10-Q 1 d347085d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

Form 10-Q

 

 

(Mark one)

x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 24, 2012

OR

 

¨ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                     to                     

Commission File Number 001-32627

 

 

HORIZON LINES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   74-3123672

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

4064 Colony Road, Suite 200, Charlotte, North Carolina   28211
(Address of principal executive offices)   (Zip Code)

(704) 973-7000

(Registrant’s telephone number, including area code)

NOT APPLICABLE

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such a shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨     No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

At July 23, 2012, 34,164,884 shares of the Registrant’s common stock, par value $.01 per share, were outstanding.

 

 

 


Table of Contents

HORIZON LINES, INC.

Form 10-Q Index

 

     Page No.  

Part I. Financial Information

     1   

1. Financial Statements

     1   

Unaudited Condensed Consolidated Balance Sheets

     1   

Unaudited Condensed Consolidated Statements of Operations

     2   

Unaudited Condensed Consolidated Statements of Comprehensive Loss

     3   

Unaudited Condensed Consolidated Statements of Cash Flows

     4   

Notes to Condensed Consolidated Financial Statements (Unaudited)

     5   

2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     20   

3. Quantitative and Qualitative Disclosures About Market Risk

     36   

4. Controls and Procedures

     36   

Part II. Other Information

     37   

1. Legal Proceedings

     37   

1A. Risk Factors

     38   

2. Unregistered Sales of Equity Securities and Use of Proceeds

     38   

3. Defaults Upon Senior Securities

     38   

4. Mine Safety Disclosures

     38   

5. Other Information

     38   

6. Exhibits

     38   

Signature

     39   

Exhibit 10.1

  

Exhibit 31.1

  

Exhibit 31.2

  

Exhibit 32.1

  

Exhibit 32.2

  

Exhibit 101 INSTANCE DOCUMENT

  

Exhibit 101 SCHEMA DOCUMENT

  

Exhibit 101 CALCULATION LINKBASE DOCUMENT

  

Exhibit 101 LABELS LINKBASE DOCUMENT

  

Exhibit 101 PRESENTATION LINKBASE DOCUMENT

  

 

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PART I. FINANCIAL INFORMATION

1. Financial Statements

Horizon Lines, Inc.

Unaudited Condensed Consolidated Balance Sheets

(in thousands, except per share data)

 

     June 24,
2012
    December 25,
2011
 

Assets

    

Current assets

    

Cash

   $ 19,732      $ 21,147   

Accounts receivable, net of allowance of $5,116 and $6,416 at June 24, 2012 and December 25, 2011, respectively

     116,633        105,949   

Materials and supplies

     27,919        28,091   

Deferred tax asset

     7,947        10,608   

Assets of discontinued operations

     7,176        12,975   

Other current assets

     7,604        7,196   
  

 

 

   

 

 

 

Total current assets

     187,011        185,966   

Property and equipment, net

     160,082        167,145   

Goodwill

     198,793        198,793   

Intangible assets, net

     55,335        69,942   

Assets of discontinued operations

     146        —     

Other long-term assets

     19,038        17,963   
  

 

 

   

 

 

 

Total assets

   $ 620,405      $ 639,809   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity (Deficiency)

    

Current liabilities

    

Accounts payable

   $ 46,041      $ 31,683   

Current portion of long-term debt, including capital lease

     5,733        6,107   

Accrued vessel rent

     9,277        13,652   

Liabilities of discontinued operations

     7,791        45,313   

Other accrued liabilities

     81,693        97,097   
  

 

 

   

 

 

 

Total current liabilities

     150,535        193,852   

Long-term debt, including capital lease, net of current portion

     383,991        509,741   

Deferred rent

     11,317        13,553   

Deferred tax liability

     8,307        10,702   

Liabilities of discontinued operations

     41,253        51,293   

Other long-term liabilities

     24,216        26,654   
  

 

 

   

 

 

 

Total liabilities

     619,619        805,795   
  

 

 

   

 

 

 

Stockholders’ equity (deficiency)

    

Preferred stock, $.01 par value, 30,500 shares authorized, no shares issued or outstanding

     —          —     

Common stock, $.01 par value, 100,000 shares authorized, 32,087 shares issued and outstanding as of June 24, 2012 and 2,421 shares issued and 2,269 shares outstanding as of December 25, 2011

     931        605   

Treasury stock, 152 shares at cost as of December 25, 2011

     —          (78,538

Additional paid in capital

     378,690        213,135   

Accumulated deficit

     (381,843     (303,260 )

Accumulated other comprehensive income

     3,008        2,072   
  

 

 

   

 

 

 

Total stockholders’ equity (deficiency)

     786        (165,986 )
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity (deficiency)

   $ 620,405      $ 639,809   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Horizon Lines, Inc.

Unaudited Condensed Consolidated Statements of Operations

(in thousands, except per share amounts)

 

     Quarters Ended     Six Months Ended  
     June 24,
2012
    June 26,
2011
    June 24,
2012
    June 26,
2011
 

Operating revenue

   $ 270,939      $ 253,731      $ 534,294      $ 494,451   

Operating expense:

        

Cost of services (excluding depreciation expense)

     236,894        215,309        470,694        427,038   

Depreciation and amortization

     10,397        10,947        20,797        21,824   

Amortization of vessel dry-docking

     2,622        4,070        6,635        8,138   

Selling, general and administrative

     19,529        19,842        41,042        43,677   

Impairment charge

     257        2,818        257        2,818   

Legal settlements

     —          (18,202     —          (18,202

Miscellaneous expense (income), net

     233        (46 )     (77     397   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expense

     269,932        234,738        539,348        485,690   

Operating income (loss)

     1,007        18,993        (5,054     8,761   

Other expense:

        

Interest expense, net

     16,238        12,910        33,977        23,626   

Loss on conversion/modification of debt

     47,403        889        36,421        630   

Gain on change in value of debt conversion features

     (32,800     —          (19,130     —     

Other expense, net

     4        8        18        22   
  

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from continuing operations before income tax expense

     (29,838     5,186        (56,340     (15,517

Income tax expense

     49        681        346        196   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income from continuing operations

     (29,887     4,505        (56,686     (15,713

Net loss from discontinued operations

     (16,187     (9,921     (21,894     (23,774
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (46,074   $ (5,416 )   $ (78,580   $ (39,487
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net (loss) income per share:

        

Continuing operations

   $ (1.49   $ 3.63      $ (4.89   $ (12.68

Discontinued operations

     (0.81     (7.99     (1.89     (19.19
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net loss per share

   $ (2.30   $ (4.36 )   $ (6.78   $ (31.87
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net (loss) income per share:

        

Continuing operations

   $ (1.49   $ 3.63      $ (4.89   $ (12.68

Discontinued operations

     (0.81     (7.99     (1.89     (19.19
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net loss per share

   $ (2.30   $ (4.36 )   $ (6.78   $ (31.87
  

 

 

   

 

 

   

 

 

   

 

 

 

Number of weighted average shares used in calculations:

        

Basic

     20,068        1,241        11,595        1,239   

Diluted

     20,068        1,241        11,595        1,239   

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Horizon Lines, Inc.

Unaudited Condensed Consolidated Statements of Comprehensive Loss

(in thousands)

 

     Quarters Ended     Six Months Ended  
     June 24,
2012
    June 26,
2011
    June 24,
2012
    June 26,
2011
 

Net loss

   $ (46,074   $ (5,416 )   $ (78,580   $ (39,487

Other comprehensive income:

        

Unwind of interest rate swap

     339        —          679        —     

Amortization of pension and post-retirement benefit transition obligation, net of tax

     129        118        257        236   

Change in fair value of interest rate swap, net of tax

     —          20        —          474   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     468        138        936        710   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (45,606   $ (5,278 )   $ (77,644   $ (38,777
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

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Horizon Lines, Inc.

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

 

     Six Months Ended  
     June 24,
2012
    June 26,
2011
 

Cash flows from operating activities:

    

Net loss from continuing operations

   $ (56,686   $ (15,713 )

Adjustments to reconcile net loss to net cash used in operating activities:

    

Depreciation

     10,672        11,663   

Amortization of other intangible assets

     10,125        10,161   

Amortization of vessel dry-docking

     6,635        8,138   

Amortization of deferred financing costs

     1,404        2,018   

Loss on conversion/modification of debt

     36,421        630   

Impairment charge

     257        2,818   

Legal settlements

     —          (18,202

Gain on change in value of debt conversion features

     (19,130     —     

Deferred income taxes

     266        2.026   

Gain on equipment disposals

     (213     (368

Stock-based compensation

     258        364   

Accretion of interest on convertible notes

     3,931        5,764   

Accretion of interest on legal settlements

     1,121        284   

Changes in operating assets and liabilities:

    

Accounts receivable

     (10,764     (21,449

Materials and supplies

     94        (3,772

Other current assets

     (407     (2,933

Accounts payable

     14,358        (10,973

Accrued liabilities

     4,875        (2,844

Vessel rent

     (6,612     (2,237

Vessel dry-docking payments

     (9,336     (6,839

Legal settlement payments

     (1,500     (1,884

Other assets/liabilities

     32        (837
  

 

 

   

 

 

 

Net cash used in operating activities from continuing operations

     (14,199     (44,185

Net cash used in operating activities from discontinued operations

     (19,891     (20,975
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of property and equipment

     (4,230     (6,708

Proceeds from the sale of property and equipment

     830        1,402   
  

 

 

   

 

 

 

Net cash used in investing activities from continuing operations

     (3,400     (5,306

Net cash used in investing activities from discontinued operations

     —          (390
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Payments on long-term debt

     (1,125     (9,375

Borrowing under ABL facility

     42,500        —     

Borrowing under revolving credit facility

     —          97,500   

Payments on revolving credit facility

     —          (9,000 )

Payment of financing costs

     (4,400     (6,848

Payments on capital lease obligations

     (900     (783
  

 

 

   

 

 

 

Net cash provided by financing activities

     36,075        71,494   
  

 

 

   

 

 

 

Net increase in cash from continuing operations

     18,476        22,003   

Net decrease in cash from discontinued operations

     (19,891     (21,365
  

 

 

   

 

 

 

Net (decrease) increase in cash

     (1,415     638   

Cash at beginning of period

     21,147        2,751   
  

 

 

   

 

 

 

Cash at end of period

   $ 19,732      $ 3,389   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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HORIZON LINES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Organization

Horizon Lines, Inc. (the “Company”) operates as a holding company for Horizon Lines, LLC (“Horizon Lines”), a Delaware limited liability company and wholly-owned subsidiary, Horizon Logistics, 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. (“HSI”), a Hawaii corporation and wholly owned subsidiary. Horizon Lines operates as a Jones Act container shipping business with primary service to ports within the continental United States, Puerto Rico, Alaska, and Hawaii. Under the Jones Act, all vessels transporting cargo between covered locations must, subject to limited exceptions, be built in the U.S., registered under the U.S. flag, manned by predominantly U.S. crews, and owned and operated by U.S.-organized companies that are controlled and 75% owned by U.S. citizens. Horizon Lines also offers terminal services. HLPR operates as an agent for Horizon Lines in Puerto Rico and also provides terminal services in Puerto Rico.

2. Basis of Presentation

The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany items have been eliminated in consolidation. Certain prior period balances have been reclassified to conform to current period presentation.

At a special meeting of the Company’s stockholders held on December 2, 2011, the Company’s stockholders approved an amendment to the Company’s certificate of incorporation effecting a reverse stock split. On December 7, 2011, the Company filed its restated certificate of incorporation to, among other things, effect the 1-for-25 reverse stock split. In connection with the reverse stock split, stockholders received one share of common stock for every 25 shares of common stock held at the effective time. The reverse stock split reduced the number of shares of outstanding common stock from 56.7 million to 2.3 million. Unless otherwise noted, all share-related amounts herein reflect the reverse stock split. In addition, proportional adjustments were made to the number of shares issuable upon the vesting of restricted shares and the exercise of outstanding options to purchase shares of common stock and the per share exercise price of those options.

During the third quarter of 2011, the Company began a review of strategic alternatives for its Five Star Express (“FSX”) service. As a result of several factors, including: 1) the projected continuation of volatile trans-Pacific freight rates, 2) high fuel prices, and 3) significant operating losses, the Company decided to discontinue its FSX service. On October 21, 2011, the Company finalized a decision to terminate the FSX service, and ceased all operations related to the FSX service during the fourth quarter of 2011. The entire component comprising the FSX service has been discontinued. Accordingly, there will not be any significant future cash flows related to these operations. As a result, the FSX service has been classified as discontinued operations in all periods presented.

During 2011, the entire component comprising the third-party logistics operations was discontinued. As part of the divestiture, the Company transitioned some of the operations and personnel to other logistics providers. There will not be any significant future cash flows related to these operations. In addition, the Company does not have any significant continuing involvement in the divested logistics operations. As a result, the logistics operations have been classified as discontinued operations in all periods presented.

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and accordingly, certain financial information has been condensed and certain footnote disclosures have been omitted. Such information and disclosures are normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 25, 2011. The Company uses a 52 or 53 week (every sixth or seventh year) fiscal year that ends on the Sunday before the last Friday in December.

The financial statements as of June 24, 2012 and the financial statements for the quarters and six months ended June 24, 2012 and June 26, 2011 are unaudited; however, in the opinion of management, such statements include all adjustments necessary for the fair presentation of the financial information included herein, which are of a normal recurring nature. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions and to use judgment that affects the amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates. Results of operations for interim periods are not necessarily indicative of results for the full year.

 

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3. Long-Term Debt

As of the dates below, long-term debt consisted of the following (in thousands):

 

     June 24,
2012
    December 25,
2011
 

First lien senior secured notes

   $ 226,767      $ 228,228   

Second lien senior secured notes

     108,186        96,781   

ABL facility

     42,500        —     

Capital lease obligations

     6,617        7,530   

6.0% convertible senior secured notes

     3,410        181,098   

4.25% convertible notes

     2,244        2,211   
  

 

 

   

 

 

 

Total long-term debt

     389,724        515,848   

Less current portion

     (5,733     (6,107
  

 

 

   

 

 

 

Long-term debt, net of current portion

   $ 383,991      $ 509,741   
  

 

 

   

 

 

 

First Lien Notes

The 11.00% First Lien Senior Secured Notes (the “First Lien Notes”) were issued pursuant to an indenture on October 5, 2011. The First Lien Notes bear interest at a rate of 11.0% per annum, payable semiannually, beginning on April 15, 2012 and mature on October 15, 2016. The First Lien Notes are callable by the Company at 101.5% of their aggregate principal amount, plus accrued and unpaid interest in the first year after their issuance and at par plus accrued and unpaid interest thereafter. The Company is obligated to make mandatory prepayments of 1%, on an annual basis, of the original principal amount. These prepayments are payable on a semiannual basis and commenced on April 15, 2012. The First Lien Notes are fully and unconditionally guaranteed by all of the Company’s domestic subsidiaries (collectively, the “Notes Guarantors”).

