Matson Inc

NYSE:MATX

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to Matson's Third Quarter 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. [Operator Instructions]

I would now like to turn the call over to Lee Fishman. Please go ahead sir.

[Lee Fishman, Director of Investor Relations]

Thank you, Jenifer. 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 presentation and are more fully detailed under the caption Risk Factors on Pages 24 to 34 of our Form 10-Q filed on November 2, 2020, and in our subsequent filings with the SEC. Please also note that the date of this conference call is November 2, 2020, 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.

I will now turn the call over to Matt.

[Matt Cox, Chairman and Chief Executive Officer]

Thanks Lee and thanks for those on the call. I'm going to start with a quick recap of our third quarter results, so please turn to Slide 3. Matson's businesses continued to perform well, despite the ongoing challenges from the COVID-19 pandemic and related economic effects. Ocean transportation had a very strong quarter and was led primarily by our China service, which included a full quarter of the CLX+ service as well as year-over-year volume improvement in our regular CLX service as a result of increased capacity.

Volumes in Hawaii, Alaska and Guam improved from levels achieved in the second quarter as freight demand improved with the reopening of local economies. Volumes in Alaska and Guam were higher year-over-year and Hawaii volume approached the level in the third quarter of last year. And logistics had a good quarter as the continued reopening of the U.S. economy led to improved performance in all of business lines. In the fourth quarter, we expect our businesses to continue to perform well and to generate strong financial results.

Before moving on to our current priorities and the current trends we see in our business, I want to spend a few minutes on the CLX+ service and why we believe we can make it permanent. Please turn to Slide 4. There are three main reasons we're confident we can make the CLX+ service permanent. First, Matson has a 15 year track record of operating the industry leading expedited China to Long Beach service.

Our CLX service has demonstrated a best-in-class on time freight availability and through our relentless focus on reliability we've developed strong longstanding relationships with customers where service has been integral in their growth. Many of our long-term customers are riding on both the CLX and CLX+ given the outsized growth in their volumes, which they've experienced this year.

The introduction of the Alaska-to-Asia Express service, or AAX service, as the westbound seafood backhaul from Dutch Harbor to China is expected to help the long-term economics of the CLX+ service. And third, the demand and supply dynamics in the transpacific tradelane, which I'll go into in a moment, have been favorable and we expect those federal trends to continue.

So let me spend a few minutes on the key demand and supply factors in the tradelane. Since the start of the pandemic in the U.S. in early March, there's been a seismic shift in e-commerce activity, and we expect the key drivers behind the shift to remain for some time. It's estimated that at least four to six years worth of e-commerce sales growth was pulled forward into 2020. For the second quarter of 2020, the U.S. Commerce Department estimated that $1 out of five spent on retail was purchased online as both retailers and consumers adapted to the new environment.

With the ease for which an e-commerce transaction can take place and the time saved in the process, e-commerce growth is expected to remain robust even as COVID-19 restrictions become less stringent over time. And lastly, e-commerce wants and needs an expedited transit. Consumer spending on services such as travel and leisure shifted to home improvement, home appliances and electronics and other discretionary and non-discretionary items.

Early on in the pandemic, there was outsized demand for refrigerators and freezers to store perishable items and electronics to support the working from home experience. Demand for key household items, such as dishwashers, refrigerators, washers and dryers has been so strong since the pandemic hit, there are key shortages in many models and those shortages are expected to last into 2021.

And demand for household appliances continue to remain strong for three reasons: one, family sheltering in place, and many working from home are using their appliances more frequently and thereby reducing the replacement cycle time; two, the housing market has been and remains strong as many residents in cities opted to move out to more suburban and rural settings with increased turnover of homes comes an upgrade cycle in household appliances; and three, many homeowners have opted to improve their surroundings given the amount of time they're spending in their homes with do-it-yourself and professional home improvement projects.

As service businesses continued to reopen, we expect some consumer dollars to migrate back, but with consumers adapting to less spend on services, home ownership and relatively high demand and companies embracing the work from home environment as a part-time or full-time solution. We expect demand for home improvement appliances and other home electronics to remain elevated relative to pre-pandemic levels.

I briefly touched on this a moment ago on shortages in appliance, but a significant amount of inventory restocking across many industries is needed to keep pace with the elevated consumption trends and manage through any further disruptions. Inventories were depleted shortly after the pandemic hit, and companies have been playing catch up ever since. To avoid disruption this fall and winter from any COVID related lockdowns, manufacturers are moving quickly to ensure enough inventories is on hand and warehouses in the U.S.

Beyond the risk of further COVID disruptions, many manufacturers are expected to evolve their inventory management to increase inventory of fast moving items in the end markets where the consumption is likely the greatest. The pre-COVID just-in-time inventory managed model is giving way to a more resilient inventory model. Lastly, on demand, the end of this pandemic may be gradual and could potentially take several years until it ends.

There were many unknowns on the timing of the vaccine, whether herd immunity could be achieved and the distribution of the vaccine and the general response to a vaccine, the U.S. economy has rebounded sharply from the second quarter lockdown aided by government stimulus, but the recovery going forward is likely to be slow and may require further government support efforts to assist those businesses and individuals negatively impacted by the pandemic.

