Earnings Call: Q3 2015

Nov 4, 2015

Good day, ladies and gentlemen, and welcome to the Matson Third Quarter 2015 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 call over to Jerome Holland, Director of Investor Relations. Please begin. Thanks, Latoya. Aloha, and welcome to our third quarter 2015 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 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 in this conference call. These risk factors are described in our press release and are more fully detailed under the caption Risk Factors on pages 7 to 15 of our 2014 Form 10-K, filed on February 27, 2015, and in our subsequent filings with the SEC. Please also note that the date of this conference call is November 4, 2015, 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'll turn the call over to Matt. Thanks, Jerome. Aloha from Honolulu, and thanks to those joining us on the call today. Matson had a strong third quarter, highlighted by continued strength in our expedited China service, a full quarter contribution from our new Alaska business, volume improvements in Hawaii, and improved performances at both SSA Terminals and Logistics. As outlined last quarter, we incurred an additional $10 million of expenses related to the ongoing integration of our acquired Alaska operations, negatively impacting our earnings per share by $0.14. Our Alaska integration is progressing well, and we remain on track to achieve our earnings and cash flow targets within 2 years. Before moving on to discuss the quarter's results in more detail, I'm pleased to announce our board's authorization of a share repurchase program for up to 3 million common shares over the next 3 years. Joel will provide some additional color on this later in the call. Slide 4 shows our strong financial metrics for the third quarter. Consolidated net income was up $20 million, nearly double that of the third quarter 2014. We generated EBITDA of $100.8 million, up nearly 50% year-over-year, and earnings per share for the quarter was $0.94, up 88% year-over-year. Similar to last quarter, we highlighted the impact of the acquisition-related SG&A on our financial performance in the stacked bar graph data with red dotted lines. Turning to slide 5, you can see Matson's year-to-date financial metrics. We have shown the respective impacts of the acquisition-related SG&A and the molasses settlement on our year-to-date financial performance in the stacked bar graph data with dotted lines. Excluding the acquisition SG&A and molasses settlement costs, EBITDA would have been $260.6 million, an increase of over $100 million from 2014. Reported EPS was $1.74 per share, up 74% year-over-year. Excluding the acquisition SG&A cost and the molasses settlement, EPS would have been $2.20, more than double the prior year level. All in all, a very good nine-month result. Turning now to our individual service lines on slide 6. Our Hawaii service saw volume grow by 14.8% year-over-year, reflecting an improved market position as we deployed additional vessels in response to Pasha's service reconfiguration and a vessel mechanical failure they suffered. As a reminder, we had previously expected container ship capacity in Hawaii to increase this year with the launch of Pasha's new vessel, the Marjorie C. However, Pasha deployed its new vessel as a replacement for one of Horizon's older steamships, thereby negating the 5%-10% capacity growth we had previously expected. Looking ahead, we continue to believe that Hawaii is in a multi-year recovery and anticipate modest market growth in the fourth quarter. Further, we expect to have 11 ships deployed through the end of November, and as such, expect Hawaii container volume growth similar to the 14.8% growth realized in the third quarter of 2015. On slide 7, our expedited China service drove strong results in the third quarter, achieving rates similar to those in the first half of 2015. The general market, as represented by the SCFI, was very poor and continued to decline with current SCFI rates 35%-45% lower year-over-year. Matson's service remained highly differentiated, providing a 5-to-10-day service advantage over the other international carriers. This advantage results from several factors, including our industry-leading transit time, efficient cargo offloading at our dedicated terminal in Long Beach, and superior on-time performance. The third quarter this year also included an additional sailing, which contributed to the 5.3% higher China volume on a year-over-year basis. For the fourth quarter, Matson's China service will face a more difficult year-over-year comparison. We expect our China rates to approximate the rates achieved during the fourth quarter of 2014. However, we expect volume to be moderately lower on a year-over-year basis. You may recall that in the fourth quarter last year, demand for our expedited service was amplified by cargo availability delays experienced by other ocean carriers associated with port congestion on the U.S. West Coast. In addition, we will have one fewer sailing in the fourth quarter this year, and more recently, we have noticed a softening of demand in the China market. In this environment, we will continue to focus on maintaining our 5- to 10-day service differential and premium yield. On Slide 8, Guam container volume in the third quarter was in line with the prior year as economic activity remained stable. However, there have been also a couple of meaningful recent developments in Guam. First, at the end of August, the Department of the Navy signed the record of decision for relocating U.S. Marines to Guam. This relocation will see approximately 5,000 Marines plus 1,300 of their dependents moved to Guam around 2022 and will represent an estimated investment of approximately $8 billion. This project is expected to begin in 2017 with the infrastructure needed to support the relocation. While the announced relocation is smaller and more spread out than previously announced, we view this as a long-term positive for Guam container volume. Second, in early October 2015, a competitor announced its intention to launch a biweekly U.S.