Earnings Call: Q1 2016

May 4, 2016

Good day, ladies and gentlemen, and welcome to the Matson first quarter 2016 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 operator assistance during the conference, please press star then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Jerome Holland, Director of Investor Relations. Sir, you may begin. Thank you, Eric. Aloha, and welcome to our first quarter 2016 earnings conference call. 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 their expectations and assumptions are reasonable. We caution you to consider the risk factors that could cause actual results to differ materially from those in the forward-looking statements in the press release and this conference call. These risk factors are described in our press release and are more fully detailed under the caption Risk Factors on pages 8 to 15 of our 2015 Form 10-K, filed on February 26, 2016, and in our subsequent filings with the SEC. Please also note that the date of this conference call is May 4, 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. Also, reference is made to certain non-GAAP numbers in this presentation. A reconciliation to GAAP numbers and description of calculation methodologies is provided in the addendum. With that, I will turn the call over to Matt. Thanks, Jerome, and thanks to those on the call. Our core businesses performed largely as expected in the first quarter of 2016, with operating results declining year-over-year in the absence of last year's extraordinarily strong demand for our China service. Market conditions in the China trade have deteriorated further in 2016 as international ocean carriers have continued to lower rates in an attempt to attract cargo in this heavily oversupplied trade lane. As a result, we are revising down our full year 2016 outlook with the expectation that our ocean transportation operating income will be approximately 15%-20% lower than the $187.8 million we earned in 2015. While these challenging dynamics in China will weigh on our 2016 results, we continue to see solid fundamentals and performance in our other core trade lanes and also SSA Terminals and logistics. In Hawaii, where we recently deployed an 11th ship, we expect to benefit from continued market growth and a stronger market position. Our integration activities in Alaska are progressing well, and we remain on track for complete integration by the end of the third quarter of this year. Slide 4 shows our financial metrics. In the first quarter of 2016, we generated EBITDA of $66.4 million and diluted earnings per share of $0.41. The graphs on this slide show the EBITDA was roughly flat year-over-year, while EPS declined by $0.16, largely due to incremental depreciation and amortization, which Joel will describe in more detail later on. I'd also like to point out that the first quarter is historically our lowest in terms of earnings and cash flow. However, our results in the first quarter of 2015 benefited from exceptional demand for our expedited China service and from the sharp decline in bunker fuel prices as fuel surcharge collections outpaced fuel expenditures. Turning to our Hawaii service on Slide 5. In the first quarter of 2016, the trade experienced modest market growth, and Matson maintained competitive volume gains in continued response to Pasha's service reconfiguration. Looking ahead, we expect the multi-year recovery in Hawaii to continue, and for the full year 2016, we expect our Hawaii container volume to be moderately higher than it was in 2015, with nearly all of that relative increase coming in the first half of 2016. You'll recall that we had 11 ships deployed for most of the second half of 2015, so our volume growth in the second half of this year is expected to be more challenged. Two weeks ago, we shifted back into an 11-ship deployment in Hawaii, enhancing our service and underscoring Matson's enduring focus on Hawaii and our commitment to serving customers better than anyone. Slide 6, which leads to the next slide of a longer-term update on our Hawaii fleet. Construction is now underway at the Philly Shipyard on our two new 3,600 TEU container ships, which we call the Aloha Class, and delivery is expected to be in the third quarter of 2018 and the first quarter of 2019. These first two Aloha-class vessels will be used as replacement capacity for our oldest active vessels in Hawaii and allow us to operate 100% diesel fleet and be fully compliant with the emission regulations, which become effective in 2020. However, our oldest diesel ships will be approaching 40 years old at that time, which we view as a threshold for replacement. So we're continuing to evaluate ordering two additional new vessels that would meet our fleet renewal needs in Hawaii until approximately 2030. These additional vessels could be ordered in 2016 and 2017 and be delivered in the 2019 and 2020 timeframe. We expect our new ships to have among the lowest operating cost per container of any ship in the Jones Act trades and gives us the ability to deploy fewer vessels at much higher volume than in the past. We would expect to move from our current 11-ship deployment to a 10-ship deployment with the delivery of the first two Aloha Class vessels, and then to a nine-ship deployment upon the delivery of the third and fourth new ships. In addition, lower fuel consumption, lower crew costs, and reduced maintenance and repair expenses will be important drivers to produce meaningful savings. Slide seven highlights some of the key metrics that support our moderate volume growth expectations for the Hawaii economy, as forecast by the University of Hawaiʻi Economic Research Organization, or UHERO. As we've mentioned before, much of the incremental market growth we expect to see in Hawaii will come from the continued progress in the construction cycle. Residential building permitting and construction jobs picked up considerably in 2015, and growth is forecast to continue through 2016 and 2017. The bulk of current construction activity is focused on the advancement of several high-rise projects in urban Honolulu and on Honolulu's $5.2 billion rail project. However, we are beginning to see increased activity on the neighbor islands. In addition, two long-planned master community projects have received favorable Supreme Court rulings that will allow their developers to move forward. D.R. Horton's Ho'opili project for nearly 12,000 homes in West Oahu looks to be moving ahead later this year, and Castle & Cooke's Koa Ridge project is expecting to start construction of an initial phase of 3,500 homes next year. Moving to our China service on the next slide. Matson's container volume in the first quarter of 2016 was 18.1% lower year-over-year due to the absence of the extraordinarily high demand experienced in the first quarter of 2015 during the U.S. West Coast labor disruptions and continued market softness amid a slower than normal post-lunar New Year recovery. Our expedited service continued to