Consumption trends are likely to remain intact and possibly supported by government efforts during this unprecedented time until the vaccine is effective and distributed. So the demand picture remains favorable given current consumption trends, relatively low inventory levels and manufacturers trying to get ahead of the elevated demand and the possible need for further government support to aid individuals and businesses greatly impacted by the pandemic and to help the economy recover.

Please turn to Slide 5. On the supply side, the constraints in the transpacific air and ocean markets are expected to remain for some time. On the second quarter call, we discussed the dislocation in transpacific air freight markers due to the loss of passenger plane belly capacity. Although some transpacific passenger routes have been reinstated in the last few months, according to IATA global passenger plane belly space capacity, which is approximately 50% of the global air cargo capacity. It's unlikely to see pre-COVID levels until 2024.

Complicating the airfreight picture is the means by which a vaccine and related injection supplies will be handled and distributed. According to IATA, providing a single dose of the vaccine to $7.8 billion people would fill 8,747 cargo airlifts at a time when freighter utilization is already operating at a high level. DHL recently noted that delivering 10 billion doses over the next two years would require 25,000 flights about 2,000 pallet and container moves and 15 million cooler boxes. This is an enormous logistical effort that will strain the air cargo resources further.

Turning to capacity of the ocean transportation market, there are a couple of points I want to make regarding capacity. One, several transpacific ocean carriers have fully deployed capacity in the tradelanes in recent months to manage the elevated import volumes. And the order book for new container ships is at its lowest level since 2003, due to a number of factors, including global economic uncertainty. So at least in the short to medium-term, the ability for ocean carriers to add additional capacity in the tradelane is limited. And two, industry consolidation in the last decade and the formation of alliances in the last three years should lead to better alignment of capacity to avoid over tonnaging the markets.

10 years ago, there were 21 international ocean carriers and today there were 12. The three alliances that most of the remaining 12 operate in control approximately 85% of the capacity across the transpacific. Today, it's much easier for these alliances to balance market demand by adding small increments of capacity across their constituencies. And lastly, on the supply fundamentals, there were significant equipment demand and port congestion in the U.S. West Coast. These two factors are an incredibly important governor on the growth capacity in the tradelane, particularly during the peak volume periods, such as the one we're experiencing now.

As container volume ramped in the second and third quarters of this year to meet the elevated consumer demand, demand for containers and chassis was exceptionally high. Many inbound containers were being trucked and sent on rail to the interior without paying a return trip, thereby expanding a supply of available containers. The increase in intermodal volume led to congestion at the rail yards in Southern California, and also led to delays in the delivery and return of equipment.

Warehouses on the West coast were taking on more and more volume, given the demand with many containers sitting on chassis in the warehouse slots. In the ports with increased volume comes increased time to offload and increased turn times at the terminals. This has also had an impact on the availability of equipment. It's also led to berthing delays of vessels. According to the Pacific Merchant Shipping Association, the PMSA, in September 2020, 21.2% of the containers at the ports of LA and Long Beach stayed on the terminals for five or more days before getting picked up. In September 2019, it was 2.8%.

Every ocean carrier is undertaking a massive effort to reposition containers to Asia to meet the elevated demands. We don't expect the equipment demand and the port congestion factors to change in the near future. So the supply side trends are quite favorable given the capacity constraints in the ocean and air freight markets as well as the outsized demand for equipment and the issues that come from increased volume and congestion at the West coast ports. Our CLX+ service has proven to be the second best service in the transpacific tradelane behind our CLX service. Both services rely on the same competitive advantages at the destination end.

We own and control our own chassis. This is an important differentiator for us, given the terminal congestion and equipment availability challenges in Southern California that I just described. We avoid the issues with chassis pools that our competitors rely on. And by providing the chassis ourselves, we help the truckers to save time and money. We also have a great combination of SSA Terminal operation and the Shippers Transport off-dock facility. SSAT is the best terminal operator on the West coast, which are efficient operations. And the Shippers Transport facility is a unique off-dock bonded facility that is difficult to replicate.

Taken together our competitive advantages and destination services drive industry leading turn times and provide next day cargo availability for our customers that is simply unrivaled. We also avoid the congestion issues that other carriers face during these peak periods. In summary, I am confident we can make the CLX+ permanent. We have 15 years of experience operating an expedited service in the tradelane, offering unparalleled destination services that our customers' value. Our customers' businesses are growing to meet the challenge of this time and so are we.

We seek opportunities to improve the long-term economics of the service, the AAX service is one such opportunity that not only helps lower the breakeven economics, but also drives additional customer engagement on a new service offering. And we have the backdrop of favorable demand and supply fundamentals that are unlikely to dissipate anytime soon.

Our expedited ocean services and air freight are perfectly suited for the demands of an increasing e-commerce world, but given the constraints in the air cargo markets we expect demand for our expedited service to remain elevated. With all this said a number of demand and supply factors could change that they alter our views, but as we sit here today, this is how we see it in our planning for into 2021.

