Good day, ladies and gentlemen. This is your conference operator today. At this time, I would like to welcome everyone to the Matson First Quarter 2019 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Lee Fishman. You may begin your conference.

Thank you, Laurie. Joining me on the call today are Matt Cox, Chairman and Chief Executive Officer; and Joel Wine, Senior Vice President and Chief Financial Officer. Slides from this presentation are available for download at our website, www.matson.com under the investors tab. Before we begin, I would like to remind you that during the course of this call, we will make forward-looking statements within the meaning of the federal securities laws regarding expectations, predictions, projections, or future events. We believe that our expectations and assumptions are reasonable. We caution you to consider the risk factors that could cause actual results to differ materially from those in the forward-looking statements, in the press release, the presentation slides, and this conference call. These risk factors are described in our press release and are more fully detailed under the caption, Risk Factors, on Pages 11 through 20 of our 2018 Form 10-K filed on March 4, 2019 and in our subsequent filings with the SEC. Please also note that the date of this conference call is May 8, 2019, and any forward-looking statements that we make today are based on assumptions as of this date. We undertake no obligation to update these forward-looking statements. And with that, I will now turn the call over to Matt.

Thanks, Lee, and thanks to those on the call. Please turn to Slide 3 for my opening remarks. Matson is off to a good start to the year. Ocean Transportation's first quarter operating income came in as expected with a number of positive and negative year-over-year comparisons. We saw strong demand in our China service with stronger volume post-lunar new year and SSAT continued its steady performance excluding the one-time favorable items in the year ago period. But we also faced significant weather related issues that primarily impacted our Hawaii service. In logistics, another outstanding quarter with stronger-than-expected operating income as a result of all lines of service performing well. Moving onto the outlook for the full year 2019. We are maintaining our outlook for Ocean Transportation operating income and we're raising our outlook for Logistics. Joel will go into more detail on the financials and outlook later in this presentation. Please turn to Slide 4 On our last earnings call, I went through our current priorities, which are a mix of operational and financial objectives. Given the size and scope of the priorities, we wanted to provide a quick update on each of them and will continue to do so as we progress throughout the year. So I'll start with the Hawaii fleet renewal. The Kaimana Hila was delivered on March 28 and we placed her into service on April 18, working the PNW Oakland Triangulation. Lurline delivery is on track for the fourth quarter of 2019 and her christening is coming up in the middle of June. We look forward to the first of the Kanaloa Class vessels entering service, which will allow us to shift to a 9 ship fleet deployment and deliver operational and financial benefits. And lastly, after nearly 6 months in operation, the Daniel…

Thanks, Matt. Now, we're onto our financial results on Slide 14. Ocean Transportation operating income for the quarter decreased $15.1 million year-over-year in the first quarter to $9.4 million. The decrease was primarily due to higher vessel operating costs, including weather-related impacts, and the Maunalei lease expense, higher terminal handling costs, and lower container volume in Alaska and Hawaii. Partially offsetting these unfavorable year-over-year comparisons was a higher contribution from the China service. The company's SSAT terminal joint venture investment contributed $8.5 million or $2 million less than the prior year period. The decrease was primarily attributable to the absence of favorable one-time items in the year ago period. Logistics operating income for the quarter was $8.1 million versus $4.2 million in the prior year period. The increase was due primarily to higher contributions from transportation brokerage and freight forwarding. EBITDA for the quarter decreased $12.8 million year-over-year to $49.3 million due to lower consolidated operating income of $11.2 million, a small decrease in other income of $200,000, and a reduction of $1.4 million in depreciation and amortization, which includes dry-dock amortization. Interest expense for the quarter was $4.6 million and as a reminder, capitalized interest associated with the Kaimana Hila vessel ended at the beginning of this quarter when the vessel was delivered. So therefore, we will have a greater amount of income statement interest expense each quarter going forward this year. Lastly, on the tax rate for the period. As we mentioned on our fourth quarter call in February, we expected a non-cash adjustment of $2.9 million related to the reversal of an expense adjustment in 2018 arising from the enactment of the Tax Cuts and Job Act of 2017. Adjusting for this favorable one-time item, the effective tax rate for the quarter would have been 29%. And…

Thanks, Joel. We're pleased with our start to the year and look forward to progressing through the year on our new vessels and the Sand Island infrastructure project. We remain intensely focused on cash flow generation and managing our leverage levels as we head down the home stretch on the last 2 new Hawaii vessels. And with that, I will turn the call back to the operator and ask for your questions.

