I know you said on the margin but how much impact was there to utilization of the fleet as a result of that?
I mean, was it a couple of points? Or was it less than that?
Joe Pyne
Yeah, I would say it was less than that, but I think that maybe what you’re looking for is what does it really cost us? And it costs us roughly about $0.5 million a month.
That’s the cost of the cargoes that you’re – the reduced cargo capacity and little to weigh.
John Barnes – RBC Capital
All right. I was just trying to see if the low water conditions result in you having to use more barges to handle the same amount of freight.
Does that have an abnormal impact on utilization and, therefore, does it kind of push spot prices up maybe a little more than in a normal environment?
Joe Pyne
Yeah. On the river most of that business is contract and it services a couple of customers.
Now the majority of it services a couple of customers. Where the market is very tight is more on the canal, frankly, than on the river.
Because of that major customer that had the plant maintenance outages we actually had capacity we probably could have sold. I don’t think that made a real difference in your ability to price up the spot market at least in our fleet because we just haven’t had much spot business there.
Did that answer your question, John?
John Barnes – RBC Capital
(Inaudible) issue. Are those customers fully back to – I mean, are they back to full volumes at this point?
Joe Pyne
Yeah, they are.
John Barnes – RBC Capital
All right. Very good.
Thanks for your time, guys.
Stephen Holcomb
Yep.
Operator
The next question comes from Ken Hoexter from Merrill Lynch. Please go ahead.
Ken Hoexter – Merrill Lynch
Great. Good morning.
Joe, can you talk about how you’re seeing Petrochemical demand now and you mentioned a little bit of softness before or I guess because of the customer, but you’re also targeting, Greg mentioned, capacity up 4% I guess year-over-year by the end of this year, so I just want to throw that in for your thoughts on the demand growth?
Joe Pyne
Yeah. We’re still seeing a good demand for Petrochemical equipment.
There was some de-stocking in the second quarter but even with the de-stocking we still had utilization rates in the 90% to 95% range and we’re not hearing anything from our customers that suggests declines in our volumes. Now there is some noise out there with your major Chemical companies that are talking about global economic conditions that affect their chemicals.
But we don’t think that’s going to translate into our volumes. With respect to the 4%, I don’t know if that’s the right math.
Its 350,000 barrels over 16.2
Stephen Holcomb
16.4
Joe Pyne
Is that...you can do the math, Ken.
Ken Hoexter – Merrill Lynch
Okay. 2%.
So then maybe if you keep going on that, on the CapEx, you thoughts on where capacity goes going forward into next year? It sounds like you’re already starting to plan your order book into next year.
Joe Pyne
We are. And let’s just talk generally about industry capacity because I know that’s on some people’s minds.
The industry is building a number of barges this year. We think that it’s driven by the tax benefits you get this year that you’re not going to get next year.
Capacity additions are something that you watch closely. But as we look at the capacity that’s coming in the current fleet utilization and the growth in our markets, we’re really not that concerned about it for a couple of years.
Where you get concerned about it is that if this building continued and you had a market issue where your volumes dropped. Then you could go into an overcapacity situation pretty quickly.
I think that they way the industry is building you’re not going to see sharp drops in utilization without an effect on volume. And if utilization stays in the 90% range, you should continue to have some pricing power.
If it begins to drop then you’d worry about it. And 2013, specific to your question about Kirby’s fleet, we could add about 300,000 barrels.
Is that right? 300,000 barrel of additional capacity.
And I would tell you that in our building plans, that’s kind of our intent. But if we got worried about utilization then we would pre-empt some replacement and just keep the fleet flat.
Ken Hoexter – Merrill Lynch
Great. Appreciate the insight.
Thanks, Joe.
Joe Pyne
Yep.
Operator
Our next question comes from Kevin Sterling from BB&T Capital Markets. Please, go ahead.
Kevin Sterling – BB&T Capital Markets
Thank you. Good morning, gentlemen.
Joe Pyne
Good morning.
Stephen Holcomb
Morning.
Kevin Sterling – BB&T Capital Markets
Joe, do you think we are near an inflection point regarding the slowdown in the manufacturing of fracking equipment and maybe an improvement in servicing of this equipment? And what I mean by this maybe has the rate of decline slowed enough regarding manufacturing and the service and refurbishing has begun to catch up with maybe a slower rate of decline?
