Item 1.
Business
Background
Horizon Lines, Inc., a Delaware corporation, (the “Company” and together with its subsidiaries, “we”) operates as a holding company for Horizon Lines, LLC (“Horizon Lines”), a Delaware limited liability company and wholly-owned subsidiary, Horizon Logistics Holdings, LLC (“Horizon Logistics”), a Delaware limited liability company and wholly-owned subsidiary, Horizon Lines of Puerto Rico, Inc. (“HLPR”), a Delaware corporation and wholly-owned subsidiary, and Hawaii Stevedores, Inc., a Hawaii corporation (“HSI”).
Our long operating history dates back to 1956, when Sea-Land Service, Inc. (“Sea-Land”) pioneered the marine container shipping industry and established our business. In 1958 we introduced container shipping to the Puerto Rico market, and in 1964 we pioneered container shipping in Alaska with the first year-round scheduled vessel service. In 1987, we began providing container shipping services between the U.S. west coast and Hawaii and Guam through our acquisition from an existing carrier of all of its vessels and certain other assets that were already serving that market. In December 1999, CSX Corporation, the former parent of Sea-Land Domestic Shipping, LLC (“SLDS”), sold the international marine container operations of Sea-Land to the A.P. Møller Maersk Group (“Maersk”) and SLDS continued to be owned and operated by CSX Corporation as CSX Lines, LLC. On February 27, 2003, Horizon Lines Holding Corp. (“HLHC”) (which at the time was indirectly majority-owned by Carlyle-Horizon Partners, L.P.) acquired from CSX Corporation, 84.5% of CSX Lines, LLC, and 100% of CSX Lines of Puerto Rico, Inc., which together with Horizon Logistics and HSI constitute our business today. CSX Lines, LLC is now known as Horizon Lines, LLC and CSX Lines of Puerto Rico, Inc. is now known as Horizon Lines of Puerto Rico, Inc. The Company was formed as an acquisition vehicle to acquire, on July 7, 2004, the equity interest in HLHC. The Company was formed at the direction of Castle Harlan Partners IV. L.P. (“CHP IV”), a private equity investment fund managed by Castle Harlan, Inc. (“Castle Harlan”). In 2005, the Company completed its initial public offering. Subsequent to the initial public offering, the Company completed three secondary offerings, including a secondary offering (pursuant to a shelf registration) whereby CHP IV and other affiliated private equity investment funds managed by Castle Harlan divested their ownership in the Company. Today, as the only Jones Act vessel operator with one integrated organization serving Alaska, Hawaii and Puerto Rico, we are uniquely positioned to serve customers requiring shipping and logistics services in more than one of these markets.
Operations
The Company’s services can be classified into two principal businesses, Horizon Lines and Horizon Logistics. Horizon Lines operates as a Jones Act container shipping business with primary service to ports within the continental United States, Puerto Rico, Alaska, Hawaii, and Guam. Horizon Lines also offers terminal services at certain ports. Horizon Logistics provides integrated logistics service offerings, including rail, trucking, warehousing, distribution, expedited logistics, and non-vessel operating common carrier (“NVOCC”) operations.
For financial information with respect to our business segments, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations,” and Note 6 to our Consolidated Financial Statements. Item 7 and Note 6 contain information about sales and profits for each segment, and Note 6 contains information about each segment’s assets.
Horizon Lines
Overview
We believe that we are the nation’s leading Jones Act container shipping and integrated logistics company, accounting for approximately 37% of total U.S. marine container shipments from the continental U.S. to Alaska, Puerto Rico and Hawaii, constituting the three non-contiguous Jones Act markets; and to Guam, the U.S. Virgin Islands and Micronesia. We own or lease 20 vessels, 15 of which are fully qualified Jones Act vessels, and approximately 18,500 cargo containers. We also provide comprehensive shipping and sophisticated logistics services in our markets. We have access to terminal facilities in each of our ports, operating our terminals in Alaska, Hawaii, and Puerto Rico and contracting for terminal services in the seven ports in the continental U.S. and in the ports in Guam, Yantian and Xiamen, China and Kaohsiung, Taiwan.
We ship a wide spectrum of consumer and industrial items used every day in our markets, ranging from foodstuffs (refrigerated and non-refrigerated) to household goods and auto parts to building materials and various materials used in manufacturing. Many of these cargos are consumer goods vital to the populations in our markets, thereby providing us with a relatively stable base of demand for our shipping and logistics services. We have many long-standing customer relationships with large consumer and industrial products companies, such as Costco Wholesale Corporation, Johnson & Johnson, Lowe’s Companies, Inc., Safeway, Inc., Toyota Motor Corporation and Wal-Mart Stores, Inc. We also serve several agencies of the U.S. government, including the Department of Defense and the U.S. Postal Service. Our customer base is broad and diversified, with our top ten customers accounting for approximately 35% of revenue and our largest customer accounting for approximately 8% of revenue.
The Jones Act
During 2009, approximately 85% of our revenues were generated from our shipping and logistics services in markets where the marine trade is subject to the coastwise laws of the United States, also known as the Jones Act, or other U.S. maritime cabotage laws.
The Jones Act is a long-standing cornerstone of U.S. maritime policy. Under the Jones Act, all vessels transporting cargo between covered U.S. ports must, subject to limited exceptions, be built in the U.S., registered under the U.S. flag, manned by predominantly U.S. crews, and owned and operated by U.S.-organized companies that are controlled and 75% owned by U.S. citizens. U.S.-flagged vessels are generally required to be maintained at higher standards than foreign-flagged vessels and are supervised by, as well as subject to rigorous inspections by, or on behalf of the U.S. Coast Guard, which requires appropriate certifications and background checks of the crew members. Our trade routes between Alaska, Hawaii and Puerto Rico and the continental U.S. represent the three non-contiguous Jones Act markets. Vessels operating on these trade routes are required to be fully qualified Jones Act vessels. Other U.S. maritime laws require vessels operating on the trade routes between Guam, a U.S. territory, and U.S. ports to be U.S.-flagged and predominantly U.S.-crewed, but not U.S.-built.
Cabotage laws, which reserve the right to ship cargo between domestic ports to domestic vessels, are not unique to the United States; similar laws are common around the world and exist in over 50 countries. In general, all interstate and intrastate marine commerce within the U.S. falls under the Jones Act, which is a cabotage law. We believe the Jones Act enjoys broad support from President Obama and both major political parties in both houses of Congress. We believe that the ongoing war on terrorism has further solidified political support for the Jones Act, as a vital and dedicated U.S. merchant marine is a cornerstone for a strong homeland defense, as well as a critical source of trained U.S. mariners for wartime support.
Market Overview and Competition
The Jones Act distinguishes the U.S. domestic shipping market from international shipping markets. Given the limited number of existing Jones Act qualified vessels, the high capital investment and long delivery lead times associated with building a new containership in the U.S., the substantial investment required in infrastructure and the need to develop a broad base of customer relationships, the markets in which we operate have been less vulnerable to overcapacity and volatility than international shipping markets.
Although the U.S. container shipping industry is affected by general economic conditions, the industry does not tend to be as cyclical as other sectors within the shipping industry. Specifically, most of the cargos shipped via container vessels consist of a wide range of consumer and industrial items as well as military and postal loads. Since many of these types of cargos are consumer goods vital to the populations in our markets, they provide us with a stable base of demand for our shipping and logistics services.
The Jones Act markets are not as fragmented as international shipping markets. We are one of only two major container shipping operators currently serving the Alaska market, where we account for approximately 42% of total container loads traveling from the continental U.S. to Alaska. Horizon Lines and TOTE serve the Alaska market. We are also only one of two container shipping companies currently serving the Hawaii and Guam markets with an approximate 37% share of total domestic marine container shipments from the continental U.S. to these markets. This percentage reflects 36% and 49% shares of total domestic marine container shipments from the continental U.S. to Hawaii and Guam markets, respectively. Horizon Lines and Matson Navigation Co (“Matson”) serve the Hawaii and Guam market. In Puerto Rico, we are the largest provider of marine container shipping, accounting for approximately 34% of Puerto Rico’s total container loads from the continental U.S. The Puerto Rico market is currently served by two containership companies, Horizon Lines and Sea Star Lines (“Sea Star”). Sea Star is an independently operated company majority-owned by an affiliate of TOTE. Two barge operators, Crowley and Trailer Bridge, Inc., also currently serve this market.
The U.S. container shipping industry as a whole is experiencing rising customer expectations for real-time shipment status information and the on-time pick-up and delivery of cargo, as customers seek to optimize efficiency through greater management of the delivery process of their products. Commercial and governmental customers are increasingly requiring the tracking of the location and status of their shipments at all times and have developed a strong preference to retrieve information and communicate using the Internet. During 2008, we introduced the ReeferPlus ®
GPS container tracking and shipment monitoring solution for refrigerated ocean containers moving between the continental U.S. and Puerto Rico. This innovative solution is designed to improve the visibility and security of high-value perishable cargo requiring cold chain logistics; a term used to describe the maintenance of product temperature through the entire transport chain from packing to delivery. Key capabilities of ReeferPlus ®
GPS include GPS-enabled real-time container tracking; in-box sensors reporting temperature, atmosphere and security updates via the web; and remote monitoring and adjusting of reefer conditions with one computer click. During 2007, we established a fully-functional intermodal active radio frequency identification (“RFID”) solution providing customers in our Alaska trade real-time shipment visibility during all phases of transit. The active RFID-based real-time tracking system, when matched with Horizon’s industry-leading web-based event management system, offers shipment visibility and supply chain efficiencies by providing real-time detailed shipment information throughout the container’s transit from origin loading facility through to final destination. A broad range of domestic and foreign governmental agencies are also increasingly requiring access to shipping information in automated formats for customs oversight and security purposes.
To ensure on-time pick-up and delivery of cargo, shipping companies must maintain strict vessel schedules and efficient terminal operations for expediting the movement of containers in and out of terminal facilities. The departure and arrival of vessels on schedule is heavily influenced by both vessel maintenance standards (i.e., minimizing mechanical breakdowns) and terminal operating discipline. Marine terminal gate and yard efficiency can be enhanced by efficient yard layout, high-quality information systems, and streamlined gate processes.
Vessel Fleet
Our management team adheres to an effective strategy for the maintenance of our vessels. Early in our 52-year operating history, when we pioneered Jones Act container shipping, we recognized the vital importance of maintaining our valuable Jones Act qualified vessels. Our on-shore vessel management team carefully manages all of our ongoing regular maintenance and dry-docking activity.
We maintain our vessels according to our own strict maintenance procedures, which meet or exceed U.S. government requirements. All of our vessels are regulated pursuant to rigorous standards promulgated by the U.S. Coast Guard and subject to periodic inspection and certification, for compliance with these standards, by the American Bureau of Shipping, on behalf of the U.S. Coast Guard. Our procedures protect and preserve our fleet to the highest standards in our industry and enable us to preserve the usefulness of our ships. During each of the last four years, our vessels have been in operational condition, ready to sail, over 99% of the time when they were required to be ready to sail.
The table below lists our vessel fleet, which is the largest containership fleet within the Jones Act markets, as of December 20, 2009. Our vessel fleet consists of 20 vessels of varying classes and specifications, 15 of which are fully Jones Act qualified. Of the 16 vessels that are actively deployed, 11 are Jones Act qualified. Three Jones Act qualified vessels are spare vessels available for seasonal and dry-dock needs and to respond to potential new revenue opportunities. A fourth spare Jones Act qualified vessel could be available for deployment after undergoing dry-docking for inspection and maintenance.
(1)
Twenty-foot equivalent unit, or TEU, is a standard measure of cargo volume correlated to the volume of a standard 20-foot dry cargo container.
(2)
Reefer capacity, or refrigerated container capacity, refers to the total number of 40-foot equivalent units, or FEUs, which the vessel can hold. The FEU is a standard measure of refrigerated cargo volume correlated to the volume of a standard 40-foot reefer, or refrigerated cargo container.
(3)
Serves as a spare vessel available for deployment in any of our markets and seasonal operation in the Alaska trade from June through August.
(4)
Vessels are available for seasonal needs, dry-dock relief and to respond to potential new revenue opportunities, and thus are not specific to any given market. Horizon Hawaii must undergo inspection and maintenance (dry-docking) in order to be available for deployment. Given current economic conditions, and if the new revenue opportunities fail to materialize we may make a decision to scrap one of more of the spare vessels.
Vessel Charters
Eight of our vessels, the Horizon Anchorage, Horizon Tacoma, Horizon Kodiak, Horizon Hunter, Horizon Hawk, Horizon Eagle, Horizon Falcon and Horizon Tiger are leased, or chartered. The charters for the Horizon Anchorage, Horizon Tacoma, and Horizon Kodiak are due to expire in January 2015, for the Horizon Hunter in 2018 and for the Horizon Hawk, Horizon Eagle, Horizon Falcon and Horizon Tiger in 2019. Under the charter for each chartered vessel, we generally have the following options in connection with the expiration of the charter: (i) purchase the vessel for its fair market value, (ii) extend the charter for an agreed upon period of time at a fair market value charter rate or, (iii) return the vessel to its owner.
The obligations under the existing charters for the Horizon Anchorage, Horizon Tacoma and Horizon Kodiak are guaranteed by our former parent, CSX Corporation, and certain of its affiliates. In turn, certain of our subsidiaries are parties to the Amended and Restated Guarantee and Indemnity Agreement, referred to herein as the GIA, with CSX Corporation and certain of its affiliates, pursuant to which these subsidiaries have agreed to indemnify these CSX entities if any of them should be called upon by any owner of the chartered vessels to make payments to such owner under the guarantees referred to above.
Container Fleet
As summarized in the table below, our container fleet as of December 20, 2009 consists of owned and leased containers of different types and sizes. All of our container leases are operating leases.
Maersk Arrangements
In connection with the sale of the international marine container operations of Sea-Land by our former parent, CSX Corporation, to Maersk, in December 1999, our predecessor, CSX Lines, LLC and certain of its subsidiaries entered into a number of commercial agreements with various Maersk entities that encompass terminal services, equipment sharing, sales agency services, trucking services, cargo space charters, and transportation services. These agreements, which were most recently renewed and amended in December 2006, generally are now scheduled to expire at the end of 2010. Maersk is our terminal service provider in the continental U.S., at our ports in Elizabeth, New Jersey, Jacksonville, Florida, Houston, Texas, Los Angeles, California, and Tacoma, Washington. We are Maersk’s terminal operator in Hawaii, Guam, Alaska and Puerto Rico. We share containers with Maersk and also pool chassis and generator sets with Maersk. We are Maersk’s sales agent in Alaska and Puerto Rico, and Maersk serves as our sales agent in Canada. On the U.S. west coast, we provide trucking services for Maersk.
Under our cargo space charter and transportation service agreements with Maersk, we currently operate five foreign-built, U.S.-flagged vessels that sail from the U.S. west coast to Hawaii, continuing from Hawaii to Guam, and then from Guam to Yantian and Xiamen, China, and Kaohsiung, Taiwan, with a return trip to Los Angeles and Oakland, California. We utilize Maersk containers to carry a portion of our cargo westbound to Hawaii and Guam, where the contents of the containers are unloaded. We ship the empty Maersk containers to the three ports in Asia. When the vessels arrive in
Asia, Maersk unloads the empty containers and replaces them with loaded containers for the return trip to the U.S. west coast. We achieve significantly greater vessel capacity utilization and revenue on this route as a result of this arrangement. We do not transport any domestic cargo between the U.S. mainland and Hawaii on these vessels. We do carry some international cargo to and from Hawaii for Maersk. We also use Maersk equipment on our service to Hawaii from our U.S. west coast ports, as well as from select U.S. inland locations.
Capital Construction Fund
The Merchant Marine Act, 1936, as amended, permits the limited deferral of U.S. federal income taxes on earnings from eligible U.S.-built and U.S.-flagged vessels and U.S.-built containers if the earnings are deposited into a Capital Construction Fund (“CCF”), pursuant to an agreement with the U.S. Maritime Administration, (“MARAD”). Any amounts deposited in a CCF can be withdrawn and used for the acquisition, construction or reconstruction of U.S.-built and U.S.-flagged vessels or U.S.-built containers.
Horizon Lines has a CCF agreement with MARAD under which it occasionally deposits earnings attributable to the operation of its Jones Act qualified vessels into the CCF and makes withdrawals of funds from the CCF to acquire U.S.-built and U.S.-flagged vessels. From 2003-2005, Horizon Lines utilized CCF deposits totaling $50.4 million to acquire six U.S.-built and U.S.-flagged vessels (Horizon Enterprise, Horizon Pacific, Horizon Hawaii, Horizon Fairbanks, Horizon Navigator, and Horizon Trader).
Any amounts deposited in a CCF cannot be withdrawn for other than the qualified purposes specified in the CCF agreement. Any nonqualified withdrawals are subject to federal income tax at the highest marginal rate. In addition, such tax is subject to an interest charge based upon the number of years the funds have been on deposit. If Horizon Lines’ CCF agreement was terminated, funds then on deposit in the CCF would be treated as nonqualified withdrawals for that taxable year. In addition, if a vessel built, acquired, or reconstructed with CCF funds is operated in a nonqualified operation, the owner must repay a proportionate amount of the tax benefits as liquidated damages. These restrictions apply (i) for 20 years after delivery in the case of vessels built with CCF funds, (ii) ten years in the case of vessels reconstructed or acquired with CCF funds more than one year after delivery from the shipyard, and (iii) ten years after the first expenditure of CCF funds in the case of vessels in regard to which qualified withdrawals from the CCF fund have been made to pay existing indebtedness (five years if the vessels are more than 15 years old on the date the withdrawal is made). In addition, the sale or mortgage of a vessel acquired with CCF funds requires MARAD’s approval. Our consolidated balance sheets at December 20, 2009 and December 21, 2008 include liabilities of approximately $14.2 million and $12.9 million, respectively, for deferred taxes on deposits in our CCF.
Horizon Logistics
Horizon Logistics offers integrated logistics services through relationships with affiliated and third-party truckers, railroads, and worldwide ocean carriers. Horizon Logistics was formed in 2007 from the merger of our existing logistics operations and the acquisition of Aero Logistics, a U.S. third-party logistics provider specializing in expedited delivery and special projects. Horizon Logistics’ operations rely substantially on independent contractors to fulfill the transportation services for most of its shipments.
Horizon Logistics service offerings are divided into the following categories:
•
truck brokerage, offering less-than-truckload and full-truck-load services utilizing trucks owned by our affiliate, Sea-Logix, and a nationwide network of vans, flatbeds and drop-deck trailers;
•
non-vessel operating common carrier, offering small to medium sized shippers a single source solution for ocean shipping worldwide;
•
rail, providing a cost-effective alternative for less time sensitive delivery requirements;
•
warehouse and distribution, consisting of centralized storage and other value-added distribution services including pick and pack, and
•
expedited logistics, consisting of unique and expedited point-to-point service for customers with extremely time sensitive delivery requirements.
Horizon Logistics operates a warehouse and cross-dock facility in Compton, California to offer integrated inbound and export logistics services to manufacturers and retailers. The 176,000 square-foot distribution center is located 10 miles from the Los Angeles/Long Beach ports with connections to rail and road infrastructure within the Alameda Corridor. Horizon Logistics is using the facility to offer an integrated distribution solution, including a port drayage service using Sea-Logix-owned and leased Clean Truck and Transportation Worker Identification Credential (“TWIC”) compliant fleet; air freight forwarding; rapid transload for international import and export logistics; intermodal transportation management; value-added distribution services; and long-term storage as required by customers.
Market Overview and Competition
The worldwide transportation and logistics market is an integral part of the global economy. According to Armstrong & Associates, an independent research firm, gross revenue for third-party logistics in the United States has grown from approximately $34.0 billion in 1997 to approximately $127.0 billion in 2008. The global logistics industry consists of companies, large and small, that provide supply chain management, freight forwarding, distribution, warehousing and customs brokerage services. As business requirements for efficient and cost-effective logistics services have increased, so has the importance and complexity of effectively managing freight transportation. Businesses increasingly strive to minimize inventory levels, perform manufacturing and assembly operations in the lowest cost locations, and distribute their products in numerous global markets. As a result, companies are increasingly looking to third-party logistics providers to help them execute their supply chain strategies.
Competition within the freight forwarding, logistics and supply chain management industry is intense, and is expected to remain so. We compete with large international firms that have worldwide capabilities to provide all of the services that we offer. We also face competition from smaller regional and local logistics providers, integrated transportation companies that operate their own aircraft, cargo sales agents and brokers, surface freight forwarders, ocean carriers, airlines, associations of shippers organized to consolidate their members’ shipments to obtain lower freight rates, and internet-based freight exchanges. In addition, computer information and consulting firms, which traditionally have operated outside of the supply chain management industry, are now expanding their scope of services to include supply chain related activities as a means of serving the logistics needs of their existing and potential customers.
Sales and Marketing
We manage a sales and marketing team of 113 employees strategically located in our various ports, as well as in five regional offices across the continental U.S., including from our headquarters in Charlotte, North Carolina and from Compton, California. Senior sales and marketing professionals are responsible for developing sales and marketing strategies and are closely involved in servicing our largest customers. All pricing activities are also coordinated from Charlotte and from Renton, Washington, enabling us to manage our customer relationships. The marketing team located in Charlotte is responsible for providing appropriate market intelligence and direction to the Puerto Rico sales organization. The marketing team located in Renton is responsible for providing appropriate market intelligence and direction to the members of the team who focus on the Hawaii, Guam and Alaska markets.
Our regional sales and marketing presence ensures close and direct interaction with customers on a daily basis. Many of our regional sales professionals have been servicing the same customers
for over ten years. We believe that we have the largest sales force of all container shipping and logistics companies active in our markets. Unlike our competitors, our sales force cross-sells our shipping and logistics services across all of these markets. We believe that the breadth and depth of our relationships with our customers is the principal driver of repeat business from our customers.
Customers
We serve a diverse base of long-standing, established customers consisting of many of the world’s largest consumer and industrial products companies. Such customers include Costco Wholesale Corporation, Johnson & Johnson, Lowe’s Companies, Inc., Safeway, Inc., Toyota Motor Corporation and Wal-Mart Stores, Inc. In addition, we serve several agencies of the U.S. government, including the Department of Defense and the U.S. Postal Service.
We believe that we are uniquely positioned to serve these and other large national customers due to our position as the only shipping and logistics company serving all three non-contiguous Jones Act markets and Guam and Asia. Approximately 55% of our transportation revenue in 2009 was derived from customers shipping with us in more than one of our markets and approximately 32% of our transportation revenue in 2009 was derived from customers shipping with us in all three markets.
We generate most of our revenue through customer contracts with specified rates and volumes, and with durations ranging from one to six years, providing stable revenue streams. The majority of our customer contracts contain provisions that allow us to implement fuel surcharges based on fluctuations in our fuel costs. In addition, our relationships with many of our customers extend far beyond the length of any given contract. For example, some of our customer relationships extend back over 40 years and our top ten customer relationships average 32 years.
We serve customers in numerous industries and carry a wide variety of cargos, mitigating our dependence upon any single customer or single type of cargo. For 2009, our top ten largest customers represented approximately 36% of transportation revenue, with the largest customer accounting for approximately 9% of transportation revenue. During 2009, our top ten largest customers comprised approximately 35% of total revenue, with our largest customer accounting for approximately 8% of total revenue. Total revenue includes transportation, non-transportation and other revenue.
Industry and market data used throughout this Form 10-K, including information relating to our relative position in the shipping and logistics industries are approximations based on the good faith estimates of our management. These estimates are generally based on internal surveys and sources, and other publicly available information, including local port information. Unless otherwise noted, financial data and industry and market data presented herein are for a period ending in December 2009.
Operations Overview
Our operations share corporate and administrative functions such as finance, information technology, human resources, legal, and sales and marketing. Centralized functions are performed primarily at our headquarters and at our operations center in Irving, Texas.
We book and monitor all of our shipping and logistics services with our customers through the Horizon Information Technology System (“HITS”). HITS, our proprietary ocean shipping and logistics information technology system, provides a platform to execute a shipping transaction from start to finish in a cost-effective, streamlined manner. HITS provides an extensive database of information relevant to the shipment of containerized cargo and captures all critical aspects of every shipment booked with us. In addition, HITS supports a wide variety of our logistics services including less-than-truckload (LTL), full truckload (FTL), NVOCC, air freight, expedited ground and warehousing. In a typical transaction, our customers go on-line to book a shipment or call, fax or e-mail our customer service department. Once applicable shipping information is input into the booking system,
a booking number is generated. The booking information then downloads into other systems used by our dispatch team, terminal personnel, vessel planners, documentation team, logistics team and other teams and personnel who work together to produce a seamless transaction for our customers.
Our dispatch team coordinates truck and/or rail shipping between inland locations and ports on intermodal bookings. We currently purchase rail services directly from the railroads involved through confidential transportation service contracts. Our terminal personnel schedule equipment availability for containers picked up at the port. Our vessel planners develop stowage plans and our documentation teams process the cargo bill. We review space availability and inform our other teams and personnel when additional bookings are needed and when bookings need to be changed or pushed to the next vessel. After containers arrive at the port of origin, they are loaded on board the vessel. Once the containers are loaded and are at sea, our destination terminal staff initiates their process of receiving and releasing containers to our customers. Customers accessing HITS via our internet portal have the option to receive e-mail alerts as specific events take place throughout this process. All of our customers have the option to call our customer service department or to access HITS via our internet portal, 24 hours a day, seven days a week, to track and trace shipments. Customers may also view their payment histories and make payments on-line.
Insurance
We maintain insurance policies to cover risks related to physical damage to our vessels and vessel equipment, other equipment (including containers, chassis, terminal equipment and trucks) and property, as well as with respect to third-party liabilities arising from the carriage of goods, the operation of vessels and shoreside equipment, and general liabilities which may arise through the course of our normal business operations. We also maintain workers compensation insurance, business interruption insurance, and directors’ and officers’ insurance providing indemnification for our directors, officers, and certain employees for some liabilities.
Security
Heightened awareness of maritime security needs, brought about by the events of September 11, 2001 and numerous maritime piracy attacks around the globe, have caused the United Nations through its International Maritime Organization (“IMO”), the U.S. Department of Homeland Security, through its Coast Guard, and the states and local ports to adopt a more stringent set of security procedures relating to the interface between port facilities and vessels. In addition, the U.S. Congress has enacted legislation requiring the implementation of Coast Guard approved vessel and facility security plans.
Certain aspects of our security plans require our investing in infrastructure upgrades to ensure compliance. We have applied in the past and will continue to apply going forward for federal grants to offset the incremental expense of these security investments. While we were successful through two early rounds of funding to secure substantial grants for specific security projects, the current grant award criteria favor the largest ports and stakeholder consortia applications, limiting the available funds for standalone private maritime industry stakeholders. In addition, the current administration is continuously reviewing the criteria for awarding such grants. Such changes could have a negative impact on our ability to win grant funding in the future. Security surcharges are evaluated regularly and we may at times incorporate these surcharges into the base transportation rates that we charge.
Employees
As of December 20, 2009, we had 1,895 employees, of which approximately 1,277 were represented by seven labor unions.
We completed a non-union workforce reduction initiative during the first quarter of 2009. The reduction in workforce impacted approximately 80 non-union employees and resulted in a $4.0 million restructuring charge. Of the $4.0 million, $3.2 million, or $0.11 per fully diluted share, was recorded during the fourth quarter of 2008 and the remaining $0.8 million was recorded during the first quarter
of 2009. Of the $0.8 million recorded during the first quarter of 2009, $0.7 million was included within the Horizon Lines segment and the remaining $35 thousand was included in the Horizon Logistics segment. In addition, during the quarter ended June 21, 2009, we recorded an additional $0.2 million of severance costs related to the elimination of certain positions in connection with the loss of a major customer and reorganization within the Horizon Logistics segment.
The table below sets forth the unions which represent our employees, the number of employees represented by these unions as of December 20, 2009 and the expiration dates of the related collective bargaining agreements:
(1)
Multi-employer arrangement representing workers in the industry, including workers who may perform services for us but are not our employees.
The table below provides a breakdown of headcount by non-contiguous Jones Act market and function for our non-union employees as of December 20, 2009.
(a)
Corporate headcount includes employees in both Charlotte, North Carolina (headquarters) and in Irving, Texas and other locations.
(b)
Administration headcount is comprised of back-office functions and also includes customer service and documentation.
Environmental Initiatives
We are committed to protecting the environment. We strive to support our commitment to protect the environment with programs that promote best practices in environmental stewardship. During 2008, we launched our Horizon Green initiative. Through our Horizon Green initiative, we strive to better understand and measure our impact on the environment, and to develop programs that
incorporate environmental stewardship and impact into our core operations. Within the Horizon Green initiative, we are addressing four key areas:
Marine Environment
To protect the marine environment, we have established several programs in addition to compliance with the MARPOL Convention (International Convention for the Prevention of Pollution from Ships) and ISM Code (International Safety Management Code) created by the IMO. These programs include vessel management controls and audits, ballast water management, waste stream analyses, low sulfur diesel fuel usage and marine terminal pollution mitigation plans.
