Ladies and gentlemen, welcome to the Third Quarter 2019 Financial Results Conference Call. [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. Please go ahead.

Thank you, Grace. 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 November 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. 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 consolidated performance in the third quarter came in as expected. Ocean transportation was slightly weaker than expected, with strong demand in China, but we also saw weakness in our Hawaii market and a softer-than-expected volume in our Alaska service. In Logistics, we saw a stronger performance, with nearly all service lines making positive contributions to operating income. As a result of the first nine months performance and our expectations for the business in the final quarter of the year, we are maintaining our consolidated operating income outlook for the full-year 2019. We expect a slight decrease in the outlook for ocean transportation operating income provided on the second-quarter earnings call, offset by a slight increase in the outlook for logistics, despite some market headwinds. Joel will go into more detail on the financials and 2019 outlook later on in the presentation. We're also reaffirming the approximately $30 million in financial benefits in 2020 compared to 2019, with a significant financial benefit coming from the reduction in Hawaii fleet deployment to nine vessels, which I will cover in a moment. Please turn to Slide 4. This table outlines our current operational and financial priorities. And I'll start with progress on the Hawaii fleet renewal. Lurline is on track for delivery later this quarter, and we expect her to be placed into service shortly following delivery. When she enters service, we expect to step down into a nine-ship deployment for our Hawaii service and begin to realize the financial benefits of one last fleet unit. As a result of this fleet transition, vessels are expected to go into reserve status. The new Matsonia remains on track for delivery in the third quarter of…

All right. Thanks Matt. Now on to our financial results on Slide 13. Ocean Transportation operating income for the third quarter decreased $4.8 million year over year to $43.9 million. The decrease was primarily due to higher terminal handling costs, higher vessel operating costs including the Maunalei lease expense and lower container volume in Hawaii. The company's SSAT terminals joint venture investment contributed $8.4 million or $0.8 million less than the prior-year period. The decrease was primarily due to higher terminal operating costs, partially offset by the timing of some of the additional expenses related to the early adoption of the new lease accounting standard in the second quarter and higher lift volume. Logistics operating income for the quarter was $11.3 million or $1.4 million higher than the prior-year period. The increase was due primarily to a higher contribution from freight forwarding. EBITDA for the quarter decreased $2.4 million year over year to $89.1 million due to lower consolidated operating income of $3.4 million, a decrease in other income expense of $1.2 million, partially offset by an increase of $2.2 million in depreciation and amortization, which includes dry-dock amortization. Interest expense for the quarter was $6.2 million and the effective tax rate in the quarter was $25.4 million. Slide 14 shows how we allocated our trailing 12 months of cash flow generation. For the LTM period, we generated cash flow from operations of $282.4 million and received proceeds from sale-leaseback transactions of $106 million, from which we used $25.1 million to repay debt, $80.6 million for capital - maintenance capital expenditures, $224.7 million on new vessel CapEx including capitalized interest and owners' items, and $1 million on other items, while returning $36.8 million to shareholders via dividends. Our cash flow remains strong to support investments in our new vessels and…

Joel thanks. As we look to close out this transition year with Lurline entering service, we're making a significant step forward in realizing our previously mentioned approximately $30 million in financial benefits in 2020. As a reminder, we'll provide the outlook for 2020 on our fourth-quarter call in February. And with that, I will turn the call back to the operator and ask for your questions. Operator?

[Operator Instructions] Your first question comes from Jack Atkins from Stephens Inc. Your line is open.

So Matt or Joel, I guess just to start off on the incremental benefits to 2020, that, Matt, you just highlighted in your prepared comments. But that $30 million number, that is an EBITDA number. Is that correct?

Yes, Jack.

So is there a way to think about, all else being equal, like the incremental depreciation that you would - I'm just trying to net that down to the EBIT impact from those, from the new vessels. Is there a way to think about that, Joel?

Yes. I mean, we haven't discussed that element. We did earlier this year in our February call and our annual outlook, we did provide some multiyear outlook, Jack, how we thought our depreciation and amortization numbers would be. So those numbers are still good. We haven't updated those. That's still our approximate estimates for D&A. So the way I would encourage you to look at is, look at the $30 million of benefit we've talked about here recently as an EBITDA benefit, and then continue to use what we have out there in our disclosure around D&A.