The First Lien Notes are secured by a first priority lien on all Secured Notes Priority Collateral and a second priority lien on all ABL Priority Collateral (each as defined below). The First Lien Notes contain affirmative and negative covenants which are typical for senior secured high-yield notes with no financial maintenance covenants. The First Lien Notes contain other covenants, including: change of control put at 101% (subject to a permitted holder exception); limitation on asset sales; limitation on incurrence of indebtedness and preferred stock; limitation on restricted payments; limitation on restricted investments; limitation on liens; limitation on dividends; limitation on affiliate transactions; limitation on sale/leaseback transactions; limitation on guarantees by restricted subsidiaries; and limitation on mergers, consolidations and sales of all/substantially all of the assets of the Company. These covenants are subject to certain exceptions and qualifications. The Company was in compliance with all such applicable covenants as of June 24, 2012.

On October 5, 2011, the fair value of the First Lien Notes was $228.4 million, which reflects the Company’s ability to call the First Lien Notes at 101.5% during the first year and at par thereafter. The original issue premium of $3.4 million is being amortized through interest expense through the maturity of the First Lien Notes.

The Company entered into a registration rights agreement with the purchasers of the First Lien Notes, which was amended on July 13, 2012. The Company is obligated to complete an A/B Exchange Offer as soon as practicable, but in no event later than 400 days after the issuance of the First Lien Notes.

Second Lien Notes

On October 5, 2011, the Company completed the sale of $100.0 million aggregate principal amount of its 13.00%-15.00% Second Lien Senior Secured Notes (the “Second Lien Notes”). The Second Lien Notes are fully and unconditionally guaranteed by the Notes Guarantors.

The Second Lien Notes bear interest at a rate of either: (i) 13% per annum, payable semiannually in cash in arrears; (ii) 14% per annum, 50% of which is payable semiannually in cash in arrears and 50% is payable in kind; or (iii) 15% per annum payable in kind, payable semiannually, beginning on April 15, 2012, and maturing on October 15, 2016. The Second Lien Notes are non-callable for 2 years from the date of their issuance, and thereafter the Second Lien Notes will be callable by the Company at (i) 106% of their aggregate principal amount, plus accrued and unpaid interest thereon in the third year, (ii) 103% of their aggregate principal amount, plus accrued and unpaid interest thereon in the fourth year, and (iii) at par plus accrued and unpaid interest thereafter.

The Second Lien Notes are secured by a second priority lien on all Secured Notes Priority Collateral and a third priority lien on all ABL Priority Collateral (each as defined below). The Second Lien Notes contain affirmative and negative covenants which are typical for senior secured high-yield notes with no financial maintenance covenants. The Second Lien Notes contain other covenants, including: change of control put at 101% (subject to a permitted holder exception); limitation on asset sales; limitation on incurrence of indebtedness and preferred stock; limitation on restricted payments; limitation on restricted investments; limitation on liens; limitation on dividends;

 

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limitation on affiliate transactions; limitation on sale/leaseback transactions; limitation on guarantees by restricted subsidiaries; and limitation on mergers, consolidations and sales of all/substantially all of the assets of the Company. These covenants are subject to certain exceptions and qualifications. The Company was in compliance with all such applicable covenants as of June 24, 2012.

On October 5, 2011, the fair value of the Second Lien Notes was $96.6 million. The original issue discount of $3.4 million is being amortized through interest expense through the maturity of the Second Lien Notes.

The Company entered into a registration rights agreement with the purchasers of the Second Lien Notes, which was amended on July 13, 2012. The Company is obligated to complete an A/B Exchange Offer as soon as practicable, but in no event later than 400 days after the issuance of the First Lien Notes.

As discussed in Note 5, the Company entered into a Global Termination Agreement with Ship Finance International Limited (“SFL”) whereby the Company issued $40.0 million aggregate principal amount of its Second Lien Notes and warrants to purchase 9,250,000 shares of the Company’s common stock to satisfy its obligations for certain vessel leases. The liability for the $40.0 million of Second Lien Notes has been presented as a long-term liability of discontinued operations on the Company’s Condensed Consolidated Balance Sheet as of June 24, 2012.

ABL Facility

On October 5, 2011, the Company entered into a $100.0 million asset-based revolving credit facility (the “ABL Facility”) with Wells Fargo Capital Finance, LLC (“Wells Fargo”). Use of the ABL Facility is subject to compliance with a customary borrowing base limitation. The ABL Facility includes an up to $30.0 million letter of credit sub-facility and a swingline sub-facility up to $15.0 million, with Wells Fargo serving as administrative agent and collateral agent. The Company has the option to request increases in the maximum commitment under the ABL Facility by up to $25.0 million in the aggregate; however, such incremental facility increases have not been committed to in advance. The ABL Facility was used on the closing date for the rollover of certain issued and outstanding letters of credit and is used by the Company for working capital and other general corporate purposes.

The ABL Facility matures October 5, 2016 (but 90 days earlier if the First Lien Notes and the Second Lien Notes are not repaid or refinanced as of such date). The interest rate on the ABL Facility is LIBOR or a base rate plus an applicable margin based on leverage and excess availability ranging from (i) 1.25% to 2.75%, in the case of base rate loans and (ii) 2.25% to 3.75%, in the case of LIBOR loans. A fee ranging from 0.375% to 0.50% per annum will accrue on unutilized commitments under the ABL Facility. As of June 24, 2012, borrowings outstanding under the ABL facility totaled $42.5 million and total availability was $17.3 million. The Company had $18.9 million of letters of credit outstanding as of June 24, 2012.

The ABL Facility is secured by (i) a first priority lien on the Company’s interest in accounts receivable, deposit accounts, securities accounts, investment property (other than equity interests of the subsidiaries and joint ventures of the Company) and cash, in each case with certain exceptions and (ii) a fourth priority lien on all or substantially all other assets of the Company securing the First Lien Notes, the Second Lien Notes and the 6.00% Convertible Notes.

The ABL Facility requires compliance with a minimum fixed charge coverage ratio test if excess availability is less than the greater of (i) $12.5 million or (ii) 12.5% of the maximum commitment under the ABL Facility. In addition, the ABL Facility includes certain customary negative covenants that, subject to certain materiality thresholds, baskets and other agreed upon exceptions and qualifications, will limit, among other things, indebtedness, liens, asset sales and other dispositions, mergers, liquidations, dissolutions and other fundamental changes, investments and acquisitions, dividends, distributions on equity or redemptions and repurchases of capital stock, transactions with affiliates, repayments of certain debt, conduct of business and change of control. The ABL Facility also contains certain customary representations and warranties, affirmative covenants and events of default, as well as provisions requiring compliance with applicable citizenship requirements of the Jones Act. The Company was in compliance with all such applicable covenants as of June 24, 2012.

6.00% Convertible Notes

On October 5, 2011, the Company issued $178.8 million in aggregate principal amount of new 6.00% Series A Convertible Senior Secured Notes due 2017 (the “Series A Notes”) and $99.3 million in aggregate principal amount of new 6.00% Series B Mandatorily Convertible Senior Secured Notes (the “Series B Notes” and, together with the Series A Notes, the “6.00% Convertible Notes”). The Series A Notes and the Series B Notes are each fully and unconditionally guaranteed by all of the Notes Guarantors. The 6.00% Convertible Notes were issued pursuant to an indenture, which the Company and the Notes Guarantors entered into with U.S. Bank National Association, as trustee and collateral agent, on October 5, 2011 (the “6.00% Convertible Notes Indenture”).

On January 11, 2012, the Company completed the mandatory debt-to-equity conversion of approximately $49.7 million of the Series B Notes. Approximately $18.5 million of the Series B Notes were converted into 1.0 million shares of common stock with the remainder being converted into warrants exercisable into 1.7 million shares of common stock. As a result of the conversion of a portion of the Series B Notes, the Company recorded a gain on conversion of approximately $11.3 million during the quarter ended March 25, 2012.

On March 27, 2012, the Company announced that it had signed restructuring support agreements with more than 96% of its noteholders to further deleverage its balance sheet in connection with and contingent upon a restructuring of the vessel charter obligations related to the Company’s discontinued FSX service. The restructuring support agreements provided, among other things, that substantially all of the remaining $228.4 million of the Company’s Series A and Series B Notes would be converted into the Company’s stock, or warrants for non-U.S. citizens.

On May 3, 2012, the Company completed the conversion process and converted $175.8 million of Series A Notes and $48.9 million of Series B Notes into equity. In addition, the Company converted $6.1 million of Series A Notes and $1.7 million of Series B Notes issued as payment in kind during the second quarter of 2012 to satisfy the interest obligations associated with the 6.0% Convertible Notes. As a result of the conversion transactions, the Company issued approximately 27.7 million shares of the Company’s common stock and warrants for the purchase of approximately an additional 45.5 million shares of the Company’s common stock to holders of the Series A Notes. In addition, the Company issued approximately 1.0 million shares of the Company’s common stock and warrants for the purchase of approximately an additional 1.7 million shares of the Company’s common stock to holders of the Series B Notes. The conversion price of the warrants is $0.01 per common share. As a result of the conversion of the Series A Notes and Series B Notes, the Company recorded a loss on conversion of approximately $48.5 million during the quarter ended June 24, 2012, which includes the payment of legal and other related fees of $2.6 million.

 

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The remaining $3.7 million face value of the 6.00% Convertible Notes bear interest at a rate of 6.00% per annum, payable semiannually. The Series A Notes mature on April 15, 2017, and are convertible at the option of the holders, and at the Company’s option under certain circumstances, including listing of the Company’s shares of common stock on either the NYSE or NASDAQ markets, beginning on the one-year anniversary of the issuance of the Series A Notes, into shares of the Company’s common stock or warrants, as the case may be.

The remaining Series A Notes are convertible into shares of the Company’s common stock at a conversion rate equal to 402.3272 shares of common stock per $1,000 principal amount of Series A Notes. Beginning on October 5, 2012, the Company will have the option to convert all or any portion of the outstanding Series A Notes, upon not more than 60 days and not less than 20 days prior notice to noteholders; provided that (i) the Company’s common stock is listed on either the NYSE or NASDAQ markets and (ii) the 30 trading day volume weighted average price for the Company’s common stock for the 30-day period ending on the trading day preceding the date of such notice is equal to or greater than $15.75 per share. Holders of the Series A Notes may convert their notes at any time through the maturity date. Upon conversion, foreign holders may, under certain conditions, receive warrants in lieu of shares of common stock.

The Series B Notes are mandatorily convertible into shares of the Company’s common stock at a conversion rate equal to 54.7196 shares of common stock per $1,000 principal amount of Series B Notes, subject to the conditions that the Company’s common stock is listed on the NYSE or NASDAQ markets and that the Company is not in default under its debt obligations. The Series B Notes are mandatorily convertible at the Company’s option into shares of the Company’s common stock or warrants, as the case may be, in two equal installments of $49.7 million each on the three-month and nine-month anniversaries of the consummation of the exchange offer. The remaining Series B Notes will be automatically converted into Series A Notes on the one-year anniversary of the issuance of the 6.00% Convertible Notes if the Company is unable to effect the second mandatory conversion prior to such date.

The conversion rate of the remaining Series A Notes and Series B Notes may be increased in certain circumstances to compensate the holders thereof for the loss of the time value of the conversion right (i) if at any time the Company’s common stock or the common stock into which the new notes may be converted is greater than or equal to $11.25 per share and is not listed on the NYSE or NASDAQ markets or (ii) if a change of control occurs, unless at least 90% of the consideration received or to be received by holders of common stock, excluding cash payments for fractional shares, in connection with the transaction or transactions constituting the change of control, consists of shares of common stock, American Depositary Receipts or American Depositary Shares traded on a national securities exchange in the United States or which will be so traded or quoted when issued or exchanged in connection with such change of control. Upon a change of control, holders will have the right to require the Company to repurchase for cash the outstanding Series A Notes and Series B Notes at 101% of the aggregate principal amount, plus accrued and unpaid interest.

The long-term debt and embedded conversion options associated with the Series A Notes and Series B Notes were recorded on the Company’s balance sheet at their fair value on October 5, 2011. Fair value of the Series A Notes was calculated using a trinomial lattice convertible bond valuation model, which incorporated the terms and conditions of the Series A Notes. One of the inputs to the trinomial lattice model is the bond yield of a hypothetical note identical to the Series A Notes, excluding the conversion features and its related make-whole provisions. The trinomial lattice model produces an estimated fair value based on the assumed changes in prices of the underlying equity over successive periods of time. The Series B Notes were valued using a Monte-Carlo simulation to estimate the probability of conversion. The probability of equity conversion is multiplied by the common stock price as of the valuation date. The estimation of the probability was performed by using a Monte- Carlo simulation in order to estimate a range of simulated future market capitalization over the conversion term. For each equity path, the daily stock price of the Company is considered to follow a Geometric Brownian Motion with a drift equal to the cost of equity. On October 5, 2011, the fair value of the long-term debt portion of the Series A Notes and Series B Notes was $105.6 million and $58.6 million, respectively. The original issue discounts are being amortized through interest expense through the maturity of the Series A and Series B Notes.

On October 5, 2011, the fair value of the embedded conversion options within the Series A and the Series B Notes totaled $98.5 million and were classified within level 3 of the fair value hierarchy. To calculate the fair value of the embedded derivatives, a “with” and “without” scenario comparison was used. The methodology used to value the Series A Notes and Series B Notes constitute the “with” scenarios. The “without” scenario was estimated as a bond paying the same coupon payments as the

 

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securities without any conversion features. The fair value of the embedded conversion features was estimated as the difference between the two scenarios. At each fiscal quarter end, the Company is required to mark-to-market these embedded conversion features. As of June 24, 2012, the fair value of the embedded conversion features was $1.1 million, which was calculated using the Black-Scholes Pricing Model. The Company recorded a non-cash gain of $32.8 million and $19.1 million during the quarter and six months ended June 24, 2012, respectively, for the change in fair value of embedded conversion features, which are recorded within other expense on the Condensed Consolidated Statement of Operations.

Warrants

Certain warrants, not including the warrants issued to SFL, were issued pursuant to a warrant agreement, which the Company entered into with The Bank of New York Mellon Trust Company, N.A, as warrant agent, on October 5, 2011, as amended by Amendment No. 1, dated as of December 7, 2011 (the “Warrant Agreement”). Pursuant to the Warrant Agreement, each warrant entitles the holder to purchase common stock at a price of $0.01 per share, subject to adjustment in certain circumstances. In connection with the reverse stock split, warrant holders will receive 1/25th of a share of the Company’s common stock upon conversion. Upon issuance, in lieu of payment of the exercise price, a warrant holder will have the right (but not the obligation) to require the Company to convert its warrants, in whole or in part, into shares of its common stock without any required payment or request that the Company withhold, from the shares of common stock that would otherwise be delivered to such warrant holder, shares issuable upon exercise of the Warrants equal in value to the aggregate exercise price.

Warrant holders will not be permitted to exercise or convert their warrants if and to the extent the shares of common stock issuable upon exercise or conversion would constitute “excess shares” (as defined in the Company’s certificate of incorporation) if they were issued in order to abide by the foreign ownership limitations imposed by the Company’s certificate of incorporation. In addition, a warrant holder who cannot establish to the Company’s reasonable satisfaction that it (or, if not the holder, the person that the holder has designated to receive the common stock upon exercise or conversion) is a United States citizen, will not be permitted to exercise or convert its warrants to the extent the receipt of the common stock upon exercise or conversion would cause such person or any person whose ownership position would be aggregated with that of such person to exceed 4.9% of the Company’s outstanding common stock.