I will now move on to Slide 6. I want to spend a few moments on our current priorities as we continue to navigate our way through this pandemic and period of economic uncertainty. Our first priority, we continue to safeguard the health and safety of our employees throughout the organization, guided by the processes on PPE disinfecting and social distancing put forth by the coastguard, CDC and other government agencies. We're also maintaining our position and working from home for those whose job functions allow them to do so.

Our second priority is ensuring the consistency of our ocean transportation services and delivering exceptional service for our and Matson logistics customers. Within ocean transportation, we're focused on maintaining our best-in-class on time performance, ensuring quick turn times at the terminals and providing the quickest cargo availability for our customers. For our logistics customers, we continue to provide the highest quality customer service and execution for our customers as the supply and demand conditions remain volatile.

Our third priority is to find new opportunities in this evolving pandemic environment and drive organic growth. The organic opportunities tend to be low risk and high investment returns given the low capital outlay. On our second quarter call, went into greater detail on one such opportunity the CLX+ services, which is a key contributor to our year-over-year improvement and financial results. In August, we announced the introduction of the AAX service that is a backhaul service on the CLX+ from Alaska-to-China.

Our fourth priority is maintaining costs and – excuse me. Our fourth priority is maintaining cost and capital discipline during this period of economic uncertainty. Since we amended our debt agreements in the early days of the pandemic in March, we've been intently focused on free cash flow generation and reducing leverage. And I'm happy to say that our leverage under those amended debt agreements is now approximately 2.4 times versus 3.4 times at the end of the first quarter. Since the end of 2019, we've reduced our total debt by nearly $135 million. On our first quarter earnings call, we outlined the operational changes and management initiatives to address the challenges of the pandemic. We meaningfully exceeded the high end of the $40 million to $50 million range that we provided with the introduction of the CLX+ as the largest contributor to this effort.

With respect to capital expenditures, we continue to be selective in our investments. We are investing in new equipment to support the China service and AAX, which is approximately $30 million as well as some equipment that we've leased to support these efforts. We're also completing our committed capital projects that are coming to an end this quarter; namely: the first phase of the Sand Island terminal renovation and the last new vessel in the Hawaii service which are the next few priorities, which I'll discuss.

The final vessel and the four-vessel new build program for the Hawaii service is expected to be delivered at the end of this quarter. Matsonia's arrival will mark the end of a major achievement for us, and is nearly $930 million program that will have taken eight years to complete from the design stages through delivery. We're coming to an end of the work on the first phase of the Sand Island terminal in Honolulu. We completed the last major items in this space earlier this quarter, and we'll begin to wrap-up the smaller items by the end of this year.

We expect to begin work on the second phase in 2021. We have indicated before that we expected trend on our maintenance CapEx level of between $50 million to $60 million per annum following the completion of the Hawaii new build program. As I noted a few moments ago, we're investing approximately $30 million in new equipment to support the growth of our China service at AAX to maximize the opportunities for us. So we expect to be higher than the maintenance levels in 2021 in light of this equipment investment.

And our last current priority is to complete the scrubber program, which means which remains on track. The last vessel in the sixth vessel program is currently in dry dock and is expected to be back in service early next year. I will now go through the third quarter performance and provide commentary on current business trends.

Please turn to Slide 7. Hawaii container volume for the third quarter decreased 0.8% year-over-year and the westbound container market declined modestly year-over-year. The westbound container market benefited from the reopening of the local economy, following the shelter in place and temporary retail store closures in the second quarter. And it also benefited from government stimulus efforts, but these benefits were outweighed by the continued negative impact from the state's COVID-19 mitigation efforts, including the restrictions on tourism and the second shelter in place that took effect in August. The second shelter in place had a modest negative impact on volume in September. Lastly, we did not carry any major volume during the quarter.

I will now go through the current business trends in our Hawaii service. So please turn to Slide 8. The Hawaii economy remains in a significant downturn challenged by the near zero tourism in the last half year. Travel restrictions to Hawaii were eased on October 15th with the pre-travel testing program. However, in the near-term the levels of tourism are expected to remain low and to have a meaningfully negative impact on Hawaii's economy. The economic recovery trajectory in Hawaii remains highly uncertain given the low levels of tourism. The difficult business environment for tourism related businesses and the uncertainty with government stimulus and support efforts for the businesses and individuals deeply impacted by the pandemic and its related economic effects.

UHEROs latest economic projection shows GDP growth in 2020 and 2021 of minus 11.8% and 1.2% respectively. Unemployment in the state remains elevated and is projected to be well above 2019 levels for the next several years. September unemployment rate for the state was 15.1%, the highest in the country and UHERO is projecting the unemployment rate for 2020 and 2021 to be 12.4% and 9.7% respectively. These levels are well above the 2009 unemployment rate of approximately 2.7%. To give you a sense of the volume trend one-month into the fourth quarter, our westbound container volume in October decreased, approximately 0.3% year-over-year and was consistent week-to-week in the month. The westbound volume largely consistent assessments, home improvement and retail goods in advance of the holiday season.

