Matson Inc (MATX) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2016 financial results conference call. (Operator Instructions)

As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Jerome Holland, Director of Investor Relations. Mr. Holland, you may begin.

Thanks, Danielle. Matt Cox, President and Chief Executive Officer, and Joel Wine, Senior Vice President and Chief Financial Officer, are joining the call today.

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, the presentation slides, and this conference call. These risk factors are described in our press release and are more fully detailed under the captions Risk Factors on pages 8 to 15 of our 2015 Form 10-K filed on February 26, 2016, and ion our subsequent filings with the SEC.

Please also note that the date of this conference call is August 2nd, 2016, and any forward-looking statements that we make today are based on assumptions as of this date. We undertake no obligation to update these forward-looking statements.

With that, I'll turn the call over to Matt.

Thanks, Jerome, and thanks to those on the call.

Matson's core businesses delivered second-quarter operating results in line with our expectations.

Market conditions in the China trade remained at depressed levels during the quarter which hurt our year-over-year results when compared to the exceptional demand that benefited our premium, expedited China Service last year.

Our Hawaii trade produced solid results benefiting from an 8.4% increase in year-over-year volume, while we deployed 11 ships during the quarter in order to maintain adequate capacity to serve our customers amid continued market growth.

In Alaska, I'm pleased to report that our integration is substantially complete and we remain on track to achieve our earnings and cash flow accretion expectations for this business.

Looking to the remainder of 2016, we're focused on closing and integrating our recently announced acquisition of Span Alaska, underscoring our long-term commitment to Alaska and solidifying Matson's position as a critical freight transportation provider there.

We expect our core businesses to continue to generate significant cash flow, which, when combined with our strong balance sheet, will provide for the Span Alaska acquisition, the construction of our new Aloha Class vessels, the consideration of additional fleet renewal investments, and the ongoing return of capital to shareholders.

Turning to the next two slides, 4 and 5, I will touch on our high-level financial results, leaving it to Joel to provide more color later in the call.

In the second quarter of 2016, we earned net income of $18 million, or $0.42 per share, and generated EBITDA of $68.8 million.

Year to date 2016, Matson earned net income of $36.1 million, or $0.83 per diluted share, and generated EBITDA of $135.2 million.

While these measures are all higher year over year for both the quarter and the year-to-date period, I'd like to remind you that the second quarter of 2015 was negatively impacted by the Horizon acquisition-related SG&A and the Molasses settlement-related costs, the respective effects of which are shown in the stacked bar graph data with dotted lines.

I should also note that earnings per share were negatively impacted by an unusually high tax rate in the second quarter of 2015.

Turning to our Hawaii Service on slide 6, the second quarter of 2016 turned out largely as expected, with Matson achieving 8.4% year-over-year container volume growth amid continuing modest market growth and competitive gains resulting from the reconfiguration of Pasha Service.

In mid-April, we shifted back into an 11-ship deployment in Hawaii to add capacity out of the PNW.

For the full year 2016, we continue to expect Hawaii container volume to be moderately higher than 2015. And consistent with our previous outlook, the increased volume came in the first half of the year.

You'll recall that Matson's volume in the second half of 2015 reflected competitive gains due to Pasha's service reconfiguration and a vessel mechanical failure they suffered, which make challenging comps in 2016.

As a result, our second-half 2016 expectations are for container volume to approximate the level achieved in the second half of 2015.

Slide 7 highlights some of the key metrics that support our market growth expectations for the Hawaii economy as forecast by the University of Hawaii's Economic Research Organization, or UHERO.

As we've mentioned before, much of the incremental market growth we can expect to see in Hawaii will come from the continued progress of the construction cycle.

Residential building permitting and construction jobs picked up considerably in 2015, and growth is forecast to continue through 2016 and 2017.

While Honolulu is much further along in the construction cycle driven by Kaka'ako condominium developments, commercial building, and the light rail project, the neighbor islands are seeing resort development and the beginnings of a residential pickup. But the extent of this building upswing will likely be more limited than in past cycles.

And I should also mention that tourism is having another strong year. Just last week, the Hawaii Tourism Authority reported that 2016 mid-year performance for visitor all arrivals and visitor spending is tracking ahead of the record pace set in 2015.

Moving to our China Service on the next slide, Matson's container volume in the second quarter of 2016 was 9.7% lower year over year due to continued market softness and the absence of the exceptionally high demand we experienced in the second quarter of 2015 during the US West Coast labor disruptions.