The warrants contain no provisions allowing the Company to force redemption and there is no conditional obligation of the Company to redeem or convert the warrants. Each warrant is convertible into shares of the Company’s common stock at an exercise price of $0.01 per share, which the Company has the option to waive. In addition, the Company has sufficient authorized and unissued shares available to settle the warrants during the maximum period the warrants could remain outstanding. As a result, the warrants do not meet the definition of an asset or liability and were classified as equity on the date of issuance, on December 25, 2011, and on June 24, 2012. The warrants will be evaluated on a continuous basis to determine if equity classification continues to be appropriate.

4.25% Convertible Senior Notes

On August 8, 2007, the Company issued the 4.25% Convertible Notes. On October 5, 2011, the Company completed its offer to exchange $327.8 million in aggregate principal amount of its 4.25% Convertible Notes, representing 99.3% of the aggregate principal amount, for shares of its common stock, warrants to purchase shares of its common stock, and the 6.00% Convertible Notes.

The remaining $2.2 million face value of the 4.25% Convertible Notes are general unsecured obligations of the Company and rank equally in right of payment with all of the Company’s other existing and future obligations that are unsecured and unsubordinated. The 4.25% Convertible Notes bear interest at the rate of 4.25% per annum, which is payable in cash semiannually on February 15 and August 15 of each year. The 4.25% Notes mature on August 15, 2012.

Fair Value of Financial Instruments

The estimated fair values of the Company’s debt as of June 24, 2012 and December 25, 2011 were $423.9 million and $489.0 million, respectively. The fair value as of June 24, 2012 includes the portion of the Second Lien Notes that has been allocated to discontinued operations. The fair value of the 4.25% Convertible Notes is based on quoted market prices and was classified within level 2 of the fair value hierarchy. The fair value of the other long-term debt approximates carrying value.

4. Restructuring

In an effort to continue to effectively manage costs, during the fourth quarter of 2010 the Company initiated a plan to reduce its non-union workforce by at least 10%, or approximately 65 positions. The Company substantially completed the workforce reduction initiative on January 31, 2011, by eliminating a total of 64 positions, including 35 existing and 29 open positions.

 

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The following table presents the restructuring reserves at June 24, 2012, as well as activity during the year (in thousands):

 

     Balance at
December 25,
2011
     Provision      Payments     Balance at
June  24,
2012
 

Personnel related costs

   $ 233       $ —         $ (209   $ 24   

In the consolidated balance sheets as of June 24, 2012 and December 25, 2011, the reserve for restructuring costs is recorded in other accrued liabilities.

5. Discontinued Operations

FSX Service

On October 21, 2011, the Company finalized a decision to terminate the FSX service, and ceased all operations related to the FSX service during the fourth quarter of 2011. The entire component comprising the FSX service has been discontinued. Accordingly, there will not be any significant future cash flows related to these operations.

On April 5, 2012, the Company entered into a Global Termination Agreement with SFL which enabled the Company to terminate early the bareboat charters of the five foreign-built, U.S.-flag vessels that formerly operated in the FSX service. The Global Termination Agreement became effective April 9, 2012. In connection with the Global Termination Agreement, the Company adjusted the restructuring charge related to its vessel lease obligations originally recorded during the 4th quarter of 2011. Based on (i) the issuance to SFL of $40.0 million in aggregate principal amount of Second Lien Notes, (ii) the 9,250,000 warrants issued to SFL on April 9, 2012, (iii) fees associated with the vessel lease termination and reimbursement obligations to the SFL Parties, and (iv) the net present value of the vessel lease liability as of April 9, 2012, the Company recorded an additional restructuring charge of $14.1 million during the 2nd quarter of 2012, which was recorded as part of discontinued operations.

The following table presents the restructuring reserves at June 24, 2012, as well as activity during the year (in thousands):

 

     Balance at
December 25,
2011
     Payments     Provisions(1)      Adjustments(2)     Balance at
June  24,
2012
 

Vessel leases, net of estimated sublease(2)

   $ 77,060       $ (8,159   $ 4,150       $ (72,300   $ 751   

Rolling stock per-diem and lease termination costs

     9,921         (8,897        —          1,024   

Personnel related costs

     5,330         (1,085     442         —          4,687   

Facility leases

     135         (157     22         —          —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 92,446       $ (18,298   $ 4,614       $ (72,300   $ 6,462   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) The Company recorded the net present value of its future lease obligations, net of estimated sublease, during the fourth quarter of 2011. The $4.2 million recorded during the six months of 2012 represents non-cash accretion of the liability.
(2) On April 5, 2012, the Company entered into a Global Termination Agreement which which enabled the Company to terminate these vessel leases in advance of the originally scheduled expiration date.

Logistics Operations

During 2011, the entire component comprising the third-party logistics operations was discontinued. As part of the divestiture, the Company transitioned some of the operations and personnel to other logistics providers. There will not be any significant future cash flows related to these operations. In addition, the Company does not have any significant continuing involvement in the divested logistics operations.

The following table includes the major classes of assets and liabilities that have been presented as Assets of discontinued operations and Liabilities of discontinued operations in the Consolidated Balance Sheets (in thousands):

 

     June 24, 2012      December 25, 2011  
     FSX Service      Logistics      Total      FSX Service      Logistics      Total  

Accounts receivable, net of allowance

   $ 407       $ 232       $ 639       $ 4,414       $ 293       $ 4,707   

Property and equipment, net

     6,022         —           6,022         6,031         —           6,031   

Deferred tax asset

     300         —           300         620         —           620   

Other assets

     215         —           215         1,595         22         1,617   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total current assets of discontinued operations

     6,944         232         7,176         12,660         315         12,975   

Long-term deferred tax asset

     146         —           146         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets of discontinued operations

   $ 7,090       $ 232       $ 7,322       $ 12,660       $ 315       $ 12,975   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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     June 24, 2012      December 25, 2011  
     FSX Service      Logistics      Total      FSX Service      Logistics      Total  

Accounts payable

   $ 539       $ —         $ 539       $ 1,312       $ 15       $ 1,327   

Current restructuring liabilities

     6,462         —           6,462         41,337         —           41,337   

Other current liabilities

     790         —           790         2,649         —           2,649   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total current liabilities of discontinued operations

     7,791         —           7,791         45,298         15         45,313   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Long-term debt

     41,253         —           41,253         —           —           —     

Long-term portion of vessel lease obligation

     —           —           —           51,109         —           51,109   

Deferred tax liability

     —           —           —           184         —           184   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total long-term liabilities of discontinued operations

     41,253         —           41,253         51,293         —           51,293   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities of discontinued operations

   $ 49,044       $ —         $ 49,044       $ 96,591       $ 15       $ 96,606   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents summarized financial information for the discontinued operations included in the Consolidated Statements of Operations (in thousands):

 

     Three Months Ended June 24, 2012     Three Months Ended June 26, 2011  
     FSX Service     Logistics      Total     FSX Service     Logistics      Total  

Operating revenue

   $ 401      $ —         $ 401      $ 53,796      $   3,099       $ 56,895   

Operating (loss) income

     (14,341     —           (14,341     (13,777     2,145          (11,632

Net (loss) income

     (16,187     —           (16,187     (11,511     1,590         (9,921

 

     Six Months Ended June 24, 2012     Six Months Ended June 26, 2011  
     FSX Service     Logistics      Total     FSX Service     Logistics      Total  

Operating revenue

   $ 487      $ —         $ 487      $ 98,430      $ 13,683       $ 112,113   

Operating (loss) income

     (16,491     —           (16,491     (26,469     1,365         (25,104

Net (loss) income

     (21,894     —           (21,894     (24,604     830         (23,774

The following table presents summarized cash flow information for the discontinued operations included in the Consolidated Statements of Cash Flows (in thousands):

 

     Six Months Ended June 24 2012     Six Months Ended June 26, 2011  
     FSX Service     Logistics      Total     FSX Service     Logistics     Total  

Net cash (used in) provided by operating activities

   $ (20,046   $ 155       $ (19,891 )   $ (26,073   $ 5,098      $ (20,975

Net cash used in investing activities

     —          —           —          (333     (57     (390
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash from discontinued operations

   $ (20,046   $ 155       $ (19,891   $ (26,406   $ 5,041      $ (21,365
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

6. Income Taxes

During the second quarter of 2009, the Company determined that it was unclear as to the timing of when it will generate sufficient taxable income to realize its deferred tax assets. Accordingly, the Company recorded a valuation allowance against its deferred tax assets. The valuation allowance is reviewed quarterly and will be maintained until sufficient positive evidence exists to support the reversal of the valuation allowance. In addition, until such time that the Company determines it is more likely than not that it will generate sufficient taxable income to realize its deferred tax assets, income tax benefits associated with future period losses will be fully reserved.

During the second quarter of 2012, the Company recognized the impact of the conversion of the Series A Notes and Series B Notes to equity and the Global Termination Agreement with SFL as a discrete item. These significant events had a minimal impact on the Company’s Condensed Statement of Operations in the second quarter of 2012, as the Company continues to recognize a full valuation allowance against all of its net deferred tax assets for U.S. federal and state tax purposes. However, the change for such significant events resulted in an overall adjustment to the Company’s deferred taxes recognized on its balance sheet. After the impact of the valuation allowance, the Company recorded a decrease to its current deferred tax asset of $2.4 million and an offsetting decrease to its noncurrent deferred tax liability of $2.4 million as of June 24, 2012. The Company has not changed its judgment regarding its overall realizability of its net deferred tax assets.

During the first quarter of 2012, after evaluating the merits and requirements of the tonnage tax regime, the Company revoked its election under subchapter R of the tonnage tax regime effective for the tax years beginning January 1, 2012. As a

 

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result, the activities attributable to the Company’s operation of the vessels in the Puerto Rico tradelane are no longer eligible as qualifying shipping activities under the tonnage tax regime, and therefore, the income (loss) derived from the Puerto Rico vessels will no longer be excluded from corporate income tax for U.S. federal income tax purposes. The Company’s decision was made based on several factors, including the expected economic challenges in Puerto Rico in the foreseeable future. Under the eligibility requirements of the tonnage tax regime, the Company may not elect back into the tonnage tax regime until five years following its revocation. The Company will reevaluate the merits of the tonnage tax regime at such time in the future.

The Company has accounted for the revocation of the tonnage tax as a change in tax status of its qualifying shipping activities. Accordingly, the Company recognized the impact of the revocation of its tonnage tax election in the first quarter of 2012, the period for which the Company filed its revocation statement with the Internal Revenue Service. The revocation had a minimal impact on the Company’s Condensed Consolidated Statement of Operations in the first quarter of 2012. The change in tax status resulted in the revaluation of the Company’s deferred taxes. The overall decrease in the Company’s net deferred tax assets was approximately $3.0 million, before the impact of the valuation allowance. After offsetting the decrease in net deferred tax assets with the valuation allowance, the impact on the Company’s net deferred taxes was minimal.

7. Stock-Based Compensation

Stock-based compensation costs are measured at the grant date, based on the estimated fair value of the award, and are recognized as an expense in the income statement over the requisite service period. Compensation costs related to stock options, restricted shares, and vested shares granted under the Amended and Restated Equity Incentive Plan (the “Plan”), the 2009 Incentive Compensation Plan (the “2009 Plan”), and purchases under the Employee Stock Purchase Plan, as amended (“ESPP”) are recognized using the straight-line method, net of estimated forfeitures. Stock options and restricted shares granted to employees under the Plan and the 2009 Plan typically cliff vest and become fully exercisable on the third anniversary of the grant date, provided the employee who was granted such options/restricted shares is continuously employed by the Company or its subsidiaries through such date, and provided performance based criteria, if any, are met. In addition, recipients who retire from the Company and meet certain age and length of service criteria are typically entitled to proportionate vesting.

The following compensation costs are included within selling, general, and administrative expenses on the condensed consolidated statements of operations (in thousands):

 

     Quarters Ended      Six Months Ended  
     June 24,
2012
    June 26,
2011
     June 24,
2012
     June 26,
2011
 

Stock options

   $ —        $ 8       $ —         $ 60   

Restricted stock / vested shares

     222        35         237         234   

Restricted stock units

     (12     39         21         39   

ESPP

     —          —           —           31   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 210      $ 82       $ 258       $ 364   
  

 

 

   

 

 

    

 

 

    

 

 

 

Stock Options

The Company’s stock option plan provides for grants of stock options to key employees at prices not less than the fair market value of the Company’s common stock on the grant date. The Company has not granted any stock options since 2008. As of June 24, 2012, there was no unrecognized compensation costs related to stock options. A summary of stock option activity is presented below:

 

Options

   Number of
Options
    Weighted-
Average
Exercise
Price
     Weighted-
Average
Remaining
Contractual
Term (years)
     Aggregate
Intrinsic
Value

(000’s)
 

Outstanding at December 25, 2011

     51,350      $ 389.58         

Granted

     —          —           

Exercised

     —          —           

Forfeited

     —          —           

Expired

     (4,679     354.00         
  

 

 

         

Outstanding, vested and exercisable at June 24, 2012

     46,671      $ 396.25         4.58       $ —     
  

 

 

   

 

 

    

 

 

    

 

 

 

 

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Restricted Stock

A summary of the status of the Company’s restricted stock awards as of June 24, 2012 is presented below:

 

Restricted Shares

   Number of
Shares
    Weighted-
Average
Fair Value
at Grant
Date
 

Nonvested at December 25, 2011

     23,719      $ 119.24   

Granted

     —          —     

Vested

     (9,791     88.00   

Forfeited

     (3,542     138.50   
  

 

 

   

Nonvested at June 24, 2012

     10,386      $ 142.00   
  

 

 

   

 

 

 

As of June 24, 2012, there was $0.2 million of unrecognized compensation expense related to all restricted stock awards, which is expected to be recognized over a weighted-average period of 1.0 year.

Restricted Stock Units

On June 2, 2011, the Company granted a total of 20,532 restricted stock units (“RSUs”) to all members of its Board of Directors including its interim President and Chief Executive Officer. The Company’s interim President and Chief Executive Officer received the grant of the RSUs in his capacity as a member of the Board of Directors. Based on the closing price of the Company’s common stock on the grant date, the total fair value of the RSUs granted was $0.6 million. Each RSU has an economic value equal to a share of the Company’s Common Stock (excluding the right to receive dividends). A portion of the RSUs vested and were settled in cash when each of the individuals granted such RSUs retired from the Company’s Board of Directors. The remaining RSUs vested on June 2, 2012 and were settled in cash when the individual granted such RSUs retired from the Company’s Board of Directors. In accordance with the award provisions, the compensation expense recorded in the Company’s Condensed Statement of Operations reflects the straight-line amortized fair value based on the closing price on the vesting date. There was no unrecognized compensation expense related to the RSUs as of June 24, 2012.

Employee Stock Purchase Plan

Effective April 1, 2011, the Company has suspended the ESPP. There will be no stock-based compensation expense recognized in connection with the ESPP until such time the ESPP is reinstated.

8. Net Loss per Common Share

Basic net loss per share is computed by dividing net loss by the weighted daily average number of shares of common stock outstanding during the period. Diluted net loss per share is based upon the weighted daily average number of shares of common stock outstanding for the period plus dilutive potential shares of common stock, including stock options, using the treasury-stock method.