Moving to our China service on Slide 9. Matson's volume in the third quarter 2020 was 124.7% higher year-over-year, approximately 85% of the year-over-year volume increase was driven by the CLX+ with the remaining approximately 15% related to increase in volume on a regular CLX service. The capacity of the CLX service increased year-over-year due to the addition of one of our larger vessels, the Daniel K. Inouye at the beginning of the third quarter, in addition to its sister vessel the Kaimana Hila towards the end of the third quarter last year. We continue to see dislocation in the air freight markets lead to strong demand for Matson's expedited service with those CLX and CLX+ vessels sailing at capacity in the third quarter. Demand for the CLX and CLX+ was driven by e-commerce and other commodities as a result of tight inventories in the U.S. and continued consumption of imported goods in lieu of services.

To give you a sense of the current volume trend, our Eastbound container volume in October increased 148.6% year-over-year led by the CFX+ service, but also higher volume on CLX due to the Daniel K. Inouye in the service. The volume strength we saw in the third quarter continued through October. Throughout the month, we saw increasing customer demand to get on our CLX and CLX+ services as a means to avoid U.S. West Coast port congestion.

Please turn to Slide 10. On August 26, we announced the introduction of the Alaska-to-Asia express or AAX as a backhaul service on the CLX+. The first voyage took place on September 29th from Dutch Harbor. The AAX will serve as an important route for Alaska seafood exports to Asia consisting of dry and frozen fish volume. We will provide connecting service from Anchorage and Kodiak from our domestic Alaska service that is served by three vessels. We expect the AAX service to be a modest contributor to the Alaska volume and not a material contributor to consolidate operating income for the full year 2020. We're excited to provide this service for the upcoming fishing season in the beginning of 2021.

Turning to Slide 11. In Guam, Matson's container volume in the third quarter 2020 increased 2.1% year-over-year primarily due to increased demand for home improvement and government cargo. Volume in the quarter benefited from the reopening of the local economy, following the shelter in place in the second quarter, and it also benefited from government stimulus efforts. The local government issued a shelter – second shelter in place order in August to mitigate the spread of COVID-19, which had a minimal impact on our volume.

Similar in many respects to the Hawaii economy, the Guam economy is in a downturn as tourism levels remain depressed and tourism related business activity remains incredibly low. Unemployment remains elevated and well above pre-pandemic levels. The economic recovery trajectory remains highly uncertain. For the month of October, our westbound container volume decreased 1.5% year-over-year with modest negative impact from COVID-19 restrictions and partially offset by higher government cargo. In the near-term, we expect to see a stable retail environment, but we also expect tourism to remain challenged that COVID-19 and have a negative impact on freight demand.

Moving now to Slide 12. In Alaska, Matson's container volume for the third quarter of 2020 increased 1.5%, despite the summer's seafood season being in its off-season and our expectations for lower volumes, we saw higher southbound volumes year-over-year as a result of a stronger seafood volume compared to the prior year. This increase in southbound volume was partially offset by modestly lower northbound volume. Northbound volume in the quarter benefited from the reopening of the local economy following the shelter in place and temporary retails foreclosures in the second quarter.

And it's also benefited from government stimulus efforts, including the early issuance of the permanent fund dividend. The Alaska economy continues to recover from the second quarter lows, but the recovery trajectory remains highly uncertain. Unemployment remains elevated above pre-crisis levels. The Alaska government paid its permanent fund dividend early in July versus typically in October, which may impact customers spending in the fourth quarter. And the continued low oil price environment has negatively impacted and is expected to continually continue to negatively impact oil exploration and production. Northbound volume in October 2020 increased 12.1% year-over-year driven primarily by higher volume of assessments goods and home improvement in advance of the holiday and winter period.

Turn next to Slide 13. Our terminal joint venture SSAT contributed $7.7 million in the third quarter of 2020 compared to $8.4 million in the prior year period. The lower contribution was primarily a result of lower lift volume. SSATs lift volume was impacted by blank sailings from the larger ocean carriers in the first half of the quarter and was close to flat year-over-year in September. Deployed capacity and the transpacific trade lane is higher than last year to manage through the elevated demand during this peak season. We expect SSAT to be a beneficiary through the elevated import volumes.

Putting that on logistics on Slide 14. Operating income in the third quarter came in at $11.9 million or $600,000 higher than the operating results in a year-ago period. The increase was primarily due to improve performance in all of the business lines driven by the continued reopening of the U.S. economy. In the near-term, we expect the elevated consumption of e-commerce and other high demand goods and inventory restocking trends to could benefit most of the business lines. Within transportation brokerage we continue to see increasing intermodal volumes in line with the trends in the U.S. West Coast in-port volume with increased freight demand and terminal congestion in Southern California comes rail congestion and a chaotic truck conditions, which historically has benefited our transportation brokerage business. That's been Alaska; our freight forwarding business performance steadily improved since the second quarter low and is tracking similarly with the northbound volume trends in our Alaska ocean business. We continue to see steady business activity and warehousing and supply chain services in line with what we've seen in the first three quarters of the year.

And with that, I will turn the call over to Joel for a review of our financial performance. Joel?

[Joel Wine]

Okay. Thanks, Matt.