Our Expedited Service continued to realize a sizable rate premium in the second quarter 2016, but, as expected, average freight rates were significantly lower than the second quarter 2015, largely due to the challenging market conditions in the Trans-Pacific trade, with underlying market rates at historic lows amid chronic over capacity.

In recent weeks, we've seen some improved capacity balance in the market, as two Trans-Pacific [strings] were idled and the peak season GRIs have had a positive impact, but still the SCFI is only around $1,300 per TEU, and well below last year's level.

As a reminder, about one half of our China business is based on the spot market and the other half based on annual contracts that were signed in May at substantially lower rates than 2015.

With that, we're leaving our outlook for China unchanged, with the expectation that Matson's sizable rate premium will endure in the second half of 2016, but at rates significantly lower than those achieved in the second half 2015.

Turning to slide 9, in Guam, Matson's container volume in the second quarter 2016 was essentially flat on a year-over-year basis, as modest market growth was offset by competitive losses to the biweekly US flag container ship service that launched early this year.

For the balance of 2016, we are expecting modest competitive losses to this new service.

Moving now to our Alaska service on slide 10, in Alaska, Matson's container volume for the second quarter of 2016 was moderately lower than the level carried by Horizon Lines and Matson in the second quarter 2015, primarily due to the continuing muted economic activity in Alaska related to the sharp decline in energy prices.

On a more positive note, as I mentioned at the outset, we can now report that our integration of the Alaska operations is substantially complete. You may recall that we originally placed a 24-month timeline on the integration project. So to be completed in roughly half that amount of time is a real success and a testament to the hard work of our integration teams.

Looking ahead to the remainder of 2016, we expect the challenging macroeconomic and freight environment in Alaska to again result in container volume modestly lower than the level achieved in the second half 2015.

Turning to slide 11, less than a week ago on July 27th, the Anchorage Economic Development Corporation, or AEDC, published its annual three-year economic outlook. And we've shown a summary of their forecast for select economic indicators.

While this does not represent a statewide forecast, it does provide a useful window into the state's largest market.

For now, we'll just note some headlines. But we've provided a link to the full report at the bottom of the slide for your reference for more detail.

As much of Matson's cargo volume is consumption-related, we wanted to draw attention to the consumption-related indicators. Both population and employment are forecast to decline modestly this year and next and flatten out in 2018.

With a record permanent fund dividend in 2015, AEDC estimates personal income growth for Anchorage residents increased by 3.8% in 2015. However, with job losses and possibly lower permanent fund dividend, personal income is expected to fall 2% in 2016, slight growth of 1% is expected in 2017, before a return to 3.2% annual growth in 2018.

Alaska's healthy visitor industry can be viewed through the air passenger volumes where AEDC forecasts a strong visitor season in 2016, and slightly lower growth for 2017 and 2018.

Overall, increased visitor arrivals are expected to outweigh reduced business in state of Alaska government travel.

And AEDC anticipates building permit values to fall 5% in 2016 due to reduced public and private spending, before flattening out in 2017 and 2018.

All in all, the AEDC outlook is consistent with what we've been hearing from our customers in Alaska, pointing towards a muted economic environment for the next two years and the feeling that the economic impact of the decline in oil prices is yet to fully materialize.

Moving to slide 12, our terminal joint venture SSAT contributed $3 million in the second quarter 2016, compared to $5.2 million in the second quarter of 2015.

As expected, SSAT experienced strong volume growth in Oakland, related to the closure of the Outer Harbor Terminal and the transition of nearly all of its container lists to SSAT's OICT Terminal.

However, the positive impact of improved lift volume in Oakland was more than offset by the absence of the benefits related to the clearing of international cargo volume after the US West Coast labor disruptions in the second quarter 2015.

Looking to the remainder of 2016, we expect SSAT to make a slightly higher contribution to our ocean transportation operating income that it made in the second half of 2015.

Moving on to Logistics, slide 13 summarizes the key transaction highlights of Matson Logistics' recently announced acquisition of Span Alaska, which, when closed, will significantly expand our asset light logistics platform to include Less-than-Container load, or LCL, freight consolidation and forwarding to Alaska.

This is a strategically and financially compelling acquisition that underscores our long-term commitment to Alaska.

Matson Logistics will acquire Span Alaska for a cash purchase price of $197.6 million. Matson will not be assuming any of Span's debt. And we expect the transaction to be treated as an asset purchase for federal tax purposes, which will allow for a tax basis step up of assets worth an estimated $35 million of net present value to Matson.