 

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Net loss per share is as follows (in thousands, except per share amounts):

 

     Quarters Ended     Six Months Ended  
     June 24,
2012
    June 26
2011
    June 24
2012
    June 26,
2011
 

Numerator:

        

Net (loss) income from continuing operations

   $ (29,887   $ 4,505      $ (56,686   $ (15,713 )

Net loss from discontinued operations

     (16,187     (9,921 )     (21,894     (23,774 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (46,074   $ (5,416 )   $ (78,580   $ (39,487 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for basic net (loss) income per common share:

        

Weighted average shares outstanding

     20,068        1,241        11,595        1,239   
  

 

 

   

 

 

   

 

 

   

 

 

 

Effect of dilutive securities:

        

Stock-based compensation

     —          —          —          —     

Warrants to purchase common stock

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted net (loss) income per common share

     20,068        1,241        11,595        1,239   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net (loss) income per common share

        

From continuing operations

   $ (1.49 )   $ 3.63      $ (4.89 )   $ (12.68 )

From discontinued operations

     (0.81 )     (7.99 )     (1.89 )     (19.19 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per common share

   $ (2.30 )   $ (4.36 )   $ (6.78 )   $ (31.87 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Warrants outstanding to purchase 54.0 million and 54.6 million common shares have been excluded from the denominator during the quarter and six months ended June 24, 2012, respectively, as the impact would be anti-dilutive.

Certain of the Company’s unvested stock-based awards contain non-forfeitable rights to dividends. In periods when the Company generates net income from continuing operations, shares are included in the denominator for these participating securities. However, in periods when the Company generates a net loss from continuing operations, shares are excluded from the denominator for these participating securities as the impact would be anti-dilutive. A total of 2 thousand shares have been excluded from the denominator for basic net loss per share during the quarter ended June 24, 2012. In addition, a total of 3 thousand and 6 thousand shares have been excluded from the denominator for basic net loss per share during the six months ended June 24, 2012 and June 26, 2011, respectively.

 

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9. Property and Equipment

Property and equipment consists of the following (in thousands):

 

     June 24, 2012      December 25, 2011  
     Historical
Cost
     Net Book
Value
     Historical
Cost
     Net Book
Value
 

Vessels and vessel improvements

   $ 152,439       $ 64,295       $ 150,658       $ 67,379   

Containers

     37,362         22,188         37,831         23,114   

Chassis

     12,556         4,866         12,713         5,429   

Cranes

     27,722         14,132         27,641         15,144   

Machinery and equipment

     31,866         10,993         31,015         11,661   

Facilities and land improvements

     28,030         21,348         27,257         21,293   

Software

     25,175         1,379         25,169         1,268   

Construction in progress

     20,881         20,881         21,857         21,857   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 336,031       $ 160,082       $ 334,141       $ 167,145   
  

 

 

    

 

 

    

 

 

    

 

 

 

10. Intangible Assets

Intangible assets consist of the following (in thousands):

 

     June 24,
2012
    December 25,
2011
 

Customer contracts/relationships

   $ 141,430      $ 141,430   

Trademarks

     63,800        63,800   

Deferred financing costs

     11,979        15,450   
  

 

 

   

 

 

 

Total intangibles with definite lives

     217,209        220,680   

Accumulated amortization

     (161,874     (150,738
  

 

 

   

 

 

 

Net intangibles with definite lives

     55,335        69,942   

Goodwill

     198,793        198,793   
  

 

 

   

 

 

 

Intangible assets, net

   $ 254,128      $ 268,735   
  

 

 

   

 

 

 

As a result of the conversion of Series B Notes during the first quarter of 2012 and the conversion of Series A Notes and Series B Notes during the second quarter of 2012, the Company wrote-off a total of $3.9 million of deferred financing costs.

11. Other Accrued Liabilities

Other accrued liabilities consist of the following (in thousands):

 

     June 24,
2012
     December 25,
2011
 

Vessel operations

   $ 10,694       $ 13,783   

Payroll and employee benefits

     15,367         13,594   

Marine operations

     5,901         7,077   

Terminal operations

     8,188         9,297   

Fuel

     5,671         10,590   

Interest

     5,451         12,368   

Legal settlements

     10,180         8,066   

Restructuring

     24         233   

Other liabilities

     20,217         22,089   
  

 

 

    

 

 

 

Total other accrued liabilities

   $ 81,693       $ 97,097   
  

 

 

    

 

 

 

The Company has recorded certain of its legal settlements at their net present value and is recording an accretion of the liability balance through interest expense. In addition to the current liabilities related to legal settlements, the Company also has commitments to make payments after June 24, 2013. The Company is required to make payments related to the plea agreement with the Antitrust Division of the Department of Justice (“DOJ”) of $3.0 million on or before March 24, 2014, $4.0 million on or before March 24, 2015, and $4.0 million on or before March 21, 2016, all of which are recorded in other long-term liabilities on the accompanying Condensed Consolidated Balance Sheets.

 

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12. Fair Value Measurement

U.S. accounting standards establish a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs when determining fair value. The three levels of inputs used to measure fair value are as follows:

 

Level 1:   observable inputs such as quoted prices in active markets
Level 2:   inputs other than the quoted prices in active markets that are observable either directly or indirectly
Level 3:   unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions

As of June 24, 2012, the Company’s liabilities measured at fair value on a recurring basis are as follows (in thousands):

 

     Quoted Prices
in Active
Markets for
Identical
Assets

(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Total  

Conversion features within Series A Notes (Note 3)

   $ —         $ —         $ 825       $ 825   

Conversion features within Series B Notes (Note 3)

     —           —           276        276  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

   $ —         $ —         $ 1,101       $ 1,101   
  

 

 

    

 

 

    

 

 

    

 

 

 

13. Pension and Post-retirement Benefit Plans

The Company provides pension and post-retirement benefit plans for certain of its union workers. Each of the plans is described in more detail below. A decline in the value of assets held by these plans, caused by negative performance of the investments in the financial markets, and lower discount rates due to lower interest rates have resulted in higher contributions to these plans.

Pension Plans

The Company sponsors a defined benefit plan covering approximately 30 union employees as of June 24, 2012. The plan provides for retirement benefits based only upon years of service. Employees whose terms and conditions of employment are subject to or covered by the collective bargaining agreement between Horizon Lines and the International Longshore & Warehouse Union Local 142 are eligible to participate once they have completed one year of service. Contributions to the plan are based on the projected unit credit actuarial method and are limited to the amounts that are currently deductible for income tax purposes. The Company recorded net periodic benefit costs of $0.2 million during each of the quarters ended June 24, 2012 and June 26, 2011, and 0.4 million during each of the six months ended June 24, 2012 and June 26, 2011.

The HSI pension plan covering approximately 50 salaried employees was frozen to new entrants as of December 31, 2005. Contributions to the plan are based on the projected unit credit actuarial method and are limited to the amounts that are currently deductible for income tax purposes. The Company recorded net periodic benefit costs of $0.1 million during each of the quarters ended June 24, 2012 and June 26, 2011, and 0.2 million during each of the six months ended June 24, 2012 and June 26, 2011.

The Company expects to make contributions to the above mentioned pension plans totaling $1.1 million during 2012.

Post-retirement Benefit Plans

In addition to providing pension benefits, the Company provides certain healthcare (both medical and dental) and life insurance benefits for eligible retired members (“post-retirement benefits”). For eligible employees hired on or before July 1, 1996, the healthcare plan provides for post-retirement health coverage for an employee who, immediately preceding his/her retirement date, was an active participant in the retirement plan and has attained age 55 as of his/her retirement date. For eligible employees hired after July 1, 1996, the plan provides post-retirement health coverage for an employee who, immediately preceding his/her retirement date, was an active participant in the retirement plan and has attained a combination of age and

 

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service totaling 75 years or more as of his/her retirement date. The Company recorded net periodic benefit costs related to the post-retirement benefits of $0.1 million during each of the quarters ended June 24, 2012 and June 26, 2011, and 0.2 million during each of the six months ended June 24, 2012 and June 26, 2011.

Effective June 25, 2007, the HSI plan provides for post-retirement medical, dental and life insurance benefits for salaried employees who had attained age 55 and completed 20 years of service as of December 31, 2005. Any salaried employee already receiving post-retirement medical coverage as of June 25, 2007 will continue to be covered by the plan. For eligible union employees hired on or before July 1, 1996, the healthcare plan provides for post-retirement medical coverage for an employee who, immediately preceding his/her retirement date, was an active participant in the retirement plan and has attained age 55 as of his/her retirement date. For eligible union employees hired after July 1, 1996, the plan provides post-retirement health coverage for an employee who, immediately preceding his/her retirement date, was an active participant in the retirement plan and has attained age 55 and has a combination of age and service totaling 75 years or more as of his/her retirement date. The Company recorded net periodic benefit costs of $0.1 million during each of the quarters ended June 24, 2012 and June 26, 2011, and 0.2 million during each of the six months ended June 24, 2012 and June 26, 2011.

Other Plans

Under collective bargaining agreements, the Company participates in a number of union-sponsored, multi-employer benefit plans. Payments to these plans are made as part of aggregate assessments generally based on hours worked, tonnage of cargo moved, or a combination thereof. Expense for these plans is recognized as contributions are funded. In addition to the higher contributions the Company has made as a result of negative investment performance and lower discount rates due to lower interest rates, the Company has also made higher payments related to increased assessments as a result of lower container volumes and increased benefit costs. If the Company exits these markets, it may be required to pay a potential withdrawal liability if the plans are underfunded at the time of the withdrawal. Any adjustments would be recorded when it is probable that a liability exists and it is determined that markets will be exited.

14. Commitments and Contingencies

Legal Proceedings

On April 17, 2008, the Company received a grand jury subpoena and search warrant from the United States 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. On February 23, 2011, the Company entered into a plea agreement with the DOJ and on March 22, 2011, the Court entered judgment accepting the Company’s plea agreement and imposed a fine of $45.0 million payable over five years without interest. The Company recorded a charge of $30.0 million during the year ended December 26, 2010, which represented the present value of the $45.0 million fine in installment payments. On April 28, 2011, the Court reduced the fine from $45.0 million to $15.0 million payable over five years without interest. As a result, during the six months ended June 26, 2011, the Company recorded a reversal of $19.2 million of the charge originally recorded during December 26, 2010.

Subsequent to the commencement of the DOJ investigation, thirty-two class action lawsuits on behalf of direct purchasers of ocean shipping services in the Puerto Rico tradelane were consolidated into a single multidistrict litigation (“MDL”) proceeding in the District of Puerto Rico. On June 11, 2009, the Company entered into a settlement agreement with the named plaintiff class representatives in the Puerto Rico MDL. Under the settlement agreement, the Company paid $20.0 million and agreed to provide a base-rate freeze to class members who elect such freeze in lieu of a cash payment.

One class action lawsuit relating to ocean shipping services in the Alaska tradelane is pending in the District of Alaska. The Company and the class plaintiffs have agreed to stay the Alaska litigation, and the Company intends to vigorously defend against the purported class action lawsuit in Alaska.

The Company received an administrative subpoena from the Department of Defense (“DOD”) for documents relating to an investigation involving fuel surcharges that freight forwarders may have improperly charged to the DOD. The Company is cooperating with the government with respect to this matter.

In the ordinary course of business, from time to time, the Company becomes involved in various legal proceedings. These relate primarily to claims for loss or damage to cargo, employees’ personal injury claims, and claims for loss or damage to the person or property of third parties. The Company generally maintains insurance, subject to customary deductibles or self-retention amounts, and/or reserves to cover these types of claims. The Company also, from time to time, becomes involved in routine employment-related disputes and disputes with parties with which it has contractual relations.

 

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SFL Agreements

In April 2006, the Company completed a series of agreements with SFL to charter five new non-Jones Act qualified container vessels. On April 5, 2012, the Company entered into a Global Termination Agreement with SFL which enabled the Company to terminate early the bareboat charters of the five foreign-built, U.S.-flag vessels that formerly operated in the FSX service.

Pursuant to the Global Termination Agreement, in consideration for the early termination of the vessel leases, and related agreements and the mutual release of all claims thereunder, the Company agreed to: (i) issue to SFL $40.0 million in aggregate principal amount of Second Lien Notes; (ii) issue to SFL the number of warrants to purchase 9,250,000 shares of the Company’s common stock at a conversion price of $0.01 per common share; (iii) transfer to SFL certain property on board the vessels (such as bunker fuel, spare parts and equipment, and consumable stores) at the time of redelivery to SFL without any additional payment; (iv) reimburse reasonable costs incurred by SFL to (a) return the vessels from their current laid up status to operating status, which reimbursement shall not exceed $0.6 million, (b) reposition the vessels from the Philippines to either Hong Kong or Singapore, which reimbursement shall not exceed $0.1 million, (c) remove the Company’s stack insignia and name from the vessels, which reimbursement shall not exceed $0.1 million, and (d) complete the reflagging of the vessels to the Marshall Islands registry, which approximated $0.1 million; and (v) reimburse SFL for their reasonable costs and expenses incurred in connection with the transaction, which we estimate represents an aggregate reimbursement obligation to the SFL Parties of $0.6 million. The Company paid a total of $0.7 million during the first half of 2012 and expects to pay up to $0.8 million during the second half of 2012.

In connection with the Global Termination Agreement, the Company adjusted the restructuring charge related to its vessel lease obligations originally recorded during the 4th quarter of 2011. Based on (i) the issuance to SFL of $40.0 million in aggregate principal amount of Second Lien Senior Secured Notes due 2016, (ii) the 9,250,000 warrants issued to SFL multiplied by the closing price of the Company’s stock on April 9, 2012, which served as the effective date of the agreement, (iii) fees associated with the vessel lease termination, (iv) reimbursement obligations to the SFL Parties, and (v) the net present value of the vessel lease liability as of April 9, 2012, the Company recorded an additional restructuring charge of $14.1 million during the second quarter of 2012, which has been recorded as part of discontinued operations.

Standby Letters of Credit

The Company has standby letters of credit, primarily related to its property and casualty insurance programs. On June 24, 2012 and December 25, 2011, these letters of credit totaled $18.9 million and $19.6 million, respectively.

 

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15. Recent Accounting Pronouncements

In June 2011, the FASB issued changes to the manner in which entities present comprehensive income in their financial statements. The new guidance requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The new guidance does not change the items that must be reported in other comprehensive income. In December 2011, the FASB deferred the requirement that companies present reclassification adjustments for each component of accumulated other comprehensive income in both net income and other comprehensive income on the face of the financial statements. The new reporting requirement is effective for fiscal years and interim reporting periods within those years beginning after December 15, 2011, with early adoption permitted. The Company elected to early adopt the accounting pronouncement as of December 25, 2011, and the effect on the Company’s consolidated financial statements was to present activity impacting net income and other comprehensive loss in two consecutive statements.

In May 2011, the FASB issued changes to certain portions of the authoritative literature related to fair value measurements and disclosures in order to achieve common fair value measurement and disclosure requirements under GAAP and International Financial Reporting Standards. The update clarifies disclosures for financial instruments categorized within level 3 of the fair value hierarchy that require companies to provide quantitative information about unobservable inputs used, the sensitivity of the measurement to changes in those inputs, and the valuation processes used by the reporting entity. Implementation of this standard is effective for fiscal years and interim periods within those years beginning after December 15, 2011. Implementation of this standard did not have a material impact on the Company’s consolidated financial statements.

16. Subsequent Events

On July 5, 2012, the Company granted Samuel A. Woodward, its President and Chief Executive Officer, 3,000,000 RSUs. The grant was made pursuant to the employment agreement between Mr. Woodward and the Company.