Emissions
We strive to reduce transportation emissions, including carbon dioxide, particulates, nitrous oxides and sulfur dioxide, through improvements in vessel fuel consumption and truck efficiency combined with the use of alternative fuels and more efficient transportation alternatives, such as coastwise shipping.
Sustainability
We believe in a long-term, sustainable approach to logistics management which will benefit the Company, its associates, customers, shareholders and the community. Examples include reducing empty backhaul miles through logistics network optimization, reduced fossil fuel consumption and using recycled materials to build containers.
Carbon Offsets
Freight shipping is one of the world’s leading sources of carbon dioxide emissions that contribute to global climate change. To address this challenge together with our customers, Horizon Logistics has introduced a new carbon offset shipping program, developed by our custom delivery and special handling division. The carbon offset program offers customers a carbon-neutral shipping solution through which retailers and manufacturers can purchase environmental credits that fund carbon offset programs, such as forestation and alternative energy projects.
Available Information
The mailing address of the Company’s Executive Office is 4064 Colony Road, Suite 200, Charlotte, North Carolina 28211 and the telephone number at that location is (704) 973-7000. The Company’s most recent SEC filings can be found on the SEC’s website, www.sec.gov, and on the Company’s website, www.horizonlines.com. The Company’s 2009 annual report on Form 10-K will be available on the Company’s website as soon as reasonably practicable. All such filings are available free of charge. The contents of our website are not incorporated by reference into this Form 10-K. The public may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling 1-800-SEC-0330.
Item 1A.
Item 1A.
Risk Factors
We are the Subject of an Investigation by the Antitrust Division of the Department of Justice Regarding Possible Antitrust Violations in the Domestic Ocean Shipping Business. The Government Investigation Could Result in a Material Criminal Penalty and Could Have a Material Adverse Effect on Our Business.
On April 17, 2008, we received a federal grand jury subpoena and search warrant from the U.S. District Court for the Middle District of Florida seeking information regarding an investigation by the Antitrust Division of the Department of Justice (“DOJ”) into possible antitrust violations in the
domestic ocean shipping business. Subsequently, the DOJ expanded the timeframe covered by the subpoena. We are currently providing documents to the DOJ in response to the subpoenas, and we intend to continue to fully cooperate with the DOJ in its investigation.
It is possible that we, our current or former directors, officers or employees could be subject to criminal prosecution and, if found guilty, imprisonment and substantial and material fines and penalties. Three of our former employees have plead guilty to a conspiracy to eliminate competition and raise prices for moving freight between the continental U.S. and Puerto Rico and were sentenced to varying prison terms. The effect of an indictment being returned by the grand jury against us or our directors or officers could, by itself, have a significant impact on us and our business.
It is possible that the government investigation may lead to a criminal conviction or settlement providing for the payment of substantial fines by us. It is also possible that the outcome of the investigation would damage our reputation and might impair our ability to conduct our ocean shipping business in one or more of the domestic trade lanes or with one or more of our customers. Any conviction or potential settlement with the DOJ could have a substantial and material effect on our financial position, liquidity and cash flow.
Numerous Purported Class Action Lawsuits Related to the Subject of the Antitrust Investigations Have Been Filed Against Us and We May Be Subject to Civil Liabilities.
Subsequent to the commencement of the DOJ investigation, fifty-seven purported class action lawsuits were filed against us and other domestic shipping carriers alleging price-fixing in violation of the Sherman Act. The complaints seek treble monetary damages, costs, attorneys’ fees, and an injunction against the allegedly unlawful conduct. The federal cases have been consolidated by the federal Panel on Multidistrict Litigation in the District of Puerto Rico for the cases including the Puerto Rico tradelane and the Western District of Washington for the cases including the Hawaii and Guam tradelanes. A federal class action lawsuit was filed in the District of Alaska for the Alaska tradelane. A similar complaint was filed in Duval County, Florida, against us and other domestic shipping carriers by a customer alleging price-fixing in violation of the Florida Antitrust Act and the Florida Deceptive and Unlawful Trade Practices Act.
A related securities class action lawsuit was filed in the District of Delaware against us and several of our current and former employees, including our Chief Executive Officer. The lawsuit alleges that the defendants made material misrepresentations and omissions, including with respect to the alleged price-fixing and violations of the Sherman Act, causing the plaintiffs to pay inflated prices for our shares. The securities litigation seeks unspecified monetary damages, among other things.
Further, it is possible that there could be unfavorable outcomes in the lawsuits that could result in the payment by us of substantial monetary damages. We could also be required to make payments for settlements in amounts that are not determinable. For example, in connection with the Puerto Rico multidistrict litigation (“MDL”), we have entered into a settlement agreement, subject to count approval, and have agreed to pay $20.0 million and to certain base-rate freezes. We have paid $5.0 million into an escrow account pursuant to the terms of the settlement agreement. The existence of these proceedings could have a material adverse effect on our ability to access the capital markets to raise additional funds to refinance indebtedness or for other purposes. We cannot predict or determine the timing or final outcomes of the investigation or the lawsuits and are unable to estimate the amount or range of loss that could result from unfavorable outcomes but, adverse results in some or all of these legal proceedings could be material to our results of operations, financial condition or cash flows.
We have Incurred Significant Costs in Connection with the Antitrust-Related Proceedings and These Costs Will Continue to Have a Material Adverse Effect on Our Financial Condition, Liquidity and Cash Flow.
The legal costs associated with the investigation and the lawsuits and the amount of time required to be spent by management and the board of directors on these matters has had a material adverse
effect on our business, financial condition and results of operations. In addition to expenses incurred for our defense in these matters, under Delaware law and our bylaws, we may have an additional obligation to indemnify our current and former officers and directors in relation to those matters, and we have advanced, and may continue to advance, legal fees and expenses to certain other current and former employees. We have incurred legal fees and costs for antitrust-related investigations and legal proceedings of $12.2 million in fiscal year 2009 and $10.7 million in fiscal year 2008. Our legal costs and fees have had a material adverse effect on our financial condition, liquidity and cash flow and will continue have a substantial impact on our financial condition.
Our Ability to Pay any Settlement in Connection with the Class Action Lawsuits or the Government Investigation or Satisfy any Judgment or Criminal Penalty May be Constrained by the Terms of Our Debt Agreements.
Our ability to pay any settlement of either the class action lawsuits or in connection with the government investigation is limited by the terms of our credit agreement and the indenture governing our convertible notes. Our credit agreement includes financial covenants that limit our ability to pay a fine or settlement. In addition, the events of default under both the credit agreement and the indenture governing our convertible notes may require an amendment in order to pay a substantial fine or penalty. The lenders under our credit agreement or the holders of our convertible notes may not agree to amend the terms of the debt or they may require us to pay substantial fees and incur unreasonable expenses in order to obtain an amendment.
For example, the pending settlement agreement entered into in connection with the Puerto Rico MDL litigation required the amendment of our credit agreement to permit the payments required under the settlement agreement. To amend the credit agreement, our lenders required us to pay a substantial consent fee and the interest rate for borrowings under the credit agreement was increased by 1.50% and the commitment fee was increased. The fees and expenses incurred in connection with the amendment of our credit agreement had a material adverse effect on our financial condition. If we have to amend our credit agreement or the indenture governing our convertible notes to effect any other settlements or satisfy a judgment, we cannot assure you that our lenders will permit such amendment, or that such amendment will be available on terms that are acceptable to us.
Our Ability to Pay a Fine, Settlement or Judgment is Very Limited, and a Substantial Fine, Settlement or Judgment Would Have a Material Adverse Effect on Our Business, Operations and Financial Condition.
Our ability to satisfy any fine or judgment or pay any settlement is limited by our limited cash, limited borrowing capacity, lack of unencumbered assets, limited cash flow and our need to fund necessary capital expenditures, including vessel maintenance and replacement of old vessels. We cannot assure you that we would be able to borrow sufficient money or generate sufficient cash flow to pay any fine, judgment or settlement in connection with the antitrust-related matters. If we were required to pay a substantial fine, it would have a material adverse effect on our business plans, as well as our financial condition and results of operations.
If We do not Meet the New York Stock Exchange Continued Listing Requirements, Our Common Stock May be Delisted, and We May be Required to Repurchase or Refinance Our 4.25% Convertible Notes Due 2012.
In order to maintain our listing on the New York Stock Exchange (“NYSE”), we must continue to meet the NYSE minimum share price listing rule, the minimum market capitalization rule and other continued listing criteria. If our common stock were delisted, it could (i) reduce the liquidity and market price of our common stock; (ii) negatively impact our ability to raise equity financing and access the public capital markets; and (iii) materially adversely impact our results of operations and financial condition. In addition, if our common stock is not listed on the NYSE or another national exchange, holders of our 4.25% convertible notes due 2012 will be entitled to require us to repurchase their
convertible notes. Our senior secured credit facility provides that the occurrence of this repurchase right constitutes a default under such facility.
Further Economic Decline and Decrease in Market Demand For the Company’s Services in the Jones Act and Guam Markets Will Adversely Affect the Company’s Operating Results and Financial Condition.
A further slowdown in economic conditions of our Jones Act and Guam markets may adversely affect our business. Demand for our shipping services depends on levels of shipping in our Jones Act markets and in the Guam market, as well as on economic and trade growth and logistics. Cyclical or other recessions in the continental U.S. or in these markets can negatively affect our operating results. Consumer purchases or discretionary items generally decline during periods where disposable income is adversely affected or there is economic uncertainty, and, as a result our customers may ship fewer containers or may ship containers only at reduced rates. For example, shipping volume in Hawaii was down approximately 10% and Puerto Rico and Alaska volumes were down approximately 5% in 2009 as compared to 2008 as a result of poor economic conditions. The economic downturn in our tradelanes has negatively affected our earnings. We cannot predict the length of the current economic downturn or whether further economic decline may occur. At this time, we are also unable to determine the impact to our customers and business, if any, of programs adopted by the U.S. or other governments to stabilize and support the economy.
Volatility in Fuel Prices May Adversely Affect Our Profits.
Fuel is a significant operating expense for our shipping operations. The price and supply of fuel is unpredictable and fluctuates based on events outside our control, including geopolitical developments, supply and demand for oil and gas, actions by OPEC and other oil and gas producers, war and unrest in oil producing countries and regions, regional production patterns and environmental concerns. As a result, variability in the price of fuel, such as we are currently experiencing, may adversely affect profitability. There can be no assurance that our customers will agree to bear such fuel price increases via fuel surcharges without a reduction in their volumes of business with us, nor any assurance that our future fuel hedging efforts, if any, will be successful.
Repeal, Substantial Amendment, or Waiver of the Jones Act or Its Application Could Have a Material Adverse Effect on Our Business.
If the Jones Act was to be repealed, substantially amended, or waived and, as a consequence, competitors with lower operating costs were to enter any of our Jones Act markets, our business would be materially adversely affected. In addition, our advantage as a U.S.-citizen operator of Jones Act vessels could be eroded by periodic efforts and attempts by foreign interests to circumvent certain aspects of the Jones Act. If maritime cabotage services were included in the General Agreement on Trade in Services, the North American Free Trade Agreement or other international trade agreements, or if the restrictions contained in the Jones Act were otherwise altered, the shipping of maritime cargo between covered U.S. ports could be opened to foreign-flag or foreign-built vessels.
In September 2005, the Department of Homeland Security issued limited temporary waivers of the Jones Act solely to permit the transport of petroleum and refined petroleum products in the United States in response to the damage caused to the nation’s oil and gas production facilities and pipelines by Hurricanes Katrina and Rita. There can be no assurance as to the timing of any future waivers of the Jones Act or that any such waivers will be limited to the transport of petroleum and refined petroleum products.
Change in Tax Laws or the Interpretation Thereof, Adverse Tax Audits and Other Tax Matters Related to Our Tonnage Tax Election or Such Tax May Adversely Affect Our Future Results.
During 2006, after evaluating the merits and requirements of the tonnage tax, we elected the application of the tonnage tax instead of the federal corporate income tax on income from our qualifying shipping activities. Changes in tax laws or the interpretation thereof, adverse tax audits, and other tax matters related to such tax election or such tax may adversely affect our future results.
During the fourth quarter of 2007, a draft of a Technical Corrections Act proposed redefining the Puerto Rico trade to not qualify for application of the tonnage tax. The tax writing committee in Congress removed the tonnage tax repeal language from the Technical Corrections Act before its passage, but there can be no assurance that there will not be future efforts to repeal all, or any portion of, the tonnage tax as it applies to our shipping activities.
Our Failure to Renew Our Commercial Agreements With Maersk in the Future Could Have a Material Adverse Effect on Our Business.
We have several commercial agreements with Maersk, an international shipping company, that encompass terminal services, equipment sharing, cargo space charters, sales agency services, trucking services, and transportation services. For example, under these agreements, Maersk provides us with terminal services at five ports located in the continental U.S. (Elizabeth, New Jersey; Jacksonville, Florida; Houston, Texas; Los Angeles, California; and Tacoma, Washington). In general, these agreements, which were most recently renewed and amended in December 2006, are currently scheduled to expire at the end of 2010. If we fail to renew these agreements in the future, the requirements of our business will necessitate that we enter into substitute commercial agreements with third parties for at least some portion of the services contemplated under our existing commercial agreements with Maersk, such as terminal services at our ports located in the continental U.S. There can be no assurance that, if we fail to renew our commercial agreements with Maersk, we will be successful in negotiating and entering into substitute commercial agreements with third parties and, even if we succeed in doing so, the terms and conditions of these new agreements, individually or in the aggregate, may be significantly less favorable to us than the terms and conditions of our existing agreements with Maersk or others. Furthermore, if we do enter into substitute commercial agreements with third parties, changes in our operations to comply with the requirements of these new agreements (such as our use of other terminals in our existing ports in the continental U.S. or our use of other ports in the continental U.S.) may cause disruptions to our business, which could be significant, and may result in additional costs and expenses and possible losses of revenue.
Our Industry is Unionized and Strikes By Our Union Employees or Others in the Industry May Disrupt Our Services and Adversely Affect Our Operations.
As of December 20, 2009, we had 1,895 employees, of which 1,277 were unionized employees represented by seven different labor unions. Our industry is susceptible to work stoppages and other adverse employee actions due to the strong influence of maritime trade unions. We may be adversely affected by future industrial action against efforts by our management or the management of other companies in our industry to reduce labor costs, restrain wage increases or modify work practices. For example, in 2002 our operations at our U.S. west coast ports were significantly affected by a 10-day labor interruption by the International Longshore and Warehouse Union. This interruption affected ports and shippers throughout the U.S. west coast.
In addition, in the future, we may not be able to negotiate, on terms and conditions favorable to us, renewals of our collective bargaining agreements with unions in our industry and strikes and disruptions may occur as a result of our failure or the failure of other companies in our industry to negotiate collective bargaining agreements with such unions successfully. Our collective bargaining agreements are scheduled to expire as follows: three in 2011, five in 2012, one in 2103 and one in 2014.
Our Employees are Covered By Federal Laws That May Subject Us to Job-Related Claims in Addition to Those Provided By State Laws.
Some of our employees are covered by several maritime statutes, including provisions of the Jones Act, the Death on the High Seas Act, the Seamen’s Wage Act and general maritime law. These laws typically operate to make liability limits established by state workers’ compensation laws inapplicable to these employees and to permit these employees and their representatives to pursue actions against employers for job-related injuries in federal courts. Because we are not generally protected by the limits imposed by state workers’ compensation statutes for these employees, we may have greater exposure for any claims made by these employees than is customary in the United States.
Due to Our Participation in Multi-Employer Pension Plans, We May Have Exposure Under Those Plans That Extends Beyond What Our Obligations Would Be With Respect to Our Employees.
We contribute to fifteen multi-employer pension plans. In the event of a partial or complete withdrawal by us from any plan which is underfunded, we would be liable for a proportionate share of such plan’s unfunded vested benefits. Based on the limited information available from plan administrators, which we cannot independently validate, we believe that our portion of the contingent liability in the case of a full withdrawal or termination would be material to our financial position and results of operations. In the event that any other contributing employer withdraws from any plan which is underfunded, and such employer (or any member in its controlled group) cannot satisfy its obligations under the plan at the time of withdrawal, then we, along with the other remaining contributing employers, would be liable for our proportionate share of such plan’s unfunded vested benefits. We have no current intention of taking any action that would subject us to any withdrawal liability and cannot assure you that no other contributing employer will take such action.
In addition, if a multi-employer plan fails to satisfy the minimum funding requirements, the Internal Revenue Service, pursuant to Section 4971 of the Internal Revenue Code of 1986, as amended, referred to herein as the Code, will impose an excise tax of five (5%) percent on the amount of the accumulated funding deficiency. Under Section 413(c)(5) of the Code, the liability of each contributing employer, including us, will be determined in part by each employer’s respective delinquency in meeting the required employer contributions under the plan. The Code also requires contributing employers to make additional contributions in order to reduce the deficiency to zero, which may, along with the payment of the excise tax, have a material adverse impact on our financial results.
Compliance With Safety and Environmental Protection and Other Governmental Requirements May Adversely Affect Our Operations.
The shipping industry in general and our business and the operation of our vessels and terminals in particular are affected by extensive and changing safety, environmental protection and other international, national, state and local governmental laws and regulations. For example, our vessels, as U.S.-flagged vessels, generally must be maintained “in class” and are subject to periodic inspections by the American Bureau of Shipping or similar classification societies, and must be periodically inspected by, or on behalf of, the U.S. Coast Guard. In addition, the United States Oil Pollution Act of 1990 (referred to as OPA), the Comprehensive Environmental Response, Compensation & Liability Act of 1980 (referred to as CERCLA), the Clean Air Act and other federal environmental laws, and certain state laws require us, as a vessel operator, to comply with numerous environmental regulations and to obtain certificates of financial responsibility and to adopt procedures for oil or hazardous substance spill prevention, response and clean up. In complying with these laws, we have incurred expenses and may incur future expenses for ship modifications and changes in operating procedures. Changes in enforcement policies for existing requirements and additional laws and regulations adopted in the future could limit our ability to do business or further increase the cost of our doing business.
We believe our vessels are maintained in good condition in compliance with present regulatory requirements, are operated in compliance in all material respects with applicable safety/environmental laws and regulations and are insured against the usual risks for such amounts as our management deems appropriate. Our vessels’ operating certificates and licenses are renewed periodically during the required annual surveys of the vessels. However, there can be no assurance that such certificates and licenses will be renewed. Also, in the future, we may have to alter existing equipment, add new equipment to, or change operating procedures for, our vessels to comply with changes in governmental regulations, safety or other equipment standards to meet our customers’ changing needs. If any such costs are material, they could adversely affect our financial condition.
We are Subject to Statutory and Regulatory Directives in the United States Addressing Homeland Security Concerns That May Increase Our Costs and Adversely Affect Our Operations.
Various government agencies within the Department of Homeland Security (“DHS”), including the Transportation Security Administration, the U.S. Coast Guard, and U.S. Bureau of Customs and Border Protection, have adopted, and may adopt in the future, rules, policies or regulations or changes in the interpretation or application of existing laws, rules, policies or regulations, compliance with which could increase our costs or result in loss of revenue.
The Coast Guard’s maritime security regulations, issued pursuant to the Maritime Transportation Security Act of 2002 (“MTSA”), require us to operate our vessels and facilities pursuant to both the maritime security regulations and approved security plans. Our vessels and facilities are subject to periodic security compliance verification examinations by the Coast Guard. A failure to operate in accordance with the maritime security regulations or the approved security plans may result in the imposition of a fine or control and compliance measures, including the suspension or revocation of the security plan, thereby making the vessel or facility ineligible to operate. We are also required to audit these security plans on an annual basis and, if necessary, submit amendments to the Coast Guard for its review and approval. Failure to timely submit the necessary amendments may lead to the imposition of the fines and control and compliance measures mentioned above. Failure to meet the requirements of the maritime security regulations could have a material adverse effect on our results of operations.
DHS may adopt additional security-related regulations, including new requirements for screening of cargo and our reimbursement to the agency for the cost of security services. These new security-related regulations could have an adverse impact on our ability to efficiently process cargo or could increase our costs. In particular, our customers typically need quick shipping of their cargos and rely on our on-time shipping capabilities. If these regulations disrupt or impede the timing of our shipments, we may fail to meet the needs of our customers, or may increase expenses to do so.
Increased Inspection Procedures and Tighter Import and Export Controls Could Increase Costs and Disrupt Our Business.
Domestic and international container shipping is subject to various security and customs inspection and related procedures, referred to herein as inspection procedures, in countries of origin and destination as well as in countries in which transshipment points are located. Inspection procedures can result in the seizure of containers or their contents, delays in the loading, offloading, transshipment or delivery of containers and the levying of customs duties, fines or other penalties against exporters or importers (and, in some cases, shipping and logistics companies such as us). Failure to comply with these procedures may result in the imposition of fines and/or the taking of control or compliance measures by the applicable governmental agency, including the denial of entry into U.S. waters.
We understand that, currently, only a small proportion of all containers delivered to the United States are physically inspected by U.S., state or local authorities prior to delivery to their
destinations. The U.S. government, foreign governments, international organizations, and industry associations have been considering ways to improve and expand inspection procedures. There are numerous proposals to enhance the existing inspection procedures, which if implemented would likely affect shipping and logistics companies such as us. Such changes could impose additional financial and legal obligations on us, including additional responsibility for physically inspecting and recording the contents of containers we are shipping. In addition, changes to inspection procedures could impose additional costs and obligations on our customers and may, in certain cases, render the shipment of certain types of cargo by container uneconomical or impractical. Any such changes or developments may have a material adverse effect on our business, financial condition and results of operations.
Restrictions on Foreign Ownership of Our Vessels Could Limit Our Ability to Sell Off Any Portion of Our Business or Result in the Forfeiture of Our Vessels.
The Jones Act restricts the foreign ownership interests in the entities that directly or indirectly own the vessels which we operate in our Jones Act markets. If we were to seek to sell any portion of our business that owns any of these vessels, we would have fewer potential purchasers, since some potential purchasers might be unable or unwilling to satisfy the foreign ownership restrictions described above. As a result, the sales price for that portion of our business may not attain the amount that could be obtained in an unregulated market. Furthermore, at any point Horizon Lines, LLC, our indirect wholly-owned subsidiary and principal operating subsidiary, ceases to be controlled and 75% owned by U.S. citizens, we would become ineligible to operate in our current Jones Act markets and may become subject to penalties and risk forfeiture of our vessels.
No Assurance Can Be Given That Our Insurance Costs Will Not Escalate.
Our protection and indemnity insurance (“P&I”) is provided by a mutual P&I club which is a member of the International Group of P&I clubs. As a mutual club, it relies on member premiums, investment reserves and income, and reinsurance to manage liability risks on behalf of its members. Increased investment losses, underwriting losses, or reinsurance costs could cause international marine insurance clubs to increase the cost of premiums, resulting not only in higher premium costs, but also higher levels of deductibles and self-insurance retentions.
Our coverage under the Longshore Act for U.S. Longshore and Harbor Workers compensation is provided by Signal Mutual Indemnity Association Ltd. Signal Mutual is a non-profit organization whose members pool risks of a similar nature to achieve long-term and stable insurance protection at cost. Signal Mutual is now the largest provider of Longshore benefits in the country. This program provides for first-dollar coverage without a deductible.
Catastrophic Losses and Other Liabilities Could Adversely Affect Our Results of Operations and Such Losses and Liability May Be Beyond Insurance Coverage.
The operation of any oceangoing vessel carries with it an inherent risk of catastrophic maritime disaster, mechanical failure, collision, and loss of or damage to cargo. Also, in the course of the operation of our vessels, marine disasters, such as oil spills and other environmental mishaps, cargo loss or damage, and business interruption due to political or other developments, as well as maritime disasters not involving us, labor disputes, strikes and adverse weather conditions, could result in loss of revenue, liabilities or increased costs, personal injury, loss of life, severe damage to and destruction of property and equipment, pollution or environmental damage and suspension of operations. Damage arising from such occurrences may result in lawsuits asserting large claims.
Although we maintain insurance, including retentions and deductibles, at levels that we believe are consistent with industry norms against the risks described above, including loss of life, there can be no assurance that this insurance would be sufficient to cover the cost of damages suffered by us from the occurrence of all of the risks described above or the loss of income resulting from one or
more of our vessels being removed from operation. We also cannot be assured that a claim will be paid or that we will be able to obtain insurance at commercially reasonable rates in the future. Further, if we are negligent or otherwise responsible in connection with any such event, our insurance may not cover our claim.
In the event that any of the claims arising from any of the foregoing possible events were assessed against us, all of our assets could be subject to attachment and other judicial process.
As a result of the significant insurance losses incurred in the September 11, 2001 attack and related concern regarding terrorist attacks, global insurance markets increased premiums and reduced or restricted coverage for terrorist losses generally. Accordingly, premiums payable for terrorist coverage have increased substantially and the level of terrorist coverage has been significantly reduced.
Additionally, new and stricter environmental regulations have led to higher costs for insurance covering environmental damage or pollution, and new regulations could lead to similar increases or even make this type of insurance unavailable.
The reliability of our service may be adversely affected if our spare vessels reserved for relief are not deployed efficiently under extreme circumstances, which could damage our reputation and harm our operating results. We generally keep spare vessels in reserve available for relief if one of our vessels in active service suffers a maritime disaster or must be unexpectedly removed from service for repairs. However, these spare vessels may require several days of sailing before it can replace the other vessel, resulting in service disruptions and loss of revenue. If more than one of our vessels in active service suffers a maritime disaster or must be unexpectedly removed from service, we may have to redeploy vessels from our other trade routes, or lease one or more vessels from third parties. We may suffer a material adverse effect on our business if we are unable to rapidly deploy one of our spare vessels and we fail to provide on-time scheduled service and adequate capacity to our customers.
Interruption or Failure of Our Information Technology and Communications Systems Could Impair our Ability to Effectively Provide Our Shipping and Logistics Services, Especially HITS, Which Could Damage Our Reputation and Harm Our Operating Results.
Our provision of our shipping and logistics services depends on the continuing operation of our information technology and communications systems, especially HITS. We have experienced brief system failures in the past and may experience brief or substantial failures in the future. Any failure of our systems could result in interruptions in our service reducing our revenue and profits and damaging our brand. Some of our systems are not fully redundant, and our disaster recovery planning does not account for all eventualities. The occurrence of a natural disaster, or other unanticipated problems at our facilities at which we maintain and operate our systems could result in lengthy interruptions or delays in our shipping and logistics services, especially HITS.
Our Vessels Could Be Arrested By Maritime Claimants, Which Could Result in Significant Loss of Earnings and Cash Flow.
Crew members, suppliers of goods and services to a vessel, shippers of cargo, lenders and other parties may be entitled to a maritime lien against a vessel for unsatisfied debts, claims or damages. In many jurisdictions, a claimant may enforce its lien by either arresting or attaching a vessel through foreclosure proceedings. Moreover, crew members may place liens for unpaid wages that can include significant statutory penalty wages if the unpaid wages remain overdue (e.g., double wages for every day during which the unpaid wages remain overdue). The arrest or attachment of one or more of our vessels could result in a significant loss of earnings and cash flow for the period during which the arrest or attachment is continuing.
In addition, international vessel arrest conventions and certain national jurisdictions allow so-called sister-ship arrests, which allow the arrest of vessels that are within the same legal ownership as the vessel which is subject to the claim or lien. Certain jurisdictions go further, permitting not only the arrest of vessels within the same legal ownership, but also any associated vessel. In nations with these laws, an association may be recognized when two vessels are owned by companies controlled by the same party. Consequently, a claim may be asserted against us or any of our vessels for the liability of one or more of the other vessels that we own.
We are Susceptible to Severe Weather and Natural Disasters.
Our operations are vulnerable to disruption as a result of weather and natural disasters such as bad weather at sea, hurricanes, typhoons and earthquakes. Such events will interfere with our ability to provide the on-time scheduled service our customers demand resulting in increased expenses and potential loss of business associated with such events. In addition, severe weather and natural disasters can result in interference with our terminal operations, and may cause serious damage to our vessels, loss or damage to containers, cargo and other equipment and loss of life or physical injury to our employees. Terminals in the South Pacific Ocean, particularly in Guam, and terminals on the east coast of the continental U.S. and in the Caribbean are particularly susceptible to hurricanes and typhoons. In the recent past, the terminal at our port in Guam was seriously damaged by a typhoon and our terminal in Puerto Rico was seriously damaged by a hurricane. These storms resulted in damage to cranes and other equipment and closure of these facilities. Earthquakes in Anchorage and in Guam have also damaged our terminal facilities resulting in delay in terminal operations and increased expenses. Any such damage will not be fully covered by insurance.
We May Face New Competitors.
Other established or start-up shipping operators may enter our markets to compete with us for business.
