Earnings Call: Q2 2019

Aug 7, 2019

Good afternoon, ladies and gentlemen, and welcome to the second quarter 2019 financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Lee Fishman, Director of Investor Relations. Sir, please go ahead. Thank you, Joanna. Joining me on the call today are Matt Cox, Chairman and Chief Executive Officer, and Joel Wine, Senior Vice President and Chief Financial Officer. Slides from this presentation are available for download at our website, www.matson.com, under the Investors tab. Before we begin, I would like to remind you that during the course of this call, we will make forward-looking statements within the meaning of the federal securities laws regarding expectations, predictions, projections, or future events. We believe that our expectations and assumptions are reasonable. We caution you to consider the risk factors that could cause actual results to differ materially from those in the forward-looking statements in the press release, the presentation slides, and this conference call. These risk factors are described in our press release and are more fully detailed under the caption "Risk Factors" on pages 11 to 20 of our 2018 Form 10-K filed on March 4, 2019, and in our subsequent filings with the SEC. Please also note that the date of this conference call is August 7, 2019, and any forward-looking statements that we make today are based on assumptions as of this date. We undertake no obligation to update these forward-looking statements. With that, I'll now turn the call over to Matt. Thanks, Lee, and thanks to those on the call. Please turn to slide 3 for my opening remarks. Matson's performance in the second quarter was mixed, with Ocean Transportation coming in below expectations and Logistics continuing its good performance and coming in stronger than expected. Within Ocean Transportation, we saw continued strong demand in China and improved performance in Alaska. These solid contributions were outweighed by a weaker than expected Hawaii market and a lower contribution from SSA Terminals, which was hurt by additional expenses related to the early adoption of the new lease accounting standard and higher terminal operating costs. We expect the additional expense from the lease accounting adoption to reverse in the second half of the year. To be clear, all of our trade lanes performed as expected, except for the shortfall in Hawaii, which I'll discuss later. In Logistics, we continue to perform well with all service lines making positive contributions to operating income. As a result of the first half performance, we are updating our outlook for the full year 2019. We are lowering our outlook for Ocean Transportation operating income, and we are raising our outlook for Logistics. The net result is that we now expect EBITDA outlook for the year to be approximately $18 million lower than the previous outlook as a result of continued weakness in the Hawaii trade lane, as well as higher operating costs in the SSA Terminals, LLC in the second quarter that are largely behind us. We view 2019 as a transition year as we prepare for IMO 2020 and migrate from a 10-ship fleet servicing Hawaii to nine ships and begin to benefit from one less vessel. We remain confident in achieving the approximately $30 million in previously mentioned annual financial benefits from the new vessels when they were all in service. For 2020, we expect to see the majority of the financial benefits from the new vessels and to realize the financial benefits from other recent vessel infrastructure and infrastructure projects, which in total will result in approximately $30 million in financial benefits compared to 2019. In 2021 and thereafter, we expect the full year run rate of those total investments to produce approximately $40 million of annual financial benefit compared to 2019. Joel Wine will go into more detail on the financials and the 2019 outlook later in this presentation. Please turn to slide 4. This table outlines our current operational and financial priorities, and I will start with the progress on the Hawaii fleet renewal. We christened the Lurline on June 15 in San Diego, and the vessel remains on track for delivery in the fourth quarter of this year. Construction of the Matsonia is on the building ways at NASSCO and has started, and it remains on track for delivery in the third quarter of next year. Lastly, both the Aloha Class vessels are performing to our expectations. Next to the Sand Island terminal upgrade. We received our three new gantry cranes in April and expect them to be in service by the end of the third quarter. The remaining infrastructure work to support the new cranes, the three retrofitted cranes and other systems continues, and we expect the major cost item in phase one to be completed in the first half of 2020. Our preparations for IMO 2020 continue as we near the effective date of the regulations, and I continue to believe we are very well positioned. The first of the six vessels to receive a scrubber is back in service with a fully operational scrubber. The second vessel is now in dry dock, and we expect the third vessel to be in dry dock later this year. The remaining three vessels in the program will receive scrubbers next year. By the end of 2020, we will have scrubbers on eight of the 12 active vessels serving our core trade lanes and one scrubber on a reserve vessel. On to the next priority. Our leverage covenant level for the second quarter remained just below 3.0, and our trailing 12-month cash flow remains strong to fund the vessel and Sand Island terminal investments. We continue to expect our debt level to peak in the first quarter of 2020, and shortly thereafter, we will begin to de-lever the balance sheet to our targeted levels of the low twos. On the organic growth opportunities front, I wanted to highlight two important developments. The first one is we made a decision to shift the Kaimana Hila to the CLX service in light of the muted growth expected in the Hawaii market. This repositioning will accomplish two things. It will help relieve CLX vessels entering dry dock for scrubber installations, which will consequently bring a bit more capacity into the CLX service during a seasonally strong period, and it better aligns capacity and demand in the Hawaii trade lane. The U.S.