One half (1,500,000) of the RSUs will vest over December 31, 2012, December 31, 2013, December 31, 2014, and June 30, 2015, if Mr. Woodward remains in continuous employment with the Company. The Company expects to record approximately $1.0 million of compensation expense during the second half of 2012 related to these RSUs.

The other half (1,500,000) of the RSUs will vest on any of the same dates if Mr. Woodward remains in continuous employment with the Company and certain performance goals established by the Board of Directors or the Compensation Committee have been met. The Company expects to record approximately $0.2 million of compensation expense during the second half of 2012 related to these performance based RSUs.

On July 25, 2012, the Company granted 150,000 RSUs to each non-employee member of the Board of Directors. The RSUs for each director will vest over March 31, 2013, March 31, 2014 and March 31, 2015, if the director is continuously a member of the Board of Directors at those dates. The Company expects to record approximately $0.5 million of compensation expense during the second half of 2012 related to these RSUs.

On July 25, 2012, the Company granted certain senior management employees of the Company a total of approximately 2.8 million RSUs. One half of the RSUs granted will vest over March 31, 2013, March 31, 2014 and March 31, 2015 solely if the employee remains in continuous employment with the Company. The Company expects to record approximately $0.7 million of compensation expense during the second half of 2012 related to these service based RSUs. The other half of the RSUs will vest on any of those same dates if certain performance goals are met and the employee remains in continuous employment with the Company. The Company expects to record approximately $0.2 million of compensation expense during the second half of 2012 related to these performance based RSUs.

The Company is in discussions with representatives from APM Terminals (“APMT”), its terminal services provider in southern California, in connection with APMT’s participation in negotiations of the collective bargaining agreement with the Office and Clerical Union. Such negotiations could result in a strike, work stoppage or other slowdown by union represented employees. Any disruptions may result in higher operating costs or may adversely impact the Company’s operations, either of which could have a material and adverse effect on the Company’s business, financial condition or results of operations.

 

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2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with the financial statements of the Company and notes thereto included elsewhere in this quarterly report. In this quarterly report, unless the context otherwise requires, references to “we,” “us,” and “our” mean the Company, together with its subsidiaries, on a consolidated basis.

Executive Overview

 

     Quarters Ended     Six Months Ended  
     June 24,
2012
    June 26,
2011
    June 24,
2012
    June 26,
2011
 
     ($ in thousands)  

Operating revenue

   $ 270,939      $ 253,731      $ 534,294      $ 494,451   

Operating expense

     269,932        234,738        539,348        485,690   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

   $ 1,007     $ 18,993      $ (5,054 )   $ 8,761   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating ratio

     99.6     92.5     100.9     98.2

Revenue containers (units)

     59,768        57,677        116,854        114,518   

Average unit revenue

   $ 4,269      $ 4,079      $ 4,263      $ 3,988   

We believe that in addition to GAAP based financial information, EBITDA and Adjusted EBITDA are meaningful disclosures for the following reasons: (i) EBITDA and Adjusted EBITDA are components of the measure used by our board of directors and management team to evaluate our operating performance, (ii) EBITDA and Adjusted EBITDA are components of the measure used by our management team to make day-to-day operating decisions, (iii) EBITDA and Adjusted EBITDA are components of the measure used by our management to facilitate internal comparisons to competitors’ results and the marine container shipping and logistics industry in general and (iv) 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 EBITDA and Adjusted EBITDA as components. We acknowledge that there are limitations when using EBITDA and Adjusted EBITDA. EBITDA and Adjusted EBITDA 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. Additionally, EBITDA and Adjusted EBITDA are not intended to be a measure of free cash flow for management’s discretionary use, as it does not consider certain cash requirements such as tax payments and debt service requirements. Because all companies do not use identical calculations, this presentation of EBITDA and Adjusted EBITDA may not be comparable to other similarly titled measures of other companies. The EBITDA amounts presented below contain certain charges that our management team excludes when evaluating our operating performance, for making day-to-day operating decisions and that have historically been excluded from EBITDA to arrive at Adjusted EBITDA when determining the payment of discretionary bonuses.

 

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A reconciliation of net loss to EBITDA and Adjusted EBITDA is included below (in thousands):

 

     Quarters Ended     Six Months Ended  
     June 24,
2012
    June 26,
2011
    June 24,
2012
    June 26,
2011
 

Net loss

   $ (46,074 )   $ (5,416 )   $ (78,580 )   $ (39,487 )

Net loss from discontinued operations

     (16,187     (9,921     (21,894     (23,774
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income from continuing operations

     (29,887     4,505        (56,686     (15,713

Interest expense, net

     16,238        12,910        33,977        23,626   

Income tax expense

     49        681        346        196   

Depreciation and amortization

     13,019        15,017        27,432        29,962   
  

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

     (581     33,113        5,069        38,071   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss on modification of debt/other refinancing costs

     47,706        889        37,370        1,508   

Department of Justice antitrust investigation costs

     427        949        1,183        3,127   

Impairment charge

     257        2,818        257        2,818   

Union/other severance charge

     156        141        1,279        2,946   

Gain on change in value of debt conversion features

     (32,800     —          (19,130     —     

Legal settlements

     —          (18,202     —          (18,202
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 15,165      $ 19,708      $ 26,028      $ 30,268   
  

 

 

   

 

 

   

 

 

   

 

 

 

In addition to EBITDA and Adjusted EBITDA, we use various other non-GAAP measures such as adjusted net income (loss) and adjusted net income (loss) per share. As with EBITDA and Adjusted EBITDA, the measures below are not recognized terms under GAAP and do not purport to be an alternative to net income (loss) 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.

 

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The tables below present a reconciliation of net loss to adjusted net loss and net loss per share to adjusted net loss per share (in thousands, except per share amounts):

 

     Quarters Ended     Six Months Ended  
     June 24,
2012
    June 26,
2011
    June 24,
2012
    June 24,
2011
 

Net loss

   $ (46,074 )   $ (5,416 )   $ (78,580 )   $ (39,487 )

Net loss from discontinued operations

     (16,187     (9,921     (21,894     (23,774
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income from continuing operations

     (29,887     4,505        (56,686     (15,713

Adjustments:

        

Loss on modification of debt/other refinancing costs

     47,706        889        37,370        1,508   

Department of Justice antitrust investigation costs

     427        949        1,183        3,127   

Impairment charge

     257        2,818        257        2,818   

Union/other severance charge

     156        141        1,279        2,946   

Accretion of legal settlements

     578        44        1,121        284   

Gain on change in value of debt conversion features

     (32,800     —          (19,130     —     

Legal settlements

     —          (18,202     —          (18,202

Tax impact of adjustments

     —          1,315        —          (127
  

 

 

   

 

 

   

 

 

   

 

 

 

Total adjustments

     16,324        (12,046 )     22,080        (7,646 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net loss

   $ (13,563   $ (7,541   $ (34,606   $ (23,359
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Quarters Ended     Six Months Ended  
     June 24,
2012
    June 26,
2011
    June 24,
2012
    June 26,
2011
 

Net loss per share

   $ (2.30   $ (4.36 )   $ (6.78   $ (31.87 )

Net loss per share from discontinued operations

     (0.81     (7.99 )     (1.89     (19.19 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income per share from continuing operations

     (1.49     3.63        (4.89     (12.68 )

Adjustments:

        

Loss on modification of debt/other refinancing costs

     2.38        0.72        3.22        1.22   

Department of Justice antitrust investigation costs

     0.02        0.76        0.10        2.52   

Impairment charge

     0.01        2.27        0.02        2.27   

Union/other severance charge

     0.01        0.11        0.11        2.38   

Accretion of legal settlements

     0.03        0.04        0.10        0.23   

Gain on change in value of debt conversion features

     (1.64     —          (1.64     —     

Legal settlements

     —          (14.67     —          (14.69

Tax impact of adjustments

     —          1.06        —          (0.10
  

 

 

   

 

 

   

 

 

   

 

 

 

Total adjustments

     0.81        (9.71 )     1.91        (6.17 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net loss per share

   $     (0.68   $     (6.08   $     (2.98)      $   (18.85
  

 

 

   

 

 

   

 

 

   

 

 

 

Recent Developments

We are in discussions with representatives from APM Terminals (“APMT”), our terminal services provider in southern California, in connection with APMT’s participation in negotiations of the collective bargaining agreement with the Office and Clerical Union. Such negotiations could result in a strike, work stoppage or other slowdown by union represented employees. Any disruptions may result in higher operating costs or may adversely impact our operations, either of which could have a material and adverse effect on our business, financial condition or results of operations.

General

We believe that we are one of the nation’s leading Jones Act container shipping and integrated logistics companies. In addition, we are the only ocean cargo carrier serving all three noncontiguous domestic markets of Alaska, Hawaii and Puerto Rico from the continental United States. 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.

 

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We own or lease 15 vessels, all of which are fully qualified Jones Act vessels, and approximately 24,900 cargo containers. We provide comprehensive shipping and integrated logistics services in our markets. 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.

History

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 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 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.

Critical Accounting Policies

We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of our financial statements requires us to make estimates and assumptions in the reported amounts of revenues and expenses during the reporting period and in reporting the amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of our financial statements. Since many of these estimates and assumptions are based upon 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 reevaluated 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. There have been no material changes to the Company’s critical accounting policies during the six months ended June 24, 2012. The critical accounting policies can be found in the Company’s Annual Report on Form 10-K for the fiscal year ended December 25, 2011 as filed with the Securities and Exchange Commission (“SEC”).

Seasonality

Our container volumes are subject to seasonal trends common in the transportation industry. Financial results in the first quarter are normally lower due to reduced loads during the winter months. Volumes typically build to a peak in the third quarter and early fourth quarter, which generally results in higher revenues, improved margins, and increased earnings and cash flows.

Results of Operations

Operating Revenue Overview

We derive our revenue primarily from providing comprehensive shipping and integrated logistics services to and from the continental U.S. and Alaska, Puerto Rico, and Hawaii. 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.

Over 90% of our revenue was generated from our shipping and integrated logistics services in markets where the marine trade is subject to the Jones Act. The balance of our revenue was 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, (iv) warehousing services for third-parties, and (v) other non-transportation services.

As used in this Form 10-Q, the term “revenue containers” refers to containers that are transported for a charge, as opposed to empty containers.

 

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Table of Contents

Cost of Services Overview

Our cost of services consist primarily of vessel operating costs, marine operating costs, inland transportation costs, land costs and rolling stock rent. Our vessel operating costs consist primarily of vessel fuel costs, crew payroll costs and benefits, vessel maintenance costs, space charter costs, vessel insurance costs and vessel rent. We view our vessel fuel costs as subject to potential fluctuation as a result of changes in unit prices in the fuel market. Our marine operating costs consist of stevedoring, port charges, wharfage and various other costs to secure vessels at the port and to load and unload containers to and from vessels. Our inland transportation costs consist primarily of the costs to move containers to and from the port via rail, truck or barge. Our land costs consist primarily of maintenance, yard and gate operations, warehousing operations and terminal overhead in the terminals in which we operate. Rolling stock rent consists primarily of rent for street tractors, yard equipment, chassis, gensets and various dry and refrigerated containers.

Quarter Ended June 24, 2012 Compared with the Quarter Ended June 26, 2011

 

     Quarters Ended              
     June 24,
2012
    June 26,
2011
    Change     % Change  
     ($ in thousands)        

Operating revenue

   $ 270,939      $ 253,731      $ 17,208        6.8

Operating expense:

        

Vessel

     92,222        78,184        14,038        18.0

Marine

     51,740        46,991        4,749        10.1

Inland

     46,629        44,642        1,987        4.5

Land

     35,609        35,119        490        1.4

Rolling stock rent

     10,694        10,373        321        3.1
  

 

 

   

 

 

   

 

 

   

Cost of services

     236,894        215,309        21,585        10.0

Depreciation and amortization

     10,397        10,947        (550     (5.0 )% 

Amortization of vessel dry-docking

     2,622        4,070        (1,448     (35.6 )% 

Selling, general and administrative

     19,529        19,842        (313 )     (1.6 )% 

Impairment charge

     257        2,818        (2,561     (90.9 )% 

Legal settlements

     —          (18,202     18,202        (100.0 )% 

Miscellaneous expense (income), net

     233        (46     279        (608.7 )% 
  

 

 

   

 

 

   

 

 

   

Total operating expense

     269,932        234,738        35,194        15.0
  

 

 

   

 

 

   

 

 

   

Operating income

   $ 1,007      $ 18,993      $ (17,986     (94.7 )% 
  

 

 

   

 

 

   

 

 

   

Operating ratio

     99.6     92.5       7.1

Revenue containers (units)

     59,768        57,677        2,091        3.6

Average unit revenue

   $ 4,269      $ 4,079      $ 190        4.7

Operating Revenue. Our operating revenue increased $17.2 million, or 6.8% during the quarter ended June 24, 2012 as compared to the quarter ended June 26, 2011. This revenue increase can be attributed to the following factors (in thousands):

 

Bunker and intermodal fuel surcharges increase

   $ 10,988   

Revenue container volume increase

     6,599   

Revenue container rate increase

     2,101   

Other non-transportation services revenue decrease

     (2,480
  

 

 

 

Total operating revenue increase

   $ 17,208   
  

 

 

 

Bunker and intermodal fuel surcharges, which are included in our transportation revenue, accounted for approximately 23.7% of total revenue in the quarter ended June 24, 2012 and approximately 21.0% of total revenue in the quarter ended June 26, 2011. 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. Our Hawaii tradelane experienced continued volume improvement during the quarter ended June 24, 2012, helped in part by a modest rebound in tourism and ongoing support from customers amid an otherwise sluggish business environment. The increase in revenue container volume in our Puerto Rico tradelane was also due to growth with certain key customers. The increases in Hawaii and Puerto Rico tradelanes were partially offset by a slight decrease in our Alaska tradelane. The increase in revenue container rate was primarily due to rate increases to mitigate increased variable expenses, including port security and wharfage fees. The decrease in non-transportation revenue was primarily due to a reduction in terminal services, partially offset by higher revenue from certain transportation services agreements.

 

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Table of Contents

Cost of Services. The $21.6 million increase in cost of services is primarily due to both higher vessel costs, as a result of a rise in fuel prices and higher duplicate fuel and vessel operating expenses associated with vessel dry-dockings, and higher marine and inland expenses due to the increase in container volumes.

Vessel expense, which is not primarily driven by revenue container volume, increased $14.0 million for the quarter ended June 24, 2012 compared to the quarter ended June 26, 2011. This increase can be attributed to the following factors (in thousands):

 

Vessel fuel costs increase

   $ 10,265   

Labor and other vessel operating expense increase

     3,519   

Vessel space charter expense increase

     404   

Vessel lease expense decrease

     (150
  

 

 

 

Total vessel expense increase

   $ 14,038   
  

 

 

 

The $10.3 million rise in fuel costs is comprised of a $5.6 million increase due to higher fuel prices and $4.7 million primarily due to increased consumption as a result of additional operating days. The increase in labor and other vessel operating expense during 2012 is primarily due to dry-docking certain of our vessels in China.

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. The $4.7 million increase in marine expense during the quarter ended June 24, 2012 was primarily due to contractual rate increases, port security fees, and higher container volumes.

Inland expense increased to $46.6 million for the quarter ended June 24, 2012 compared to $44.6 million during the quarter ended June 26, 2011. The $2.0 million increase in inland expense is primarily due to higher fuel costs, contractual increases, higher container volumes, and more empty repositioning costs as a result of the shutdown of our FSX service.