[Operator Instructions] Your first question comes from Steve O'Hara from Sidoti.

I guess on the pricing and negotiations with the China service, can you just walk me through the rate, the way rates work in that market given the fact that it sounds pretty, like there's a lot of clarity in terms of what happens with rates next year with IMO 2020, and fuel, and all that.

Yes, so it's an interesting dynamic, Steve. Let me speak to both Matson and the trade in general. And I'll make sure I distinguish between the 2. So I would say for Matson and for the trade, these first comments are around the rollout of the IMO 2020 and the new fuel standards. And so what you see happening there on that dynamic are most transpacific carriers have not installed scrubbing devices like we have, or emission scrubbers. And what we understand in the market are the discussions and mechanisms around how to handle the fuel impact have been put off until the end of the year, as they get more sense probably in the fourth quarter when they need to be actually purchasing this fuel so that they have it available and they have the noncompliant fuel out of their systems before January 1. So my sense is, is that there's a lot of wait and see. There are discussions about mechanisms and I think for the customers of the international ocean carriers, it's sort of a wait-and-see approach in terms of determining what is the impact and of that impact, how much is that going to be borne by the customers versus absorbed by the international shipping lines. And so it's a really open question. I would say for Matson, who has advantage of having a scrubber strategy, our discussions with our customers was somewhat different in the sense that our discussion was around seeking to earn a reasonable return or a recovery of the cost of installing the emission scrubbers. But once the recovery is complete, it's our customer's expectation and our belief that we will continue to have a very effective fuel pricing relative to the rest of the market. But again, in the big picture of things, Matson has a very differentiated service and we don't compete on fuel anyway. So I would say that with that backdrop, Matson, about some portion of our business is done on that May 1 to April 30 contracting cycle. We had a satisfactory outcome with regard to our customers in terms of that portion of our business. And the rest of it is on a more spot basis with shorter-term contracts. But again, we feel very well positioned given our highly differentiated service.

And then just following up to that, I mean, what does the competitive landscape look like in the Jones Act trades that you're in? Is everybody going to be compliant, to your knowledge, by IMO, by the date and if not, how does that work?

So what we know is that, I'll start with the Alaska trade. Steve, I mentioned that we've installed emissions scrubbers and our base fuel cost will not change. And IMO, what we have needed to do for IMO 2020 has already happened in the Alaska trade. Our principal competitor in Alaska is Totem Ocean Express. They are burning compliant fuel now and they're in the process of taking a slightly different approach, which is to convert their vessels to accommodate liquefied natural gas. So they're in the process of converting their vessels to an LNG solution that will likely happen over a longer period than 1/1/2020 but will be fully compliant, it's our understanding, as they are today by burning low emission fuel. In the Hawaii trade, where our principal competitor is Pasha, they have 2 vessels that are compliant not. These are roll-on/roll-off vessels. They have 2 vessels, as we know, are under construction now. Those will be delivered in, some time both during 2020 after January 1, 2020. And then are in the process, we don't know but they still have 2 remaining steamships that will no longer be compliant. And they've not indicated what their plans are with respect to how they're going to address compliance on those remaining steam vessels that are in their fleet. So I would not predict any significant changes on 1/1, although I can say that we are very confident in our ability and a plan in place to be fully compliant from Matson's perspective, on 1/1.

Our next question comes from Jack Atkins with Stephens.

This is Andrew on for Jack. I wanted to follow-up on one of those previous questions around the pricing in the transpacific lane you're trying to service. We've heard from some of our contacts we talk to about carriers looking to putting in some sort of a floating bunker surcharge. I don't know if that's the right term to call it, but something along those lines in their contracts. Is that something that, one, you guys put in your contracts or two, that you guys came across during bid season this year?

So there are existing floating bunker mechanisms that we also, and the trade uses today. And there are various calculations in the way that those are addressed. And so I think it's fair to say, and thanks for asking Andrew, to be a little more precise, that there are existing mechanisms in place to handle this floating, or this fuel surcharge or bunker adjustment factor, a BAF, or there's different terms for it. But it's largely those mechanisms, which will need to be addressed, and whether or not those mechanisms need to be adjusted based on the higher cost of fuel, all is going to get kind of played out in the fourth quarter of this year we think. At least that's what we understand. But you're right, there are existing bunker, floating bunker mechanisms. Whether the existing mechanisms allow for carriers to recover their full cost of fuel remains unclear but there are mechanisms in place.