And then not to state too much of the line items, but just kind of - I think it's important to think about the moving pieces. Is there a way to kind of think about interest expense and how that flows now that the capitalized interest income is falling off into next year?

Yes. That's a great question, Jack. Thanks for that. And so we've been purposely highlighting the last couple of years how much capitalized interest there is each quarter. So you can see this past quarter was 3.5 and 3.3 in Q2, 4.7. So those amounts will begin to decline. When the Lurline is delivered here in the fourth quarter, we'll only be capitalizing interest on our last vessel, the Matsonia. And then as of the third quarter of next year when the Matsonia's delivered, that capitalized interest will totally go away. So the interest expense going through our income statement will increase commensurately for that no longer being capitalized. So that's exactly the right way to think about it.

And then, I guess a bigger picture question just on the Ocean Transportation segment. And I guess when we look at the implied operating income for this year, it's right around $100 million, maybe just south of $100 million. And you have to go back really to 2011 to sort of find an operating income sub-$100 million. And I know that next year we've got the new vessels coming in, and that should definitely help with the financial performance, I guess, theoretically. But I guess as you guys look at the organization within Ocean Transportation, are there maybe some other areas where there's some potential efficiencies to be gained or costs that can maybe be trimmed just in an effort to help improve profitability while the Hawaii market sort of finds its footing?

Yes. I would just say, Jack, it's an ongoing process. And clearly, as you've heard us say throughout the year, Hawaii has been a disappointment for us; we expected more growth. We'll have more comments about 2020. But the environment looks relatively flattish. We said that on the call. So the question is what are we, as a management team, going to do, given the more muted prospects for Hawaii? It's likely that we're going to continue to look to grow, and it's likely going to be outside of Hawaii, and what asset and overhead and investments are required, are yet to be determined. But for example, you saw us redeploy the Kaimana Hila, one of the new Aloha Class vessels, into our CLX service. In part, it's to cover the scrubber installations that we're in the middle of. But to the extent, for example, that the market remains muted in Hawaii, does it have a more permanent place in our CLX? Those are the kinds of things we'll look at to make sure that we've got our assets deployed in such a way that reflects our maximum ability to leverage those assets. And then, the ongoing blocking and tackling of operating costs happens every day behind the scenes here. We're always looking for ways in which to become more efficient and to operate very effectively. So I would say that's more of an ongoing process.

Then last one for me, and I'll hand it over. But with IMO 2020, it's now just around the corner - we've been talking about it for so long, it's hard to believe it's almost here. But I guess, Matt, just be curious to know what you're hearing. I found it interesting that we really haven't seen the changes in prices within the distillate markets of any significant magnitude. I'm just curious why you think that's the case and just sort of what you're hearing out there? If it's enforcement. If it's adoption to IMO 2020. I'm just curious what's going on out there and why you think we haven't really seen fuel prices really change all that much, given, I think that's been the expectation now for quite some time.

Yes. I mean, our sense is we're just getting into it. Like if you look at current pricing, contractual spreads, Matson has - we think we're well-positioned. We've dealt with all the suppliers that provide different grades of fuel, depending on our fleet. And as you know, part of it will be either sold for content for the use in our scrubbers and our newer shifts will be using the compliant fuel. We've secured all those sources, feel really good about them. There are current spreads that we see in those markets, which are consistent with what we're seeing around the world. I think what you're going to see here in just in the next four weeks or six weeks, or even sooner, in the case of the international shipping lines, they're in the process of taking vessels out of service and removing the noncompliant fuel. And so you're going to start seeing increases. People are starting to purchase this fuel now. So I think we're just at the very beginning of it. And again, you might have noted that Matson had announced a fuel surcharge increase from 32% to 35% in our Hawaii and Guam trade. We actually took fuel prices - our surcharge down 2% in the Alaska trades, because we're going to continue to burn the higher residual fuel content given the scrubber installation. So we've already made the step that we need to make. We've got very good ability in our other trades, including our China trade, to recover the higher fuel cost. So I think we'll start to see it. Whether the market accepts it and the larger dynamics on the international side remain unclear. But Matson feels really good about the investments we've made and we feel really good about our ability to recover fuel through our various surcharge mechanisms. So let's wait and see. But time will tell. But we feel really good about the position we find ourselves in.

You guys are in a fantastic spot to take advantage of market dislocations on that. That's why I was just curious. Guys, thanks again for the time.