-China trade situation is likely, in the short term, to create volatility in the Transpacific trade lane, and we tend to outperform in unsettled environments. After the Lurline enters service and we step down to a nine-ship fleet in Hawaii in the fourth quarter of this year, we will have the option to reposition the Daniel K. Inouye to the CLX, depending on the outlook for the Hawaii market and the U.S.-China trade situation at that time. The second development we briefly mentioned on our last earnings call. Our SSA Terminals joint venture picked up an additional terminal in Seattle during the quarter. I will discuss SSA Terminals operations in Seattle later in this presentation. Turning to slide five. As I mentioned a moment ago, we christened the Lurline on June 15th at the NASSCO Shipyard. It was a special event for all involved, including our employees who put in countless hours in the development of the Kanaloa Class vessels. We look forward to taking delivery of the vessel later this year. Now on to our trade lane services, so please turn to slide six. For the second quarter in our Hawaii service, container volume declined 2.3% year over year, primarily due to negative container market growth. We are certainly disappointed by the weaker-than-expected performance in the market as the key economic indicators remain largely favorable and the GDP of Hawaii continues to grow, but at a slowing pace. I will go into more detail in a minute about what we are seeing in Hawaii. For our full-year 2019 outlook, we now expect volume to be lower than the level achieved in 2018, which reflects less containerized freight volume in Hawaii and a stable market share. Please turn to slide seven. I want to spend a few moments discussing what we are seeing in the Hawaii market in light of the second quarter results. On the left side of the slide are select economic statistics from University of Hawaiʻi Economic Research Organization's second quarter report, some of which we provided on the first quarter call. The trends noted in this table are mixed and we believe reflect a slowing economy. We believe the trends will continue, and for some indicators, we expect more short-term pressure as the economy continues to slow. As you may recall, our westbound container volume is primarily driven by consumption and replenishment, construction activity, and population growth. Consumption and replenishment is impacted positively or negatively by trends in tourism, including visitor arrivals and expenditure, as well as the population spending, which is influenced by a number of things, including disposable income, employment, inflation, to name a few. What Hawaii is experiencing today is record tourism arrivals, but aggregate and per visitor expenditures are declining, and this directly impacts consumption and replenishment. Furthermore, the population growth has been muted in both civilian population and the armed forces, which also has a direct impact on the growth and consumption of recurring goods we carry to the islands. Anecdotally, we saw our retail customers in the second quarter adjust to this slowing economy as aggregate consumption flattens. We expect the trends in consumption and replenishment to persist in the short term. Construction in the state has remained stable at a relatively high plateau of activity. This construction cycle is unlike the previous boom and bust cycles in real estate. This cycle started with meaningful condo development on Oahu and little to no activity on the neighbor islands. Today, there is still some condo development, and neighbor island construction has been slower to start but is occurring. At this point in the cycle, we expected the construction environment to shift from condos to master-planned residential communities, but this development has been more gradual than anticipated given the ongoing acute shortage of primary residential housing. Nevertheless, we expect construction activity to remain flat at this higher plateau of activity in the near term. In summary, Hawaii container volume in the second quarter was not what we expected, and the slowing economy presents some headwinds for growth, but the trajectory and volume we've been experiencing for the last several quarters and anticipate for the rest of the year in the core westbound market is around flat. This flat market view is going forward as the primary driver to our downward revision of approximately $18 million in annual 2019 EBITDA that I mentioned earlier, and Joel will comment in his section of the financial report. Moving on to our China service on Slide 8. Matson's volume in the second quarter 2019 was 2.5% higher year-over-year. We also continue to realize a sizable rate premium and achieved average freight rates over the quarter that were moderately higher than the second quarter of 2018. We believe volatility in Transpacific trade lane capacity and demand will continue into the second half of the year as capacity adjusts to tariff-related demand changes and the realities of the coming IMO 2020. With respect to Matson, we expect another strong year for Matson's highly differentiated service within the volatile landscape. We expect the CLX volume in the second half of the year to be lower than the strong level achieved in 2018 as volume normalizes to more traditional levels of activity. As we noted before, the third and fourth quarters of 2018 were exceptionally strong due to the pull forward of volume associated with the U.S.-China trade situation. As for average freight rates, we are up against a difficult comparison in the second half of the year as last year was exceptionally favorable due to the U.S.