Good afternoon, ladies and gentlemen, and welcome to the Second Quarter 2019 Financial Results Conference Call. At this time all participants are in a listen only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Lee Fishman, Director of Investor Relations. Sir, please go ahead.

Thank you, Joanna. Joining me on the call today are Matt Cox, Chairman and Chief Executive Officer; and Joel Wine, Senior Vice President and Chief Financial Officer. Slides from this presentation are available for download at our website, www.matson.com, under the Investors tab. Before we begin, I would like to remind you that, during the course of this call, we will make forward-looking statements within the meaning of the federal securities laws regarding expectations, predictions, projections, or future events. We believe that our expectations and assumptions are reasonable. We caution you to consider the risk factors that could cause actual results to differ materially from those in the forward-looking statements in the press release, the presentation slides, and this conference call. These risk factors are described in our press release and are more fully detailed under the caption, Risk Factors on Pages 11 to 20 of our 2018 Form 10-K filed on March 4, 2019 and in our subsequent filings with the SEC. Please also note that the date of this conference call is August 7, 2019, and any forward-looking statements that we make today are based on assumptions as of this date. We undertake no obligation to update these forward-looking statements. With that, I'll now turn the call over to Matt.

Thanks, Lee, and thanks to those on the call. Please turn to Slide 3 for my opening remarks. Matson's performance in the second quarter was mixed, with ocean transportation coming in below expectations and logistics continuing its good performance and coming in stronger than expected. Within ocean transportation, we saw continued strong demand in China and improved performance in Alaska. But these solid contributions were outweighed by a weaker-than-expected Hawaii market and a lower contribution from SSAT, which was hurt by additional expenses related to the early adoption of the new lease accounting standard and higher terminal operating costs. We expect the additional expense from the lease accounting adoption to reverse in the second half of the year. To be clear, all of our trade lanes performed as expected except for the shortfall in Hawaii, which I'll discuss later. In logistics, we continue to perform well, with all service lines making positive contributions to operating income. As a result, for the first half performance, we're updating our outlook for the full year 2019. We are lowering our outlook for ocean transportation operating income and we are raising our outlook for logistics. The net result is that we now expect EBITDA outlook for the year to be approximately $18 million lower than the previous outlook as a result of continued weakness in the Hawaii trade lane as well as higher operating costs in the SSAT in the second quarter that are largely behind us. We view 2019 as a transition year as we prepare for IMO 2020 and migrate from a 10-ship fleet servicing Hawaii to 9 ships and begin to benefit from one less vessel. We remain confident in achieving the appropriately $30 million in previously mentioned annual financial benefits from the new vessels when they're all in service. For…

Thanks, Matt. Now, on to our financial results on Slide 16. Ocean transportation operating income for the quarter decreased $16.8 million year-over-year in the second quarter to $19.7 million. The decrease was primarily due to higher vessel operating costs, including the Mauna Loa lease expense, a lower contribution from SSAT, higher terminal handling costs, and lower container volume in Hawaii. Partially offsetting these unfavorable year-over-year comparisons was a higher contribution from the Alaska service and higher average freight rates in China. The company's SSAT joint venture contributed $0.9 million, or $8.2 million less than the year-ago period. The decrease was primarily due to additional expense related to the early adoption of the new lease accounting standard in the quarter, as well as higher terminal operating costs. On a year-over-year basis, about a third of the $8.2 million decline is attributable to these lease-related costs, most of which will reverse in the second half of the year. However, when compared to our previous outlook, we expect approximately $5.8 million in lease-related costs, or approximately $0.10 per share to reverse and be a benefit to SSAT's results in the second half of 2019. For logistics, operating income for the quarter was $11.3 million, or $1.8 million higher than the year-ago period. The increase was due primarily to higher contributions from freight forwarding and transportation brokerage. EBITDA for the quarter decreased $14.4 million year-over-year to $64.9 million due to lower consolidated operating income of $15 million, partially offset by an increase in other income of $0.4 million and an increase of $0.2 million in depreciation and amortization, which includes drydock amortization. Interest expense for the quarter was $6.1 million, or $1.5 million higher than the first quarter this year largely as a result of the Kaimana Hila entering service in the quarter and…

Okay. Thanks, Joel. Why don't we open the call up, operator, to questions?

[Operator Instructions] Our first question comes from the line of Jack Atkins from Stephens, Inc.

So I guess let's start off, Joel, to go back to your prepared comments around the change in the guidance, down $18 million I think versus your prior outlook. Could you maybe just, if you could, bridge us again, just to make sure everybody's on the same page, in terms of what the primary drivers are between the $270 million now versus $288 million before? Could you just walk us through that if you could?