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. The increase in land expense can be attributed to the following (in thousands):

 

     Quarters Ended         
     June 24,
2012
     June 26,
2011
     % Change  
     (in thousands)         

Land expense:

        

Maintenance

   $ 13,678       $ 13,345         2.5

Terminal overhead

     12,905         13,327         (3.2 )% 

Yard and gate

     7,159         6,757         5.9

Warehouse

     1,867         1,690         10.5
  

 

 

    

 

 

    

Total land expense

   $ 35,609       $ 35,119         1.4
  

 

 

    

 

 

    

Non-vessel related maintenance expenses increased primarily due to higher fuel costs and additional repair and maintenance activities. Yard and gate expenses were higher as a result of contractual increases related to reefer monitoring and increased container volumes.

 

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Table of Contents

Depreciation and Amortization. Depreciation and amortization was $10.4 million during the quarter ended June 24, 2012 as compared to $10.9 million during the quarter ended June 26, 2011. The decrease in depreciation-owned vessels was due to certain vessel assets becoming fully depreciated and no longer subject to depreciation expense.

 

     Quarters Ended         
     June 24,
2012
     June 26,
2011
     % Change  
     (in thousands)         

Depreciation and amortization:

        

Depreciation—owned vessels

   $ 2,104       $ 2,500         (15.8 )% 

Depreciation and amortization—other

     3,229         3,364         (4.0 )% 

Amortization of intangible assets

     5,064         5,083         (0.3 )% 
  

 

 

    

 

 

    

Total depreciation and amortization

   $ 10,397       $ 10,947         (5.0 )% 
  

 

 

    

 

 

    

Amortization of vessel dry-docking

   $ 2,622       $ 4,070         (35.6 )% 
  

 

 

    

 

 

    

Amortization of Vessel Dry-docking. Amortization of vessel dry-docking was $2.6 million during the quarter ended June 24, 2012 compared to $4.1 million for the quarter ended June 26, 2011. 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 $19.5 million for the quarter ended June 24, 2012 compared to $19.8 million for the quarter ended June 26, 2011, a decrease of $0.3 million or 1.6%. This decrease is primarily due to a $0.5 million decrease in legal and professional fees expenses associated with the antitrust investigation and related legal proceedings.

Impairment Charge. During the quarter ended June 24, 2012, we accrued an additional $0.3 million related to certain leased equipment that was not deployed. During the third quarter, we purchased the equipment from the lessor and subsequently sold it to a third party, which resulted in a net cash outflow of $0.8 million.

We have made payments for the construction of three new cranes which are not yet placed into service. These cranes were initially purchased for use in our Anchorage, Alaska terminal and were expected to be installed and become fully operational in December 2010. However, the Port of Anchorage Intermodal Expansion Project has encountered significant delays. As such, at that time, we were marketing these cranes for sale and expected to complete the sale within one year. As a result of the reclassification to assets held for sale during the second quarter of 2011, we recorded an impairment charge of $2.8 million to write down the carrying value of the cranes to their estimated fair value less costs to sell. We are exploring installation of these cranes in our Honolulu, Hawaii terminal during 2013.

Legal Settlements. As discussed in Legal Proceedings, on March 22, 2011, the Court entered a judgment against us whereby we were required to pay a fine of $45.0 million to resolve the investigation by the DOJ. On April 28, 2011, the Court reduced the fine from $45.0 million to $15.0 million payable over five years without interest. During the second quarter of 2011, we reversed $19.2 million of the $30.0 million charge recorded during the year ended December 26, 2010 related to this legal settlement.

In January 2012, we entered into an agreement with the U.S. Department of Justice and pled guilty to two counts of providing federal authorities with false vessel oil record-keeping entries. Pursuant to the agreement and judgment entered by the United States District Court for the Northern District of California, we agreed to pay a fine of $1.0 million and donate an additional $0.5 million to the National Fish & Wildlife Foundation for environmental community service programs. Based on our best estimate at the time, we recorded a charge of $0.5 million related to this investigation during the year ended December 26, 2010. We recorded an additional $1.0 million during the quarter ended June 26, 2011.

Miscellaneous Expense, Net. Miscellaneous expense, net increased $0.3 million during the quarter ended June 24, 2012 compared to the quarter ended June 26, 2011 primarily as a result of lower gains on the sale of assets.

Interest Expense, Net. Interest expense, net increased to $16.2 million for the quarter ended June 24, 2012 compared to $12.9 million for the quarter ended June 26, 2011, an increase of $3.3 million or 25.6%. This increase was primarily due to a rise in interest rates resulting from the comprehensive refinancing and the accretion of non-cash interest related to our long-term debt and legal settlements.

Income Tax Expense. The effective tax rate for the quarters ended June 24, 2012 and June 26, 2011 was (0.2)% and 13.1%, respectively. As a result of the application of the accounting for income tax rules related to the intra-period allocations and alternatives for computing the overall effective tax rate applied during the quarter ended March 27, 2011, we recorded tax expense of $0.7 million during the quarter ended June 26, 2011, which resulted in a 13.1% effective tax rate. However, the year to date effective tax rate during 2011 was (1.2%). 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 a result, we do not expect to record a current or deferred tax benefit or expense and only minimal state tax provisions during those periods.

 

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Table of Contents

Six Months Ended June 24, 2012 Compared with the Six Months Ended June 26, 2011

 

     Six Months Ended              
     June 24,
2012
    June 26,
2011
    Change     % Change  
     ($ in thousands)        

Operating revenue

   $ 534,294      $ 494,451      $ 39,843        8.1

Operating expense:

        

Vessel

     180,868        153,733        27,135        17.7

Marine

     102,344        95,503        6,841        7.2

Inland

     93,326        86,934        6,392        7.4

Land

     73,489        70,774        2,715        3.8

Rolling stock rent

     20,667        20,094        573        2.9
  

 

 

   

 

 

   

 

 

   

Cost of services

     470,694        427,038        43,656        10.2

Depreciation and amortization

     20,797        21,824        (1,027     (4.7 )% 

Amortization of vessel dry-docking

     6,635        8,138        (1,503     (18.5 )% 

Selling, general and administrative

     41,042        43,677        (2,635 )     (6.0 )% 

Impairment charge

     257        2,818        (2,561     (90.9 )% 

Legal settlements

     —          (18,202     18,202        (100.0 )% 

Miscellaneous (income) expense, net

     (77 )     397        (474     (119.4 )% 
  

 

 

   

 

 

   

 

 

   

Total operating expense

     539,348        485,690        53,658        11.0
  

 

 

   

 

 

   

 

 

   

Operating (loss) income

   $ (5,054 )   $ 8,761      $ (13,815     (157.7 )% 
  

 

 

   

 

 

   

 

 

   

Operating ratio

     100.9     98.2       2.7

Revenue containers (units)

     116,854        114,518        2,336        2.0

Average unit revenue

   $ 4,263      $ 3,988      $ 275        6.9

Operating Revenue. Our operating revenue increased $39.8 million, or 8.1% during the six months ended June 24, 2012 as compared to the six months ended June 26, 2011. This revenue increase can be attributed to the following factors (in thousands):

 

Bunker and intermodal fuel surcharges increase

   $ 29,835   

Revenue container volume increase

     7,427   

Revenue container rate increase

     3,762   

Other non-transportation services revenue decrease

     (1,181
  

 

 

 

Total operating revenue increase

   $ 39,843   
  

 

 

 

Bunker and intermodal fuel surcharges, which are included in our transportation revenue, accounted for approximately 22.9% of total revenue in the six months ended June 24, 2012 and approximately 18.7% of total revenue in the six months ended June 26, 2011. 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 increase in revenue container volume was due to continued customer support in our Hawaii tradelane. The increase in revenue container rate was primarily due to rate increases to mitigate increased variable expenses, including port security and wharfage fees. The decrease in non-transportation revenue was primarily due to a reduction in terminal services, partially offset by higher revenue from certain transportation services agreements.

Cost of Services. The $43.7 million increase in cost of services is primarily due to both higher vessel costs, as a result of a rise in fuel prices and increased duplicate fuel and vessel operating expenses associated with dry-dockings, and higher marine and inland expenses due to the increase in container volumes.

 

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Table of Contents

Vessel expense, which is not primarily driven by revenue container volume, increased $27.1 million for the six months ended June 24, 2012 compared to the six months ended June 26, 2011. This increase can be attributed to the following factors (in thousands):

 

Vessel fuel costs increase

   $ 20,428   

Labor and other vessel operating expense increase

     5,877   

Vessel space charter expense increase

     895   

Vessel lease expense decrease

     (65
  

 

 

 

Total vessel expense increase

   $ 27,135   
  

 

 

 

The $20.4 million rise in fuel costs is comprised of a $16.3 million increase due to higher fuel prices and $4.1 million primarily due to higher consumption as a result of additional operating days. The increase in labor and other vessel operating expense during 2012 is primarily due to dry-docking three of our vessels in China and vessel-related service interruptions.

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. The $6.8 million increase in marine expense during the six months ended June 24, 2012 was primarily due to contractual rate increases and the newly enacted cargo scanning fee in Puerto Rico, cargo claims as a result of certain vessel-related service interruptions, and higher container volumes.

Inland expense increased to $93.3 million for the six months ended June 24, 2012 compared to $86.9 million during the six months ended June 26, 2011. The $6.4 million increase in inland expense is primarily due to higher fuel costs, contractual increases, and empty container repositioning costs as a result of the shutdown of our FSX service.

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. The increase in land expense can be attributed to the following (in thousands):

 

     Six Months Ended         
     June 24,
2012
     June 26,
2011
     % Change  
     (in thousands)         

Land expense:

        

Maintenance

   $ 27,681       $ 26,836         3.1

Terminal overhead

     27,158         26,610         2.1

Yard and gate

     15,201         14,076         8.0

Warehouse

     3,449         3,252         6.1
  

 

 

    

 

 

    

Total land expense

   $ 73,489       $ 70,774         3.8
  

 

 

    

 

 

    

Non-vessel related maintenance expenses increased primarily due to higher fuel costs and additional repair and maintenance activities. Terminal overhead increased primarily due to higher utilities expense and severance for certain union employees that elected early retirement. Yard and gate expenses were higher as a result of contractual increases related to reefer monitoring and increased container volumes.

 

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Table of Contents

Depreciation and Amortization. Depreciation and amortization was $20.8 million during the six months ended June 24, 2012 as compared to $21.8 million during the six months ended June 26, 2011. The decrease in depreciation-owned vessels was due to certain vessel assets becoming fully depreciated and no longer subject to depreciation expense.

 

     Six Months Ended         
     June 24,
2012
     June 26,
2011
     % Change  
     (in thousands)         

Depreciation and amortization:

        

Depreciation—owned vessels

   $ 4,199       $ 5,013         (16.2 )% 

Depreciation and amortization—other

     6,472         6,650         (2.7 )% 

Amortization of intangible assets

     10,126         10,161         (0.3 )% 
  

 

 

    

 

 

    

Total depreciation and amortization

   $ 20,797       $ 21,824         (4.7 )% 
  

 

 

    

 

 

    

Amortization of vessel dry-docking

   $ 6,635       $ 8,138         (18.5 )% 
  

 

 

    

 

 

    

Amortization of Vessel Dry-docking. Amortization of vessel dry-docking was $6.6 million during the six months ended June 24, 2012 compared to $8.1 million for the six months ended June 26, 2011. 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 $41.0 million for the six months ended June 24, 2012 compared to $43.7 million for the six months ended June 26, 2011, a decrease of $2.7 million or 6.0%. This decrease is primarily comprised of a $2.0 million reduction in severance charges and a $1.9 million decline in legal and professional fees expenses associated with the antitrust investigation and related legal proceedings, partially offset by professional fees of $0.3 million incurred related to the search for a permanent CEO, and legal and tax consulting fees of $0.9 million associated with our refinancing efforts.

Impairment Charge. During the six months ended June 24, 2012, we accrued an additional $0.3 million related to certain leased equipment that was not deployed. During the third quarter, we purchased the equipment from the lessor and subsequently sold it to a third party, which resulted in a net cash outflow of $0.8 million.

We have made payments for the construction of three new cranes which are not yet placed into service. These cranes were initially purchased for use in our Anchorage, Alaska terminal and were expected to be installed and become fully operational in December 2010. However, the Port of Anchorage Intermodal Expansion Project has encountered significant delays. As such, at that time, we were marketing these cranes for sale and expected to complete the sale within one year. As a result of the reclassification to assets held for sale during the second quarter of 2011, we recorded an impairment charge of $2.8 million to write down the carrying value of the cranes to their estimated fair value less costs to sell. We are exploring installation of these cranes in our Honolulu, Hawaii terminal during 2013.

Legal Settlements. As discussed in Legal Proceedings, on March 22, 2011, the Court entered a judgment against us whereby we were required to pay a fine of $45.0 million to resolve the investigation by the DOJ. On April 28, 2011, the Court reduced the fine from $45.0 million to $15.0 million payable over five years without interest. During the second quarter of 2011, we reversed $19.2 million of the $30.0 million charge recorded during the year ended December 26, 2010 related to this legal settlement.

In January 2012, we entered into an agreement with the U.S. Department of Justice and pled guilty to two counts of providing federal authorities with false vessel oil record-keeping entries. Pursuant to the agreement and judgment entered by the United States District Court for the Northern District of California, we agreed to pay a fine of $1.0 million and donate an additional $0.5 million to the National Fish & Wildlife Foundation for environmental community service programs. Based on our best estimate at the time, we recorded a charge of $0.5 million related to this investigation during the year ended December 26, 2010. We recorded an additional $1.0 million during the quarter ended June 26, 2011.

Miscellaneous (Income) Expense, Net. Miscellaneous (income) expense, net increased $0.5 million during the six months ended June 24, 2012 compared to the six months ended June 26, 2011 primarily as a result of lower bad debt expense.

Interest Expense, Net. Interest expense, net increased to $34.0 million for the six months ended June 24, 2012 compared to $23.6 million for the six months ended June 26, 2011, an increase of $10.4 million or 44.1%. This increase was primarily due to a rise in interest rates resulting from the comprehensive refinancing and the accretion of non-cash interest related to our long-term debt and legal settlements.

Income Tax Expense. The effective tax rate for the six months ended June 24, 2012 and June 26, 2011 was (0.6)% and (1.3)%, 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 a result, we do not expect to record a current or deferred tax benefit or expense and only minimal state tax provisions during those periods.

 

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Liquidity and Capital Resources

Our principal sources of funds have been (i) earnings before non-cash charges and (ii) borrowings under debt arrangements. Our principal uses of funds have been (i) capital expenditures on our container fleet, our terminal operating equipment, improvements to our owned and leased vessel fleet, and our information technology systems, (ii) vessel dry-docking expenditures, (iii) working capital consumption, and (iv) principal and interest payments on our existing indebtedness. Our total liquidity as of June 24, 2012 was $37.0 million, which is comprised of $19.7 million of cash on hand and $17.3 million of borrowing availability under the ABL Facility.

