American Commercial Lines Inc. Q3 2008 Earnings Call Transcript

Nov. 6.08 | About: American Commercial (ACLI)

American Commercial Lines Inc. (ACLI) Q3 2008 Earnings Call Transcript November 6, 2008 10:00 AM ET

Executives

David Parker – VP of IR and Corporate Communications

Mike Ryan – President and CEO

Tom Pilholski – SVP and CFO

Tamra Koshewa – VP of Finance and Corporate Controller

Analysts

Ken Hoexter – Merrill Lynch

Alex Brand – Stephens Inc.

Jimmy Gilbert – Rice Voelker

Chaz Jones – Morgan Keegan

John Barnes – BB&T Capital Markets

Operator

Good day, ladies and gentlemen and welcome to the third quarter 2008 American Commercial Lines Incorporated earnings conference call. My name is Eric, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate the question and answer session at the end of the presentation. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. David Parker, Vice President, Investor Relations and Corporate Communications. Please proceed.

David Parker

Thank you, Eric. Good morning and thank you for joining us. Today we will be discussing our third quarter and nine months ended September 30, 2008 financial results. Before we begin our discussion, I want to remind you that statements made during this conference call with respect to the future are forward-looking statements. Forward-looking statements involve risks and uncertainties. Our actual results may differ materially from those anticipated as a result of various factors. A list of some of these factors can be found in our SEC filings including our Form 10-K for the year ended December 31, 2007 and Form 10-Q for the most recent quarter on file with the Securities and Exchange Commission.

During the 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 www.aclines.com in the Investor Relations section under non-GAAP financial data. As a reminder, you can follow on today via a live web cast featuring a slide presentation which may be accessed at Aclines.com. If you plan on viewing the slide presentation, please listen to the call via your computer speakers rather than dialing in by telephone in order to avoid a time lapse between the slide presentation and the audio.

Joining me on the call today, we have Mike Ryan, our President and CEO; Tom Pilholski, our Senior Vice President and CFO; and Tamra Koshewa, our Vice President of Finance and Corporate Controller.

With that, I would now like to turn the call over to Mike.

Mike Ryan

Thanks, Dave, and good morning. I will be providing you with an overview of our third quarter performance as well as an update on other key metrics for the quarter. Tom will give a more in-depth review of our financials and I will wrap up with some final thoughts, including our outlook for the rest of the year, and then we'll open it up for questions.

If you go to the overview slide, there are three key messages I would like to start the call with. One, our financial results during the quarter were positive. Two, our revenue continues to grow. And three, we are making progress on our productivity and cost initiatives.

During the quarter, we faced both challenges and opportunities. We had multiple weather events in Q3. We experienced two significant hurricanes in the Gulf, Hurricane Ike and Gustav in early September, as well as both low and high water conditions in several river segments, which limited our operating capabilities throughout the quarter. Despite these conditions, we delivered $49.6 million in EBITDA, a 15% improvement over third quarter last year and EPS from continuing operations of $0.36, $0.06 better than last year. This was at the high end of the preannouncement earnings range we gave in early September.

Some of the key drivers to our third quarter results were revenue growth, up 21%. This is driven by 28% increase in freight rates as our contract fuel escalation adjustment exceeded our fuel inflation this quarter, but year-to-date price increases still exceed our recoveries. An 8% fuel neutral rate increase, growth in liquids for the sixth consecutive quarter with 20% fuel neutral price increases, higher external sales from Jeffboat as all production this quarter was for external customers, while last year almost half of our production was for internal builds, and professional services revenue from our two subsidiaries, Summit and Elliott Bay.

Ton mile volumes were down 14% in the quarter, largely due to the multiple weather events that impacted our grain and liquid volumes, and a later-than-normal progression of the grain harvest. We had almost 11,000 idle barge days from hurricanes Gustav and Ike, and sustain high water conditions that again shut down the Illinois River for an extended period of time. We continued to make progress on running our boats smarter, not just faster by consuming less fuel per ton mile and increasing the percentage of our loaded ton miles. I will share with you some of the specifics in a few minutes.

And we remained focused on reducing SG&A costs, building on our two reductions enforced earlier this year, that are saving us over $5.5 million annually with additional reductions in discretionary spending areas such as travel, corporate vehicles and other headquarter expenses.

Two final areas I would like to comment on are our financing and the July oil spill. We are devoting the necessary amount of time and attention to our refinancing options. We have completed most of the preparation and due diligence work, including a preliminary independent appraisal of our fleet as of August 15, 2008 that was in excess of $1 billion. We believe this valuation remains consistent with the current market. Given the challenges in the current market dynamics and the high cost of capital in today's market, we have not completed the refinancing of our credit facility. We continue to evaluate all of our options. Our ultimate goal is to develop a capital structure that utilizes our significant asset base and provide us with longer term resources and flexibility we need to reinvest in our fleet and achieve our broader business goals.

With regard to the oil spill in late July, I am pleased to report that the cleanup efforts are complete. Our insurance companies have been funding the cleanup. We continue to believe that we have satisfactory insurance coverage when combined with other legal remedies to cover the cleanup costs and other potential liabilities arising from the incident.

