S-1/A 1 ds1a.htm AMENDMENT NO. 1 TO FORM S-1 Amendment No. 1 to Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on August 31, 2006

Registration No. 333-136558

 


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


Amendment No. 1

to

Form S-1

REGISTRATION STATEMENT

UNDER THE SECURITIES ACT OF 1933

 


HORIZON LINES, INC.

(Exact name of registrant as specified in Its Charter)

 

Delaware    4400    74-3123672

(State or other jurisdiction of

incorporation or organization)

   (Primary Standard Industrial Classification Bankruptcy Code Number)   

(I.R.S. Employer

Identification Number)

 


4064 Colony Road, Suite 200

Charlotte, North Carolina 28211

(704) 973-7000

(Address, including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Office)

M. Mark Urbania, Chief Financial Officer

4064 Colony Road, Suite 200

Charlotte, North Carolina 28211

(704) 973-7000

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service)

 


Copies to:

 

André Weiss, Esq.

Schulte Roth & Zabel LLP

919 Third Avenue

New York, NY 10022

Ph: (212) 756-2000

Fax: (212) 593-5955

 

William M. Hartnett, Esq.

Richard E. Farley, Esq.

Cahill Gordon & Reindel LLP

80 Pine Street

New York, NY 10005

Ph: (212) 701-3000

Fax: (212) 269-5420

 

Robert S. Zuckerman, Esq.

General Counsel

Horizon Lines, Inc.

4064 Colony Road, Suite 200

Charlotte, NC 28211

Ph: (704) 973-7000

Fax: (704) 973-7010

 


Approximate Date of Commencement of Proposed Offer to the Public:  As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 


The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 



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Subject to Completion. Dated August 31, 2006.

 

5,300,000 Shares

 

LOGO

 

Horizon Lines, Inc.

 

Common Stock

 

The selling stockholders identified in this prospectus are offering 5,300,000 shares of common stock. Horizon Lines, Inc. will not receive any of the proceeds from the sale of the shares being sold by the selling stockholders.

 

Our common stock is quoted on The New York Stock Exchange under the symbol “HRZ”. The last reported sale price of our common stock on August 31, 2006 was $15.93 per share.

 

Before buying shares, you should carefully consider the risk factors described in “ Risk Factors” beginning on page 14.

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

     Per Share

   Total

Public offering price

   $             $                

Underwriting discount

   $             $                

Proceeds, before expenses, to the selling stockholders

   $             $                

 

The underwriters may also purchase up to an additional 795,000 shares of common stock from the selling stockholders at the public offering price less the underwriting discounts and commissions within 30 days from the date of this prospectus.

 

The underwriters expect to deliver the shares against payment in New York, New York on or about                         , 2006.

 

Deutsche Bank Securities

JPMorgan

 


 

Goldman, Sachs & Co.

 

The date of this prospectus is                      , 2006.

 

The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.


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LOGO

Horizon Enterprise, one of our container vessels, underway to the port of Tacoma, Washington.


Table of Contents

TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

   1

RISK FACTORS

   14

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

   35

TRADEMARKS AND SERVICE MARKS

   35

INDUSTRY AND MARKET DATA

   36

USE OF PROCEEDS

   37

PRICE RANGE OF COMMON STOCK

   38

DIVIDEND POLICY

   39

CAPITALIZATION

   40

UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

   41

SELECTED CONSOLIDATED AND COMBINED FINANCIAL DATA

   45

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   51

BUSINESS

   80

MANAGEMENT

   106

PRINCIPAL AND SELLING STOCKHOLDERS

   125

HISTORICAL TRANSACTIONS

   129

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

   135

DESCRIPTION OF CAPITAL STOCK

   139

SHARES ELIGIBLE FOR FUTURE SALE

   147

DESCRIPTION OF CERTAIN INDEBTEDNESS

   149

MATERIAL U.S. FEDERAL INCOME AND ESTATE TAX CONSEQUENCES FOR NON-U.S. HOLDERS

   158

UNDERWRITING

   161

VALIDITY OF COMMON STOCK

   164

EXPERTS

   164

WHERE CAN YOU FIND MORE INFORMATION

   164

INDEX TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS

   F-1

We and the selling stockholders have not authorized anyone to provide you any information other than the information contained in this prospectus. The selling stockholders and the underwriters are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information contained in this prospectus is accurate only as of the date of this prospectus regardless of the time of delivery of this prospectus or any sale of the common stock.

 

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PROSPECTUS SUMMARY

This summary does not contain all the information that may be important to you. You should carefully read this prospectus in its entirety before making an investment decision. In particular, you should read the section titled “Risk Factors” and the consolidated financial statements and notes related to those statements included elsewhere in this prospectus.

In this prospectus, unless the context otherwise requires, the term “issuer” or “company” refers to Horizon Lines, Inc., a Delaware corporation, the terms “we,” “our” and “us” refer to the company and its subsidiaries. Unless the context otherwise requires, the term “H-Lines Finance” refers to the issuer’s direct wholly-owned subsidiary, H-Lines Finance Holding Corp., a Delaware corporation, the term “Horizon Lines Holding” refers to the issuer’s indirect wholly-owned subsidiary, Horizon Lines Holding Corp., a Delaware corporation, and the term “Horizon Lines” refers to Horizon Lines, LLC, the company’s indirect wholly-owned subsidiary and principal operating subsidiary.

Our Company

We believe that we are the nation’s leading Jones Act container shipping and integrated logistics company, accounting for approximately 36% of total U.S. marine container shipments from the continental U.S. to the three non-contiguous Jones Act markets, Alaska, Hawaii and Puerto Rico, and to Guam. We are the only Jones Act container shipping and logistics company with an integrated organization operating in all three non-contiguous Jones Act markets. Our operating history dates back to 1956, when Sea-Land Service, Inc. pioneered the marine container shipping industry and established our business.

With 16 vessels and approximately 23,900 cargo containers, we operate the largest Jones Act containership fleet, providing comprehensive shipping and sophisticated logistics services to our markets. We have long-term access to terminal facilities in each of our ports, operating our own terminals in Alaska, Hawaii, and Puerto Rico and contracting for terminal services in our seven ports in the continental U.S. and in our ports in Guam, Hong Kong and Taiwan. We also offer extensive inland cargo trucking and logistics for our customers through our relationships with third-party truckers, railroads and barge operators in our markets, and our own trucking operations on the U.S. West Coast. Over 90% of our revenue is generated from our shipping and logistics services in markets where the marine trade is subject to the Jones Act or other U.S. maritime laws.