Operating Activities

Net cash used in operating activities was $14.2 million for the six months ended June 24, 2012 compared to $44.2 million for the six months ended June 26, 2011. The decrease in cash used in operating activities is primarily due to the following (in thousands):

 

Increase in accounts payable

   $ 25,331   

Decrease in accounts receivable

     10,685   

Increase in accrued liabilities

     7,572   

Decrease in materials and supplies

     3,866   

Increase in payments related to vessel leases

     (4,375

Earnings adjusted for non-cash charges

     (14,678

Other changes in working capital, net

     1,585   
  

 

 

 

Total decrease in cash used in operating activities

   $ 29,986   
  

 

 

 

Investing Activities

Net cash used in investing activities was $3.4 million for the six months ended June 24, 2012 compared to $5.3 million for the six months ended June 26, 2011. The decrease in cash consumed is related to a decline in capital spending.

Financing Activities

Net cash provided by financing activities during the six months ended June 24, 2012 was $36.1 million compared to $71.5 million for the six months ended June 26, 2011. The net cash provided by financing activities during the six months ended June 24, 2012 included $42.5 million borrowed under the ABL Facility as compared to $88.1 million, net of payments, borrowed under the Senior Credit Facility during the six months ended June 26, 2011. In addition, during the six months ended June 26, 2011, we paid $6.8 million in financing costs related to fees associated with the amendment to the Senior Credit Facility, our efforts to obtain consent from our convertible noteholders, and our overall refinancing efforts, and we paid $4.4 million during the six months ended June 24, 2012 in financing costs related to fees associated with our efforts to obtain consent from our convertible noteholders, and the conversion of debt to equity.

Outlook

We expect 2012 volumes to be slightly above 2011 levels due to modest improvements in market conditions. During 2011, we implemented many cost savings initiatives including a reduction in non-union workforce, and through our relationships with our vessel and other union partners, we received union labor savings. In addition, many of our other transportation service providers either provided rate reductions or maintained rate levels. During 2012, we are incurring increases from our vessel union partners, transportation service providers, and other contractual increases for marine services, including wharfage. We believe we will be able to continue to mitigate expense increases through rate increases to our customers. Fuel prices remain volatile and our ability to implement and maintain fuel surcharge adjustments will have a significant impact on our earnings. We are extremely focused on liquidity preservation and expansion. We expect total liquidity during the remainder of 2012 to remain near or above the $37.0 million as of June 24, 2012.

We are also committed to ensuring quality service to our customers. As such, during 2012 we are making a significant investment in our Jones Act fleet by dry-docking three of our Puerto Rico vessels in Asia. Although this adds a considerable amount of transit expense in 2012, dry-docking the vessels in Asia enables us to make high quality enhancements to the vessels in the most efficient and cost effective manner.

Capital Requirements and Commitments

Based upon our current level of operations, as well as the recent restructuring and conversion of our debt and resolution of the lease obligations related to the vessels that served our FSX service, we believe cash flow from operations and available cash, together with borrowings available under the ABL Facility, will be adequate to meet our liquidity needs for the next twelve months.

During the next 12 months, we expect to spend approximately $28.0 million and $19.0 million on capital expenditures and dry-docking expenditures, respectively. Such capital expenditures will include vessel enhancements, rolling stock, and terminal infrastructure and equipment. We are dry-docking three of the vessels utilized in our Puerto Rico tradelane in China during 2012. Despite the significantly higher transit costs to get the vessels to Asia, we expect these dry-dockings will enable us to make high quality cargo modifications and other enhancements to our core Puerto Rico fleet that will be instrumental in ensuring service integrity for our customers. In addition, we are exploring installation of the cranes previously intended for Anchorage in our Hawaii terminal. If we decide to install these cranes in our Hawaii terminal, we expect to spend an additional $4.4 million on capital expenditures during the next twelve months.

We also expect to spend approximately $12.5 million during the next twelve months for legal settlements and legal expenses associated with the DOJ investigation and related antitrust legal matters, as well as approximately $6.5 million specifically related to the shutdown of our FSX service. The $6.5 million of FSX shutdown costs includes equipment per diem and termination charges, crew severance, other employee severance, and certain vessel related expenses.

Three of our vessels, the Horizon Anchorage, Horizon Tacoma, and Horizon Kodiak are leased, or chartered, under charters that are due to expire in January 2015. The charters for these vessels permit us to renew the charters or purchase the applicable vessel at the expiration of the charter period for a fixed price or fair market value specified in the relevant charter that is determined through a pre-agreed appraisal procedure. The fair market values of these vessels at the expiration of their charters cannot be predicted with any certainty.

 

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Contractual Obligations and Off-Balance Sheet Arrangements

Contractual obligations as of June 24, 2012, are as follows (in thousands):

 

     Total
Obligations
     2012      2013-2014      2015-2016      Thereafter  

Principal and operating lease obligations:

              

First lien notes

   $ 223,875       $ 1,125       $ 4,500       $ 218,250       $ —     

Second lien notes(1)

     140,000         —           —           140,000         —     

ABL Facility

     42,500         —           —           42,500         —     

6.00% convertible senior notes

     3,669         —           —           —           3,669   

4.25% convertible senior notes

     2,244         2,244         —           —           —     

Operating leases

     254,532         40,284         139,417         51,868         22,963   

Capital lease

     6,617         772         2,045         2,507         1,293   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     673,437         44,425         145,962         455,125         27,925   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest obligations:

              

First lien notes(2)

     108,839         12,313         48,758         47,768         —     

Second lien notes(2)(3)

     143,783         —           —           143,783         —     

ABL Facility

     8,343         967         3,848         3,528         —     

6.00% convertible senior notes

     490         50         195         195         50   

4.25% convertible senior notes

     48         48         —           —           —     

Capital lease

     1,940         320         1,007         545         68   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     263,443         13,698         53,808         195,819         118   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Legal settlements

     22,000         4,000         10,000         8,000         —     

Other commitments(4)

     9,120         2,868         6,252         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total obligations

   $ 968,000       $ 64,991       $ 216,022       $ 658,944       $ 28,043   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Standby letters of credit

   $ 18,901       $ 14,616       $ —         $ 4,285       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes $40 million in aggregate principal amount of second lien notes issued to SFL pursuant to the Global Termination Agreement. See “Recent Developments” for additional details.
(2) Does not reflect additional interest expense should we fail to file an effective registration statement for first and second lien notes by November 8, 2012. Such additional interest expense would equal 0.25% per annum every 90 days provided that such increases would not, in total, exceed 1.0% per annum.
(3) The second lien notes bear interest at a rate of either: (i) 13% per annum, payable semiannually in cash in arrears; (ii) 14% per annum, 50% of which payable semiannually in cash in arrears and 50% payable in kind; or (iii) 15% per annum payable in kind, payable semiannually. The table above reflects interest obligations under the second lien notes at 15% per annum payable in kind.
(4) Other commitments includes the purchase commitment related to the three new cranes and restructuring liabilities.

Long-Term Debt

On October 5, 2011, we completed an offer to exchange $327.8 million in aggregate principal amount of our 4.25% Convertible Senior Notes due 2012 (the “4.25% Notes”), representing 99.3% of the aggregate principal amount of the 4.25% Notes outstanding, for (i) 1.0 million shares of our common stock, (ii) warrants to purchase 1.0 million shares of our common stock (the “Warrants”) and (iii) $178.8 million in aggregate principal amount of new 6.00% Series A Convertible Senior Secured Notes due 2017 (the “Series A Notes”) and $99.3 million in aggregate principal amount of new 6.00% Series B Mandatorily convertible Senior Secured Notes (the “Series B Notes” and, together with the Series A Notes, the “6.00% Convertible Notes”).

Concurrently with the consummation of the exchange offer, Horizon Lines, LLC issued (i) $225.0 million aggregate principal amount of new 11.00% First Lien Senior Secured Notes due 2016 (the “First Lien Notes”) and (ii) $100.0 million of new 13.00%-15.00% Second Lien Senior Secured Notes due 2016 (the “Second Lien Notes”). Horizon Lines, LLC also entered into a new $100.0 million asset-based revolving credit facility (the “ABL Facility”) at the consummation of the exchange offer.

On March 27, 2012, we announced that we had signed restructuring support agreements with more than 96% of our noteholders to further deleverage our balance sheet in connection with and contingent upon a restructuring of the vessel charter obligations related to the Company’s discontinued trans-Pacific service. The restructuring support agreements provide, among other things, that substantially all of the remaining $228.4 million of our Series A and Series B Notes will be converted into the Company’s stock, or warrants for non-U.S. citizens. The conversion of the Series A and Series B Notes was contingent upon a number of conditions, including the restructuring of our charter obligations with respect to the vessels formerly used in the FSX service.

On March 29, 2012, we launched consent solicitations to make certain amendments to the indentures which govern the First Lien Notes, Second Lien Notes, and the Series A Notes and Series B Notes. These amendments provided (i) for the issuance of

 

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$40.0 million in aggregate principal amount of Second Lien Notes to SFL pursuant to the Global Termination Agreement, subordinated to the existing Second Lien Notes under certain circumstances, (ii) for the Company to pay-in-kind (PIK) interest payments on the Second Lien Notes, the Series A Notes and the Series B Notes, (iii) for SFL to purchase, at its option, all other outstanding Second Lien Notes from the holders (at a purchase price equal to the principal amount of the Second Lien Notes, plus accrued and unpaid interest) under circumstances where, among other things, the Company commences liquidation, administration, or receivership or other similar proceedings and (iv) for Series B Note holders to convert their notes at their option.

On May 3, 2012, the Company completed the conversion process and converted $175.9 million of Series A Notes and $48.9 million of Series B Notes into equity. In addition, the Company converted $5.6 million of Series A Notes and $1.6 million of Series B Notes issued during the second quarter of 2012 to satisfy the interest obligations associated with the 6.0% Convertible Notes. As a result of the conversion transactions, the Company issued approximately 27.7 million shares of the Company’s common stock and warrants for the purchase of approximately an additional 45.5 million shares of the Company’s common stock to holders of the Series A Notes. In addition, the Company issued approximately 1.0 million shares of the Company’s common stock and warrants for the purchase of approximately an additional 1.7 million shares of the Company’s common stock to holders of the Series B Notes. The conversion price of the warrants is $0.01 per common share. After completion of the conversion process, and assuming the exercise of all of the warrants issued to the holders of the Series A Notes and Series B Notes, holders of Series A Notes would hold approximately 80% of the Company’s outstanding shares and holders of Series B Notes would hold approximately 3% of the Company’s outstanding shares.

On October 5, 2011, we completed an offer to exchange $327.8 million in aggregate principal amount of our 4.25% Convertible Senior Notes due 2012 (the “4.25% Notes”), representing 99.3% of the aggregate principal amount of the 4.25% Notes outstanding, for (i) 1.0 million shares of our common stock, (ii) warrants to purchase 1.0 million shares of our common stock (the “Warrants”) and (iii) $178.8 million in aggregate principal amount of new 6.00% Series A Convertible Senior Secured Notes due 2017 (the “Series A Notes”) and $99.3 million in aggregate principal amount of new 6.00% Series B Mandatorily convertible Senior Secured Notes (the “Series B Notes” and, together with the Series A Notes, the “6.00% Convertible Notes”).

Concurrently with the consummation of the exchange offer, Horizon Lines, LLC issued (i) $225.0 million aggregate principal amount of new 11.00% First Lien Senior Secured Notes due 2016 (the “First Lien Notes”) and (ii) $100.0 million of new 13.00%-15.00% Second Lien Senior Secured Notes due 2016 (the “Second Lien Notes”). Horizon Lines, LLC also entered into a new $100.0 million asset-based revolving credit facility (the “ABL Facility”) at the consummation of the exchange offer.

6.00% Convertible Notes

On October 5, 2011, we issued $278.1 million aggregate principal amount of 6.00% Convertible Notes due 2017. The Series A Notes and the Series B Notes are each fully and unconditionally guaranteed by all of our domestic subsidiaries (collectively, the “Notes Guarantors”). The New Notes were issued pursuant to an indenture, which we and the Guarantors entered into with U.S. Bank National Association, as trustee and collateral agent, on October 5, 2011 (the “New Notes Indenture”).

Warrants

Certain warrants, not including the warrants issued to SFL, were issued pursuant to a warrant agreement, which we entered into with The Bank of New York Mellon Trust Company, N.A, as warrant agent, on October 5, 2011, as amended by Amendment No. 1 as of December 7, 2011 (the “Warrant Agreement”). Pursuant to the Warrant Agreement, each warrant entitles the holder to purchase common stock at a price of $0.01 per share, subject to adjustment in certain circumstances. Upon issuance, in lieu of payment of the exercise price, a warrant holder will have the right (but not the obligation) to require us to convert its warrants, in whole or in part, into shares of our common stock, without any required payment or request that we withhold, from the shares of common stock that would otherwise be delivered to such warrant holder, shares issuable upon exercise of the warrants equal in value to the aggregate exercise price.

Warrant holders will not be permitted to exercise or convert their warrants if and to the extent the shares of common stock issuable upon exercise or conversion would constitute “excess shares” (as defined in our certificate of incorporation) if they were issued. In addition, a warrant holder who cannot establish to our reasonable satisfaction that it (or, if not the holder, the person that the holder has designated to receive the common stock upon exercise or conversion) is a United States citizen, will not be permitted to exercise or convert its warrants to the extent the receipt of the common stock upon exercise or conversion would cause such person or any person whose ownership position would be aggregated with that of such person to exceed 4.9% of our outstanding common stock.

The warrants contain no provisions allowing us to force redemption and we have no conditional obligation to redeem or convert the warrants. Each warrant is convertible into shares of our common stock at an exercise price of $0.01 per share, which we have the option to waive. In addition, we have sufficient authorized and unissued shares available to settle the warrants during the maximum period the warrants could remain outstanding. As a result, the warrants do not meet the definition of an asset or liability and were classified as equity on the date of issuance. The warrants will be evaluated on a continuous basis to determine if equity classification continues to be appropriate.

 

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First Lien Notes

The First Lien Notes were issued pursuant to an indenture on October 5, 2011. The First Lien Notes bear interest at a rate of 11.0% per annum, payable semiannually, beginning on April 15, 2012 and mature on October 15, 2016. The First Lien Notes are callable at 101.5% of their aggregate principal amount, plus accrued and unpaid interest in the first year after their issuance and at par plus accrued and unpaid interest thereafter. We are obligated to make mandatory prepayments of 1%, on an annual basis, of the original principal amount. These prepayments are due on a semiannual basis and commenced on April 15, 2012.

The First Lien Notes are fully and unconditionally guaranteed by the Notes Guarantors. The First Lien Notes are secured by a first priority lien on all Secured Notes Priority Collateral and a second priority lien on all ABL Priority Collateral (each as defined below). The First Lien Secured Notes contain affirmative and negative covenants which are typical for senior secured high-yield notes with no financial maintenance covenants. The First Lien Secured Notes contain other covenants, including: change of control put at 101% (subject to a permitted holder exception); limitation on asset sales; limitation on incurrence of indebtedness and preferred stock; limitation on restricted payments; limitation on restricted investments; limitation on liens; limitation on dividends; limitation on affiliate transactions; limitation on sale/leaseback transactions; limitation on guarantees by restricted subsidiaries; and limitation on mergers, consolidations and sales of all/ substantially all of our assets. These covenants are subject to certain exceptions and qualifications. We were in compliance with all such applicable covenants as of June 24, 2012.