realize a sizable rate premium in the first quarter of 2016, but as expected, average freight rates were significantly lower than the first quarter 2015. For the remainder of 2016, the company expects increasingly challenged market conditions in the Transpacific trade, with underlying market rates at historic lows amid chronic overcapacity in the trade. Alphaliner is projecting global container fleet capacity growth of 3.9% in 2016, and while this may sound low, it'll do little to address the massive capacity growth that has taken place over the last several years. The liners have continued to order larger and larger vessels to lower their unit cost. But with their aggressive focus on filling these large vessels, there's been significant erosion of freight rates. As a result, the international liners are again expected to lose billions of dollars in 2016. There are several liner mergers in the works and another reshuffling of alliances, which could hopefully bring some order to the market. But with regulatory approvals required, any improvement is unlikely to be until 2017 at the earliest. In addition, there have been several recent announcements of new expedited service offerings in the Transpacific that have the potential to narrow Matson's service differential and potentially narrow our premium-to-market freight rates. I should note that we've had many challengers over the years to attempt to match our service in the past, but their track record of execution and longevity has been poor. We recently concluded our annual contracting cycle, where these challenging dynamics resulted in market contract rates being offered at the lowest levels I've seen in 30 years. As a reminder, about one half of our China business is based on annual contracts, with the other half based on the spot market. With this backdrop, we have revised our expectations for China rates in 2016 to trend lower than the declines factored into our previous outlook. Despite the significantly lower rate environment, we do expect to continue to earn a substantial rate premium, and given our dual head haul structure, we expect our China service to remain solidly profitable. Turning to slide 9. In Guam, economic activity was stable in the first quarter, but the launch of a new competitor's biweekly U.S.-flag container ship service resulted in modest competitive volume losses compared to the first quarter 2015. For the full year of 2016, we expect to experience continued modest competitive losses to this new service. Moving on now to our Alaska service on Slide 10. In Alaska, the company's container volume for the first quarter of 2016 approximated the level carried by Horizon in the first quarter of 2015, primarily due to muted economic activity associated with the decline in energy prices, with modestly lower northbound volume largely offset by stronger southbound volume. In 2016, we expect the Alaska economy to face economic headwinds, largely due to the sustained low oil price environment. Sustained low oil prices impact Alaska's economy directly through cuts to the oil industry investment and employment, and indirectly through state government budget deficits that lead to spending cuts. From a container volume standpoint, the Alaska market has been relatively stable over the past 10 to 15 years across a wide range of commodity prices. With the container volumes we carry largely skewed towards customers like grocery stores, big box retailers and other impact of the underlying macro challenges in Alaska, we expect our 2016 container volume to be only modestly lower than the 67,300 containers carried by Horizon and Matson in 2015. Moving to slide 11. Our terminal joint venture, SSA Terminals, contributed $2.6 million in the first quarter of 2016, compared to $3.4 million in the first quarter of 2015. This year-over-year decrease primarily reflects lower lift volume. Looking ahead, we expect strong volume growth in Oakland to result from the closure of the Outer Harbor Terminal to our SSA Terminals' OICT terminal. While this incremental lift volume in Oakland will clearly benefit SSA Terminals' 2016 results, we do not expect it to outweigh the year-over-year absence of factors related to the clearing of international cargo backlog after the resolution of the protracted labor disruptions on the U.S. West Coast last year. As a result, we expect our SSA Terminals joint venture to contribute healthy profits to our ocean transportation operating income in 2016, albeit at a modestly lower level than the $16.5 million contribution it made in 2015. Slide 11. I am sorry. Slide 12 highlights the results at Logistics, which benefited from higher intermodal volume, warehouse operating improvements, and highway yield improvements to deliver an operating income margin of 1.8%. As we look out into 2016, we expect volume improvements together with continued expense control should result in modestly higher earnings in 2016. With that, I will now turn the call over to Joel for a review of our financial performance and consolidated outlook. Joel? Thanks, Matt. As shown on slide 13, ocean transportation operating income decreased $10.9 million or 24.8% during the first quarter 2016 compared with the first quarter 2015. The decrease was primarily due to lower freight rates and volume in the China service, increased depreciation and amortization expense, higher vessel operating expenses related to the deployment of an additional vessel in the Hawaii service, additional SG&A related to the Alaska acquisition, and higher terminal handling expenses. Partially offsetting these unfavorable items were higher container volume and yield improvements in Hawaii, and the inclusion of operating results from the company's acquired Alaska service. SSA Terminals contributed $2.6 million during the first quarter 2016, down from $3.4 million in the first quarter 2015, primarily due to modestly lower lift volume. Operating income for logistics increased in the first quarter year-over-year by $0.6 million, driven by the items Matt mentioned earlier. Slide 14 highlights our consolidated results for the year. You can see that EBITDA was almost flat year-over-year, while operating income and net income declined year-over-year due to additional depreciation and amortization related to our Alaska acquisition, the relatively heavy dry docking schedule, and higher than normal maintenance CapEx. You will recall that prior to acquiring the Alaska operations, Matson's long-term outlook for average annual spend on maintenance CapEx was roughly $35 million to $40 million. After we closed the acquisition, we amended Matson's long-term outlook for normal annual maintenance capital spending to a range of $40 million to $50 million annually. However, as we mentioned on our last earnings call, we expect higher than normal maintenance CapEx of approximately $65 million in 2016, largely 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. 