Matt, you guys called out some weather headwinds in Hawaii during the quarter. I think you said in your prepared comments it was several million I think is the word you used in terms of the impact. Is there any way you can help us put maybe a finer point on that, maybe from a volume or an EPS standpoint, just to get a sense for the headwind you faced. And then also in Hawaii, the guidance of the year, flat in volumes. I know the weather, I think one less sailing impacted the first quarter results. But as you look at the rest of the year, is there any green chutes that you see in terms of maybe getting those volume, seeing a little bit of a tick up in volumes to kind of get back to that level?

I think with regard to the cost in the first quarter of the weather-related days, we said several million. You can use $2 million pretax as a good proxy. That would get you in the ballpark as we had to deploy additional vessels and we had to do other things in order to try to keep our base schedules intact given the difficult weather situation. Of course, we do not expect significant weather-related delays now that we've gotten out of the winter months and that's baked into our thinking about the rest of the year. I would say, I wouldn't want at this point to go above our general feeling in the Hawaii trade for, we're seeing very low single-digit growth in the overall economy. It hasn't translated into freight volumes. It hasn't, over the last couple of years, translated into meaningful freight volumes. So we're just approaching it being relatively flat for the market. I think we're more optimistic about Alaska and the start you can see there. But in Hawaii our best thinking at this point, just because we haven't seen it, is significant incremental growth in the overall market. So it's a little ahead of where we'd like to be in terms of how we're approaching the Hawaii market.

And then last one for Joel. I think, I guess as we look out, the new vessel payments start to wind down this year and especially in 2020. And then I think you guys added some CapEx next year for the new scrubbers. Maybe if you could, just from a high level, maybe talk through some of the committed CapEx that you see for next year and maybe how you're approaching or thinking about potential free cash flow in 2020 now that the new ships will be in the business and these payments are kind of winding down.

Sure, Andrew. So in terms of the commitments next year, it's all baked into the $112 million number we talked about in our CapEx schedule slide. But even on top of that, you get the $112 million plus the $62 million for the vessel payments. We expect that free cash flow somewhere near that number, potentially higher if we're at the run rates, if we maintain the run rates we're at today. So the first priority will be to deleverage. And that's the first priority after, of course, we invest in our business. So maintenance CapEx, some of the organic growth that we've been talking about, which is baked into those CapEx numbers. Those are key priorities for us, but after we have additional free cash flow above those, deleveraging back down into the 2s and our target level the low 2s is the first priority. But over time, we're certainly open to M&A as long as we remain disciplined and hit the strategic and financial targets that we've laid out, that will always be an option for us to grow. And then we'll get the dividend. We've had a good track record of growing our dividend commensurate with our growth in free cash flow. So that's something we'd like to continue. And we're not opposed to special dividends either. Returning that capital through all those mechanisms will be on the table for us as we generate that free cash flow.

Your next question comes from Ben Nolan from Stifel.

My first one relates to the Logistics business. Obviously, it's been a few quarters now and it continues to do really well and the margins, in particular, are really hanging in there well. And I appreciate that broadly speaking, the industry is in a good place and margins are largely wider. But is there anything else that you would point to that maybe gives you a level of comfort that maybe you're doing something a little bit differently than maybe you had been. Obviously, Span helps but is there something that can keep those margins a little bit higher even in periods of time when maybe cyclically it's not as good of a market?

Sure. Well, let me start off by saying that this unit continues to shake and bake, to use a Ricky Bobby phrase. So we're really happy with the performance of the unit. But I guess the way I look at it is, and then you've heard us say this before, the first thing we did was, the team did, was to look at our entire portfolio of business and we're very disciplined about re-pricing significant portions of the business. Or if the margins couldn't go up to levels that we thought were where we needed them to be, to shed those businesses. And so there's been a significant effort underway to reprice our entire transportation brokerage portfolio. And we think that certainly in this current economic environment that that will continue to pay dividends for us. You were right also in calling out Span Alaska. We don't separately break out the margins in Span. It's a different business and the margins are a little bit higher. So some of the drifting up of the margins from the old days is a result of just the mix of the margin. But I would say, and every single one of our lines of business, our China Logistics business, our Warehouse business, each of them are contributing and improving. And so it's been great. So to your question about how sustainable are the margins, I think through this current economic environment, we continue, we do expect margins to remain elevated. Now, if there's a recession in 3 or 4 years and the market dynamics change, that's a different bet. But in this current economic environment and climate, which we don't see as changing in the near-term, I think we're going to continue to produce very strong high-margin. I think that can be replicated through this cycle. So we're very optimistic about it.