We are pleased to have two consecutive quarters of positive results, overcoming the challenges and volatility we faced all year. We have had healthy freight demand for our assets, which pressurizes our system loading model, and has enabled us to operate with improved efficiency and productivity.

Going to the next chart, I would like to update you on our commercial strategy. First for our liquids business, we plan to add 24 new tank barges to our fleet for growth and replacement of units we are retiring, for a net increase of 20 units to our liquid fleet. We expect more than 15 of these to be delivered from Jeffboat in the fourth quarter and the rest in early 2009. These barges are being built for contract business. We have firm commitments already in place on a large portion of these barges and are in negotiations with customers to contract the remaining barges prior to building them. All of these contracts are at a very attractive contribution margin level.

In 2009, we will continue our successful tank barge fleet rehab program. We are currently evaluating additional liquid market opportunities as well as other strategic capital considerations to determine where and when we will invest in incremental liquid asset growth in 2009. We plan to share both our liquid and dry 2009 capital investment plan with you in the near future.

On the next page, I would like to update you on our transportation contract renewals. The fourth quarter is renew season for many of our contracts, especially in the dry business. Approximately $180 million is up for repricing in our dry and liquid portfolios, and although the market remains competitive, we expect to renew a high percentage of these contracts as we have historically. We anticipate average fuel neutral price increases in the mid to high single digits on our contract renewals this year, although the range could be quite wide as some contracts are one year renewals, and others are from two or three years ago.

While we expect a larger portion of our business to be under contract in 2009 versus spot, our volumes are not guaranteed. We also continue to build strong strategic partnerships with our customers. One of our key liquid customers is LyondellBasell Industries, a $45 billion chemical, polymer, and petroleum company. We now have an ACL customer service representative housed in their Houston offices. This greatly benefits LyondellBasell by providing on-site customer service that is part of their team. Our commitment to an investment in customer service excellence, a program we launched here in 2006 continues to pay dividends for ACL and for our customers.

We are proceeding with a commercial strategy of improved profitability and transportation through rate strength, portfolio enhancement, customer service, and bringing new growth to the services lanes where we operate at highest efficiency. While we see no major obstacles advancing this strategy in the long term, we know recent economic conditions will affect our customers in the short term. We will remain flexible in responding to any short-term commodity shifts to keep our fleet loaded.

On the next several slides, you will see additional specifics detailing our commercial initiatives. On this page, you can see we have achieved sustained progress on improving our mix of business. Year-to-date in 2008, our transportation revenue mix is 30% liquid, 33% bulk, 18% grain, 12% coal, and 7% services. Services represent revenue from our fleet and terminal operations, which previously was reported in bulk.

During the quarter, freight demand for our barges was strong, particularly in coal and bulk. However, we were not able to keep up with the demand due to the weather related operating disruptions in our grain and liquid markets. Our grain ton mile volume was down 29% and our bulk was down 10%, while our liquids volume was down almost 17%. Our coal volume was up 1% over last year. Year to date, our liquid volume variance is better than the industry, while the other commodities are slightly lower than the industry volume trends. We continue to downsize our dry fleet, with our average number of operating barges down almost 5% compared to the third quarter last year.

At the bottom of the page, you can see the status of our backlog and legacy contracts at Jeffboat. During the quarter, we sold a mix of legacy and non-legacy barges and improved our contribution margin by 1% over third quarter last year, excluding an inventory valuation adjustment that negatively impacted last year's results. A percentage of our backlog that represents legacy contracts at the end of the third quarter has declined to approximately 23% of our $263 million backlog compared to 51% at the end of 2007.

On the next page, you can see our organic growth progress. We continue to book new business with existing and new customers. In the third quarter, we contracted $23 million in organic growth across all our major product lines. This takes us to $64 million for the year, $4 million ahead of what we booked for the entire year in 2007. Our pipeline continues to be strong. We did not renew or lose any contracts during the quarter. As I mentioned earlier, we have the majority of our 2008 expiring contracts up for renewal in the fourth quarter. We booked one new contract at Jeffboat this quarter, which grew our backlog by almost $2 million, and we had one customer that changed their 2009 option exercise from hoppers to tankers, which added a net $6 million to the backlog. For the year, we have added $45 million in new business to our manufacturing backlog. We are currently evaluating external order opportunities for the next few years; along with our own internal build needs to fill out our manufacturing capacity.

Going to the next slide, you can see two important metrics that contributed to our performance this quarter. First, we continued to make progress on reducing our fuel consumption. As we discussed last quarter, we measure fuel consumption by gallons consumed per boat operating hour. We have completed the rollout of new technology tools on our vessels, which are helping us optimize our fuel burn. We have also focused on limiting fuel consumption and other boat related costs during periods of poor operating conditions, like we incurred this quarter. Both of these factors contributed to our lowest level of gallons consumed per boat operating hour in several years, and a reduction of $8 million in our fuel cost this quarter versus last year, with 18% fewer gallons consumed. In the third quarter, we reduced our fuel consumption by 13% over the second quarter, while moving 5% more affreightment ton miles.

