Matson Inc (MATX) 2012 Q2 法說會逐字稿

Good afternoon and welcome to Matson's second-quarter earnings call.

For your information all participants will be in the listen-only mode during the Company's presentation. There will be an opportunity for you to ask questions at the end of today's presentation. (Operator Instructions) This conference is being recorded.

I would now like to turn the conference over to Phyllis Proffer, Investor Relations for Matson, Inc.

Thank you, Denise, and welcome to our first earnings conference call as Matson, Inc. Joining me today are Matt Cox, President and CEO, and Joel Wine, Senior Vice President and CFO. Slides from this presentation are available for your download at our website, www.Matson.com, under the Investor Relations tab.

Before we begin I would like to take this opportunity to remind you that during the course of this call we will make forward-looking statements within the meaning of the federal securities law 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 statement in the news release and this conference call. These risk factors are described in our news release and are more fully detailed under the caption Risk Factors on pages 19 through 29 and the 2011 Form 10-K filed by Alexander & Baldwin Inc. on February 28, 2012, and all of our other subsequent filings with the SEC.

In addition, please note that the date of this conference call is August 2, 2012, and any forward-looking statements that we make today are based on our assumptions as of this date. We undertake no obligation to update these forward-looking statements.

Now it is my pleasure to introduce Matt Cox.

Thanks and aloha from Honolulu. Today is another milestone for Matson as we report our financial results for the first time after our successful separation from Alexander & Baldwin. We now have our own headquarters in Honolulu and have recently launched our own corporate giving program called Matson Foundation to serve Hawaii, Guam, and the mainland. This affirms our commitment to supporting the communities in which we live and work.

Another highlight for the quarter was the positive reception we received in both the debt and equity markets as we put in place new debt agreements in May and met with perspective equity investors in June. Our common stock began trading under the stock symbol MATX on the NYSE on July 2, and perhaps most importantly, we have accomplished all this while maintaining our focus on our core operations.

As shown on slide five, Matson's operating income for the quarter increased 11.3% to $32.5 million compared with $29.2 million last year. Operating income for the first six months of the year was $38.6 million compared with $35.9 million last year, an increase of 7.5%.

Our operating income improved year over year despite one-time separation costs of $5.8 million in the second quarter and $8.3 million for the first half of 2012. The improvement was primarily due to performance of our Ocean Transportation unit as we will show on the next slide.

On slide six, Ocean Transportation operating profit increased approximately 15% compared with the second quarter and first half of the year, despite the $5.8 million in separation costs for the quarter and $8.3 million for the first six months of the year. Supporting the year-over-year positive comparison was an increase in Guam volume and improved freight rates in China, partially offset by volume declines in Hawaii and lower contribution from our SSAT joint venture due to fewer container lifts compared with last year.

SSAT is included in the operating profit for Ocean Transportation and is shown as a contra expense on our consolidated income statement. I will now talk about each trade lane.

On slide seven, in the Hawaii service container volume was down nearly 5% in the quarter owing primarily to three factors. Firstly, we continue to see a modest decline in the overall Hawaii market with the lack of construction activity among the most significant drivers of lower volume.

Secondly, some non-US origin cargo that was typically delivered to the US West Coast, then carried by Matson or our competitors to Hawaii has converted to foreign direct. This cargo, a portion of which is carried by Matson Direct on our China service, is now counted for us as an increase in our China volumes.

Thirdly, we are experiencing some competitive pressure on selected commodity types which have also negatively impacted our Hawaii volume. Auto volume was down almost 12%, primarily due to the timing of rental fleet replacement. For the second half of 2012 we now expect relatively flat to modestly lower container volume compared with last year, which is in part a result of the freight conversion I just described and in part the lack of construction activity which we do not expect to improve this year.

Our view of Hawaiian volumes is influenced by some of the key economic indicators which are shown on the next slide. The table on slide eight indicates the Hawaiian economy GDP has been improving and it is expected to continue to improve, but nevertheless construction in the state of Hawaii has not yet rebounded which has in part suppressed our Hawaiian volumes.

This chart highlights construction jobs as a proxy for construction spending, because we have found that the jobs measure, coupled with this other data, to be the most correlated with our actual freight volumes. Historically, we track building permits as a key indicator but have found construction jobs to be a better indicator.

On slide nine, in Guam we continue to benefit from the exit of a major competitor from the trade last November which explains the significant increase in volume year over year. This increase in Matson volume masks a moderate contraction in the overall market itself. Expansion in this trade will occur when construction related to the relocation of the 5,000 Marines from Okinawa to Guam occurs. However, we currently don't see any signs of a near-term startup to the buildup.