2011 and 2012 were the last years to have relatively high levels of dry docking spend on our Hawaii fleet. Given that vessels in our Hawaii fleet require dry docking roughly every five years, we expect 2016 and 2017 to be busy dry docking years as well. On top of that, the vessels we acquired from Horizon added to our ongoing dry docking requirements. Consequently, for 2016, we expect dry docking expenditures to total approximately $60 million. Based on our outlook for capital expenditures in dry docking, we expect depreciation and amortization for 2016 to total approximately $133 million compared to $105.8 million in 2015. This amount is inclusive of expected dry docking amortization of approximately $35 million for 2016. Turning to slide 15, our balance sheet continues to be in very good shape with a net debt to EBITDA ratio of only 1.5 times. Our share repurchase program continued at a steady pace in the first quarter, with 518,600 shares repurchased at an average price of $38.81 per share. Since the inception of the share repurchase program in November of 2015, and as of yesterday, May 3rd, 2016, Matson had repurchased a total of approximately 777,000 shares at an average price of $39.75 per share. We continue to expect a steady measured pace for the share repurchase program, which reinforces our confidence in Matson's free cash flow generation to provide for our capital investment needs and growth opportunities, while also returning capital to shareholders via both dividends and share repurchases. Slide 16 shows a summary of our cash sources and uses over the last 12 months. The key takeaway here is that our net borrowings increased by only $108.5 million. That is after the inclusion of the $495 million of cash needed to close the Horizon acquisition, while also funding $152 million of CapEx, dividends, and share repurchases over the last 12 months, which overall is a testament to the strength of our internally generated cash flow from operations. With that, let me now turn to slide 17 to provide our updated outlook for the full year and second quarter of 2016, which is being provided relative to the prior year's operating income for each period. For ocean transportation, operating income for the full year 2016 is expected to be approximately 15%-20% lower than the $187.8 million achieved in 2015. In the second quarter of 2016, operating income is expected to approximate the $31.4 million achieved in the second quarter of 2015. In terms of headwinds, we expect to have significantly lower average freight rates in China, increased depreciation in amortization expense, competitive volume losses in Guam, and a modestly lower contribution from SSA Terminals. 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 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 continue to expect interest expense for the full year 2016 to be approximately $19 million, and our effective tax rate for the full year to be approximately 39%. I will now turn the call back over to Matt for final remarks. Thanks, Joel. In summary, our first quarter results came in largely as expected, but the continued deterioration of conditions in the China market has further tempered our outlook for 2016. In Hawaii, we remain encouraged by the strength of our core Hawaii operation and expect to benefit from continued market growth and our stronger market position. In Alaska, while low energy prices present near-term economic headwinds, I am pleased with our integration progress and feel like we are hitting our marks as we move towards our targeted $70 million of EBITDA run rate within two years of closing. In Guam, while the U.S. Marine relocation provides a longer-term positive for container demand, we expect some impact from the competitor that entered the trade in January. Overall, we 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 fund our fleet and equipment investments and consider growth opportunities while continuing to return capital to shareholders. With that, I will turn the call back to the operator and ask for your questions. Ladies and gentlemen, if you have a question at this time, please press the star then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Once again, that is star and then the number one. Our first question comes from the line of Kevin Sterling from BB&T Capital Markets. Your line is now open. Thank you. Good afternoon, gentlemen. Hi, Kevin. Hey, Matt, let me start with the 11th ship you're introducing in Hawaii. Is that permanent or temporary? It sounds like then when you bring in your Aloha Class vessel in late 2018, you'll go back to a 10-ship string. Do you plan to run this 11th vessel until you introduce your new ships? Yeah, it's a good question, Kevin. I think what we found in introducing the 11th ship just a couple of weeks ago is that we were not able to serve the entire market the way we wanted to. One of the primary places in our network that we were struggling to carry all the cargo that was demanded or presented to us was in the Pacific Northwest, is where you'll recall that Pasha, as they reconfigured their fleet last year, withdrew from that market to focus on California and in particular, Southern California. What we found is we had a large ship and a small ship, and some of that cargo was flowing over to the barges. Since we long-term continue to believe that the construction segment is going to be the segment that grows the fastest, and much of that construction-related cargo comes out of the Pacific Northwest and Canada over Seattle, we felt we were not serving the market the way we wanted to. What I would say is, yes, we do expect to stay in an 11-ship fleet for the foreseeable future. There may be times during some slack months that we revert to a 10-ship fleet. For the most part, our view is that we're in an 11-ship fleet and will stay there until the delivery of the Aloha Class vessels. In which case, our planning now suggests that we're going to move into a 10-ship fleet. Got you. Okay, thanks, Matt. It sounds like what you're seeing in Hawaii, it's a combination of growing demand there, but also the Pasha reconfiguration. Is that right? Yeah. When they initially reconfigured to pull out of the Northwest, as you'll recall, we went from last year from 9 ships to 10 ships to 11 ships as the cargo flows were adjusting to the reconfiguration of Pasha's fleet. Yeah, that's the background behind it. Okay, cool. Lately, we've seen the yen strengthen here the past couple of months. Help me, when do you guys start seeing maybe some benefit of the yen strengthening with maybe more tourism in Hawaii? How much of a lag is there before we maybe start seeing that additional kicker or if there is a kicker as we think about the yen? Yeah, I do think there's an impact there, but I would say what we have seen is that overall, as you followed the company for many years, the tourism story continues to be very strong overall. The Japanese tourists are an important part of the market, but certainly much, much smaller than the U.S. mainland, where we derive most