Improving our percentage of loaded ton miles is also an important initiative that drives productivity and growth. This is an area we have refocused on for the past three years. The goal is to match origin and destination pairs that fit within our optimal freight lanes and more fully utilize our assets on round trip moves. As you can see on the right side of the chart, our trend is very positive with loaded miles reaching into the mid-80% range this year. We have had strong backhauls this year due to northbound domestic freight contracts we entered into at the end of last year. Our concentration on filling our core lanes of business will be an on going area of focus for us as we renew contracts and bring new geographically targeted organic growth to ACL.

Now shifting to our other key metrics. The next slide highlights productivity. Our transportation ton miles per average dry affreightment barge in the third quarter increased 7% compared to the second quarter. Our dry business experienced fewer delay days, improved operating efficiencies, and better lane density in the quarter. We experience the 2% reduction in our liquid barge productivity from the second quarter, and a much greater decline over last year. The Gulf hurricanes had a significant impact on our liquids business. Several of our tank barges were idle for an extended period of time as they waited for the west canal and its industries to reopen.

Our productivity at Jeffboat continues to improve. As you can see from the chart on the right side, labor hours in the quarter on both our hopper and tanker lines again decreased significantly over last year. This is a result of achieving higher labor utilization in the shipyard. This is our third consecutive quarter of improved labor productivity in the shipyard. Also we were pleased to announce that during the quarter Jeffboat received the Governor's Award for Environmental Excellence from the Indiana Department of Environmental Management for its successful work on pollution prevention and improving our green footprint.

And as I mentioned earlier, the number of barge days lost to river delays was up over 7,000 days in the quarter, an increase of over 175% compared to last year. Most parts of the inland waterways were affected at some point during the quarter by weather disruptions. Our proactive steps in advance of these weather events resulted in our having minimal damage to our fleet, operational costs control, and coordination with our customers as we shut down our impacted operations and then reopened our shipping lanes after the storms. Jeffboat was not affected by weather this quarter with less than one day of disruption.

I would like to now turn the call over to Tom, who will offer a more detailed analysis of our financial results.

Tom Pilholski

Thanks, Mike. Revenue for the quarter was $314 million, up 21% over last year due primarily to higher pricing on affreightment contracts, higher outside towing and charter/day rate revenues, increased Jeffboat external revenues, and the consolidation of Summit Contracting and Elliott Bay Design Group into our results, which together contributed over $12 million of revenue in the quarter.

Operating income was $36.6 million, up 18.5% from last year. EPS from continuing operations was $0.36 a share, compared to $0.30 a share in the period year quarter. Last year’s third quarter included a negative inventory valuation adjustment in the manufacturing segment that had an impact of $2.1 million net of tax, which reduced earnings per share by $0.04 in last year’s quarter. We also had $1.5 million in favorable tax benefits last year in the third quarter, which increased earnings per share by $0.03 and they did not repeat this year.

EBITDA from continuing operations for the quarter was $49.6 million, a 15% increase over last year. The transportation segment increased $1.1 million due to the factors listed on the right of the chart. As discussed on our second quarter call, we have a 45-day lag in passing on fuel cost changes to our customers, which negatively impacted our earnings in the first half of the year. Conversely, we benefit when prices decline as they have since mid July. This allowed our weight adjustments to catch up, recovering approximately $6.9 million more than our fuel cost increases in the quarter compared to last year, including $1.4 million in hedging gains. We also expect to benefit from the continued recent fuel costs declines in the fourth quarter, although the benefit will be tampered by losses on our fuel hedging program initiated late in 2007, as well as from the widening in the spread between future prices on which our cost escalation contracts are based on and prices paid at the pump.

Fuel neutral rate increases approximating 8% during the quarter, drove over $12 million of positive EBITDA improvements. We also generated $4 million of scrapping income during the quarter; $2.5 million higher than last year, driven by increases in scrap steel rates. Given the recent decline in spot steel scrap prices, we plan to curtail our normal scrapping program in the fourth quarter, which will temporarily curtail the source of income. Also, higher incentive bonus accrual expense this quarter negatively impacted our results by $2.9 million compared to last year. And the insurance deductible repaid, related to the July oil spill reduced EBITDA by $900,000 in the quarter.

Our boat productivity again suffered from the extreme weather conditions, but was almost completely offset by the benefits of favorable fuel consumption that Mike spoke of. Jeffboat delivered increased EBITDA of $5.1 million in the quarter or $2.8 million excluding the negative inventory adjustments in the prior year quarter, resulting from better labor productivity and more barges produced for external sale, partially offset by one-time inefficiencies associated with a changeover from hoppers to tankers on our major production line.

Going to the next page. For the nine months, our revenue was $907 million, an increase of 21% over 2007, driven by the same variances I mentioned for the third quarter. Operating income was $59.6 million, down 11% from last year. EPS from continuing operations was $0.47 a share, including the impacts in the current year of after-tax debt retirement expenses of $1.5 million or $0.03 per share and an after-tax benefit of $1.3 million or $0.03 per share related to the decision not to withdraw from a multi-employer pension plan. Last year’s nine months result had debt retirement expenses, reducing earnings per share by $0.26, which we have excluded for comparative purposes.