We expect Matson's increased volume in Guam to continue into the second half of 2012 unless a new carrier enters the trade lane. We do expect another competitor longer term, but it is difficult to predict the timing in the shorter term.

On slide 10 Matson's ship remained full in the China service and we were pleased to see that the improvement in freight rates achieved in the first and second quarters remain largely in place as a result of capacity management by the carriers in this trade. The chart in the upper right-hand corner of the slide reflects the rate increases taken in this trade during the first half of the year. It is the Shanghai Containerized Freight Index and captures industry spot rates.

Our China business is about half on the spot rate market and about half under annual contract. Also, the freight conversion from Hawaii to China service I mentioned earlier improved our volumes in the first half. We also benefited from opportunities to optimize our yields through cargo selection.

For the remainder of the year in the trans-Pacific we expect to run our China ships at full capacity. Freight rates are expected to continue at approximately the level experienced in the second quarter through the peak season in mid-October. Then we expect a modest decline in freight rates following the peak season when the industry enters its traditional slack season.

From a macro perspective, there is currently a surplus of container vessel capacity in the world international container market relative to demand. Sustaining current trans-Pacific freight rates primarily depends on rational industry-wide carrier management of vessel capacity and, secondarily, on the strength of the US economy.

On slide 11, while we are encouraged to see logistics continued sequential improvement in operating profit in the second quarter, the profits were lower than last year resulting from a decrease in highway revenue, primarily in the full truckload service segment and lower warehouse results due to our Northern California operations. Our domestic international business -- our domestic intermodal business was up in the quarter, but was offset by lower international intermodal volume due to the discontinuation of our CLX2 service last year and a loss of a major international customer.

Second-half 2012 performance for this segment is expected to be flat to modestly lower than last year and will be dependent upon improved Northern California warehouse operations and also improvement in the US mainland economy, allowing for at least a modest peak season. Logistics management team remains focused on expansion and improvement at the warehouse facilities, organic growth in the intermodal and highway business, and the rollout of a domestic 53-foot container pilot program to improve profitability in this segment.

Now let me turn the call over to Joel for a review of our financial performance and outlook.

Thanks, Matt. On slide 12 let me start with an update on the separation, because it had a significant impact on our financial results and our year-over-year comparisons.

Due to the structure of the separation, A&B's financial results are reported as discontinued operations on our consolidated financial statements which had a negative impact on our net income results for the quarter. Additionally, the nonrecurring costs related to the separation were $5.8 million for the quarter and $8.3 million year-to-date. These costs are in line with the range we have provided previously and were primarily related to outside professional fees and registration fees.

Slide 13 is a summary of our unaudited income statement for the quarter. Total consolidated revenue for the quarter was $394.2 million, a 4.5% increase over last year. Revenues increased due to our Ocean Transportation segment.

Operating costs and expenses increased primarily due to higher costs in our Ocean Transportation segment due primarily to higher fuel costs, higher outside transportation costs, and higher terminal handling costs. Income before taxes for the quarter increased on a year-over-year basis despite the added separation costs, but our effective tax rate increased significantly for the quarter to 50%, which reduced our reported income from continuing operations. I will talk more about the tax rate in a moment.

Net income for the second quarter of 2012 was $7.8 million, or $0.18 per diluted share, including the $4.8 million of after-tax costs related to the separation from A&B. This compared with net income for the second quarter 2011 of $18.7 million, or $0.44 per diluted share. Net income was reduced by a $7.5 million loss from discontinued operations for the quarter, which I would like to highlight in detail on slide 14.

In the table in slide 14 you can see a summary of our unaudited income and losses from discontinued operations for the second quarter and first half of 2011 and 2012. The CLX2 operations have been fully shutdown at this point and all chartered vessels have been returned to their owners. The negative effect of CLX2 for the quarter was $1.4 million and going forward we do not expect any material losses in discontinued operations from CLX2.

Since A&B is being accounted for as a discontinued operation on Matson's financials, A&B's unadjusted GAAP reported loss for the quarter of $4.4 million flows through Matson's income statement as a loss from discontinued operations. Going forward, with the separation transaction having been completed, there will be no impact from the A&B operations in future periods for Matson but all historical periods will show this A&B-related line item under discontinued operations.

So in summary, we do not expect any material amounts in recorded discontinued operations in the future from either CLX2 or A&B. Consequently, income from continuing operations, as reported per GAAP on our financial statements, is an important measure of the operations that comprise Matson going forward. This is highlighted on slide 15 where income from continuing operations for the second quarter was $15.3 million, or $0.36 per diluted share, which compares to $17.7 million, or $0.42 per diluted share last year.