And we also have Ben Nolan from Stifel. You may now ask your question.

How's my favorite management team doing?

Good, Ben. How are you?

Yes. Don't tell anybody that. I don't want it to get out. I'm still trying to wrap my head around Hawaii a little bit and the fact that the GDP is growing but the container volumes aren't. Do you think that there is any element of a shift in mode at all? And I know in the past we talked a little bit about aviation. And curious if there's any airfreight dilution, per se. But also, given sort of all the trade wars and we've seen west coast volumes flat to slightly declining coming in from international, is there maybe more direct cargoes coming in directly into Hawaii from Asia or elsewhere? Or is consumption just lower? How do you see all that?

Yes. So we took a deep dive. It's a great question, and we said we've been disappointed, and this is one of our core markets, right? So I think it's been, first of all, we looked at airfreight, there is an Amazon effect of Amazon Prime. And so there's a very small slice of the market that is using Prime like everywhere else. But it's limited to a container a day equivalent of cargo that goes into Hawaii. So it's very small. Similarly, keep an eye on the international freight volumes that come directly from Asia into Hawaii. There have been no discernible changes in volumes at all. But we've seen some of our large customers be more careful about inventory management. We've seen a little bit of slowdown in there's a small net migration of people out, but just small on the margin. Construction has been a little slower. But in talking to our construction customers, who are moving in, they feel they personally and their businesses are projecting toward a pretty solid 2020, based on what's in the backlog as we mentioned in our comments. So it's a little unclear about what's going on. It's probably a combination of factors, including, of course, an overall slowing in the growth rate. But absent a U.S. recession or some other shock, we're continuing to expect a flattish environment. We're not saying, this is the beginning of a big slide. We're careful not to say it, because we don't believe it. None of our customers are telling us that, and that's not what the economic stats are telling us either. But I acknowledge, it's a bit of a puzzle.

Now switching over to Alaska a little bit. Span apparently was the real rock star of maybe the whole company last quarter. And that's despite the fact that the Alaska volumes were sort of unimpressive. And I guess the new cross-dock doesn't really even kick in until this quarter. Is it market share gains? I mean, is that business doing anything different? Or is the trajectory of that business different than maybe you thought that it was?

Well, I guess the way -- first of all, we've seen increases across all of our lines of business, expect the rail and truck brokerage in the last quarter as we've started to see that overall market change. But if you were to look at the income statement by segment, which you can't, because we don't show it to you, all of our lines are contributing in year-to-date above last year, including Span Alaska, which, of course is a large part of the now consolidated operating income. And Span has done well. Span has continued to perform well. Just as a reminder, when we acquired Span Alaska a couple years ago, they had, in the previous year before we acquired them, purchased another Alaskan freight forwarder, PAF. And they were continuing to wring out the internal efficiencies on the mainland side. We're also now taking the second step to consolidate our two warehouse operation in Anchorage to a single warehouse there. But I would say, they've continued to perform as or better than we expected and they have performed -- when we acquired the company a few years ago, we knew at the time that the state of Alaska was likely going into a recession, which, in fact, did occur. And the volumes there have been good. But I think it's a lot of factors. I mean, clearly, Span has done well. But we've got a lot of well-performing units. And even within our domestic brokerage lines of business, we've seen reductions in volume, but the margins in our brokerage businesses have remained pretty healthy, which has helped our overall contribution as well.

And just sticking on that for a second. The new cross-dock in Alaska, the impact from that is part of the $30 million or $40 million in 2021, it's all incorporated in there. Correct?

No. It's not in that $30 million number.

Is there any way to maybe quantify? Does it just make you a little bit more efficient? Or is it material in terms of --

It's not going to be material in 2020. We still have a couple of the existing leases that are scheduled to continue in 2020. So we're not going to get necessarily immediate benefit on the lease expense side. We'll get some benefit on the efficiency side and on the final delivery side. But it's not something material that we've baked -- we'll, of course, include what those amounts are in our annual outlook in February. But it hasn't been such a big number that we called it out in advance.

But I would say -- this is Matt -- one of the things that we are excited about is our ability to serve our customers faster, make that freight available earlier upon delivery. So there's a lot of operational benefits that will be seen from our customers in that business, which I know our team at Span are very excited about.