Based on our estimated current annual EBITDA run rate of approximately $21 million for Span, the EV to EBITDA multiple for this transaction is approximately 9.4 times and net of the estimated tax benefits related to the basis step up, the transaction multiple would be approximately 7.7 times.

We expect this transaction to be immediately accretive to earnings, with annual EPS accretion expected to be approximately $0.10 to $0.12 per share, excluding one-time transaction, closing, and integration costs of between $4 million and $5 million.

The transaction received HSR early termination on July 29th. And subject to other customary conditions, we expect to close this acquisition in early August, and plan to fund the closing from available borrowings under our $400 million revolving credit facility, at closing.

And for those who may have missed the announcement, I would refer you back to our July 18th presentation and conference call for a more complete description and discussion.

Slide 14 highlights results at Logistics for the second quarter where lower intermodal yields were partially offset by higher volume to deliver an operating income margin of 2.3%.

As we look to the remainder of 2016, our focus in logistics will be on closing and integrating the pending Span Alaska acquisition.

We plan to update our outlook for the effects of the transaction after closing. So for now, excluding Span Alaska, we continue to expect modestly higher operating income from Logistics in 2016.

I will now turn the call over to Joel for review of our financial performance and consolidated outlook. Joel.

Thanks, Matt. As shown on slide 15, Ocean Transportation operating income for the quarter increased $2.5 million year over year. The increase was primarily due to the absence of SG&A expenses related to the Horizon acquisition and costs related to the Molasses settlement, as well as higher container volume in Hawaii.

Partially offsetting these favorable year-over-year comparisons were lower freight rates and volume in the China Service, higher vessel operating expenses related to the deployment of additional vessels in the Hawaii trade, and higher terminal handling expenses.

The Company's SSAT joint venture investment contributed $3 million during the second quarter 2016, compared to a $5.2 million contribution in the second quarter 2015.

On a year-over-year basis, SSAT's lift volume improved in the second quarter 2016. However, the positive impact of improved lift volume was more than offset by the absence of the benefits related to the clearing of international cargo volume after the US West Coast labor disruptions in the second quarter 2015.

Operating income for Logistics was relatively flat in the second quarter year over year, due to the items Matt mentioned earlier.

As shown on slide 16, Ocean Transportation operating income decreased $8.4 million during the six months ended June 30, 2016, compared with the six months ended June 30, 2015. The decrease was primarily due to lower freight rates and volume in the China service, higher vessel operating expenses related to the deployment of additional vessels in the Hawaii trade, and higher terminal handling expenses.

Partially offsetting these unfavorable items were the absence of SG&A expenses related to the Horizon acquisition and costs related to the Molasses settlement, higher container volume and yield improvements in Hawaii, and the inclusion of operating results from the Company's acquired Alaska service.

SSAT contributed $5.6 million in the first half 2016, compared to an $8.6 million contribution in the first half of last year, with the year-over-year decrease due to the same reasons I outlined for the second quarter.

Turning to slide 17, at quarter end, our balance sheet continued to be in very good shape, with a net debt to EBITDA ratio of only 1.4 times, and our share repurchase program continued steadily in the quarter.

As Matt mentioned earlier, we expect to close the Span Alaska transaction in early August, using funds from our bank revolver. For the longer term, we felt it would be prudent to match this long-term investment with a similar amount of long-term debt financing.

As such, we also announced two weeks ago a $200 million private placement financing at 3.14% for a 15-year final maturity approximate 8.5-year weighted average life senior unsecured debt instrument.

The covenants on the new debt are expected to be substantially similar to our existing covenants and we expect to close this new debt transaction in September.

On slide 18, you can see an updated pro forma cap table for the Span Alaska and private placement transactions, with our leverage ratio still in the 1.7 to 1.8 times range, which will still be below our long-term targeted level of in the low two times.

Our liquidity position will also remain strong with only approximately $57 million of borrowings under our $400 million bank revolving line of credit, which does not mature until 2020.

Slide 19 shows a summary of the balanced and disciplined manner in which we allocate our cash flow generation. On a last 12 months basis, we generated cash flow from operations of $221.2 million and had net CCF withdrawals of $27.5 million, from which we used $53.8 million to repay indebtedness, spent $88 million on maintenance CapEx, and put $33.4 million toward the construction of our Aloha Class vessels, and we also returned $31.6 million to shareholders in the form of our quarterly dividends and $37.1 million via our share repurchases.

You'll notice that our maintenance CapEx is tracking higher than our normalized range of $40 million to $50 million per year. This was largely expected and is outlined in our last two earnings calls, and is primarily due to the completion of the scrubber installation program on our Alaska vessels and other capital projects related to what will be a relatively heavy dry-docking year for us this year.