As a reminder, income from continuing operations for the second quarter of 2012 was negatively impacted by two significant items in the quarter. First, the previously mentioned separation costs which had a negative $4.8 million after-tax effect and, secondly, we experienced the significantly higher tax rate when compared to last year due to the separation.

This high effective tax rate is highlighted on slide 16, which was 50% in the second quarter of 2012 which caused the rate to be 50.1% for the full first half of 2012. The rate was higher than our previously estimated normal course effective tax rate of 38.8%, due primarily to certain separation-related transaction costs incurred for which we recorded no tax benefit and the non-cash re-measurement of uncertain tax provisions required as part of the separation tax accounting treatment. Going forward, we expect the effective tax rate to be approximately 38.5% for the third and fourth quarters of 2012, which is in line with our previously stated normal course effective tax rate.

Turning to cash flow highlights on slide 17, cash flows provided by operating activities were $25.4 million for the six months ended June 30, 2012, which was relatively consistent with the same period last year. Cash from investing activities was a positive $9.7 million this year compared with a negative $10.7 million last year, due mainly to a required accounting entry of contributions from A&B that are shown on the cash flow statement of our press release. These amounts were $26.7 million in 2012 and $16.3 million in 2011 and resulted mainly from Matson being the remain co entity for accounting purposes under GAAP.

Importantly, within this investing section of our cash flow statement, Matson's capital expenditures for the six months of this year were $17.5 million compared with $27.9 million last year. Moving down the slide, cash provided from financing activities this year were roughly flat at a negative $200,000, primarily to $173.4 million in net debt borrowings which were mostly offset by the distribution of $156.1 million to A&B upon separation.

Lastly, Matson's cash flow statements also include the historical dividends paid amount of A&B given that Matson is remain co for accounting purposes. These amounts are not indicative of Matson's dividend going forward because, as we previously announced, Matson's Board of Directors declared a third-quarter cash dividend of $0.15 per share payable on September 6 this year which will amount to an approximate $6.4 million quarterly payment.

Turning to the next slide on 18, CapEx for Ocean Transportation for the first two quarters of this year has been relatively consistent between $8 million and $9 million and have totaled $17.2 million year-to-date. Our CapEx plans for the remainder of the year fall in the range of approximately $22 million to $32 million heavily weighted towards Ocean Transportation, which would bring our total CapEx spend for the year to be in the range of approximately $40 million to $50 million, which is in line with what we had previously stated we expect our annual maintenance CapEx to be.

Lastly, given this quarter included a number of nonrecurring cash outflow items related to separation, we also wanted to highlight for investors the total cash outflows Matson incurred. The chart at the bottom of the slide shows that we incurred total cash outflows of $166.3 million in relation to the separation, which are comprised of three components.

The capital distribution to A&B of $156.1 million, the primary purpose of which was to implement the allocation of the former parent company's total debt 60/40 between Matson and A&B. This contribution was made at the end of June. Secondly, separation costs (technical difficulty) commented on earlier. We do not expect any material separation costs going forward.

And, lastly, capitalized debt issuance costs of $1.9 million related to Matson's previously announced financing transactions completed during the quarter.

Turning to the balance sheet on slide 19, the two balance sheet periods shown on this slide are not necessarily apples to apples because the 12/31/2011 data includes the assets, liabilities, and shareholders' equity of A&B. For the June 30 reporting period and going forward A&B's balance sheet amounts will no longer be included, so as you can see the assets and liabilities of A&B have not been included in the June 30 data.

Additionally, Matson's shareholders' equity count has been reduced for the removal of A&B's historical book equity, which includes the impact of the $156.1 million contribution to A&B I previously mentioned.

The other important balance sheet item that changed significantly was our debt capitalization which is highlighted on slide 20. Here you can see Matson's debt balance at the end of the quarter was $372.8 million as new debt was raised to fund the contribution payment to A&B. Our debt at the end of the quarter consisted of $72 million drawn on the Company's revolving bank facility and $300.8 million of long-term funded debt.

Our key credit statistics at the end of the quarter were healthily at a debt to EBITDA ratio of 2.3 times and an EBITDA to interest coverage ratio over 20 times.

Now I would like to summarize our outlook for the remainder of 2012 on slide 21. Ocean Transportation operating profit for the second half of the year is expected to be modestly better than last year. However, our operating profit for the third quarter will be negatively impacted by the timing of ship and barge dry dockings and other expense-related items compared with last year.

Both of these operating profit comments for the remainder of the year and the third quarter include the full effect of our expected $8 million to $10 million of incremental annual corporate expenses, but exclude the $7.1 million of CLX2 related expenses that were not classified as discontinued operations in the second half of 2011.