For the fiscal year ended December 25, 2005, we generated revenue of $1,096.2 million, EBITDA of $100.4 million, and net loss available to common stockholders of $23.4 million. For the six months ended June 25, 2006, we generated revenue of $564.8 million, EBITDA of $71.5 million, and net income available to common stockholders of $8.8 million. For the twelve months ended December 25, 2005, we generated pro forma EBITDA of $130.8 million and pro forma net income available to common stockholders of $12.8 million, after giving effect to certain adjustments, and based upon certain assumptions, as more fully described in “Unaudited Pro Forma Condensed Consolidated Financial Statements,” beginning on page 41 of this prospectus. For the definition of EBITDA and its reconciliation to net income, see footnote 4 to the table under “—Summary Consolidated, Combined and Unaudited Pro Forma Financial Data,” beginning on page 9 of this prospectus.

On April 11, 2006, we concluded a series of agreements to charter, for an initial period of twelve years, five newly built U.S.-flag container vessels, each with a capacity of 2,824 twenty-

 

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foot equivalent units, or TEUs, and a potential service speed of 23 knots. These five container vessels of the same class are currently being built in South Korea and are scheduled to be delivered over a seven-month period starting in the fourth quarter of 2006. Upon the delivery of these five vessels by the end of the first half of 2007, the average age of our active vessels will be reduced from 31 years to 20 years.

This initiative will allow us to use the new vessels for our non-Jones Act routes between the U.S. West Coast and Guam and Asia in a very capital efficient manner, at approximately one third the cost of comparable U.S.-built vessels. The deployment of these new vessels will enable us to provide Maersk Line (“Maersk”) with additional capacity on the transpacific route where we currently provide vessel container space to Maersk on a take or pay basis. In addition, our larger Jones Act vessels currently operating in the transpacific service will be redeployed to our Hawaii and Puerto Rico markets resulting in additional capacity to meet market growth requirements and an improved network cost structure.

Our vessels are maintained according to our own strict maintenance procedures, which meet or exceed U.S. government requirements. We also offer extensive inland cargo trucking and logistics for our customers through our own trucking operations on the U.S. West Coast and our relationships with third-party truckers, railroads, and barge operators in our markets. We book and monitor all of our shipping and logistics services with our customers through the Horizon Information Technology System, or HITS, our industry-leading ocean shipping and logistics information technology system, which is a key feature of our complete shipping logistics solutions. Our focus is on maintaining our reputation for service and operational excellence by emphasizing strict vessel maintenance, employing experienced vessel crews, expanding and improving our national sales presence, and employing industry-leading information technology as part of our complete logistics solutions.

We transport a wide spectrum of consumer and industrial items used everyday in the markets we serve, ranging from foodstuffs (refrigerated and non-refrigerated) to household goods and auto parts to building materials and various materials used in manufacturing. Many of these cargos are consumer goods vital to the expanding populations in our markets, thereby providing us with a stable base of growing demand for our shipping and logistics services. We have approximately two thousand customers and have many long-standing customer relationships, including large consumer and industrial products companies and several agencies of the U.S. government. Our customer base is broad and diversified, with our top ten customers accounting for approximately 32% of revenue and our largest customer accounting for approximately 7% of revenue in 2005. Approximately 51% of our revenue in 2005 was derived from customers shipping with us in more than one of our geographic markets and approximately 29% of our revenue in 2005 was derived from customers shipping with us in all of our geographic markets.

The Jones Act

Under the coastwise laws of the United States, also known as 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. Our trade routes between Alaska, Hawaii and Puerto Rico and the continental U.S. represent the three non-contiguous Jones Act markets. Vessels operating on these trade routes are required to be fully qualified Jones Act vessels. Other U.S. maritime laws require vessels operating on the trade routes between Guam, a U.S. territory, and U.S. ports to be U.S.-flagged and

 

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predominantly U.S.-crewed, but not U.S.-built. The Jones Act and these other maritime laws enjoy broad support from both major political parties. We believe that there are no Jones Act qualified container vessels or roll-on/roll-off vessels currently under construction in the United States or on order. Given the limited uncommitted capacity of shipyards in the United States and the long lead time required for the construction of such vessels, we believe that no new Jones Act qualified container vessels or roll-on/roll-off vessels will become available for use in our Jones Act markets for at least three years.

Market Overview

The Jones Act distinguishes the U.S. domestic shipping market from international shipping markets by making the U.S. domestic shipping market the exclusive domain of Jones Act qualified vessels. Given the limited number of existing Jones Act qualified vessels, the relatively high capital investment and long delivery lead times associated with building a new containership in the U.S., the substantial investment required in infrastructure and the need to develop a broad base of customer relationships, the markets in which we operate have been less prone to overcapacity and volatility than international shipping markets. Since 1995, Alaska, Hawaii and Guam and Puerto Rico have experienced low average rate volatility of 0.4%, 1.7% and 3.8% per annum while the major transpacific and transatlantic trade routes have experienced average rate volatility of 23.7% and 9.4% per annum.

The Jones Act markets are not as fragmented as international shipping markets. In particular, the three non-contiguous Jones Act markets and Guam are currently served predominantly by four shipping companies, including Horizon Lines, Matson Navigation Company, Inc., Crowley Maritime Corporation, and Totem Ocean Trailer Express, Inc., or TOTE. Horizon Lines and Matson serve the Hawaii and Guam market. Pasha Hawaii Transport Lines LLC operates a vessel with roll-on/roll-off vessel service shipping vehicles between the U.S. West Coast and Hawaii. Horizon Lines and TOTE serve the Alaska market. The Puerto Rico market is currently served by two containership companies, Horizon Lines and Sea Star Lines, which is an independently operated company majority-owned by an affiliate of TOTE. Two barge operators, Crowley and Trailer Bridge, Inc., also currently serve the Puerto Rico market.

The U.S. container shipping industry as a whole is experiencing rising customer expectations for real-time shipment status information and on-time pick-up and delivery of cargo, as customers seek to optimize efficiency through greater management of the delivery process of their products. Commercial and governmental customers are increasingly requiring the tracking of the location and status of their shipments at all times and have developed a strong preference to retrieve information and communicate using the Internet. To ensure on-time pick-up and delivery of cargo, shipping companies must maintain strict vessel schedules and efficient terminal operations for expediting the movement of containers in and out of terminal facilities.