-China trade situation. But we remain cautiously optimistic that the average freight rates for the year will approach the healthy levels achieved in 2018. Our updated CLX outlook includes the effect of adding the Kaimana Hila into the CLX fleet. It's important to note that this 2019 outlook is predicated on a neutral outcome to the U.S.-China trade situation. Turning to Slide 9, Guam container volume in the second quarter was flat year-over-year, and the overall container market was also essentially flat. For the full year 2019 outlook, we expect volume to approximate the 2018 levels as the highly competitive environment remains. Our strategy remains to fight to retain every single container of our customers' business. Given our long history in Guam with strong customer ties, a shorter transit time, and significantly better on-time performance, we expect to retain an outsized share of the market there. Moving to Slide 10. In Alaska, Matson's container volume for the second quarter 2019 was 8% higher year-over-year due to the timing of two additional northbound sailings. Adjusting for the additional sailings in the quarter, we saw a modest year-over-year increase in volume. The container market in Alaska also grew year-over-year as economic conditions in Alaska continue to improve. For 2019, we expect volume to be moderately higher than the level achieved in 2018, with higher northbound volume supported by improving economic conditions in Alaska and higher southbound seafood-related volume due to a stronger seafood harvest level than in 2018. Turning to Slide 11, the Anchorage Economic Development Corporation, or AEDC, recently released its three-year outlook. There are a number of positive developments taking shape in Alaska's economic recovery, but the ultimate trajectory will be greatly influenced by state policy decisions to address the budget. Certain industries that were most affected by the oil recession are on the rebound, supported by increased activity on the North Slope. But there are other areas of the economy that have not participated in the recovery as a result of state budget considerations. We remain cautiously optimistic about the economic recovery as we see increased activity from our customers, but we fully appreciate the fragility of the recovery as a result of the fiscal situation. Turning next to Slide 12. Our terminal venture, SSAT, contributed $900,000 in the second quarter of 2019, or $8.2 million lower than the prior year period. The decrease was primarily attributable to additional expense related to the early adoption of the new lease accounting standard and higher terminal operating costs. For the quarter, SSAT saw slightly higher lift volume compared to the prior year. For 2019, we expect SSAT's contribution to our ocean transportation operating income to be lower than the level achieved in 2018, largely due to higher terminal operating costs, partially offset by higher lift volume, with lift volume expected to be a benefit in the second half of the year from terminal expansion and a new customer in Seattle. With respect to our previous outlook, we expect approximately $5.8 million in lease-related costs to reverse and be a benefit to SSAT's results in the second half 2019. In summary, despite the recent challenges of higher terminal operating costs and the additional expense related to the early adoption of the accounting standard, we expect the performance at SSAT in the second half of the year to be much closer to the strong second half of last year as each of its terminals remain well-positioned. Please turn to the next slide as I wanted to briefly discuss the specific terminal plan in Seattle and some recent changes that have occurred. The map on this slide shows the Port of Seattle with the key terminals. Matson's move to Terminal 5, or T5, in the second quarter is part of a multi-stage plan to organize operations at a few terminals. The first step was for Matson to move to T5 to facilitate the movement of other ocean carriers to new locations. Some of the users of T18 were moved to T30, and users at T46 were moved to T18. As of July 1st, SSA Terminals, LLC is operating at three terminals in Seattle with opportunities for growth, particularly at T5, which is being renovated to accommodate some of the largest ocean vessels. As a result of the reorganizations, SSA Terminals, LLC now has interest in all of the container terminal in Seattle and one terminal in Tacoma. We look forward to the opportunities this reorganization presents. Turning now to logistics on slide 14. Operating income in the second quarter of 2019 of $11.3 million, or an increase of $1.8 million over last year, came in stronger than expected. The increase was primarily due to higher contributions from freight forwarding and transportation brokerage. But similar to the first quarter, all the service lines posted year-over-year contributions. Span Alaska performed well as a result of improving economic conditions in Alaska. Although logistics quarterly revenue declined year-over-year, its operating income increased, and operating income margin improved quite significantly to 7.9% for reasons which I'll touch on in a moment. In the interest of time, I'll skip over the logistics outlook, which Joel will provide later on in the presentation. However, I did want to provide a status update on a couple of organic projects that we've mentioned on previous calls. First, the new Span Alaska facility in Anchorage is coming along nicely, and we look forward to its opening in the fall. The new facility will be state-of-the-art and built to our specifications and will continue to support our leading position in the freight forwarding market in Alaska. Second, 110 new 53-foot boxes for our intermodal program will be placed into service this quarter, and we look forward to the opportunities this affords us with customers. Turning now to slide 15. Since our acquisition of Span Alaska in the third quarter of 2016, the operating income and margin for logistics has