Existing non-Jones Act qualified shipping operators whose container ships sail between ports in Asia and the U.S. west coast could add Hawaii, Guam or Alaska as additional stops on their sailing routes for non-U.S. originated or destined cargo. Shipping operators could also add Puerto Rico as a new stop on sailings of their vessels between the continental U.S. and ports in Europe, the Caribbean, and Latin America for non-U.S. originated or destined cargo. Further, shipping operators could introduce U.S.-flagged vessels into service sailing between Guam and U.S. ports, including ports on the U.S. west coast or in Hawaii. On these routes to and from Guam no limits would apply as to the origin or destination of the cargo dropped off or picked up. In addition, current or new U.S. citizen shipping operators may order the building of new vessels by U.S. shipyards and may introduce these U.S.-built vessels into Jones Act qualified service on one or more of our trade routes. These potential competitors may have access to financial resources substantially greater than our own. The entry of a new competitor on any of our trade routes could result in a significant increase in available shipping capacity that could have a material adverse effect on our business, financial condition, results of operations and cash flows.
We May Not Exercise Our Purchase Options For Our Chartered Vessels.
We intend to exercise our purchase options for the three Jones Act vessels that we have chartered upon the expiration of their charters in January 2015. In addition, we have not determined whether we will exercise our scheduled purchase options for the five recently built U.S.-flag vessels that we have chartered. There can be no assurance that, when these options for these eight vessels become exercisable, the price at which these vessels may be purchased will be reasonable in light of the fair market value of these vessels at such time or that we will have the funds required to make these purchases. As a result, we may not exercise our options to purchase these vessels. If we do not exercise our options, we may need to renew our existing charters for these vessels or charter replacement vessels. There can be no assurance that our existing charters will be renewed, or, if
renewed, that they will be renewed at favorable rates, or, if not renewed, that we will be able to charter replacement vessels at favorable rates.
We May Face Significant Costs As the Vessels Currently in Our Fleet Age.
We believe that each of the vessels we currently operate has an estimated useful life of approximately 45 years from the year it was built. As of the date hereof, the average age of our active vessels is approximately 22 years and the average age of our Jones Act vessels is approximately 32 years. We expect to incur increasing costs to operate and maintain the vessels in good condition as they age. Eventually, these vessels will need to be replaced. We may not be able to replace our existing vessels with new vessels based on uncertainties related to financing, timing and shipyard availability.
We May Face Unexpected Substantial Dry-Docking Costs For Our Vessels.
Our vessels are dry-docked periodically to comply with regulatory requirements and to effect maintenance and repairs, if necessary. The cost of such repairs at each dry-docking are difficult to predict with certainty and can be substantial. Our established processes have enabled us to make on average six dry-dockings per year over the last five years with a minimal impact on schedule. There are some years when we have more than the average of six dry-dockings annually. In addition, our vessels may have to be dry-docked in the event of accidents or other unforeseen damage. Our insurance may not cover all of these costs. Large unpredictable repair and dry-docking expenses could significantly decrease our profits.
Loss of Key Personnel Could Adversely Affect Our Business.
Our future success will depend, in significant part, upon the continued services of Charles G. Raymond, our Chairman of the Board, President and Chief Executive Officer, Michael T. Avara, our Senior Vice President, Chief Financial Officer, John V. Keenan, our President, Horizon Lines, LLC, and Brian W. Taylor, our President, Horizon Logistics, LLC. The loss of the services of any of these executive officers could adversely affect our future operating results because of their experience and knowledge of our business and customer relationships. If key employees depart, we may have to incur significant costs to replace them and our ability to execute our business model could be impaired if we cannot replace them in a timely manner. We do not expect to maintain key person insurance on any of our executive officers.
We are Subject to, and May in the Future Be Subject to, Disputes, or Legal or Other Proceedings, That Could Have a Material Adverse Effect on Us.
The nature of our business exposes us to the potential for disputes, or legal or other proceedings, from time to time relating to labor and employment matters, personal injury and property damage, environmental matters and other matters, as discussed in the other risk factors disclosed in this Form 10-K. In addition, as a common carrier, our tariffs, rates, rules and practices in dealing with our customers are governed by extensive and complex foreign, federal, state and local regulations which are the subject of disputes or administrative and/or judicial proceedings from time to time. These disputes, individually or collectively, could harm our business by distracting our management from the operation of our business. If these disputes develop into proceedings, these proceedings, individually or collectively, could involve significant expenditures by us or result in significant changes to our tariffs, rates, rules and practices in dealing with our customers that could have a material adverse effect on our future revenue and profitability.
Our Cash Flows and Capital Resources May Be Insufficient to Make Required Payments on Our Substantial Indebtedness and Future Indebtedness.
As of December 20, 2009, on a consolidated basis, we had (i) $542.5 million of outstanding funded long-term debt (exclusive of outstanding letters of credit with an aggregate face amount of $11.1 million), (ii) approximately $202.4 million of aggregate trade payables, accrued liabilities and other balance sheet liabilities (other than the long-term debt referred to above) and (iii) a funded debt-to-equity ratio of approximately 5.4:1.0.
Because we have substantial debt, we require significant amounts of cash to fund our debt service obligations. Our ability to generate cash to meet scheduled payments or to refinance our obligations with respect to our debt depends on our financial and operating performance which, in turn, is subject to prevailing economic and competitive conditions and to the following financial and business factors, some of which may be beyond our control:
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operating difficulties;
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increased operating costs;
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increased fuel costs;
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general economic conditions;
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decreased demand for our services;
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market cyclicality;
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tariff rates;
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prices for our services;
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the actions of competitors;
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regulatory developments; and
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delays in implementing strategic projects.
If our cash flow and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and might be forced to reduce or delay capital expenditures, dispose of material assets or operations, seek to obtain additional equity capital, or restructure or refinance our indebtedness. Such alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In particular, in the event that we are required to dispose of material assets or operations to meet our debt service obligations, we cannot be sure as to the timing of such dispositions or the proceeds that we would realize from those dispositions. The value realized from such dispositions will depend on market conditions and the availability of buyers, and, consequently, any such disposition may not, among other things, result in sufficient cash proceeds to repay our indebtedness. Also, the senior credit facility contains covenants that may limit our ability to dispose of material assets or operations or to restructure or refinance our indebtedness. Further, we cannot provide assurance that we will be able to restructure or refinance any of our indebtedness or obtain additional financing, given the uncertainty of prevailing market conditions from time to time, our high levels of indebtedness and the various debt incurrence restrictions imposed by the senior credit facility. If we are able to restructure or refinance our indebtedness or obtain additional financing, the economic terms on which such indebtedness is restructured, refinanced or obtained may not be favorable to us.
We may incur substantial indebtedness in the future. The terms of the senior credit facility permit us to incur or guarantee additional indebtedness under certain circumstances. As of December 20, 2009, we had approximately $113.9 million of additional borrowing availability under the revolving credit facility, subject to compliance with the financial and other covenants and the other terms set forth therein. Based on our leverage ratio, borrowing availability under the revolving credit facility was
$98.4 million as of December 20, 2009. Our incurrence of additional indebtedness would intensify the risk that our future cash flow and capital resources may not be sufficient for payments of interest on and principal of our substantial indebtedness.
Financial and Other Covenants Under Our Current and Future Indebtedness Could Significantly Impair Our Ability to Operate Our Business.
Our senior credit facility contains covenants that, among other things, restrict the ability of us and our subsidiaries to:
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dispose of assets;
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incur additional indebtedness, including guarantees;
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prepay other indebtedness or amend other debt instruments;
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pay dividends or make investments, loans or advances;
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create liens on assets;
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enter into sale and lease-back transactions;
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engage in mergers, acquisitions or consolidations;
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change the business conducted by them; and
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engage in transactions with affiliates.
In addition, under the senior credit facility, we are required to comply with financial covenants, comprised of leverage and interest coverage ratio requirements. Our ability to comply with these covenants will depend on our ongoing financial and operating performance, which in turn will be subject to economic conditions and to financial, market and competitive factors, many of which are beyond our control, and will be substantially dependent on our financial and operating performance which, in turn, is subject to prevailing economic and competitive conditions and to various financial and business factors, including the DOJ investigation and related lawsuits and those discussed in the other risk factors disclosed in this Form 10-K, some of which may be beyond our control.
Under our senior credit facility we are required, subject to certain exceptions, to make mandatory prepayments of amounts under the senior credit facility with all or a portion of the net proceeds of certain asset sales and events of loss, certain debt issuances, certain equity issuances and a portion of their excess cash flow. Our circumstances at the time of any such prepayment, particularly our liquidity and ability to access funds, cannot be anticipated at this time. Any such prepayment could, therefore, have a material adverse effect on us. Mandatory prepayments are first applied to the outstanding term loans and, after all of the term loans are paid in full, then applied to reduce the loans under the revolving credit facility with corresponding reductions in revolving credit facility commitments.
Our Substantial Indebtedness and Future Indebtedness Could Significantly Impair Our Operating and Financial Condition.
The required payments on our substantial indebtedness and future indebtedness, as well as the restrictive covenants contained in the senior credit facility could significantly impair our operating and financial condition. For example, these required payments and restrictive covenants could:
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make it difficult for us to satisfy our debt obligations;
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make us more vulnerable to general adverse economic and industry conditions;
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limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions and other general corporate requirements;
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expose us to interest rate fluctuations because the interest rate on the debt under our revolving credit facility is variable;
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require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow for operations and other purposes;
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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and
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place us at a competitive disadvantage compared to competitors that may have proportionately less debt.
We may incur substantial indebtedness in the future. Our incurrence of additional indebtedness would intensify the risks described above.
Our Secured Credit Facility Exposes Us to the Variability of Interest Rates.
The term loan and revolving credit portions of our senior credit facility bear interest at variable rates. As of December 20, 2009, we had outstanding a $112.5 million term loan and $100.0 million under the revolving credit facility, which bear interest at variable rates. The interest rates applicable to the senior credit facility vary with the prevailing corporate base rate offered by the administrative agent under the senior credit facility or with LIBOR. If these rates were to increase significantly, our ability to borrow additional funds may be reduced and the risks related to our substantial indebtedness would intensify. Each quarter point change in interest rates would result in a $0.3 million change in annual interest expense on the revolving credit facility. Accordingly, a significant rise in interest rates would adversely affect our financial results.
If Non-U.S. Citizens Own More Than 19.9% of Our Stock, We May Not Have the Funds or the Ability to Redeem Any Excess Shares and We Could Be Forced to Suspend Our Jones Act Operations.
Our certificate of incorporation contains provisions voiding transfers of shares of any class or series of our capital stock that would result in non-U.S. citizens, in the aggregate, owning in excess of 19.9% of the shares of such class or series. In the event that this transfer restriction would be ineffective, our certificate of incorporation provides for the automatic transfer of such excess shares to a trust specified therein. These trust provisions also apply to excess shares that would result from a change in the status of a record or beneficial owner of shares of our capital stock from a U.S. citizen to a non-U.S. citizen. In the event that these trust transfer provisions would also be ineffective, our certificate of incorporation permits us to redeem such excess shares. However, we may not be able to redeem such excess shares because our operations may not have generated sufficient excess cash flow to fund such redemption. If such a situation occurs, there is no guarantee that we will be able to obtain the funds necessary to affect such redemption on terms satisfactory to us or at all. The senior credit facility permits upstream payments from our subsidiaries, subject to exceptions, to the Company to fund redemptions of excess shares.
If, for any of the foregoing reasons or otherwise, we are unable to effect such a redemption when such ownership of shares by non-U.S. citizens is in excess of 25.0% of such class or series, or otherwise prevent non-U.S. citizens in the aggregate from owning shares in excess of 25.0% of any such class or series, or fail to exercise our redemption right because we are unaware that such ownership exceeds such percentage, we will likely be unable to comply with applicable maritime laws. If all of the citizenship-related safeguards in our certificate of incorporation fail at a time when ownership of shares of any class or series of our stock is in excess of 25.0% of such class or series, we will likely be required to suspend our Jones Act operations. Any such actions by governmental authorities would have a severely detrimental impact on our results of operations.
Our Share Price Will Fluctuate.
Stock markets in general and our common stock in particular have experienced significant price and volume volatility over the past year. The market price and trading volume of our common stock may continue to be subject to significant fluctuations due not only to general stock market conditions but also to variability in the prevailing sentiment regarding our operations or business prospects, as well as potential further decline of our common stock due to margin calls on loans secured by pledges of our common stock.
We May Not Have the Necessary Funds to Pay Dividends on Our Common Stock or We May Elect Not to Pay Dividends on Our Common Stock.
We require continuing, significant cash flow in order for us to make payments of regular dividends to our stockholders. However, we have no operations of our own and have derived, and will continue to derive, all of our revenue and cash flow from our subsidiaries. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to make funds available to us. They may not have sufficient funds or assets to permit payments to us in amounts sufficient to fund future dividend payments. Also, our subsidiaries are subject to contractual restrictions (including with their secured and unsecured creditors) that may limit their ability to upstream cash indirectly or directly to us. Thus, there is a significant risk that we may not have the requisite funds to make regular dividend payments in the future. In addition, we may elect not to pay dividends as a substantial portion of our future earnings will be utilized to make payments of principal and interest on our indebtedness and to fund the development and growth of our business.
Environmental Regulation and Climate Change
All of our operations are subject to various federal, state and local environmental laws and regulations implemented principally by the Environmental Protection Agency (the “EPA”), the United States Department of Transportation, the United States Coast Guard and state environmental regulatory agencies. These regulations govern the management of hazardous wastes, discharge of pollutants into the air, surface and underground waters, including rivers, harbors and the 200-mile exclusive economic zone of the United States, and the disposal of certain substances.
The operation of our vessels is also subject to regulation under various international and federal laws, as interpreted and implemented by the United States Coast Guard (the “Coast Guard”) and port state authorities in our non-U.S. ports of call, as well as certain state and local laws. Additionally, our vessels are required to meet construction and repair standards established by the American Bureau of Shipping (ABS), Det Norske Veritas (DNV), the IMO and/or the Coast Guard, and to meet operational, security and safety standards and regulations presently established by the Coast Guard. The Coast Guard further licenses our seagoing supervisory personnel and certifies our seamen.
Our marine operations are further subject to regulation by various federal agencies or the successors to those agencies, including the Surface Transportation Board (the successor federal agency to the Interstate Commerce Commission), the United States Department of Transportation Maritime Administration (“MARAD”), the Federal Maritime Commission and the Coast Guard. These regulatory authorities have broad powers over operational safety, tariff filings of freight rates, service contracts, certain mergers, contraband, environmental contamination, financial reporting and homeland, port and vessel security.
Our common and contract motor carrier operations are regulated by the United States Surface Transportation Board and various state agencies. The Company’s drivers also must comply with the safety and fitness regulations promulgated by the United States Department of Transportation (“DOT”), including certain regulations for drug and alcohol testing and hours of service. The officers and unlicensed crew members employed aboard our vessels must also comply with numerous safety and fitness regulations promulgated by the Coast Guard, the DOT, and the IMO, including certain regulations for drug testing and hours of service.
The United States Oil Pollution Act of 1990 and the Comprehensive Environmental Response, Compensation and Liability Act
In 1990, the Oil Pollution Act of 1990 (“OPA”) was enacted to establish an extensive regulatory and liability regime designed to protect the environment from the damage caused by oil spills. OPA is applicable to all owners and operators whose vessels trade with the United States or its territories or possessions, or whose vessels operate in the navigable waters of the United States, which include the United States territorial sea and the 200 nautical mile exclusive economic zone around the United States. Additionally, under OPA, vessel owners, operators and bareboat charterers are “responsible parties” and are jointly, severally and strictly liable (unless the spill results solely from the act or omission of a third party, an act of God or an act of war) for all containment and clean-up costs and other damages arising from discharges or threatened discharges of oil from their vessels. “Damages” are defined broadly under OPA to include:
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natural resources damages and the costs of assessment thereof;
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damages for injury to, or economic losses resulting from the destruction of, real and personal property;
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the net loss of taxes, royalties, rents, fees and profits by the United States government, and any state or political subdivision thereof;
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lost profits or impairment of earning capacity due to property or natural resources damage;
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the net costs of providing increased or additional public services necessitated by a spill response, such as protection from fire, safety or other hazards; and
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the loss of subsistence use of natural resources.
Effective July 31, 2009, the OPA regulations were amended to increase the liability limits for responsible parties for any vessel other than a tank vessel to $1,000 per gross ton or $854,400, whichever is greater. These limits of liability do not apply if an incident was directly caused by violation of applicable federal safety, construction or operating regulations or by a responsible party’s gross negligence or willful misconduct, or if the responsible party fails or refuses to report the incident or to cooperate and assist in connection with oil removal activities.
In 1980, the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) was adopted and is applicable to the discharge of hazardous substances (other than oil) whether on land or at sea. CERCLA also imposes liability similarly to OPA and provides for cleanup, removal and natural resource damage. Liability per vessel under CERCLA is limited to the greater of $300 per gross ton or $5 million, unless the incident is caused by gross negligence, willful misconduct, or a violation of certain regulations, in which case liability is unlimited.
OPA requires owners and operators of vessels to establish and maintain with the Coast Guard evidence of financial responsibility sufficient to meet their potential liabilities under the OPA. Effective July 1, 2009, the Coast Guard regulations requiring evidence of financial responsibility were amended to conform the OPA financial responsibility requirements to the July 2009 increases in liability limits. Current Coast Guard regulations require evidence of financial responsibility in the amount of $1,000 per gross ton for non-tank vessels, which includes the OPA limitation on liability of $700 per gross ton and the CERCLA liability limit of $300 per gross ton. Congress enacted the Delaware River Protection Act (“DRPA”) to increase OPA liability limits to levels that would reflect a proper apportionment between responsible parties and the National Pollution Fund. Congress was also concerned that inflation would further erode responsible party liability and shift the economic risk of oil spills to the public. The DRPA therefore also required that OPA limits of liability be adjusted not less than every three years to reflect significant increases in the CPI in order to preserve the “polluter pays” principle embodied by OPA.
Under the regulations, vessel owners and operators may evidence their financial responsibility by showing proof of insurance, surety bond, self-insurance or guaranty. Under OPA, an owner or operator of a fleet of vessels is required only to demonstrate evidence of financial responsibility in an amount sufficient to cover the vessels in the fleet having the greatest maximum liability under OPA.
The Coast Guard’s regulations concerning certificates of financial responsibility provide, in accordance with OPA, that claimants may bring suit directly against an insurer or guarantor that furnishes certificates of financial responsibility. In the event that such insurer or guarantor is sued directly, it is prohibited from asserting any contractual defense that it may have had against the responsible party and is limited to asserting those defenses available to the responsible party and the defense that the incident was caused by the willful misconduct of the responsible party. Certain organizations, which had typically provided certificates of financial responsibility under pre-OPA laws, including the major protection and indemnity organizations, have declined to furnish evidence of insurance for vessel owners and operators if they are subject to direct actions or are required to waive insurance policy defenses.
OPA specifically permits individual states to impose their own liability regimes with regard to oil pollution incidents occurring within their boundaries, and some states have enacted legislation providing for unlimited liability for oil spills. In some cases, states, which have enacted such legislation, have not yet issued implementing regulations defining vessels owners’ responsibilities under these laws. We intend to comply with all applicable state regulations in the ports where our vessels call.
We maintain Certificates of Financial Responsibility as required by the Coast Guard for our vessels.
The United States Clean Water Act
Enacted in 1972, the United States Clean Water Act (“CWA”) prohibits the discharge of oil or hazardous substances in navigable waters and imposes strict liability in the form of penalties for any unauthorized discharges. The CWA also imposes substantial liability for the costs of removal, remediation and damages and complements the remedies available under OPA and CERCLA.
The EPA historically exempted the discharge of ballast water and other substances incidental to the normal operation of vessels in the United States ports from the CWA permitting requirements. On March 31, 2005, however, a United States District Court ruled that the EPA exceeded its authority in creating an exemption for ballast water. On September 18, 2006, the court issued an order invalidating the exemption in the EPA’s regulations for all discharges incidental to the normal operation of a vessel as of September 30, 2008, and directing the EPA to develop a system for regulating all discharges from vessels by that date. Under the court’s ruling, owners and operators of vessels visiting United States ports also would be required to comply with the CWA permitting program to be developed by the EPA or face penalties.
The EPA has issued regulations implementing a “Vessel General Permit” (“VGP”) that codifies “best management practices” for the control of twenty-eight listed, specific discharges, including ballast water, that occur normally in the operation of a vessel. We have obtained and are now operating each of our ships in accordance with its VGP; the VGP requirements have increased our record keeping requirements but have not otherwise expect a material impact on our operations.
Several states have specified significant, additional requirements in connection with such state mandated CWA certifications relating to the VGP rules and regulations. Currently implemented state requirements have not significantly increased our compliance efforts but we cannot predict what additional state requirements may come into effect in the future and, therefore, the future effect of the VGP regulations. Various states have also enacted legislation restricting ballast water discharges and the introduction of non-indigenous species considered to be invasive. These and any similar restrictions enacted in the future could increase the costs of operating in the relevant waters.
The National Invasive Species Act
The United States National Invasive Species Act (“NISA”) was enacted in 1996 in response to growing reports of harmful organisms being released into United States waters through ballast water taken on by vessels in foreign ports. The Coast Guard adopted regulations under NISA in July 2004 that impose mandatory ballast water management practices for all vessels equipped with ballast water tanks entering United States waters. These requirements can be met by performing mid-ocean ballast exchange, by retaining ballast water on board the vessel, or by using environmentally sound alternative ballast water management methods approved by the Coast Guard. Mid-ocean ballast exchange is the primary method for compliance with the Coast Guard regulations, since holding ballast water can prevent vessels from performing cargo operations upon arrival in the United States, and alternative methods are still under development. Vessels that are unable to conduct mid-ocean ballast exchange due to voyage or safety concerns may discharge minimum amounts of ballast water, provided that they comply with recordkeeping requirements and document the reasons they could not follow the required ballast water management requirements. In the August 28, 2009 Federal register, the Coast Guard proposed to amend their regulations on ballast water management by establishing standards for the allowable concentration of living organisms in ship’s ballast water discharged in US waters. As proposed it is a two tier standard; the initial limits match those set internationally by IMO in the Ballast Water Convention. These limits are proposed to come into force by January 1, 2012. Technology is available that will enable ships to meet these discharge standards. The second tier standard is more stringent and cannot be met using existing treatment technology. This second tier, as proposed, would come into effect on January 1, 2017
The United States House of Representatives recently passed a bill that amends NISA by prohibiting the discharge of ballast water unless it has been treated with specified methods or acceptable alternatives. Similar bills have been introduced in the United States Senate, but it cannot be predicted which bill, if any, will be enacted into law. In the absence of federal standards, states have enacted legislation or regulations to address invasive species through ballast water and hull cleaning management and permitting requirements. For instance, the State of California has recently enacted legislation extending its ballast water management program to regulate the management of “hull fouling” organisms attached to vessels and adopted regulations limiting the number of organisms in ballast water discharges. Additionally, a United States District Court dismissed challenges to the State of Michigan’s ballast water management legislation mandating the use of various techniques for ballast water treatment; this decision was affirmed by the United States Court of Appeals for the Sixth Circuit on November 21, 2008. Other states may proceed with the enactment of similar requirements that could increase the costs of operating in state waters.
The United States Clean Air Act
In 1970, the United States Clean Air Act (as amended by the Clean Air Act Amendments of 1977 and 1990, the “CAA”) was enacted and required the EPA to promulgate standards applicable to emissions of volatile organic compounds and other air contaminants. The CAA also requires states to draft State Implementation Plans (“SIPs”), which are designed to attain national health-based air quality standards in primarily major metropolitan and/or industrial areas. Several SIPs regulate emissions resulting from vessel loading and unloading operations by requiring the installation of vapor control equipment. The EPA and some states, however, have each proposed more stringent regulations of air emissions from ocean-going vessels. For example, the California Air Resources Board of the State of California (the “CARB”) has petitioned the EPA to permit California clean-fuel regulations applicable to all vessels sailing within 24 nautical miles of the California coastline whose itineraries call for them to enter any California ports, terminal facilities, or internal or estuarine waters. Although currently under a court challenge, and pending an EPA decision on CARB’s petition, these regulations are being enforced in California.
The state of California is also implementing regulations that will require vessels to either shut down the auxiliary engines while in port in California and use electrical power supplied at the dock or
implement alternatives means to significantly reduce emissions from the vessel’s electric power generating equipment while it is in port. Generally, a vessel will run its auxiliary engines while at port in order to power lighting, ventilation, pumps, communication and other onboard equipment. The emissions from running auxiliary engines while at port may be contributors to particulate matter in the ambient air. The purpose of the regulations is to reduce the emissions from a vessel while it is in port. The cost of reducing vessel emissions while at port may be substantial if we determine that we cannot use or the ports will not permit us to use electrical power supplied at the dock. Alternatively, the ports may pass the cost of supplying electrical power at the port to us, and we may incur additional costs in connection with modifying our vessels to use electrical power supplied at the dock.
International Law, the MARPOL (International Convention for the Prevention of Pollution from Ships, 1973, as modified by the Protocol of 1978 relating thereto) Convention, may, in the future, require the use of low sulfur fuels worldwide in both auxiliary and main propulsion diesel engines on ships. By July 1, 2010, the MARPOL Amendments are expected to require all diesel engines on ships built between 1990 and 2000 to meet a Nitrous Oxide (NOx) standard of 17.0g-NOx/kW-hr. On January 1, 2011 the NOx standard will be lowered to 14.4 g-NOx/kW-hr and on January 1, 2016 it will be further lowered to 3.4 g-NOx/kW-hr, for vessels operating in a designated Emission Control Area (ECA).
In addition, the current global sulfur cap of 4.5% Sulfur will be reduced to 3.5% Sulfur in 2010 and further reduced to as low as 0.5% sulfur as early as 2020, and no later than 2025, depending upon recommendations made in connection with a MARPOL fuel availability study scheduled for 2018. Under these MARPOL Amendments, the current 1.5% maximum sulfur omission permitted in designated Emission Control Areas (ECAs) will be reduced to 1.0% sulfur on July 1, 2010, and then further reduced to 0.1% sulfur on January 1, 2015. These sulfur limitations will be applied to all subsequently approved ECAs under the MARPOL Amendments. The EPA has received preliminary approval of the IMO, in coordination with Environment Canada, to designate all waters within 200 nautical miles of the U.S and Canadian coasts as ECA’s. Under EPA regulations the North American ECA could go into force as early as 2012 limiting the sulfur content in fuel that is burned as described above. Beginning in 2016, NOx after-treatment requirements become applicable in this ECA as well.
The Resource Conservation and Recovery Act
Our operations occasionally generate and require the transportation, treatment and disposal of both hazardous and non-hazardous solid wastes that are subject to the requirements of the United States Resource Conservation and Recovery Act or comparable state, local or foreign requirements. In addition, from time to time we arrange for the disposal of hazardous waste or hazardous substances at offsite disposal facilities. If such materials are improperly disposed of by third parties, we may still be held liable for cleanup costs under applicable laws.
Endangered Species Regulation
The Endangered Species Act, federal conservation regulations and comparable state laws protect species threatened with possible extinction. Protection of endangered species may include restrictions on the speed of vessels in certain ocean waters and may require us to change the routes of our vessels during particular periods. For example, in an effort to prevent the collision of vessels with the North Atlantic right whale, federal regulations restrict the speed of vessels to ten knots or less in certain areas along the Atlantic Coast of the U.S. The reduced speed of our vessels and special routing along the Atlantic Coast of our vessels is expected to result in the use of additional fuel, which will affect our results of operations.
Greenhouse Gas Regulation
In February 2005, the Kyoto Protocol to the United Nations Framework Convention on Climate Change (the “Kyoto Protocol”) was enacted. Pursuant to the Kyoto Protocol, adopting countries are required to implement national programs to reduce emissions of certain gases, generally referred to as greenhouse gases, which are suspected of contributing to global warming. In October 2007, the California Attorney General and a coalition of environmental groups petitioned the EPA to regulate greenhouse gas emissions from ocean-going vessels under the CAA. Any passage of climate control legislation or other regulatory initiatives in the United States that restrict emissions of greenhouse gases could entail financial impacts on our operations that cannot be predicted with certainty at this time. The issue is being heavily debated within various international regulatory bodies, such as the IMO, as well and climate control measures that effect shipping could also be implemented on an international basis potentially affecting our vessel operations.
Vessel Security Regulations
Since September 11, 2001, there have been a variety of initiatives intended to enhance vessel security within the United States. On November 25, 2002, the Maritime Transportation Security Act of 2002 (the “MTSA”) came into effect. To implement certain portions of the MTSA, in July 2003, the Coast Guard issued regulations requiring the implementation of certain security requirements aboard vessels operating in waters subject to the jurisdiction of the United States. Similarly, in December 2002, amendments to the International Convention for the Safety of Life at Sea (“SOLAS”) created a new chapter of the convention dealing specifically with maritime security. The new chapter came into effect in July 2004 and imposes various detailed security obligations on vessels and port authorities, most of which are contained in the newly created International Ship and Port Facilities Security Code (the “ISPS Code”). Among the various requirements are:
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on-board installation of automatic information systems to enhance vessel-to-vessel and vessel-to-shore communications;
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on-board installation of ship security alert systems;
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the development of vessel and facility security plans;
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the implementation of a Transportation Workers Identification Credential program; and
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compliance with flag state security certification requirements.