of our spending. That yen talks about could be helpful for investment in real estate and also for tourism. I think it does provide, on the margin, a potential catalyst for some improvements. Got you. Okay. Thanks, Matt. As I think about your guidance, it sounds like it is all related to China and understand what is going on there, freight rates. We have heard rumblings of a new expedited service. Are you lowering your guidance just because of China? I am curious, is there any offset maybe because of strengthening Hawaii, or are you not baking that into your new guidance with any Hawaii strength? Yeah. I think to answer your first question, China is the catalyst here. We do have the full year benefit of Alaska. We have the benefits of a growing Hawaii trade. Those are all factors that are partly offsetting what turns out to be a pretty nasty cycle in the China market. All of that mixed together is factored into our thinking of this 10%-15% lower than last year. Okay. So no potential offset from maybe Hawaii getting a little bit better or anything like that. Is that right? Yeah, it is hard to know. The biggest uncertainty, Kevin, is really in the depth and duration of the cycle in China. As we see it, that is the biggest question mark. Again, we do see an improving Hawaii market. We do see the full year benefit of Alaska. We do see the benefit of these one-time costs that we incurred last year not repeating. All of that mixed together creates our expectation. Yeah. Got you. Matt, how much of an impact into your thinking when you adjusted your guidance with Hanjin introducing their expedited service, I think, next month? Or is it just mainly based upon what you're seeing with just such depressed rates? Yeah. The way we think about it is like this. The overall market is in a very tough spot, and as I mentioned in my prepared comments, this is the worst market I have seen in my entire 30-year career, and perhaps it goes further back than that. We're in a very nasty down cycle. There are actually several expedited services on the books. One, of course, is the Hanjin service that's been announced. APL introduced an expedited service last year that is planning on continuing this year. And the G6 Alliance, minus APL, also has talked about introducing a service. The way we think about it, just generally is, say 70%-80% of our expectations about future rates are really related to the broad macro cycle and the very unhappy outcome for the market on the BCO annual contracting cycle. There is a marginal impact, but it is certainly less than the overall market situation that's factored into our thinking. So it's a little bit of both, but much more the market than the expedited service. Got you. Okay, thanks. Last question here, and I'm going to go back a couple of years when you guys first started your China expedited service. We saw Horizon get in, and if I'm not mistaken, correct me if I'm wrong, there were two smaller Chinese players who got in who subsequently went out of business because they couldn't make money. And what we saw back then was that the big players come in, the international carriers come in and just depress rates and drive those guys out of business, except for you guys. Where we are today, it seems to me rates are at a floor, and so the big carriers can't come in and depress rates much more, in my opinion. I'd like to get your thoughts on that, if you don't mind, comparing maybe what we're seeing now and the introduction of these services compared to what we saw a few years ago and why those guys exited the market. Yeah. It's a good question. I would say several months ago, Alphaliner had predicted the international ocean carriers as a group are going to lose something like $5 billion-$6 billion this year. Rates have gotten worse since they put their forecast out, and if they were to reforecast it wouldn't surprise me to see it being $10 billion-$12 billion in losses for the industry. In the TransPacific, the rates that are being quoted in the market, not Matson's rates, are below their variable operating costs. They are pricing below their variable cost, and this is clearly not sustainable. Something has got to give. The tough part is exactly when they're done beating each other up and who can blink first. I will tell you these expedited ocean services, in particular Hanjin, you'll recall, Kevin, we had a CLX2 service a few years ago where we tried to replicate our CLX service into South China. If we use those same numbers but apply today's freight rates, these expedited services, which are primarily one haul, don't benefit from the back haul that we have, are probably losing just these strings $50 million-$60 million a year individually for the five-ship service. Clearly these are not sustainable services. The only question is how long will they suffer before they come to their senses. Right. Okay. Matt, thank you so much for that clarification and the comparison. Really appreciate it. Thank you, guys. Take care. Okay, Kevin. Thanks. Our next question comes to the line of Steve O'Hara from Sidoti & Company. Your line is now open. Yeah. Hi, good morning or good afternoon. Hi, Steve. Hi, Steve. Hi. I had a question on the China service as well. I see the volumes are down pretty good, and I think in the past, you guys were running at capacity or, for the most part, at capacity. Is it a problem of rate and volume, or are we just expecting rate to be down at this point? Yeah, it's a good question, Steve. I think the starting point is our longstanding premise is that we could fill our ship any time we wanted. We have the fastest, most differentiated service. That's not going to change with the introduction of Hanjin or APL's last year expedited services. The question for us in this extreme market dislocation where we find ourselves in is where we find ourselves for the customers that we have and we've renewed, we've probably earned the largest market premium we've ever had, albeit in a very bad market. The question is, we certainly could fill our ship with cargo that is below our variable cost, but it doesn't make a lot of sense for us to take some of these extremely low offerings if it produces a worse result for the company. We may, in fact, find ourselves for the period of this year or until the market settles, or at least until we get into a busier time of year, we've been more choosy not to price below our variable cost. So you may see a little bit lighter ship. I would say it's 90% freight rate, but there's a little bit of volume here as we hold our nose and stay away from some of the more volatile parts of the market. Okay. Thank you. On the ship deployments, the total ship deployments, I think it's at 11 now. I'm just wondering with the new ships coming in, based on Pasha's current service offerings and your service offerings, could you bring that back down to nine? I thought that was the original idea was that you can carry peak volumes with a nine-ship fleet. I'm just wondering how that changes