Matson Logistics operating profit for the second half of the year is expected to be flat to modestly down compared with last year. We do not anticipate any material impact from separation costs or losses from discontinued operations for the rest of the year, and going forward we expect our effective tax rate to be approximately 38.5% for the third and fourth quarters of 2012.

Now let me turn the call back over to Matt who will provide some closing remarks before we open the call for Q&A.

Thanks, Joel. On slide 22, in summary, our financial results for the quarter were mixed. For Ocean Transportation our long-term goal is to return to operating margins in the 10% to 12% range on an annualized basis, and we are not there yet. For Logistics, while we are seeing some favorable growth trends in new initiatives in our business, we are not yet producing the result profit levels of 2% to 4% that we expect longer term from this business.

However, having achieved our separation transaction we remain confident about our prospects as a stand-alone company. Overall the Company remains financially strong and our businesses are well positioned to participate in the Hawaiian and overall US economic recovery.

That concludes our prepared remarks today and the call is now open for any questions you may have.

(Operator Instructions) Michael Webber, Wells Fargo.

Good morning, guys. Just wanted to jump in with a couple questions and maybe jump right into the segments here. Within Ocean Trans that margin came in a bit better than we had expected and better on a year-over-year basis.

Can you talk a little, maybe give a little bit more color around those margins in the second quarter and then maybe some color in terms of how they are trending so far in Q3 and Q4, whether we should see some sequential improvement in Q3? Just a little bit of color there.

Sure, yes, I can do that. I think we were pleased in the quarter by the strength in the China freight rate environment. As we have been talking, there continues to be an industry-wide overhang of vessel capacity, but the international ocean carriers really made a determined effort to get freight rates up and have done a good job, a little better than we expected, overall in that trade. And margins improved somewhat in the second quarter related to the China rate environment.

The other thing that has happened, we didn't touch on it too much, but our volumes -- our ships in China were effectively full for the quarter. What is interesting and what is happening is there is an unusually strong amount of demand in the expedited segment of the market, in part owing to retailers shortening their lead times and requiring many customers to use our expedited service rather than more traditional slower ocean freight rate services. So there was terrific demand for expedited services.

In Guam, of course, we continue to benefit as we expected. There was no announcement or start up of another service and we benefited from that additional volume. Then, of course, Hawaii has been flattish and we talked about the reasons for that. All of that really did translate into good margins.

As you know, there is a strong seasonal component to Matson's business. The second and third quarters are the best two quarters of the year with the fourth and first being our weakest two, so we did expect some margin improvement for the second and third quarters.

Moving forward to the other part of your question, Mike, we do see, as we said, Joel pointed out, that in the second half of the year some improvements year over year in our operating results in the second half. Although we wanted to note a bit more cautious tone on the third quarter relative to just the timing of dry docks, and there are some incidental expenses associated with our dry docking periods. But, as I said, we do remain confident that second half will show some modest improvements year over year.

Got you. I guess two follow-ups to that margin question; I guess one for you Matt and one for Joel. You mentioned the significant demand for the expedited service. There is certainly an expectation that we are going to see rates rollover, I guess after peak season. Probably not to the degree we saw in 2011.

But can you talk a little bit about how elastic you think or inelastic that expedited demand might been in the back half of the year? And then kind of related to that, most of the weakness we have been seeing has been more Asia Europe centered, trans-Pac rates have held in better than most. Maybe a little bit of color there in terms of why those have held up a little bit better.

Those are two good observations. I would say as it relates to the demand for expedited services I think while there continues to be a lot of uncertainty in retailers' minds, that uncertainty translates into keeping as little inventory as they can, which we think translates into increased demand for our expedited products. So we are reasonably comfortable that, given our transit advantages, we are going to see relatively decent demand through the balance of this seasonal cycle.

As it relates to the trans-Pac, your observation again is another good one. We are seeing overall industry utilization now in the trans-Pac at 90%; in the low 90%s it is being reported. It is lower in Asia Europe; it is reportedly to be in the 80%s. The carriers on the Asia Europe side have had more problems in trying to get their freight rates up and in many cases it is the same carriers.

I think part of the problem is much of these very large mega container vessels are required to be deployed into the Asia Europe market because those are the markets that have the facilities to accommodate those large vessels. It is that overhang of additional capacity that is required to go into the Asia Europe trade that could be part of the reason why carriers have been more successful on the trans-Pac than Asia Europe.

Got you. That is very helpful. Not to spend too much time on the margin there but, Joel, we are still running through the numbers and making it all work. It came out after the close, but are those separation costs that you guys called out, are those embedded in that margin figure, that 10.3?