-flagged container ship service to Guam starting in late November 2015, which is expected to be 10 days slower and less frequent than Matson's weekly service. Despite this inferior service, it is our view that some Guam customers will be interested in supporting a second carrier, and therefore, we do expect to experience some competitive losses after this service is launched. Turning to our Alaska service on Slide 9, this was the first full quarter of operating results. Alaska container volume increased by approximately 2% year-over-year due to stronger seafood volume that was partially offset by the muted economic activity related to the steep decline in energy prices and lower building supply volume. During this quarter, we also made several investments to improve our services and capabilities in Alaska, including a new 65-ton gantry crane that replaced one half its size at the Kodiak terminal, new ground equipment, and a fleet of new dry and insulated containers. While the muted economic activity in Alaska seems likely to persist, I am pleased that our integration efforts continue to go well. From a volume standpoint, we do expect fourth quarter volume this year to be lower than the level achieved by Horizon in the fourth quarter 2014. Turning now to Slide 10, SSAT contributed $4.5 million to our third quarter ocean transportation operating income, compared to a $3.1 million contribution in 2014. This year-over-year increase can be attributed to improved lift volumes. For the fourth quarter of 2015, we expect profit at SSAT to exceed the fourth quarter 2014 level, as SSAT is well-positioned in Long Beach and Oakland for increased lift volumes from major international carrier customers. Slide 11 highlights the results of logistics. Operating income increased by half a million dollars during the third quarter 2015 compared with the third quarter 2014, primarily due to warehouse operating improvements and improved per-unit margin, partially offset by lower international intermodal volume. As we look to the remainder of 2015, we expect logistics operating income to approximate 2014 levels. I'll now turn the call over to Joel for a review of our financial performance and consolidated outlook for the fourth quarter of 2015. Joel? Thanks, Matt. As shown on Slide 12, ocean transportation operating income increased to $26.3 million during the third quarter 2015 compared with the third quarter of 2014. The increase was primarily due to the higher freight rates in China, the inclusion of operating results for the Alaska trade, and Hawaii volume improvements. However, these favorable items were partially offset by additional SG&A related to our ongoing integration of the Alaska operations, incremental vessel operating expenses related to the deployment of additional vessels in Hawaii, and higher terminal handling expenses associated with greater volumes. In the stacked bar graph on the left, you can see that excluding the largely non-recurring incremental acquisition SG&A, ocean transportation operating income would've been $78.9 million, which represents a year-over-year increase of over 85%. On the right-hand side of the page, logistics operating income increased by $500,000 in the third quarter 2015 compared with 2014 for the reasons mentioned by Matt. The next slide shows our year-to-date results. For the nine months ending September 30, 2015, Ocean Transportation operating income increased to $59.4 million over the prior year period. The increase was primarily due to higher freight rates in China, the inclusion of operating results for the Alaska trade, the timing of fuel surcharge collections, container volume improvements in Hawaii, and improved results at SSA Terminals. Partially offsetting these favorable operating income items were additional SG&A expenses related to the acquisition, higher vessel operating expenses related to the deployment of additional vessels in the Hawaii trade, higher terminal handling expenses, molasses settlement costs, and lower Guam container volume. Absent the acquisition-related incremental SG&A and the molasses settlement costs, Ocean Transportation operating income for the nine months of 2015 would have more than doubled to $179.1 million. Logistics posted operating income results of $6.2 million for the first nine months of the year, compared to $5.8 million in 2014. The increase was primarily due to warehouse operating improvements and improved per-unit margins, partially offset by the absence of a favorable litigation settlement received in 2014 and lower international intermodal volume. On Slide 14, looking at our condensed income statement, total revenue increased by 23.2% on a year-over-year basis, due primarily to the inclusion of the Alaska trade lane and despite a considerable decline in our fuel surcharge revenues. On the expense side, our SG&A was higher due primarily to the acquisition. Also of note, our consolidated operating margin for the quarter increased 300 basis points to 13.2% from 10.2% last year. For interest expense and taxes for the fourth quarter of this year, we now expect interest expense to be approximately $5 million and the effective tax rate to be approximately 40%. With this strong performance, our balance sheet continues to be in very good shape. Turning to slide 15, you will note