now maybe permanently if Pasha is in this type of a rotation like they are now. Yeah. Our current thinking, Steve, is that based on the reset of market share last year as a result of the pullout of the Pacific Northwest as we've talked about, and our resultant share increase and the way we see the market growing, that we're going to be well into an 11-ship fleet. We're in an 11-ship fleet perhaps earlier than we might have otherwise guessed a few years ago. That vessel capacity and the demand for Matson services will likely allow us to go from 11 ships at the time to a 10-ship deployment upon the introduction of both vessels. Our own expectations of how fast the market has recovered and grown based on the deployment changes has affected our thinking on that. We're thinking of going from 11 to 10, and then with the introduction of the second set of two vessels will put us back into a nine-ship deployment. That's our current thinking, Steve. But each of those series of investments, we believe will be accretive and continue to be accretive based on the reduction of operating costs and fewer operating ships in our network to carry the same amount of cargo. Both remain very attractive investments for us. Okay. Thank you very much. Sure. Our next question comes to the line of Jack Atkins from Stephens. Your line is now open. Great. Thanks for the time, guys. When we think about what you are seeing in the Guam lane, we have seen some competitive pressures there that you all called out in the presentation. Is the 3.5% decline in volume there indicative of what you would expect to see for the remainder of the year, or do you think that is probably going to be maybe a little bit worse just given the timing of when that competitor came in in the first quarter? Yeah, Jack, I think the 3.5% over the longer term will probably accelerate. They had just gotten off. As you recall, just started the first week of January, and their own internal ramping up was, I am sure, a little bit slower than they expected. We do expect volume losses to probably be greater than that as they settle into their share. As I will remind everyone, we do see some growth in the long-term catalyst for the Marine relocation. I would also point out that the service that they offer is significantly longer transits than our own service and is only every other week. We expect them to settle into a much lower market share than you might expect for a second competitor. No, that all makes a lot of sense. I am just curious, when you think about the rate environment in Guam, given that this is really a degraded service relative to your own service, are you seeing any rate pressure at all in terms of the Guam lane, or is it just volume losses there? Yeah. I would say the volume losses so far have been modest. The service differential is significant. I would say we've seen a little bit of tactical stuff, but at this point, we haven't seen a significant amount of price competition yet. Okay. When we think about your market share in Hawaii and the utilization of your current 11-ship fleet, I guess, how should we think about where you stand now? Because I know there's been a lot of changes in the marketplace over the last 12 months, given the emergence of Pasha as your second competitor relative to Horizon Lines. If you could maybe update us on where you think your market share stands, and would be curious to know your utilization of your fleet. Yeah. Okay. We were doing a little catch up when the original deployment took place post-closing with Pasha. We went from nine ships, to 10 ships, to 11 ships. We reverted back to 10 ships towards the end of last year. What we found was that we were not effectively able to carry the market in the Pacific Northwest, and some of that was flowing to the barges, which we wanted to correct. The 11th ship also produces really important other network benefits, which allows us to get our vessels there more on time, allows us to end a week open. There's a number of benefits to our fleet. The additional cargo that we're going to attract as a result of adding this 11th ship will more than pay for that 11th ship. Now, having said all that, you asked a question about utilization and market share. I would say our long-term market share has been around two-thirds of the market. We're probably above that now. Our expectations for growth in the market are pretty good. I would say when we were in the 10-ship fleet, we were probably in around 90% utilization. We're in the 80% utilizations now. But again, that 11th ship has been paid for by the incremental cargo we've been able or expect to attract associated with the additional capacity out of the Pacific Northwest. So I think we're feeling good. We like the 11-ship fleet. The customers like it. It puts us in a terrific competitive position. But we're not at a 95% or 98% utilization going down, but we really like the operating and network benefits. Again, the 11th ship pays for itself with the cargo and other cost efficiencies associated with adding it. Great. So as we think about incremental volume from here, now that that 11th ship is in, I would think the incremental revenue should have a very high drop down in terms of incremental EBIT. Is that fair to say? Yes, that's the right way to look at it. Okay, great. One last question from me. When we think about the impact of rising fuel to your P&L, I know that it is typically a pass-through, or it is a pass-through for the most part in your Jones Act lanes, but does that maybe create some timing issues? Is that reflected in your guidance? It is not. Our own internal expectations are for slow increases in pricing, although, it has been a little tricky to forecast where energy prices go, but our own internal thinking is energy prices continue to gradually rise. There may be a little bit of a lag effect. We do not see it as significant. It hurts us more when there are dramatic increases. When they are slow and gradual, we tend to not have as much of a timing impact, Jack, in terms of our profitability. Okay, great. Thank you for the additional color. Sure. Okay. Thanks, Jack. And our next question comes from the line of Ben Nolan from Stifel. Your line is now open. Yeah, great. Following on maybe if I could on one of Jack's questions. When we think about the little over 8% increase in the Hawaii volumes in the first quarter, I am trying to just get my head around if it is possible to break that down between what was just the organic growth in the market versus share gains. How you might think of that going forward. Maybe another way to put this is, what do you think is currently the rate of organic growth in container volumes in Hawaii? Yeah. Okay, Ben. This 8%, just as a look back. At the end of May, Pasha closed on the Horizon Hawaii business. You will recall there was a fleet reconfiguration out of the Northwest, also some operating challenges as they went live with the new computer system caused a significant surge in Matson's fleet. Most