Yes, they are. They are embedded and allocated to the Ocean Transportation segment.

Got it. Do you have an ex number there if we strip those out?

Give it after tax.

Yes, in the materials we have commented on both the pretax and after-tax, so 5.8 is pretax and 4.8 is after-tax.

Right. Ex -- I can follow up off-line. Just trying to get the margin ex those embedded costs.

You could just add that right to the operating profit number that we reported and use the same revenue number, and that will give you the number.

Matt, just one more for me and I will turn it over. You mentioned the stronger volumes you guys are seeing in and out of Guam, and you have obviously had a major competitor leave. When you think about new entrants into that trade, how do you think about it in terms of timing?

And then that is a US flag trade. Are you think that is going to be a pure Jones Act carrier, or are you going to see Maersk US flag or someone else try to come in and compete in that trade?

First of all, it is hard to know precisely so I will speculate a little bit. As you rightly point out, it is a US flag trade, not a Jones Act trade, and so to us it seems more likely that a US flag operator would seek to start a service than a Jones Act operator. And as you point out, the two main existing operators in the trans-Pac today that operate in the container business are Maersk Line, which has a US flag subsidiary, and APL, which has a US flag subsidiary. So it seems most likely to us that one of the two of those carriers may eventually come in.

It is really difficult to tell on your question on timing. Perhaps it may be as we get closer to seeing a catalyst around the construction activity related to the relocation of the Marines from Okinawa, but in some ways it is surprising that it hasn't already occurred. So it is just really hard for us to get visibility.

As to lead time, it is a relatively straightforward matter for either of those carriers to charter a non-US vessel and put it under the US flag and operate a feeder service over one of their US flag relay ports in Asia. So we think the time constraints and lead times is relatively short should one of them decide to jump in.

Got you. And I lied; I am going to ask one more question. The last couple -- actually today or yesterday we saw a pretty high profile Title 11 financing application get denied and we saw a couple more earlier this year. It is a program you guys have used successfully in the past.

Can you maybe give some color about what would separate you all from some of the applications that have gotten denied? Then I guess has anything within that program changed to the point where you have got to start maybe backing that out of your return metrics when you look at starting to renew your fleet and then kind of the benefits of that low cost long-term debt?

I will comment on this, Mike -- this is Matt -- and then I will turn it over to Joel if he wants to add something. From my point of view, this reinforces one of the fundamental tenets of Matson's initial positioning which is to remain investment grade. Because what it allows us to do is to have multiple options to finance the vessel replacement program that we have talked about wanting to put in place in the next three to five years.

And so it may be that because we are investment grade our application around our vessel replacement program would be seen more favorably than perhaps other applicants who have submitted applications.

But secondly, and importantly, it doesn't require us to use Title 11 and order to finance our vessel replacement program. So there have been times, depending upon the bank markets and lending markets, where in fact one of our last four vessels that we built in the Jones Act was actually more competitive for us to finance on the non-Title 11 side than on the Title 11 side.

We also have reason to believe that our application would be received favorably, but to the extent that that program were not to be available we are not sweating that at all, given, again, the orientation towards investment grade credit. I don't know, Joel, if you wanted to add to that.

No, I think that is exactly right, Matt. There has been no fundamental change, Mike, to the program that would lead us to think about things differently economically at this point. But I would also say we are still in the early planning stage for the process.

We have talked about how that is going to be important activity over the next 18 to 24 months. We have got plenty of time to adjust our financing programs and overall financing plans depending upon how the next couple of years play out, but we will have all the flexibility that Matt mentioned.

Right. Okay, that is really helpful, guys. Thank you for the time.

Jack Atkins, Stephens.

Great, thank you, guys. Congratulations on a good quarter and being a public company now.

Thanks, Jack.

First off here, just kind of touching on the margin issue on the Ocean Transportation business for a minute. If you back out the separation costs from Ocean Transportation it sounds like your margin in that business would have been, what, 12.4% this quarter? Is that right?

Adding back, Jack, what item?

Adding back the separation costs, is that correct? Do you add it back there or do you add it back on the corporate line?

No, add it back there. That is correct.

Okay, so at 12.4% I mean that is, we talked about it, a great margin. Typically margins ramp sequentially from the second to the third quarter. I know you have some dry docking going on, but is there any reason to believe that we shouldn't see at least a similar type margin in that business in the third quarter? Or do you expect the dry docking to have a material negative impact there?

We don't think it will be material. What we are saying is that it is going to be an impact though, Jack, but it is not going to be a material impact. We still expect third quarter to be strong. We are not commenting on exactly where it is going to come in from a margin perspective.