Our Competitive Strengths

We believe that our competitive strengths include:

Leading Jones Act container shipping and logistics company. We are the only container vessel operator with an integrated organization serving all three non-contiguous Jones Act markets and have a number-one or a number-two market position within each of our markets. We are one of only two major marine container shipping operators currently serving the Alaska

 

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market, one of two marine container shipping companies currently serving the Hawaii and Guam markets and the largest of four marine container shipping companies currently serving the Puerto Rico market. As a result, we are able to serve the needs of customers shipping to individual markets as well as the needs of large customers that require shipping and sophisticated logistics services across more than one of these markets. Approximately 51% of our revenue in 2005 was derived from customers shipping with us in more than one of our geographic markets and approximately 29% of our revenue in 2005 was derived from customers shipping with us in all of our geographic markets.

Favorable industry dynamics. Given the requirements of the Jones Act, the level of services already provided by us and our existing competitors in our markets and the increasing requirements of customers in our markets, any future viable competitor would not only have to make substantial investments in vessels and infrastructure but also establish regularity of service, develop customer relationships, develop inland cargo shipping and logistics solutions and acquire or build infrastructure at ports that are currently limited in space, berths and water depth.

Stable and growing revenue base. We have achieved five consecutive years of revenue growth. Our revenue base is stable and growing due to our presence across three geographic markets, the breadth of our customer base served and the diversity of our cargos shipped, all of which better protect us against external events that may adversely affect any one of our markets. In addition, our use of non-exclusive customer contracts, with durations ranging from one to six years, generates most of our revenue and provides us with stable revenue streams.

Long-standing relationships with leading, established customers. We serve a diverse base of long-standing, established customers consisting of many of the world’s largest consumer and industrial products companies, as well as a variety of smaller and middle-market customers. Our customers include Costco Wholesale Corporation, Johnson & Johnson, Lowe’s Companies, Inc., Safeway, Inc., Toyota Motor Corporation and Wal-Mart Stores, Inc. In addition, we serve several agencies of the U.S. government, including the Department of Defense and the Postal Service. We have a long-standing history of service to our customer base, with some of our customer relationships extending back over 40 years and our relationships with our top ten customers averaging 28 years. In addition, during 2005, we experienced a retention rate of approximately 99% with respect to customers who generated more than $100,000 in revenue during such year. For 2005, no customer accounted for more than approximately 7% of total revenue and nearly all of our customer relationships are based on non-exclusive contracts.

Customer-oriented sales and marketing presence. Our approximately 120-person national and regional sales and marketing presence enables us to forge and maintain close customer relationships. Our sales headquarters is based in Charlotte, North Carolina and we also maintain a regional sales presence strategically located in our various ports as well as in seven regional offices across the continental U.S. Our national and regional presence, combined with our operational excellence, results in high levels of repeat business from our diverse customer base.

Operational excellence. As the leading Jones Act shipping and integrated logistics company, we pride ourselves on our operational excellence and our ability to provide consistent, high quality service. The quality of our vessels as well as the expertise of our vessel crews and engineering resources help us to maintain highly reliable and consistent dock-to-dock on-time arrival performance. Our track record of service and operational excellence continues to

 

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be widely recognized by some of the most demanding customers in the world. Wal-Mart named us as its 2005 Jones Act Carrier of the Year (the fifth time we have received this award over the last six years for which the award has been given), Lowe’s awarded us with its 2005 Gold Carrier Award for the fifth straight year, and Toyota recognized us with its Logistics Excellence for On Time Performance award for the seventh consecutive year and with its Logistics Excellence Award for Customer Service for 2005.

Experienced management with strong culture of commitment to service and operational excellence. Our senior management, headed by Charles G. Raymond, is comprised of seasoned leaders in the shipping and logistics industry with an average of 25 years of experience in the industry. Our senior management has a long history of working together as a team, with four of our eight most senior managers having worked together at Horizon Lines or our predecessors for over 22 years. Furthermore, as of the date hereof, after giving effect to this offering, our management team, including family members, continues to own approximately 11% of our common equity on a fully diluted basis.

Our Business Strategy

Our financial and operational success has largely been driven by providing customers with reliable shipping and logistics solutions, supported by consistent and value-added service and expertise. Our goal is to continue to provide high-quality service while pursuing continued strong revenue and earnings growth both in our core markets and in selected non-Jones Act shipping markets through the principal strategies outlined below. There are many uncertainties associated with the risks of the implementation of our business strategy. These uncertainties relate to economic, competitive, energy cost, operational, regulation, catastrophic loss and other factors that are discussed on pages 14 - 28, many of which are beyond our control.

Continue to organically grow our revenue. We intend to achieve ongoing revenue growth in each of our markets by focusing our national and regional sales force on acquiring business from new customers, growing business with existing customers, continuing to focus on increasing the share of our revenue that is derived from our customers’ higher margin cargo and through the continued economic growth within our geographic markets.

Expand our services and logistics solutions. We seek to build on our market-leading logistics platform and operational expertise by providing new services and integrated logistics solutions. These services and solutions include delivery planning and comprehensive shipping and logistics. By offering a wider range of services and logistics solutions, we believe that we can strengthen our franchise and further grow our revenues and profits.

Expand and enhance our customer relationships. We seek to leverage our capabilities to serve a broad and growing range of customers across varied industries and geographies of different size and growth profiles. In order to enhance our overall cargo mix, we place a strong emphasis on the development and expansion of our relationships with customers which meet high credit standards and have sophisticated container shipping and logistics requirements across more than one of the geographic markets that we serve. This strategy has resulted in our long-term and successful relationships with customers who are growing their operations in our markets.

Reduce operating costs. We continually seek to identify opportunities to reduce our operating costs, and our continued examination of unit cost economics is a critical part of our culture. In May, 2006, we formed a dedicated team of employees to develop and implement a

 

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program, referred to as “Horizon Edge,” over the next two and a half years, with the combined goals of reducing operating costs and enhancing customer focus and service efficiency. With the assistance of outside advisors, we are targeting improvements in maintenance management, marine productivity, supply chain management and information technology.

Leverage our brand. We actively promote, through our sales and marketing efforts, the broad recognition that Horizon Lines has a long and successful history of service to customers in the three non-contiguous Jones Act trades and in Guam. We believe that Horizon’s brand Always There. Always Delivering.® is synonymous with quality and operational excellence and we intend to continue to build and leverage our brand in order to further enhance our business.

Maintain leading information technology. We are focused on maintaining HITS as an industry-leading ocean shipping and logistics information technology system with cargo booking, tracking and tracing capabilities more advanced than those of any system employed by our competitors. Since the launch of HITS in 2000, we have migrated our customers to the on-line interfaces of HITS, with on-line bookings via HITS totaling approximately 50% of our total bookings. We routinely incorporate additional enhancements into HITS to meet the changing needs of our business and further differentiate us from our competitors. We believe that HITS’ functionality and cost savings potential for our customers produce strong loyalty.