And then another thing that came up that obviously, you shifted things around a bit and SSAT had added a peer in Seattle. Are there any implications to Matson away from SSAT there? Is this neutral to your business as a whole and additive to SSAT? Or how else should we think about that?

I think I understood your question but I think the way we have seen this, and Ben, this has been a, at least a, it's been a 20-year joint venture and Matson's position has been we would rather the joint venture continue to reinvest and grow its footprint on the U.S. West Coast. And as opportunities have presented themselves, we want to increase that joint venture's share of the total lift market. And so for example, the Terminal 5 or T5 lease that we put in place allows for other carriers to come on T18 and some of our other joint venture terminals to increase our volume the Seattle-Tacoma area. That's probably not going to be a needle mover in terms of operating results in 2019. But we do expect moving into the future it will just be another element that allows SSAT to continue to step up and grow as we, I mean I should say the distributions from SSAT remain very healthy but we've always been focused on identifying organic growth in that joint venture and will continue to do so into the future. I'm not sure if I answered your question fully, Ben.

That's helpful. I guess the other part of my question was is there outside of SSAT, just in terms of the Matson standalone business, does this have any real impact on how you do business other than maybe calling at a different spot?

No, I don't think so. The joint venture terminals are defined on the U.S. West Coast. Carrix, the parent company of our joint venture partner, operates marine terminals in other parts of the world. Those are not something that we would look to participate in. But I can think of no other benefit or detriment to this joint venture. It operates on a relatively standalone basis and I can't think of anything that would impede anything that has to do with Matson associated with this investment.

And Ben, I'd just throw out a reminder. So for our Hawaii operations, we call on Seattle, but our competitor, Pasha, does not. So there's no impact relative to competition for our Hawaii trade. With this move and then for the Alaska trade, both we have competitor call down in Takoma. We actually don't call Seattle. So none of this Seattle movement from one terminal to another for us had any impact whatsoever on our Alaska business or our competitors.

And then lastly from me, I wanted to circle back to make sure I understood your comments about the scrubbers. And you talked about negotiations with your customers. There's sort of an earn back of the capital costs associated with the scrubbers in the contracts, after which it's effectively fuel neutral. Is there any way, though, that scrubber, other than just getting back your investment, is there any way that these can give you sort of a competitive advantage or enable you to sort of earn returns over and above just earning back?

I think we do believe that for Matson installing scrubbers is the right thing for us to do. and it allows us, over a long period of time, to burn a less expensive mix of fuel. What the spreads are relative to the other, it's difficult for anyone to know. And for us, it's really about optionality. We want to earn an adequate return on the scrubbers, and we continue to be confident in our ability to do it. You know, we have fuel surcharge mechanisms that allow us to recover most of our fuel, or all of our fuel in the Jones Act trades. And once we recover the capital cost of these scrubbers, I think our goal would be to operate as economically as we can, and be as competitive as we can. For example, I've just mentioned in the Hawaii trade, we understand that the Pasha ships will be burning LNG once they're delivered from Day 1. At least those are the announcements that the Pasha Group has made in that regard. And so I would expect, I don't know exactly where the equivalent BTU cost per container is on LNG relative to conventional fuels that can be treated with emission scrubbers. But again, we want to be competitive. I think it would be an overstatement to think that we could gain a competitive advantage. But I can tell you, for example, in our discussion with our China customers, it's a lot easier for them to understand our approach and it's much more transparent than trying to use a very complicated fuel surcharge mechanism that is really difficult for them to understand. So we're simple and transparent and I think our customers appreciate that approach.

And that might translate into better customer relationships, more volume eventually, or something like that?

Yes. And we don't like to boast very much, but we already have a terrific reputation in the China trade as straight shooters. And this just reinforces that we know what we're doing. We're credible and we're reliable. So I think it just enhances what I think is the best reputation in the transpacific trade.

We have a question from Michael Webber from Wells Fargo.

First off, it's a great Talladega Nights reference, man. Appreciate it. I wanted to loop back to, I think you kind of touched on this with your answer to Ben's last question. But as it pertains to actually passing through I guess your fuel surcharge mechanism, one, are you guys going to look to secure your forward HSFO fuel supplies on a long-term basis? And then two, how does that actually work its way into your fuel surcharge mechanism if you've hedged that far enough out I guess on a forward basis? Just curious how that would work.