Now on to our third quarter financial results on Slide 15. Ocean transportation operating income for the third quarter increased $42.6 million year-over-year to $86.5 million. The increase was primarily due to a higher contribution from the China service, including CLF+. Lower vessel operating costs, including the impact of one last vessel operating in the Hawaii service and the timing of fuel related charges – surcharge collections. Partially offset by lower contribution from the Hawaii service and higher general and administrative expenses. The company's SSAT terminal joint venture investment contributed $7.7 million or $0.7 million less than the prior year period. The decrease was primarily due to lower lift volume.

Logistics operating income for the quarter was $11.9 million or $0.6 million higher than the prior year period. The increase was due primarily to a higher contribution from transportation brokerage. EBITDA for the quarter increased $45.6 million year-over-year to $134.7 million due to a higher consolidated operating income of $43.2 million and higher other income of $2.9 million partially offset by $0.5 million and lower depreciation and amortization, which includes dry dock amortization. Interest expense for the quarter was $5.7 million or $2.5 million lower than the second quarter of 2020. Lastly, the effective tax rate in the quarter was 25.4%.

On a year-to-date basis ocean transportation operating income increased $63.7 million year-over-year to $136.7 million. The increase was primarily due to a higher contribution from the China service including CLX plots and lower vessel operating costs, including the impact of one last vessel operating in the Hawaii service partially offset by lower contribution from the Hawaii service. The company's SSAT terminal joint venture investment contributed $15.4 million or $2.4 million less than the prior year period. The decrease was largely attributable to lower lift volume. Logistics operating income on a year-to-date basis was $25.9 million or $4.8 million lower than the prior year period. The decrease is primarily was due primarily to lower contributions from transportation brokerage and freight forwarding.

Slide 16 shows how we allocated our trailing 12 months of cash flow generation. For the LTM period we generated cash flow from operations of $339.2 million and received $14.3 million from sale leasebacks from which we use $59.4 million retired debt, $80 million on maintenance CapEx, $168.2 million on new vessel CapEx including capitalized interest and owners items, and $21.9 million on other cash outflows including $18.5 million in financing costs related to the two Title XI transactions, and amendments to the debt agreements in the first half of 2020 while returning $38.6 million to shareholders via dividends.

Turning to Slide 17, for summary of our balance sheet. You'll note that our total debt at the end of the quarter was $823.6 million and our total debt net of cash and cash equivalents was $810.9 million. During the quarter we retired $66.4 million of debt. At the end of the third quarter, our leverage ratio per the amended debt agreements with 2.4 times compared to 3.03 times at the end of the second quarter. Footnote 4 on this page shows the total debt and EBITDA as defined in the amended debt agreements. Revolver balance at quarter end was $123 million and our available borrowings was approximately $519 million.

Please turn to the next slide. On Slide 18 to review of our new vessel payments for the third quarter, we had new vessel cash capital expenditures of $39.3 million and capitalize interest of $2 million for total capitalized vessel construction expenditures of $41.3 million. The table on the right-hand side of the slide shows the cumulative and remaining new vessel progress payments as of September 30th. Our final payment on Matsonia will be due upon delivery and as Matt said, we expect the vessel to be delivered by the end of the quarter. The picture on this slide is of Matsonia on her way to see trials from the NASSCO shipyard in San Diego and Matsonia is currently 99% complete.

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

[Matt Cox, Chairman and Chief Executive Officer]

Thanks, Joel.

There's been no shortage of uncertainty in 2020 for us, but Matson and its employees adapted to the extraordinary conditions and fostered organic growth opportunities to drive exceptional financial results in the third quarter. I'm proud of our accomplishments year-to-date, but we are heads down to finish-off a good year and prepare for 2021 and the evolving challenges during this unprecedented time. As key supply chain provider to lifeline economies and a leading provider of expedited ocean services to the U.S. West Coast, we're focused on what we do best providing exceptional customer service and on-time delivery to meet our customer's needs.

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

[Operator]

[Operator Instructions] Your first question comes from the line of Jack Atkins [Stephens Inc.] Jack, your line is open.

[Jack Atkins, Stephens Inc.]

Okay. Great. Thank you operator and guys congratulations on another great quarter here.

[Matt Cox, Chairman and Chief Executive Officer]

Thanks, Jack.

[Jack Atkins, Stephens Inc.]

So I guess maybe just looking at star with the outlook, you know, I noticed that this quarter you guys sort of didn't provide your normal line item guidance, and I certainly understand given all the uncertainty out there right now, it's just tough, tough to predict. I guess I was just sort of curious if, if we could maybe talk about some high level directional trends sequentially, typically we see earnings, let's talk about the ocean transportation segment, down anywhere between 30% and 50% from an operating income perspective sequentially it's just sounds like volume is actually ramping sequentially for you guys though. So can you kind of help us think about how we should be thinking about normal seasonality and how the business is going to be trending third quarter and fourth quarter?