The Coast Guard regulations, intended to align with international maritime security standards, exempt non-United States vessels from MTSA vessel security measures provided such vessels have on board a valid International Ship Security Certificate that attests to the vessel’s compliance with SOLAS security requirements and the ISPS Code as ratified by the ship’s flag state. Vessels native to the United States, however, are not exempted from the security measures addressed by the MTSA, SOLAS and the ISPS Code. We have implemented the various security measures addressed by the MTSA, SOLAS and the ISPS Code.
Item 1B.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Item 2.
Properties
We lease all of our facilities, including our terminal and office facilities located at each of the ports upon which our vessels call, as well as our central sales and administrative offices and regional sales offices. The following table sets forth the locations, descriptions, and square footage of our significant facilities as of December 20, 2009:
(1)
Square footage for marine terminal facilities excludes common use areas used by other terminal customers and us.
(2)
Excludes 1,647,952 square feet of terminal property, which we have the option to use and pay for on an as-needed basis.
Item 3.
Item 3.
Legal Proceedings
On April 17, 2008, we received a grand jury subpoena and search warrant from the U.S. District Court for the Middle District of Florida seeking information regarding an investigation by the Antitrust Division of the Department of Justice (the “DOJ”) into possible antitrust violations in the domestic ocean shipping business. Subsequently, the DOJ expanded the timeframe covered by the subpoena. We are currently providing documents to the DOJ in response to the subpoena. We intend to cooperate fully with the DOJ in its investigation.
We have entered into a conditional amnesty agreement with the DOJ under its Corporate Leniency Policy. The amnesty agreement pertains to a single contract relating to ocean shipping
services provided to the United States Department of Defense. The DOJ has agreed to not bring any criminal prosecution with respect to that government contract as long as we, among other things, continue our full cooperation in the investigation. The amnesty does not bar a claim for damages that may be sought by the DOJ under any applicable federal law or regulation.
On October 9, 2009, we received a Request for Information and Production of Documents from the Puerto Rico Office of Monopolistic Affairs. The request relates to an investigation into possible price fixing and unfair competition in the Puerto Rico domestic ocean shipping business. We are currently providing documents in response to this request, and we intend to cooperate fully in this investigation.
Subsequent to the commencement of the DOJ investigation, a number of purported class action lawsuits were filed against us and other domestic shipping carriers. Fifty-seven cases have been filed in the following federal district courts: eight in the Southern District of Florida, six in the Middle District of Florida, twenty in the District of Puerto Rico, eleven in the Northern District of California, two in the Central District of California, one in the District of Oregon, eight in the Western District of Washington, and one in the District of Alaska. Nineteen of the foregoing district court cases that related to ocean shipping services in the Puerto Rico tradelane were consolidated into a single multidistrict litigation (“MDL”) proceeding in the District of Puerto Rico. All of the foregoing district court cases that related to ocean shipping services in the Hawaii and Guam tradelanes were consolidated into MDL proceedings in the Western District of Washington. One district court case remains in the District of Alaska, relating to the Alaska tradelane.
Each of the federal district court cases purports to be on behalf of a class of individuals and entities who directly, or indirectly in one case, purchased domestic ocean shipping services from the various domestic ocean carriers. The complaints allege price-fixing in violation of the Sherman Act and seek treble monetary damages, costs, attorneys’ fees, and an injunction against the allegedly unlawful conduct.
On June 11, 2009, we entered into a settlement agreement with the plaintiffs in the Puerto Rico MDL litigation. Under the settlement agreement, which is subject to Court approval, we have agreed to pay $20.0 million and to certain base-rate freezes to resolve claims for alleged antitrust violations in the Puerto Rico tradelane. We paid $5.0 million into an escrow account pursuant to the terms of the settlement agreement and will be required to pay $5.0 million within 90 days after preliminary approval of the settlement agreement by the district court and $10.0 million within five business days after final approval of the settlement agreement by the district court.
The base-rate freeze component of the settlement agreement provides that class members who have contracts in the Puerto Rico trade with us as of the effective date of the final settlement agreement would have the option, in lieu of receiving cash, to have their “base rates” frozen for a period of two years. The base-rate freeze would run for two years from the expiration of the contract in effect on the effective date of the final settlement agreement. All class members would be eligible to share in the $20.0 million cash component, but only contract customers of ours would be eligible to elect the base-rate freeze in lieu of receiving cash. We have the right to terminate the settlement agreement under certain circumstances. On July 8, 2009, the plaintiffs filed a motion for preliminary approval of the settlement agreement in the Puerto Rico MDL litigation. Several hearings on the motion for preliminary approval of the settlement agreement have been held where the Court has heard the objections of certain non-settling defendants. We are awaiting the Court’s decision.
On March 20, 2009, we filed a motion to dismiss the claims in the Hawaii and Guam MDL litigation. The plaintiffs filed a response to our motion to dismiss on April 20, 2009, and we filed a reply on May 8, 2009. On August 18, 2009, the District Court for the Western District of Washington entered an order dismissing, without prejudice, the Hawaii and Guam MDL litigation. In dismissing the complaint, however, the plaintiffs were granted thirty days to amend their complaint, and we and the plaintiffs agreed to extend the time to file an amended complaint to November 16, 2009. Subsequently, the Court granted the plaintiffs until May 10, 2010 to file an amended complaint. We and the plaintiffs have agreed to stay discovery in the Alaska litigation. We intend to vigorously defend against these purported class action lawsuits.
In addition, on July 9, 2008, a complaint was filed by Caribbean Shipping Services, Inc. in the Circuit Court, 4th Judicial Circuit in and for Duval County, Florida, against us and other domestic shipping carriers alleging price-fixing in violation of the Florida Antitrust Act and the Florida Deceptive and Unlawful Trade Practices Act. The complaint seeks treble damages, injunctive relief, costs and attorneys’ fees. The case is not brought as a class action. This case is pending discovery.
Through December 20, 2009, we have incurred approximately $22.9 million in legal and professional fees associated with the DOJ investigation and the antitrust related litigation. In addition, we have paid $5.0 million into an escrow account pursuant to the terms of the Puerto Rico MDL settlement agreement. Further, a reserve of $15.0 million related to the expected future payments pursuant to the terms of the settlement of the Puerto Rico MDL litigation has been included in other accrued liabilities on our consolidated balance sheet. We are unable to predict the outcome of the Hawaii and Guam MDL litigation, the Alaska class-action litigation and the Florida Circuit Court litigation. We have not made a provision for any of these claims in the accompanying financial statements. It is possible that the outcome of these proceedings could have a material adverse effect on our financial condition, cash flows and results of operations.
In addition, in connection with the DOJ investigation, it is possible that we could suffer criminal prosecution and be required to pay a substantial fine. We have not made a provision for any possible fines or penalties in the accompanying financial statements, and we can give no assurance that the final resolution of the DOJ investigation will not result in significant liability and will not have a material adverse effect on our financial condition, cash flows and results of operations.
On December 31, 2008, a securities class action lawsuit was filed by the City of Roseville Employees’ Retirement System in the United States District Court for the District of Delaware, naming us and six current and former employees, including our Chief Executive Officer, as defendants. We filed a motion to dismiss and the Court granted the motion to dismiss on November 13, 2009; however, the plaintiffs were granted eleven days to file an amended complaint. We and the plaintiffs agreed to extend the time to file the amended complaint, and the plaintiffs filed their amended complaint on December 23, 2009. The amended complaint added two of our current and former employees as defendants.
The amended complaint purports to be on behalf of purchasers of our common stock. The complaint alleges, among other things, that we made material misstatements and omissions in connection with alleged price-fixing in our shipping business in Puerto Rico in violation of antitrust laws. We are preparing a response to the amended complaint. We are unable to predict the outcome of this lawsuit; however, we believe that we have appropriate disclosure practices and intend to vigorously defend against the lawsuits.
On May 13, 2009, we were served with a complaint filed by a shareholder in Delaware Chancery Court seeking production of certain books and records pursuant to Section 220 of the Delaware General Corporation law. We have reached an agreement on the scope of the required document production and produced the required documents. Subsequently, the suit was dismissed.
In the ordinary course of business, from time to time, we become involved in various legal proceedings. These relate primarily to claims for loss or damage to cargo, employees’ personal injury claims, and claims for loss or damage to the person or property of third parties. We generally maintain insurance, subject to customary deductibles or self-retention amounts, and/or reserves to cover these types of claims. We also, from time to time, become involved in routine employment-related disputes and disputes with parties with which we have contractual relations.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders through the solicitation of proxies or otherwise during the fourth quarter of fiscal 2009.
Part II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s Common Stock is traded on the New York Stock Exchange under the ticker symbol HRZ. As of January 29, 2010, there were approximately 2,656 holders of record of the Common Stock. The following table sets forth the intraday high and low sales price of the Company’s common stock on the New York Stock Exchange for the fiscal periods presented.
On January 28, 2010, our Board of Directors declared a quarterly cash dividend of $0.05 per share for our common stock, which is payable on March 15, 2010 to holders of record at the close of business on March 1, 2010. We have regularly paid quarterly dividends as set forth in the table above. We currently expect that cash dividends comparable to the most recent declaration will continue to be paid in the future although we have no commitment to do so and can provide no assurance this will occur.
During the fourth quarter of 2009, there were no purchases of shares of the Company’s common stock, by or on behalf of the Company or any “affiliated purchaser” as defined by Rule 10b-18(a)(3) of the Securities Exchange Act of 1934.
Equity Compensation Plan Information
The information required by this item will be included in the Company’s proxy statement to be filed for the Annual Meeting of Stockholders to be held on June 1, 2010, and is incorporated herein by reference.
Total Return Comparison Graph
The below graph compares the cumulative total shareholder return of the public common stock of Horizon Lines, Inc. to the cumulative total returns of the Dow Jones U.S. Industrial Transportation Index and the S&P 500 Index for the period in which the Company’s stock has been publicly traded. Cumulative total returns assume reinvestment of dividends.
Comparison of Cumulative Total Return*
Notwithstanding anything to the contrary set forth in any of our filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that might incorporate other filings with the Securities and Exchange Commission, including this annual report on Form 10-K, in whole or in part, the Total Return Comparison Graph shall not be deemed incorporated by reference into any such filings.
*
Comparison graph is based upon $100 invested in the given average or index at the close of trading on September 26, 2005 and $100 invested in the Company’s stock by the opening bell on September 27, 2005, as well as the reinvestment of dividends.
Item 6.
Item 6.
Selected Financial Data
The five year selected financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in this Form 10-K, and our consolidated financial statements and the related notes appearing in Item 15 of this Form 10-K.
We have a 52- or 53-week fiscal year (every sixth or seventh year) that ends on the Sunday before the last Friday in December. Each of the years presented below consisted of 52 weeks.
Selected Financial Data is as follows (in thousands, except per share data):
(1)
As discussed in Item 7
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with Selected Consolidated and Combined Financial Data and our annual audited consolidated financial statements and related notes thereto included elsewhere in this Form 10-K. The following discussion includes forward-looking statements that involve certain risks and uncertainties. For additional information regarding forward looking statements, see the Safe Harbor Statement on page (i) of this Form 10-K.
Executive Overview
The ongoing challenging economic conditions continued to negatively impact our results of operations during 2009. Although we experienced some moderation in volumes towards the end of 2009, our markets were impacted by weakness in consumer spending, tourism, and commercial construction. Throughout 2009, we remained focused on cost containment with the goal of prudently managing our business.
Operating revenue decreased as a result of lower container volumes along with lower fuel surcharges, slightly offset by unit revenue improvements resulting from general rate increases and cargo mix upgrades. General rate increases are typically implemented in order to mitigate contractual expense increases. Terminal services revenue declined as a result of lower exports.
The decrease in operating expense during the year ended December 20, 2009 is primarily due to lower fuel prices, lower container volumes, and a decrease in selling, general and administrative expenses, largely due to the reduction in workforce and lower stock-based compensation expense. Operating expense for the year ended December 20, 2009 includes a $20 million accrual for the potential settlement of the Puerto Rico MDL litigation.
General
We believe that we are the nation’s leading Jones Act container shipping and integrated logistics company, accounting for approximately 37% of total U.S. marine container shipments from the continental U.S. to Alaska, Puerto Rico and Hawaii, constituting the three non-contiguous Jones Act markets, and to Guam and Micronesia. Under the Jones Act, all vessels transporting cargo between U.S. ports must, subject to limited exceptions, be built in the U.S., registered under the U.S. flag, manned by predominantly U.S. crews, and owned and operated by U.S.-organized companies that are controlled and 75% owned by U.S. citizens. We own or lease 20 vessels, 15 of which are fully qualified Jones Act vessels, and approximately 18,500 cargo containers. We also provide comprehensive shipping and logistics services in our markets, including rail, trucking, warehousing, distribution and non-vessel operating common carrier (“NVOCC”) operations. We have long-term access to terminal facilities in each of our ports, operating our terminals in Alaska, Hawaii, and Puerto Rico and contracting for terminal services in the seven ports in the continental U.S. and in the ports in Guam, Yantian and Xiamen, China and Kaohsiung, Taiwan.
History and Transactions
Our long operating history dates back to 1956, when Sea-Land pioneered the marine container shipping industry and established our business. In 1958, we introduced container shipping to the Puerto Rico market and in 1964 we pioneered container shipping in Alaska with the first year-round scheduled vessel service. In 1987, we began providing container shipping services between the U.S. west coast and Hawaii and Guam through our acquisition from an existing carrier of all of its vessels and certain other assets that were already serving that market. Today, as the only Jones Act vessel operator with an integrated organization serving Alaska, Puerto Rico, and Hawaii, we are uniquely positioned to serve our customers that require shipping and logistics services in more than one of these markets.
Horizon Lines, Inc., a Delaware corporation, (the “Company” and together with its subsidiaries, “we”) operates as a holding company for Horizon Lines, LLC (“Horizon Lines”), a Delaware limited liability company and wholly-owned subsidiary, Horizon Logistics Holdings, LLC (“Horizon Logistics”), a Delaware limited liability company and wholly-owned subsidiary, Horizon Lines of Puerto Rico, Inc. (“HLPR”), a Delaware corporation and wholly-owned subsidiary, and Hawaii Stevedores, Inc., a Hawaii corporation (“HSI”).
In December 1999, CSX Corporation, the former parent of Sea-Land Domestic Shipping, LLC (“SLDS”), sold the international marine container operations of Sea-Land to the A.P. Møller Maersk Group (“Maersk”) and SLDS continued to be owned and operated by CSX Corporation as CSX Lines, LLC. On February 27, 2003, Horizon Lines Holding Corp. (“HLHC”) (which at the time was indirectly majority-owned by Carlyle-Horizon Partners, L.P.) acquired from CSX Corporation, 84.5% of CSX Lines, LLC, and 100% of CSX Lines of Puerto Rico, Inc., which together with Horizon Logistics and HSI constitute our business today. CSX Lines, LLC is now known as Horizon Lines, LLC and CSX Lines of Puerto Rico, Inc. is now known as Horizon Lines of Puerto Rico, Inc. The Company was formed as an acquisition vehicle to acquire, on July 7, 2004, the equity interest in HLHC. The Company was formed at the direction of Castle Harlan Partners IV. L.P. (“CHP IV”), a private equity investment fund managed by Castle Harlan, Inc. (“Castle Harlan”). In 2005, the Company completed its initial public offering. Subsequent to the initial public offering, the Company completed three secondary offerings, including a secondary offering (pursuant to a shelf registration) whereby CHP IV and other affiliated private equity investment funds managed by Castle Harlan divested their ownership in the Company.
Basis of Presentation
The accompanying consolidated financial statements include the consolidated accounts of the Company as of December 20, 2009, December 21, 2008 and December 23, 2007 and for the fiscal years ended December 20, 2009, December 21, 2008 and December 23, 2007. Certain prior period balances have been reclassified to conform to current period presentation. In addition, as noted below, certain prior period balances have been adjusted to conform to recent accounting pronouncements.
Fiscal Year
We have a 52- or 53-week (every sixth or seventh year) fiscal year that ends on the Sunday before the last Friday in December. The fiscal years ended December 20, 2009, December 21, 2008 and December 23, 2007 each consisted of 52 weeks.
Critical Accounting Policies
We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of our financial statements requires us to make estimates and assumptions in the reported amounts of revenues and expenses during the reporting period and in reporting the amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of our financial statements. Since many of these estimates and assumptions are
based on future events which cannot be determined with certainty, the actual results could differ from these estimates.
We believe that the application of our critical accounting policies, and the estimates and assumptions inherent in those policies, are reasonable. These accounting policies and estimates are periodically re-evaluated and adjustments are made when facts or circumstances dictate a change. Historically, we have found the application of accounting policies to be appropriate and actual results have not differed materially from those determined using necessary estimates.
We believe the following accounting principles are critical because they involve significant judgments, assumptions, and estimates used in the preparation of our financial statements.
Revenue Recognition
We account for transportation revenue based upon method two under Emerging Issues Task Force No. 91-9 “Revenue and Expense Recognition for Freight Services in Process.” Under this method we record transportation revenue for the cargo when shipped and an expense accrual for the corresponding costs to complete delivery when the cargo first sails from its point of origin. We believe that this method of revenue recognition does not result in a material difference in reported net income on an annual or quarterly basis as compared to recording transportation revenue between accounting periods based upon the relative transit time within each respective period with expenses recognized as incurred. We recognize revenue and related costs of sales for our terminal and other services upon completion of services.
We recognize revenue from logistics operations as service is rendered. Gross revenue consists of the total dollar value of services purchased by shippers. Revenue and the associated costs for the following services are recognized upon proof of delivery of freight: truck brokerage, rail brokerage, expedited international air, expedited domestic ground services, and drayage. Horizon Logistics also offers warehousing/long-term storage for which revenue is recognized based upon warehouse space occupied during the reporting period.
Allowance for Doubtful Accounts and Revenue Adjustments
We maintain an allowance for doubtful accounts based upon the expected collectability of accounts receivable reflective of our historical collection experience. In circumstances in which we are aware of a specific customer’s inability to meet its financial obligation (for example, bankruptcy filings, accounts turned over for collection or litigation), we record a specific reserve for the bad debts against amounts due. For all other customers, we recognize reserves for these bad debts based on the length of time the receivables are past due and other customer specific factors including, type of service provided, geographic location and industry. We monitor our collection risk on an ongoing basis through the use of credit reporting agencies. Accounts are written off after all means of collection, including legal action, have been exhausted. We do not require collateral from our trade customers.
In addition, we maintain an allowance for revenue adjustments consisting of amounts reserved for billing rate changes that are not captured upon load initiation. These adjustments generally arise: (1) when the sales department contemporaneously grants small rate changes (“spot quotes”) to customers that differ from the standard rates in the system; (2) when freight requires dimensionalization or is reweighed resulting in a different required rate; (3) when billing errors occur; and (4) when data entry errors occur. When appropriate, permanent rate changes are initiated and reflected in the system. These revenue adjustments are recorded as a reduction to revenue.
Casualty and Property Insurance Reserves
We purchase insurance coverage for our exposures related to employee injuries (state worker’s compensation and compensation under the Longshore and Harbor workers’ compensation Act), vessel collisions and allisions, property loss and damage, third party liability, and cargo loss and
damage. Most insurance policies include a deductible applicable to each incident or vessel voyage and deductibles can change from year to year as policies are renewed or replaced. Our current insurance program includes deductibles ranging from $0 to $2,000,000. In most cases, our claims personnel work directly with our insurers’ claims professionals or our third-party claim administrators to continually update the anticipated residual exposure for each claim. In this process, we evaluate and monitor each claim individually, and use resources such as historical experience, known trends, and third-party estimates to determine the appropriate reserves for potential liability. Changes in the perceived severity of previously reported claims, significant changes in medical costs, and legislative changes affecting the administration of our plans could significantly impact the determination of appropriate reserves.
Goodwill and Other Identifiable Intangible Assets
Goodwill is reviewed annually, or when events or circumstances dictate, more frequently. The impairment review for goodwill consists of a two- step process of first determining the fair value of the reporting unit and comparing it to the carrying value of the net assets allocated to the reporting unit. If the fair value of the reporting unit exceeds the carrying value, no further analysis or write-down of goodwill is required. If the fair value of the reporting unit is less than the carrying value of the net assets, the implied fair value of the reporting unit is allocated to all the underlying assets and liabilities, including both recognized and unrecognized tangible and intangible assets, based on their fair value. If necessary, goodwill is then written down to its implied fair value. The indefinite-life intangible asset impairment review consists of a comparison of the fair value of the indefinite-life intangible asset with its carrying amount. If the carrying amount exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. If the fair value exceeds its carrying amount, the indefinite-life intangible asset is not considered impaired.
The fair value of a reporting unit is based on quoted market prices, if available. Quoted market prices are often not available for individual reporting units. Accordingly, we base the fair value of a reporting unit on an expected present value technique. The expected present value technique for a reporting unit consists of estimating expected future cash flows discounted using a rate commensurate with the business risk. The estimation of fair value utilizing discounted expected future cash flows includes numerous uncertainties which require our significant judgment when making assumptions of expected revenue, operating costs, marketing, selling and administrative expenses, as well as assumptions regarding the overall shipping and logistics industries, competition, and general economic and business conditions, among other factors.
The majority of the customer contracts and trademarks on the balance sheet as of December 20, 2009 were valued on July 7, 2004, as part of the Acquisition-Related Transactions, using the income appraisal methodology. The income appraisal methodology includes a determination of the present value of future monetary benefits to be derived from the anticipated income, or ownership, of the subject asset. The value of our customer contracts includes the value expected to be realized from existing contracts as well as from expected renewals of such contracts and is calculated using unweighted and weighted total undiscounted cash flows as part of the income appraisal methodology. The value of our trademarks and service marks is based on various factors including the strength of the trade or service name in terms of recognition and generation of pricing premiums and enhanced margins. We amortize customer contracts and trademarks and service marks on a straight-line method over the estimated useful life of four to fifteen years. Long-lived assets are reviewed annually, or more frequently if events or changes in circumstances indicate that the carrying amount of these assets may not be fully recoverable. The assessment of possible impairment is based on our ability to recover the carrying value of our asset based on our estimate of its undiscounted future cash flows. If these estimated future cash flows are less than the carrying value of the asset, an impairment charge would be recognized for the difference between the asset’s estimated fair value and its carrying value.
The determination of fair value is based on quoted market prices in active markets, if available. Such quoted market prices are often not available for our identifiable intangible assets. Accordingly,
we base fair value on projected future cash flows discounted at a rate determined by management to be commensurate with the business risk. The estimation of fair value utilizing discounted forecasted cash flows includes numerous uncertainties which require our significant judgment when making assumptions of revenues, operating costs, marketing, selling and administrative expenses, as well as assumptions regarding the overall shipping and logistics industries, competition, and general economic and business conditions, among other factors.
Vessel Dry-docking
Under U.S. Coast Guard Rules, administered through the American Bureau of Shipping’s alternative compliance program, all vessels must meet specified seaworthiness standards to remain in service carrying cargo between U.S. marine terminals. Vessels must undergo regular inspection, monitoring and maintenance, referred to as dry-docking, to maintain the required operating certificates. These dry-dockings generally occur every two and a half years, or twice every five years. The costs of these scheduled dry-dockings are customarily deferred and amortized over a 30-month period beginning with the accounting period following the vessel’s release from dry-dock because dry-dockings enable the vessel to continue operating in compliance with U.S. Coast Guard requirements.
We also take advantage of vessel dry-dockings to perform normal repair and maintenance procedures on our vessels. These routine vessel maintenance and repair procedures are expensed as incurred. In addition, we will occasionally, during a vessel dry-docking, replace vessel machinery or equipment and perform procedures that materially enhance capabilities of a vessel. In these circumstances, the expenditures are capitalized and depreciated over the estimated useful lives.
Income Taxes
Deferred tax assets represent expenses recognized for financial reporting purposes that may result in tax deductions in the future and deferred tax liabilities represent expense recognized for tax purposes that may result in financial reporting expenses in the future. Certain judgments, assumptions and estimates may affect the carrying value of the valuation allowance and income tax expense in the consolidated financial statements. We record an income tax valuation allowance when the realization of certain deferred tax assets, net operating losses and capital loss carryforwards is not likely. In conjunction with the election of tonnage tax, we revalued our deferred taxes to accurately reflect the rates at which we expect such items to reverse in future periods.
The application of income tax law is inherently complex. As such, we are required to make many assumptions and judgments regarding our income tax positions and the likelihood whether such tax positions would be sustained if challenged. Interpretations and guidance surrounding income tax laws and regulations change over time. As such, changes in our assumptions and judgments can materially affect amounts recognized in the consolidated financial statements.
Stock-Based Compensation
The value of each equity-based award is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model takes into account volatility in the price of our stock, the risk-free interest rate, the estimated life of the equity-based award, the closing market price of our stock and the exercise price. Due to the relatively short period of time since our stock became publicly traded, we base our estimates of stock price volatility on the average of (i) our historical stock price over the period in which it has been publicly traded and (ii) historical volatility of similar entities commensurate with the expected term of the equity-based award; however, this estimate is neither predictive nor indicative of the future performance of our stock. The estimates utilized in the Black-Scholes calculation involve inherent uncertainties and the application of management judgment. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those options expected to vest.
Property and Equipment
We capitalize property and equipment as permitted or required by applicable accounting standards, including replacements and improvements when costs incurred for those purposes extend the useful life of the asset. We charge maintenance and repairs to expense as incurred. Depreciation on capital assets is computed using the straight-line method and ranges from 3 to 40 years. Our management makes assumptions regarding future conditions in determining estimated useful lives and potential salvage values. These assumptions impact the amount of depreciation expense recognized in the period and any gain or loss once the asset is disposed.
We evaluate each of our long-lived assets for impairment using undiscounted future cash flows relating to those assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When undiscounted future cash flows are not expected to be sufficient to recover the carrying amount of an asset, the asset is written down to its fair value.
Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standards Codification (“Codification”) as the single source of authoritative GAAP to be applied by nongovernmental entities, except for the rules and interpretive releases of the SEC under authority of federal securities laws, which are sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification does not change GAAP. Instead, it takes the thousands of individual pronouncements that currently comprise GAAP and reorganizes them into approximately 90 accounting Topics, and displays all Topics using a consistent structure. Contents in each Topic are further organized first by Subtopic, then Section and finally Paragraph. The Paragraph level is the only level that contains substantive content. Citing particular content in the Codification involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure. FASB suggests that all citations begin with “FASB ASC,” where ASC stands for Accounting Standards Codification. SFAS 168, now included within FASB ASC 105 is effective for interim and annual periods ending after September 15, 2009. The adoption of FASB ASC 105 did not have an impact on our consolidated results of operations and financial position, but changes the referencing system for accounting standards.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”), now included within FASB ASC 810. FASB ASC 810 amends the evaluation criteria to identify the primary beneficiary of a variable interest entity and requires ongoing reassessment of whether an enterprise is the primary beneficiary of the variable interest entity. FASB ASC 810 is effective for fiscal years beginning after November 15, 2009, and interim periods within those years. We are in the process of determining the impact the adoption of FASB ASC 810 will have on our results of operations and financial position.
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140” (“SFAS 166”), now included within FASB ASC 860. FASB ASC 860 amends the derecognition guidance in FASB Statement No. 140 and eliminates the exemption from consolidation for qualifying special-purpose entities. FASB ASC 860 is effective for fiscal years beginning after November 15, 2009, and interim periods within those years. We are in the process of determining the impact the adoption of FASB ASC 860 will have on our results of operations and financial position
In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”), now referred to as FASB ASC 855 “Subsequent Events” (“FASB ASC 855”). FASB ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date, but before the financial statements are issued or are available to be issued. FASB ASC 855 requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that
date. This disclosure is intended to alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. FASB ASC 855 is effective on a prospective basis for interim or annual periods ending after June 15, 2009. The adoption of FASB ASC 855 did not have an impact on our consolidated results of operations and financial position.
In May 2008, the FASB issued Staff Position No. APB 14-1, “Accounting for Convertible Debt Instruments that may be Settled in Cash Upon Conversion”, now included within FASB ASC 470 “Debt with Conversion and Other Options” (“FASB ASC 470’’). FASB ASC 470-20 requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate. As a result, the liability component would be recorded at a discount reflecting its below market coupon interest rate, and the liability component would be accreted to its par value over its expected life, with the rate of interest that reflects the market rate at issuance being reflected in the results of operations. This change in methodology affects the calculations of net income and earnings per share, but does not increase our cash interest payments. FASB ASC 470-20 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Retrospective application to all periods presented is required and early adoption is prohibited. Our convertible notes payable are within the scope of FASB ASC 470-20. We have adopted the provisions of FASB ASC 470-20, and as such, have adjusted the reported amounts in our Statements of Operations for the years ended December 21, 2008 and December 23, 2007 and our Balance Sheet as of December 21, 2008 and December 23, 2007 as follows (in thousands except per share amounts):
In June 2008, the FASB issued Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”, now included within FASB ASC 260 “Earnings Per Share” (“FASB ASC 260”). FASB ASC 260-10-45 concludes that unvested share-based payment awards that contain rights to receive non-forfeitable dividends or dividend equivalents (whether paid or unpaid) are participating securities, and thus, should be included in the two-class method of computing earnings per share (“EPS”). FASB ASC 260-10-45 is effective
for fiscal years beginning after December 15, 2008, and interim periods within those years. Retrospective application to all periods presented is required and early application is prohibited. We have adopted the provisions of FASB ASC 260-10-45 and as such, have adjusted the reported amounts of basic and diluted shares outstanding for the years ended December 21, 2008 and December 23, 2007 as follows (in thousands):
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities”, now included within FASB ASC 815. FASB ASC 815 requires companies with derivative instruments to disclose information that should enable financial statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB ASC 815 and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. FASB ASC 815 is effective for financial statements issued for fiscal years beginning after November 15, 2008. As this statement relates only to disclosure requirements, the adoption did not have an impact on our results of operations or financial position.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements”, now included within FASB ASC 810 “Consolidation” (“FASB ASC 810”). FASB ASC 810 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. FASB ASC 810 also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. The adoption did not have an impact on our results of operations or financial position.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations”, now included within FASB ASC 805 “Business Combinations” (“FASB ASC 805”). FASB ASC 805 establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. FASB ASC 805 also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. This standard is effective for fiscal years beginning after December 15, 2008 and early adoption is prohibited. The adoption did not have an impact on our results of operations or financial position.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-including an amendment of FASB Statement No. 115”, now included within FASB ASC 825 “Financial Instruments” (“FASB ASC 825”). FASB ASC 825 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement of certain financial assets and liabilities under an instrument-by-instrument election. Subsequent measurements for the financial assets and liabilities an entity elects to measure at fair value will be recognized in the results of operations. FASB ASC 825 also establishes additional disclosure requirements. This standard is effective for fiscal years beginning after November 15, 2007. Effective for fiscal year 2008, we have adopted the provisions of FASB ASC 825. The adoption did not have an impact on our results of operations and financial position.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, now referred to as FASB ASC 820. FASB ASC 820 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. As a result of FASB ASC 820 there is now a common definition of fair value to be used throughout GAAP. The FASB believes that the new standard will make the measurement of fair value more consistent and comparable and improve disclosures about those measures. The provisions of FASB ASC 820 were to be effective for fiscal years beginning after November 15, 2007. On February 6, 2008, the FASB agreed to defer the effective date for one year for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Effective for fiscal 2008, we have adopted FASB ASC 820 except as it applies to those nonfinancial assets and nonfinancial liabilities. The adoption did not have an impact on our results of operations and financial position.
Shipping Rates
We publish tariffs with rates rules and practices for all three of our Jones Act trade routes. These tariffs are subject to regulation by the Surface Transportation Board (“STB”). However, in the case of our Puerto Rico and Alaska trade routes, we primarily ship containers on the basis of confidential negotiated transportation service contracts that are not subject to rate regulation by the STB. We also publish tariffs for transportation of international cargo which are subject to regulation by the Federal Maritime Commission (“FMC”).
Seasonality
Our container volumes are subject to seasonal trends common in the transportation industry. Financial results in the first quarter are normally lower due to reduced loads during the winter months. Volumes typically build to a peak in the third quarter and early fourth quarter, which generally results in higher revenues, improved margins, and increased earnings and cash flows.
Results of Operations
Operating Revenue Overview
We derive our revenue primarily from providing comprehensive shipping and logistics services to and from the continental U.S. and Alaska, Puerto Rico, Hawaii and Guam. We charge our customers on a per load basis and price our services based primarily on the length of inland and ocean cargo transportation hauls, type of cargo, and other requirements such as shipment timing and type of container. In addition, we assess fuel surcharges on a basis consistent with industry practice and at times may incorporate these surcharges into our basic transportation rates. There is occasionally a timing disparity between volatility in our fuel costs and related adjustments to our fuel surcharges (or the incorporation of adjusted fuel surcharges into our base transportation rates) that may result in variances in our fuel recovery.
During 2009, over 85% of our revenue was generated from our shipping and logistics services in markets where the marine trade is subject to the Jones Act or other U.S. maritime laws. The balance of our revenue is derived from (i) vessel loading and unloading services that we provide for vessel operators at our terminals, (ii) agency services that we provide for third-party shippers lacking administrative presences in our markets, (iii) vessel space charter income from third-parties in trade lanes not subject to the Jones Act, (iv) management of vessels owned by third-parties, (v) warehousing services for third-parties, and (vi) other non-transportation services.
As used in this Form 10-K, the term “revenue containers” refers to containers that are transported for a charge, as opposed to empty containers.
Cost of Services Overview
Our cost of services consist primarily of vessel operating costs, marine operating costs, inland transportation costs, land costs and rolling stock rent. Our vessel operating costs consist primarily of vessel fuel costs, crew payroll costs and benefits, vessel maintenance costs, space charter costs, vessel insurance costs and vessel rent. We view our vessel fuel costs as subject to potential fluctuation as a result of changes in unit prices in the fuel market. Our marine operating costs consist of stevedoring, port charges, wharfage and various other costs to secure vessels at the port and to load and unload containers to and from vessels. Our inland transportation costs consist primarily of the costs to move containers to and from the port via rail, truck or barge. Our land costs consist primarily of maintenance, yard and gate operations, warehousing operations and terminal overhead in the terminals in which we operate. Rolling stock rent consists primarily of rent for street tractors, yard equipment, chassis, gensets and various dry and refrigerated containers.
Year Ended December 20, 2009 Compared to Year Ended December 21,
Horizon Lines Segment
Horizon Lines provides container shipping services and terminal services primarily in the U.S. domestic Jones Act trades, operating a fleet of 20 U.S.-flag containerships and five port terminals linking the continental U.S. with Alaska, Hawaii, Guam, Micronesia, Asia and Puerto Rico. The amounts presented below exclude all intercompany transactions.
Operating Revenue. Operating revenue decreased $147.0 million, or 11.6%, and accounted for approximately 96.7% of consolidated operating revenue. This revenue decrease can be attributed to the following factors (in thousands):
The revenue container volume declines are primarily due to soft market conditions in all of our tradelanes and are partially offset by general rate increases. General rate increases are implemented to mitigate rising contractual costs. Bunker and intermodal fuel surcharges, which are included in our transportation revenue, accounted for approximately 11.5% of total revenue in the year ended December 20, 2009 and approximately 16.4% of total revenue in the year ended December 21, 2008. We adjust our bunker and intermodal fuel surcharges as a result of changes in the cost of bunker fuel for our vessels, in addition to diesel fuel fluctuations passed on to us by our truck, rail, and barge service providers. Fuel surcharges are evaluated regularly as the price of fuel fluctuates, and we may at times incorporate these surcharges into our base transportation rates that we charge. The decrease in non-transportation revenue is primarily due to lower space charter revenue resulting from a decline in fuel surcharges, a reduction in terminal services and the expiration of certain government contracts.
Cost of Services. The $125.5 million reduction in cost of services is primarily due to lower fuel costs as a result of a decrease in fuel prices and a decline in inland costs as a result of lower container volumes and reduced expenses associated with our cost control efforts.
Vessel expense, which is not primarily driven by revenue container volume, decreased $84.3 million for the year ended December 20, 2009. This decrease can be attributed to the following factors (in thousands):
The $81.0 million reduction in fuel costs is comprised of a $73.2 million decrease due to fuel prices and a $7.8 million decline due to lower daily consumption as a result of lower active vessel operating days, changes in vessel deployment, and our focus on both departure and arrival schedule integrity lowering overall consumption. The decline in labor and other vessel operating expense is due to a decrease in the expense accrual for voyages in progress at the end of the year and the recovery of certain employer-paid payroll taxes, partially offset by more operating days in 2009 due to 3 more dry-dockings as compared to 2008. We continue to incur labor expenses associated with the vessels in dry-dock, while at the same time incurring expenses associated with the spare vessel deployed to serve as dry-dock relief.
Marine expense is comprised of the costs incurred to bring vessels into and out of port, and to load and unload containers. The types of costs included in marine expense are stevedoring and associated benefits, pilotage fees, tug fees, government fees, wharfage fees, dockage fees, and line handler fees. Marine expense of $210.3 million for the year ended December 20, 2009 increased $4.4 million as compared to the year ended December 21, 2008 as the increases in multi-employer plan benefit assessments for our west coast union employees and contractual rate increases were partially offset by a decrease in marine expense related to lower container volumes.
Inland expense decreased to $177.4 million for the year ended December 20, 2009 compared to $205.9 million during the year ended December 21, 2008. The $28.5 million decrease in inland expense is primarily due to lower fuel costs, lower container volumes, and our cost control efforts.
Land expense is comprised of the costs included within the terminal for the handling, maintenance and storage of containers, including yard operations, gate operations, maintenance, warehouse and terminal overhead.
Non-vessel related maintenance expenses decreased primarily due to lower fuel costs. Terminal overhead decreased primarily due to lower utilities expense, a decline in compensation costs as a result of the reduction in workforce, and a decrease in severance charges related to certain union employees who elected early retirement. Yard and gate expense is comprised of the costs associated with moving cargo into and out of the terminal facility and the costs associated with the storage of equipment and revenue loads in the terminal facility. Yard and gate expenses increased primarily as a result of $0.2 million due to a one-time stevedoring revenue opportunity, a $0.2 million write down of certain prepaid capital expenditures related to our San Juan, Puerto Rico port redevelopment project as a result of the bankruptcy filing of the general contractor, and $0.2 million of rate increases in the monitoring of refrigerated containers.
Rolling stock expense decreased $7.0 million or 15.9% during the year ended December 20, 2009 as compared to the year ended December 21, 2008. This decrease is primarily due to the off-hire of certain leased container units and increased efficiencies in association with our cost control efforts.
Depreciation and Amortization. Depreciation and amortization was $44.3 million during the year ended December 20, 2009 compared to $44.5 million for the year ended December 21, 2008. The decrease in depreciation-owned vessels is due to certain vessel assets becoming fully depreciated and no longer subject to depreciation expense.
Amortization of Vessel Dry-docking. Amortization of vessel dry-docking was $13.7 million during the year ended December 20, 2009 compared to $17.2 million for the year ended December 21, 2008. Amortization of vessel dry-docking fluctuates based on the timing of dry-dockings, the number of dry-dockings that occur during a given period, and the amount of expenditures incurred during the dry-dockings. Dry-dockings generally occur every two and a half years and historically we have dry-docked approximately six vessels per year.
Selling, General and Administrative. Selling, general and administrative costs decreased to $93.4 million for the year ended December 20, 2009 compared to $100.2 million for the year ended
December 21, 2008, a decline of $6.8 million or 6.7%. This decrease is comprised of a $4.3 million reduction in consultant fees incurred during 2008 related to our process re-engineering initiative, $5.6 million related to the reduction in workforce, and $0.6 million decline in stock-based compensation expense, partially offset by $1.5 million of higher expenses related to the antitrust investigation and related legal proceedings, $3.0 million related to our performance incentive plan, and $1.0 million increase in legal fees unrelated to the antitrust investigation.
Settlement of Class Action Lawsuit. On June 11, 2009, we entered into a settlement agreement with the plaintiffs in the Puerto Rico MDL litigation. Under the settlement agreement, which has not yet been approved by the Court, we have agreed to pay $20.0 million and to certain base-rate freezes, to resolve claims for alleged antitrust violations in the Puerto Rico tradelane.
Impairment Charge. Impairment of assets of $1.9 million during the year ended December 20, 2009 related to a write-down of the carrying value of our spare vessels. Impairment of assets during the year ended December 21, 2008 included $3.3 million and $2.7 million related to our spare vessels and certain owned and leased equipment, respectively.
Restructuring Charge. Restructuring costs of $0.8 million during the year ended December 20, 2009 included $0.7 million and $0.1 million related to severance costs and other costs associated with our workforce reduction initiative, respectively. The $0.7 million of severance costs included $0.5 million related to the acceleration of certain stock-based compensation awards. Restructuring costs during the year ended December 21, 2008 included $3.0 million and $0.1 million related to severance costs and contract termination and legal costs, respectively.
Miscellaneous Expense, Net. Miscellaneous expense, net decreased $1.8 million during the years ended December 20, 2009 compared to the year ended December 21, 2008 primarily as a result of lower bad debt expense during 2009 due to a decrease in revenue.
Horizon Logistics Segment
Horizon Logistics manages integrated logistics service offerings, including rail, trucking and distribution operations. The amounts presented below exclude all intercompany transactions.
Operating Revenue. Horizon Logistics operating revenue accounted for approximately 3.3% of consolidated operating revenue. Revenue increased to $37.7 million during the year ended
December 20, 2009 compared to $36.4 million during the year ended December 21, 2008. This increase is primarily due to the NVOCC and brokerage operations expansion, partially offset by a decline in the demand for our expedited logistics service offering.
Cost of Services. Cost of services increased to $36.5 million for the year ended December 20, 2009 compared to $30.8 million for the year ended December 21, 2008, an increase of $5.7 million. The increase in cost of services is primarily due to the expansion of lower margin service offerings.
Depreciation and Amortization. Depreciation and amortization was $0.6 million during the year ended December 20, 2009 compared to $1.1 million for the year ended December 21, 2008. The decrease in amortization is due to the impairment of the customer relationship intangible asset during the fourth quarter of 2008.
Selling, General and Administrative. Selling, general and administrative costs increased to $8.8 million for the year ended December 20, 2009 compared to $8.0 million for the year ended December 21, 2008, an increase of $0.8 million. This increase is primarily due to increased personnel costs, including $0.4 million related to our performance incentive plan and $0.5 million related to headcount additions in 2009.
Impairment of Assets. Impairment of assets during the year ended December 21, 2008 included $17.7 million and $1.7 million related to goodwill and customer contracts acquired, respectively.
Unallocated Expenses
Interest Expense, Net. Interest expense, net of $39.7 million for the year ended December 20, 2009 was lower compared to $41.4 million during the year ended December 21, 2008. The decrease in interest expense due to the lower outstanding balance on the revolving line of credit and lower LIBOR base rates was partially offset by the higher credit spread percentage rate resulting from the June 2009 amendment to our Senior Credit Facility.
Income Tax Expense. The effective tax rate for the years ended December 20, 2009 and December 21, 2008 was (49.6)% and 81.9%, respectively. During the second quarter of 2009, we determined that it was unclear as to the timing of when we will generate sufficient taxable income to realize our deferred tax assets. Accordingly, we recorded a valuation allowance against our deferred tax assets. Although we have recorded a valuation allowance against our deferred tax assets, it does not affect our ability to utilize our deferred tax assets to offset future taxable income. Until such time that we determine it is more likely than not that we will generate sufficient taxable income to realize our deferred tax assets, income tax benefits associated with future period losses will be fully reserved. As such, the Company’s federal and state tax rates are expected to effectively be 0% and 1%-2%, respectively, during those periods.
During 2006, we elected the application of tonnage tax. Prior to recording a valuation allowance against our deferred tax assets, the effective tax rate was impacted by our income from qualifying shipping activities as well as the income from our non-qualifying shipping activities and will fluctuate based on the ratio of income from qualifying and non-qualifying activities and the relative size of our consolidated income (loss) before income taxes.
Year Ended December 21, 2008 Compared to Year Ended December 23,
Horizon Lines Segment
Operating Revenue. Operating revenue increased $76.9 million, or 6.5%, and accounted for approximately 97.2% of consolidated operating revenue. This revenue increase can be attributed to the following factors (in thousands):
The revenue container volume decline is primarily due to deteriorating market conditions in Puerto Rico and Hawaii and is partially offset by general rate increases. Bunker and intermodal fuel surcharges, which are included in our transportation revenue, accounted for approximately 16.4% of total revenue in the year ended December 21, 2008 and approximately 12.1% of total revenue in the year ended December 23, 2007. We adjusted our bunker and intermodal fuel surcharges several times throughout 2008 and 2007 as a result of fluctuations in the cost of fuel for our vessels, in addition to fuel fluctuations passed on to us by our truck, rail, and barge service providers. Fuel surcharges are evaluated regularly as the price of fuel fluctuates, and we may at times incorporate these surcharges into our base transportation rates that we charge. The increase in non-transportation revenue is primarily due to higher space charter revenue resulting from an increase in fuel surcharges, offset by a decrease in terminal services.
Cost of Services. The $101.0 million increase in cost of services is primarily due to an increase in fuel costs as a result of an increase in fuel prices, which is partially offset by reduced expenses associated with lower container volumes and reduced expenses associated with our cost control efforts.
Vessel expense, which is not primarily driven by revenue container volume, increased $70.8 million for the year ended December 21, 2008. This increase can be attributed to the following factors (in thousands):
The $64.2 million increase in fuel costs is comprised of $75.3 million increase in fuel prices offset by an $11.1 million decrease due to lower fuel consumption, despite an increase in vessel operating days. The decrease in labor and other vessel operating expense is due to lower operating expenses associated with less dry-dockings in 2008 and $3.5 million related to certain one-time expenses associated with the activation of the new vessels during the year ended December 23, 2007. We continue to incur labor expenses associated with vessels that are in dry-dock, while also incurring expenses associated with the spare vessels deployed to serve as dry-dock relief. The reductions were partially offset by higher vessel lay up costs of $1.2 million during the year ended December 21, 2008 and a supplementary premium call related to our protection and indemnity insurance policy totaling $1.3 million for the year ended December 21, 2008.
Marine expense is comprised of the costs incurred to bring vessels into and out of port, and to load and unload containers. The types of costs included in marine expense are stevedoring and benefits, pilotage fees, tug fees, government fees, wharfage fees, dockage fees, and line handler fees. Marine expense increased to $205.9 million for the year ended December 21, 2008 from $198.9 million for the year ended December 23, 2007. The increase in marine expenses can be attributed to increased stevedoring costs related to contractual rate increases and services provided to third parties as a result of the acquisition of HSI, partially offset by lower container volumes.
Inland expense increased to $205.9 million for the year ended December 21, 2008 from $197.6 million for the year ended December 23, 2007, an increase of $8.3 million or 4.2%. The increase in inland expense is due to $12.8 million in higher fuel costs and contractual rates increases, offset slightly by lower container volumes.
Land expense is comprised of the costs included within the terminal for the handling, maintenance and storage of containers, including yard operations, gate operations, maintenance, warehouse and terminal overhead.
Non-vessel related maintenance expenses increased primarily due to $3.1 million of additional fuel expenses. In addition, $0.7 million of maintenance expenses incurred by HSI was offset by a decrease in overall repair expenses. The decrease in overall repair expenses is associated with lower
volumes and our cost control efforts. Terminal overhead increased primarily due to the acquisition of HSI, an increase in rent expense as a result of the move to our warehouse to Compton, California, a severance charge for several union employees who elected early retirement, and labor and other inflationary increases. Yard and gate expense is comprised of the costs associated with moving cargo into and out of the terminal facility and the costs associated with the storage of equipment and revenue loads in the terminal facility. Yard and gate expenses increased primarily due to rate increases in the monitoring of refrigerated containers.
Depreciation and Amortization. Depreciation and amortization was $44.5 million during the year ended December 21, 2008 compared to $41.7 million for the year ended December 23, 2007. The increase in depreciation and amortization-other is primarily due the timing of the purchase and sale of our containers. The increase in amortization of intangible assets is due to the amortization of the intangible assets recorded in conjunction with the acquisition of HSI.
Amortization of Vessel Dry-docking. Amortization of vessel dry-docking during the year ended December 21, 2008 was flat compared to the year ended December 23, 2007. Amortization of vessel dry-docking fluctuates based on the timing of dry-dockings, the number of dry-dockings that occur during a given period, and the amount of expenditures incurred during the dry-dockings. Dry-dockings generally occur every two and a half years and historically we have dry-docked approximately six vessels per year on average.
Selling, General and Administrative. Selling, general and administrative costs increased to $100.2 million for the year ended December 21, 2008 compared to $85.6 million for the year ended December 23, 2007, an increase of $14.6 million or 17.0%. This increase is comprised of $10.7 million of expenses related to the Department of Justice antitrust investigation and related legal proceedings and an increase of approximately $2.0 million in the accrual related to a discretionary performance-based payout.
Impairment of Assets. Impairment of assets included $3.3 million and $2.7 million related to our spare vessels and certain owned and leased equipment, respectively.
Restructuring Costs. Restructuring costs included $3.0 million and $0.1 million related to severance costs and contract termination and legal costs, respectively.
Miscellaneous Expense, Net. Miscellaneous expense, net increased $2.0 million during the year ended December 21, 2008 compared to the year ended December 23, 2007 primarily as a result of an increase in bad debt expense due to higher revenue and lower gain on the sale of assets during 2008.
Horizon Logistics Segment
Horizon Logistics manages integrated logistics service offerings, including rail, trucking and distribution operations. The amounts presented below exclude all intercompany transactions.
Operating Revenue. Horizon Logistics operating revenue accounted for approximately 2.8% of consolidated operating revenue. Approximately $18.9 million of the $20.8 million increase during the year ended December 21, 2008 is due to the acquisition of Aero Logistics.
Cost of Services. Cost of services increased to $30.8 million for the year ended December 21, 2008 compared to $11.1 million for the year ended December 23, 2007, an increase of $19.7 million. The increase in cost of services is primarily due to increased inland expenses as a result of the acquisition of Aero Logistics.
Depreciation and Amortization. Depreciation and amortization was $1.1 million during the year ended December 21, 2008 compared to $6.2 million for the year ended December 23, 2007. The decrease in depreciation-other is due to certain capitalized software assets becoming fully depreciated and no longer subject to depreciation expense. The increase in amortization of intangible assets is due to the amortization of the intangible assets recorded in conjunction with the acquisition of Aero Logistics.
Selling, General and Administrative. Selling, general and administrative costs increased to $8.0 million for the year ended December 21, 2008 compared to $5.3 million for the year ended December 23, 2007, an increase of $2.7 million. This increase is due to the ramp up of activities and personnel within the logistics segment, including the acquisition of Aero Logistics.
Impairment of Assets. Impairment of assets included $17.7 million and $1.7 million related to goodwill and customer contracts acquired, respectively.
Unallocated Expenses
Interest Expense, Net. Interest expense, net decreased to $41.4 million for the year ended December 21, 2008 from $44.9 million for the year ended December 23, 2007, a decrease of $3.5 million or 7.7%. This decrease is a result of the August 2007 refinancing and the related lower interest rates payable on the outstanding debt.
Loss on Early Extinguishment of Debt. Loss on early extinguishment of debt was $38.5 million for the year ended December 23, 2007. The loss on extinguishment of debt is due to the write off of net deferred financing costs and premiums paid in connection with the tender offer for the 9% senior notes and 11% senior discount notes and the extinguishment of the prior senior credit facility.
Income Tax Benefit. The effective tax rate for the years ended December 21, 2008 and December 23, 2007 was 81.9% and (129.8)%, respectively. During 2006, we elected the application of tonnage tax. We modified our trade routes between the U.S. west coast and Guam and Asia during the first quarter of 2007. As such, our shipping activities associated with these modified trade routes became qualified shipping activities, and thus the income from these vessels is excluded from gross income in determining federal income tax liability. During 2007, we recorded a $7.3 million tax benefit related to a revaluation of the deferred taxes associated with the activities now subject to tonnage tax as a result of the modified trade routes and related to a change in estimate resulting in refinements in our methodology for computing secondary activities and cost allocations for tonnage tax purposes. The effective tax rate is impacted by our income from qualifying shipping activities as well as the income from our non-qualifying shipping activities and will fluctuate based on the ratio of income from qualifying and non-qualifying activities and the relative size of our consolidated income (loss) before income taxes.
Liquidity and Capital Resources
Our principal sources of funds have been (i) earnings before non-cash charges and (ii) borrowings under debt arrangements. Our principal uses of funds have been (i) capital expenditures on our container fleet, our terminal operating equipment, improvements to our owned and leased vessel fleet, and our information technology systems, (ii) vessel dry-docking expenditures, (iii) working capital consumption, (iv) principal and interest payments on our existing indebtedness, (v) dividend payments to our common stockholders, (vi) acquisitions, (vii) share repurchases, (viii) premiums associated with the tender offer, and (ix) purchases of equity instruments in conjunction with the Notes. Cash totaled $6.4 million at December 20, 2009. As of December 20, 2009, total unused borrowing capacity under the revolving credit facility was $113.9 million, after taking into account $100.0 million outstanding under the revolver and $11.1 million utilized for outstanding letters of credit. Based on our leverage ratio, borrowing availability under the revolving credit facility was $98.4 million as of December 20, 2009.
Operating Activities
Net cash provided by operating activities was $57.5 million for the year ended December 20, 2009 compared to $89.4 million for the year ended December 21, 2008, a decrease of $31.9 million. The decrease in cash provided by operating activities is primarily due to the following (in thousands):
Net cash provided by operating activities increased by $34.6 million to $89.4 million for the year ended December 21, 2008 from $54.8 million for the year ended December 23, 2007. Net earnings adjusted for depreciation, amortization, deferred income taxes, accretion and other non-cash operating activities, which includes non-cash stock-based compensation expense, resulted in cash flow generation of $92.3 million for the year ended December 21, 2008 compared to $131.6 million for the year ended December 23, 2007, a decrease of $39.3 million. The reduction in cash provided by operating activities is primarily related to a $21.1 million decrease in vessel rent payments in excess of accruals, a decrease of $10.5 million in performance incentive payments in excess of accruals, an $18.5 million decrease in accounts receivable, and a $15.0 million decrease in materials and supplies.
Investing Activities
Net cash used in investing activities was $11.8 million for the year ended December 20, 2009 compared to $38.8 million for the year ended December 21, 2008. The reduction is primarily related to a $26.1 million decrease in capital spending. Capital expenditures during the years ended December 20, 2009 and December 21, 2008 include $2.5 million and $14.1 million, respectively, of progress payments for three new cranes in our Anchorage, Alaska terminal.
Net cash used in investing activities was $38.8 million for the year ended December 21, 2008 compared to $59.4 million for the year ended December 23, 2007. The reduction is primarily related to a $31.1 million decrease in the purchases of businesses, partially offset by a $2.8 million decrease in proceeds from the sale of equipment increase and a $7.7 million increase in capital expenditures, which includes $14.1 million of progress payments for three new cranes in our Anchorage, Alaska terminal.
Financing Activities
Net cash used in financing activities during the year ended December 20, 2009 was $44.8 million compared to $51.3 million for the year ended December 21, 2008. The net cash used in financing activities during the year ended December 20, 2009 included $28.0 million of net debt repayments and $13.4 million of dividends to stockholders. In addition, during the year ended December 20, 2009, we paid $3.5 million in financing costs related to fees associated with the amendment to the Senior Credit Facility.
Net cash used in financing activities during the year ended December 21, 2008 was $51.3 million compared to $83.1 million for the year ended December 23, 2007. The net cash used in financing activities during the year ended December 21, 2008 included $8.5 million of net repayments made on the Senior Credit Facility, $13.3 million of dividends to stockholders and $29.3 million to complete the stock repurchase program. During the year December 23 2007, we refinanced our debt structure. We
used the proceeds provided by the Senior Credit Facility (as defined below) and the Notes (as defined below) to (i) repay $192.8 million of borrowings outstanding under the prior senior credit facility (ii) purchase the outstanding principal and pay associated premiums of the 9% senior notes and 11% senior discount notes purchased in our tender offer, and (iii) purchase 1,000,000 shares of our common stock. Concurrent with the issuance of the Notes, we entered into hedge transactions whereby, under certain circumstances, we have the option to receive shares of our common stock, and we sold warrants whereby certain financial institutions have the option to receive shares of our common stock. Our cost of the note hedge transactions was approximately $52.5 million and we received proceeds of $11.9 million related to the sale of the warrants. The net cash used in financing activities during the year ended December 23, 2007 also includes a $25.0 million prepayment under the Prior Senior Credit Facility, $14.7 million of dividends to stockholders, $20.7 million of treasury stock purchased under the stock repurchase program, and $4.5 million in long-term debt payments related to the outstanding indebtedness secured by mortgages on the Horizon Enterprise and the Horizon Pacific.
Stock Repurchase Program
On November 19, 2007, our Board of Directors authorized the Company to commence a stock repurchase program to buy back up to $50.0 million worth of our common stock. The program allowed us to purchase shares through open market repurchases and privately negotiated transactions at a price of $26.00 per share or less until the program’s expiration on December 31, 2008. We acquired 1,172,700 shares at a total cost of $20.7 million under this program during the fourth quarter of 2007. We completed our share repurchase program in the first quarter of 2008, acquiring an additional 1,627,500 shares at a total cost of $29.3 million.
Capital Requirements and Liquidity
Continued uncertainty in the credit markets has made financing terms for borrowers less attractive and in certain cases has resulted in the unavailability of certain types of debt financing. Although these factors may make it difficult or expensive for us to access credit markets, we have access to credit. We believe we have sufficient liquidity to meet our current needs and are closely managing our cash flows, including capital spending, based on current and anticipated volume levels. We will defer or limit capital additions where economically feasible. Based upon our current level of operations, we believe that cash flow from operations and available cash, together with borrowings available under the senior credit facility, will be adequate to meet our liquidity needs throughout 2010. During 2010, we expect to spend approximately $20.0 million and $25.0 million on capital expenditures and dry-docking expenditures, respectively. Such capital expenditures will include terminal infrastructure and equipment, continued redevelopment of our San Juan, Puerto Rico terminal, and vessel regulatory, modification, and maintenance initiatives. We intend to utilize our cash flows for working capital needs, to make debt repayments, to fund the potential settlement of the Puerto Rico MDL, and to pay dividends. Our term loan payments increase from $6.3 million in 2009 to $18.8 million in 2010. Although, we currently expect that cash dividends will continue to be paid in the future, we have no commitment to do so and can provide no assurance this will occur. Due to the seasonality within our business, we will utilize borrowings under the senior credit facility in the first half of 2010, but plan to repay such borrowings in the second half of the year.
Contractual Obligations and Off-Balance Sheet Arrangements
Contractual obligations as of December 20, 2009 are as follows (in thousands):
(1)
The above contractual obligations table does not include the residual guarantee related to our transaction with Ship Finance Limited. If Horizon Lines does not elect to purchase the vessels at the end of the initial twelve year period and the vessel owners sell the vessels for less than a specified amount, Horizon Lines is responsible for paying the amount of such shortfall which will not exceed $3.8 million per vessel. Such residual guarantee has been recorded at its fair value of approximately $0.2 million as a liability.
(2)
Included in contractual obligations are scheduled interest payments. Interest payments on the term loan portion of the senior credit facility are fixed and based on the interest rate swap (as defined below). Interest payments on the revolver portion of the senior credit facility are variable and are based as of December 20, 2009 upon the London Inter-Bank Offered Rate (LIBOR) plus 3.25%. The three-month LIBOR /swap curve has been utilized to estimate interest payments on the senior credit facility. Interest on the 4.25% convertible senior notes is fixed and is paid semi-annually on February 15 and August 15 of each year, until maturity on August 15, 2012.
(3)
Other commitments includes the purchase commitment related to the Anchorage, Alaska cranes, restructuring liabilities, and pending settlement of the class action lawsuit.
We are not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Long-Term Debt
Senior Credit Facility
On August 8, 2007, we entered into a credit agreement (the “Senior Credit Facility”) secured by substantially all our owned assets. On June 11, 2009, the Senior Credit Facility was amended resulting in a reduction in the size of the revolving credit facility from $250.0 million to $225.0 million. The terms of the Senior Credit Facility also provide for a $20.0 million swingline subfacility and a $50.0 million letter of credit subfacility.
The amendment to the Senior Credit Facility is intended to provide us the flexibility that we need to effect the settlement of the Puerto Rico class action litigation and to incur other antitrust related
litigation expenses. The amendment revises the definition of Consolidated EBITDA by allowing for certain charges, including (i) the Puerto Rico settlement and (ii) litigation expenses related to antitrust litigation matters in an amount not to exceed $25 million in the aggregate and $15 million over a 12-month period, to be added back to the calculation of Consolidated EBITDA. In addition, the Senior Credit Facility was amended to (i) increase the spread over LIBOR and Prime based rates by 150 bps, (ii) increase the range of fees on the unused portion of the commitment, (iii) eliminate the $150 million incremental facility, (iv) modify the definition of Consolidated EBITDA to eliminate the term “non-recurring charges”, and (v) incorporate other structural enhancements, including a step-down in the secured leverage ratio and further limitations on the ability to make certain restricted payments. As a result of the amendment to the Senior Credit Facility, we paid $3.5 million in financing costs and recorded a loss on modification of debt of $0.1 million.
We have made quarterly principal payments on the term loan of approximately $1.6 million since December 31, 2007. Effective December 31, 2009, quarterly payments will increase to $4.7 million through September 30, 2011, at which point quarterly payments will increase to $18.8 million until final maturity on August 8, 2012. The interest rate payable under the Senior Credit Facility varies depending on the types of advances or loans we select. Borrowings under the Senior Credit Facility bear interest primarily at LIBOR-based rates plus a spread which ranges from 2.75% to 3.5% (LIBOR plus 3.25% as of December 20, 2009) depending on our ratio of total secured debt to EBITDA (as defined in the Senior Credit Facility). We also have the option to borrow at Prime plus a spread which ranges from 1.75% to 2.5% (Prime plus 2.25% as of December 20, 2009). The weighted average interest rate at December 20, 2009 was approximately 5.1%, which includes the impact of the interest rate swap (as defined below). We also pay a variable commitment fee on the unused portion of the commitment, ranging from 0.375% to 0.50% (0.50% as of December 20, 2009).
The Senior Credit Facility contains customary affirmative and negative covenants and warranties, including two financial covenants with respect to our leverage and interest coverage ratio and limits the level of dividends and stock repurchases in addition to other restrictions. It also contains customary events of default, subject to grace periods. We were in compliance with all such covenants as of December 20, 2009 and expect to be in compliance during 2010.
Derivative Instruments
On March 31, 2008, we entered into an Interest Rate Swap Agreement (the “swap”) with Wachovia Bank, National Association, a current subsidiary of Wells Fargo & Co., (“Wachovia”) in the notional amount of $121.9 million. The swap expires on August 8, 2012. Under the swap, the Company and Wachovia have agreed to exchange interest payments on the notional amount on the last business day of each calendar quarter. We have agreed to pay a 3.02% fixed interest rate, and Wachovia has agreed to pay a floating interest rate equal to the three-month LIBOR rate. The critical terms of the swap agreement and the term loan are the same, including the notional amounts, interest rate reset dates, maturity dates and underlying market indices. The purpose of entering into this swap is to protect us against the risk of rising interest rates by effectively fixing the base interest rate payable related to our term loan.
The swap has been designated as a cash flow hedge of the variability of the cash flows due to changes in LIBOR and has been deemed to be highly effective. Accordingly, we record the fair value of the swap as an asset or liability on our consolidated balance sheet, and any unrealized gain or loss is included in accumulated other comprehensive (loss) income. As of December 20, 2009, we recorded a liability of $4.5 million, of which $0.7 million is included in other accrued liabilities and $3.8 million is included in other long-term liabilities, in the accompanying consolidated balance sheet. We also recorded $0.2 million and $3.9 million in other comprehensive income (loss) for the years ended December 20, 2009 and December 21, 2008, respectively. No hedge ineffectiveness was recorded during the years ended December 20, 2009 and December 21, 2008. If the hedge was deemed ineffective, or extinguished by either counterparty, any accumulated gains or losses remaining in other comprehensive income would be fully recorded in interest expense during the period.
4.25% Convertible Senior Notes
On August 8, 2007, we issued $330.0 million aggregate principal amount of 4.25% Convertible Senior Notes due 2012 (the “Notes”). The Notes are general unsecured obligations of the Company and rank equally in right of payment with all of our other existing and future obligations that are unsecured and unsubordinated. The Notes bear interest at the rate of 4.25% per annum, which is payable in cash semi-annually on February 15 and August 15 of each year. The Notes mature on August 15, 2012, unless earlier converted, redeemed or repurchased in accordance with their terms prior to August 15, 2012. Holders of the Notes may require us to repurchase the Notes for cash at any time before August 15, 2012 if certain fundamental changes occur.
Each $1,000 of principal of the Notes will initially be convertible into 26.9339 shares of our common stock, which is the equivalent of $37.13 per share, subject to adjustment upon the occurrence of specified events set forth under the terms of the Notes. Upon conversion, we would pay the holder the cash value of the applicable number of shares of our common stock, up to the principal amount of the note. Amounts in excess of the principal amount, if any, may be paid in cash or in stock, at our option. Holders may convert their Notes into our common stock as follows:
•
Prior to May 15, 2012, if during any calendar quarter, and only during such calendar quarter, if the last reported sale price of our common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter exceeds 120% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter;
•
During any five business day period prior to May 15, 2012, immediately after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of notes for each day of such measurement period was less than 98% of the product of the last reported sale price of our common stock on such date and the conversion rate on such date;
•
If, at any time, a change in control occurs or if we are a party to a consolidation, merger, binding share exchange or transfer or lease of all or substantially all of its assets, pursuant to which the Company’s common stock would be converted into cash, securities or other assets; or
•
At any time after May 15, 2012 through the fourth scheduled trading day immediately preceding August 15, 2012.
Holders who convert their Notes in connection with a change in control may be entitled to a make-whole premium in the form of an increase in the conversion rate. In addition, upon a change in control, liquidation, dissolution or de-listing, the holders of the Notes may require us to repurchase for cash all or any portion of their Notes for 100% of the principal amount plus accrued and unpaid interest. As of December 20, 2009, none of the conditions allowing holders of the Notes to convert or requiring us to repurchase the Notes had been met. We may not redeem the Notes prior to maturity.
Concurrent with the issuance of the Notes, we entered into note hedge transactions with certain financial institutions whereby if we are required to issue shares of our common stock upon conversion of the Notes, we have the option to receive up to 8.9 million shares of our common stock when the price of our common stock is between $37.13 and $51.41 per share upon conversion, and we sold warrants to the same financial institutions whereby the financial institutions have the option to receive up to 17.8 million shares of our common stock when the price of our common stock exceeds $51.41 per share upon conversion. The separate note hedge and warrant transactions were structured to reduce the potential future share dilution associated with the conversion of Notes. The cost of the note hedge transactions to the Company was approximately $52.5 million which has been accounted for as an equity transaction. We recorded a $19.1 million income tax benefit related to the cost of the hedge transaction that was subsequently fully reserved as part of recording a full valuation allowance against
our deferred tax assets. We received proceeds of $11.9 million related to the sale of the warrants, which has also been classified as equity.
The Notes and the warrants sold in connection with the hedge transactions will have no impact on diluted earnings per share until the price of the Company’s common stock exceeds the conversion price (initially $37.13 per share) because the principal amount of the Notes will be settled in cash upon conversion. Prior to conversion of the Notes or exercise of the warrants, we will include the effect of the additional shares that may be issued if our common stock price exceeds the conversion price, using the treasury stock method. The call options purchased as part of the note hedge transactions are anti-dilutive and therefore will have no impact on earnings per share.
Goodwill
We review our goodwill, intangible assets and long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable, and also review goodwill annually.
As of December 20, 2009, the carrying value of goodwill related to our Horizon Lines and Horizon Logistics segments was $314.2 million and $2.9 million, respectively. Earnings estimated to be generated related to our Horizon Lines segment are expected to support the carrying value of its goodwill. Our Horizon Logistics business is currently facing the challenges of building and expanding a business during difficult economic times. If these overall economic conditions worsen or continue for an extended period of time, we may be required to record an additional impairment charge against the carrying value of the goodwill related to our Horizon Logistics segment.
Performance Metrics
In addition to EBITDA and Adjusted EBITDA, we use various other non-GAAP measures such as adjusted net income, and adjusted net income per share. We believe that in addition to GAAP based financial information, the non-GAAP amounts presented below are meaningful disclosures for the following reasons: (i) each are components of the measure used by our board of directors and management team to evaluate our operating performance, (ii) each are components of the measure used by our management team to make day-to-day operating decisions, (iii) each are components of the measures used by our management to facilitate internal comparisons to competitors’ results and the marine container shipping and logistics industry in general, (iv) results excluding certain costs and expenses provide useful information for the understanding of the ongoing operations with the impact of significant special items, and (v) the payment of discretionary bonuses to certain members of our management is contingent upon, among other things, the satisfaction by Horizon Lines of certain targets, which contain the non-GAAP measures as components. We acknowledge that there are limitations when using non-GAAP measures. The measures below are not recognized terms under GAAP and do not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. Similar to the amounts presented for EBITDA and Adjusted EBITDA, because all companies do not use identical calculations, the amounts below may not be comparable to other similarly titled measures of other companies.
The tables below present a reconciliation of net loss to adjusted net income and net loss per share to adjusted net income per share (in thousands, except per share amounts):
Outlook
We expect conditions in the markets where we operate to remain challenging in 2010. Some of our market economies are beginning to exhibit possible signs of modest recovery, which could be further fueled by the federal economic stimulus program. While we see the potential for volume stabilization and slight rate improvement given this scenario, we also expect ongoing fuel price volatility and increased contractual labor costs and benefits assessments through 2010. Based on these expectations, we will continue to aggressively manage costs, maintain liquidity, and closely manage cash flow. We also anticipate some ongoing antitrust-related legal fees as we continue to cooperate with the DOJ in its ongoing investigation. And like last year, we expect that first-half comparisons will be more difficult than in the second half, due to higher fuel prices, flat container rates and increased dry-dock costs. We see the potential for volumes to begin strengthening in line with seasonal and economic firming trends in the second half of the year. Lastly, we are continuing to review our Maersk agreements in anticipation of their scheduled expiration in December 2010. Key among these agreements are arrangements in which we pay Maersk for terminal services at ports in
the continental United States, and those whereby Maersk pays Horizon Lines for space on our vessels that run between Asia and the U.S. West Coast.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Our primary interest rate exposure relates to the Senior Credit Facility. As of December 20, 2009, we had outstanding a $112.5 million term loan and $100.0 million under the revolving credit facility, which bear interest at variable rates.
On March 31, 2008, the Company entered into an Interest Rate Swap Agreement (the “swap”) with Wachovia Bank, National Association, a current subsidiary of Wells Fargo & Co., (“Wachovia”) in the notional amount of $121.9 million. The swap expires on August 8, 2012. Under the swap, the Company and Wachovia have agreed to exchange interest payments on the notional amount on the last business day of each calendar quarter. The Company has agreed to pay a 3.02% fixed interest rate, and Wachovia has agreed to pay a floating interest rate equal to the three-month LIBOR rate. The critical terms of the swap agreement and the term loan are the same, including the notional amounts, interest rate reset dates, maturity dates and underlying market indices. The purpose of entering into this swap is to protect the Company against the risk of rising interest rates by effectively fixing the base interest rate payable related to its term loan. Interest rate differentials paid or received under the swap are recognized as adjustments to interest expense. The Company does not hold or issue interest rate swap agreements for trading purposes. In the event that the counter-party fails to meet the terms of the interest rate swap agreement, the Company’s exposure is limited to the interest rate differential.
Each quarter point change in interest rates or spread would result in a $0.3 million change in annual interest expense on the revolving credit facility.
We maintain a policy for managing risk related to exposure to variability in interest rates, fuel prices and other relevant market rates and prices which includes entering into derivative instruments in order to mitigate our risks.
Our exposure to market risk for changes in interest rates is limited to our senior credit facility and one of our operating leases. The interest rate for our senior credit facility is currently indexed to LIBOR of one, two, three, or six months as selected by us, or the Alternate Base Rate as defined in the senior credit facility. One of our operating leases is currently indexed to LIBOR of one month.
In addition, at times we utilize derivative instruments tied to various indexes to hedge a portion of our quarterly exposure to bunker fuel price increases. These instruments consist of fixed price swap agreements. We do not use derivative instruments for trading purposes. Credit risk related to the derivative financial instruments is considered minimal and is managed by requiring high credit standards for its counterparties.
Changes in fair value of derivative financial instruments are recorded as adjustments to the assets or liabilities being hedged in the statement of operations or in accumulated other comprehensive income (loss), depending on whether the derivative is designated and qualifies for hedge accounting, the type of hedge transaction represented and the effectiveness of the hedge.
The table below provides information about our funded debt obligations indexed to LIBOR. The principal cash flows are in thousands.
(1)
We receive the arithmetic average of the reference price calculated using the unweighted method of averaging.
Item 8.
Item 8.
Financial Statements and Supplementary Data
See index in Item 15 of this annual report on Form 10-K. Quarterly information (unaudited) is presented in a Note to the consolidated financial statements.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures designed to ensure information required to be disclosed in Company reports filed under the Securities Exchange Act of 1934, as amended (“the Exchange Act”), is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in Company reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15(b) of the Exchange Act as of December 20, 2009. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of December 20, 2009.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) under the Securities Exchange Act of 1934. Pursuant to the rules and regulations of the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officers, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Due to inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Further, because of changes in conditions, effectiveness of internal control over financial reporting may vary over time.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our internal control over financial reporting as of December 20, 2009 based on the control criteria established in a report entitled Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on such evaluation management has concluded that our internal control over financial reporting is effective as of December 20, 2009.
Ernst and Young LLP, our independent registered public accounting firm, has issued an attestation report on the effectiveness of the Company’s internal controls over financial reporting, which is on page of this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during our fiscal quarter ending December 20, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information
None.
Part III
Item 10.
Item 10.
Directors and Executive Officers of the Registrant
The information required by this item as to the Company’s executive officers, directors, director nominees, audit committee financial expert, audit committee, and procedures for stockholders to recommend director nominees will be included in the Company’s proxy statement to be filed for the Annual Meeting of Stockholders to be held on June 1, 2010, and is incorporated by reference herein. The information required by this item as to compliance by the Company’s directors, executive officers and certain beneficial owners of the Company’s Common Stock with Section 16(a) of the Securities Exchange Act of 1934 also will be included in said proxy statement and also is incorporated herein by reference.
The Company has adopted a Code of Business Conduct and Ethics that governs the actions of all Company employees, including officers and directors. The Code of Business Conduct and Ethics is posted within the Investor Relations section of the Company’s internet website at www.horizonlines.com. The Company will provide a copy of the Code of Business Conduct and Ethics to any stockholder upon request. Any amendments to and/or any waiver from a provision of any of the Code of Business Conduct and Ethics granted to any director, executive officer or any senior financial officer, must be approved by the Board of Directors and will be disclosed on the Company’s internet website as soon as reasonably practical following the amendment or waiver. The information contained on or connected to the Company’s internet website is not incorporated by reference into this Form 10-K and should not be considered part of this or any other report that the Company files with or furnishes to the Securities and Exchange Commission.
Item 11.
Item 11.
Executive Compensation
The information required by this item will be included in the Company’s proxy statement to be filed for the Annual Meeting of Stockholders to be held on June 1, 2010, and is incorporated herein by reference.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item will be included in the Company’s proxy statement to be filed for the Annual Meeting of Stockholders to be held on June 1, 2010, and is incorporated herein by reference.
Item 13.
Item 13.
Certain Relationships and Related Transactions
The information required by this item will be included in the Company’s proxy statement to be filed for the Annual Meeting of Stockholders to be held on June 1, 2010, and is incorporated herein by reference.
Item 14.
Item 14.
Principal Accountant Fees and Services
The information required by this item will be included in the Company’s proxy statement to be filed for the Annual Meeting of Stockholders to be held on June 1, 2010, and is incorporated herein by reference.
Part IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a)(1) Financial Statements:
Horizon Lines, Inc.
Index to Consolidated Financial Statements
(a)(2) Exhibits:
*
Exhibit represents a management contract or compensatory plan.

Portions of this document were omitted and filed separately pursuant to a request for confidential treatment in accordance with Rule 406 of the Securities Act.

Portions of this document were omitted and filed separately pursuant to a request for confidential treatment in accordance with Rule 24b-2 of the Exchange Act.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on the 4th day of February 2010.
HORIZON LINES, INC.
By:
/s/ Charles G. Raymond
Charles G. Raymond
Chairman, Chief Executive Officer and President
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrants and in the capacities and on the 4th day of February 2010.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Horizon Lines, Inc.
We have audited the accompanying consolidated balance sheets of Horizon Lines, Inc. as of December 20, 2009 and December 21, 2008, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 20, 2009. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Horizon Lines, Inc. at December 20, 2009 and December 21, 2008, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 20, 2009 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, effective December 22, 2008 the Company adopted Financial Accounting Standards Board Staff Position No. 14-1, “Accounting for Convertible Debt Instruments that may be Settled in Cash Upon Conversion”, now included in FASB ASC 470, “Debt with Conversion Features”, and Financial Accounting Standards Board Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”, now included in FASB ASC 260 “Earnings Per Share”, and retrospectively adjusted all periods presented in the consolidated financial statements referred to above.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Horizon Lines, Inc.’s internal control over financial reporting as of December 21, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 4, 2010 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Charlotte, North Carolina
February 4, 2010
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Horizon Lines, Inc.
We have audited Horizon Lines, Inc.’s internal control over financial reporting as of December 20, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Horizon Lines, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Horizon Lines, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 20, 2009, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Horizon Lines, Inc. as of December 20, 2009 and December 21, 2008, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 20, 2009 and our report dated February 4, 2010 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Charlotte, North Carolina
February 4, 2010
Horizon Lines, Inc.
Consolidated Balance Sheets
The accompanying notes are an integral part of these consolidated financial statements.
Horizon Lines, Inc.
Consolidated Statements of Operations
The accompanying notes are an integral part of these consolidated financial statements.
Horizon Lines, Inc.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these consolidated financial statements.
Horizon Lines, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
(1)
Adjusted as a result of the retrospective adoption of FSP APB 14-1.
The accompanying notes are an integral part of these consolidated financial statements.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements
1.
Basis of Presentation and Operations
Horizon Lines, Inc. (the “Company”) operates as a holding company for Horizon Lines, LLC (“Horizon Lines”), a Delaware limited liability company and wholly-owned subsidiary, Horizon Logistics Holdings, LLC (“Horizon Logistics”), a Delaware limited liability company and wholly-owned subsidiary, Hawaii Stevedores, Inc. (“HSI”), a Hawaii corporation, and Horizon Lines of Puerto Rico, Inc. (“HLPR”), a Delaware corporation and wholly-owned subsidiary. Horizon Lines operates as a Jones Act container shipping business with primary service to ports within the continental United States, Puerto Rico, Alaska, Hawaii, and Guam. Under the Jones Act, all vessels transporting cargo between covered locations must, subject to limited exceptions, be built in the U.S., registered under the U.S. flag, manned by predominantly U.S. crews, and owned and operated by U.S.-organized companies that are controlled and 75% owned by U.S. citizens. Horizon Lines also offers terminal services. Horizon Logistics manages integrated logistics service offerings, including rail, trucking, warehousing, distribution, and non-vessel operating common carrier (“NVOCC”) services. HLPR operates as an agent for Horizon Lines in Puerto Rico and also provides terminal services in Puerto Rico.
The accompanying consolidated financial statements include the consolidated accounts of the Company and its majority owned subsidiaries and the related consolidated statements of operations, stockholders’ equity and cash flows. All significant intercompany accounts and transactions have been eliminated. Certain prior period balances have been reclassified to conform to current period presentation. In addition, as noted below, certain prior period balances have been adjusted to conform to recent accounting pronouncements.
In June 2009, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standards Codification (“Codification”) as the single source of authoritative GAAP to be applied by nongovernmental entities, except for the rules and interpretive releases of the SEC under authority of federal securities laws, which are sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification does not change GAAP. Instead, it takes the thousands of individual pronouncements that currently comprise GAAP and reorganizes them into approximately 90 accounting Topics, and displays all Topics using a consistent structure. Contents in each Topic are further organized first by Subtopic, then Section and finally Paragraph. The Paragraph level is the only level that contains substantive content. Citing particular content in the Codification involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure. FASB suggests that all citations begin with “FASB ASC,” where ASC stands for Accounting Standards Codification. SFAS 168, now included within FASB ASC 105, is effective for interim and annual periods ending after September 15, 2009. The adoption of FASB ASC 105 did not have an impact on the Company’s consolidated results of operations and financial position, but changes the referencing system for accounting standards.
In May 2008, the FASB issued Staff Position No. APB 14-1, “Accounting for Convertible Debt Instruments that may be Settled in Cash Upon Conversion”, now included within FASB ASC 470 “Debt with Conversion and Other Options” (“FASB ASC 470-20”). FASB ASC 470-20 requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate. As a result, the liability component would be recorded at a discount reflecting its below market coupon interest rate, and the liability component would be accreted to its par value over its expected life, with the rate of interest that reflects the market rate at issuance being reflected in the results of operations. This change in methodology affects the calculations of net income and earnings per share, but does not increase the Company’s cash interest
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
payments. FASB ASC 470-20 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Retrospective application to all periods presented is required and early adoption is prohibited. The Notes (as defined in Note 10) are within the scope of FASB ASC 470-20. The Company has adopted the provisions of FASB ASC 470-20, and as such, has adjusted the reported amounts in its Statements of Operations for the years ended December 21, 2008 and December 23, 2007 and its Balance Sheets as of December 21, 2008 and December 23, 2007 as follows (in thousands except per share amounts):
In June 2008, the FASB issued Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”, now included within FASB ASC 260 “Earnings Per Share” (“FASB ASC 260”). FASB ASC 260-10-45 concludes that unvested share-based payment awards that contain rights to receive non-forfeitable dividends or dividend equivalents (whether paid or unpaid) are participating securities, and thus, should be included in the two-class method of computing earnings per share (“EPS”). FASB ASC 260-10-45 is effective for fiscal years beginning after December 15, 2008, and interim periods within those years. Retrospective application to all periods presented is required and early application is prohibited. The Company has adopted the provisions of FASB ASC 260-10-45 and as such, has adjusted the reported amounts
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
of basic and diluted shares outstanding for the years ended December 21, 2008 and December 23, 2007 as follows (in thousands):
2.
Significant Accounting Policies
Cash
Cash of the Company consists principally of cash held in banks and temporary investments having a maturity of three months or less at the date of acquisition.
Allowance for Doubtful Accounts and Revenue Adjustments
The Company maintains an allowance for doubtful accounts based upon the expected collectability of accounts receivable reflective of its historical collection experience. In circumstances in which management is aware of a specific customer’s inability to meet its financial obligation to the Company (for example, bankruptcy filings, accounts turned over for collection or litigation), the Company records a specific reserve for the bad debts against amounts due. For all other customers, the Company recognizes reserves for these bad debts based on the length of time the receivables are past due and other customer specific factors including, type of service provided, geographic location and industry. The Company monitors its collection risk on an ongoing basis through the use of credit reporting agencies. Accounts are written off after all means of collection, including legal action, have been exhausted. The Company does not require collateral from its trade customers.
In addition, the Company maintains an allowance for revenue adjustments consisting of amounts reserved for billing rate changes that are not captured upon load initiation. These adjustments generally arise: (1) when the sales department contemporaneously grants small rate changes (“spot quotes”) to customers that differ from the standard rates in the system; (2) when freight requires dimensionalization or is reweighed resulting in a different required rate; (3) when billing errors occur; and (4) when data entry errors occur. When appropriate, permanent rate changes are initiated and reflected in the system. These revenue adjustments are recorded as a reduction to revenue. During 2009, average revenue adjustments per month were approximately $0.5 million, on average total revenue per month of approximately $96.5 million (less than 0.5% of monthly revenue). In order to estimate the allowance for revenue adjustments related to ending accounts receivable, the Company prepares an analysis that considers average total monthly revenue adjustments and the average lag for identifying and processing these revenue adjustments. Based on this analysis, the Company establishes an allowance for approximately 80-90 days (dependent upon experience in the last twelve months) of average revenue adjustments, adjusted for rebates and billing errors. The lag is periodically adjusted based on actual historical experience. Additionally, the average amount of revenue adjustments per month can vary in relation to the level of sales or based on other factors (such as personnel issues that could result in excessive manual errors or in excessive spot quotes being granted). Both of these significant assumptions are continually evaluated for validity.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
The allowance for doubtful accounts and revenue adjustments approximated $7.6 million at December 20, 2009 and $8.2 million at December 21, 2008.
Materials and Supplies
Materials and supplies consist primarily of fuel inventory aboard vessels and inventory for maintenance of property and equipment. Fuel is carried at cost on the first in, first out (FIFO) basis, while all other materials and supplies are carried at average cost.
Property and Equipment
Property and equipment are stated at cost. Certain costs incurred in the development of internal-use software are capitalized. Routine maintenance, repairs, and removals other than vessel dry-dockings are charged to expense. Expenditures that materially increase values, change capacities or extend useful lives of the assets are capitalized. Depreciation and amortization is computed by the straight-line method over the estimated useful lives of the assets. The estimated useful lives of the Company’s assets are as follows:
The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When undiscounted future cash flows will not be sufficient to recover the carrying amount of an asset, the asset is written down to its fair value.
Vessel Dry-docking
Vessels must undergo regular inspection, monitoring and maintenance, referred to as dry-docking, to maintain the required operating certificates. United States Coast Guard regulations generally require that vessels be dry-docked twice every five years. The costs of these scheduled dry-dockings are customarily capitalized and are then amortized over a 30-month period beginning with the accounting period following the vessel’s release from dry-dock, because dry-dockings enable the vessel to continue operating in compliance with U.S. Coast Guard requirements,.
The Company takes advantage of vessel dry-dockings to also perform normal repair and maintenance procedures on the vessels. These routine vessel maintenance and repair procedures are charged to expense as incurred. In addition, the Company will occasionally during a vessel dry-docking, replace vessel machinery or equipment and perform procedures that materially enhance capabilities of a vessel. In these circumstances, the expenditures are capitalized and depreciated over the estimated useful lives.