of that was really felt from June till the rest of the year. They have corrected some of their IT and operational issues. But there had been some permanent shift associated with their change in deployments. This 8%, back now to your question, we are going to continue to see positive comps and volume through the end of May as we get to the full year impact of this deployment change in the market. But to your specific question, we think the Hawaii market is growing maybe 1%-2% right now. That level, I think we see as sustainable or slightly increasing into the next 12, 24, 36 months as we see ourselves in this next phase of the construction cycle and light rail and some of the residential housing projects and all the factors that we cited. The rest of it was associated with this change in deployments that are more structural. That is how that 8% plays out. Okay, that's helpful. That sort of leads into my next question. I know in the past you guys have brought up what percentage of your overall Hawaii freight was construction related, and I think at the peak it was something like 17%-18%. I'm curious where you think that number is today and how fast it's changing. Ben, it's Joel. I'll take that one. We said a quarter or so ago, it had moved up to about 7%-8%. It's in the high single digit right now. Not as a percent as high as it was before in the previous peak. You're correct, that previous number was around 17%-18%. But as Matt just mentioned, we see one of the bigger growth drivers in the Hawaii trade is the construction volumes. Some of that is moving over into barges. One of the compelling reasons for us to move into this 11-ship deployment was to be better positioned to capture some of that construction growth. We do think that's a major component of the market growth that Matt just mentioned. Low single-digit market growth for overall Hawaii, but the construction piece is higher, and we're trying to position ourselves to get that. Okay. Got you. As it relates, maybe Joel, to the integration side of it, just looking at sort of where the operating expenses are, and it looks like year-over-year, they were up about $70 million or so. Obviously, I would think the vast majority of that is related to Alaska. How much left is there in terms of being able to carve out or take some of those expenses out of the P&L at this point, do you think? The answer is there's a little bit left, but not a lot. It's not material. We're getting down to the final stages from an integration process perspective. What really remains is the final winding down of the legacy Horizon systems. So there's some IT work and IT final infrastructure, server shutdowns, things of that nature, Ben, that we think will take us probably through the late summer, early fall. We believe we'll be fairly complete with all of the integration by the September timeframe. Between now and then, there will still be a little bit of incremental cost, but by September-ish, we should be down to our normal run rate going forward. So there's a little bit of extra cost this year, but not that much and not material. Okay. Lastly from me, the way you guys were talking about the possibility of adding a third and fourth vessel to your new build fleet, it sounded as though it is almost a foregone conclusion that something would happen this year or next. First of all, am I misreading that? If not, should I think that the vessel size and cost and everything else should be relatively similar to the first two? Yeah. I think the fact that we mentioned it in our earnings call at the end of the year, the fact that we're being more prominent about it, we want to be clear to investors that we definitely are considering it. I think one of the things that, just as additional background, after 2020, when the emission regulations change, we will have only diesel ships in operation, and we'll have only steam vessels in reserve. So our decision set is, do we invest money in the best of the old steamships in order to get them to comply with new emission regulations, which do not permit the exhaust gases that are under the current configuration of the steamships by re-engineering or installing some kind of an exhaust scrubber system? Or do we accelerate a decision of investing in new ships so as to avoid investing in platforms that are end of life is part of the decision matrix. I think we have not made the decision. The board has not made the decision. We've not gotten pricing from shipyards. We're just in the study and evaluation phase, but we wanted to bring investors along and make them aware that at least we're looking at it. So I wouldn't say it's a foregone conclusion, but we wanted to be transparent to the investment community there. Yeah. Okay. The only thing I would add to that part of your question, you asked about, should I assume the same as ships one and two? We also mentioned that some of our garage capacity that we currently deploy right now is on our older vessels. So a consideration for two more ships is also getting new garage capacity for the ro-ro part of our business as well. So we are evaluating different ship types as well as part of a potential third and fourth ship order as well. Yeah, that is right. I remember now. But maybe the way to think about it is one way or the other, there is going to be some capital costs associated with either it is bringing the older vessels up to regulatory levels, which would be pretty expensive, or just replacing them now, right? But one way or the other, something like that has to happen. Is that fair? Yeah, that is fair. I think we have said many times, and Matt repeated, once you get 40 years or longer in vessels, you just really do not want to be deploying that kind of aged vessels all that long as part of long-term planning. We have got significant number of ships that hit that age in the 2023, 2024 timeframe. So even if we had to spend money on the even older steamships before that, we still then would have new ship replacements not that many years later. Right. Okay. Sounds good. Thanks, guys. Okay. Thanks, Ben. Okay. Thanks, Ben. Our next question comes from the line of Michael Webber from Wells Fargo. Your line is now open. Hey, good morning, guys. How are you? Hi, Mike. Hi, Mike. Hey, I wanted to pick up where Ben left off, just around the renewal of the fleet, which is something that's obviously got to happen. If memory serves the initial assets, Matt, were those two plus two? Do you guys actually hold options on two additional ships of the same the same spec, or am I mistaken there? You're right that we did obtain options, but those long expired. Those have expired. Yeah. So at the time, and so those, we don't have firm options in place. Okay. So if I think about the idea that within the larger scale Jones Act yard, if Aker, NASSCO, Halter, the capable yards, you're not seeing as many tanker or large-scale ATB orders right now. Does it stand to reason that they're a bit more apt to get competitive on price? And I