EBITDA from continuing operations for the nine months was $99.8 million, a decrease of approximately $5 million compared to last year. Transportation declined $15.6 million. Fuel was still one of the largest negative impacts year-to-date with direct and indirect fuel inflation, net of $59 million of fuel recovery, reducing EBITDA by $10 million. This was more than offset by higher fuel neutral year-to-date pricing increases of approximately $33.9 million, representing an 8.7% year-to-date average fuel neutral price increase.

Negative boat productivity year to date reduced EBITDA by $18 million, again largely due to the extreme weather conditions, partially offset by favorable fuel consumption. Transportation’s cost of sales increased due to higher maintenance on our boat and barge fleet, inflation on wages and external shifting, fleeting, and towing costs. Increased barge production and boat productivity levels drove the year-to-date improvement in Jeffboat’s EBITDA $5.8 million, including the impact of the prior-year inventory adjustments.

Now, we’re viewing some of our specific segment highlights. On the next page, transportation had $244 million of revenue and $46 million of EBITDA during the third quarter. Revenues were up 12% in the quarter, with a 28% increase in affreightment rates, 8% on a fuel neutral basis. Outside towing and charter/day rate, revenue rose 18.6%, and scrapping revenue increased $2 million. Affreightment volumes decreased revenues by $17.8 million, partially offsetting the other increases. Approximately 70% of the affreightment rate increases were driven by fuel escalations under our contracts and the remainder by higher fuel neutral pricing.

Fuel natural rates increased 6.6% on the dry business and 19.3% on our liquid business. Grain turnover spot rates were up over 12% in the quarter. The 15% increase in charter and day rate contract revenues were due primarily to higher contract pricing. As for the quarter, there were nine less barges on average deployed under day rate towing.

Total volume measured in ton miles declined in the third quarter to 9.9 billion from 11.6 billion in the third quarter last year. This is primarily due to a 29% decline in grain volume, driven by the poor operating conditions due to weather disruptions and to a later-than-normal progression of the grain harvest. Outside towing and charter volumes also declined in the quarter due to operating conditions, and 138 fewer barges on average operated this quarter compared to last year.

Our fuel neutral cost per gallon averaged $3.60 in the quarter, up 63% over last year. This was completely offset by a reduction in fuel consumption and favorability from fuel adjustment clauses in our contracts. We are continuing to hedge a portion of our unprotected fuel usage with forward price swaps. We generally have hedged approximately 8 million gallons on which we had unrealized losses of approximately 4.6 million at September 30. Through September 30, we booked over 3 million in gains on previously maturing swaps.

Finally, we estimate the overall direct impact of the unfavorable weather related operating conditions to be approximately $3.2 million for the quarter and $14.7 million year to date. This weather impact only includes the direct impacts we can calculate related to lost margin on idle barge days and reduced tow sizes. It does not capture the indirect lost profit impact of logistical imbalances and other operating inefficiencies resulting from weather disruptions.

On the next page, Jeffboat had $57.2 million of revenue, $3.8 million of EBITDA, and an increase in operating income of 131% during the third quarter after writing back the inventory adjustment expenses for the prior-year quarter. EBITDA, as a percentage of revenue, was 6.6% compared to 4.9% in last year’s third quarter. Year-to-date revenue was $216.9 million with $15.2 million of EBITDA. Jeffboat revenue increased $17 million during the quarter due primarily to the change of production mix to all external builds this quarter. No barges were delivered in the current year quarter for our transportation segment year to date, while 38.7 million of total production in the prior year was for internal barges.

Both the EBITDA and the margin rate float were driven by productivity and improved pricing from producing non-legacy barges this quarter. As Mike reviewed in his metrics discussion, we reduced the total average per ton of steel process by 20% on our dry hopper builds and by 7% in our tanker builds versus last year’s third quarter. During the quarter, we transitioned our Line 1 production from building hoppers to 10K barrel tank barges. As expected, the number of barges manufactured during the quarter as well as the fourth quarter will be less than it was in the first half of the year due to this change of production mix. As Mike discussed, we plan to build 26 tank barges for the transportation segment with approximately 15 completed this year, and several on work-in-progress at year end to be completed in early 2009.

Our total estimated sales this year was approximately 280 barges for external and internal customers with almost 70% being hoppers, 29% tankers, and 1% special vessels. At September 30, Jeffboat sales backlog including legacy and non-legacy contracts was approximately $263 million, with expected deliveries extended into the second half of 2010. This is a decline of approximately $166 million from the end of 2007. The backlog does not include internal builds or legacy options until exercised, but we expect all legacy options will eventually be exercised.

With a renegotiation of a significant legacy contract after the end of the second quarter, we now estimate that approximately 23% of our backlog is legacy contracts. Before the outstanding legacy contract options are exercised we expect approximately 50% to 55% of our volume in 2008 to be affected, 25% to 30% in 2009, and 30% to 35% in 2010. Almost all legacy contacts contain steel price escalation clauses; however, the majority of dry option barges are not covered by labor or other cost inflation.

