Matson Inc (MATX) 2013 Q3 法說會逐字稿

Good afternoon, and welcome to Matson's Third Quarter 2013 Earnings Call. (Operator Instructions) The conference is being recorded. I would now like to turn the call over to Jerome Holland, Director, Investor Relations.

Thank you, Kate. Aloha, and welcome to our Third Quarter 2013 Earnings Conference Call. Matt Cox, President and Chief Executive Officer, Joel Wine, Senior Vice President and Chief Financial Officer, and Ron Forest, Senior Vice President Operations, are joining the call from Oakland. Slides from this presentation are available for download at our website, www.matson.com, under the Investor Relations 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, 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 9 to 15 of our 2012 Form 10-K, filed on March 1, 2013, and in our subsequent filings with the SEC.

Please also note that the date of this conference call is November 6, 2013, 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.

Also, references made to certain non-GAAP numbers in this presentation, a reconciliation to GAAP numbers, and a description of calculation methodologies is provided in the addendum.

With that, I will turn the call over to Matt.

Thanks, Jerome, and thanks to those on the call today. We have an expansive call today with exciting news about our ship build program and attractive private placement financing, and of course, a review of the most recent quarter results and updated outlook for the fourth quarter.

Third quarter results were mixed. Our core transportation services performed well despite a lull in container volume in the Hawaii market following strong volume growth in the first half of the year. Several unfavorable items impacted earnings in the quarter as well, including higher than expected transition cost at SSAT's Oakland terminal, an adverse arbitration decision in Guam, and response cost and third party claims related to the molasses incident in Honolulu Harbor.

On the positive side, we continue to see strong demand for our premium service out of China, performance in Guam remains steady, and logistics continues to rebound with stronger volume levels and improving warehouse operations. Today, we also separately announced a contract with Aker Philadelphia Shipyard to construct two dual fuel container ships with delivery expected in 2018. The decision to build these state-of-the-art vessels was based on our continued confidence in the long term prospects for Hawaii. We'll have a lot more on this later in the call, but needless to say, we're excited about bringing state-of-the-art green technologies to our home trade.

And finally, we also announced an agreement for a $100 million senior unsecured private placement of 30-year debt. We expect to take down the notes in early 2014 at an attractive low coupon rate of just 4.35%. Joel will speak more to this later.

Now, I'd like to discuss the results for the quarter. Turning to slide four, you can see that financial results were off modestly from the prior year. EBITDA decreased $8.4 million in the quarter as compared to last year, attributable to lower earnings. Earnings per share decreased from $0.45 last year to $0.40 in this quarter.

Net income was off less than $2 million during the quarter despite the numerous non-operational charges we incurred. All in all, a solid quarter.

Year to date, we continue ahead of our 2012 pace. The first nine months have been characterized by modestly stronger Hawaii volume, flat volume in our China and Guam trades, lower results at SSAT, improved performance in logistics, and lower vessel operating expenses. Recall that we've been in a nine-ship fleet for the entirety of this year and the benefits of running this optimal configuration have flowed into our financial results.

Year-to-date EBITDA is nearly $134 million, while earnings per share have shown significantly higher levels. Some of the year-over-year improvement in EPS was driven by separation expenses we incurred in 2012.

Turning now to our individual service lines on slide six, our Hawaii service hit a lull in container volume in the third quarter, which was off over 3% from the prior year. The down draft was seen across the board cross section of cargo types, and we don't believe there was any loss of market share. Based on discussions with our customers, there were a couple of construction projects in the third quarter of 2012 that didn't repeat in 2013. Also, we saw some inventory rebalancing in our beverage segment that resulted in lower volumes. Another driver was our household good shipper volume drops based on a shift in the military household goods cycle.

As we mentioned on the last call, we still think it's too early to say that the Hawaii recovery is complete and this lull is an example of the uneven nature of the market rebound. Offsetting the volume decline, we had favorable cargo mix as compared to the prior year, which resulted in higher yields for the trade, and we benefited from operating a nine-ship fleet throughout the quarter. Last year, we were in a 10-ship fleet deployment for a significant portion of the third quarter due to vessel dry dockings.

Looking to the fourth quarter, we expect volume to be at or perhaps modestly lower than prior year in the Hawaii trade. We also expect to continue to operate a nine-ship fleet.

Slide seven details some of the key metrics of the Hawaii economy based on recent forecasts by the Hawaii Department of Business and the University of Hawaii Economic Research Corporation, UHERO. With the latest releases, UHERO and DBEDT have extended their forecasts through 2016. The Hawaii real gross domestic product has been a solid indicator of general container volume growth and you can see that it is forecast to be up by 2.4% for 2014 and 2015.

Of particular note for us is the double-digit growth expected in construction activity for 2014 and 2015. That's in line with what we were seeing and hearing on the ground in Hawaii as several high rises are underway or in the planning stages in the Honolulu urban core. There is always some lag between building permitting and when construction materials are actually shipped. So we look at the forecast uptick in permitting and hiring as positive signs moving forward. And visitor arrivals are expected to continue to grow although at a slightly slower pace than in the past three years, and that's to be expected given the high visitor counts in Hawaii today.