But what we are saying is that there is going to be some costs embedded in this third quarter that we did not experience the same quarter last year, and that is going to have an effect when you look at year-over-year comparisons for the quarter.

Okay, I got you. Then, Joel, for your comment on operating income last year in 3Q 2011, could you just give us the figure that you are using there? Just to make sure we are all on the same page.

Well, the operating profit number for the Company is comparable on a year-over-year basis. The comment I made was on income from continuing operations and that is a lower item below operating profit, so it is going to be a number after expense and a number of other items.

So the most comparable year over year is operating profit, so you can still go with that. But then income from continuing operations is going to be the clean number that reflects the business going forward.

Okay, I got you. Sorry about that confusion. Then, Matt, I am just kind of curious on the utilization rate in the Hawaii service in the second quarter. Where does that stand today just out of curiosity?

Jack, we operated in the second quarter at about mid-90% utilization, about 95% for the quarter. What that does, 95% -- effectively it is very difficult to get to 100% and what you find is you are spending a lot of efforts moving freight around because it isn't always delivered in packages that are easy to accommodate.

So we are spending a little bit of money trucking it up and down the coast to be able to accommodate, but part of our operating margin improvement, despite a weaker Hawaii overall environment, is the fact that we are able to operate a nine-ship deployment and operate it relatively full during the quarter.

Sure, absolutely. And so when you think about that 95% utilization rate, what are some of the considerations about maybe adding a 10th ship there? It doesn't sound like Hawaii volumes are all that robust, but I mean at what point do you maybe need to put a 10th ship into the fleet?

It is a good question, one we watch all the time, Jack. Our view is absent a catalyst in the Hawaii market, which we don't see, our goal will be to stay in this nine-ship deployment. We will -- obviously, to the extent that as time passes we start to see a different freight pattern emerge in Hawaii, that will be the thing that requires us to take a look at it.

I would say just as a small note that there will be times because of dry docking that we do break into a 10th ship during brief periods of time as we do dry dock relief and those kinds of things. But as we think about our core deployment, as I said, we see ourselves at nine ships until we see a different market which we haven't yet seen.

Got you. When we think about the China service I think most of the upside, at least versus our forecast, was really driven by a better rate in that trans-Pac lane. Like you said, I think the carriers did a very good job keeping capacity rationalized.

So going forward I know the average rate from [Drewry] in the second quarter was about $2,400 an FEU. Is that around the number we should use for the third quarter?

Well, without commenting on the Drewry rate, I think our own internal calculation is we should use about the same rate that we saw in the second quarter. So embedded in that you may note that in the [TP Jack] a number of carriers are looking to put another GRI or peak season surcharge in place mid-August. We will be watching that with interest.

But our view is that given the supply and demand fundamentals we are about at a free equilibrium, at least until we get to slack season. Then, of course, the question is going to be will the carriers withdraw capacity, insufficient capacity to create an orderly slack season market and all of that is too early to call at this point.

Sure. Then when we think about the trans-Pacific rate, which rose not only on a year-over-year basis but sequentially this quarter, and the decline we saw in bunker fuel prices, could you maybe comment on the impact both of those items had on your incremental margins in the quarter? Which the way we are calculating it looks like they were about 64%.

Yes, I can touch on each. If we are talking about China, we do have mechanisms in essentially all of our contracts in the China trade which allow for our freight rates to move up and down based on published indices of bunker freight rates. And so we have seen embedded in the average rate, which we haven't separately called out, freight rates have declined somewhat associated with the declining bunker. And that is all embedded in our comments.

Then on the Hawaii side, of course, we announced as a result of falling bunker prices a reduction; there are several reductions in our fuel surcharge. In fact, we announced on July 10 that effective July 15 we had lowered our surcharges in Hawaii and Guam and Micronesia. Those, as I said, went into effect on July 15. So we are going to continue to monitor that and adjust as we need to changing prices.

But there weren't dramatic improvements or degradations in margin associated with field. There is always a little bit on the margin of timing, but it was not a significant driver.

Okay, I got you. Then, Matt, when you think about peak season on the trans-Pac I know you guys are operating it essentially 100% capacity utilization there. So doesn't -- this question may not necessarily relate to you guys as much, but when you think about what you are hearing as far as industry chatter on expectations around peak, I would just be curious again to get your thoughts on how the peak shipping season may be shaping up so far this year?

It is a great question and I don't have any special insight. We have talked to our customers every day and every week about their expectations in their transportation departments, and there continues to be a lot of uncertainty as to what this retail season will bring. Our customers are telling us there is just a lot of caution and people are expecting a modest peak season.