Joe Pyne
Yeah. Is the question that we’re kind of at the bottom of the decline of making things?
Is that what you’re wanted there?
Kevin Sterling – BB&T Capital Markets
Yes. Have you seen maybe – I’m not saying it’s bottomed and it’s going back up but have you seen that – we saw such a rapid rate of decline.
Joe Pyne
Yes.
Kevin Sterling – BB&T Capital Markets
But have you seen that rate of decline slow?
Joe Pyne
Well, yeah because there’s not much left to (inaudible). But what’s encouraging, and Greg you should chime in here, what’s encourage is that the pace of remand is picking up and we – and everything that we’re seeing and hearing suggests that demand is there.
And that natural gas has moved from, at one point below $2 to $3.10 and at some point between $3 and $4 you’re going to get demand for finding gas again. So you sense that you’re getting close to the bottom and you want to...
Stephen Holcomb
The other thing I would add, Kevin, is that the – we watch the kind of enquiry level also around new equipment as well and it’s improved a little bit since it – over what we saw a couple of months ago, so the general trend is that, that’s starting to improve a little bit. And as Joe pointed out, most importantly to us, in this – as we’re trying to build out the service aspect of this business, is that interest in remand continues to be robust and we continue to work on that business model to make as many stations as we possibly can.
Joe Pyne
The other point I’ll make is – our folks in Oklahoma will want me to make it – is that the -typically the order book begins to look at the next year in the third, fourth quarter. You don’t typically see the order book before about now.
So by, I would say, by next quarter we’ll have a better sense for what that order book might look like for new equipment. I remember our objective is, yes, to build new equipment, but our – but not at the expense of developing this service model.
Kevin Sterling – BB&T Capital Markets
Right, right. So you’re encouraged by what you’re seeing on the servicing side and that’s – and I guess the reason you like that is that’s more of a recurring revenue stream, is that the right way to think about it?
Joe Pyne
Well that’s exactly right. The more consistent the margins actually should be better, the barriers of entry should be higher.
You should be able to develop long-term relationships with the major users of the equipment, based on how you service it and availability and that kind of thing. It’s more the kind of business that we do here.
It’s consistent with the marine diesel service model. It’s even consistent with the marine transportation model.
Long-term relationships that go for upgradeable kind of steady business.
Stephen Holcomb
And Kevin, one other point, and that is that akin to what we do at Kirby Engine Systems servicing our marine customers is that we, in the remand business have been servicing some projects that are destined for international applications, even though we’re doing the work here. And specifically what I’m talking about is the remanufacturing of some hydraulic fracturing units that will be shipped offshore to foreign destinations for use in those, in foreign venues.
So that’s – that again, similar to the business model that we have at KEX.
Kevin Sterling – BB&T Capital Markets
Okay. And then I’ll just, a follow-up, kind of shifting gears here, this will be my last question.
When you look at the Coastwise trade, what was the real – what’s been the real issue there? Is it one that’s been – is it an industry that’s been oversupplied?
Is there too much capacity? And how much capacity’s going to come out in the next couple years as you think about single skin barges?
David Grzebinski
Yeah. Yeah, hi, Kevin.
This is David. The real issue is the economy and particularly in the New York area and the East Coast, miles driven and gasoline consumption, diesel consumption, it’s been low.
There is excess equipment. In the New York Harbor we’ve had the entrant of – entrance of a competitor that got pretty aggressive too.
The positive is we are seeing things improve a little bit on the West Coast and as Joe mentioned, there’s some possibility for condensate moves, cross-Gulf condensate moves that could use some of the industry capacity in the 80,000 to 100,000 barrel range, which should tighten it up. But yeah, clearly it’s a supply and demand situation.
A lot of refined products are moved Coastwise and that demand is down because of the general economic weakness and so the market’s a little oversupplied. As Joe mentioned in his prepared remarks, it – we knew it wasn’t a one quarter story, this is going to take some time to tighten up.
There are approximately 40 to 45 coastal barges that are 185,000 barrels or less that are over 25 years old, so sooner or later that equipment’s going to come out and pricing, the market doesn’t justify building any new equipment right now. So it will gradually tighten up.
Kevin Sterling – BB&T Capital Markets
All right. Okay.
Great. Thanks so much for your time today, gentlemen.
Stephen Holcomb
Thank you, Kevin.