In addition, we recently took advantage of highly attractive container prices to accelerate our purchases of container equipment at near record low levels.

With that, now let me turn to slide 20 to discuss our outlook for the full year and second half of 2016. As a reminder, our outlook is being provided relative to the prior year's operating income and excludes any impact from the Span Alaska acquisition.

We expect to update our operating income outlook for the Logistics segment to reflect the effects of the Span acquisition after it closes in early August.

For Ocean Transportation, we continue to expect operating income for the full year 2016 to be approximately 15% to 20% lower than the $187.8 million achieved in 2015. And in the third quarter, operating income is expected to be approximately 25% lower than the $68.9 million achieved in the third quarter of 2015.

In terms of headwinds, we expect to have significantly lower average freight rates in China, increased depreciation and amortization expense, modest competitive volume losses in Guam, a modestly lower contribution from SSAT.

As partially offsetting tailwinds, we expect to benefit from moderately higher Hawaii container volume, the inclusion of operating results from Alaska for the full year, and the absence of acquisition-related SG&A, and the Molasses settlement costs.

For Logistics, we expect operating income for the full year 2016 to modestly exceed the 2015 level of $8.5 million, driven by volume growth and continued expense control.

Regarding items below the operating income line, we expect interest expense for the full year 2016 to be approximately $23 million and our effective tax rate for the full year to be approximately 39%.

And regarding capital spending, we now expect maintenance CapEx of approximately $85 million, which is $20 million higher than our previous outlook, primarily due to the additional opportunistic spending on container equipment I mentioned on the prior page.

Consistent with our prior outlook, for the full year, we expect new vessel construction progress payments to total $67.2 million and dry-docking payments to total approximately $60 million.

With that, I'll now turn the call back over to Matt for final remarks.

Thanks, Joel. In summary, the second-quarter results were in line with our expectation.

And now, for the remainder of 2016, we'll turn our attention to closing and integrating the Span Alaska acquisition. We'll continue to evaluate ordering additional new vessels to complete the renewal of our Hawaii fleet. And most importantly, we'll be focused on our mission, which is to move freight better than anyone and delivering on out long-term commitment to be the service leader in all the markets we serve.

Overall, I continue to be very confident in the strong cash flow generated from Matson's core businesses that, combined with our balance sheet, will provide ample capacity to close this pending Span Alaska acquisition, fund our fleet and equipment initiatives, while continuing to return capital to shareholders.

And with that, I will turn the call back to the operator and ask for your questions.

Thank you. (Operator Instructions) Jack Atkins from Stephens.

So I guess just to start off with a question about the Hawaii market. The 8.4% container growth in the second quarter obviously benefiting from having some extra capacity in there, could you maybe comment around what's your westbound utilization looking like now with the 11-ship deployment in place?

And sort of how do you view underlying market growth in the Hawaii market sort of as we stand here today?

Sure, Jack. To answer your second question first, we continue to believe that the Hawaii economy is sort of in a mid-inning recovery. We do see continued growth in the economy. With the indicators, as we talked about, construction, of course, is the big mover, employment, all those things continue to make us feel good.

Also, while not directly attributed necessarily to our business, the visitor industry remains healthy and that growth does provide a source of confidence for hotel renewals and other long-term development.

So we continue to feel good there. We continue to feel there's [legs] to it.

With respect to the movement into an 11-ship, our utilization of an 11-ship, the entire 11-ship fleet, is in the 80%.

So we went from a 10- to 11-ship fleet, as we mentioned in previous quarters, primarily because we had a chokepoint in our network out of the PNW as a result in part of Pasha's reconfiguration of its fleet, which they decided to no longer serve the market.

And so the incremental freight we expect to receive from that 11th ship has more than paid for the deployment of that 11th ship.

So while our utilization is a bit under our long-term norms of once we, say get above 90%, it's time to add another vessel, that 11th vessel has been paid for by incremental freight and other fleet efficiencies.

So we really feel good about our deployments. We've got surplus capacity in places that we believe it will be needed over the next few years. And we feel, again, really good about both our current Hawaii fleet and, of course, are excited about the arrival of the Alohas. And, of course, we're continuing to evaluate two more ships to complete the modernization.

So overall, we feel great about where we are in the Hawaii market.

Okay, great, Matt. Thank you for that response. And then shifting gears to Alaska for a moment. If you go back to the prepared comments, Matt, you commented that the expected accretion of both cash flow and earnings from that Alaska acquisition, you're still on target, I guess, as it relates to both of those items.