Next up is Kevin Sterling from Seaport Global Securities. Your line is open.

Matt, if I can follow up a little bit on Ben's question and talking about international and your China service. International airfreight, as you know, has been pretty weak this year. And your China container volumes were down, I think looks like 3.4% year over year. And we kind of think, when we think of your China Service, it is essentially a deferred airfreight offering. Is there a correlation there, do you believe, between some of the weakness you saw in your China service in terms of volume as it relates to kind of what we're seeing in the international air markets?

I think what you're seeing is the numbers are a little misleading in the sense that we had an extra sailing in the prior-year quarter that we didn't have this quarter, but otherwise we were full every week. So and we could have said that a little differently. But what we're seeing is, when we looked at 2018, and we said, because of all these tariffs and deadlines and we just saw this unbelievable contribution from our China tradelane, and what you're hearing us say now is that we now believe that both volume and rate have approached and will be the same as the unbelievably good year in 2018 was repeated in 2019. And so we're seeing a continued strong interest in moving cargo out of airfreight. And of course, we have our traditional garment, electronics. We're seeing e-commerce. And a lot of stuff is looking for ways to move out of airfreight into our deferred airfreight product. So I don't want to say we're beating them off with a stick, but the demand has remained very bland. I think that's what our corporate communication team would encourage me to say instead of beating them off with a stick.

No. No. That's very helpful. Thank you. I think that's a very good explanation. And you may have touched on this. I apologize if you have. Some of the weakness we saw in Alaska this quarter, do you think it's combined to Q3, or could it linger?

Well, there's such a strong seasonal component to the Alaska trade. Right? It's the second and third quarter. It's the tourist season. It's the construction season. And so I think we've seen, so I would say a more normal sort of looking third quarter going into the fourth quarter. Nothing pops out at us. And despite the weaker volume, we feel really good about our position in the Alaska market and the investments we've made. And time will tell. I know we're talking to a number of our customers, including the North Slope folks, and there's a lot of investment that's going on in the North Slope, and we're not necessarily a large participant in the North Slope market, but the entire state benefits from the investments that go through that Anchorage gateway up through to the North Slope. So while there's questions about the overall economy, the North Slope remains a silver lining to the state's economy. Southbound, I would say, conversely, has been a little disappointing. It's an every-other-year fishing season based on mother nature and the southbound volume's partly due to a lower fishing harvest and catchment in the markets we've participated in than we expected. If there was a downside, it was just a little bit in the disappointment there. But overall, we're feeling okay or pretty good about where we are in Alaska.

Lastly, on Logistics, obviously, you mentioned freight forwarding and Span just really being the star there. But also, it seems like you took advantage of some of the capacity looseness out there in truck brokerage and intermodal and bought capacity much cheaper and better. So do you think kind of what we're seeing in Logistics, as you've scaled that business, are you guys getting better at buying capacity or is it just you're taking advantage of kind of what the market gives you?

I think it's -- I mean, I'd like to say the former, but it's more the latter. I think the market has changed. I think if you were an asset-based truckload guy, and we've seen through other quarterly reports, those guys have taken a pretty hard turn on their margins and volumes in the markets, and the same on the rail side. There was almost no peak season surcharge on the rail network this year. But for us, in our business, the margins have held up better than the asset base overall rates have been in the market. And as we all know, the peak season's been relatively muted. But I would say the benefit, and I've said this a few times is, we had, through the last cycle, the benefit of resetting our margins on all that rail and truck brokerage business and moving away from some of the very thin margin business, and the management team at Matson Logistics and Rusty and his team, like where they are. Now, of course, the market's going to change and we'll have more to say about the market in 2020 at the year-end earnings call, and it's likely to be different. But we'll see what happens. But I think overall we're feeling pretty good about our position and where we are as we end the year.

I'm relieved. I thought you were going to give all the credit to Jerome.

No. Jerome, he's the behind-the-scenes guy in charge of everything, basically.

We also have Steve O'Hara from Sidoti & Company. Your line is open.

Just I guess going to the outlook for logistics. So in third quarter, you had good margin improvement on declining revenue. And then I guess we're looking for kind of a decline in operating income in the unit. And I'm just kind of curious what the dynamic between 3Q and 4Q is? Is it because of the way the -- I mean, I know you had a very strong year last year? But is that kind of the normal seasonality in the business? Is that that's what's happening kind of, as well as having a real good year last year?