Before moving to other service lanes, I'd like to give an update on the unfortunate molasses release that occurred in Honolulu Harbor in early September. As most of you know, we have suspended our molasses operation. The response phase was completed on September 20 and Keehi Lagoon was reopened to the public the next day after the Hawaii Department of Health reported that dissolved oxygen and pH levels in the Harbor and nearby Keehi Lagoon had returned to normal target levels. In early October, as we reported in an 8-K filing, we received a Federal Grand Jury subpoena for documents related to the release of the molasses. We are cooperating fully.

In the third quarter, we incurred $1.3 million in response costs, legal expenses, and third party claims. To be clear, there was no impact to our container operations. At this early stage in the proceedings, the Company is not able to estimate the future costs, penalties, damages, or expenses that it may incur related to the incident. As a result, at this time no assurance can be given that the impact of the incident on the Company's financial position, results of operation, or cash flows will not be material.

Slide nine shows the results for SSAT, our terminal operations joint venture. SSAT's performance in the quarter was negatively impacted by higher than expected transition costs at the new mega terminal in Oakland largely due to a delay in getting access to one of the two new facilities, resulting in significant congestion. As a result, we have booked a $2.4 million loss. We expect some of these additional transition costs to spill into the fourth quarter, so we expect a modest loss at the joint venture. Volume at the other terminals that SSAT operates were essentially flat during the quarter. However, we did have some customer gains in select markets.

The investment that SSAT has made in Oakland positioned the joint venture well for 2014 and beyond. As many of you know, SSAT is an essential component of our service capabilities and value proposition to our customers. The dedicated terminals SSAT operates provide a distinct competitive advantage for us in on loading and offloading our vessels, as well as receiving and delivering cargo.

Turning to our Guam service on slide 10, container volume decreased by 3.2% in the quarter on a year-over-year basis relating primarily to the timing of select shipments. The decrease was minimal, only 200 containers, and is reflective of the muted level of economic activity in Guam. For the year, for example, Guam volume is essentially flat compared to 2012.

Financial results were negatively impacted by $3.8 million due to an adverse terminal operation arbitration decision related to the sale of jointly owned cranes that was triggered by Horizon's decision to leave the trade in 2011. We expect fourth quarter 2013 volume to be about the same as last year, and performance in this trade to remain steady.

Our China expedited service continues to perform well in a challenging trans-Pacific market. We see strong demand for our expedited service and are running at essentially 100% utilization for our eastbound carriage. As well, we continue to command a rate premium in this trade as a result of our unique service offerings, industry-leading transit time, efficient cargo offloading at our dedicated terminal in Long Beach, and our superior on-time performance. Market spot rates did drop significantly on a year-over-year basis in this trade as we expected. However, our rates did not fall by nearly the same amount, in part because of the premium we command and in part because only half our business is based on the spot rate.

During the quarter, volume was down 5.3% related to an additional sailing we recorded in the third quarter of 2012.

Looking to the fourth quarter, we expect to see similar volume and rate dynamics. We expect flat container volume on a year-over-year basis and expect that spot rates will continue to contract somewhat.

Slide 12 describes the result at Logistics, which showed improvement over the prior year. Driven by higher intermodal and highway volume, lower G&A expenses, and continuing progress at our Northern California warehouse operations.

Like many in the industry, we saw margins contract a bit during the quarter off earlier year levels, but we are pleased by the 1.6% operating income margin recorded.

Due to the same factors that led to a positive quarter, we expect that our operating income margin for the fourth quarter will be 1% to 2% of revenues. This will significantly surpass the performance from the same period of the prior year. Recall that in the fourth quarter of 2012, Logistics incurred a $3.9 million one-time loss associated with its Northern California warehousing operations.

I will now turn the call over to Joel for a review of our financial performance and consolidated outlook for the second half of the year. Joel?

Thank you, Matt. As shown on slide 13, Matson's consolidated operating income for the quarter was $27.2 million as compared to $34.2 million for the third quarter of 2012. Ocean transportation's operating income this quarter was $25.5 million, a decrease of $7.4 million from the prior year. The drop in operating income for Ocean Transportation was related to the lull in Hawaii volume, lower China freight rates, and $7.3 million in unfavorable nonoperational items in three components. First, the adverse arbitration decision Matt mentioned of $3.8 million. Second, a $2.2 million tax allocation item related to our separation. This $2.2 million tax allocation hurt operating income, but was offset by an equal reduction to our income tax expense for the quarter, and therefore did not affect our net income or EPS. And thirdly, $1.3 million in costs directly related to the molasses release. Both the $3.8 million arbitration decision and the $1.5 million molasses release cost figures are pre-tax and did impact EPS on an after-tax basis.

In addition to these three unfavorable items, year-over-year comparisons were also negatively impacted by $3.1 million from SSAT's loss of $2.4 million this quarter, compared to a positive $700,000 contribution in the third quarter of 2012. The loss was attributable to higher than expected transition costs related to the expansion of SSAT's new terminal at Oakland, which Matt mentioned. These negative items in our Ocean Transportation segment were partially offset by freight rate and cargo mix improvements in select trades and lower vessel operating expenses.