increased quite significantly. In the last 18 months, all of our lines of business and logistics have been delivering solid contributions, driving operating income and margin to all-time highs. Most recently, operating income has increased in the face of declining revenue, and I wanted to spend a moment on this. In the second quarter of 2019, logistics revenue declined primarily due to lower transportation brokerage, partially offset by revenue gains in freight forwarding. Within transportation brokerage, we saw the effect of lower truck pricing impact our intermodal highway business volume, but this did not translate into lower margins for us. And our freight forwarding business to Alaska has relatively higher margins than the other business lines in logistics, so it was also a contributor to the higher operating income. For the rest of the year, we expect similar conditions to persist, with transportation brokerage revenue challenged, but margins to remain favorable. With that, I will turn the call over to my partner, Joel, for a review of our financial performance and outlook. Joel? Thanks, Matt. Now onto our financial results on slide 16. Ocean transportation operating income for the quarter decreased to $16.8 million year-over-year in the second quarter to $19.7 million. The decrease was primarily due to higher vessel operating costs, including the Maunalei lease expense, a lower contribution from SSAT, higher terminal handling costs, and lower container volume in Hawaii. Partially offsetting these unfavorable year-over-year comparisons was a higher contribution from the Alaska service and higher average freight rates in China. The company's SSAT joint venture contributed $0.9 million, or $8.2 million less than the year-ago period. The decrease was primarily due to additional expense related to the early adoption of the new lease accounting standard in the quarter, as well as higher terminal operating costs. On a year-over-year basis, about a third of the $8.2 million decline is attributable to these lease-related costs, most of which will reverse in the second half of the year. However, when compared to our previous outlook, we expect approximately $5.8 million in lease-related costs, or approximately $0.10 per share to reverse and be a benefit to SSAT's results in the second half of 2019. For logistics, operating income for the quarter was $11.3 million, or $1.8 million higher than the year-ago period. The increase was due primarily to higher contributions from freight forwarding and transportation brokerage. EBITDA for the quarter decreased to $14.4 million year-over-year to $64.9 million due to lower consolidated operating income of $15 million, partially offset by an increase in other income of $0.4 million and an increase of $0.2 million in depreciation and amortization, which includes dry dock amortization. Interest expense for the quarter was $6.1 million or $1.5 million higher than the first quarter this year, largely as a result of the Kaimana Hila entering service in the quarter and the capitalized interest associated with the vessel moving into interest expense on the P&L. Lastly, the effective tax rate in the quarter was 20.4%. Slide 17 shows how we allocated our trailing 12 months of cash flow generation. For the LTM period, we generated cash flow from operations of $294.1 million. Received proceeds from sale leaseback transactions of $124.6 million and had other positive cash flows of $3.3 million, from which we used $87.9 million to repay debt, $75.5 million on maintenance CapEx, and $202.4 million on new vessel CapEx, including capitalized interest and owners items, while returning $36.3 million to shareholders via dividends. In short, our cash flow remains strong to support investments in our new vessels and the terminal upgrade at Sand Island, as well as to support our other growth initiatives. Turning to slide 18 for a summary of our balance sheet. You will note that our total debt at the end of the quarter was $844.6 million, and our net debt to LTM EBITDA ratio was 3 times. As a reminder, the EBITDA we report in our press release and in this presentation is different and lower than the EBITDA calculated under our debt agreements. We continue to expect the leverage ratio to peak in the mid 3s in the first quarter of 2020, after which we will focus our strong cash flows on reducing leverage back towards our targeted levels of the low 2s. On an annual basis, we continue to expect about a half a turn reduction in the leverage ratio after the completion of our vessel program. The last point I wanted to make, as you would expect, is that we are continuing to look at debt capital structure financing alternatives, including Title XI, to further optimize our balance sheet. Turning to slide 19 for a review of our new vessel payments. For the second quarter, we had new vessel cash capital expenditures of $6.4 million and capitalized interest of $3.3 million, for a total capitalized vessel construction expenditures of $9.7 million. As you can see in the middle chart, Lurline is now 94% complete, and delivery of the vessel is expected in the fourth quarter of this year. Matsonia remains on track for delivery in the third quarter of 2020 and is 24% complete. The table at the bottom shows the cumulative and remaining new vessel progress payments. For the remaining six months of 2019, we expect approximately $172.3 million in payments, and for 2020, we expect only $62.7 million in remaining payments, which is less than our normal free cash flow generation, which is why we expect our de-leveraging to begin after the first quarter next year. With that, let me now turn to slide 20 to discuss our full year and third quarter outlook. As a result of the continued weakness in the Hawaii market and the higher operating costs at SSA Terminals, LLC in the second quarter that are largely behind us, we are lowering our outlook for the full year. For the full year 2019, we expect operating income for ocean transportation to be