guess how should we think about pricing dynamics today relative to when you placed your initial order? Yeah. First of all, we certainly will put our project out to bid to get the most competitive pricing we can. I would note that these vessels are among the largest that they will be building. And pricing is really much more of a function of where engine and all the components are, where steel is, where their cost of labor is. So, where all that shakes out, is the idea that we're going to get a bargain. That's hard to know. We haven't seen pricing yet. But, we do expect that, as you pointed out in your question, there are windows opening up in all the yards we're talking to as a result of slots available in a lull in some of the tanker manufacturing or construction activity. Okay. All right. That's helpful. I guess as it pertains to that, I think you guys still have a pending application on the Title XI financing. I think it's actually just pending at your request. Is that tied to these initial options, or would that need to be reworked if you guys went with another yard or another spec? How would that work? Well, the pending application we have is for the first two ships. Okay. That's for the first two. Okay. So that would continue. That would change. If we do order a third and fourth ship, then what we could do is have a second application for those ships. Right and have two applications at the same time. Okay. Mike, this is Matt. I would also point out that you may know that we have, in some cases, used Title XI. In other cases, we find more competitive pricing outside of the Title XI program, given our credit profile. We certainly are going to be looking very closely at the Title XI application. It is very attractive, but we're also equally looking at other sources of long-term debt to finance this project. Fair enough. I guess as it pertains to the competitive dynamics in the space, I think we've talked a lot about the different fleet configurations in the new entrant and I guess the larger competitor as a result of the M&A from two years ago. Are you seeing more competition for yard slots? Do you think there's a possibility that you could see one of your competitors place a large order to kind of put a more serious threat into your kind of primary market share? Are you talking about in the Jones Act trades, Mike? Yeah. Or, Yeah, I'm talking about Jones Act container tonnage or potentially, I guess Yeah ro-ro too, but some sort of combo or container tonnage. Yeah. What I can say is that, in Alaska, TOTE has relatively modern vessels that they're in the process of re-engining, or at least in planning to have re-engined. Again, those are modern, capable ro-ro vessels that I believe are going to continue to suit their needs into the foreseeable future. In the Hawaii trade, we know with regard to the dynamics there, that Pasha, as part of its acquisition of the Hawaii assets, purchased four older steamships that face the same deadline of 2020 for modification that ours do. Whether they choose to modify those older platforms or invest in new tonnage is really up to them. They haven't made any announcements with that regard, but we do know that that's something that they face over the next few years. Right. In terms of looking at yard slots and things like that, you haven't noticed an uptick in competition for those slots? Any indication around that kind of dynamic? Well, we're confident that we'll be able to get within the yards that are capable of building a project our size. We're not worried about somebody. Got it. trumping us on that side. Okay. Just, I guess one for Joel, then Matt, I'll just come back for one more operating question. Around the buyback, I guess with some round numbers here, you guys, I think you said 777,000 shares have been bought back since, I want to say November, which is, I believe it was a three-year program, so you guys are a little bit ahead of pace, not tremendously. Just curious as to whether or not the current pace would continue, which would put you guys up to reauthorize at some point in a year or two, kind of before this would actually end. Whether or not when you think about just uses of cash and continuing to renew the fleet, does the idea of renewing that buyback or buying back at a pace kind of beyond the 3 million share allotment, how do you think about that from a liquidity perspective, I guess? Does that start to impact the way MARAD would look at you for financing or your banks would look at you? No, I don't think so. We're not worried about liquidity. We've got a great balance sheet overall, and the way we think about it is slow and steady over time, Mike. You're correct. 777,000 is since November. That is a little bit ahead of pace, but we think we'll be generally still on pace for the 3 million shares in three years. There might be little periods we're a little ahead of pace, a little behind pace, depending upon how things ebb and flow, but it shouldn't be dramatic, and the overall philosophy is slow and steady long-term. We're not going to comment beyond this authorization. This is an authorization we have for the 3 million shares, and no comment beyond that. Overall philosophy will be one of slow and steady, measured over time, and we purposefully size all this and think about all this in the context of our balance sheet, where we're at today, and the investments we need to make in the future. We're still- Right confident in our overall balance. Maybe, yeah, and around the liquidity specifically, I guess what I'm getting is like MARAD financing, which you're not using, but you still have the application open for. It's just notoriously tricky, and just given your prior experience with that, successful experience with that, are you close to a point where you would actually have to think about that and relative to how they would look at the financing? It might not be an issue, I'm just curious, because I know it's notoriously difficult. It's not really an issue. If you look at our balance sheet today, we've got very little Title XI financing. We believe we've got very strong investment-grade metrics. We feel confident we can issue long-term unsecured debt in the private placement market. Sure. From a liquidity perspective, we've got strong support from our bank group. We've got over a $400 million unsecured bank revolver. Our banks would love us to borrow more money, and our long-term private placement partners would love us to borrow more money, all of that on unsecured basis. Got you. We feel good about our access to capital irrespective of the Title XI program and- Sure the peculiarities to closing Title XI deals. Okay. Just one more for Matt, and I'll turn it over. I think this has been kind of poked and prodded a number of different ways, but if I think about, obviously there's some tough comps coming up the next couple of quarters, but 2015 went just about as well for you guys as possibly could have. So it's not a horrible problem to have, all things