Turning to the next slide, I will give you some insight into our cash flow and liquidity. During the quarter we generated almost $33 million of cash flow from operations and $75 million year to date, compared to almost $59 million in the year to date period last year. The increase in cash provided by operations was due primarily to working capital changes in the current year from higher current incentive accruals related to prior year unpaid balances, increased deferred revenue on higher revenue rates, higher fuel and other accruals, improvement in days sales outstanding, and improved vendor terms, partially offset by lower income, after adding back the debt retirement expenses to 2007, as those are considered a financing cash flow, and higher accounts receivable and inventory balances, driven by higher revenues in steel and fuel pricing.

We spent $30 million in the quarter and $55 million year to date on capital expenditures, which as you can see from the chart on the right were maintenance improvements of our transportation boat and barge fleets, and work-in-progress on our new tank barge builds. We plan to spend approximately $100 million to $110 million in CapEx this year. We also plan to scrap approximately 180 dry hopper barges during the year and expect to not renew charters on approximately 70 dry hopper barges. We have scrapped 167 barges year to date. Our outstanding debt balance at September 30 was $434 million, representing 2.7 times leverage as calculated under our credit facility. This gives us over $110 million of liquidity.

I will now turn the call back over to Mike.

Mike Ryan

Thanks, Tom. In concluding our Q3 call today, I would like to focus on the progress we are making as we move towards the end of the year and into the beginning of 2009. Eight months ago, when I became CEO, I communicated that our team would approach our business with a ‘back to basics’ philosophy, moving barges and building barges and pricing our products and services at market-based prices. This approach is starting to gain traction within our company. With respect to our strategic goals, we are in the final stages of defining the specific business and capital needs associated with our long term strategy. This strategy will serve as a compass for the company, our employees, and our investors as we pursue our goals. We are analyzing our business demand along with our industrial site development opportunities and matching that to an optimal geographic operating footprint. Modeling this business potential over specific river segments will help us to determine the asset base required to support the best business. The outcome of this review will be a specific determination of the allocation of capital investment necessary in our liquid and dry fleet, in our boat power, and in our manufacturing yards to optimize profitable growth. We will share the details of these plans with you in the very near future.

In terms of our outlook for Q4 and 2009, we are proceeding aggressively to ensure our fleet is loaded without compromising our value proposition to the customer and ultimately our pricing. Our business fundamentals have been positive with good demand and pricing strength. But we cannot clearly predict the impact that the current global economic uncertainties may have on our freight volumes. We will continue to monitor these conditions closely and proactively adjust our near term business plans based on market conditions. We will be flexible on responding to short term shifts in commodities and continue to focus on the basics and key drivers of our business that are within our control.

A very smart and experienced leader of a large company in our industry told me recently that this business is not sophisticated, but it is complex. There are many moving parts which can be and need to be controlled to drive growth, performance, and profitability. ACL will continue to focus on reducing and containing our costs, improving our performance and the reliability of our on-time service, running our boats smarter, not just faster, and growing our business in our strongest operating lanes.

Now I’ll turn the call back over to the operator for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Ken Hoexter with Merrill Lynch. Please proceed.

Ken Hoexter – Merrill Lynch

Great. Good morning. Mike, can you just talk further on the concept of the refinancing? I’m just wondering, you noted that the value is still similar to the $1 billion back in August, but since August, we’ve obviously had a lot of activity with the September volume drop off with the hurricanes, with scrap steel dropping really quite significantly, the credit crunch, it is kind of hard to believe that the value of the fleet hasn’t changed. And then kind of follow-up to the question is also just can you give us a progress on how the discussions are going with the banks on the refinance, because it’s such a major near-term mission?

Mike Ryan

Yes, Ken, I am going to let Tom comment on that. He is into the intimate details on that, and that’s a great question, an opportunity for him to expand on.

Tom Pilholski

Ken, regarding the question on the valuation of the fleet. We published a number saying that the fleet value; and that was only the fleet – was in excess of a $1 billion based on an independent appraisal performed related to the financing we were pursuing – or are pursuing. We spoke to the appraisal firm nearing completion of the appraisal and based on our recent discussion, we do not see that valuation number changing in any meaningful way. And one key issue really is you mentioned the scrap steel prices. The valuation of the fleet is not based on scrap steel prices, which have decreased significantly. It’s more based on a replacement cost factor. And the replacement cost of the fleet is geared towards plate and structural steel, which has not nearly decreased anywhere near scrap steel prices. From the peak, the type of steel that goes into the barges maybe up 20%, not the much more dramatic declines we’ve seen in the scrap steel prices.

And just over the general concept of question regarding the financing. Obviously, this is a key area of focus for us. And we are mindful of the time frame of the current credit facility. We have been evaluating all of our options as well as the appropriate timing given the current market dynamics and the cost of capital in today’s market. And as we said in our last call, our objective is to develop a capital structure that utilizes this significant asset base as well as our improved financial performance to provide the appropriate longer term resources needed to execute our strategy. We are focused on the strategies that we discussed, and I don’t want to comment on the specific packets on the timing, but we are comfortable with where we are.

Ken Hoexter – Merrill Lynch

So, you are then – to follow on that, you are fairly confident this is not going to be as big of issue in this market, I am just looking at kind of the credit tightness that we see out there, that you feel based on discussions that it is not something that can shut you down and stop you that you feel that this is something you can progress forward?