approximately 20% lower than the $131.1 million achieved in 2019, after adjusting for the additional 11 months impact of the vessel sale leaseback of $6.6 million. For logistics, we now expect operating income to be 10%-15% higher than the level achieved in 2018 of $32.7 million. We expect depreciation and amortization to approximate $133 million, inclusive of $38 million of dry dock amortization. These amounts include the effect of accelerated dry dock amortization of $4.2 million for the full year on two of the six vessels in the scrubber program. We expect EBITDA to approximate $270 million or approximately $18 million lower than our previous outlook. The breakdown of the $18 million EBITDA outlook decline is approximately one-third from this quarter's results, and the majority of the remaining two-thirds due to lower expected Hawaii volumes and a small portion due to some of the ongoing higher operating costs continuing at SSA Terminals into the third quarter. We expect other income to be approximately $2.7 million in income. We expect interest expense to be approximately $25 million. Finally, for the year, we expect our effective tax rate to be approximately 26%, excluding the $2.9 million reversal we recorded in the first quarter related to the Tax Act. For the third quarter 2019, we expect ocean transportation operating income to be moderately lower than the $48.7 million achieved in the third quarter of 2018. For logistics, we expect operating income to approximate the $9.9 million achieved in the third quarter 2018. Now turning to slide 21. In Matt's opening remarks, he briefly mentioned our expectations for financial benefits in 2020 and thereafter from the new vessels and other infrastructure investments. At this time, we reaffirm the approximately $30 million in total benefits we expect from the four new vessels on an annual run rate basis once all four vessels are deployed. In addition, we have mentioned on our more recent quarterly calls that we expect significant financial benefits from our investments in scrubber installations on our vessels, as well as the cranes and other infrastructure projects at the Sand Island terminal. Given the magnitude of all of the investments and the different timing of when each will begin to positively affect our financial results, we wanted to give investors a sense of the annual benefits we expect from the investments in calendar year 2020 and beyond. Specifically, in 2020, we expect approximately $30 million of incremental benefit from these investments when compared to 2019. After 2020, we expect approximately $40 million in incremental benefit when compared to 2019. These benefits will be generated primarily from the reduction of 10 shifts to nine in our Hawaii trade lane, operating and maintenance cost reductions from the four new vessels, the benefits from the exhaust gas scrubbers, autos and rolling stock efficiencies on the Kanaloa Class vessels, higher volume from the larger capacity vessel in the CLX trade, and the newly installed and modified cranes in Sand Island. We may also achieve financial and operational benefits in other areas over time from these investments, but the areas noted on this slide are expected to be the largest. Overall, we believe we will achieve the noted $30 and $40 million benefits mentioned before. Lastly, I want to emphasize that this is not an outlook of $30 million higher performance in 2020 than 2019 and should not be interpreted as such. We are making no comment at this time about our 2020 and beyond outlook, but rather describing the benefits we expect from all these investments. Our 2020 and beyond outlook and performance could be higher or lower due to fluctuating trends in all of our trade lanes and business units, and we are not making any comment on those trends or outlook today. We plan to provide our 2020 outlook on the fourth quarter earnings call in February of next year. With that, I'll now turn the call back over to Matt. Okay, thanks, Joel. Why don't we open the call up to operator to questions? Ladies and gentlemen, if you have a question at this time, please press star and then the number one key on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from the line of Jack Atkins from Stephens Inc. Your line is open. Hey, guys. Good morning. Really appreciate the time, and thank you for taking my questions. You bet, Jack. I guess, let us start off just, Joel, to go back to your prepared comments around the change in the guidance, down $18 million, I think, versus your prior outlook. Could you maybe just, if you could, kind of bridge us again just to make sure everybody is on the same page in terms of what the primary drivers are between the $270 million now versus $288 million before. Could you just kind of walk us through that, if you could? Sure, Jack. Sure. Thanks for that. So, of the $18 million, about a third of it was embedded in this second quarter results. So approximately $6 million of EBITDA, translating down to about $0.10 of earnings per share. And of that $6 million, Matt mentioned, we talked about the Hawaii volumes came in less than expected, and we also experienced some higher costs at SSA Terminals. So of that $6 million, it was about half and half between those two drivers, Hawaii volumes and SSA Terminals in the second quarter. The remaining $12 million of downward reduction in our outlook for the, really, the second half of the year, the vast majority of that is the Hawaii volume impact, Jack. We expected there to be some growth this year and in the second half of the year, and it is not materializing. We are seeing a flattish market. That is the majority of the remaining 12 coming down. A small portion of that remaining 12, though, also is some of the SSA Terminals higher costs spilling over into the third quarter. We believe those are largely behind us, but not 100%. So there is a little bit of impact of that as well. But those are the components of the 18 down for the full year. Okay. All right. That