that our total debt at the end of the quarter was $481.5 million, and our net debt-to-EBITDA ratio was only 1.5 times. On October 1st this year, we closed the previously announced $75 million private placement of 30-year senior unsecured notes bearing interest at 3.92%, using the proceeds to pay down our revolver. Slide 16 shows a summary of our cash sources and uses over the last 12 months. The key takeaway from this slide is that our net additional borrowings over this period were just over $100 million, and that includes the $495 million of total cash needed to close the acquisition while also funding over $60 million of CapEx and dividends. This low level of borrowed funds required to finance the $495 million acquisition is a testament to the strength of our internally generated cash flow from operations performance. In addition, as Matt mentioned earlier, and as summarized on slide 17, we announced the authorization of a share repurchase program today for up to 3 million common shares over the next three years, representing about 7% of our current shares outstanding. We view share repurchases as an important capital efficiency tool to use, and we expect our repurchases to occur at a relatively steady, measured pace over the three-year authorization period. As we have said before, our focus remains on cash flow generation and creating long-term shareholder value, and this share repurchase program 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. With that, now let me turn to slide 18 to provide our specific updated outlook for the fourth quarter 2015, which is being provided relative to 2014 operating income and is exclusive of the approximate $7.5 million of acquisition-related SG&A in excess of our incremental run rate expected in the fourth quarter. For Ocean Transportation, we are increasing our operating income outlook for the fourth quarter to approximate the $46.3 million achieved during the fourth quarter of 2014, as we expect the first two year-over-year positive items listed on this page of higher Hawaii volumes and the inclusion of the Alaska trade lane to mostly be offset by, firstly, a decline in China volumes resulting from the recent market softness we are seeing in that business, which Matt mentioned earlier. Secondly, the timing of fuel surcharge collections in Hawaii, which was a strong favorable item in the fourth quarter last year that we do not expect to repeat in the fourth quarter of this year. For Logistics, we continue to expect full year 2015 operating income to approximate the 2014 level. For CapEx in the fourth quarter, we expect to spend approximately $30 million on maintenance CapEx and make an additional $20.9 million of scheduled construction progress payments on our new Aloha Class vessels. I will now turn the call back over to Matt. Thanks, Joel. In summary, we had a good third quarter this year, and looking ahead, we are encouraged by the strength of our core Hawaii operations, where we expect to benefit from continued market growth and a stronger market position. In Alaska, while low energy prices are creating near-term economic headwinds, I am pleased with our integration progress, and I feel like we are hitting our marks as we move towards our targeted $70 million EBITDA run rate within two years of closing. In China, we are starting to lap the very strong results achieved in late 2014, when the U.S. West Coast port congestion reached peak levels. So while we remain very pleased with the overall contribution of this service, we will have some tougher year-over-year comparisons. In Guam, while the U.S. Marine relocation provides a longer-term positive for the container demand, we do expect some impact from the competitor entering the trade in late November 2015. Overall, I continue to be very confident in the strong cash flow generated from Matson's core businesses that, combined with our balance sheet, will provide ample capacity to fund our fleet renewal program, pay down debt, and consider growth investments while continuing to return capital to shareholders. With that, I will turn the call back to the operator and ask for your questions. Thank you. Ladies and gentlemen, if you have a question at this time, please press the star then 1 key on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue, you may press the pound key. Once again, if you do have a question, please press star then 1. The first question is from Jack Atkins of Stephens. Your line is open. Great. Guys, congratulations on an excellent third quarter, and thanks for taking my questions. Sure, Jack. I guess just to start off with, could we maybe touch on Hawaii? Clearly, some interesting things happening in that market as it relates to your business there. Could you talk about your current fleet deployment? You said you are in an 11-ship deployment. What utilization are you guys currently seeing on your assets there? And how would you expect that deployment to change, if at all, as you move through the fourth quarter? Sure, Jack. I will tackle that question. Basically, the Hawaii market, we have seen, as we noted, an increase in demand for our services. Immediately prior to the close, you may recall we were in a 9-ship deployment. We were 95-plus percent utilization. The additional volume that we received associated with Pasha's deployment changes, those that you may recall involved them no longer calling the Northwest, choosing an indirect service from Oakland, but adding more capacity to the Southern California market, a second call, caused net improvements in our volume levels. We then moved to a 10-ship deployment, and then as a result of a mechanical failure of one of the Pasha vessels, we deployed an 11th vessel. The 11th vessel