Operator
Our next question comes from Jimmy Gilbert from Iberia Capital. Please go ahead.
Jimmy Gilbert – Iberia Capital
Hey, guys. Thanks for taking my questions.
I was looking a little bit at the Dow Chemical results today and they’re – I mean they’ve taken a buck out of the stock, but they seem to be pretty cautious, worried about Europe and so on, but they say they plan to spend $4 billion to expand their Texas refineries, which obviously is right in the heart of where you guys operate, so could you talk a little bit about how you view the refiners and even if the world possibly slows a little bit they obviously see enough to want to expand these refineries there quite a bit, $4 billion.
Stephen Holcomb
Yeah. We can talk a little bit about what is being expanded.
But, Jimmy that is all about beach dock costs. Low natural gas prices that put the U.S.
at a competitive advantage really almost everywhere in the world. And their perspective, their time of rising is going to be beyond the quarter or even the next several years.
Their time of rising is out there with the clear assumption that we’re going to get through these economic problems and that there’s going to be strong demand going forward. I mean, frankly, there’s strong demand right now.
With respect to the actual announced capacity, I think principally in the Ethylene business, why don’t you go through that, Greg, because I think it’s significant?
Greg Binion
Yes. Jimmy, they’re going to expand their current St.
Charles facility by about 400,000 tons and then longer-term they’re planning on adding the world scale cracker to the U.S. Gulf Coast, hopefully down here in the Freeport complex, is what’s going to happen.
As Joe talked about, the timeline to make that world scale addition happen is out in the future pretty far, four to five years from here. But you know the good news is, is that the U.S.
Gulf Coast and North America in general is becoming a place of preferred venue for investment for the Petrochemical players as it has been for some time for the refiners. We’ve seen quite a bit of investment in the refining complex down on the Gulf Coast making it one of the most efficient and flexible ones in the world.
Stephen Holcomb
And with respect to Dow Chemical, they’re also restarting a cracker and that happens at the end of this year.
Jimmy Gilbert – Iberia Capital
So it’s pretty near term. And then I wanted to ask a question about the margins on the legacy Diesel Engine Maintenance business.
I mean just from what you guys tell us, I can kind of back into an operating margin right now a little bit north of 16%. But I was trying, I mean that seems higher than what I remember of the operating margin being prior to the acquisition of United so it would appear to me – and from what we see here in offshore service vessels and shallow water, midwater, and deepwater reutilizations in the Gulf of Mexico that business is doing pretty good.
Am I thinking about these margins correctly? 16%?
A little bit higher than that?
David Grzebinski
Yeah, Jimmy, this is David. You’re a little high.
We said United was in the high single digits and maybe if you round that off that would imply the 16. We’re approaching the midteens margins.
It’s better, but it’s not above midteens so maybe you got a rounding error there or depending on your assumption on what you backed into for United. But we had a lot of carryover in the Midwest marine market in the legacy business which really helped margins this quarter and as you mentioned the Gulf Coast oil service market has picked up.
Legacy diesel business utilization, labor utilization is up and clearly that helps drive their margins higher, but it’s not quite above that midteens range. But it’s approaching it.
Joe Pyne
Yeah. And I would say the midteens – is that, that’s the sweet spot.
That’s where that business should be on a consistent basis in a normal market. They’ve been there before, 2007, 2008, they were in that range, maybe a little higher actually.
Operator
Thank you. Our next question comes from Chaz Jones from Wunderlich.
Please go ahead.
Chaz Jones – Wunderlich
Good. Hey, guys.
Good morning.
Stephen Holcomb
Morning.
Chaz Jones – Wunderlich
Just one more question maybe on the operating margins at DES. I know there’s been a lot of questions around that, but really the question was as we go through this transition with United for a couple more quarters is it right to assume that maybe DES operating margins stay in the high single digit range for a couple more quarters?
Stephen Holcomb
This is the Diesel Engine margin?
Chaz Jones – Wunderlich
Yeah. The consolidated.
Stephen Holcomb
High single digits.
Joe Pyne
I think that’s right. We might get back to the double digits.
It depends as Greg mentioned, the ramp up of United’s remand. As Greg mentioned, the remand, once it’s up and running and lined out should be higher margins but that’s going to take some time to sort itself out and as we ramp it up, but maybe high single digits on a combined basis for a quarter or two more but as it improves it could get back into the double digits.