helps. And I guess for my second question, if I could, I would like to shift gears a little bit and kind of think about your CLX service. Matt, we have seen, obviously, accelerating tariff rhetoric over the last year. And it seems like everyone is expecting it to get better, and it only gets a little bit worse. Could you sort of talk about this last round of, or I guess the tariffs that are going to go into effect on September 1st. How do you think that impacts your business? What are your customers telling you about their freight flows as a result of these tariffs, if that is changing at all? And this potential change in tariff policy coming up next month, does that have any impact on your outlook for CLX in the second half of the year? Okay, sure. A super easy question to answer, so thank you for asking. In all seriousness, I would make a couple of general observations and then dive down. I think what we're seeing, Jack, in talking to our customers, is that if you were a customer that sourced only out of China, I think there's a lot of risk mitigation planning on developing sourcing from other countries to the extent that the U.S.-China situation worsens or if tariffs go up above even current levels. So we see a lot of our customers, many of them have sourced from multiple countries. In those cases, they're looking at talking to their partners in these other countries about whether they have the ability to increase production. So there's a lot of thinking going on around risk mitigation. But I still think you'll see, independent of what's happening with tariffs, which are more difficult to predict, that there is still a very difficult to replicate in the short run ecosystem in China for the commodities we care about, which are garments, footwear, electronics, things that are fashion and electronics. Let's just call those items. So we will see some stickiness, but with a fair degree of planning. The second thing I would say, Jack, as it relates to the Transpacific market in general is to the extent, let's say, that production is shifted incrementally out of China into Malaysia, to India, to Vietnam, and to the Philippines or wherever that might go, the international ocean carriers can change their allocations from some market to others. So they can point more capacity towards the markets that are growing incrementally. It doesn't necessarily mean that there's a disruption to the Transpacific trade in its entirety if the international ocean carriers migrate some capacity from China to these other origins because very little of what we're hearing of what potentially is leaving China is coming back to the United States. I think that ship has sailed for a lot of the commodities we deal with. Then to Matson more specifically, I think we're also seeing, of course, there's a significant degree of uncertainty, and Matson thrives in chaos. We don't say it to boast, but we have the fastest service. Just because of where we are with respect to future concerns about the economic cycle, retailers are being more cautious. They're carrying less inventory. They're waiting till the last minute to place orders. All of that falls exactly into the market, this expedited ocean market as an alternative to air freight. So despite all the ongoing uncertainty, including the IMO 2020, we're continuing to feel and hear from our customers, that there continues to be a strong demand for Matson's product, admittedly, a fairly uncertain environment. Okay. No, that definitely makes sense. I know you guys have a very unique and specialized service. That all makes a lot of sense. I appreciate that, Matt. One last one, I will jump back in queue and hand it over to someone else. I was interested in the commentary around shifting of some capacity, particularly at least one of the new vessels out of the Hawaii turnaround service and into CLX. You may do that again with, I think you said the Daniel K. Inouye when the Lurline is delivered, if I am not mistaken. I guess could you just talk about what capacity does that add to the CLX service and what does that do to capacity in the Hawaii service? I am just trying to get a feel for how capacity could be shifting between those two different services. Yeah. I think the view, at least between now and the end of the year in the Hawaii market is it is likely to remain muted. As we took down our outlook, Joel mentioned, our expectations for growth have now been reset. We are looking for a flat environment for the remainder of the year. The other thing I would say is the vessels, the two new Aloha Class vessels, the two large container ships that you mentioned, that are now in service, are going to be busy anyway, some of them replacing vessels on our CLX service as we take those vessels out to install emission scrubbers. These CLX vessels will be coming out of service. The third thing I will mention about the Aloha Class vessels is, number one, it allows us to slip into a nine-ship fleet, but they were also built to accommodate future growth. Our view is that they can be moved from our Hawaii service, which will continue to allow us to carry all of the cargo for the Hawaii service. Potentially the idea is to point additional capacity into the CLX trade where we have a better chance of filling that capacity, especially during seasonally busy times. I think what we will see is that the increase in China capacity, let us say between now and the end of the year, replacing a CV2600 that is in there now, with one of the Aloha Class vessels adds a few hundred container slots, 200, 300 container slots on a voyage every five weeks. It is not a huge mover to capacity, but potentially both of those vessels could be deployed in China, or in our CLX service to the extent that Hawaii remains muted. Our CLX vessels could easily carry our entire cargo package in the Hawaii service and stay into a nine-ship fleet, against the previous. It is an idea. We are not overreacting to a short-term Hawaii flattish market, but we are also