is in operation. We do expect, before the end of the year, to revert back to a 10-ship deployment. Our overall utilization has been, if you look at the entire fleet right now at the 11th ship, probably in the low 90% utilization. We do expect it to be higher than that once we put the 11th vessel away and revert back to a 10-ship core deployment. Okay. That's really helpful, Matt. Thank you for that. Joel, on the integration expenses, $10 million this quarter, stepping down a little bit into the fourth quarter. How would you expect those integration expenses to trend as you look out several quarters beyond the fourth quarter? Do you expect it to take a step down once you finish the fourth quarter until the integration is complete? Or how should we think about those costs lingering for the next, call it, 12 months or so until you get the acquisition completed? Yeah, Jack. We definitely think they'll continue to decline. We're not commenting now on our 2016 outlook, so I'm not going to be any more specific other than we expect them to continue to decline on a quarterly basis. Okay. Could you maybe just for a moment talk about what exactly those expenses are? Just remind us what comprises that $10 million. Sure. It is really three main categories. The first two are people related, and that is additional headcount while we spend time integrating and move that business over to our systems. We have additional headcount during that period of time. The second piece is severance as we wind down operations in some of the previous locations of Horizon, we have severance expenses. The third is professional service and consultants to help us along the way. So that is the majority of the incremental cost. Okay. Last question, I will turn it over. You all mentioned a softening in demand coming out of China. I think that is the first time I have heard you guys talk about that in a while. Could you maybe speak to what is driving that? Is this more of a macro situation or is this something related to maybe specific customers of yours? Yeah, Jack, this is Matt. I will take a crack at that. I think you will note that we called it out third of the three conditions under which we are seeing lower China volumes. The first being the one fewer sailing, the second being the absolutely unbelievably strong demand in the fourth quarter of last year associated with all the frustrated cargo around the labor disruptions of last year. But it was notable that we did see a little bit of softness. In talking with our customers, we hear them ramping up for the busy period as they get into the pre-Lunar New Year period. Everything seems to be fine. We do expect our ships to be filling up as we get closer to the end of the year and then, of course, up through the very busy time of Lunar New Year. In some cases, customers had commented that they had shipped early this year, and in other cases, they were seeing a slackening of demand, but there was no specific thing, nor do we expect this weakness to continue. But it was notable given how full our ships have been historically. When we say there was a lull, our vessels are right now in the 90% utilization, so not a dramatic falloff, but something that was relatively new to us. Okay. Thanks again for the time, guys. Sure. Thanks, Jack. Thank you. The next question is from Kevin Sterling of BB&T Capital Markets. Your line is open. Aloha, gentlemen. It is actually William Horner on for Kevin. Hi, William. Hey. Matt, maybe sticking with the China commentary for a second. I know you just touched on you're facing tougher comps, and that things are still pretty well-utilized. I guess in talking with your customers, would you classify this as just kind of maybe some seasonal weakness, and not really any sort of major shift in the market or demand for your services? Yeah, I would say that's how we're interpreting our customer comments. There's no specific thing people are putting a finger on. Clearly, the macro Transpacific environment is miserable. Carriers, the rates are as low or approaching the lows since they began tracking the Shanghai Containerized Freight Index. Amid a pretty ugly backdrop, our container volumes remain good, and we're not overly concerned about the long-term level of demand for our service. Okay. That's fair. Just stick on that for a second. In terms of the rate environment, obviously, I know you can't get too granular with the premium you're getting, but when we look at your spot business, which is about 50% of what you do for China, and we look against the market rates in the Transpacific, I would assume that you're a little more insulated from the week-to-week volatility that we see in the underlying indices and rates. Am I thinking about that in the right way? Obviously, you're not fully insulated, but I would think that your rates would not be as kind of wildly swinging as the Transpacific. Yeah. That is correct, William. We do, as you pointed out, about half our business is under annual contract that runs from May 1 to April 30. Those freight rates are not moving. On the spot side, we continue to command a significant premium, but we are not immune to the overall rates. While we are enjoying a significant premium relative to the market, we do see some impact to those spot rates. The overall effect of that allows us to moderate these very significant market cycles that the other international ocean carriers experience. That is fair. That is a good color. Thanks, Matt. Sure. Switching gears and going back to Hawaii for a second. Obviously, you have got the 10th and the 11th vessel deployed temporarily at the moment. In terms of your outlook for Hawaii, are things maybe moving a little bit better or faster than you