Turning to our Logistics segment, operating income was $1.7 million for the third quarter 2013, an increase of $0.4 million over the prior year, primarily driven by lower G&A expenses.

The next slide shows our year-to-date results. For the first nine months of 2013, consolidated operating income was $82.4 million, an increase of $9.6 million or over 13% from 2012. Ocean transportation operating income was $78.3 million, an increase of $8.4 million over the prior year driven by lower vessel operating expenses, higher volume in the Hawaii trade, and to the absence of separation costs, partially offset by higher terminal handling expense associated with higher volume and higher general and administrative expenses and previously described nonoperational unfavorable items in the third quarter.

Logistics posted improved operating income results of $4.1 million for the first nine months of the year, driven by lower G&A expenses and higher intermodal volume.

Looking at our condensed income statement on slide 15, total revenue increased by 3.4% on a year-over-year basis driven mostly by higher logistics volume. Total operating costs and expenses increased 5.6%, selling, general and administrative expenses increased $1.2 million, mostly related to our acquisition of assets in the South Pacific. Our effective tax rate during the quarter was 27.1%, which was significantly lower than the 37.1% rate we had in the third quarter of 2012. The difference in income tax expense was attributable to the previously mentioned $2.2 million tax allocation related to the Company's separation in the prior year.

We expect the fourth quarter effective tax rate this year to return to our normal rate of approximately 38.5%.

Turning to slide 16, we continue to generate significant levels of cash from operations, which is attributable to the strength of our core market positions and generally improving economic conditions. The waterfall graphic on this slide shows sources and uses of our cash year-to-date. We have generated $137.8 million in cash from operations for the year. $19.7 million was used for maintenance CapEx, $19.9 million was paid in dividends, debt was reduced by $32.7 million, and we acquired assets in the South Pacific for $9.3 million. The remainder of $61.9 million has increased our balance sheet cash position.

We expect cash from operations to continue to be strong in the future, which will bolster our balance sheet cash position.

Turning to the balance sheet on slide 17, the Company made a deposit of $111.8 million to its capital construction fund as we neared the finalization of our vessel replacement plan during the quarter. The deposit consisted of an assignment of our trade accounts receivable to the capital construction fund. The receivables are unencumbered, meaning they are ours, so the assigned receivables remain embedded in other current assets on the balance sheet. Also, while the deposit had the effect of deferring a portion of the Company's current cash tax liabilities which led to an increase in our long term deferred income tax account on the balance sheet, the CCF deposit does not affect our current period income tax expense rate on the income statement.

Regarding debt and leverage, we ended the quarter with total debt of $289.9 million of which $12.5 million is current. Our net debt to LTM EBITDA ratio is down to a very strong level of 1.19, which continues to position us well for future investments. Overall, we remain focused on maintaining strong investment grade credit metrics for the long haul.

Turning to slide 18, we are pleased to also announce today our $100 million debt transaction. We believe this 30-year final maturity debt is attractive capital for the Company at a fixed rate of 4.35% on a senior unsecured basis. The closing and funding are expected to occur in January. The transaction demonstrates Matson's strong access to external capital at rates consistent with an investment grade balance sheet.

As we turn to our updated outlook on slide 19, I want to note that our outlook excludes any impact from the molasses release because such future impacts are presently unknown. With that said, we expect Ocean Transportation's fourth quarter operating income to be near to slightly below prior year levels, driven by modestly lower volume in Hawaii, modest erosion of freight rates in China, and losses at SSAT associated with the Oakland terminal transition. These items are expected to be offset somewhat by the benefit of operating our core nine-ship fleet for the fourth quarter this year. We continue to expect Logistics operating income to be 1% to 2% of revenues for the balance of the year based on modest volume increase, ongoing expense control, and improvements in the warehouse operations. If this is achieved, Logistics operating income performance will be a significant improvement year-over-year due to the warehouse consolidation charges totaling $3.9 million that Matt mentioned before.

We expect our maintenance CapEx to be approximately $25 million for the year, exclusive of any progress payments or deposits associated with our new vessels.

And with that I'll now turn the call back to Matt.

Thanks, Joel. We continue to be optimistic about our operations and prospects. While Hawaii volume hit a lull during the third quarter, we remain confident in the long term prospects for our home trade. Our China service continues to perform at a high level as we have established a strong niche in our expedited service as reflected in the premium we command in our rates. We are also encouraged by better ongoing results in Logistics, the result of a lot of hard work we've put into the business in terms of expense control and improving operations.

While there was a short-term impact from the transition at Oakland, we are excited about the expansion of terminal operations at SSAT, which will better service Matson and will also meet the needs of a growing customer base. All of these contribute to solid earnings and cash flow generation that give us the confidence to invest in Hawaii's future. With two new ships that will reinforce our market leadership position by adding a needed capacity for future growth while ensuring superior reliability, a hallmark of Matson's service.