acknowledging that we have assets that can move where potentially we have greater chances for utilization. Okay. That makes a lot of sense. Well, I will hand it over. Thanks again for the time, guys. Thanks, John. Thanks, John. Our next question comes from the line of Kevin Sterling of Seaport Global. Kevin, your line is open. Thank you. Good afternoon, gentlemen. Hi, Kevin. Matt, if we could step back here. I have been following you guys a long time, and even when you were part of Alexander & Baldwin, I can always remember you could always look at construction volume and get a good read on your end markets for Hawaii and kind of see how you guys are doing. It seems like now that historical relationship may have changed a little because when I hear you talk about Hawaii, it seems like construction activity, construction jobs, permitting, what have you, is doing okay, but maybe it is the other part of Hawaii, whether it is tourism, consumption, the population growth, is now impacting you maybe a little bit more than it has historically. Can you help me bridge that gap from in the past when we could always look at construction volume as a good read to where we are today? Yeah. It is a good question, Kevin, and I would make a couple of observations. You are right in saying that the level of construction activity, the level of construction employment, have historically been good indicators. At the beginning of this more recent cycle, when we were seeing a lot of the construction activity primarily occurring in urban Honolulu or Oahu, we have noted that we get less of a benefit from high-rise construction because concrete, steel often moves in break bulk style and not in containerized relative to previous cycles where we saw single-family home construction being more active than more dense urban condominium-type projects. That continues to this day. I think we are seeing that flatten out. We, longer term, continue to be encouraged by some of the projects that we've mentioned in West Oahu, Koa Ridge and others that will continue to benefit us, but those are longer term and will happen over the next few years. The other thing I would say is that we ourselves were a little bit surprised based on trends, and we did a dive into what we're hearing from all of our customers. It was really not any single thing. Some customers, as Joel mentioned in his comments, were looking at more carefully managing inventory levels. There were no dramatic changes. There were others that were looking to pack their containers a little bit more efficiency. There were more 45-foot containers instead of 40-foot containers. There was nothing that jumped out at us that was a cause for deep worry. But we are observing that the market is weaker than we expected because of some of the items that you mentioned. Those are my thoughts on the market, just a little additional color. Yeah, I really appreciate that. Thank you. Are you seeing any aggressive pricing by a competitor in Hawaii as a result of some of the market weakness? I would say, there's always a healthy level of competition between the two of us, but we've not seen anything super unusual, nor have we seen any dramatic shifts in share. I would say it's just the normal competitive environment there. Okay, cool. Got you. Talking about the SSAT costs being a little bit higher, what were some of the drivers behind that? Was it mainly labor, or was there anything else going on there? Yeah. We took a dive into that as well, Kevin Sterling. I think it's, again, there are three or four things that drove those costs up. As Joel Wine mentioned in his comments, we see those mostly behind us as we get into the second half of the year. I think I'll just cite some examples. There were some expenses related to the movement of terminals within the Pacific Northwest that I mentioned. We also saw some higher labor costs because SSAT had some difficulty getting a full-time longshoreman instead of a more casual type workforce that impacted their own internal productivity. Those issues are largely behind it. There was a little bit of catch-up crane maintenance in Oakland that is now largely behind us. Nothing that caused us. Well, first of all, I don't think we had fully understood the impact or how it would impact the results in the quarter, which was one of the smaller factors in our underperformance there. But we're satisfied that we don't have, except for a very small tail, a chronic issue of performance at SSAT. Okay, thanks. Joel Wine, you mentioned some possible Title XI debt financing alternatives. Could you expand on that some? Would that help result in maybe lower interest expense savings going forward? It would at treasury rates today, Kevin Sterling, I'll tell you that. They might go lower. Yeah, exactly. We've talked about for a while, we don't need to do any more financing. We're in great shape. Our banks have been supportive. We've got a $650 million revolver that's drawn less than half of that. We have plenty of room to fund the remaining portions of our investment programs off the revolver. But when you look at the Title XI program, and the all-in rate that you can get on a fixed basis for 25-year paper, that's really attractive. We don't like having very much secured paper in our capital structure, and so the negative of Title XI is that you've got to pledge one of the vessels. But we've talked about for a while, it's public knowledge that we've got applications in for Title XI financing. And the first vessel's been delivered. So you can close on a transaction after a vessel's been delivered. We're continuing to look at that and work on that, and that may be something that we do going forward. And to answer your specific question about interest expense, yes, at the rates that you would achieve now, it would be cheaper all-in borrowing than where we're at on the revolver. So not a huge differential on interest expense, but slightly favorable. Yeah, but you can lock it in for long term. Lock it in long