considered. But if I think about that China expedited service, and Matt, I think in your prepared remarks, you mentioned about half being on spot and half being kind of longer-term business, and I can't recall if you put a one-year term on it or not. I'm just curious as to, are we going to be through any sort of legacy repricing by the end of 2016? I guess, would you be fully mark-to-market on that business for the softer environment by the middle of this year, end of this year? Or whether any of that would bleed into 2017? Yeah. So Mike, the traditional cycle for the annual contracting is typically May 1 to April 30. So the contracts we've just renewed at lower rates will extend through April 30 of 2017. Right. Of course, the NVOCC or the spot pricing gets reset every month, every week, every quarter, so at different frequencies. But for the annual contracting cycle, which is about half our business, it runs in that cycle. Right. Okay. Yeah, that is the way it works. If it is any, so you should be fully mark-to-market by that point. So there shouldn't be any legacy overhang in 2017 from previous business. Okay. Well, through April 30. Through April 30, that half the business in the annual contracting cycle will trail through April 30. Sure. Okay. Yep, I think that's all I've got. I appreciate the time, guys. Thanks. Sure. Thanks, Mike. Our next question comes from the line of Dan Natoli from Oppenheimer. Your line is now open. Hi, thanks for taking the question. Just in terms of getting back to the Alaska operation, I realize it was touched upon a bit. Do you have a projection, or maybe it doesn't have to be a point estimate, but an oil price range where you feel that business could reach its potential and be fully integrated? I think, Dan, when we did our due diligence on the acquisition, we looked at the correlation between the market oil price and the amount of cargo or containers in the entire market. What we found was that across a broad range of low and high prices, there was a very steady base of cargo that Horizon had developed. Again, it's the grocery store business. It's that which supports the population base. While clearly the lower energy prices is minimizing investment and is hurting the state's finances, what we find as important a correlation is the population of the state in terms of Horizon was never really involved in the specialty North Slope delivery and a lot of those projects, they were more of a supplier. What we find is the population base in the state is expected to remain relatively stable. That's kind of what we're seeing. It's a little muted, but no dramatic changes. The question about where energy prices need to go for the oil majors and others to make significant reinvestment in the economy, that could be a catalyst, I'm less familiar with. I'm sure it's got to be much more than in the '60s and '70s before it starts to become a catalyst again. I don't know that specific number. Great. Thank you. That was very helpful. Thank you. Thank you. Our next question comes from the line of Kevin Sterling from BB&T Capital Markets. Your line is now open. Thank you. I just had a follow-up question. Going back to the China service, Matt, those carriers that are introducing the expedited service, will their sailings be a little bit different than you guys? I imagine it might be, and is it going to be a little bit slower in their service offering, if you know? Yeah, I do, Kevin. What we have found, and not to pick on Hanjin. Hanjin is a great carrier. These are all reputable carriers. This is not a disparagement of anyone. But if I were to disparage Hanjin, I would say they're currently in receivership or in a form of bankruptcy, but I won't disparage any great carrier that we compete with. But when we looked at their specific service profile and their port pairs and their service, we find Matson services a day faster at origin. It's 1 to 1.5 days faster on the water, and probably 2 days faster on the marine terminal on the West Coast. So while they can advertise it's a day behind, the reality is that it's 4 days plus behind the Matson service. We also know all the carriers who advertise these fast services rarely achieve the pro formas that they advertise in comparison to Matson, who has a 10-year track record in our customers' minds of being able to deliver. So that's why when the question was asked earlier about how big of a deal is this over our lower year-over-year rates, we're not saying it's nothing. It is a part of the answer, but it is a smaller part of the answer, because at the end of the day, we don't think these services are going to be able to provide the kind of level of service that we've proven we can make. Got you. Okay. Well, thanks for letting me have a follow-up. I appreciate it. Sure, Kevin. Thanks. Our next question comes from the line of Jack Atkins from Stephens. Your line is now open. Hey, guys. Thanks. I had a couple quick follow-ups as well. First, Joel, when we think about the first quarter, were there any integration expenses or sort of one-time items that we should be thinking about there that may have negatively impacted profitability in the quarter? Yeah, Jack, as I mentioned earlier on the question on where is it, the Alaska integration, there is a little bit of additional cost as we wind down our final integration activity. It's not material. Okay. There is a little bit in there. That will run through some of the final IT projects through the August, September time frame is our current planning. Okay. When we think about the cadence of the ocean transportation operating income, we have the first quarter in the bag. You kind of gave us a pretty good idea what to think about for the second quarter, but that would imply a decent ramp in the 3Q and the 4Q. Is there anything we should be thinking about from a timing perspective that would explain that? I know there's some seasonality impact there, but can you help us think through the cadence of earnings as we move through the year? Yeah, Jack, I think you framed the question correctly. I think we gave you our best thinking on the second quarter. There's no reason to believe that the traditional third quarter being the strongest of the year, followed by the fourth quarter, with being slightly lower, falling back to our traditional second and third quarters being the best. That certainly was amplified a little bit by the Alaska acquisition, where in the summertime, that's when the tourism and construction activity peaks. So clearly, we think second and third quarter tends to be our strongest quarter traditionally. Okay. Matt, thank you very much for the time. Sure. Okay. Thanks, Jack. I am showing no further questions at this time. I would like to turn the call back to Matt Cox for any closing remarks. Okay. Well, thank you everyone for your participation today. We look forward to catching up with you on the next quarterly call. Aloha. Ladies and gentlemen, this does conclude the program, and you may all disconnect.