And given the decline that we've seen, moderate decline we've seen in Alaska container activity, just given what's happening in the economy there, be curious to know what sort of leverage you guys have been able to pull internally to get the profitability and the cash flow in line, because it seems like container activity's a little bit lower, but, obviously, you guys are doing some things to boost the profitability there.

Yes. I would say, Jack, it's a good question. And as we talked about, we did provide a little bit more outside context for Alaska. The AEDC might be useful indicator.

But clearly, freight volume has declined on a year-over-year basis. We expect the overall economy to be muted. We've also noted previously that the segment of the economy that we trade, more of that retail segment has been more resilient and less subject to very large swings and is more based on the population and personal income.

It is also the case that our integration, now complete, and our expectation for the need for additional headcount in our corporate infrastructure, has been less than we expected, which has allowed us to continue to believe that once we get the new vessels or the vessels with the scrubbers back into service, which will happen by the end of this year, and with a slightly lower expectation for corporate overhead, that we continue to be confident that we're going to hit our original cash flow and earnings expectations out of Alaska. So we, despite the headwinds, continue to be confident in that.

Okay. That's excellent. Excellent. And then, as it relates -- just a housekeeping item on interest expense. It seemed like interest expense was perhaps a little bit higher than originally expected in the second quarter. Could you maybe comment on what drove that?

And then, the $23 million in interest expense for the full year, if I'm reading the press release right, that includes the private placement. Could you maybe give us a number excluding that if we're going to back that out to exclude Span completely from the guidance?

Sure. On that second piece, Jack, we're assuming that the new transaction closes in September. And so you can take interest expense on $200 million at 3.14% for September through the end of the year, and then that'll back out.

Okay.

You can back that out of the $23 million number.

Okay.

With respect to the slightly higher number here in this quarter, you'll see in our pension footnote when we filed our Q, there was a slight adjustment to our withdraw liability to the Horizon Puerto Rico pension. And that gave rise to a $1.1 million slight increased charge of interest expense, [bump] to the interest expense line for this quarter. So that's what led to a slight increase in Q2.

Okay. Thank you very much.

Thank you. Ben Nolan from Stifel.

Well, first, just to follow on what Jack was asking. So that $1.1 million, that is one time in nature, so it's not something that should be modeled going forward. Is that correct, Joel?

That's correct. That's correct, yes.

Okay. All right. Now, on to a few of my, I guess other questions. So as it relates to Hawaii, and, again, sort of thinking through the impact of the market share gains that you guys have had, and a lot of it having to do with Pacific Northwest, at this point, do you think it's fair to categorize the market share gains that you have captured is actually sticky and not transient? This is the kind of the new normal? Is that a fair way to think of it, do you think?

Ben, I think it is. I mean, I think what we saw was when we saw originally Pasha's change, you'll recall that they, as we've mentioned, pulled out that the PNW. They have only an indirect service out of northern California, but effectively doubled their capacity in southern California, choosing to focus on that market.

So our original expectation was we were going to pick up freight in the PNW, some in Oakland, and lose some in LA. But net net, that was a benefit to Matson. And that's basically what's happened.

And we do see, at least our share, based on this revised deployment, the series of revised deployments for those, the share breakout to be about settled at where it is now. That's why we're not really expecting in the second half of this year any change in volume, except for that might come out of market growth. So that's kind of our expectation.

Okay. And along those lines, it looked like there was a pretty big increase in the auto volume. I know that's a low margin business for you guys.

But is that a function of you guys having excess capacity and just finding something to generate extra income as a function of being able to, or was it unique to the quarter maybe more something?

Yes. I mean, there are effects around when the auto, rental car companies, primarily, will move rental cars, where they bring new cars into Hawaii, then return them to the mainland for auction, into auctions.

Retail sales for cars have been relatively healthy in Hawaii as part of the broader economic strength. And so I would say, as you've heard us say before, a lot of those cars are moved through our auto manufacturer customers. The margins on those business are not significant.

And so we often talk about those as changes in volume. But rarely do we talk about them as movers in our operating income.

So, yes, we did carry more cars. We think it was more of a function of sort of when the auto rental companies chose to move those cars based on auto fleet renewals and a strong economy. But I wouldn't say there was anything more exceptional than those factors.

Okay, great. And then shifting quickly to China. Obviously, the broader market was really weak in the second quarter. But as you mentioned, there's been a pretty material uplift in the Trans-Pacific international rates, almost a doubling of rates since July. Still not exceptional levels, but better anyway.