Our Growth Initiatives

Our management team has a demonstrated track record of delivering revenue and earnings growth to our stockholders. Going forward, we intend to actively pursue new business opportunities as well as grow our core business by improving our cargo mix and operating margins in each of our core markets. In order to achieve this growth in our business, we plan to execute the following initiatives:

Optimize fleet deployment. In April 2006, we entered into a series of agreements to charter five new U.S.-flag container vessels, each with a capacity of 2,824 TEUs, over an initial period of 12 years beginning in the fourth quarter of 2006. We plan to deploy these new U.S.-flag, non-Jones Act vessels, beginning in the first quarter of 2007, on our non-Jones Act trade routes between the U.S. West Coast and Guam and Asia. The new vessels will increase our weekly effective capacity on this route by approximately 20%, allowing us to expand our service to Guam and to offer additional space to Maersk on a take or pay basis eastbound from Asia. We will redeploy the Jones Act vessels currently serving on this route into Hawaii and Puerto Rico, thereby increasing our effective weekly capacity to Hawaii to satisfy growing market demand, and allowing us to serve Puerto Rico with a more cost efficient fleet configuration. We expect that these vessels will enhance our service quality as a result of faster service speeds and enhanced reliability and will operate more cost efficiently with lower fuel consumption and maintenance costs than the current vessels serving these markets.

Upside revenue potential for inactive Jones Act vessels. As a result of our initiative to optimize our fleet deployment, we will have four inactive Jones Act vessels available to provide us with surge capacity during peak shipping volume seasons as well as to serve as relief vessels during drydockings of active vessels. These vessels will also enable us to pursue other Jones Act trade routes, new contracts and vessel charter opportunities.

 

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Additional government and military business. We plan to increase our U.S. government and military cargo business. In 2004, we secured a contract to manage seven oceanographic vessels for the U.S. government. The recent addition to our senior management team of General John W. Handy, a retired four-star Air Force general who most recently served as head of air, land and sea transportation for the U.S. Department of Defense, will further position us to pursue additional government and military cargo opportunities.

Expand Operating Platform. We believe that there are significant new and expansion opportunities available for us within the overall shipping and logistics markets under the Jones Act or other U.S. maritime laws. We intend to identify and pursue strategic acquisitions within these markets on a financially disciplined basis with the goal of expanding our operating platform to increase our penetration of these markets.

Corporate Information

Our principal executive offices are located at 4064 Colony Road, Suite 200, Charlotte, North Carolina 28211. Our telephone number is (704) 973-7000. Our website address is http://www.horizonlines.com. The contents of our website are not incorporated by reference into this prospectus.

 

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The Offering

 

Company

Horizon Lines, Inc.

 

Common stock offered by the selling stockholders

5,300,000 shares of common stock.

 

Underwriters’ option to purchase additional common stock from the selling stockholders

795,000 shares of common stock.

 

Common stock outstanding

33,614,170 shares of our common stock.

 

Use of proceeds

We will not receive any proceeds from the sale of shares by the selling stockholders.

 

New York Stock Exchange symbol

“HRZ”

Except as otherwise indicated, we have presented information in this prospectus based on the assumption that the underwriters do not exercise their option (described on the front cover page of this prospectus) to purchase additional shares from the selling stockholders.

Common Stock Subject to Issuance

Except as otherwise indicated in this prospectus, the number of shares of our common stock that are outstanding excludes a total of 3,327,534 shares issuable as follows:

 

    308,866 shares of our common stock that will be issuable to our eligible employees pursuant to our employee stock purchase plan;

 

    1,657,993 shares of our common stock that will be issuable to our eligible directors, officers or employees (or upon the exercise of options that will be granted to such persons) pursuant to our equity incentive plan, as amended, referred to in this prospectus as our equity incentive plan; and

 

    1,360,675 shares of our common stock that will be issuable upon the exercise of outstanding options granted to our directors, officers and employees pursuant to the equity incentive plan.

We refer to Castle Harlan, a New York-based private equity investment firm, and its affiliates and associates (other than us), including Castle Harlan Partners IV, L.P. (“CHP IV”), in this prospectus as the “Castle Harlan Group.”

Unless we specifically state otherwise, we use the term “pre-IPO stockholders” in this prospectus to refer to the owners of our common stock immediately prior to the consummation of our Initial Public Offering who consisted of CHP IV and its affiliates and associates, Stockwell Fund, L.P., our directors and certain members of our management team (and their family members).

Risk Factors

You should carefully consider all of the information set forth in this prospectus and, in particular, the information under the heading “Risk Factors,” beginning on page 14, prior to purchasing the common shares offered hereby.

 

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Summary Consolidated, Combined and Unaudited

Pro Forma Financial Data

The following tables provide summary consolidated, combined and unaudited pro forma financial data and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” beginning on page 51 of this prospectus, and our consolidated and combined financial statements and the related notes appearing elsewhere in this prospectus.

The consolidated balance sheet data and combined and consolidated statement of operations data as of and for the year ended December 25, 2005, and as of and for the twelve months ended December 26, 2004 and December 21, 2003, presented below have been derived from the audited financial statements contained in this prospectus. The consolidated statement of operations data for the six months ended June 25, 2006 and June 26, 2005 and the consolidated balance sheet data as of June 25, 2006 and June 26, 2005 presented below have been derived from the unaudited financial statements contained in this prospectus. The combined and consolidated statement of operations data for the twelve months ended December 21, 2003 is derived by combining the statement of operations data for the period December 23, 2002 through February 26, 2003 with the data for the period from February 27, 2003 through December 21, 2003. The combined and consolidated statement of operations data for the twelve months ended December 26, 2004 is derived by combining the statement of operations data for the period December 22, 2003 through July 6, 2004 with the data for the period from July 7, 2004 through December 26, 2004.

The unaudited pro forma consolidated statement of operations data for the fiscal year ended December 25, 2005 gives effect to the Initial Public Offering and related transactions, which are described in “Historical Transactions,” beginning on page 129 of this prospectus, as if they had occurred on December 27, 2004. The unaudited pro forma financial data does not purport to represent what our results of operations would have been if the transactions referred to above had occurred as of such dates or what such results will be for future periods. See “Unaudited Pro Forma Condensed Consolidated Financial Statements” beginning on page 41 of this prospectus for a description of items or events that may impact the pro forma information.