So it is just owing mostly to the macroeconomic factors, but it is really tough to say. People don't have really firm opinions. There continues to be, at least in our customers' minds, a lot of uncertainty about how this retail season is going to end up.

Ian Zaffino, Oppenheimer & Company.

Thank you very much. Question would be on the utilization side. Given that Hawaii is somewhat weak or you are saying it is weak, is their opportunity to essentially take market share, particularly given the competitive environment and what is going on there? How are you reacting to that and do you think you will be able to pick up share?

There is two questions there; one around the capacity utilization. So as I mentioned we are operating our fleet relatively full. As the overall freight market in Hawaii has contracted over the last few years, we have reduced the number of fleet units in our operation to better match the supply and demand of our freight package.

Matson has historically had a relatively large market presence in Hawaii owing to our 130-year history here, and I think our view about further share gains that is not the way we think about the business. Our goals are really around operating at about the same level and growing as the overall market will recover, rather than looking for share gains.

Okay. So just given the competitive environment, given where your competitor's financial situation is you are just going to kind of sit pat and wait for the market just to recover on its own?

Yes, I think, given our market presence, the idea of going after additional share is one that doesn't make a lot of sense to us.

Great, thanks.

Rick McGuire, Marcato Capital Management.

I actually just was hoping to quickly just clarify a couple of the questions that I think the first analyst was asking about kind of operating income and some of the adjustments. So just to be clear, the total operating income that you show I guess on slide five of the presentation that $32.5 million for the quarter, that includes the $5.8 million of separation costs. So we would add back the separation costs to get to kind of like a true operating, adjusted operating number?

Yes, that is correct.

And the same, obviously, for the first half? So when I do that I am showing kind of year-over-year growth rates and operating income that are a little over 30 as opposed to 11 or 7.5?

Yes, that is correct.

Okay. And then as we go to Ocean Transportation the same thing would apply when we go to the Ocean Transportation segment. Again, we should add back the -- add $5.8 million back to the $31.2 million of operating profit and add back the $8.3 million to the $37 million of operating profit?

That is correct.

Okay. So one question I would have, if we do that -- I had done some of the arithmetic here to back into what the operating margin percent levels are if we back off those separation costs and I get something just over 12% for the quarter.

12.4% is correct.

Yes, and a little under 8% for the first half. When you talk about your target operating income margins in the Ocean Transportation segment of 10% to 12%, what does that mean in terms of kind of total percentage improvement opportunity you think you have from where you are today?

What is the right number to compare that to? Is it the 8% kind of adjusted first-half operating profit margin, so you have 200 to 400 basis points of margin opportunity when you get to where you think you can be?

What is the right -- I guess what is the right amount of additional operating margin potential you think the business has after you back off these one-time separation charges and things like that?

Sure, I will take a crack at that -- this is Matt -- and then if Joel wants to add something he can. I guess our view is really if you look historically the business, we think, has produced and can produce operating margins in the 10% to 12% range. We think there is no reason why the businesses can't operate in that range and probably should.

But what it will require is for a return of the growth in the Hawaii trade. As was commented on earlier, we are extremely well-positioned, we are operating our fleet very effectively that we expect, if history repeats itself, a recovery in the Hawaiian economy and multiyear recovery, especially as the conditions are right again for construction to resume. We will benefit from the volume growth.

Matson's pricing approach in the Hawaiian market has long been small annual increases in pricing reflecting underlying changes in cost. So it is really changes in Hawaii volume that will need to return in order for us to get back into this 10% to 12% margin range.

So we are at 6.6% operating margin year-to-date, the adjustments that are included bring that number up. Effectively, it is an okay quarter but we are not satisfied because we are not in the 10% to 12% range that we think this business will return to when Hawaii volumes began to grow again.

Joel, did you want to add anything?

No, I think that is exactly right. But you alluded to what to compare that with, long-term trend analysis, I think was embedded in your question if I heard you right. Admittedly that is difficult because when you look at long-term trend analysis fuel costs, as an example, are such a big element that if you can compare volumes that we had five years ago with what you think might happen next two, three, four years you will have two different fuel environments too.

So admittedly a long-term trend analysis on margin is hard because of fuel. But as Matt said, we look at all of that and we think of the business as 10% to 12%, all of that included over time through the cycle.

Okay, that is helpful. And I guess on the Hawaii market you have the economic indicators here that show a forecast of some pretty strong recovery on the construction side. Obviously the permitting is visible today.

I think these construction jobs are -- I think these are percentage changes maybe in the baseline level of the construction employment. If you see this -- if in fact over the next two years you see something like a 15% increase in construction employment or this trend plays out, do you have a sense for what that might imply for container volumes?