So let me differentiate our trades because in the Jones Act trades, we have a fuel surcharge mechanism that, as you know, allows us to recover 100% of our fuel. So we have an economic mechanism that allows us to recover our fuel over time. In other words, there can be quarters where if you see a big, a change up or down that we can be over or under collected. But given that we have an economic hedge, we don't need to engage in a financial hedge in our Jones Act Trades. Nor, do we expect we're going to need to in the future.

I guess that was kind of the question was do you think need to in order, in terms of the payback period on the scrubbers, the last thing you would want would be to not be able to get access to HSFO to utilize the scrubbers. So I guess the question is, I guess within the pass through mechanism, passing through all of your fuel costs, I guess is that done on, like, a real-time basis? Or I guess the actual, the nuance of the mechanism I guess is what I was trying to get at. I don't know if that was particularly clear.

That's helpful. I think we've been in discussion with our fuel suppliers and are reasonably confident that fuel is going to be available. We also remain confident that our fuel surcharge mechanisms are going to allow us to recover over a fairly short order the capital cost of putting those in. And we continue to think it's the right decision for us. And then I was just going to comment on China. There's more pieces moving in that trade. But again, we were satisfied with the contract increases we got, a portion of which was going to be assigned towards the beginning of the capital recovery process of the scrubbers. And we feel confident, continue to feel confident in our ability to be able to recover all the capital cost.

Okay. And I can follow-up offline in terms of the details of the surcharge I guess. Matt, as it pertains to your guidance and I think it's just kind of going through one of your earlier slides. Just kind of referencing the westbound volumes, you mentioned one fewer sailing and Q1 numbers that were just a touch inside of 2018. Just from a volume basis, you also kind of pointed to a 2019 volume outlook that looks like it was going to be relatively on par with '18. Is the implication there that you guys are seeing or have already started to see this seasonal bump that you would need to kind of get back to that 2018 level from a volume basis? 2018 was a pretty strong year and you had a pretty sizable bump in Q2. I'm just curious if you've seen that early indication.

Yes. I would say that, of course, as you know, Mike, the second and third quarters are the big quarters for the Hawaii trade. That's seasonally when a lot of it moves. Of course, the overlay there is around construction projects that have their own life that add volume at different phases. Yes, we're a little bit behind last year. There's always a little noise if a voyage sails a day later or a few hours later and then falls into the next quarter. So we were trying to call that out. But I think overall, our feeling is that while we're a little behind in the first quarter, we think the seasonal factors are going to allow us to end the year about where we finished '18. And implied in that is we don't really see any big share shifts as we go through the rest of the year. So we're looking for a flattish environment and we will do better as the seasonal elements start to kick in, in the second and third quarter. Although, I think we've called out our second quarter guidance, Joel did, and our comments are consistent with our expectations for Hawaii volumes and all the other volumes that are embedded in our trade.

And then I guess last one, just big picture. Matt, your, the last vessel you guys took from Aker Philly, I believe it's the last commercial vessel that they've built. In the scenario where there would only be one provider of commercial Jones Act tonnage of the kind of scale that you guys would need, I guess being NASSCO, is that a positive or a negative for Matson on a long-term basis? And if it's not at least a minor concern, I guess why? I guess what some of the mitigating factors would be there.

Yes, I mean I guess as we see, first of all, Aker is the, the Philly shipyard has built two beautiful ships. I mean our engineering teams and our operating teams, these vessels are operating well, at or above spec and the yard takes such pride in its work. We're rooting for that yard to survive. But having said that, and nobody knows what's going to happen, whether they convert to military work or whether they get some additional ships. We know they're working hard trying to find their next contract. But tactically, with regard to Matson. After we built or took delivery of the two NASSCO ships, the Kanaloa Class vessels, we're going to go through a relatively long period where we're not going to need to build ships. And those ships that we are going to be building next are somewhere in the second half of the 2020s, sort mid-to-late 2020s. And those are for the Alaska ship, replacements. Those are likely to be somewhat smaller than these very large ships and that opens another level of yard to be able to be on the project. And so I guess while we're rooting for Aker to survive or Philly Shipyard to survive, we know that we're going to be in great shape moving into the future and we're not going to be back in the market unless there is some acquisition or some other opportunity, and that would be a good news story for some time. So those are my thoughts at this point.

[Operator Instructions] There are no further questions at this time. Speakers, you may continue.

Thank you so much for your attention to the call. Again, I think we're off to a good start for the year and we look forward to catching up with everyone on the second quarter call. Aloha.

This concludes today's conference call. Thank you everyone for your participation. You may now disconnect.