The issuer was formed in connection with the Acquisition-Related Transactions, which are described in “Historical Transactions,” and has no independent operations. All combined and consolidated financial data for the period (or any portion thereof) from December 22, 2002 through February 26, 2003 reflect the combined company CSX Lines, LLC and its wholly owned subsidiaries, CSX Lines of Puerto Rico, Inc., and the Domestic Liner Business of SL Service, Inc. (formerly known as Sea-Land Service, Inc.), all of which were stand-alone wholly owned entities of CSX Corporation. All combined and consolidated financial data for the period (or any portion thereof) from February 27, 2003 through July 6, 2004 reflect Horizon Lines Holding on a consolidated basis. All combined and consolidated financial data for the period (or any portion thereof) from July 7, 2004 through June 25, 2006 reflect the issuer on a consolidated basis.

We have a 52- or 53-week fiscal year (every sixth or seventh year) that ends on the Sunday before the last Friday in December. The fiscal year ended December 22, 2002 and the twelve months ended December 21, 2003 and December 25, 2005 each consisted of 52 weeks. The twelve months ended December 26, 2004 consisted of 53 weeks.

Certain prior period balances have been reclassified to conform with the current period presentation.

 

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The information for the twelve months ended December 21, 2003 and December 26, 2004 presented below reflects financial data for us and our predecessors that has been combined and consolidated to present this information on a comparative annual basis. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” beginning on page 51 in this prospectus for a description of the items or events that may impact the period-to-period comparability of the operating results covered by the following tables:

 

   

Twelve

Months Ended
December 21,

2003

   

Twelve

Months Ended 
December 26,

2004

  Year Ended
December 25,
2005
   

Pro Forma

Year Ended

December 25,

2005

  Six Months
Ended
June 26,
2005
    Six Months
Ended
June 25,
2006
 
    ($ in thousands, except per share data)  

Statement of Operations Data:

           

Operating revenue

  $    885,978     $    980,328   $ 1,096,156     $ 1,096,156   $    528,106     $    564,781  

Operating expense

    718,231       780,343     867,307       867,307     422,469       444,347  

Depreciation and amortization

    29,954       45,570     51,141       51,141     25,441       25,095  

Amortization of vessel drydocking

    16,343       15,861     15,766       15,766     8,544       7,971  

Selling, general and administrative

    80,064       84,805     114,639       84,245     54,634       47,694  

Miscellaneous expense, net(1)

    3,173       2,160     649       649     1,220       1,383  
                                           

Total operating expenses

    847,765       928,739     1,049,502       1,019,108     512,308       526,490  
                                           

Operating income

    38,213       51,589     46,654       77,048     15,798       38,291  

Interest expense, net(2)

    8,940       26,881     51,357       42,577     26,238       24,024  

Interest expense—preferred units of subsidiary

    4,477       2,686     —         —       —         —    

Loss on early extinguishment of debt

    —         —       13,154       13,154     —         —    

Other expense, net

    68       22     26       26     1       (186 )
                                           

Income (loss) before income taxes

    24,728       22,000     (17,883 )     21,291     (10,441 )     14,453  

Income tax expense (benefit)

    9,615       8,439     438       8,524     226       5,686  
                                           

Net income (loss)

    15,113       13,561     (18,321 )     12,767     (10,667 )     8,767  

Less: accretion of preferred stock

    —         6,756     5,073       —       3,122       —    
                                           

Net income (loss) available to common stockholders

  $ 15,113     $ 6,805   $ (23,394 )   $ 12,767   $ (13,789 )   $ 8,767  
                                           

Net income (loss) per share:

           

Basic

    *       *   $ (1.05 )   $ 0.38   $ (0.73 )   $ 0.26  

Diluted

    *       *   $ (1.05 )   $ 0.38   $ (0.73 )   $ 0.26  

Number of shares used in calculations:

           

Basic

    *       *     22,376,797       33,544,170     18,912,639       33,544,170  

Diluted

    *       *     22,381,756       33,570,364     18,912,639       33,586,992  

Dividends declared per common share

    —         —     $ 0.11     $ 0.44     —       $ 0.22  

*   The twelve months ended December 21, 2003 and December 26, 2004 are derived by combining data from different entities and thus no net income per share has been calculated.

 

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December 21,

2003

    December 26,
2004
   December 25,
2005
  

June 26,
2005

  

June 25,
2006

     ($ in thousands)

Balance Sheet Data:

             

Cash and cash equivalents

   $ 41,811        $ 56,766    $ 41,450    $61,440    $ 44,187

Working capital

   46,192     67,252    67,111    88,323    83,184

Total assets

   492,554     937,792    927,319    1,017,067    925,034

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

   165,417     610,201    527,905    615,049    529,821

Total debt, including capital lease obligations(2)

   165,570     612,862    530,575    617,710    532,500

Series A redeemable preferred stock(3)

   —       56,708    —      60,202    —  

Stockholders’ equity

   96,860     25,608    151,760    22,756    153,011

 

                                   
    Twelve
Months
Ended
December 21,
2003
    Twelve
Months
Ended
December 26,
2004
   
Year Ended
December 25,
2005
    Pro Forma
Year
Ended
December 25,
2005
  Six
Months
Ended
June 26,
2005
    Six
Months
Ended
June 25,
2006
 
    ($ in thousands)  

EBITDA(4)

  $ 84,442        $ 112,998     $ 100,381     $ 130,775   $ 49,782     $ 71,543  

Capital expenditures(5)

  35,150     32,889     41,234     41,234   2,217     7,218  

Vessel drydocking payments

  16,536     12,273     16,038     16,038   9,991     12,129  

Cash flows provided by (used in):

           

Operating activities

  44,048     69,869     70,881       8,395     19,391  

Investing activities(6)

  (350,666 )   (694,563 )   (38,817 )     (1,804 )   (5,663 )

Financing activities(3)(6)

  305,687     657,805     (47,380 )     (1,917 )   (10,991 )