Yes. The seasonality is a factor, and so it's both those things, Stephen. So last year we declined just a little bit, Q3 into Q4, about $800,000, this year probably a little bit more. Remember Span is a very big piece of that business, and Span is more seasonal, just given the nature of the Alaska business, than the traditional brokerage businesses. So it is going to, on average, introduce a little bit more Q1 and Q4 seasonality and logistics relative to before. So that's definitely a factor. Then the softening in the brokerage businesses that we talked about is the other important factor heading into this year's fourth quarter.

And then maybe on the financial benefits commentary, I mean, just curious in terms of how that translates into cash flow. I mean, it would seem like taking out interest costs and that should get you pretty close to operating cash flow. Maybe if you can tell if you're a cash tax -- you expect to be a cash taxpayer and, if not, when that might become a factor. And then you just talked about maintenance CapEx going forward, maybe on a long-term run rate as opposed to with the current program as well. I mean, it looks like you guys should generate good free cash flow in 2020 and 2021. But I don't know if you could just kind of delve into that a little bit.

Sure. Sure, Stephen. Always happy to talk about cash flow. Yes. We still expect that strong cash flow we've been talking about for a while. So the first part there, the $30 million, that really should translate into EBITDA and directly to cash flow. And the reason is most of that's coming from capital we've already put out the door. So if you look at ratcheting down from 10 ships to nine, well, that's because of the vessel expenditures themselves. If you look at the scrubbers, that capital would have gone out the door, for the most part, and then we've got some of that still in 2020. But after the scrubbers are installed, then there's no more capital going out the door. So it's going from efficiencies and a rolling stock and better capacity utilization in our garages. So that's tied to the capital of the vessels themselves. And then the other item is the cranes that we've invested in, in Sand Island. So most of that is all behind us, and so we're ready to reap the benefit. So think of the $30 million as translating at a very, very high pace into free cash flow. And then the second part of your question around maintenance CapEx, we still feel good, $50 million. There'll be some years where it's higher. There'll be some years where it's lower. But that's a good run rate for us as we look at the next five, 10 years. And if we see that changing, we'll certainly update investors. But we still feel good that when we get through this period of time and finalize the longest item, which is the Sand Island terminal upgrades, that we'll be landing around that $50 million free cash flow number. So when you look at the upside on the EBITDA and then getting back at some point to the $50 million of maintenance CapEx, and then the other item is the cash taxes point that you mentioned, we believe that it's still about two years away before we're going to be a cash taxpayer. So you're looking at very strong free cash flow numbers, that back half of 2020 continuing into 2021, '22, and beyond.

And then maybe just on use of that cash flow. I know you want to kind of delever relatively quickly. And then, I mean, so when you begin to delever, is there a point at which you start to divert more to share repurchases, things like that, maybe increase the size of the dividend? Is it based on -- is there kind of a leverage range you can talk about?

Yes. I mean, the leverage range -- the target leverage range is that low twos, and so we do want to get back to that level. We also believe long term in rewarding our shareholders with an increasing dividend as we earn it through free cash flow generation. So that will be a part of the equation. We've also said we're not opposed to special one-time dividends, and we've done share buybacks in the past. So what you're going to see from us is looking at all those different alternatives to maximize the benefit to shareholders from a long-term cash flow ROIC perspective and overall shareholder value perspective. So all of those things will be on the table for us to look at what's the best equation as we look at '20, '21, '22, '23, '24, those years, as our leverage comes down and begins to glide path toward the low twos where you want to go or lower into the ones, we'll look at those other return of capital alternatives. And then we talked a lot about M&A and the priorities in M&A. And the key there is finding things that fit to it -- fit for us, but also being disciplined and not stretching ourselves, make sure we're very disciplined with respect to our financial criteria and fit criteria. So that's the way we've articulated how we'll think about capital allocation in the years to come. Does that make sense?

[Operator Instructions] I am showing no further questions at this time. I would now like to turn the conference back to our CEO, Matt Cox, for any closing remarks.

Thank you. Hey, we'll look forward to speaking with everyone at our year-end earnings call in February. And we hope everyone has a safe and enjoyable holiday period, if we don't talk to you before. Aloha.

Ladies and gentlemen that concludes today's conference call. Thank you all for joining. You may now disconnect.