Chaz Jones – Wunderlich
Got it. And then just one follow-up.
I was wondering to see if you guys could maybe comment on labor markets as it just kind of relates to the crewing of vessels. Any issues or pressures there that you’re encountering?
Joe Pyne
In our Transportation businesses not yet. We watch that.
Now we do think that afloat labor rates are going to be above the cost of inflation going forward into the foreseeable future. But we’re certainly not seeing the kind of shortages that we saw in the 2006 and 2007 years.
Operator
Our next question comes from David Beard from Iberia. Please go ahead.
David Beard – Iberia
Good morning.
Stephen Holcomb
Hey, good morning, David.
David Beard – Iberia
Stephen Holcomb
Well, yeah. We think that there are a number of orders being built.
But there’s a lot of replacement too. So I think I’d look at fleet growth somewhat in the 3% to 4% this year and a little less next year.
And at those levels, just given what we’re seeing with respect to volumes, I think we’re okay. In that period, what you’d worry about is something happens to volumes.
But I think if the volumes are there that, that capacity should get absorbed. Certainly we’re already halfway through the year.
And certainly the capacity thus far has been absorbed and there is still a need for some additional equipment.
David Beard – Iberia
Okay. And just as a follow-on when the industry is looking at scrapping, are current rates not adequate to overcome the big maintenance costs of an older barge?
Or would we need rates to come in a little bit to push scrapping higher?
Stephen Holcomb
Yeah. I think we’re still seeing scrapping.
I think that what that industry learned and we certainly learned was that older barges are just less efficient and they’re more expensive. And the market, when it slows, immediately has a bias against the older equipment.
So we’re certainly pushing a lot more equipment out than we did in 2006, 2007 and 2008. And I think the industry is generally doing the same.
David Beard – Iberia
Okay, good. That’s helpful.
Thank you.
Stephen Holcomb
Sure.
Operator
Our next question comes from Steve O’Hara from Sidoti. Please go ahead.
Steve O’Hara – Sidoti
Hi. Good morning.
Joe Pyne
Good morning.
Steve O’Hara – Sidoti
Just real quick, in terms of depreciation for the Diesel Engine Services business, it dropped pretty significantly. I’m just kind of curious what drove that and if that’s kind of a good rate to assume going forward?
Joe Pyne
Yeah, no, that’s the intangibles. As you do your purchase price allocation with the acquisition, there was some intangibles that are short-lived and that rolls off fairly quickly.
It’s as simple as that.
Steve O’Hara – Sidoti
Okay. Thank you.
Stephen Holcomb
Operator, let’s ask one more question, please.
Operator
Sure. Our last question comes from Jon Chappell from Evercore Partners.
Please go ahead.
Jon Chappell – Evercore Partners
Start and finish. Thanks for letting me get on one more time, guys.
Really important thing here that I think hasn’t been addressed yet, and that’s the cash flow. You – I noticed you put a separate section in your release on cash generation and I’m assuming after a year of pretty hefty CapEx spend, the CapEx is going to be down next year.
So I’m just wondering as you think about cash allocation for next year, if you could talk about buybacks, potentially initiating a dividend in 2013? And then also just what the acquisition landscape looks like?
Stephen Holcomb
Yeah. Well, we still think that the acquisition environment is strong and we’re going to pursue acquisitions principally in the transportation space.
With respect to share repurchases, that’s a function where your stock is trading and we like to be opportunistic acquirers of our stock. Dividends is something that we have talked a lot about.
We’re beginning to get into a cash flow generation situation where we can actually do – do acquisitions and dividends. I think what we want to do is get through these heavy CapEx years and then, at the board level, address the possibility of a dividend.
So I don’t want to project when that might happen but certainly, this year, we have a heavy CapEx year. And depending on if we make acquisitions that’s going to affect cash flow so we’ll put all that together and make a decision whether we’re going to pay a dividend or whether we’ll buy back stock based on the stock price.
Jon Chappell – Evercore Partners
All right. Sounds great, Joe.
Thank you.
Joe Pyne
Yep.
Joe Pyne
We appreciate your interest in Kirby Corporation, and participating in our call. If you have any additional questions, please give me a call.
My direct dial number is 713-435-1135 and we wish you a good day.
Operator
Thank you. Ladies and gentlemen, this concludes today’s conference.
Thank you for participating. You may now disconnect.