[Matt Cox, Chairman and Chief Executive Officer]

Yes. Jack, I'll do the best I can. It's difficult to forecast in this environment. We've had conversations with our customers and they're doing as best they can to meet this demand that they're seeing throughout their networks. And it's really, again, I would say some of the things we're seeing in our Jones Act end markets, and what we're seeing in Matson logistics, what frankly, including China is the very strong demand we're seeing in the U.S. associated with the items that we discussed in the call around the work from home experience, inventory stocking, the benefits of stimulus and all of the factors that are making it creating this very robust freight demand environment.

We are pleased that we have seen the improvement that we've seen in Hawaii and Guam and Alaska. And it's hard to know, we might've predicted or we might've guessed earlier in the year, let's say in March and April that we would not have seen the levels of demand that we've ended up seeing. And again, I think it's a combination of the same factors. It's a stimulus spending, we tend to provide essentials. There have been and the those are just some of the factors that go into it. So beyond that, how long Jack this remains is partly a question of macroeconomics. Is there going to be a second stimulus? Is the U.S. economy in recovery?

What's the – how will the pandemic progress? What's the election cycle look like? When is the vaccine available? So again, it's difficult for us to know what's happened. I would comment that some of our normal seasonality, it's just really hard to tell where we go from here, but we're pleased to be in a position where we're able to serve our end markets. I'm really proud of the fact that we were able to be there and stand-up our second expedited China string. But a lot of our end markets are performing better than we would have expected in March or April. So that's all I can really say, Jack without being too specific because we ourselves aren't quite sure where the economy is going from here.

[Jack Atkins, Stephens Inc.]

No. No. That I understand. I just wanted to kind of get your additional thoughts on that Matt. So that's helpful. Thank you. Maybe just a couple of other ones for me, off the items that you guys undertook this year to support and improved financial results, you said you're well ahead of the $40 million to $50 million initial expectation, obviously because of the wild success of CLX+. But we think about that, that $40 million to $50 million number going into next year. How much of that is tied to cost that you guys have maybe taken out temporarily that would maybe get better back in next year? Can you kind of maybe quantify that for us as we think about 2021?

[Joel Wine]

Hey, Jack its Joel. I'll take that one. So as we said in our last call, it's a mixed bag. There are a number of cost initiatives and some revenue initiatives. The biggest revenue initiative is of course the CLX+. So we've talked – we've talked at length about how we see the supply demand elements there and that continuing into 2021. The remaining cost items, it's really, we can't get a lot of guidance on it, because it really depends upon each market. And when volumes come back and a lot of those markets where we have to reintroduce some additional costs, it really around – typically around our terminals and the gate hours and our hours of operation, where as you have more cargo flying through, you reintroduce some of those costs. So it will be a function of the volumes returning in a lot of those Jones Act markets. This is the way to think about it.

[Jack Atkins, Stephens Inc.]

Okay. But, but Joel, with volume kind of back to flat in Hawaii, it looks like growth again in Guam and Micronesia and Alaska, I mean, would you say that those costs has kind of come – are back into the model now or no?

[Matt Cox, Chairman and Chief Executive Officer]

Some of them have, but not all of them. So it depends on the different submarkets within each of those markets. And so some of those have come back, but a lot of those have not yet. So – and then actually, I will just say Jack there will be some piece of that that will be permanent. And some of that will be permanent.

[Jack Atkins, Stephens Inc.]

Sure.

[Matt Cox, Chairman and Chief Executive Officer]

But a lot of it, more than half of the remainder that's not revenue will be dependent upon volumes in those markets.

[Jack Atkins, Stephens Inc.]

Okay. That's helpful. Maybe one last one and I'll turn it over. Just kind of thinking about the logistics segment for a moment, obviously a lot of dislocation in the domestic supply chain as well on the surface based side. I guess you guys did a really great job just in terms of maintaining your operating margin there this quarter. We didn't – we saw others not do nearly as well. How are you guys thinking about the logistics business as we head into 2021, where you should get some relief on the revenue margin side and obviously underlying demand trends and pricing trends are obviously pretty positive?

[Matt Cox, Chairman and Chief Executive Officer]

Yes. I think that the way I would answer that is first of all our logistics businesses, all of them are performing well. And as the President of our logistics business, Rusty Rolfe says that logistics business tends to thrive in chaos. And so there's been a lot of dislocation. We're a small, nimble organization. We've responded well to those markets, and if we are in the beginning of a grinding and slow economic recovery, we expect – we're not going to give guidance, but we expect the good performance to continue. But again, I think it's more subject to where the U.S. economy is in macro. But if there is more congestion on the rails, if there's more congestion at ports and terminals, the better off we do.

[Jack Atkins, Stephens Inc.]

Okay. That makes sense. Thanks again for the time guys. Congratulations.

[Matt Cox, Chairman and Chief Executive Officer]

Thanks, Jeff.

[Operator]

Your next question comes from the line of Ben Nolan [Stifel]. Ben, your line is open.

[Ben Nolan, Stifel]

Thank you, operator. Good quarter guys. I want to start a little bit and you, Matt it's been a whole lot of time and it was very helpful about thinking through the permanency or permanence of the CLX+ service and sort of how things are different now this time. But I wanted to maybe see if there's a tie-in here between some of the chaos that's happening and congestion issues and everything else in the West Coast. Are you being able to leverage your expedited service to maybe win more long-term business or alternatively have you seen any expansion in the premium that you get? Is there – if people are grappling for spots, is there anything you're doing this sort of leverage that that position at all?