On October 5, 2011, the fair value of the First Lien Notes was $228.4 million, which reflects our ability to call the First Lien Notes at 101.5% during the first year and at par thereafter. The original issue premium is being amortized through interest expense through the maturity of the First Lien Notes. We entered into a registration rights agreement with the purchasers of the First Lien Notes, which was amended on July 13, 2012. We are obligated to complete an A/B Exchange Offer as soon as practicable but in no event later than 400 days after the issuance of the First Lien Notes. If we do not complete the A/B Exchange Offer within the 400 day period, this will result in a registration default and 0.25% of additional interest per 90 days of registration default will be added to the interest payable on the First Lien Notes, up to a maximum of 1.00% of additional interest per annum.

Second Lien Notes

On October 5, 2011, we completed the sale of $100.0 million aggregate principal amount of our Second Lien Notes. The Second Lien Notes are fully and unconditionally guaranteed by the Notes Guarantors. The Second Lien Notes are secured by a second priority lien on all Secured Notes Priority Collateral and a third priority lien on all ABL Priority Collateral (each as defined below). The proceeds from the First Lien Notes and the Second Lien Notes were used, among other things, to satisfy in full our obligations outstanding under our previous first-lien revolving credit facility and term loan, which totaled $265.0 million on October 5, 2011.

The Second Lien Notes bear interest at a rate of either: (i) 13% per annum, payable semiannually in cash in arrears; (ii) 14% per annum, 50% of which payable semiannually in cash in arrears and 50% payable in kind; or (iii) 15% per annum payable in kind, payable semiannually, beginning on April 15, 2012, and mature on October 15, 2016. The Second Lien Notes are non-callable for 2 years from the date of their issuance, and thereafter the Second Lien Notes will be callable at (i) 106% of their aggregate principal amount, plus accrued and unpaid interest thereon in the third year, (ii) 103% of their aggregate principal amount, plus accrued and unpaid interest thereon in the fourth year, and (iii) at par plus accrued and unpaid interest thereafter.

The Second Lien Notes contain affirmative and negative covenants which are typical for senior secured high-yield notes with no financial maintenance covenants. The Second Lien Notes contain other covenants, including: change of control put at 101% (subject to a permitted holder exception); limitation on asset sales; limitation on incurrence of indebtedness and preferred stock; limitation on restricted payments; limitation on restricted investments; limitation on liens; limitation on dividends; limitation on affiliate transactions; limitation on sale/leaseback transactions; limitation on guarantees by restricted subsidiaries; and limitation on mergers, consolidations and sales of all/substantially all of our assets. These covenants are subject to certain exceptions and qualifications. We were in compliance with all such applicable covenants as of June 24, 2012.

On October 5, 2011, the fair value of the Second Lien Notes was $96.6 million. The original issue discount is being amortized through interest expense through the maturity of the Second Lien Notes. We entered into a registration rights agreement with the purchasers of the Second Lien Notes, which was amended July 13, 2012. We are obligated to complete an A/B Exchange Offer as soon as practicable but in no event later than 400 days after the issuance of the Second Lien Notes. If we do not complete the A/B Exchange Offer within the 400 day period, this will result in a registration default and 0.25% of additional interest per 90 days of registration default will be added to the interest payable on the Second Lien Notes, up to a maximum of 1.00% of additional interest per annum.

SFL Note

On April 5, 2012, we entered into a Global Termination Agreement with Ship Finance International Limited and certain of its subsidiaries (“SFL”) which enabled us to terminate early the bareboat charters of the five foreign-built, U.S.-flag vessels that formerly operated in the FSX service. The Global Termination Agreement became effective on April 9, 2012.

Pursuant to the Global Termination Agreement, in consideration for the early termination of the vessel leases, and related agreements and the mutual release of all claims thereunder, we agreed to: (i) issue to SFL $40.0 million in aggregate principal

 

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amount of Second Lien Senior Secured Notes; (ii) issue to SFL the number of warrants to purchase 9,250,000 shares of our common stock at a conversion price of $0.01 per common share; (iii) transfer to SFL certain property on board the vessels (such as bunker fuel, spare parts and equipment, and consumable stores) at the time of redelivery to SFL without any additional payment; (iv) reimburse reasonable costs incurred by SFL to (a) return the vessels from their current laid up status to operating status, which reimbursement shall not exceed $0.6 million, (b) reposition the vessels from the Philippines to either Hong Kong or Singapore, which reimbursement shall not exceed $0.1 million, (c) remove our stack insignia and name from the vessels, which reimbursement shall not exceed $0.1 million, and (d) complete the reflagging of the vessels to the Marshall Islands registry, which reimbursement is currently expected to approximate $0.1 million; and (v) reimburse SFL for their reasonable costs and expenses incurred in connection with the transaction, which we estimate represents an aggregate maximum reimbursement obligation to the SFL Parties of $0.6 million. We paid a total of $0.7 million during the first half of 2012, and expect to pay up to $0.8 million during the second half of 2012.

ABL Facility

On October 5, 2011, we entered into a $100.0 million asset-based revolving credit facility (the “ABL Facility”) with Wells Fargo Capital Finance, LLC (“Wells Fargo”). Use of the ABL Facility is subject to compliance with a customary borrowing base limitation. The ABL Facility includes an up to $30.0 million letter of credit sub-facility and a swingline sub-facility up to $15.0 million, with Wells Fargo serving as administrative agent and collateral agent. We have the option to request increases in the maximum commitment under the ABL Facility by up to $25.0 million in the aggregate; however, such incremental facility increases have not been committed to in advance. The ABL Facility was used on the closing date for the rollover of certain issued and outstanding letters of credit and thereafter is used by us for working capital and other general corporate purposes.

The ABL Facility matures October 5, 2016 (but 90 days earlier if the First Lien Notes and the Second Lien Notes are not repaid or refinanced as of such date). The interest rate on the ABL Facility is LIBOR or a base rate plus an applicable margin based on leverage and excess availability ranging from (i) 1.25% to 2.75%, in the case of base rate loans and (ii) 2.25% to 3.75%, in the case of LIBOR loans. A fee ranging from .375% to .50% per annum will accrue on unutilized commitments under the ABL Facility. As of June 24, 2012, total availability under the ABL Facility was $17.3 million after taking into account $42.5 million of outstanding borrowings and $18.9 million utilized for letters of credit.

The ABL Facility is secured by (i) a first priority lien on our interest in accounts receivable, deposit accounts, securities accounts, investment property (other than equity interests of the subsidiaries and joint ventures) and cash, in each case with certain exceptions and (ii) a fourth priority lien on all or substantially all other of our assets securing the First Lien Notes, the Second Lien Notes and the 6.00% Convertible Notes.

The ABL Facility requires compliance with a minimum fixed charge coverage ratio test if excess availability is less than the greater of (i) $12.5 million or (ii) 12.5% of the maximum commitment under the ABL Facility. In addition, the ABL Facility includes certain customary negative covenants that, subject to certain materiality thresholds, baskets and other agreed upon exceptions and qualifications, will limit, among other things, indebtedness, liens, asset sales and other dispositions, mergers, liquidations, dissolutions and other fundamental changes, investments and acquisitions, dividends, distributions on equity or redemptions and repurchases of capital stock, transactions with affiliates, repayments of certain debt, conduct of business and change of control. The ABL Facility also contains certain customary representations and warranties, affirmative covenants and events of default, as well as provisions requiring compliance with applicable citizenship requirements of the Jones Act. We were in compliance with all such applicable covenants as of June 24, 2012.

Goodwill

We review our goodwill, intangible assets and long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable, and also review goodwill annually. As of June 24, 2012, the carrying value of our goodwill was $198.8 million. Earnings estimated to be generated are expected to support the carrying value of goodwill. However, should our operating results differ from what is expected or other triggering events occur, it could imply that our goodwill may not be recoverable and may result in the recognition of a non-cash write down of goodwill.

 

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Interest Rate Risk

Our primary interest rate exposure relates to the ABL Facility. As of June 24, 2012, we had $42.5 million outstanding under the ABL Facility. The interest rate on the ABL Facility is based on LIBOR or a base rate plus an applicable margin based on leverage and excess availability ranging from (i) 1.25% to 2.75%, in the case of base rate loans and (ii) 2.25% to 3.75%, in the case of LIBOR loans. Each quarter point change in interest rates would result in a $0.1 million change in annual interest expense on the ABL facility.

Recent Accounting Pronouncements

In June 2011, the FASB issued changes to the manner in which entities present comprehensive income in their financial statements. The new guidance requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The new guidance does not change the items that must be reported in other comprehensive income. In December 2011, the FASB deferred the requirement that companies present reclassification adjustments for each component of accumulated other comprehensive income in both net income and other comprehensive income on the face of the financial statements. The new reporting requirement is effective for fiscal years and interim reporting periods within those years beginning after December 15, 2011, with early adoption permitted. We have elected to early adopt the accounting pronouncement as of December 25, 2011 and the effect on our consolidated financial statements was to present activity impacting net income and other comprehensive loss in two consecutive statements.

In May 2011, the FASB issued changes to certain portions of the authoritative literature related to fair value measurements and disclosures in order to achieve common fair value measurement and disclosure requirements under GAAP and International Financial Reporting Standards. The update clarifies disclosures for financial instruments categorized within level 3 of the fair value hierarchy that require companies to provide quantitative information about unobservable inputs used, the sensitivity of the measurement to changes in those inputs, and the valuation processes used by the reporting entity. Implementation of this standard is effective for fiscal years and interim periods within those years beginning after December 15, 2011. Implementation of this standard did not have a material impact on our consolidated financial statements.

Forward Looking Statements

This Form 10-Q 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:

 

   

volatility in fuel prices,

 

   

decreases in shipping volumes,

 

   

our ability to maintain adequate liquidity to operate our business,

 

   

our ability to make interest payments on our outstanding indebtedness,

 

   

work stoppages, strikes, and other adverse union actions,

 

   

the reaction of our customers and business partners to our announcements and filings, including those referred to herein,

 

   

government investigations and legal proceedings,

 

   

suspension or debarment by the federal government,

 

   

compliance with safety and environmental protection and other governmental requirements,

 

   

failure to comply with the terms of our probation,

 

   

increased inspection procedures and tighter import and export controls,

 

   

repeal or substantial amendment of the coastwise laws of the United States, also known as the Jones Act,

 

   

catastrophic losses and other liabilities,

 

   

the successful start-up of any Jones-Act competitor,

 

   

failure to comply with the various ownership, citizenship, crewing, and build requirements dictated by the Jones Act,

 

   

the arrest of our vessels by maritime claimants,

 

   

severe weather and natural disasters, or

 

   

the aging of our vessels and unexpected substantial dry-docking or repair costs for our vessels.

 

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In light of these risks and uncertainties, expected results or other anticipated events or circumstances discussed in this Form 10-Q 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 our Form 10-K for the fiscal year ended December 25, 2011, as filed with the SEC for a more complete discussion of these risks and uncertainties and for other risks and uncertainties. Those factors and the other risk factors described therein 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.

3. Quantitative and Qualitative Disclosures About Market Risk

We maintain policies 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. We do not currently have any derivative instruments outstanding.

Our exposure to market risk for changes in interest rates is limited to our ABL Facility and one of our operating leases. The interest rate for our ABL Facility is currently indexed to LIBOR of one, two, three, or six months as selected by us (or nine or twelve months, if available, and consented to by the Lenders), or the Alternate Base Rate as defined in the ABL 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. We currently do not have any bunker fuel price hedges in place.

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 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.

4. Controls and Procedures

Disclosure Controls and Procedures

The Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on such evaluation, each of the Company’s Chief Executive Officer and Chief Financial Officer has concluded that the Company’s disclosure controls and procedures are effective.

Changes in Internal Control

There were no changes in the Company’s internal control over financial reporting during the Company’s fiscal quarter ending June 24, 2012, that have materially affected or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

1. Legal Proceedings

On April 17, 2008, we received a grand jury subpoena and search warrant from the United States District Court for the Middle District of Florida seeking information regarding an investigation by the Antitrust Division of the DOJ into possible antitrust violations in the domestic ocean shipping business. On February 23, 2011, we entered into a plea agreement with the DOJ, and the Court has entered judgment accepting our plea agreement and has imposed a fine of $15.0 million payable over five years without interest. We recorded a charge of $30.0 million during the year ended December 26, 2010, which represented the present value of the $45.0 million fine in installment payments. On April 28, 2011, the Court reduced the fine from $45.0 million to $15.0 million payable over five years without interest. As a result, during the six months ended June 26, 2011, we recorded a reversal of $19.2 million of the charge originally recorded during December 26, 2010.

Subsequent to the commencement of the DOJ investigation, thirty-two class action lawsuits on behalf of direct purchasers of ocean shipping services in the Puerto Rico tradelane were consolidated into a single multidistrict litigation (“MDL”) proceeding in the District of Puerto Rico. On June 11, 2009, we entered into a settlement agreement with the named plaintiff class representatives in the Puerto Rico MDL. Under the settlement agreement, we paid $20.0 million and agreed to provide a base-rate freeze to class members who elect such freeze in lieu of a cash payment.

One class action lawsuit relating to ocean shipping services in the Alaska tradelane is pending in the District of Alaska. We and the class plaintiffs have agreed to stay the Alaska litigation, and we intend to vigorously defend against the purported class action lawsuit in Alaska.

We received an administrative subpoena from the Department of Defense (“DOD”) for documents relating to an investigation involving fuel surcharges that freight forwarders may have improperly charged to the DOD. We are cooperating with the government with respect to this matter.

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.

 

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1A. Risk Factors

There have been no material changes from our risk factors as previously reported in our Annual Report on Form 10-K for the fiscal year ended December 25, 2011, as filed with the SEC.

2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

3. Defaults Upon Senior Securities

None.

4. Mine Safety Disclosures

None.

5. Other Information

None.

6. Exhibits

 

    4.1   Second Supplemental Indenture governing the 6.00% Series A Convertible Senior Secured Notes due 2017 and 6.00% Series B Mandatorily Convertible Senior Secured Notes, dated May 3, 2012 Association (filed as Exhibit 4.1 to the Company’s report on Form 8-K filed May 7, 2012).
  10.1*   Restricted Stock Unit Agreement among the Company and Samuel A. Woodward dated July 7, 2012
  31.1*   Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2*   Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1*   Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2*   Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**   XBRL Instance Document
101.SCH**   XBRL Taxonomy Extension Schema Document
101.CAL**   XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB**   XBRL Taxonomy Extension Label Linkbase Document
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document

 

* Filed herewith.
** Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: August 2, 2012

 

HORIZON LINES, INC.
By:  

/s/ MICHAEL T. AVARA

  Michael T. Avara
  Executive Vice President & Chief Financial Officer
  (Principal Financial Officer & Authorized Signatory)

 

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EXHIBIT INDEX

 

Exhibit
No.

 

Description

    4.1   Second Supplemental Indenture governing the 6.00% Series A Convertible Senior Secured Notes due 2017 and 6.00% Series B Mandatorily Convertible Senior Secured Notes, dated May 3, 2012 Association (filed as Exhibit 4.1 to the Company’s report on Form 8-K filed May 7, 2012).
  10.1*   Restricted Stock Unit Agreement among the Company and Samuel A. Woodward dated July 7, 2012
  31.1*   Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2*   Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1*   Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2*   Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**   XBRL Instance Document
101.SCH**   XBRL Taxonomy Extension Schema Document
101.CAL**   XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB**   XBRL Taxonomy Extension Label Linkbase Document
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document

 

* Filed herewith.
** Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.