(1)   Miscellaneous expense, net generally consists of bad debt expense accrued during the year, accounts payable discounts taken, gain or loss on the sale of assets and various other miscellaneous income and expense items.
(2)   During 2003 we incurred interest charges totaling $8.9 million on the outstanding debt borrowed to finance the February 27, 2003 purchase transaction, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 51 of this prospectus. On July 7, 2004, as part of the Acquisition-Related Transactions, the $250.0 million original principal amount of 9% senior notes were issued, $250.0 million was borrowed under the senior secured term loan facility, $6.0 million was borrowed under the revolving credit facility and interest began to accrue thereon. On December 10, 2004, 11% senior discount notes with an initial accreted value of $112.3 million were issued and the accreted value thereof began to increase. During the fourth quarter of 2005, utilizing proceeds from the Initial Public Offering, we redeemed $53.0 million principal amount and $43.2 million in accreted value of the 9% senior notes and 11% senior discount notes, respectively. As of June 25, 2006, total debt outstanding included $197.0 million principal amount of 9% senior notes, $245.6 million of borrowing under the senior secured term loan facility, the 11% senior discount notes with an accreted value of $84.9 million, $4.5 million of notes issued by owner trustees, and capital lease obligations with a carrying value of $0.4 million.
(3)   In connection with the financing of the Acquisition-Related Transactions, we issued and sold 8,391,180 shares of our Series A preferred stock in July 2004. No dividends accrued on these shares. We recorded these shares on our books and records at their fair value in accordance with FAS No. 141 “Business Combinations.” As these shares had no dividend rate, we determined that a 10% discount rate was appropriate. The issuer classified the value of these shares outside the equity section of the balance sheet. During October 2004, an additional 1,898,730 Series A preferred shares were issued and sold. During December 2004, 5,315,912 Series A preferred shares were redeemed for $53.2 million. During January 2005, we repurchased 53,520 Series A preferred shares with an aggregate stated value of $0.5 million. Also, during January 2005, we sold 45,416 Series A preferred shares and 130,051 common shares for $0.5 million. In connection with the Initial Public Offering, the issuer redeemed all shares of its non-voting $.01 par value Series A preferred stock for $62.2 million. During 2005, the company recorded $5.1 million of accretion of its Series A preferred stock.
(4)  

EBITDA is defined as net income plus interest expense (net of interest income), income taxes, depreciation and amortization. We believe that GAAP-based financial information for highly leveraged businesses, such as ours, should be supplemented by EBITDA so that investors better understand our financial information in connection with their analysis of our business. The following demonstrates and forms the basis for such belief: (i) EBITDA is a component of the measure used by our board of directors and management team to evaluate our operating performance, (ii) the senior credit facility contains covenants that require Horizon Lines Holding and its subsidiaries to maintain certain interest expense coverage and leverage ratios, which contain EBITDA as a component, and

 

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restrict upstream cash payments if certain ratios are not met, subject to certain exclusions, and our management team uses EBITDA to monitor compliance with such covenants, (iii) EBITDA is a component of the measure used by our management team to make day-to-day operating decisions, (iv) EBITDA is a component 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 (v) the payment of discretionary bonuses to certain members of our management is contingent upon, among other things, the satisfaction by Horizon Lines of certain targets, which contain EBITDA as a component. We acknowledge that there are limitations when using EBITDA. EBITDA is not a recognized term under GAAP and does 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 is 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 may not be comparable to other similarly titled measures of other companies. A reconciliation of net income (loss) to EBITDA is included below:

 

   

Twelve
Months
Ended
December 21,

2003

    Twelve
Months
Ended
December 26,
2004
  Year
Ended
December 25,
2005(a)
    Pro Forma
Year
Ended
December 25,
2005(a)
  Six Months
Ended
June 26,
2005
    Six Months
Ended
June 25,
2006
    ($ in thousands)

Net income (loss)

  $   15,113       $13,561   $ (18,321 )     $12,767   $ (10,667 )   $ 8,767

Interest expense, net

    13,417       29,567     51,357       42,577     26,238       24,024

Income tax expense

    9,615       8,439     438       8,524     226       5,686

Depreciation and amortization

    46,297       61,431     66,907       66,907     33,985       33,066
                                         

EBITDA

  $ 84,442     $ 112,998   $ 100,381     $ 130,775   $ 49,782     $ 71,543
                                         

 

  (a)   Adjustments from the year ended December 25, 2005 to pro forma for the year ended December 25, 2005 include the elimination of $9.7 million of management fees, $19.0 million of compensation charges, and $1.7 million of Initial Public Offering related expenses. See pages 41-44 in this prospectus for the unaudited pro forma statement of operations and footnotes thereto.

The EBITDA amounts presented above contain certain charges that were incurred and are not anticipated to recur regularly in the ordinary course of business as described in the following table:

 

   

Twelve
Months
Ended
December 21,

2003

  Twelve
Months
Ended
December 26,
2004
  Year
Ended
December 25,
2005
  Pro Forma
Year
Ended
December 25,
2005
  Six Months
Ended
June 26,
2005
  Six Months
Ended
June 25,
2006
    ($ in thousands)

Merger related expenses(a)

  $   4,287   $   2,934   $ 457   $ 457   $ —     $   —  

Management fees(b)

    250     2,204     9,698     —       1,500     —  

Compensation charges(c)

    —       —       18,953     —       10,412     —  

Transaction Related Expenses

    —       —       1,743     —       189     858

Loss on extinguishment of debt

    —       —       13,154     13,154     —       —  

 

  (a)   As a result of the February 27, 2003 purchase transaction, we incurred $1.7 million of severance costs related to the departure of three of our executives, $0.8 million of expenses related to the renaming and rebranding of vessels and equipment with the Horizon Lines name, and $1.8 million in professional fees. Professional fees include legal fees related to the re-documentation of our vessels, registration of trademarks and other intellectual property, establishment of various employee benefit plans, and costs associated with moving our technology data center and establishing our financial system software license on a standalone basis. Adjustments also include legal fees incurred in connection with an arbitration case regarding trucking services provided to a third party in Long Beach, California. We incurred $2.9 million and $0.5 million in expenses related to the Acquisition-Related Transactions during 2004 and 2005, respectively.