[Matt Cox, Chairman and Chief Executive Officer]

Yes. I mean, from our perspective, having been at this for 15 years, we've developed a really good base of customers who have – who as their businesses expanded, we've been able to accommodate that growth. And so the way I see the market today then is that obviously we're seeing some very busy hectic congestion on the U.S. West Coast. There's a lack of empty equipment, not matching but in the market, there's a lack of chassis, there's shortages of labor, there's disruption of rails is as very [indiscernible]. That part of it is temporary. And I can't say when that will end it. It may end in two weeks; it may not end until after Luna New Year, really hard to know where that part ends. But we're not relying on any of that cargo to impact our belief on the continuity of our CLX+ service.

A lot of our thinking around CLX+ we outlined in and we went into quite a bit of detail, but among the more important factors, this is growth in e-commerce and the way in which cargo is being shifted and e-commerce wants an expedited transit and together with a more orderly container supply demand, the air freight, all of those things separate from the congestion we're seeing right now gives us confidence and not the least of which is to have identified and are in the execution stage of identifying a backhaul in the AAX to give us somewhat dual head-haul economics are all factors that give us that confidence that we described.

And we always look for balancing; leveraging the opportunities in the short run with making sure we're maintaining enduring customer relationships that go year in and year out. So there are some markets where we could charge a lot more and other markets – than other kinds of market, but I can just give you as a data point. We are turning away each week more cargo on our CLX and CLX+ service than we are carrying to give you a sense of the demand right now. And again, we don't expect that super high demand to continue, but we expect enough demand to continue to make this we think long-term of success.

[Ben Nolan, Stifel]

Okay. And I guess and that's what I would have expected. I guess, I was asking and maybe you've answered it a little bit. Is there a way to turn that leverage that you have with a really unique product into saying, okay, I'll fit you in here, but I want to know that I'm going to have 10 boxes a week from you for the next year or something like that, or is that just not part of the…

[Matt Cox, Chairman and Chief Executive Officer]

No, that conversation has been going on for 15 years where, well – everybody wants to get on the ship in the peak season, right, which customers can give us those containers every week, 52 weeks a year, right. So it is an ongoing element, so that we might, in peak season, forego the highest cargo, because people can give us cargo 40 weeks a year. And so, we're balancing the seasonal impact with the year round customer contribution. Yes, so that is just – that's a core part of how we approach the market and have for a long time.

[Ben Nolan, Stifel]

Okay, that's helpful. And then maybe for Joel or both of you, de-leveraging, I think, is happening a lot faster than any of us thought that it would. And you did walk through your capital allocation hierarchy and I appreciate that, but to the extent that let's hope and say that some of this elevated level of cash flow continues to be here for a little while, and you do delever really quickly. Are there things as you look out into the future, maybe capital projects or refleeting Alaska or anything else where you say, okay, well, we thought this was maybe five years away or something else, but now we're in a position where we can maybe pull that forward or is that not even necessary, you don't – the timeline is what the timeline is and it's not a function of capital.

[Joel Wine]

Yes, Ben, thanks for that question. So, I'd say, we do very much think long-term in everything that we do. So we do have a view of when we're going to need Alaska vessels and other major investments as well. And all that was really baked in to what we've been describing for the last couple of years and the overall plan of deleveraging when we're finished with this vessel cycle. So what we're going to continue to do is stick with that plan, because we did look at all those long-term needs if you put that client together.

It just still happens at the – that this is all happening in this very uncertain time of the pandemic where we've seen some businesses opportunities to really expand for us. So the deleveraging has definitely accelerated because of this performance, but it hasn't changed our view that we still stick with this plan and the capital allocation hierarchy is something that we feel very good about and it's very appropriate. So it looks for us – continue to focus on de-leveraging in any kind of organic growth or other types of investments. Ben, it's still going to be subject to our normal discipline that kind of return thresholds that we see. So we're really – the overall message is we're sticking with that plan.

[Ben Nolan, Stifel]

Okay, I appreciate Joel. And then last for me and I'll turn it over. Still I scratched my head at like the Hawaii volumes, given unemployment and everything else. And it's great for you guys, but how much of that and then particularly Hawaii, but maybe also Alaska. And Matt, you mentioned a little bit about stimulus and a perpetual payment in Alaska and so forth. How much of that do you think is – the cargo is stimulus specific or at least linked to stimulus that might be at risk if those payments don't continue. So are you at all concerned that there might be a little bit of a volume cliff at some point?

[Matt Cox, Chairman and Chief Executive Officer]

Yes, I mean, I said it all three of the Jones Act markets that this has come back faster than we expected. And I think in part it's the same package on the U.S. Mainland, right. I mean, there's demand for work from home and home improvement and getting money into the hands of the unemployed and the PPP loans keeping small businesses afloat. And all of the really timely federal government response to the pandemic has all helped. What we've remained cautious because our point is it's unclear what's going to happen next, are we – or is the delivery of the vaccine going to bridge and additional stimulus bridge us into a lasting recovery will there be an air pocket in any of our trades, those all are really hard to forecast.