term, exactly. Yep. Got you. Lastly, you talked about, I guess, peak debt in Q1 2020. Will you bump into any potential covenant issues from what you see right now? Because I know you said the banks look at EBITDA calculation on a much different basis than how we look at it. Well, it is not dramatically different. It is just there is a few more things in EBITDA to make EBITDA higher, but it is not dramatically different. We can go up to 3.75 on our leverage ratio, Kevin. Right now we are at 3. We got plenty of headroom on that. We are only 6-8 months away from our peak levels. I mentioned here today that our Vessel payments that remain in 2020 are only $63 million. That's quite a bit less than our free cash flow generation. We feel good that we're not going to have any kind of covenant issues up in the 3.75 leverage ratio level. Okay, great. That's all I had today. Thanks for your time. Okay. Thanks, Kevin. Thanks, Kevin. Once again, if you would like to ask a question, you may press star 1 on your touchtone telephone. I'm not showing any. Oh, we just have a follow-up question coming from the line of Jack Atkins from Stephens Inc. Your line is open. Okay, great. Thanks, guys. I just had a couple of additional follow-ups here since we have a few minutes. Matt, I'd be curious to get your thoughts on, I think there's been some reports about a potential grace period related to IMO 2020. We'd just be kind of curious to get your thoughts and if you think anything like that's going to maybe go through. I think China also has banned open-loop scrubbers. I believe you guys have closed loop scrubbers, but just wanted to make sure about that. Could you kind of touch on those IMO topics? Sure, I can. Yes. We're hearing of no strong push for broad-based waivers of IMO. But to the extent, let's say, a company had a vessel under construction and was looking for a 6-month or 9-month waiver until the delivery of their new vessel, something like that might be asked and might be accepted, on a onesie-twosie basis, but we don't really see any large waivers expected. Now, to the extent that there were some fuel disruptions or unavailability in some ports, there may be some limited waivers until that. We're not hearing of any of that at that point. But those are a couple of exceptions that I think would be short term. We're not expecting any of those to occur in our own fleet as you know. With respect to your second question about, let's say, China implementing its own rules in an open-loop scrubber versus a closed-loop scrubber, I would say that Matson's Alaska vessels are closed loop, which mean that when they're in the emission control area or eco zone or when they're in special sensitive zones, they go closed loop where they're not letting the scrubbed emission residue go into the ocean. But during most of the voyage, it's in an open loop situation. Matson's six new scrubbers are open-loop scrubbers, most likely. What that just means is while we're in the coastal area of China, it requires us to burn a different fuel. We're doing that now and expect to continue to do so. Because the majority of the voyage, it would be in open-loop mode in the open ocean. When we transited either the U.S. West Coast or in China, we will be using alternative fuels and we have a method in which to change. Our economics and our payback periods on scrubbers and all of that has been factored into that view. We do not see any significant impact as it relates to Matson's use of open-loop scrubbers and the way we have designed it. Okay. That is very helpful. Thank you for that. Then just last one for me, just going back to the Hawaii volumes for a moment, just to make sure I have got that correctly. Matt, if I have heard your comments correctly, it sounds like part of what is going on here is just some inventory destocking going on in Hawaii. I kind of want to make sure if that is the correct way to interpret it. I guess secondly, if that is the case, do you kind of think once this excess inventory gets burned off that maybe the broader market can maybe stabilize and things can start to see a little bit of growth return? I know you have kind of been a little bit burned on it this year, but I am just trying to get a feel for it. Is something sort of changing structurally in Hawaii, or is this really sort of a temporary inventory build-up that we have seen this in the past and just kind of we have got to get through it? Yeah, I think a little bit of what you said is true, Jack, but I think the reality is we were down 2.4% in our volumes in Hawaii service. Our view is that the market will remain flat. Some of the issues that we believe are like the inventory a little bit more carefully, you can only do that once and then you can no longer do it. I agree with that part of it. But I think our expectation is that we will see a flat environment moving forward. We took out the growth for the remainder of the year. It does not look like it is coming and in talking to many of our customers, nobody was seeing big significant growth. There was also a number of other smaller factors. There was no one factor that drove that 2.4%. There was a smaller amount of, for example, return eastbound cargo than we had seen before. No significant reason we could identify. I do not want to go too far down in looking at it. There were a few items that was a large solar project that we moved last year in the second quarter that did not repeat itself this quarter. So there is just lots of little things, but it kind of gave us the feel that we really did need to do a market reset and look at a flattish environment moving forward. Okay. No, that makes sense. Thank you again for the time. You bet. Thank you, Jack. Speakers, I am not showing any questions at this time. I would like to turn the conference back over to Matt Cox, CEO. Well, thanks everybody for listening. We look forward to catching up with you on next quarter's call. Thank you. This concludes today's conference call. You may now disconnect.