 

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  (b)   The adjustment represents management fees paid to Castle Harlan and to an entity that was associated with the party that was the primary stockholder of Horizon Lines Holding prior to the Acquisition-Related Transactions. Upon the completion of the Acquisition-Related Transactions, the company, Horizon Lines and Horizon Lines Holding entered into a new management agreement with Castle Harlan. On September 7, 2005, as a result of an amendment of such agreement and a related payment to Castle Harlan of $7.5 million under such amended agreement, the provisions of such agreement were terminated, except as to expense reimbursement and indemnification and related obligations of the company, Horizon Lines and Horizon Lines Holding. See “Certain Relationships and Related Party Transactions—Management Agreement” beginning on page 135 of this prospectus.
  (c)   The adjustment represents non-cash stock-based compensation charges which we incurred during the year ended December 25, 2005 related to the issuance and sale of common stock, including restricted common stock, to non-employee directors and to members of management. All of these shares vested in full upon the consummation of the Initial Public Offering.
(5)   Includes the acquisition of the rights and beneficial interests of the sole owner-participant in two separate trusts, the assets of which consist of two vessels, for $25.2 million during the year ended December 25, 2005. Includes vessel purchases of $21.9 million and $19.6 million for the years ended December 21, 2003 and December 26, 2004, respectively.
(6)   During 2003, the amounts in cash flows provided by (used in) investing and financing activities primarily represent the accounting for the February 27, 2003 purchase transaction. Investing activities related to the February 27, 2003 purchase transaction included the purchase price of $296.2 million and spending for transaction costs of $18.8 million. Financing activities related to the February 27, 2003 purchase transaction included the initial capitalization of $80.0 million and borrowings under the term loan facility of $175.0 million and the issuance of preferred and common units to CSX Corporation and its affiliates with an aggregate original cost totaling $60.0 million. During 2004, the amounts in cash flows provided by (used in) investing primarily represent the accounting for the Acquisition-Related Transactions and financing activities primarily represent the accounting for the Acquisition-Related Transactions and subsequent financing transactions, which are described in “Historical Transactions” on page 129. Investing activities related to the Acquisition-Related Transactions included the acquisition consideration and spending for transaction costs of $663.3 million. Financing activities related to the Acquisition-Related Transactions included a capital contribution of $87.0 million, the issuance of the 13% promissory notes, in the aggregate original principal amount of $70.0 million, $250.0 million borrowed under the term loan facility, $6.0 million borrowed under the revolving credit facility, and the issuance of the 9% senior notes in the aggregate original principal amount of $250.0 million. Subsequent financing transactions included the issuance of common shares and Series A preferred shares for gross proceeds of $20.7 million, and the repayment of $20.0 million of the outstanding principal amount of the 13% promissory notes, plus accrued interest of $0.7 million thereon, the issuance of $160.0 million in aggregate principal amount at maturity of 11% senior discount notes, the repayment of $52.9 million of the outstanding principal amount, together with accrued but unpaid interest thereon, of the 13% promissory notes, and the repurchase of a portion of the outstanding Series A preferred shares having an aggregate original stated value of $53.2 million. Financing activities during 2005 included the proceeds from the Initial Public Offering and the use of proceeds therefrom. The proceeds of $143.8 million and $40.0 million of cash generated from operations were used to redeem $62.2 million of the Series A preferred shares, $53.0 million principal amount of the 9% senior notes, $43.2 million in accreted value of the 11% senior discount notes, and to pay associated redemption premiums and related transaction expenses. Financing activities during the six months ended June 25, 2006 include dividends of $7.4 million to stockholders and are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financing Activities,” beginning on page 73.

 

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RISK FACTORS

An investment in our common stock involves risk. You should carefully consider the risk factors set forth below as well as the other information included in this prospectus before buying shares of common stock. Any of these risks may have a material adverse effect on our business, financial condition, results of operations and cash flows. In that case, you may lose all or part of your investment.

Risks Related to Our Business

If we are unable to implement our business strategy, our future results could be adversely affected.

Our future results of operations will depend in significant part on the extent to which we can implement our business strategy successfully. Our business strategy includes continuing to organically grow our revenue, providing complete shipping and logistics services, leveraging our capabilities to serve a broad range of customers, leveraging our brand, maintaining industry-leading information technology, and reducing operating costs. Our strategy is subject to business, economic and competitive uncertainties and contingencies, many of which are beyond our control. As a consequence, we may not be able to fully implement our strategy or realize the anticipated results of our strategy.

Repeal, substantial amendment, or waiver of the Jones Act or its application could have a material adverse effect on our business.

If the Jones Act were to be repealed, substantially amended, or waived and, as a consequence, competitors with lower operating costs were to enter any of our Jones Act markets, our business would be materially adversely affected. In addition, our advantage as a U.S.-citizen operator of Jones Act vessels could be eroded by periodic efforts and attempts by foreign interests to circumvent certain aspects of the Jones Act. If maritime cabotage services were included in the General Agreement on Trade in Services, the North American Free Trade Agreement or other international trade agreements, or if the restrictions contained in the Jones Act were otherwise altered, the shipping of maritime cargo between U.S. ports could be opened to foreign-flag or foreign-built vessels.

In September 2005, the Department of Homeland Security issued limited temporary waivers of the Jones Act solely to permit the transport of petroleum and refined petroleum products in the United States in response to the damage caused to the nation’s oil and gas production facilities and pipelines by Hurricanes Katrina and Rita. There can be no assurance as to the timing of any future waivers of the Jones Act or that any such waivers will be limited to the transport of petroleum and refined petroleum products.

A decrease in shipping volume in our markets will adversely affect our business.

Demand for our shipping services depends on levels of shipping in our Jones Act markets and in the Guam market, as well as on economic and trade growth and logistics. Cyclical or other recessions in the continental U.S. or in these markets can negatively affect our operating results as customers may ship fewer containers or may ship containers only at reduced rates. We cannot predict whether or when such downturns will occur.

Our failure to renew our commercial agreements with Maersk in the future could have a material adverse effect on our business.

We have several commercial agreements with Maersk, an international shipping company, that encompass terminal services, equipment sharing, cargo space charters, sales agency services, trucking services, and transportation services. For example, under these agreements, Maersk provides us with terminal services at our seven ports located in the continental U.S. (Elizabeth, New Jersey; Jacksonville, Florida; New Orleans, Louisiana; Houston, Texas; Long Beach and Oakland, California; and Tacoma, Washington). In general, these agreements, which

 

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were renewed and amended in May 2004, effective as of December 2004, are currently scheduled to expire at the end of 2007. If we fail to renew these agreements in the future, the requirements of our business will necessitate that we enter into substitute commercial agreements with third parties for at least some portion of the services contemplated under our existing commercial agreements with Maersk, such as terminal services at our ports located in the continental U.S. There can be no assurance that, if we fail to renew our commercial agreements with Maersk, we will be successful in negotiating and entering into substitute commercial agreements with third parties and, even if we succeed in doing so, the terms and conditions of these new agreements, individually or in the aggregate, may be significantly less favorable to us than the terms and conditions of our existing agreements with Maersk or others. Furthermore, if we do enter into substitute commercial agreements with third parties, changes in our operations to comply with the requirements of these new agreements (such as our use of other terminals in our existing ports in the continental U.S. or our use of other ports in the continental U.S.) may cause disruptions to our business, which could be significant, and may result in additional costs and expenses and possible losses of revenue.

Rising fuel prices may adversely affect our profits.