initially anticipated, or is it more a factor of just things beginning to materialize across the board from a competitive landscape and also just general growth and positivity in the market? I am just trying to get a better sense on looking at next year and how we should think about the Hawaii market in terms of the construction activity ramping up and things like that. Yeah. So we are definitely seeing a continuation of market growth. The overall market is growing, we think in the 2%-3% range. We see that we continue to be in a good part of the cycle. We see it as sustainable. There is a significant amount of construction activity that we think is going to continue. We will talk more about 2016 when we get to our year-end earnings call, but we continue to feel good about that the market is growing on a 2%-3% clip. Because of the changing competitive landscape, obviously there has been an increase in demand as well related to our services and, of course, have the reserve vessels to deploy when market changes require them to do that, and that is one of Matson's core strengths, and it has allowed us to flex up and flex down as the market demand changes over time. Those are both factors in our increase in demand. Okay. Thanks, Matt. One more, then I will turn it over. Obviously, the construction cycle has been a theme for the past couple of quarters and seems to be accelerating. Can you remind us how much of your container volumes are currently comprised of building materials and where this is relative to the recent peak? Yeah. Yeah. Oh, go ahead, Joel. Right now we are about 7%, William, and the previous peak was the high teens, around 18% or so, and that would have been 10 years ago in 2005. Okay. So still a lot of room to go as it unfolds. Yeah. And those are percentages of the volume at that time. So 7% now and 18% then. Okay. That's helpful, Joel. Thanks, and congrats on a good quarter, guys. Sure. Thank you. Thanks, William. Thank you. As a reminder, if you do have a question, please press the star then one key on your touchtone telephone. The next question is from Steve O'Hara of Sidoti & Company. Your line is open. Hi, good afternoon. Hi, Steve. Hey, I was wondering if there was a way to kind of quantify the, I don't want to say the benefit, but the impact from having an additional ship and maybe some things that are most likely going to reverse themselves, which is maybe Pasha's shipping out of service and having to kind of, I think, charter a ship from you guys. Is there a way to kind of tease that out from whatever the impact was from the service changes they had other than that? Steve, it's difficult. I can provide some color to it, but I would say that clearly we saw an increase in volume associated with the service changes and as a result of the mechanical failure. You'll recall that we do have reserve ships. Those ships are our least efficient ships, and so when we deploy them, there is additional volume, but the cost and fuel costs and other things are disproportionately higher, which eats into the margin on additional volume we're carrying. Just exactly where the volume settles out associated with those specifically related to the mechanical failure versus the deployment changes, we may have a better view of that at year-end, but it's going to be somewhere in between, is our thinking, but we really can't be much more specific than that. We'll watch it play out over time. Okay, thank you. Just on maybe the margins for Q4 and going forward. I think in the past you'd said that Alaska had more, I guess, was more peaky than Hawaii in that, the margins in the, let's say, the winter periods or Q1 and Q4 weren't as strong, maybe a little bit more in terms of the way they ramp versus the Hawaii business. Could you just talk about maybe the way you see margins maybe in Q4, and then maybe how you view the long-term operating margin for the ocean transportation business? Thank you. Thanks, Steven. You are touching upon seasonality there with Alaska, and we have commented that it is a more seasonal business than our Hawaii business. The weakest quarter tends to be the first quarter, and the second weakest quarter is the fourth quarter. Then you have a stronger second and third quarter than you do on a relative basis to Hawaii. The conclusion of that ought to be, we talked about our annual EBITDA of $70 million. More than half of that $70 million would come in Q2 and Q3, and quite a bit less than half would come in Q4 and Q1. The same would be true, that is EBITDA, the same would be true on an operating income margin basis relative to our ocean transportation business without Alaska. The second point we made is that this business will have a higher general margin through the course of 12 months because it is an attractive platform acquisition that we are able to put on top of our corporate overhead systems and functions. Therefore, all in all, it is going to have a little bit higher marginal contribution than the rest of our businesses because of that leverage of our SG&A corporate expense. Now, we have not said anything about what that is from a quantitative perspective, but we have generally talked about our ocean transportation margins in the 10%-12% range, kind of through the cycle. This will help that with this Alaska acquisition for the reason I just mentioned. Does that answer your question? Yeah, that helps. Thank you very much. Okay. Thanks, Steven. Thank you. There are no further questions in queue at this time. I will turn the call back over to Matt Cox for closing remarks. Okay. Well, thanks for being on the call today. We look forward to catching up with you at our year-end call. Aloha. Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.