If you think about the last time that -- it looks like this would take you above certainly above where you were coming into 2010, and I think even back to where you might have been to start around early 2009 if you see these growth numbers the next couple years. Is the correlation close enough that you are able to say, if the construction forecast plays out this way, that we would expect container volumes in the Hawaii market to be X higher?

We don't have the confidence to say that with precision. I think our expectation is that we are in for a multiyear, modest growth in container volumes when the construction cycle returns. We do like to watch, as we indicated, the permitting, although it is choppy and we think a better indicator is this employment. And you are right, those are percentage change terms in employment.

There is a correlation, but recall that the construction as an overall part of our market, while it may be the thing that grows the fastest, is just a subset of the overall market. And so it is really difficult to say with precision how to translate that into a market container growth. I think you are on the right track; it is just that putting a level of precision to it is difficult.

Okay, fair enough. Then, lastly, I guess my only other question is on the China service rate environment, just trying to add a little specificity and make sure that I am thinking about this right. If you continue to see the pricing in the spot market hold through the third quarter, is the arithmetic right?

We are seeing $800 or $900 a container higher year over year and you are looking at 15,000 containers during that period. If that was all in the spot market that would translate into $12 million of additional revenue that I would think be, more or less, pure margin from a pricing standpoint. Obviously, you have half of that in more longer-term contracts.

I guess, one, am I thinking about that arithmetic right? And, two, even though you do have some of that, have of that contracted out on a longer-term basis are the contracted rates that you have set today different or potentially higher than last year's contracted rates? So you still will expect to see a pretty significant year-over-year benefit from a margin standpoint?

It looks like we picked up $10 million of extra margin this quarter alone maybe from this dynamic (multiple speakers) the magnitude could be similar next quarter.

This is Matt; let me answer that and I'll answer the last part first. I think we did pick up margin improvement. Part of the margin improvement was because of this China factor, but clearly the benefit of having the entire Guam market that volume was a big driver also to the margin improvement.

But back to your question on the China rate, Matson's business, as we point out, is about half annual contract and half spot. The annual contract cycle runs May 1 to April 30, and for us and for most participants, if not all participants in the trans-Pacific, freight rates in the annual contract cycle back in May ended up renewing flat. That is at the expiring freight rates.

So there was no -- because of the competitive dynamic at the time and the market uncertainty and dynamics there was effectively no increase in freight rates on the annual contracted cycle. Since then we have seen strong attempts by the carriers and successful attempts to try to get spot rates up further. I think in part because of their lack of success in getting rates up in the contracted cycle.

And you asked a question about the math. Yes, so to the extent that half our business is flat and half our business is going up we don't exactly describe our actual rates in the market, but the math and the algebra and the way that you are approaching it is the right one.

Okay. Thanks a lot. I appreciate the time and congrats on your first quarter.

Thank you.

Steve O'Hara, Sidoti & Company.

Good morning, good afternoon. You guys, you're kind of saying that the business should do between, you think through the cycle, 10% to 12% operating margins. You are there today. Is it fair to say that you could kind of continue at this level with Hawaii where it is as long as Guam stays at the level it is?

Steve, this is Matt. I think the first point I would make that you made I don't agree with, which is we had a good quarter but if you look at our year-to-date operating margins we are still at 6% or 6.6%. Even if you adjusted upward for the separation costs, we are not where we want to be.

Typically, because of the strong seasonal component of our business, the second or third quarters typically have margins that are above it but they are weighed down by the first and fourth quarters. So I think our view is that we are not where we need to be. Certainly the Guam volumes and the China rate environment is helpful, but we do need to see, we think, a recovery of growth in the Hawaiian market before we think we will return to that 10% to 12% operating margin range.

Okay, thank you. I guess the other thing, in terms of competitive capacity, what are you seeing on that front in Hawaii and anything?

There has not been any significant changes in capacity deployed in the Hawaii trade in this year. Horizon continues to operate its fleet effectively, similarly our other competitor on the self-propelled vessel side, Pasha, continues to operate its pure car and truck carrier on a fortnightly basis.

Pasha has announced, as we have indicated before, that it has plans to build a second vessel, which we understand is in some stage of construction, and that will, if you believe their announcements, will be deployed in late 2013 or in early 2014. And that certainly could be a change when it is deployed, but there have been no changes in deployment or deployed capacity in the market this year.

Okay. All right, thank you.

You bet, Steve.

Ladies and gentlemen, that will conclude our question-and-answer session. I would like to turn the conference back over to Matson's President and CEO, Matthew Cox, for his closing remarks.

Thanks, everybody, for your interest. We will look forward to catching up with everyone next quarter. Aloha.

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.