And so, again, we feel well. And the other thing – and there has been – a lot of our business is grocery store business, right. It's going to our long-time customers, who are selling the basics. And so, we know there is a certain floor level of demand that will continue. So it's better than we expected. And it's not crystal clear whether it continues, although we hope it will. That's why it's really difficult for us to talk about exactly what's going to happen. So it's as much about the macro as it is about any of our end markets in particular.

[Ben Nolan, Stifel]

All right. Now, I appreciate that Matt and Joel, and I appreciate the time and congrats again on a fantastic quarter. It looks like it's the second of a number, so good work.

[Matt Cox, Chairman and Chief Executive Officer]

Thanks, Ben.

[Operator]

Your next question comes from the line of Steve O'Hara [Sidoti & Company]. Steve, your line is open.

[Steve O'Hara, Sidoti & Company]

Thanks. Thanks for taking the question. Good afternoon.

[Matt Cox, Chairman and Chief Executive Officer]

Hi, Steve.

[Steve O'Hara, Sidoti & Company]

Hi. I guess first just on the – talk about confidence in CLX+ being a longer term initiative. Does that mean that you were kind of in the process of taking maybe a longer term capacity acquisition or anything like that? I think you'd chartered capacity in that market, but have those charters going out in time more than maybe previously?

[Matt Cox, Chairman and Chief Executive Officer]

Yes, so Steve, we're six chartered vessels in the service. We don't envision purchasing any vessels. We continue to think the best way to address this market is chartering. And you may know that for example, the international ocean carriers charter or operated about 50% of their capacity is chartered. So it's a normal way in which an operator would have a portfolio of owned and chartered assets. So it feels normal to us to have that combination. We expect that to continue. Our confidence going into 2021 and make CLX a permanent service will – as these charters expire, we will be renewing them.

And so that – in due course I don't think we're going to do a five-year charter or whatever, but these will be rolled over on kind of six, 12 month terms and those will be negotiations with the charter owners as we go, but we're definitely keeping our feet on the ground here. We have a lot of confidence in them. We're confident we're going to be able to charter vessels to be able to continue to service and we'll be to sort of balancing the renewals with the owner's intentions there, like it's hard to be real specific about it.

[Steve O'Hara, Sidoti & Company]

Okay. That's helpful. And then maybe is there a way to think about pricing within CLX and CLX+ in terms of maybe where rates are versus previous time periods? And what the impact of this as maybe other methods of shipping come back over time? What that pricing looks like relative to what it is today?

[Matt Cox, Chairman and Chief Executive Officer]

Yes. I mean I can. I mean, our – and you know this Steve that our service commands are premium to the spot market and it has for a long time. And the same is true in this environment for both our CLX and CLX+ vessels as the fastest and second fastest service in the transpacific and owing to the fact that we have. We're turning away more part more than we're carrying. We can be selective in the cargo that we continue to carry and that commands a market premium.

And so I would say if you look at the SCFI, the Shanghai Containerized Freight Index, as one that it's had an all time high. And so, we're not giving specific rate guidance, but our rates are doing very well. And that's just as one market data point, the SCFI is at a record high, we command a premium to the spot market in half. So, we're feeling good about where we are on the pricing.

[Steve O'Hara, Sidoti & Company]

Okay. And then just on the comments, I guess, around October specifically within the China market. I mean, is that – with the way the peak season works and is there a kind of a fall off typically in November or December as kind of a peak season ends? Or is it usually kind of done by in October or I guess I'm just wondering if the expectation that may continue that very strong performance in October could continue for the entire quarter, or is it kind of typically stepped down. Would that be kind of the normal expectation that it will kind of step down from October to November to December?

[Matt Cox, Chairman and Chief Executive Officer]

Yes. I mean, I think, your point about is what happens typically that sort of by the end of October, you start to see things, most of what is going to make its way into the holiday season shopping cycle will have arrived. That's not what we're seeing. We're seeing significant congestion in Asia cargo that's just not matching, but cargo that wants to get on a ship that's being rolled, we're seeing the other international ocean carriers put in additional extra loaders. So this is not a typical season.

We're seeing a more extended season because there's such a demand for cargo. There are – many of our customers can't keep up with the demand and cargo was back ordered. And for all of those reasons, we're expecting to see the season extended to when is the big question. I mean, this could end in a few weeks and it could continue all the way into February in lunar New Year. Nobody really knows exactly how and when this ends. But at least through now, we're seeing very strong demand.

[Steve O'Hara, Sidoti & Company]

Okay. All right. Thank you very much for the time.

[Matt Cox, Chairman and Chief Executive Officer]

Okay, you bet Steve. Thanks.

[Operator]

[Operator Instructions] And there are no further questions at this time. I'll turn the call back over to Mr. Matt Cox.

[Matt Cox, Chairman and Chief Executive Officer]

Okay. Well, thanks for your interest in the call. I hope everyone has a safe holiday season, and we'll look forward to catching up with everyone at the yearend call. Thanks very much. Bye-bye.

[Operator]

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect.