Horizon Lines 10-K 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
HORIZON LINES, INC.
4064 Colony Road, Suite 200, Charlotte, North Carolina 28211
(Address of principal executive offices)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
Securities registered pursuant to Section 12 (g) of the Act: None
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Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405) of this chapter) is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K o
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Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
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The aggregate market value of common stock held by non-affiliates, computed by reference to the closing price of the common stock as of the last business day of the registrants most recently completed second fiscal quarter, was approximately $51.0 million.
As of January 29, 2010, 30,401,673 shares of common stock, par value $.01 per share, were outstanding.
The information required in Part III of this Form 10-K is incorporated by reference to the registrants definitive proxy statement to be filed for the Annual Meeting of Stockholders to be held June 1, 2010.
Horizon Lines, Inc.
This Form 10-K (including the exhibits hereto) contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that do not relate solely to historical fact. They include, but are not limited to, any statement that may predict, forecast, indicate or imply future results, performance, achievements or events. Words such as, but not limited to, believe, expect, anticipate, estimate, intend, plan, targets, projects, likely, will, would, could and similar expressions or phrases identify forward-looking statements.
All forward-looking statements involve risks and uncertainties. The occurrence of the events described, and the achievement of the expected results, depend on many events, some or all of which are not predictable or within our control. Actual results may differ materially from expected results.
Factors that may cause actual results to differ from expected results include: decreases in shipping volumes; legal or other proceedings to which we are or may become subject, including the Department of Justice antitrust investigation and related legal proceedings; volatility in fuel prices; our substantial debt; restrictive covenants under our debt agreements; our failure to renew our commercial agreements with Maersk and resulting potential alternative arrangements; labor interruptions or strikes; job related claims, liability under multi-employer pension plans; compliance with safety and environmental protection and other governmental requirements; new statutory and regulatory directives in the United States addressing homeland security concerns; the successful start-up of any Jones-Act competitor; increased inspection procedures and tighter import and export controls; restrictions on foreign ownership of our vessels; repeal or substantial amendment of the coastwise laws of the United States, also known as the Jones Act; escalation of insurance costs, catastrophic losses and other liabilities; the arrest of our vessels by maritime claimants; severe weather and natural disasters; our inability to exercise our purchase options for our chartered vessels; the aging of our vessels; unexpected substantial dry-docking costs for our vessels; the loss of our key management personnel; actions by our stockholders; changes in tax laws or in their interpretation or application (including the repeal of the application of the tonnage tax to our trade in any one of our applicable shipping routes); and adverse tax audits and other tax matters.
In light of these risks and uncertainties, expected results or other anticipated events or circumstances discussed in this Form 10-K (including the exhibits hereto) might not occur. We undertake no obligation, and specifically decline any obligation, to publicly update or revise any forward-looking statements, even if experience or future developments make it clear that projected results expressed or implied in such statements will not be realized, except as may be required by law.
See the section entitled Risk Factors in this Form 10-K for a more complete discussion of these risks and uncertainties and for other risks and uncertainties. Those factors and the other risk factors described in this Form 10-K are not necessarily all of the important factors that could cause actual results or developments to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results. Consequently, there can be no assurance that actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, us. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements.
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.
The Companys 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, Managements 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 segments assets.
We believe that we are the nations 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, Lowes 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.
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.
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 Ricos 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 Horizons industry-leading web-based event management system, offers shipment visibility and supply chain efficiencies by providing real-time detailed shipment information throughout the containers 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.
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.
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.
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.
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 Maersks 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 Maersks 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.
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 MARADs 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 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:
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.
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.
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.
We serve a diverse base of long-standing, established customers consisting of many of the worlds largest consumer and industrial products companies. Such customers include Costco Wholesale Corporation, Johnson & Johnson, Lowes 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.
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.
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.
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.
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:
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.
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:
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.
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.
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.
Freight shipping is one of the worlds 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.
The mailing address of the Companys Executive Office is 4064 Colony Road, Suite 200, Charlotte, North Carolina 28211 and the telephone number at that location is (704) 973-7000. The Companys most recent SEC filings can be found on the SECs website, www.sec.gov, and on the Companys website, www.horizonlines.com. The Companys 2009 annual report on Form 10-K will be available on the Companys 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 SECs 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.
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 Companys Services in the Jones Act and Guam Markets Will Adversely Affect the Companys 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.
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 nations 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 Seamens 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 plans 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 plans 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 employers 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 Guards 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.
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.
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.
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 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 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.
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.
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:
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:
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:
We may incur substantial indebtedness in the future. Our incurrence of additional indebtedness would intensify the risks described above.
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.
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 Companys 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:
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 partys 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 Guards 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.
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 EPAs 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 courts 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 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 ships 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 Michigans 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.
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 CARBs 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 vessels 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 ECAs. 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:
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 vessels compliance with SOLAS security requirements and the ISPS Code as ratified by the ships 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.
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:
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 Courts 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.
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.
The Companys 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 Companys 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 Companys 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.
The information required by this item will be included in the Companys proxy statement to be filed for the Annual Meeting of Stockholders to be held on June 1, 2010, and is incorporated herein by reference.
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 Companys 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.
The five year selected financial data below should be read in conjunction with Managements 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):
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.
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.
We believe that we are the nations 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.
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.
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.
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.
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.
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.
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 customers 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 workers 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 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 assets 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.
Under U.S. Coast Guard Rules, administered through the American Bureau of Shippings 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 vessels 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.
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.
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.
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.
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 issuers 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 companys 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 parents 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.
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).
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.
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.
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, 2008
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.
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 Companys 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, 2007
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.
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.
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.
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.
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.
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.
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 programs 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 as of December 20, 2009 are as follows (in thousands):
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.
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.
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.
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:
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 Companys 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.
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.
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):
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.
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 Companys 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.
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.
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 Commissions 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.
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 Companys internal controls over financial reporting, which is on page F-2 of this Annual Report on Form 10-K.
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.
The information required by this item as to the Companys executive officers, directors, director nominees, audit committee financial expert, audit committee, and procedures for stockholders to recommend director nominees will be included in the Companys 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 Companys directors, executive officers and certain beneficial owners of the Companys 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 Companys 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 Companys internet website as soon as reasonably practical following the amendment or waiver. The information contained on or connected to the Companys 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.
The information required by this item will be included in the Companys proxy statement to be filed for the Annual Meeting of Stockholders to be held on June 1, 2010, and is incorporated herein by reference.
The information required by this item will be included in the Companys proxy statement to be filed for the Annual Meeting of Stockholders to be held on June 1, 2010, and is incorporated herein by reference.
(a)(1) Financial Statements:
Horizon Lines, Inc.
Index to Consolidated Financial Statements