Turning now to slide 21, we contracted with Aker Philadelphia Shipyard to construct two new 3,600 TEU container ships, which we call the Aloha Class. These vessels have been designed specifically for Hawaii and will provide us with some key operating advantages. This considerable investment totaling $418 million is financially compelling and continues our tradition of introducing the most advanced ship to our trades. We expect to take delivery of both vessels in 2018. Many of you may recall that Aker built our four newest ships that are deployed today in our CLX service, so we have a longstanding relationship with the Aker team.

The first of the two Aloha Class ships will be named in honor of the late Senator Inouye. This decision was a natural one for us. Senator Inouye left an unparalleled legacy in Hawaii history and was a true champion of the U.S. merchant marine. Having a modern U.S. flag container ship dedicated to serving Hawaii bear his name is an appropriate tribute to this great man. And on a personal note, while I know many in Hawaii know the Senator far better than I did, I'll always treasure my one-on-one time with him and I consider him a true American hero.

So why now and why new ships? As I mentioned at the top of the call, we have continued confidence in the long term prospect for multi-year growth in Hawaii. In order to best serve that market and continue to deploy an optimal nine-ship fleet, we need to expand our capacity over time to meet the growing demand. The ongoing renewal of our Hawaii fleet will ensure that we continue to maintain our superior schedule and cargo reliability to Hawaii. We are Hawaii's lifeline and we take that responsibility very seriously.

The new builds will realize fuel efficiencies through improvement in hull and engine design and the potential to use LNG as an alternative marine fuel. The vessels will also have state-of-the-art safety and environmental systems and Ron will speak to that in a few moments.

Lastly, and as importantly, the investment is financially compelling, and based on our current forecast, will be accretive to earnings upon entering the trade. Our businesses generate significant cash, so we expect the strength of our balance sheet to remain intact and to have the capacity to invest in other areas throughout this fleet renewal cycle. And with that, I will turn the call over to Ron Forest to discuss the specifications and capabilities of the new Aloha Class.

Ron?

Thank you, Matt. We're very excited about the Aloha Class because these vessels will meet Hawaii's future freight demand and will be environmentally friendly. We're building these larger 3,600 TEU ships with engines designed to run at a high speed, which ensures timely delivery of goods. The additional 45-foot capacity and additional reefer outlets will optimize our future cargo mix and allows us to better transport perishable goods to the islands.

We also have designed the vessels with sail guide spacing to carry construction materials more effectively. These vessels will have a wider beam providing enhanced stability and loadability while reducing ballast water requirements. And as importantly, it will be able to navigate safely into some of Hawaii's smaller ports.

Finally, these new vessels will have state-of-the-art green technologies, including a fuel efficient hull design, dual fuel engines, environmentally safe double hull fuel tanks, and freshwater ballast systems. These advancements are important to Hawaii as a means to reduce fuel consumption and will result in significant emissions reductions over time.

As shown on slide 24, we have designed the vessels and the engines to use liquefied natural gas, or LNG, as a fuel source. For us to utilize LNG, there are four requirements. First, commercially available LNG and bunkering capabilities on the West Coast. Second, ships big enough to accommodate the LNG tanks without sacrificing the cargo package. Third, dual fuel engines. And fourth, piping and tanks. Today's announced investment gives us two of these four components - vessel size and dual fuel engines. We plan to finalize the piping and tanks components of the LNG package at a later date after we have determined that LNG is commercially available on the West Coast. If we do proceed, the additional work would cost approximately $20 million per ship and would include insulation of the LNG tanks, associated cryogenic piping, and other related equipment.

The prospect of LNG as a lower cost, cleaner fuel for these vessels is exciting and we certainly hope the industry matures in time for our vessel deliveries.

With that, I will turn the call over to Joel.

Thank you, Ron. The vessels are a significant investment for us and when complete these new Aloha Class ships are expected to have among the lowest operating cost per TEU of any ship in the Jones Act trades. The cost efficiencies are driven by our ability to maintain an optimal nine-ship fleet deployment at much higher volumes than in the past and also by significantly lowering our operating cost on a per TEU basis. In addition, lower fuel consumption, lower crew costs, and reduced maintenance repair expenses will be important drivers to produce meaningful savings.

In terms of CapEx timing for the investment, at the table at the bottom of slide 25 it's shown the new expected progress damage for the new build program. You can see that approximately 75% of the total investment comes in 2017 and 2018. As previously mentioned, we already made $111.8 million deposit into our CCF during this quarter, which demonstrates that the timing of our CCF deposits will likely be different than the timing of the vessel construction progress payments to the shipyards shown on this page. Going forward, we anticipate making additional deposits in our CCF in order to maximize the benefits of that program and those CCF deposits are likely to occur before the scheduled progress payments posted here.

Let me finish by saying that in summary, these vessels are expected to generate strong returns and have an attractive ROS-ROIC profile for the Company. Overall, therefore, we are excited about the shareholder value creation potential from this investment.

With that, I will now turn the call over to the operator for your questions.

(Operator Instructions) And our first question comes from the line of Jack Atkins with Stephens. Your line is open.

Good afternoon, guys. Thanks for taking my questions. First off, congratulations on the announcement of the new vessels. And my--I guess my first question relates to that. Could you talk about--and I know it's early, but could you talk about where those vessels will likely be deployed? Will they be in the Hawaii turnaround service or will they be in the Hawaii Guam China service?