Tom Pilholski

We are progressing forward. We can’t predict what the capital markets are going to be as they have obviously been pretty volatile and dynamic. But we have been making substantial progress. And again, we are focused on the strategy. We expected to be able to get an appropriate financing structure in place at an appropriate time.

Ken Hoexter – Merrill Lynch

I appreciate that feedback. Thank you. Now just – last question is just on the Jeffboat side. I am just wondering, as far as I recall, it was management’s desire to build the internal replacement fleet in the third and fourth quarter. Was that a capital decision not to do any internal builds in the third quarter? Was it the timing of switching over that first track to a liquid building facility as opposed to dry barge? I am just looking for some insight. And then where did the 10 hybrids, are those – those are not ocean going tankers, right? What kind of vessels were those 10 that were non-liquid or dry barge category?

Tamra Koshewa

Ken, this is Tamra, I will answer that. The 10 vessels are kind of exactly what we said a hybrid vessel. They are not ocean going. They are broad-bodied [ph] vessels that are kind of a cross between a tank barge and a hopper. And you are actually right; the changeover in the third quarter was deliberate. It was not a capital consideration that we made a decision not to build the tank barges for ourselves. It was more of respect to the timing of the schedule. As you might recall, we had a significant weather impact in the first quarter at the shipyard that kind of delayed our overall schedule for the year, and Ken, we made some of that up through the second and third quarter, but really pushed a lot of those internal builds to the fourth quarter. And as we mentioned, we will have some that will bleed over into the first quarter as well.

Ken Hoexter – Merrill Lynch

Okay, great. Yes, go ahead.

Mike Ryan

We are going to actually move on to the next question –

Ken Hoexter – Merrill Lynch

Okay. Thanks for the time. I appreciate it.

Mike Ryan

Thank you. Operator, next question please.

Operator

Your next question comes from the line of Alex Brand with Stephens. Please proceed.

Alex Brand – Stephens Inc.

Thanks. Good morning guys. I just wanted to ask couple of questions. The first being on the liquid capacity that you are adding; obviously there has been a lot of discussion about whether we are going to overbuild and Kirby’s, they think maybe now we won’t because we won’t be able to build at the same rate next year due to financing constraints on operators and so forth. Can you talk about what you are seeing in the market? What your thoughts are on capacity? And are you going more with 10s because 10s are a little tighter than 30s at this point.

Mike Ryan

Well, couple of comments on that, Alex. The beauty of owning a shipyard is that you can regulate what you build and what you don’t build. And being the second largest manufacturer in the system, when we don’t build, that is a pretty significant impact. So, we are very cognizant of what that supply/demand model looks like on the river system, and we have no intention of overbuilding it. So, we are very aware of that and we are going to practice that prudence as we go forward. When you look at the difference between the 30s and the 10s – the 30s that came out on to the market, they kind of raised a lot of eyebrows as far as capacity. We are really destined to and operating in the lower portions of the river system in the Gulf and on the West Canal. So, where you saw a greater influx of capacity was on that 30,000 barrel unit. On the 10,000 barrel, which is more of our utility vehicle that we use for most of our business; that has got a combination role that can operate in the Gulf but has more utility on the upriver components of the business, which is where we operate. When you look at the different profiles of business, the heart of it all for Kirby’s in the Gulf and ours is our primary event in liquids is the upriver system. So, I think to that point that Kirby believes it won’t be overbuilt, I think there is more prudence at this point as far as who is building and what we are building for. And I don’t think you are going to see any wild overbuilding. You are also not going to see a lot of wild overbuilding with the prices of units where they are. So, that’s got a filtering event taking place as well. When you look at the starts and stops on the liquid side though, I think it is obvious to us that this business, whether you are in a major economic downturn like we are now or not, it plateaus, it runs in plateaus and the plateau is what really is the defining moment, is it a short one or is it a long one. And that’s where we are right now assessing if we are into a longer one or a shorter one.

Tom Pilholski

And Alex, this is Tom. But as Mike mentioned before, the delays of getting the tank barges built and delivered in the third quarter and pushing some of it into next year was not due to any capital constraints. That was more due to the switchover in the production line. But one of the beauties of having Jeffboat is that unlike other companies that have to commit to long term procurement contracts and execute their options at least a year in advance, we have the flexibility with our own internal builds to being able to schedule those builds when we need them. We are not going to build on speculation. We have to ability to control lot capacity to keep our fleet operating at peak efficiency. So, that is one of the beauties of owning Jeffboat.

Alex Brand – Stephens Inc.

Okay. That’s good color. I appreciate that. Can you just quickly what are the target market differences between upriver 10s, and then in the Gulf the 30s are obviously intercostals waterway 30s are obviously more for chemicals?

Mike Ryan

Well, actually the upriver core of our business is chemicals. We do have a complementary piece that’s petroleum products and biodiesel, but when you look at that real steady state business, it doesn’t have a real big downside or real big upside. It’s just steady as you go. That’s chemicals for us. Now we’ve been able to layer on some higher percentage growth business in the petroleum products and in the biodiesel. And that’s been nice complementary to the chemicals piece. But the – you know, when you see that petroleum shuttle business, that is the Gulf.