Intangible Assets
Intangible assets consist of goodwill, customer contracts/relationships, trademarks, non-compete agreements and deferred financing costs. The Company amortizes customer contracts/relationships using the straight line method over the expected useful lives of 4 to 10 years. The Company also amortizes trademarks using the straight line method over the expected life of the related trademarks
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
of 15 years. The Company amortizes debt issue cost using the effective interest method over the term of the related debt.
Goodwill and other intangible assets with indefinite useful lives are not amortized but are subject to annual impairment tests as of the first day of the fourth quarter. At least annually, or sooner if there is an indicator of impairment, the fair value of the reporting unit is calculated. If the calculated fair value is less than the carrying amount, an impairment loss might be recognized.
Revenue Recognition
The Company records transportation revenue and an accrual for the corresponding costs to complete delivery when the cargo first sails from its point of origin. The Company believes this method of revenue recognition does not result in a material difference in reported net income on an annual or quarterly basis as compared to recording transportation revenue between accounting periods based upon the relative transit time within each respective period with expenses recognized as incurred. The Company recognizes revenue and related costs of sales for terminal and other services upon completion of services.
The Company recognizes revenue from logistics operations as service is rendered. Gross revenues consist of the total dollar value of services purchased by shippers. Revenue and the associated costs for the following services are recognized upon proof of delivery of freight: truck brokerage, rail brokerage, expedited international air, expedited domestic ground services, and drayage. Horizon Logistics also offers warehousing/long-term storage for which revenue is recognized based upon warehouse space occupied during the reporting period.
Insurance Reserves
The Company maintains insurance for casualty, property and health claims. Most of the Company’s insurance arrangements include a level of self-insurance. Reserves are established based on the value of cargo damaged and the use of current trends and historical data for other claims. These estimates are based on historical information along with certain assumptions about future events.
Derivative Instruments
The Company recognizes all derivative instruments in the financial statements at fair value.
The Company occasionally utilizes derivative instruments tied to various indexes to hedge a portion of its exposure to bunker fuel price increases. These instruments consist of fixed price swap agreements. The Company does not use derivative instruments for trading purposes. Credit risk related to the derivative financial instruments is considered minimal and is managed by requiring high credit standards for its counterparties.
Changes in fair value of derivative financial instruments are recorded as adjustments to the assets or liabilities being hedged in the statement of operations or in accumulated other comprehensive income (loss), depending on whether the derivative is designated and qualifies for hedge accounting, the type of hedge transaction represented and the effectiveness of the hedge.
Income Taxes
The Company accounts for income taxes under the liability method whereby deferred tax assets and liabilities are measured using enacted tax laws and rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effects on
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
deferred tax assets and liabilities of subsequent changes in the tax laws and rates are recognized in income during the year the changes are enacted. Deferred tax assets are reduced by a valuation allowance when, in the judgment of management, it is more likely than not that some portion or all of the deferred tax assets will not be realizable.
The American Jobs Creation Act of 2004 (“the Act”) instituted an elective alternative tax on qualifying shipping activities (“tonnage tax”) for corporations operating U.S.-flag vessels in U.S. foreign trade, as defined in the Act. During 2006, after evaluating the merits and requirements of the tonnage tax, the Company elected the application of the tonnage tax instead of the federal corporate income tax on income from its qualifying shipping activities. As the Company expects to continue to qualify for application of the tonnage tax, deferred tax assets and liabilities relating to the qualifying shipping activities are measured using an effective tax rate of zero.
Stock-based Compensation
The value of each equity-based award is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model takes into account volatility in the price of our stock, the risk-free interest rate, the estimated life of the equity-based award, the closing market price of our stock and the exercise price. Due to the lack of trading activity since our stock became publicly traded, we base our estimates of stock price volatility on the average of (i) our historical stock price over the period in which it has been publicly traded and (ii) historical volatility of similar entities commensurate with the expected term of the equity-based award; however, this estimate is neither predictive nor indicative of the future performance of our stock. The estimates utilized in the Black-Scholes calculation involve inherent uncertainties and the application of management judgment. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those options expected to vest.
Pension and Post-retirement Benefits
The Company has noncontributory pension plans and post-retirement benefit plans covering certain union employees. Costs of these plans are charged to current operations and consist of several components that are based on various actuarial assumptions regarding future experience of the plans. In addition, certain other union employees are covered by plans provided by their respective union organizations. The Company expenses amounts as paid in accordance with union agreements.
Amounts recorded for the pension plan and the post-retirement benefit plan reflect estimates related to future interest rates, investment returns, and employee turnover. The Company reviews all assumptions and estimates on an ongoing basis.
The Company is required to recognize the overfunded or underfunded status of its defined benefit and post-retirement benefit plans as an asset or liability, with changes in the funded status recognized as an adjustment to the ending balance of other accumulated comprehensive income in the year they occur. The pension plan and the post-retirement benefit plans are in an underfunded status.
Computation of Net Income (Loss) per Share
Basic net income (loss) per share is computed by dividing net income (loss) by the weighted daily average number of shares of common stock outstanding during the period. Certain of the Company’s unvested stock-based awards contain non-forfeitable rights to dividends. As a result, these participating securities are included in the denominator for basic net income (loss) per share. Diluted net income per share is computed using the weighted daily average number of shares of common stock
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
outstanding for the period plus dilutive potential common shares, including stock options and warrants using the treasury-stock method and from convertible preferred stock using the “if converted” method.
Fiscal Period
The fiscal period of the Company typically ends on the Sunday before the last Friday in December. For fiscal year 2009, the fiscal period began on December 22, 2008 and ended on December 20, 2009. For fiscal year 2008, the fiscal period began on December 24, 2007 and ended on December 21, 2008. For fiscal year 2007, the fiscal period began on December 25, 2006 and ended on December 23, 2007.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates. Significant estimates include the assessment of the realization of accounts receivable, deferred tax assets and long-lived assets and the useful lives of intangible assets and property and equipment.
Recent Accounting Pronouncements
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”), now included in FASB ASC 810. FASB ASC 810 amends the evaluation criteria to identify the primary beneficiary of a variable interest entity and requires ongoing reassessment of whether an enterprise is the primary beneficiary of the variable interest entity. FASB ASC 810 is effective for fiscal years beginning after November 15, 2009, and interim periods within those years. The Company is in the process of determining the impact the adoption of FASB ASC 810 will have on its results of operations and financial position.
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140” (“SFAS 166”), now included in FASB ASC 860. FASB ASC 860 amends the derecognition guidance in FASB Statement No. 140 and eliminates the exemption from consolidation for qualifying special-purpose entities. FASB ASC 860 is effective for fiscal years beginning after November 15, 2009, and interim periods within those years. The Company is in the process of determining the impact the adoption of FASB ASC 860 will have on its results of operations and financial position
In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”), now referred to as FASB ASC 855 “Subsequent Events” (“FASB ASC 855”). FASB ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date, but before the financial statements are issued or are available to be issued. FASB ASC 855 requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. This disclosure is intended to alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. FASB ASC 855 is effective on a prospective basis for interim or annual periods ending after June 15, 2009. The adoption of FASB ASC 855 did not have an impact on the Company’s consolidated results of operations and financial position.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities”, now included within FASB ASC 815. FASB ASC 815 requires companies with
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
derivative instruments to disclose information that should enable financial statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB ASC 815 and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. FASB ASC 815 is effective for financial statements issued for fiscal years beginning after November 15, 2008. As this statement relates only to disclosure requirements, the adoption did not have an impact on the Company’s results of operations or financial position.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements”, now included within FASB ASC 810 “Consolidation” (“FASB ASC 810”). FASB ASC 810 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. FASB ASC 810 also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. The adoption did not have an impact on the Company’s results of operations or financial position.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations”, now included within FASB ASC 805 “Business Combinations” (“FASB ASC 805”). FASB ASC 805 establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. FASB ASC 805 also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. This standard is effective for fiscal years beginning after December 15, 2008 and early adoption is prohibited. The adoption did not have an impact on the Company’s results of operations or financial position.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-including an amendment of FASB Statement No. 115”, now included within FASB ASC 825 “Financial Instruments” (“FASB ASC 825”). FASB ASC 825 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement of certain financial assets and liabilities under an instrument-by-instrument election. Subsequent measurements for the financial assets and liabilities an entity elects to measure at fair value will be recognized in the results of operations. FASB ASC 825 also establishes additional disclosure requirements. This standard is effective for fiscal years beginning after November 15, 2007. Effective for fiscal year 2008, the Company has adopted the provisions of FASB ASC 825. The adoption did not have an impact on the Company’s results of operations and financial position.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, now referred to as FASB ASC 820. FASB ASC 820 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. As a result of FASB ASC 820 there is now a common definition of fair value to be used throughout GAAP. The FASB believes that the new standard will make the measurement of fair value more consistent and comparable and improve disclosures about those measures. The provisions of FASB ASC 820 were to be effective for fiscal years beginning after November 15, 2007. On February 6, 2008, the FASB agreed to defer the effective date of for one year for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Effective for fiscal 2008, the Company has adopted FASB ASC 820 except as it applies to those nonfinancial assets and nonfinancial liabilities. The adoption did not have an impact on the Company’s results of operations and financial position.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Supplemental Cash Flow Information
On December 25, 2006, the Company recorded a $3.5 million increase in the liability for unrecognized tax benefit, which was accounted for as a reduction to retained earnings. The Company’s employee stock purchase plan contains a dividend reinvestment provision. As such, during 2009, 2008 and 2007, the Company retained a total of $0.1 million, $38 thousand and $29 thousand, respectively, related to quarterly dividends paid on outstanding shares purchased through the employee stock purchase plan and issued 26 thousand, 8 thousand, and 1 thousand shares, respectively, of its common stock.
Cash payments (refunds) for interest and income taxes were as follows (in thousands):
3.
Restructuring Charge
The Company completed a non-union workforce reduction initiative during the first quarter of 2009. The reduction in workforce impacted approximately 80 non-union employees and resulted in a $4.0 million restructuring charge. Of the $4.0 million, $3.2 million, or $0.11 per fully diluted share, was recorded during the fourth quarter of 2008 and the remaining $0.8 million was recorded during the first quarter of 2009. Of the $0.8 million recorded during the first quarter of 2009, $0.7 million was included within the Horizon Lines segment and the remaining $35 thousand was included in the Horizon Logistics segment. In addition, during the quarter ended June 21, 2009, the Company recorded an additional $0.2 million of severance costs related to the elimination of certain positions in connection with the loss of a major customer and reorganization within the Horizon Logistics segment.
The following table presents the restructuring reserves at December 20, 2009, as well as activity during the year (in thousands):
(1)
Includes $0.5 million of stock-based compensation recorded in additional paid in capital.
In the consolidated balance sheet, the reserve for restructuring costs is recorded in other accrued liabilities.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
4.
Impairment Charges
The following table presents the components of the impairment charges (in thousands):
Vessels
During 2006, the Company completed a series of agreements to charter five new non-Jones Act qualified container vessels (the “new vessels”). These new vessels were deployed in the Company’s trade routes between the U.S. west coast and Asia and Guam. As a result of the deployment of the new vessels, five of the Company’s Jones Act qualified vessels became spare vessels available for seasonal and dry-dock needs and to respond to potential new revenue opportunities. The Company maintains one vessel for seasonal deployment in the Alaska trade, and one dry-dock relief vessel on both the U.S east coast and U.S. west coast. The remaining two spare vessels were tested for potential impairment. The fair value of each of the spare vessels was determined using the scrap value less certain costs to sell the assets. The carrying value of the vessels was in excess of the fair value, and as such, during the year ended December 21, 2008 the Company recorded an impairment charge of $3.3 million to write down the carrying value of the vessels to their fair value. During the year ended December 20, 2009 the Company recorded an additional write-down of $1.9 million related to its spare vessels.
Goodwill
Goodwill represents the excess of costs over the fair market value of assets of businesses acquired. During 2007, the Company completed the acquisition of Aero Logistics. The Company performs tests for impairment annually, or more frequently if events or circumstances indicate it might be impaired. Impairment tests for goodwill require a two-step process. Under the first step, the estimation of fair value of the reporting unit is compared with its carrying value including goodwill. If step one indicates a potential impairment, the second step is performed to measure the amount of impairment, if any. Goodwill impairment exists when the implied fair value of goodwill is less than its carrying value. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of goodwill. As part of its impairment analysis, the Company uses a variety of methodologies in determining the fair value of the reporting unit, including cash flow analyses that are consistent with the assumptions management believes hypothetical marketplace participants would use. The Company uses a discount rate that is commensurate with the risk inherent in the projected cash flows. The implied fair value of Aero Logistics’ goodwill of $2.9 million resulted in an impairment charge of $17.7 million during 2008 based on the carrying amount of $20.6 million.
Equipment
During 2008, in response to the continued deterioration in the Company’s shipping volumes, the Company reviewed its inventory of owned and leased equipment. The company identified certain of its
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
owned and leased equipment that were not expected to be employed during the foreseeable future or that would be returned to the lessor. As a result, the Company recorded a charge of $2.7 million related to the impaired equipment.
Customer Relationships
Identifiable intangible assets were acquired in connection with the purchase of Aero Logistics. The management of Aero Logistics maintained strong relationships within certain of its customers, and as such, a portion of the purchase price was allocated to a customer relationship intangible asset. However, in an effort to consolidate services with one carrier, one of Aero Logistics’ major customers has shifted the majority of its shipping and retail replenishment activities to another carrier. As a result, future cash flows generated from this customer are expected to be minimal, and an impairment charge of $1.7 million was recorded in the fourth quarter of 2008 in order to remove the net book value of the customer relationship intangible asset.
5.
Acquisitions
On August 22, 2007, the Company completed the acquisition of Montebello Management, LLC (D/B/A Aero Logistics) (“Aero Logistics”), a full-service third party logistics provider (3-PL), for approximately $27.5 million in cash. Aero Logistics provides air, less than truckload (LTL) brokerage, warehousing and international expedited transport services. Aero Logistics results of operations have been included in the Company’s consolidated financial statements since the third quarter of 2007 and are included in the Horizon Logistics segment.
On June 26, 2007, the Company completed the purchase of Hawaii Stevedores, Inc. (“HSI”) for approximately $4.1 million in cash, net of cash acquired. HSI is a full service provider of stevedoring and marine terminal services in Hawaii. HSI’s results of operations have been included in the Company’s consolidated financial statements since the third quarter of 2007 and are included in the Horizon Lines segment.
The following table presents pro-forma financial information as though the acquisitions had occurred on December 25, 2006 (in thousands, except per share amounts):
6.
Segment Reporting
The Company’s services can be classified into two principal businesses referred to as Horizon Lines and Horizon Logistics. Through Horizon Lines, the Company provides container shipping services and terminal services primarily in the non-contiguous domestic U.S. trades, owning or leasing vessels comprising a fleet of 20 U.S.-flag containerships and five port terminals linking the continental U.S. with Alaska, Hawaii, Guam, Micronesia, Asia and Puerto Rico. Horizon Logistics was created in September 2007 to manage the Company’s then existing customized logistics solutions and to focus on the growth and further development of integrated logistics services. Horizon Lines also provides certain ground transportation services to its customers.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Prior to 2008, the Company did not maintain a separate business plan for Horizon Logistics. As such, the Company’s chief operating decision maker did not evaluate the performance of Horizon Logistics separately from that of Horizon Lines. During the first quarter of 2008, the Company began measuring the financial results for both Horizon Lines and Horizon Logistics separately. Therefore, the Company separately reports Horizon Lines and Horizon Logistics as segments.
Inter-segment revenue is presented at prices which approximate market. The information below contains certain allocations of expenses that the Company deems reasonable and appropriate for the evaluation of results of operations. The Company does not allocate interest expense or income taxes to its segments. All inter-segment revenue, expense, asset, and liability balances have been eliminated in consolidation. Certain segment information for the fiscal years ended December 21, 2008 and December 23, 2007 has been reclassified to conform to the presentation for the fiscal year ended December 20, 2009. The following table presents information about the results of operations and the assets of the Company’s two reportable segments (in thousands):
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
7.
Property and Equipment
Property and equipment consist of the following (in thousands):
The increase in facilities and land improvement is primarily due to certain assets related to the San Juan, Puerto Rico port redevelopment project being completed and placed into service. Construction in progress includes $16.9 million of payments for new cranes in the Company’s Anchorage, Alaska terminal. The cranes are expected to become operational in late 2011. During the years ended December 20, 2009 and December 21, 2008, the Company capitalized interest totaling $0.4 million and $0.3 million, respectively, related to this long term project.
The majority of depreciation expense is related to vessels. Depreciation expense related to vessels was $9.2 million, $12.3 million and $11.7 million for the years ended December 20, 2009, December 21, 2008 and December 23, 2007, respectively.
Depreciation expense related to capitalized software was $2.3 million, $1.5 million and $5.3 million for the years ended December 20, 2009, December 21, 2008 and December 23, 2007, respectively.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
8.
Intangible Assets
Intangible assets consist of the following (in thousands):
Estimated aggregate amortization expense for each of the succeeding five fiscal years is as follows (in thousands):
Changes in the carrying amount of goodwill during the years ended December 21, 2008, and December 20, 2009 are as follows (in thousands):
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
9.
Other Accrued Liabilities
Other accrued liabilities consist of the following (in thousands):
10.
Long-Term Debt
Long-term debt consists of the following (in thousands):
Senior Credit Facility
On August 8, 2007, the Company entered into a credit agreement (the “Senior Credit Facility”) secured by substantially all of the owned assets of the Company. On June 11, 2009, the Senior Credit Facility was amended resulting in a reduction in the size of the revolving credit facility from $250.0 million to $225.0 million. The terms of the Senior Credit Facility also provide for a $20.0 million swingline subfacility and a $50.0 million letter of credit subfacility.
The amendment to the Senior Credit Facility is intended to provide the Company the flexibility that it needs to effect the settlement of the Puerto Rico class action litigation and to incur other antitrust related litigation expenses. The amendment revises the definition of Consolidated EBITDA by allowing for certain charges, including (i) the Puerto Rico settlement and (ii) litigation expenses related to antitrust litigation matters in an amount not to exceed $25 million in the aggregate and $15 million over a 12-month period, to be added back to the calculation of Consolidated EBITDA. In addition, the Senior Credit Facility was amended to (i) increase the spread over LIBOR and Prime based rates by 150 bps, (ii) increase the range of fees on the unused portion of the commitment, (iii) eliminate the $150 million incremental facility, (iv) modify the definition of Consolidated EBITDA to eliminate the
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
term “non-recurring charges”, and (v) incorporate other structural enhancements, including a step-down in the secured leverage ratio and further limitations on the ability to make certain restricted payments. As a result of the amendment to the Senior Credit Facility, the Company paid $3.5 million in financing costs and recorded a loss on modification of debt of $0.1 million.
The Company has made quarterly principal payments on the term loan of approximately $1.6 million since December 31, 2007. Effective December 31, 2009, quarterly payments increased to $4.7 million through September 30, 2011, at which point quarterly payments will increase to $18.8 million until final maturity on August 8, 2012. The interest rate payable under the Senior Credit Facility varies depending on the types of advances or loans the Company selects. Borrowings under the Senior Credit Facility bear interest primarily at LIBOR-based rates plus a spread which ranges from 2.75% to 3.5% (LIBOR plus 3.25% as of December 20, 2009) depending on the Company’s ratio of total secured debt to EBITDA (as defined in the Senior Credit Facility). The Company also has the option to borrow at Prime plus a spread which ranges from 1.75% to 2.5% (Prime plus 2.25% as of December 20, 2009). The weighted average interest rate at December 20, 2009 was approximately 5.1%, which includes the impact of the interest rate swap (as defined below). The Company also pays a variable commitment fee on the unused portion of the commitment, ranging from 0.375% to 0.50% (0.50% as of December 20, 2009).
The Senior Credit Facility contains customary covenants, including two financial covenants with respect to the Company’s leverage and interest coverage ratio and covenants that limit distribution of dividends and stock repurchases. It also contains customary events of default, subject to grace periods. The Company was in compliance with all such covenants as of December 20, 2009. As of December 20, 2009, total unused borrowing capacity under the revolving credit facility was $113.9 million, after taking into account $100.0 million outstanding under the revolver and $11.1 million utilized for outstanding letters of credit. Based on the Company’s leverage ratio, borrowing availability under the revolving credit facility was $97.7 million as of December 20, 2009.
4.25% Convertible Senior Notes
On August 8, 2007, the Company issued $330.0 million aggregate principal amount of 4.25% Convertible Senior Notes due 2012 (the “Notes”). The Notes are general unsecured obligations of the Company and rank equally in right of payment with all of the Company’s other existing and future obligations that are unsecured and unsubordinated. The Notes bear interest at the rate of 4.25% per annum, which is payable in cash semi-annually on February 15 and August 15 of each year. The Notes mature on August 15, 2012, unless earlier converted, redeemed or repurchased in accordance with their terms prior to August 15, 2012. Holders of the Notes may require the Company to repurchase the Notes for cash at any time before August 15, 2012 if certain fundamental changes occur.
Each $1,000 of principal of the Notes will initially be convertible into 26.9339 shares of the Company’s common stock, which is the equivalent of $37.13 per share, subject to adjustment upon the occurrence of specified events set forth under the terms of the Notes. Upon conversion, the Company would pay the holder the cash value of the applicable number of shares of its common stock, up to the principal amount of the note. Amounts in excess of the principal amount, if any, may be paid in cash or in stock, at the Company’s option. Holders may convert their Notes into the Company’s common stock as follows:
•
Prior to May 15, 2012, if during any calendar quarter, and only during such calendar quarter, if the last reported sale price of the Company’s common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the preceding calendar
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
quarter exceeds 120% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter;
•
During any five business day period prior to May 15, 2012, immediately after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of notes for each day of such measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock on such date and the conversion rate on such date;
•
If, at any time, a change in control occurs or if the Company is a party to a consolidation, merger, binding share exchange or transfer or lease of all or substantially all of its assets, pursuant to which the Company’s common stock would be converted into cash, securities or other assets; or
•
At any time after May 15, 2012 through the fourth scheduled trading day immediately preceding August 15, 2012.
Holders who convert their Notes in connection with a change in control may be entitled to a make-whole premium in the form of an increase in the conversion rate. In addition, upon a change in control, liquidation, dissolution or de-listing, the holders of the Notes may require the Company to repurchase for cash all or any portion of their Notes for 100% of the principal amount plus accrued and unpaid interest. As of December 20, 2009, none of the conditions allowing holders of the Notes to convert or requiring the Company to repurchase the Notes had been met. The Company may not redeem the Notes prior to maturity.
Concurrent with the issuance of the Notes, the Company entered into note hedge transactions with certain financial institutions whereby if the Company is required to issue shares of its common stock upon conversion of the Notes, the Company has the option to receive up to 8.9 million shares of its common stock when the price of the Company’s common stock is between $37.13 and $51.41 per share upon conversion, and the Company sold warrants to the same financial institutions whereby the financial institutions have the option to receive up to 17.8 million shares of the Company’s common stock when the price of the Company’s common stock exceeds $51.41 per share upon conversion. The separate note hedge and warrant transactions were structured to reduce the potential future share dilution associated with the conversion of Notes. The cost of the note hedge transactions to the Company was approximately $52.5 million which has been accounted for as an equity transaction. The Company recorded a $19.1 million income tax benefit related to the cost of the hedge transaction that was subsequently fully reserved as part of recording a full valuation allowance against deferred tax assets. The Company received proceeds of $11.9 million related to the sale of the warrants, which has also been classified as equity.
The Notes and the warrants sold in connection with the hedge transactions will have no impact on diluted earnings per share until the price of the Company’s common stock exceeds the conversion price (initially $37.13 per share) because the principal amount of the Notes will be settled in cash upon conversion. Prior to conversion of the Notes or exercise of the warrants, the Company will include the effect of the additional shares that may be issued if its common stock price exceeds the conversion price, using the treasury stock method. The call options purchased as part of the note hedge transactions are anti-dilutive and therefore will have no impact on earnings per share.
Other Debt
In conjunction with the acquisition of HSI during 2007, the Company assumed a $2.2 million note payable. The note was paid in full during 2009.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Fair Value of Financial Instruments
The estimated fair values of the Company’s debt as of December 20, 2009 and December 21, 2008 were $478.0 million and $389.7 million, respectively. The fair value of the Notes are based on quoted market prices. The fair value of the other long-term debt approximates carrying value.
Annual maturities of long-term debt obligations are as follows (in thousands):
11.
Fair Value Measurement
U.S. accounting standards establish a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs when determining fair value. The three levels of inputs used to measure fair value are as follows:
Level 1:
observable inputs such as quoted prices in active markets
Level 2:
inputs other than the quoted prices in active markets that are observable either directly or indirectly
Level 3:
unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions
On a recurring basis, the Company measures the market value of its pension plan assets at their estimated fair value. The fair value of the pension plan assets is determined by using quoted market prices in active markets.
On a recurring basis, the Company measures the interest rate swap at its estimated fair value. The fair value of the swap is determined using the market standard methodology of netting the discounted future fixed cash payments (or receipts) and the discounted expected variable cash receipts (or payments). The variable cash receipts (or payments) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The unrealized loss on the interest rate swap of $4.5 million is classified within level 2 of the fair value hierarchy.
No other assets or liabilities are measured at fair value under the hierarchy as of December 20, 2009.
12.
Net (Loss) Income Per Common Share
Basic net (loss) income per share is computed by dividing net (loss) income by the weighted daily average number of shares of common stock outstanding during the period. Diluted net (loss) income per share is based upon the weighted daily average number of shares of common stock outstanding for the period plus dilutive potential common shares, including stock options using the treasury-stock
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
method and from convertible stock using the “if converted” method (in thousands, except per share amounts):
Certain of the Company’s unvested stock-based awards contain non-forfeitable rights to dividends. As a result, a total of 221 thousand, 316 thousand, and 107 thousand shares have been included in the denominator for basic net (loss) income per share for these participating securities during the years ended December 20, 2009, December 21, 2008 and December 23, 2007, respectively. In addition, a total of 346 thousand and 245 thousand shares have been excluded from the denominator for diluted net loss per common share during the years ended December 20, 2009 and December 21, 2008, respectively, as the impact would be anti-dilutive.
On November 19, 2007, the Company’s Board of Directors authorized the Company to commence a stock repurchase program to buy back up to $50.0 million worth of its common stock. The program allowed the Company to purchase shares through open market repurchases and privately negotiated transactions at a price of $26.00 per share or less until the program’s expiration on December 31, 2008. The Company acquired 1,172,700 shares at a total cost of $20.6 million under this program during the fourth quarter of 2007, and completed the program during the first quarter of 2008 by acquiring an additional 1,627,500 shares at a total cost of $29.4 million.
13.
Derivative Financial Instruments
On March 31, 2008, the Company entered into an Interest Rate Swap Agreement (the “swap”) with Wachovia Bank, National Association, a current subsidiary of Wells Fargo & Co., (“Wachovia”) in the notional amount of $121.9 million. The swap expires on August 8, 2012. Under the swap, the Company and Wachovia have agreed to exchange interest payments on the notional amount on the last business day of each calendar quarter. The Company has agreed to pay a 3.02% fixed interest rate, and Wachovia has agreed to pay a floating interest rate equal to the three-month LIBOR rate. The critical terms of the swap agreement and the term loan are the same, including the notional amounts, interest rate reset dates, maturity dates and underlying market indices. The purpose of entering into this swap is to protect the Company against the risk of rising interest rates by effectively fixing the base interest rate payable related to its term loan. Interest rate differentials paid or received under the swap are recognized as adjustments to interest expense. The Company does not hold or
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
issue interest rate swap agreements for trading purposes. In the event that the counter-party fails to meet the terms of the interest rate swap agreement, the Company’s exposure is limited to the interest rate differential.
The swap has been designated as a cash flow hedge of the variability of the cash flows due to changes in LIBOR and has been deemed to be highly effective. Accordingly, the Company records the fair value of the swap as an asset or liability on its consolidated balance sheet, and any unrealized gain or loss is included in accumulated other comprehensive income (loss). As of December 20, 2009, the Company recorded a liability of $4.5 million, of which $0.7 million is included in other accrued liabilities and $3.8 million is included in other long-term liabilities in the accompanying consolidated balance sheet. The Company also recorded $0.2 million and $3.9 million in other comprehensive income (loss) for the years ended December 20, 2009 and December 21, 2008, respectively. No hedge ineffectiveness was recorded during the years ended December 20, 2009 or December 21, 2008. If the hedge was deemed ineffective, or extinguished by either counterparty, any accumulated gains or losses remaining in other comprehensive income would be fully recorded in interest expense during the period.
14.
Leases
The Company leases certain equipment and facilities under operating lease agreements. Non-cancelable, long-term leases generally include provisions for maintenance, options to purchase at fair value and to extend the terms. Rent expense under operating lease agreements totaled $104.2 million, $106.9 million and $96.4 million for the years ended December 20, 2009, December 21, 2008 and December 23, 2007, respectively.