Hey, Jack. This is Matt. Good question. The--we envision the two vessels that will come online in 2018 to be deployed in our Hawaii turnaround service to the West Coast. So we have four vessels that are in positions that sail from the West Coast to Hawaii and turnaround back to the West Coast and, as you mentioned, five that go on from the West Coast to Hawaii, then Guam and China. So it will be in one of the two West Coast turnaround positions.

Okay, got you. And the reason I ask that is it would--if you put it in the Hawaii Guam China service that would help to increase your capacity in that lane, which is fully utilized. And also, I would think it would just enhance the fuel savings there. So could you maybe talk about is there a specific reason why you would need to have it just in the turnaround service to Hawaii or could you--?

Yes, I can Jack.

Yes.

You are right in pointing out that the benefits could potentially accrue to our CLX service in the form of additional capacity, first in that LA position, Long Beach position, to Hawaii, and then potentially out of China. The main part of the economics that Joel touched on at least initially was in allowing us to stay in a nine-ship fleet as the cargo volume returns to pre-recession levels.

Okay.

And in order for us to do that we would need to keep those vessels on the West Coast turnaround position in order to allow us to stay into a nine-ship fleet rather than having to go to an 11-ship fleet if we hadn't made the investment. So while both sets of deployments potentially are advantageous, the larger advantage comes in the West Coast turnaround service.

Okay. That makes a lot of sense. And then, Joel, as far as the $100 million borrowing, I guess the (inaudible) your private placement, could you talk about the rationale for that? Is that going to be used to fund the ships, the new vessels, the progress payments on those, or other corporate purposes? Because just from the surface it looks like you all don't really have any significant capital needs that are imminent.

Sure, Jack. Thanks for the question. The use of proceeds is general corporate purposes. But let me just say from a corporate finance perspective, we view the transaction as very attractive for a couple different reasons. First, the debt structure itself, locking in 4.35% is attractive. We view that as attractive to lock in. And secondly, getting longer duration in our capital structure is a really advantageous thing to do given the long life nature of a lot of our assets. And then also, thirdly, I'd point out that structurally we have about $100 million of scheduled amortization over the next four years. And so, this debt's been structured to not begin to amortize until well beyond that. So it has a very nice debt amortization schedule for us that fits well. So that's kind of the corporate finance capital structure point of view. But I'd also say strategically we view it as attractive as well. It allows us to diversify our funding sources. We currently have some private placed debt. We've got bank capacity and we've got Title 11 debt. So we'll look to diversify that. But also from a more strategic perspective, this will enhance our liquidity profile and allow us to really maintain strong financial flexibility to continue to pursue growth investments even as we enter this significant new CapEx phase. So for all of those really strategic reasons and financial corporate finance reasons, we felt like this is a very good deal for us and a good transaction.

Okay. Last question and I'll jump back in queue. Joel, just to the point about redeployment of capital, could you talk about the internal hurdle rates that you guys target as far as deploying capital? What sort of return would you be looking for on that capital as you invest in the business?

Well, as markets change, cost of capital changes. We think right now our weighted average cost of capital for this business is in the 8% to 9% range. So we have hurdle thresholds as we look at all of our CapEx in excess of that. And so, for these new vessels we want that to be in excess as well. And we think this one's going to be in low double-digits, so I'd say in the 10% to 12% to 13% range is where we think--where we project out and forecast out this investment return to be.

Okay, great. Thanks so much for the time.

Thanks, Jack.

Our next question comes from the line of Steve O'Hara with Sidoti and Company. Your line is open.

Hi. Good afternoon.

Hi, Steve.

Could you just talk about the--with SSAT and how long you expect these transition costs to continue? And then, I don't know if you can kind of break this out, but I mean, in terms of what they were in the quarter and would you have been profitable without that. Maybe it's not as simple as that. And then, in terms of the--how should we think about cash taxes going forward with the--this deposit into the capital construction fund?

Okay, Steve. This is Matt. I'll answer the first two questions, then I'll leave the question about taxes to Joel to comment on. The questions around SSAT were in part we do see some--we observed one of the drivers in lower performance in the quarter was our underperformance at SSAT. I would say almost all of those costs that we recorded in the quarter related to this--the transition expenses as we opened or created the single terminal from the multiple terminals there that we were operating beforehand. We do see, again, some trailing costs into the fourth quarter. We expect that those will be largely behind us as we get to the end of the year and we could--we're going to be starting 2014 without all those transition costs. And so, the results would have been far better earlier. In the previous quarter we were looking at about breakeven performance for SSAT. Without those expenses we would have been about at that level. And then, I'll leave to Joel to comment on the tax question.

Sure. On cash taxes and the way to think about the CTF is we'll get a tax shield basically for the--at our approximate effective tax rate of 38.5% for the amount that we deposited into the CTF fund, Stephen, with one caveat. If that triggers us down into alternative minimum tax status level, then we wouldn't necessarily get the full 38.5% tax benefit. But it would be a significant tax benefit. So what you'll see this year and what you'll--as you look at our cash flow, up in the cash flow from operations you'll see a significant benefit of tax add back in deferred taxes. And then, on the balance sheet what you see is an increase in a long term deferred tax liability. And so, effectively what's happening is we're getting the shield today and you're trading future tax shields out in the future for tax shields today. Does that make sense?

Yes, that helps. Thank you very much.

Okay, thank you.

Our next question comes from the line of Ben Nolan with Stifel. Your line is open.

Okay, great. Yes. I had a few follow-up questions as it relates to the new buildings, and then also on the $100 million notes. First of all, on the new buildings, I think you guys did a really nice job of sort of laying out what the vessel timetable is going to be like and the CapEx requirements and that sort of thing. One of the things that caught me off guard a little bit was how little was required upfront. Is that typical of these type of transactions, or could you maybe just walk me through how the negotiating process went in terms of capital outlay?

Yes. I can--this is Matt. I'll comment, and then if Ron wants to add something that I've missed, we'll do that. Our process, just to start with the last part of your question, we've had that--we sent our bid package around. We engaged a number of shipbuilding entities that were interested in working with us on our project. And certainly, the price of the vessel and the timing of those payments were part of our own internal decision making. But I would say part of--it's not unusual to have a relatively nominal amount at contract signing. And of course, there is some mobilization by the yard. But one of the factors that relates to the delay is the fact that the vessels themselves won't be delivered until 2018. Part of it--part of the reason for that is that they're--all of the yards or many of the yard we were in discussion with had fairly active backlogs of existing vessels owing to in part this resurgence of Jones Act shipbuilding associated with the energy boom and fracing. And so, the yards themselves are busy on other projects, and therefore, won't get started with the actual purchasing of the steel and bending and cutting until a little further along in the project, and is another reason why the payments were delayed somewhat.

And Ron, I don't know what I missed.

I think you covered it.

Okay.

Nothing to add.

Okay, great. And then, as it relates to the vessels and the design specifically, is this your own proprietary design or is it--was it done on a--off of the blueprint of an existing Korean design or something else?

Yes, Ben. This is Ron Forest. The design--each shipyard that we negotiated with provided a design from their Korean partners. And it was based on specifications that we required on what we wanted the ship to carry and speed. And we gave a list of specifications, and then they went to their Korean partners and came up with a design that was probably somewhat off the shelf and then tweaked to fit our requirements.

Okay, that's helpful. So it's not a starting from the ground up process really. It's already somewhat pretty well established in terms of the ship design aspect, I suppose.

Yes. That's--.

--So, and then my last question relates--and it goes back to what Jack was asking a little bit on the $100 million debt financing. That seemed to me to be really pretty favorable financing terms, both in terms of the duration of the money and the interest rate and the amortization. Did--and I suppose that you guys think the same. But could you maybe walk me through why you maybe didn't do more of that and pay down some existing debt currently or just increase the size of the deal a little bit, given the pretty favorable terms that you got?

Yes, Ben. It's Joel. Thanks for the question. We basically have paid down all the debt that we can that's prepayable without penalty. So what's left on our balance sheet really can only be bought back at treasuries plus 50. So it's privately placed debt. But similar to straight bond market debt, you've got to buy it back at T-50, so there's a real penalty to do that. So you're right. This is very attractive, long duration. We're pleased with it, but this is why we manage our balance sheet to--we have a really strong investment grade credit metric so we can access this kind of capital. But it is a downside that we can't take out previous capital issued in the past just because of the expensive prepayment penalties.

Okay, that's helpful. That does it for my questions. Thanks.

Our next question comes from the line of John Mims with FBR Capital Markets. Your line is now open.

Can you hear me?

Yes. Hi, John.

I had a little problem with the phone. So let me--thanks for taking my questions. Let me shift focus away from the ships for a minute, and talk about operations. When you look at conversion volumes across the board for the quarter down about 6%, revenue up 1%, how much of that gap was mix versus pure price improvement?

Yes. I don't think--it's a combination of both. I think--let me just answer the question a little more indirectly by saying that in the Hawaii trade we seek annual increases at the beginning of the year of modest amounts generally in line with our increases in underlying operating costs. And that's what we did in January of this year. And so, that is certainly part of the increase. And again, the balance is really due to mix issues. We did not in the Guam trade for the last several years increase our freight rates due to the fact that Horizon had pulled out and for the time being we felt it was--we would wait on any future rate increases there. So--and then, the China trade we saw actual freight rate declines, as we've been mentioning, because of the competitive dynamics. And so, it was a bit of a mixed bag. But again, the two factors, I would say mix was probably a slightly bigger driver than rate increases, if you look at our total revenue package.

Sure. That's fair. Are you at a point now where you can start ratcheting up Guam, or do you think that's going to stay relatively flat? And is it enough to move the needle?

Yes. I mean, our thinking--and for those that have been familiar with our story for some time, or the story of Guam, there was a significant level of interest in potential growth in Guam associated with the relocation of then 8,000 marines from Okinawa to Guam and a significant amount of additional infrastructure required to accommodate those marines. That has been pushed off. We now think that's not going to happen probably before 2016 at the earliest, but probably between 2016 and 2018. So we'll certainly provide a more--at the year-end call we'll certainly provide our views about 2014, but absent any large catalysts, we're looking for relatively muted activity in Guam volumes at this point.