Alex Brand – Stephens Inc.

I am going to hold my other questions and let somebody else have a go. Thanks a lot.

Mike Ryan

Thanks Alex. Operator, next question please.

Operator

Your next question comes from the line of Jimmy Gilbert with Rice Voelker. Please proceed.

Jimmy Gilbert – Rice Voelker

Hey, Mike, its Jimmy Gilbert, how are you?

Mike Ryan

Hey, Jimmy, how are you doing?

Jimmy Gilbert – Rice Voelker

I'm fine. I want to get your views on the Pacific Northwest corridor. You know, we see that the dry Baltic index for ocean freight is down 90% year over year, and this certainly has to have some effect on the spread for grain shippers between Pacific Northwest and the Gulf Coast. Can you talk about the effects you guys have seen from that?

Mike Ryan

Well, actually when you look at it, it's kind of weird what a year can do for freight rates, but it is actually cheaper to ship from the Gulf to Japan than it is from Minneapolis to the Gulf right now. So, we have seen a dramatic drop in the freight rates and the Gulf has really been a magnet now for that export fees. You know, what had been a sizable difference between the Pacific Northwest spread and the Gulf that was driving everything to the Pacific Northwest, now those economics favor the Gulf. There is only a $10 spread between the PNW and the Gulf. So, with that kind of a difference, that kind of a number, the grain goes to the Gulf. So, and it is pretty – not only the spread is significant, but just the overall numbers. You know, the price per ton to go from either off the West Coast or the Gulf to Japan is – it is remarkable where that has dropped to. But, for our purposes and for this grain harvest, the Gulf is the plague.

Jimmy Gilbert – Rice Voelker

All right. Okay, so that has definitely been a big help to you guys. And could you talk a little bit about – I'm not sure I'm clear on the – how you a fuel hedging program works, and maybe you could talk a little bit about why you guys need to have a fuel hedging program if you have escalators in all your contracts and the spot contracts are on a 2 to 3 months out, so you have a good handle on the fuel costs. Can you talk about that for a second?

Mike Ryan

Jimmy, we have done the calculation. Actually we reviewed it with our Board over the summer. But we do have some unprotected fuel usage, primarily in the spot market, about a third of our business, as well as on one other contract, and we have the 45-day lag time in passing on price increases. So we have poor price changes, because you get to benefit obviously when it decreases. So we implemented a policy, we looked at our unprotected fuel exposure and have a policy to hedge on a 12-month forward basis, a certain percentage of that exposure. So we (inaudible) 12 months and execute a contract each month covering 112 – and we allocated 112 to each of the following 12 months. And it is just a way basically of cost averaging our fuel exposure. We don't have visibility into what the price is going to be obviously, and it is just a way of trying to smooth out some of the significant fluctuations.

Jimmy Gilbert – Rice Voelker

Okay, that is good enough. And then just one last one. Have you guys – obviously, you have talked your customers, your refinery customers. Have they told you all about any planned slowdowns in 2009 or has that – just if you could talk about that, I mean obviously the economy is slowing it appears and how has that sort of affected your refinery customers?

Mike Ryan

Yes, Jimmy, you know, there is a lot of noise out there that is coming. We didn't see it in the third quarter. But I think there is an event, and I think most people are struggling with what is the size of the event, and what is the duration of the event, and you know, it doesn't matter what industry you are in or whether you are in the transportation industry handling any of their commodities. Nobody seems to be able to have – and no one has that visibility out into the – with any accuracy out into the first quarter. So I think there is an expectation that they will be just slowing. What people are wrestling with is what that impact is and what the duration of it is going to be. But again, our plan is to control – you know, what we can – to deal with what we can control – under our control, has the ability to load the barges and keep moving. So we have got a good base of business, we've got a good book of business, the barge portfolios and the barge transportation portfolios are much more resilient if you look at them historically versus the truck and the rail. So, we don't have wild swings upwards, but we generally don't have wild swings down either.

Jimmy Gilbert – Rice Voelker

Okay, well that is great. Thanks for taking my questions.

Mike Ryan

Okay.

Operator

(Operator instructions) And your next question comes from the line of Chaz Jones with Morgan Keegan. Please proceed.

Chaz Jones – Morgan Keegan

Yes, good morning everyone. I don't mean to really dig this question into the ground but just on the tank barge builds recognized the delays but it seems in the past you guys have talked about a number in terms of building 30, now you are talking about net 20. Can you help us understand that a little bit better?

Mike Ryan

Yes, I think we have given a number of different statements on what we are going to build over the last couple of years and I think it had more to do with what a macro look of the market look like as opposed to being more specific to building for business, building for customers and contracts. And I think as you put that specificity up against it, you don't build hoping to sell those. You build for a specific business, and as we sell that business, we come up with more precise numbers, more accurate numbers and more accurate timing. So, I think the – in the more exuberant times, when it was falling out of the sky and if you had a barge you won, you know you have to be more selective in the marketplace today and that's what I think you are seeing. You are seeing us build for business and you're seeing us not overbuilding to park and have a lot of excess capacity.

Chaz Jones – Morgan Keegan

So if we see further slowing in the market, could that 20 number come down even more then, Mike?

Mike Ryan

No, that is already locked in. That is designed and dedicated for business that we have already agreed to with clients. And we do not have any cancellations on those, we do not have any negative activity on those. Now, what we do have the ability to do though is once we get more visibility on the market and what kind of a downturn we maybe looking at and the duration of that, we have the flexibility, owning Jeffboat to say, we don't have to build on the schedules that we have laid out. We can push these things back a quarter or two and still have the ability to hit the market and not be sitting with excess capacity.

Chaz Jones – Morgan Keegan

Okay, and then I guess you made the comment that freight still is down 20%. Has the price that you're charging to build barges changed at all over the last 2 to 4 months?

Mike Ryan

The prices haven't really changed. What we have in there is a recovery index for steel. So it will float with the price of steel. So it is not necessarily what we charge in the marketplace, it is what we put in as a kind of inflationary protection for us, but the absolute price that we charge for building has not gone down.

Chaz Jones – Morgan Keegan

Right so, I would come to the conclusion that your margins should improve if the input costs are down 20% and I know that is not the only input cost, but just looking at steel prices.

Mike Ryan

And they are, and I think you saw some traction here again in the third quarter where we have seen some bottom line improvement and some productivity improvement. And we will continue to move in that direction because it is producing those types of results. Those are the results we want at Jeffboat and they are not going to be again mediocre, they are going to be quarter by quarter wins and earns and cumulative.

Tamra Koshewa

And the other thing I would add is that because we’ve purchased the steel so far in advance, we really haven't seen that price decline be reflected in what the customer is paying, and so we are not really getting a lift in the margin rate yet because of that. If the steel price continued to decline or even stays at this lower level, then we will start to see the benefit of that in the first half of next year.

Mike Ryan

Yes, the actual steel costs get passed on to the customer essentially. So, our margin dollars, the absolute margin dollars stays constant, assuming our productivity levels stay constant. So therefore the margin will change and fluctuate as the steel price fluctuates, but the absolute dollar margin will remain constant.

Chaz Jones – Morgan Keegan

Okay. And then the last one here and I'll get back in the queue. The 19% increase in pricing on the liquids side, how much of that was driven by spot versus contract? It sounds like you guys didn't renew a lot of contract business, I realize year over year, yes, you have some contract business, but it seems like everything in the year the pricing environment was not quite that robust for you guys in the liquids portfolio.

Tamra Koshewa

Yes, a majority of that is contracts pricing strength. We have renewed several large contracts earlier this year that we are starting to see the benefit of that coming through. We have certainly seen improvement in the spot as well, but our liquid business ratio of spot-to-contract is much smaller than in our dry business.

Chaz Jones – Morgan Keegan

Okay, that is helpful.

Mike Ryan

Thanks, Chaz. Operator, if you have one more question we will go ahead and take that just prior to concluding the call.

Operator

Okay, your next question comes from the line of John Barnes with BB&T Capital Markets. Please proceed.

John Barnes – BB&T Capital Markets

Hey, good morning guys. The lost days and the amount of traffic backup post hurricane, would you expect your ton miles to be a little bit better here in the fourth quarter as a result of working through some of that back up freight or would you expect that may just offset a little bit of weakness from the pure economic backdrop?

Mike Ryan

That will be an interesting observation at the end of the quarter, John. The thing that is going to be telling is – there is noise ahead of this downturn, but when you look at the post-storm event, there is a mixture of replenishing pipelines and supplies and what is going on in the economy. So, I think until we see this replenishment post the hurricanes settle out, and you get to a more even field level, you won't know how much of any downturn has begun. But I think in the fourth quarter, I think you are going to see better ton mile activity than we had in the third quarter, just because of that sheer volume of lost days.

John Barnes – BB&T Capital Markets

Okay, and then one final question on the fuel neutral rate increases that you talked about both on the dry and liquids side as you go into fourth quarter and into next year, can you give us an idea of kind of what percentage of your business has been repriced at this juncture – you know, that has already been priced up to those levels and maybe what percentage of your business that is under contract would see those kind of rate increases you have left to reprice?

Mike Ryan

Yes, there is a cumulative piece of $180 million and it is kind of a moving target how much has been done in the last few days versus what remains. But I would say most of that number still remains because they are all fourth quarter and they are all year-end loaded. But again, I think we are going to see a blend, a mix of liquid activity and dry activity on multi-year contracts that are coming up as well as annual renewals that are going to – they will produce something in that mid to high single digit range when you look at the combined pool of contracts.

John Barnes – BB&T Capital Markets

All right. Very good. Thanks for your time guys.

Mike Ryan

Thanks, John.

Operator

And we have no more questions in queue. I would like to turn the call over to Mr. Mike Ryan for closing remarks.

Mike Ryan

Okay, thank you. As we mentioned during the prepared text earlier, we will continue to work on improving the things we can control. We are obviously going to monitor all of what is going on, the state of our global economy, and we are going to monitor that with you. But at the same time we are going to focus our energy and actions improving efficiency for our customers and profitability for our shareholders. Thank you all for joining us today.

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