Sure, Jack. So of the $18 million, about 1/3 of it was embedded in this second quarter results, so approximately $6 million in EBITDA translating down to about $0.10 of earnings per share. And of that $6 million, Matt mentioned we talked about the Hawaii volumes came in less than expected, and we also experienced some higher costs at SSAT. So of that $6 million, it was about half and half between those two drivers, Hawaii volumes and SSAT, in the second quarter. The remaining $12 million of downward reduction in our outlook, and for really the second half of the year, the vast majority of that is the Hawaii volume impact, Jack. We expected there to be some growth this year and in the second half of the year, and it's just not materializing. We're seeing a flattish market. So that's the majority of the remaining $12 million coming down. A small portion of that remaining $12 million, though, also is some of the SSAT higher costs spilling over in the third quarter. We believe those are largely behind us, but not 100%, so there's a little bit of impact of that, as well. But those are the components of the $18 million down for the full year.

That helps. And I guess for my second question, if I could, I'd like to shift gears a little bit and think about your CLX service. And Matt, we've seen obviously accelerating tariff rhetoric over the last year, and it seems like everyone's expecting it to get better, and it only gets a little bit worse. So could you talk about this last round of, or the tariffs that are going to go into effect on September 1? How do you think that impacts your business? What are your customers telling you about their freight flows as a result of these tariffs, if that's changing at all? And did the potential change in tariff policy coming up next month, did that have any impact on your outlook for CLX in the second half of the year?

A super-easy question to answer, so thank you for asking. In all seriousness, I would make a couple of general observations and then dive down. I think what we're seeing, Jack, in talking to our customers, is that customers, if you were a customer that sourced only out of China, I think there's a lot of risk mitigation planning on developing sourcing from other countries to the extent that the U.S.-China situation worsens or if tariffs go up above even current levels. And so we see a lot of our customers. Many of them have sourced from multiple countries, and in those cases they're looking at talking to their partners in these other countries about whether they have the ability to increase production. So there's a lot of thinking going on around risk mitigation, but I still think you'll see, independent of what's happening with tariffs, which are more difficult to predict, that there is still a very difficult-to-replicate in the short run ecosystem in China for the commodities we care about, which are garments, footwear, electronics, things that are fashion and electronics, let's just call those items. And so we will see some stickiness, but with a fair degree of planning. The second thing I would say, Jack, as it relates to the Transpacific market in general, is to the extent, let's say, that production is shifted incrementally out of China into Malaysia, to India, to Vietnam and to the Philippines, or wherever that might go, the international ocean carriers can change their allocations from some market to others. So they could point more capacity towards the markets that are growing incrementally, and it doesn't necessarily mean that there's a disruption to the Transpacific trade in its entirety if the international ocean carriers migrate some capacity from China to these other origins, because very little of what we're hearing of what potentially is leaving China is coming back to the United States. I think that ship has sailed for a lot of the commodities we deal with. And then, to Matson more specifically, I think we're also seeing -- of course, there's a significant degree of uncertainty. And Matson thrives in chaos. And we don't say it to boast, but we have the fastest service. And just because of where we are with respect to future concerns about the economic cycle, retailers are being more cautious. They're carrying less inventory. They're waiting till the last minute to place orders. All of that falls exactly into the market, this expedited ocean market as an alternative to air freight. So despite all the ongoing uncertainty, including the IMO 2020, we're continuing to feel and hear from our customers that there continues to be a strong demand for Matson's product amid admittedly a fairly uncertain environment.

That definitely makes sense, and I know you guys have a very unique and specialized service. And so that all makes a lot of sense. I appreciate that, Matt. I was interested in the commentary around shifting of some capacity, particularly at least one of the new vessels out of the Hawaii turnaround service and into CLX, and you may do that again with -- I think you said the Daniel K. Inouye when the Luraline is delivered, if I'm not mistaken. But anyway, so could you just talk about what capacity does that add to the CLX service? And what does that do to capacity in the Hawaii service? I'm just trying to get a feel for how capacity could be shifting between those 2 different services.

Yes, so I think the view, at least between now and the end of the year in the Hawaii market, is it's likely to remain muted. So as we took down our outlook and Joel mentioned, our expectations for growth have now been reset, and we're looking for a flat environment for the remainder of the year. The other thing I would say is the vessels, the two new Aloha-class vessels, the 2 large container ships that you mentioned that are now in service, are going to be busy anyway, some of them replacing vessels on our CLX service as we take those vessels out to install emission scrubbers. So these CLX vessels will be coming out of service. So at this point, and the third thing I'll mention about the Aloha-class vessels is, number one, it allows us to slip into a nine-ship fleet, but they were also built to accommodate future growth. And so, our view is that they can be moved from our Hawaii service, which will continue to allow us to carry all of the cargo for the Hawaii service, but potentially the idea is to point additional capacity into the CLX trade, where we have a better chance of filling that capacity, especially during seasonally busy times. And so I think what we'll see is that the increase in China capacity let's say between now and the end of the year replacing a CV2600 that's in there now with one of the Aloha-class vessels adds a few hundred container slots, 200, 300 container slots on a voyage every five weeks, so it's not a huge mover to capacity, but potentially both of those vessels could be deployed in China or in our CLX service to the extent that Hawaii remains muted. And our CLX vessels could easily carry our entire cargo package in the Hawaii service and stay into a nine-ship fleet against the previous. So it's an idea. We're not over reacting to a short-term Hawaii flattish market, but we're also acknowledging that we have assets that can move where potentially we have greater chances for utilization.