Future minimum lease obligations at December 20, 2009 are as follows (in thousands):
15.
Employee Benefit Plans
Savings Plans
The Company provides a 401(k) Savings Plan for substantially all of its employees who are not part of collective bargaining agreements. Under provisions of the savings plan, an employee is immediately vested with respect to Company contributions. Historically, the Company has matched 100% of employee contributions up to 6% of qualified compensation. However, during the fourth quarter of 2009, the Company reduced its match to 50% of employee contributions up to 6% of qualified compensation. The cost for this benefit totaled $2.1 million, $2.5 million and $2.3 million for the years ended December 20, 2009, December 21, 2008 and December 23, 2007, respectively. The Company also administers a 401(k) plan for certain union employees with no Company match.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Pension and Post-Retirement Benefit Plans
The Company provides pension and post-retirement benefit plans for certain of its union workers. Each of the plans is described in more detail below. A decline in the value of assets held by these plans, caused by negative performance of the investments in the financial markets, and lower discount rates due to falling interest rates, has resulted in higher contributions to these plans.
Pension Plans
The Company sponsors a defined benefit plan covering approximately 30 union employees as of December 20, 2009. The plan provides for retirement benefits based only upon years of service. Employees whose terms and conditions of employment are subject to or covered by the collective bargaining agreement between Horizon Lines and the International Longshore & Warehouse Union Local 142 are eligible to participate once they have completed one year of service. Contributions to the plan are based on the projected unit credit actuarial method and are limited to the amounts that are currently deductible for income tax purposes. The Company recorded net periodic benefit costs of $0.8 million during the year ended December 20, 2009 and $0.4 million during each of the years ended December 21, 2008 and December 23, 2007. The plan was underfunded by $1.1 million and $3.4 million at December 20, 2009 and December 21, 2008, respectively.
As part of the acquisition of HSI during 2007, the Company assumed net liabilities related to a pension plan covering approximately 50 salaried employees. The pension plan was frozen to new entrants as of December 31, 2005. Contributions to the plan are based on the projected unit credit actuarial method and are limited to the amounts that are currently deductible for income tax purposes. The Company recorded net periodic benefit costs of $0.3 million, $0.1 million and $37 thousand during the years ended December 20, 2009, December 21, 2008 and December 23, 2007, respectively. The plan was underfunded by $2.6 million and $3.7 million at December 20, 2009 and December 21, 2008, respectively.
Post-retirement Benefit Plans
In addition to providing pension benefits, the Company provides certain healthcare (both medical and dental) and life insurance benefits for eligible retired members (“post-retirement benefits”). For eligible employees hired on or before July 1, 1996, the healthcare plan provides for post-retirement health coverage for an employee who, immediately preceding his/her retirement date, was an active participant in the retirement plan and has attained age 55 as of his/her retirement date. For eligible employees hired after July 1, 1996, the plan provides post-retirement health coverage for an employee who, immediately preceding his/her retirement date, was an active participant in the retirement plan and has attained a combination of age and service totaling 75 years or more as of his/her retirement date. The net periodic benefit costs related to the post-retirement benefits were $0.8 million during the year ended December 20, 2009 and $0.6 million during each of the years ended December 21, 2008 and December 23, 2007. The post-retirement benefit plan was underfunded by $3.5 million and $3.9 million at December 20, 2009 and December 21, 2008, respectively.
As part of the acquisition of HSI during 2007, the Company assumed liabilities related to post-retirement medical, dental and life insurance benefits for eligible active and retired employees. Effective June 25, 2007, the plan provides for post-retirement medical, dental and life insurance benefits for salaried employees who had attained age 55 and completed 20 years of service as of December 31, 2005. Any salaried employee already receiving post-retirement medical coverage as of June 25, 2007 will continue to be covered by the plan. For eligible union employees hired on or before July 1, 1996, the healthcare plan provides for post-retirement medical coverage for an employee who, immediately preceding his/her retirement date, was an active participant in the retirement plan and
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
has attained age 55 as of his/her retirement date. For eligible union employees hired after July 1, 1996, the plan provides post-retirement health coverage for an employee who, immediately preceding his/her retirement date, was an active participant in the retirement plan and has attained age 55 and has a combination of age and service totaling 75 years or more as of his/her retirement date. The Company recorded net periodic benefit costs of $0.4 million, $0.3 million and $0.2 million during the years ended December 20, 2009, December 21, 2008 and December 23, 2007, respectively. The plan was underfunded by $5.4 million and $6.2 million at December 20, 2009 and December 21, 2008, respectively.
Obligations and Funded Status
Net Periodic Benefit Cost
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Rate Assumptions
(1)
The defined benefit plan benefit payments are not based on compensation, but rather on years of service.
For every 1% increase in the assumed health care cost trend rate, service and interest cost will increase $0.2 million and the Company’s benefit obligation will increase $1.2 million. For every 1% decrease in the assumed health care cost trend rate, service and interest cost will decrease $0.2 million and the Company’s benefit obligation will decrease $1.0 million. Expected Company contributions during 2010 total $0.6 million, all of which is related to the pension plan. The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid (in thousands):
The Company’s pension plans’ investment policy and weighted average asset allocations at December 20, 2009 and December 21, 2008 by asset category, are as follows:
The objective of the pension plan investment policy is to grow assets in relation to liabilities, while prudently managing the risk of a decrease in the pension plans’ assets. The pension plan
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
management committee has established a target investment mix with upper and lower limits for investments in equities, fixed-income and other appropriate investments. Assets will be re-allocated among asset classes from time-to-time to maintain the target investment mix. The committee has established a target investment mix of 65% equities and 35% fixed-income for the plans.
The expected return on plan assets is based on the asset allocation mix and historical return, taking into account current and expected market conditions.
Other Plans
Under collective bargaining agreements, the Company participates in a number of union-sponsored, multi-employer benefit plans. Payments to these plans are made as part of aggregate assessments generally based on hours worked, tonnage moved, or a combination thereof. Expense for these plans is recognized as contributions are funded. The Company made contributions of $10.4 million during the year ended December 20, 2009 and $9.9 million during each of the years ended December 21, 2008 and December 23, 2007. In addition to the higher contributions as a result of negative investment performance and lower discount rates due to falling interest rates, the Company has made additional payments related to assessments as a result of lower container volumes and increased benefit costs. If the Company exits these markets, it may be required to pay a potential withdrawal liability if the plans are underfunded at the time of the withdrawal. Any adjustments would be recorded when it is probable that a liability exists and it is determined that markets will be exited.
16.
Stock-Based Compensation
Stock-based compensation costs are measured at the grant date, based on the estimated fair value of the award, and are recognized as an expense in the income statement over the requisite service period. Compensation costs related to stock options and restricted shares granted under the Amended and Restated Equity Incentive Plan (the “Plan”), the 2009 Incentive Compensation Plan (the “2009 Plan”), and purchases under the Employee Stock Purchase Plan, as amended (“ESPP”) are recognized using the straight-line method, net of estimated forfeitures. Stock options and restricted shares granted to employees under the Plan and the 2009 Plan typically cliff vest and become fully exercisable on the third anniversary of the grant date, provided the employee who was granted such options/restricted shares is continuously employed by the Company or its subsidiaries through such date, and provided any performance based criteria, if any, are met. In addition, recipients who retire from the Company and meet certain age and length of service criteria are typically entitled to proportionate vesting.
The following compensation costs are included within selling, general, and administrative expenses on the condensed consolidated statements of income (in thousands):
The Company recognized deferred tax assets related to stock-based compensation of $0.1 million, $1.1 million and $0.7 million during the fiscal years ended December 20, 2009, December 21, 2008 and December 23, 2007, respectively.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Stock Options
The Company maintains a stock plan for the grant of stock options and restricted stock awards to key employees of the Company. Under the Plan, up to an aggregate of 3,088,668 shares of common stock may be issued, of which, 852,093 shares are available for future issuance as of December 20, 2009. Under the 2009 Plan, up to an aggregate of 1,000,000 shares of common stock may be issued, of which, 879,833 shares are available for future issuance as of December 20, 2009. Stock options granted under the plan have been granted at an option price equal to the closing market value of the stock on the date of the grant. Options granted under this plan have 10-year contractual terms and typically become exercisable after one or three years after the grant date, subject to continuous service with the Company. The Compensation Committee of the Board of Directors of the Company (the “Board of Directors”) approves the grants of nonqualified stock options by the Company, pursuant to the Company’s Amended and Restated Equity Incentive Plan. These options are granted on such approval date.
The weighted average grant date fair values of options granted during 2008 and 2007 were $3.97 and $10.58, respectively. A total of 562,815 shares vested during 2009. The Company estimates the fair value of each stock option on the date of grant using a Black-Scholes option-pricing model, applying the following assumptions, and amortizes the expense over the option’s vesting period using the straight-line attribution approach:
Significant assumptions used to estimate the fair value of the share-based compensation awards are as follows:
Expected Life: The Company determined the expected life of the options utilizing the short-cut method due to the lack of historical evidence regarding employees’ expected exercise behavior. Under this approach, the expected term is presumed to be the mid-point between the vesting date and the end of the contractual term.
Expected Volatility: Due to the relatively short period of time since our stock became publicly traded, the Company bases its estimates of stock price volatility on the average of (i) our historical stock price over the period in which it has been publicly traded and (ii) historical volatility of similar entities commensurate with the expected term of the stock options.
As of December 20, 2009, there was $0.6 million in unrecognized compensation costs related to options granted under the Plan, which is expected to be recognized over a weighted average period of 0.7 years. As part of the restructuring plan, the Company accelerated the vesting of 95,000 stock options which resulted in $0.1 million of compensation cost.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
A summary of option activity under the Company’s stock plan is presented below:
(a)
The aggregate intrinsic value of stock options exercised during the years ended December 21, 2008 and December 23, 2007 was $2 thousand and $0.3 million, respectively.
Cash received from the exercise of stock options under the Company’s stock plan for the years ended December 21, 2008 and December 23, 2007 was $13 thousand and $0.2 million, respectively.
Restricted Stock
On June 12, 2009, the Company granted 12,320 shares of restricted stock each to all non-employee members on the Company’s Board of Directors. The grant date fair value of the restricted shares was $4.87 per share and the shares will vest in full on June 12, 2010. On June 19, 2009, the Company granted 15,235 shares of restricted stock to the lead independent director of the Company’s Board of Directors. The grant date fair value of the restricted shares was $3.61 per share and the shares will vest in full on June 19, 2010. On March 18, 2009, the Company granted a total of 444,500 shares of restricted stock to certain employees of the Company and its subsidiaries. The grant date fair value of the restricted shares was $3.38 per share. Of the 444,500 shares granted, 293,250 will vest in full on March 18, 2012. The remaining 151,250 restricted shares were performance based shares and would have vested in full on March 18, 2011 provided an earnings per share performance target for the Company’s fiscal year 2009 was met. The earnings per share performance target was not met and the performance based restricted shares have been forfeited. On September 1, 2009, the Company granted a total of 18,692 shares of restricted stock to certain employees of the Company and its subsidiaries. The grant date fair value of the restricted shares was $5.35 per share. The restricted shares will vest in full on September 1, 2012.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
A summary of the status of the Company’s restricted stock awards is presented below:
As of December 20, 2009, there was $1.4 million of unrecognized compensation expense related to all restricted stock awards, which is expected to be recognized over a weighted-average period of 1.5 years. As part of the restructuring plan, the Company accelerated the vesting of 70,000 restricted shares which resulted in $0.4 million of compensation cost.
Employee Stock Purchase Plan
On April 19, 2006, the Board of Directors voted to implement an employee stock purchase plan (as amended, the “ESPP”) effective July 1, 2006. The Company had reserved 308,866 shares of its common stock for issuance under the ESPP. On June 2, 2009, the Company’s stockholders approved the 2009 Employee Stock Purchase Plan (“2009 ESPP”). The 2009 ESPP reserved an additional 600,000 shares of its common stock for future purchases. As of December 20, 2009, there were 543,266 shares of common stock reserved for issuance under the ESPP.
Employees generally are eligible to participate in the 2009 ESPP if they are employed before the beginning of the applicable purchase period, are customarily employed more than five months in a calendar year and more than twenty hours per week, and are not, and would not become as a result of being granted an option under the 2009 ESPP, 5% stockholders of the Company or any of its designated subsidiaries. Participation in the 2009 ESPP will end automatically upon termination of employment. Eligible employees are permitted to acquire shares of common stock through payroll deductions within a percentage range of their salary as determined by the Company’s Compensation Committee. Such employee purchases are subject to maximum purchase limitations.
The 2009 ESPP is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code of 1986, as amended. The ESPP will terminate on July 1, 2016 unless it terminates earlier under the terms of the ESPP. The Board of Directors and the Compensation Committee have the authority to amend, terminate or extend the term of the ESPP, except that no action may adversely affect any outstanding options previously granted under the plan and stockholder approval is required to increase the number of shares issued or to change the terms of eligibility. The
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Board of Directors and the Compensation Committee are able to make amendments to the ESPP as it determines to be advisable if the financial accounting treatment for the 2009 ESPP changes from that in effect on the date the 2009 ESPP was adopted by the Board of Directors.
The Company estimates the fair value of each share of stock using a Black-Scholes option-pricing model, applying the following assumptions, and amortizes the expense over the plan purchase period using the straight-line attribution approach:
As of December 20, 2009, there was no unrecognized compensation expense related to the ESPP.
17.
Income Taxes
The Company periodically assesses whether it is more likely than not that it will generate sufficient taxable income to realize its deferred income tax assets. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income (including the reversal of deferred tax liabilities) during the periods in which those temporary differences will become deductible. In making this determination, the Company considers all available positive and negative evidence and makes certain assumptions. The Company considers, among other things, its deferred tax liabilities, the overall business environment, its historical earnings and losses and its outlook for future years.
During the second quarter of 2009, the Company determined that it was unclear as to the timing of when it will generate sufficient taxable income to realize our deferred tax assets. Accordingly, the Company recorded a valuation allowance against our deferred tax assets. Although the Company has recorded a valuation allowance against our deferred tax assets, it does not affect its ability to utilize deferred tax assets to offset future taxable income. Until such time that the Company determines it is more likely than not that it will generate sufficient taxable income to realize its deferred tax assets, income tax benefits associated with future period losses will be fully reserved. As such, the Company’s federal and state tax rates are expected to effectively be 0% and 1%-2%, respectively, during those periods.
During 2006, the Company elected the application of tonnage tax. Prior to the establishment of a full valuation allowance, the Company’s effective tax rate was impacted by the Company’s income from qualifying shipping activities as well as the income from the Company’s non-qualifying shipping activities and fluctuated based on the ratio of income from qualifying and non-qualifying activities. The Company’s effective tax rate for the years ended December 20, 2009, December 21, 2008 and December 23, 2007 was (49.6)%, 81.9% and (129.8)%, respectively.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Income tax expense (benefit) are as follows (in thousands):
The difference between the income tax expense (benefit) and the amounts computed by applying the statutory federal income tax rates to earnings before income taxes are as follows (in thousands):
The Company recorded a tax benefit attributable to the recognition of certain tax benefits derived from the exercise of non-qualified stock options in the amount of $15 thousand and $0.1 million as a decrease directly to additional paid-in capital for the years ended December 21, 2008 and December 23, 2007, respectively.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
The components of deferred tax assets and liabilities are as follows (in thousands):
The Company has net operating loss carryforwards for federal income tax purposes in the amount of $109.2 million and $93.2 million as of December 20, 2009 and December 21, 2008, respectively. In addition, the Company has net operating loss carryforwards for state income tax purposes in the amount of $16.1 million and $12.4 million as of December 20, 2009 and December 21, 2008, respectively. The Federal and state net operating loss carryforwards begin to expire in 2024 and 2019, respectively. Furthermore, the Company has an alternative minimum tax credit carryforward with no expiration period in the amount of $1.4 million as of December 20, 2009 and December 21, 2008. Net operating loss credits generated from tax losses in Guam begin to expire in 2023. The Company has recorded a valuation allowance against the majority of the deferred tax assets attributable to the net operating losses generated, but has not recorded a valuation allowance attributable to the net operating losses generated in certain states.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
As a result of the valuation allowance, none of the unrecognized tax benefits, if recognized, would affect the effective tax rate. The Company does not expect that there will be a significant increase or decrease of the total amount of unrecognized tax benefits within the next twelve months.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
The Company recognizes interest accrued and penalties related to unrecognized tax benefits in its income tax expense. During its fiscal years for 2007 through 2009, the Company has not recognized any interest and penalties in its statement of operations and statement of financial position. Furthermore, there were no accruals for the payment of interest and penalties at either December 20, 2009 or December 21, 2008.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2004. The tax years which remain subject to examination by major tax jurisdictions as of December 20, 2009 include 2004-2009.
During 2009, the Internal Revenue Service issued guidance describing when and how taxpayers can elect to carryback net operating losses for calculation of the alternative minimum tax (“AMT”). As such, the Company recorded a $0.2 million income tax receivable related to previous AMT payments made during 2007.
18.
Commitments and Contingencies
Legal Proceedings
On April 17, 2008, the Company received a grand jury subpoena and search warrant from the U.S. District Court for the Middle District of Florida seeking information regarding an investigation by the Antitrust Division of the Department of Justice (the “DOJ”) into possible antitrust violations in the domestic ocean shipping business. Subsequently, the DOJ expanded the timeframe covered by the subpoena. The Company is currently providing documents to the DOJ in response to the subpoena. The Company intends to cooperate fully with the DOJ in its investigation.
The Company has entered into a conditional amnesty agreement with the DOJ under its Corporate Leniency Policy. The amnesty agreement pertains to a single contract relating to ocean shipping services provided to the United States Department of Defense. The DOJ has agreed to not bring any criminal prosecution with respect to that government contract as long as the Company, among other things, continues its full cooperation in the investigation. The amnesty does not bar a claim for damages that may be sought by the DOJ under any applicable federal law or regulation.
On October 9, 2009, the Company received a Request for Information and Production of Documents from the Puerto Rico Office of Monopolistic Affairs. The request relates to an investigation into possible price fixing and unfair competition in the Puerto Rico domestic ocean shipping business. The Company is currently providing documents in response to this request, and intends to cooperate fully in this investigation.
Subsequent to the commencement of the DOJ investigation, a number of purported class action lawsuits were filed against the Company and other domestic shipping carriers. Fifty-seven cases have been filed in the following federal district courts: eight in the Southern District of Florida, six in the Middle District of Florida, twenty in the District of Puerto Rico, eleven in the Northern District of California, two in the Central District of California, one in the District of Oregon, eight in the Western District of Washington, and one in the District of Alaska. Nineteen of the foregoing district court cases that related to ocean shipping services in the Puerto Rico tradelane were consolidated into a single multidistrict litigation (“MDL”) proceeding in the District of Puerto Rico. All of the foregoing district court cases that related to ocean shipping services in the Hawaii and Guam tradelanes were consolidated into MDL proceedings in the Western District of Washington. One district court case remains in the District of Alaska, relating to the Alaska tradelane.
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Each of the federal district court cases purports to be on behalf of a class of individuals and entities who directly, or indirectly in one case, purchased domestic ocean shipping services from the various domestic ocean carriers. The complaints allege price-fixing in violation of the Sherman Act and seek treble monetary damages, costs, attorneys’ fees, and an injunction against the allegedly unlawful conduct.
On June 11, 2009, the Company entered into a settlement agreement with the plaintiffs in the Puerto Rico MDL litigation. Under the settlement agreement, which is subject to Court approval, the Company has agreed to pay $20.0 million and to certain base-rate freezes to resolve claims for alleged antitrust violations in the Puerto Rico tradelane. The Company paid $5.0 million into an escrow account pursuant to the terms of the settlement agreement and will be required to pay $5.0 million within 90 days after preliminary approval of the settlement agreement by the district court and $10.0 million within five business days after final approval of the settlement agreement by the district court.
The base-rate freeze component of the settlement agreement provides that class members who have contracts in the Puerto Rico trade with the Company as of the effective date of the final settlement agreement would have the option, in lieu of receiving cash, to have their “base rates” frozen for a period of two years. The base-rate freeze would run for two years from the expiration of the contract in effect on the effective date of the final settlement agreement. All class members would be eligible to share in the $20.0 million cash component, but only contract customers of the Company would be eligible to elect the base-rate freeze in lieu of receiving cash. The Company has the right to terminate the settlement agreement under certain circumstances. On July 8, 2009, the plaintiffs filed a motion for preliminary approval of the settlement agreement in the Puerto Rico MDL litigation. Several hearings on the motion for preliminary approval of the settlement agreement have been held where the Court has heard the objections of certain non-settling defendants. The Company is awaiting the Court’s decision.
On March 20, 2009, the Company filed a motion to dismiss the claims in the Hawaii and Guam MDL litigation. The plaintiffs filed a response to the Company’s motion to dismiss on April 20, 2009, and the Company filed a reply on May 8, 2009. On August 18, 2009, the District Court for the Western District of Washington entered an order dismissing, without prejudice, the Hawaii and Guam MDL litigation. In dismissing the complaint, however, the plaintiffs were granted thirty days to amend their complaint, and the Company and the plaintiffs agreed to extend the time to file an amended complaint to November 16, 2009. Subsequently, the Court granted the plaintiffs until May 10, 2010 to file an amended complaint. The Company and the plaintiffs have agreed to stay discovery in the Alaska litigation. The Company intends to vigorously defend itself against these purported class action lawsuits.
In addition, on July 9, 2008, a complaint was filed by Caribbean Shipping Services, Inc. in the Circuit Court, 4th Judicial Circuit in and for Duval County, Florida, against the Company and other domestic shipping carriers alleging price-fixing in violation of the Florida Antitrust Act and the Florida Deceptive and Unlawful Trade Practices Act. The complaint seeks treble damages, injunctive relief, costs and attorneys’ fees. The case is not brought as a class action. This case is pending discovery.
Through December 20, 2009, the Company has incurred approximately $22.9 million in legal and professional fees associated with the DOJ investigation and the antitrust related litigation. In addition, the Company has paid $5.0 million into an escrow account pursuant to the terms of the Puerto Rico MDL settlement agreement. Further, a reserve of $15.0 million related to the expected future payments pursuant to the terms of the settlement of the Puerto Rico MDL litigation has been included in other accrued liabilities on the Company’s consolidated balance sheet. The Company is unable to predict the outcome of the Hawaii and Guam MDL litigation, the Alaska class-action litigation and the
Horizon Lines, Inc.
Notes to Consolidated Financial Statements - (Continued)
Florida Circuit Court litigation. The Company has not made any provision for any of these claims in the accompanying financial statements. It is possible that the outcome of these proceedings could have a material adverse effect on the Company’s financial condition, cash flows and results of operations.
In addition, in connection with the DOJ investigation, it is possible that the Company could suffer criminal prosecution and be required to pay a substantial fine. The Company has not made a provision for any possible fines or penalties in the accompanying financial statements, and the Company can give no assurance that the final resolution of the DOJ investigation will not result in significant liability and will not have a material adverse effect on the Company’s financial condition, cash flows and results of operations.
On December 31, 2008, a securities class action lawsuit was filed by the City of Roseville Employees’ Retirement System in the United States District Court for the District of Delaware, naming the Company and six current and former employees, including the Company’s Chief Executive Officer, as defendants. The Company filed a motion to dismiss and the Court granted the motion to dismiss on November 13, 2009; however, the plaintiffs were granted eleven days to file an amended complaint. The Company and the plaintiffs agreed to extend the time to file the amended complaint, and the plaintiffs filed their amended complaint on December 23, 2009. The amended complaint added two of our current and former employees as defendants.
The amended complaint purports to be on behalf of purchasers of our common stock. The complaint alleges, among other things, that the Company made material misstatements and omissions in connection with alleged price-fixing in the Company’s shipping business in Puerto Rico in violation of antitrust laws. The Company is preparing a response to the amended complaint. The Company is unable to predict the outcome of this lawsuit; however, we believe that we have appropriate disclosure practices and intend to vigorously defend against the lawsuit.
On May 13, 2009, the Company was served with a complaint filed by a shareholder in Delaware Chancery Court seeking production of certain books and records pursuant to Section 220 of the Delaware General Corporation law. The Company reached an agreement on the scope of the required document production and produced the required documents. Subsequently, the suit was dismissed.
In the ordinary course of business, from time to time, the Company and its subsidiaries become involved in various legal proceedings. These relate primarily to claims for loss or damage to cargo, employees’ personal injury claims, and claims for loss or damage to the person or property of third parties. The Company and its subsidiaries generally maintain insurance, subject to customary deductibles or self-retention amounts, and/or reserves to cover these types of claims. The Company and its subsidiaries also, from time to time, become involved in routine employment-related disputes and disputes with parties with which they have contractual relations.
SFL Agreements
In April 2006, the Company completed a series of agreements with Ship Finance International Limited and certain of its subsidiaries (“SFL”) to charter five new non-Jones Act qualified container vessels. The bareboat charter for each new vessel is a “hell or high water” charter, and the obligation of the Company to pay charter hire thereunder for the vessel is absolute and unconditional. The aggregate annual charter hire for all of the five new vessels is approximately $32.0 million. Under the charters, the Company is responsible for crewing, insuring, maintaining, and repairing each vessel and for all other operating costs with respect to each vessel. The term of each of the bareboat charters is twelve years from the date of delivery of the related vessel, with a three year renewal option exercisable by the Company. In addition, the Company has the option to purchase all of the
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Notes to Consolidated Financial Statements - (Continued)
vessels following the five, eight, twelve, and, if applicable, fifteen year anniversaries of the date of delivery at pre-agreed purchase prices. If the Company elects to purchase all of the vessels after the five or eight year anniversary date, it will have the right to assume the outstanding debt related to each purchased vessel, and the amount of the debt so assumed will be credited against the purchase price paid for the vessels. If the Company elects not to purchase the new vessels at the end of the initial twelve-year period and SFL sells the new vessels for less than a specified amount, the Company is responsible for paying the amount of such shortfall, which shall not exceed $3.8 million per new vessel. If the new vessels are to be sold by SFL to an affiliated party for less than a different specified amount, the Company has the right to purchase the new vessels for that different specified amount.
Although the Company is not the primary beneficiary of the variable interest entities created in conjunction with the SFL transactions, the Company has an interest in the variable interest entities. Based on the Company’s analysis of the expected cash flows related to the variable interest entity, the Company believes only a remote likelihood exists that it would become the primary beneficiary of the variable interest entity and would be required to consolidate the variable interest entity. Certain contractual obligations and off-balance sheet obligations arising from this transaction include the annual operating lease obligations and the residual guarantee. The Company is accounting for the leases as operating leases. The residual guarantee is recorded at its fair value of approximately $0.2 million as a liability on the Company’s balance sheet.
Standby Letters of Credit
The Company has standby letters of credit, primarily related to its property and casualty insurance programs. On December 20, 2009 and December 21, 2008, these letters of credit totaled $11.1 million and $8.3 million, respectively.
Labor Relations
Approximately 67.4% of the Company’s total work force is covered by collective bargaining agreements. Our collective bargaining agreements are scheduled to expire as follows: three in 2011, five in 2012, one in 2103 and one in 2014.
19.
Quarterly Financial Data (Unaudited)
Set forth below are unaudited quarterly financial data (in thousands, except per share amounts):
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Notes to Consolidated Financial Statements - (Continued)
(1)
The first, second, third, and fourth quarter of 2009 include expenses of $4.4 million, $4.1 million, $2.0 million, and $1.7 million, respectively, related to legal and professional fees associated with the DOJ investigation and the antitrust related litigation. The second, third, and fourth quarter of 2008 include expenses of $2.4 million, $4.6 million, and $3.7 million, respectively, related to legal and professional fees associated with the DOJ investigation and the antitrust related litigation.
(2)
The first and second quarter of 2009 include a $0.8 million and $0.2 million charge, respectively, related to the Company’s restructuring plan. The second and third quarter of 2009 include $0.7 million and $1.2 million, respectively, related to an impairment charge. The second quarter of 2009 includes a $20.0 million charge for the settlement of a class action lawsuit. The fourth quarter of 2008 includes a $3.2 million charge related to the Company’s restructuring plan, an impairment charge totaling $25.4 million, and a supplementary premium call totaling $1.3 million related the Company’s protection and indemnity insurance policies for the three year period ended December 21, 2008.
(3)
During the second quarter of 2009, the Company determined it was unclear as to the timing of when it will generate sufficient taxable income to realize its deferred tax assets. Accordingly, the Company recorded a valuation allowance against its deferred tax assets which resulted in a $10.5 million income tax provision.
20.
Subsequent Events
The Company has evaluated subsequent events and transactions for potential recognition or disclosure through such time these statements were filed with the Securities and Exchange Commission (“SEC”) on February 4, 2010, and has determined there were no items deemed to be reportable.
Schedule II
Horizon Lines, Inc.
Valuation and Qualifying Accounts
Years Ended December 2009, 2008 and 2007
(1)
Includes $0.5 million of stock-based compensation recorded in additional paid in capital.
(2)
Includes $2.0 million of recorded in other comprehensive income (loss).