When I think of the premium that you guys earn, is it fair to assume that that premium is static relative to the underlying freight rates, such that -- I guess my point being, if the market is able to hold these better rate levels on the international side, do you think that might translate into potentially better results for your China Service in your forecasting?

Yes, I mean, it's possible. Although, the way we're thinking about it and we talked a little bit about it last quarter, the market could strengthen further.

What we see really, this is just more of a seasonal effect that things get busier just because of the retail cycle. They're going to remain busy for the next few months. But we're not reading anything more into it than seasonal effects as we're starting to get into a busier time of year.

I mean, it's possible, Ben. But at this point we continue to be very cautious about calling a market upturn. Maybe we've seen the bottom, maybe we haven't. But exactly when that market turns and when, it's just really too hard to say.

So that's why we're really just continuing to affirm our outlook overall. We said 15% to 20% down, which was consistent with our expectations last quarter when we saw the China market really just take a significant dive.

So we continue to be rather cautious in calling that. I mean, there's a possibility I would -- I would say the possibility is relatively low at this point.

Okay. And along those lines, I know that there's been at least one other operator that has tried to replicate the expedited service. Have you noticed any increased level of competition from that or has it not really shown up on your radar?

Yes, I mean, it's shown up on the fringes of our radar. I can't say that we've had any direct customer losses. They've done an okay job of narrowing the differences. Obviously, they've shaved the number of days off. We remain the leader by a number of days.

And again, we might see it on the margin and some Chinese [forwarders] as we get into the busier time of year. But it really only on the margin has impacted us.

Okay. Well, I could keep going. But I'll turn it over and maybe get back in the queue. But thanks for the help.

Thank you. Steve O'Hara from Sidoti Company.

I was just wondering -- I know the last caller addressed the question of the rate premium. But I mean, in terms of where this has historically been versus where it is now, I mean, is it a similar level or kind of maybe lower than it was in previous, we'll say normal periods absent West Coast port issues or something like that?

Yes. I mean, I would say that our rate premium has steadily increased over the years. In 2015, it reached a significant new high over 2014. I would say 2016's premium is at or around the 2015.

So we've not seen a significant erosion in that premium. We've seen market rates go down, us with it, but that premium has endured at very, very high levels in comparison to 2015. So we're very pleased about that.

Okay. Thank you. And then just on the scrubber installations and any dry dock that's going on, I mean, is there any hit to profitability with having maybe a in-service fleet that's maybe less optimal than you'd like it or is that not a factor right now?

Yes, it is, Steve. Just to talk about the scrubbers. We're in the process that we've gotten through two of the scrubbers, a third scrubber will be done between now and the end of the year in Alaska.

While the scrubber project has gone on, we have put in its place a steam vessel which is relatively less efficient than is supposed to be diesel engine, and has impacted our financial results. We don't talk about segment results for this year as we've gone through the scrubber project.

That's one of the reasons why when we get into next year when we get back into a three-ship diesel fleet in the Alaska Service, that will allow us to continue to be confident that we're going to hit the original marks that we said for ourselves.

But there are higher costs both in Alaska and in our fleet when we're taking diesel ships out. Now I'm switching to either the Hawaii Service, the Alaska Service, and replacing them with relatively less efficient steam vessels.

There is a hit to our operating profitability. Some of that is moderated by the fact that we're able to recover largely all of our fuel costs through our fuel surcharge mechanism. But there are other costs that do impact our earnings overall during those heavy dry-dock periods.

Okay. Thank you. And just to wrap up, just any comments on peak season, how you see that shaping out, kind of maybe at the outer edges of it or maybe before you get into it, compared to last year?

And just in terms of the peak season, is that primarily, I would assume just in China and maybe in Hawaii as well, but not really Guam. Is that kind of the way that would impact you?

Yes. I mean, the way we think about peak season is it presents itself in our domestic logistics business, it presents itself in China, as you've said. There's a little bit of a seasonal effect in the other markets. Clearly in Alaska, there's a very strong seasonal component because of the summertime when a lot of construction and tourism makes the economy much more frothy.

But I would say, in general, I would say we expect and what we've seen and what we've heard from our customers is to continue to expect a muted and orderly peak season in all the markets.

So we don't expect really, for example, in China we expect it to be muted and orderly. That is that if there is a period under which not all freight can move, it'll be very short-lived and won't have a significant effect on the market beyond just sort of the seasonal strengthening we're seeing as all of the international ocean carriers get strong.

The domestic side, we're not expecting a significant peak season on the domestic side. Again, we'll see volume increases.

The Alaska season, which is well underway, given the summer months, has proved to be very much like previous years.

And Hawaii, other than the relatively strong economy that we're seeing, that's shaping up to us to appear to be very much in line with our expectation and consistent with previous years.

So nothing remarkable, I guess is the short answer, Steve.

Okay. Thank you very much.

Thank you. Ian Zaffino from Oppenheimer.

This is Dan [Natole] in for Ian. Just as a follow-up on the China business and where that's going, is that just, to get a better understanding, is that a result of just trade slowing or is it something specific to the segment that you specialize in for transport? Maybe just get a better sense as to why that's been soft and continues to be soft.

And as a follow-up, why you're confident you can maintain your premium in that market. Thank you.

Okay. Sure, Dan. So with regard to the context, I'll take the rate premium in the second. But the first question -- your second question first which is around the rate premium.

We have been in this Trans-Pacific trade for over 10 years, approximately 10 years now. We have seen our product, this expedited, which is 10-day transit, 11-day availability, as something which is extremely difficult for other ocean carriers who are a much larger, operate much more complex networks and much larger vessels to be able to replicate what a series of smaller ships operating out of dedicated terminals can do. And that has been earned over a very long period of time.

What we've seen is that customers who really need to move their product, which are garment manufacturers, electronics, those that have some production problems but still need to hit a delivery date for a key sale or for an advertisement to want to use us, we see ourselves as something like a deferred air product, where people would rather, if they have plenty of time, they'll use the more standardized, cheaper commodity like service of the other ocean carriers. If, for whatever reason, they need to move it or there's a significant value of that product, it would move in our service. And we continue to believe that that premium will endure.

I think the broader market question is really around a chronic overcapacity of ordering very large ships, displacing smaller ships. The supply growth has grown faster than the demand growth. And that has caused the behavior by the international ocean carriers to try to undercut each other to fill their own ships, and achieving neither their volume goals nor -- and resulting in significant erosion in freight rate.

So I think it's really just more weak demand and a surplus of capacity which is creating the dynamics that has provided so much difficulty in the China market for all the international ocean carriers.

Got it. Great. Thank you very much.

Thank you. Michael Webber from Wells Fargo.

Most of my questions around the expedited freight premium have been kind of combed over. Just a couple more. It seems like, [and maybe just] (inaudible) the deck, it seems like the idea of tacking on a couple more assets to kind of further the replenishment of that fleet has taken, I guess a bit more prominence, kind of move from options to actually talking about those assets and the like.

So when you think about placing those orders and considering some of the financial stress at some of the shipyards, what's the likelihood that you would place that order elsewhere? Is that something that concerns you when you guys think about the risk profile of actually building those ships? And then just how should we think about that?

Yes. I mean, I would think that given the size of the ships as we've talked about with our Aloha Class vessels, there are three or four yards in the United States that can place those orders or that can build those vessels that we're trying to spec.

The financial health of a shipyard is always a factor in our decision making and in building this or other ships. But we feel like we can reach the right decision and find a yard or yards.

We're in discussion with several yards about our most recent project, and we'll have more to say about that once we've come to our decision in that regard.

But again, we do feel like we'll be able to find yards that can build the product or the vessels that we --

Sure.

-- that we need to find.

Right. And without kind of pinning you down on a number or anything like that - I'm sure it's too early - would you expect any meaningful or material difference in terms of cost basis on those ships if you were to kind of transition to a new yard?

Well, I think it's really the two Aloha Class vessels, I think we have previously mentioned have a contract price of $209 million per vessel.

Yes.

These vessels, if we build them, would be of a different design. That would likely be [Rokons], that is have a roll-on/roll-off component. We have a few vessels in our fleet today that provide that roll-on/roll-off container-ship combined capacity that will likely be phased out of our fleet as we move past 2020.

And so we're looking at that design. That design is more fulsome than a pure container ship. And so we would expect the price to be above the $209 million pure container ship that is the Aloha Class contract cost.

Got you. You would attribute that more to specs than any sort of inflation or deflation associated with the cost of building a similar ship or anything like that?

That's correct, yes.

Okay.

It's really the design differences, yes.

Okay. That's helpful. Just one more for me and I'll turn it over. And it's for Joel. It seems like the, around the buybacks, seems like the pace has been pretty consistent, almost kind of regardless of price, basically, since kind of November.

I'm just curious, what variables are out there or how do you look at that process that could cause you guys to either pick up or delay the buyback pace here? Is there a threshold? Or even without just kind of disclosing where that is, how fluid is that pace in your mind?

Well, Mike, it's three million share authorization. We've mentioned that we would expect to complete it broadly over about three years. We're not locked in on three years.

And we've also said we expect to be relatively steady, steady-Eddie as she goes through the period of time.

So we don't have any thresholds or anything else that we've talked about. We're just looking to add that to our toolkit, if you will, on how we return capital to shareholders over a long period of time. We think it's prudent to do that.

So beyond three million shares in about three years, we haven't commented further, and that's generally what we still expect.

Fair enough. If you happen to have offhand, how far into that authorization you guys are?

Yes. We said today 1.1 million.

Perfect.

So there's 1.9 million left.

Great. All right. That's it for me. Thanks for the time, guys.

Thank you. Jack Atkins from Stephens.

Thanks for taking the follow-up, guys. Quick question on the Guam market. You mentioned competitive losses there. But the market seems to be growing modestly.

Can you talk about, have you seen any incremental volumes coming from the US military now that they've decided to move forward with their plans there? And just sort of just if you could just speak more broadly to what's happening in Guam to drive a little bit of growth there in the underlying market?

Sure, Jack. The answer is, yes, we've seen a little bit of market growth and a small amount of growth is notable there where it's been relatively flat. So we're seeing both a slight step-up in military construction activity, not dramatic. The broader nonmilitary economy also remains reasonably healthy.

As you know, there is a military and tourism visitor component, and both seem that they've stepped up a notch. So we're pleased to see a little bit of growth there.

We'd also noted that our competition there had gotten off to a bit of a slower start than we expected, but that we do expect in the second half to find some volume challenges net of some ongoing losses related to the competitive service.

So we're showing flat for the quarter. That is the competitive losses have been offset by some growth. We think in the second half, it might turn into a little bit of negative growth as the volume and competitive dynamic change a bit.

But overall, we're feeling okay about where we are with Guam. We continue to believe that there is a story of long term, 10- or 15-year growth to accommodate military construction. But compared to the previous build-up, this'll be much, much longer and much, much less ambitious in terms of its construction. But overall, we're feeling okay about Guam.

Okay, great. Great. And then not to beat a dead horse on the China business, but just kind of a follow-up on some of the questions that have been asked there.

When you think about that 50% of your business that's sort of, quote/unquote, in the spot market, I know that we tend to look at these weekly rates, (inaudible) rate index, (inaudible).

I'm just curious, when you talk about your spot business, does that rate fluctuate weekly like we would see with these indexes? Or is it more stable and we should be looking at these indexes as just more of a directional indicator of sort of what's happening in the underlying market?

Yes, it's a good question. I think if you filled in the premium to those spot rates, what you see are a number of -- it does behave very much like the indexes that go up and down.

But what we find is, as the premise of your question, it's less volatile than the pure market and we have developed relationships with forwarders and others that participate in that spot market that make those volumes a little less volatile. But we are still exposed over time to needing to, if rates go up, we will go up. If we need to pull our rates down to address market concerns, we'll do that too.

But you're right, it is a little less volatile. But on that spot side we can't escape very far from it, I guess is the best way to answer that question.

Yes, that make sense, Matt, absolutely. I was just curious about the volatility there.

And then last question, if I remember correctly, I think two of the older Horizon line ships that you acquired with that transaction I think originally were planned to be retired. I think you put them through dry dock this year or they're going through dry dock this year.

When do those ships come out of dry dock? And then sort of what's the plan for those vessels once they're available to you guys for service?

Sure. This is Matt. I'll comment on that briefly and then ask Joel to comment.

We looked at the entire fleet during the acquisition, did an assessment of the Horizon ships. We found a couple of them worthy of investment and went through that.

We've got one of those vessels in dry dock now. The other one has been completed and is already back in service and is in the Hawaii trade as part of our 11-ship deployment, and it's working well.

Okay.

So I would say overall we're pleased with them. Joel, what would you add to that?

Yes. And just as a reminder, Jack, those vessels are subject to two and a half year dry-docking cycles, not five. So essentially, they would come up for dry-docking again two and a half years from the last nine months.

And it would be at that point in time where we'd make the next decision, whether we wanted to dry dock them one last time or retire them, scrap them at that point in time.

So the decision will be about two years away from right now.

Okay. Thanks again for the time.

Thank you. I am not showing any further questions at this time. I would now like to turn the call over to Matt Cox for any further remarks.

Okay. Well, thanks, everyone, for your participation today. We look forward to catching up with everyone at the next quarterly conference call. Thanks very much. Aloha.

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