Okay. That makes a lot of sense. Well, I'll hand it over. Thanks again for the time, guys.

Thanks, Jack.

Thanks, Jack.

Our next question comes from the line of Kevin Sterling of Seaport Global. Kevin, your line is open.

Thank you. Good afternoon, gentlemen. Matt, if we could step back here, you know I've been following you guys a long time, and even when you were part of Alexander & Baldwin. I can always remember you could always look at construction volume and get a good read on your end markets for Hawaii and see how you guys are doing. But it seems like now that historical relationship may have changed a little, because when I hear you talk about Hawaii, it seems like construction activity, construction jobs, permitting, what have you, is doing okay, but maybe it's the other part of Hawaii, whether it's tourism, consumption, the population growth, is now impacting you maybe a little bit more than it has historically. Help me bridge that gap from in the past, when we could always look at construction volume as a good read to where we are today.

Yes, it's a good question, Kevin. And I would make a couple of observations. You're right in saying that the level of construction activity, the level of construction employment, have historically been good indicators. At the beginning of this more recent cycle, when we were seeing a lot of the construction activity primarily occurring in urban Honolulu or Oahu. We've noted that we get less of a benefit from high-rise construction because concrete, steel, often moves in break bulk style and not in containerized relative to previous cycles where we saw single-family home construction being more active than more dense urban condominium-type projects. And that continues to this day. I think we're seeing that flatten out. We, longer term, continue to be encouraged by some of the projects that we've mentioned in west Oahu, Koa Ridge and others that will continue to benefit us, but those are longer term and will happen over the next few years. So the other thing I would say is we ourselves were a little bit surprised based on trends, and we did a dive into what we're hearing from all of our customers. And it was really not any single thing. Some customers, as Joel mentioned in his comments, were looking at more carefully managing inventory levels. There were no dramatic changes. There were others that were looking to pack their containers a little bit more efficiency. There were more 45-foot containers instead of 40-foot containers. There was nothing that jumped out at us that was a cause for deep worry, but we are observing that the market is weaker than we expected because of some of the items that you mentioned. So those were my thoughts on the market, just a little additional color.

Are you seeing any aggressive pricing by your competitor in Hawaii as a result of some of the market weakness?

I would say there's always a healthy level of competition between the two of us, but we've not seen anything super-unusual, nor have we seen any dramatic shifts in share. So I would say it's just the normal competitive environment there.

And talking about the SSAT costs being a little bit higher, what were some of the drivers behind that? Was it mainly labor, or was there anything else going on there?

Yes, so we took a dive into that as well, Kevin. I think, again, there are 3 or 4 things that drove those costs up. As Joel mentioned in his comments, we see those mostly behind us as we get into the second half of the year. I think I'll just cite some examples. There were some expenses related to the movement of terminals within the Pacific Northwest that I mentioned. We also saw some higher labor costs because SSAT had some difficulty getting a full-time longshoreman instead of a more casual type workforce that impacted their own internal productivity. Those issues are largely behind it. There was a little bit of catch-up crane maintenance in Oakland that is now largely behind us, nothing that caused us, well, first of all, I don't think we have fully understood the impact, or how it would impact the results in the quarter, which was one of the smaller factors in our underperformance there. But we're satisfied that we don't have, except for a very small tail, a chronic issue performance in SSAT.

Joel, you mentioned some possible Title XI debt financing alternatives. Could you expand on that some? Would that help result in maybe lower interest expense savings, going forward?

It would at Treasury rates today, Kevin, I'll tell you that.

They might go lower.

We've talked about for a while we don't need to do any more financing. We're in great shape. Our banks have been supportive. We've got a $650 million revolver that's drawn less than half of that. So we have plenty of room to fund the remaining portions of our investment programs off the revolver. But when you look at the Title XI program and the all-in rate that you can get on a fixed basis for 25-year paper, that's really attractive. We don't like having very much secured paper in our capital structure, and so the negative of Title XI is that you've got to pledge to one of the vessels. But we've talked about for a while, and it's public knowledge, that we've got applications in for Title XI financing. And the first vessel's been delivered, so you can close on a transaction after a vessel's been delivered. So we're continuing to look at that and work on that, and that may be something that we do, going forward. And to answer your question about interest expense, yes, at the rates that you would achieve now, it would be cheaper all-in borrowing than where we're at on the revolver. So, not a huge differential in interest expense, but slightly favorable.

Yes, but you can lock it in for long-term.

Lock it in long-term, exactly.

Lastly, you talked about I guess peak debt in Q1 2020. Would you bump into any potential covenant issues from what you see right now? I know you said the banks look at EBITDA calculation on a much different basis than how we look at it.

Well, it's not dramatically different. It's just there's a few more things in EBITDA to make EBITDA higher, but it's not dramatically different. And we can go up to 3.75X on our leverage ratio, Kevin, so right now we're at 3.0X, and so we've got plenty of head room on that. So we're only 6 to 8 months away from our peak levels. And I mentioned here today that our vessel payments that remain in 2020 are only $63 million, so that's quite a bit less than our free cash flow generation. So we feel good that we're not going to have any kind of covenant issues up to the 3.75X leverage ratio level.

[Operator instructions] We have a follow-up question coming from the line of Jack Atkins from Stephens, Inc.

I just had a couple of additional follow-ups here since we have a few minutes. Matt, I'd be curious to get your thoughts on I think there's been some reports about a potential grace period related to IMO 2020. Would just be kind of curious to get your thoughts and if you think anything like that's going to maybe go through. And I think China also has banned open-loop scrubbers. I believe you guys have closed-loop scrubbers, but just wanted to make sure about that. Could you touch on those IMO topics?

Sure, I can, yes. We're hearing no strong push for broad-based waivers of IMO. But to the extent, let's say, a company had a vessel under construction and was looking for a 6-month or 9-month waiver until the delivery of their new vessel, something like that might be asked and might be accepted. But we don't on a onsie-twosie basis, but we don't really see any large waivers expected. Now, to the extent that there were some fuel disruptions or unavailability in some ports, there may be some limited waivers until that. We're not hearing of any of that at that point. But those are a couple of exceptions that I think would be short-term, and we're not expecting any of those to occur in our own fleet, as you know. With respect to your second question about let's say China implementing its own rules in an open-loop scrubber versus a closed-loop scrubber, I would say that Matson's Alaska vessels are closed-loop, which mean that when they're in the emission control area, or eco-zone, or when they're in special sensitive zones, they go closed-loop where they're not letting the scrubbed emission residue go into the ocean. But during most of the voyage, it's in an open-loop situation. Matson's 6 new scrubbers are open-loop scrubbers, most likely, and what that just means is, while we're in the coastal area of China, it requires us to burn a different fuel. And we're doing that now, and expect to continue to do so, and because the majority of the voyage, it would be in open-loop mode in the open ocean. When we transited either the U.S. West Coast or in China, we'll be using alternative fuels, and we have a method in which to change. And our economics and our payback periods on the scrubbers and all of that has been factored into that view. So we don't see any significant impact as it relates to Matson's use of open-loop scrubbers and the way we've designed it.

Just last one from me, just going back to the Hawaii volumes for a moment, just to make sure I've got that correctly, Matt, if I've heard your comments correctly, it sounds like part of what's going on here is just some inventory de-stocking going on in Hawaii. And one, I wanted to make sure if that's the correct way to interpret it, and I guess, secondly, if that's the case, do you think once this excess inventory gets burned off, that maybe the broader market can maybe stabilize and things can start to see a little bit of growth return? I know you've been a little bit burned on it this year, but I'm just trying to get a feel for is something sort of changing structurally in Hawaii, or is this really sort of a temporary inventory buildup, that we've seen this in the past and just we've got to get through it?

Yes, I think a little bit of what you said is true, Jack, but I think the reality is we were down 2.4% in our volumes in Hawaii service. And so our view is that the market will remain flat. So some of the issues that we believe are, like the inventory, a little bit more careful, you can only do that once, and then you can no longer do it. So I agree with that part of it. But I think our expectation is that we'll see a flat environment, moving forward. We took out the growth for the remainder of the year. It doesn't look like it's coming. And in talking to many of our customers, nobody was seeing big, significant growth. There was also a number of other smaller factors, so there was no one factor that drove that 2.4%. There was a smaller amount of, for example, return eastbound cargo than we'd seen before. No significant reason we could identify, I don't want to get too far down in looking at it, there were a few items. That was a large solar project that we moved last year in the second quarter that didn't repeat itself this quarter. So there's just lots of little things, but it kind of gave us the feel that we really did need to do a market reset and look at a flattish environment, moving forward.

Speakers, I'm not showing any questions at this time. I would like to turn the conference back over to Matt Cox, CEO.

Well, thanks, everybody, for listening. We look forward to catching up with you on next quarter's call. Thank you.

This concludes today's conference call. You may now disconnect.