Okay. One more on pricing. In the China trade, certainly when you look at index rates, very volatile, changing kind of week-to-week. And some of your business is contract. And I know you're getting a premium on all of it. But in the spot rate, even with that premium, are you seeing the volatility week-to-week or are you able to--is your pricing a little more stable?

Yes. So by way of context, about half of our business moves under annual contracts that are generally done around April 30 to May 1--or May 1 to April 30. So that portion is relatively known--.

--Right--.

--At that period of time. Of the spot market, we have seen relatively low changes in our own freight rates week-to-week. We certainly monitor the spot rates. But for our spot rate business, it tends to be significantly more stable, especially during the six months a year when we're at peak. So we have seen not very much movement. But again, we are expecting--we're not immune from the rate cycle. We are expecting to move into the traditional slack season and our expectation is that our rates will moderate in the fourth quarter as they did in the previous year's fourth quarter.

Okay. But still, even in the spot business, it's just--it's relatively stable, but still depressed year-over-year.

Our business is lower year-over-year at a rate level that is significantly higher than the overall trade.

Okay. Yes, perfect. Now switching, one question on Logistics. Can you segment out--on the margin improvement segment out what's more net revenue side and what is more related to costs? And obviously, there are some industry headwinds across the board. Everybody's seen that. But I'm trying to see if you are able to buy better right now, or if you're--the 1.6% was more of a Company-specific cost issue.

Yes. I would say that we have seen, like everyone else has seen, margins under pressure and those have tightened. I would just attribute--and we're not immune from those market margin pressures. I would say that the majority of our increase relates to increases in our G&A and cost structure, which we've been very actively managing.

Okay, that's great. And then, actually Joel, I will ask you one question about ships and I'll turn it back over. You said the new ships will be the most efficient in the Jones Act, which makes sense. But can you give a range of how big that gap will be versus the ships you're replacing? Like the X percent of per container operating expense savings relative--not relative to the industry, but relative to the ships you'll be taking out of the market.

Yes, John. Well, let me first just clarify that these new ships will be--we're confident they'll be among the lowest in the industry. We don't obviously have data on everybody, and so we can't say that it's going to be the lowest. So just to make that--what we can say is in our own fleet on a per TEU basis we expect them to have the lowest costs. And so, that will be meaningful. It will be an important source of the return thesis that I mentioned before. But we're not going to break out how much is coming from each of the individual component parts that we talked about. But we will say that it will be--all of them blended together will lower in a significant way our cost on a per TEU delivered basis for containers in these new ships.

And this is Matt. I would just add those savings come in two forms, as I said earlier. One is the fact, as you point out, that the vessels that are being--that will be put in--will be replaced are nearing the end of their economic lives and these new vessels will be much more efficient on a vessel-per-vessel basis. But the other and large benefit is that we'll have to operate fewer of them because we built them large enough that would allow us to operate fewer of them to carry the same cargo package compared to where we were at the previous peak. So both of those elements create the returns that make this investment worthwhile.

Okay. Yes, that makes sense. And just actually I do have one more. On the new debt, am I right that we should see about $0.25 a year in interest expense after tax, or is there some other debt coming off I guess starting in 2014?

Yes. The--no, there won't be debt coming off because of this. So if you look at our--if you looked at our--if our share count stayed the same at 43.3 million, after tax this would be about $0.06 a year on an annual basis. Just $100 million at 4.35% after tax divided by 43.3--.

Yes, that's right. Sorry. Yes, I had the math wrong. So yes--okay, cool. Perfect. Thank you so much.

Okay, thanks.

Our next question comes from the line of Michael Weber with Wells Fargo. Your line is open.

Hey, guys. This is [Donald McLee] on for Michael.

Hi.

Hi, Don.

And I actually had just one quick question about--you mentioned that double-digit construction growth is a positive indicator for the Hawaiian container trade. Is there a specific inflection point that we can look to, or maybe another indicator that will indicate stronger upside for the Hawaiian economy going forward?

No. I--the data that we typically look at are construction jobs, Don, and building permits that we've also been--we've always cautioned on building permits. There can be a lot of noise, especially quarter-to-quarter, year-to-date, on building permits. So we continue to say construction jobs, people actually working in Hawaii in the industry, that's going to be probably your best, highest correlated, variable to actual container volumes. Does that answer the question you're asking?

Yes.

Okay.

I think that addresses it. That's actually my only question. All the other ones were addressed.

Great. Thanks, Don.

Our next question is a follow-up from the line of Steve O'Hara with Sidoti and Company. Your line is open.

Hi. Thanks for taking the follow-up. I guess just in terms of the dual fuel vessel, how does that work? I mean, if you--I mean, can you--how often can you kind of switch kind of back and forth? Do you have to decide on a fuel for a certain period of time, or can you kind of switch back and forth?

Yes, this is Ron. I mean, our goal would be to use LNG, if it was available all the time. But we will have the capability to switch back and forth. The ship will have fuel tank dedicated heavy fuel oil tanks, as well as distillates and LNG tanks. So we could switch back and forth.

Okay. So you could potentially fill it with whatever is cheaper at the port at that time.

Yes.

Okay. And then, in terms of--if I remember back to the pre-separation kind of investor day or update you had in New York, there was a talk about Hawaiian infrastructure and how the state had not spent on infrastructure for--they kind of missed the cycle, I guess. And are we any closer to kind of getting that moving again? I mean, it's like--the Hawaiian light rail or the Honolulu light rail is maybe moving again. And I mean, where are we in that cycle?

Yes. This is Matt, Steve. I would say there are four or five--as we think about the construction opportunities in Hawaii, there--it falls into several categories. One, of course, are the ones you are pointing out, which are the infrastructure, which is whether it's water and sewer, it's roadway, it's light rail, and we do see that in each of those cases there are--and again, especially as the state's finances continue to improve, there will be more spending on those public works type projects. And again, as you point out, rail is back on track and we're encouraged by where light rail is now. The second is in military construction. And there, the--we continue to believe that while the overall DOD budgets are impacted by sequestration and other spending, we do over the longer term feel encouraged by the importance of the Pacific and we do think that both in Hawaii and Guam over time there will be ongoing and important military construction that will take place for that part of the economy. And then, lastly, it's really in the area of private investment, and that takes the form of residential, high rise construction on Oahu and other forms of remodeling and hotels, either brand new hotels or significant refurbishments. And in that segment of the economy we're very much encouraged by what we're hearing to be, especially in Oahu, a relatively strong and healthy cycle in which while there continues to be some surplus in building, based on the current need that we're going to see a relatively robust period of private investment construction. So it's really all of those together as we think about the broader Hawaiian economy and what investments are going to be made over the next five years to 10 years.

Okay. And then, maybe just one last one. I noticed that the auto volumes was down pretty good. I mean, anything--I mean, it seemed like you had been kind of suspect about the volumes that were kind of reported or kind of maybe happily surprised in the past--recent past. I mean, is that just kind of returning to normalization there?

Yes. I mean, I think there really are two--the way we think about the auto market, there are two pieces. One are the retail sales of new cars and manufacturer movement of those cars. There we've seen relatively good improvement in year-over-year auto purchases, relatively consistent with what we're seeing in the mainland and other U.S. markets. The bigger mover of the needle for these auto shipments are really the timing of rental car replenishments. And each year, depending on how the holidays fall and the agreements reached between the manufacturers and the rental car companies, they tend to move in different quarters, but overall not by dramatic amounts. That is, over time they are relatively stable, although we have noted that from year to year they tend to move in slightly different periods. But overall, we don't--those are not significant--especially the rental car replenishments of new manufactured cars are not a significant contributor to our operating results in any given quarter.

Okay. Thank you very much.

Our next question is a follow-up from the line of Jack Atkins with Stephens. Your line is open.

Yes, guys. Thanks for taking my follow-up question. Just back to the ships for a moment, and I'm sorry if you've already answered this. But do you intend to seek Title 11 financing for those vessels? And sort of how does that work? Do they have to be delivered to you before you can finance them through that avenue? Just kind of talk about that for a moment.

Sure. We have made no decision on Title 11 financing at this point, Jack. And you have anytime to do Title 11 financing. You've got to get the application underway, but we--Title 11 financing tends to occur and close upon delivery. So we have to start the application process relatively soon, but it wouldn't be something that would come to completion and be funded until the delivery time. So we've got a number of years. So--but at this point in time, we haven't made a decision one way or the other on it.

But the only thing I would say is that based on the way we're seeing the world now, I think Joel is right in preserving our ability to do that. But the way we see it at this moment, these vessels are largely going to be financed through this $100 million financing that Joel has mentioned and operating cash flows over the next few years before the delivery of the vessels.

Got you. But generally speaking, Title 11 financing would probably be more attractive in terms of a coupon rate though, right, than something you get in the public markets?

Not--Jack, not dramatically.

Okay.

A little bit, but remember, it's secured. And so, what too much security does to your capital structure is it chokes off unsecured capital. So there has to be a balance. And we talk to our lenders about this a lot. There has to be a balance between a little bit--some security, but not too much, because otherwise you lose your investment grade type profile for your unsecured debt, which is a critical piece for us.

Okay.

So we--.

--Yes. And the last point I would make--this is Matt--is the last vessel that we--the Model A, which was the last of the Aker (inaudible) vessels that we acquired in 2006, the private placement financing net-net all in was actually less expensive for us versus using Title 11 on an NPV basis. And in part it's because of our preference to stay investment grade credit metrics. And if you're in that position, then there is not as dramatic an incentive to use Title 11 relative to more marginal borrowers.

Okay, that's great. That's very helpful. Thanks for the time.

Thanks, Jack.

(Operator Instructions) And I'm not showing any further questions at this time. I'd like to turn the call back over to Matt Cox for closing remarks.

Okay. Thanks for all of your interest today. We look forward to catching up with you at our year-end call. And aloha, and thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a good day.