Fuel is a significant operating expense for our shipping operations. The price and supply of fuel is unpredictable and fluctuates based on events outside our control, including geopolitical developments, supply and demand for oil and gas, actions by OPEC and other oil and gas producers, war and unrest in oil producing countries and regions, regional production patterns and environmental concerns. As a result, increases in the price of fuel, such as we are currently experiencing, may adversely affect profitability. There can be no assurance that our customers will agree to bear such fuel price increases via fuel surcharges without a reduction in their volumes of business with us nor any assurance that our future fuel hedging efforts (if any) will be successful.

Our industry is unionized and strikes by our union employees or others in the industry may disrupt our services and adversely affect our operations.

As of June 25, 2006, we had 1,882 employees, of which 1,274 were unionized employees represented by seven different labor unions. Our industry is susceptible to work stoppages and other adverse employee actions due to the strong influence of maritime trade unions. We may be adversely affected by future industrial action against efforts by our management or the management of other companies in our industry to reduce labor costs, restrain wage increases or modify work practices. For example, in 2002 our operations at our U.S. West Coast ports were significantly affected by a 10-day labor interruption by the International Longshore and Warehouse Union. This interruption affected ports and shippers throughout the U.S. West Coast.

In addition, in the future, we may not be able to negotiate, on terms and conditions favorable to us, renewals of our collective bargaining agreements with unions in our industry and strikes and disruptions may occur as a result of our failure or the failure of other companies in our industry to negotiate collective bargaining agreements with such unions successfully.

Our collective bargaining agreements with our unions are scheduled to expire as follows—International Brotherhood of Teamsters: 2008 and 2010; Seafarers International Union: 2011; Office & Professional Employees International Union: 2007; International Longshore and Warehouse Union: 2007 and 2008; International Longshoremen’s Association: 2010; Marine Engineers Beneficial Association: 2012; and International Organization of Masters, Mates & Pilots: 2012.

 

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Our employees are covered by federal laws that may subject us to job-related claims in addition to those provided by state laws.

Some of our employees are covered by several maritime statutes, including provisions of the Jones Act, the Death on the High Seas Act, the Seamen’s Wage Act and general maritime law. These laws typically operate to make liability limits established by state workers’ compensation laws inapplicable to these employees and to permit these employees and their representatives to pursue actions against employers for job-related injuries in federal courts. Because we are not generally protected by the limits imposed by state workers’ compensation statutes for these employees, we may have greater exposure for any claims made by these employees than is customary in the United States.

Due to our participation in multiemployer pension plans, we may have exposure under those plans that extends beyond what our obligations would be with respect to our employees.

We contribute to fourteen multiemployer pension plans. In the event of a partial or complete withdrawal by us from any plan which is underfunded, we would be liable for a proportionate share of such plan’s unfunded vested benefits. Based on the limited information available from plan administrators, which we cannot independently validate, we believe that our portion of the contingent liability in the case of a full withdrawal or termination would be material to our financial position and results of operations. In the event that any other contributing employer withdraws from any plan which is underfunded, and such employer (or any member in its controlled group) cannot satisfy its obligations under the plan at the time of withdrawal, then we, along with the other remaining contributing employers, would be liable for our proportionate share of such plan’s unfunded vested benefits. We have no current intention of taking any action that would subject us to any withdrawal liability and cannot assure you that no other contributing employer will take such action.

In addition, if a multiemployer plan fails to satisfy the minimum funding requirements, the Internal Revenue Service, pursuant to Section 4971 of the Internal Revenue Code of 1986, as amended, referred to herein as the Code, will impose an excise tax of five (5%) percent on the amount of the accumulated funding deficiency. Under Section 413(c)(5) of the Code, the liability of each contributing employer, including us, will be determined in part by each employer’s respective delinquency in meeting the required employer contributions under the plan. The Code also requires contributing employers to make additional contributions in order to reduce the deficiency to zero, which may, along with the payment of the excise tax, have a material adverse impact on our financial results.

Compliance with safety and environmental protection and other governmental requirements may adversely affect our operations.

The shipping industry in general and our business and the operation of our vessels and terminals in particular are affected by extensive and changing safety, environmental protection and other international, national, state and local governmental laws and regulations. For example, our vessels, as U.S.-flagged vessels, generally must be maintained “in class” and are subject to periodic inspections by the American Bureau of Shipping or similar classification societies, and must be periodically inspected by, or on behalf of, the U.S. Coast Guard. In addition, the United States Oil Pollution Act of 1990 (referred to as OPA), the Comprehensive Environmental Response, Compensation & Liability Act of 1980 (referred to as CERCLA), and certain state laws require us, as a vessel operator, to obtain certificates of financial responsibility and to adopt procedures for oil or hazardous substance spill prevention, response and clean up. In complying with these laws, we have incurred expenses and may incur future expenses for ship

 

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modifications and changes in operating procedures. Changes in enforcement policies for existing requirements and additional laws and regulations adopted in the future could limit our ability to do business or further increase the cost of our doing business.

We believe our vessels are maintained in good condition in compliance with present regulatory requirements, are operated in compliance in all material respects with applicable safety/environmental laws and regulations and are insured against the usual risks for such amounts as our management deems appropriate. Our vessels’ operating certificates and licenses are renewed periodically during the required annual surveys of the vessels. However, there can be no assurance that such certificates and licenses will be renewed. Also, in the future, we may have to alter existing equipment, add new equipment to, or change operating procedures for, our vessels to comply with changes in governmental regulations, safety or other equipment standards to meet our customers’ changing needs. If any such costs are material, they could adversely affect our financial condition.

We are subject to new statutory and regulatory directives in the United States addressing homeland security concerns that may increase our costs and adversely affect our operations.

Various government agencies within the Department of Homeland Security (referred to in this prospectus as DHS), including the Transportation Security Administration, the U.S. Coast Guard, and U.S. Bureau of Customs and Border Protection, have adopted, and may adopt in the future, new rules, policies or regulations or changes in the interpretation or application of existing laws, rules, policies or regulations, compliance with which could increase our costs or result in loss of revenue.

The Coast Guard’s new maritime security regulations, issued pursuant to the Maritime Transportation Security Act of 2002 (MTSA), require us to operate our vessels and facilities pursuant to both the maritime security regulations and approved security plans. Our vessels and facilities are subject to periodic security compliance verification examinations by the Coast Guard. A failure to operate in accordance with the maritime security regulations or the approved security plans may result in the imposition of a fine or control and compliance measures, including the suspension or revocation of the security plan, thereby making the vessel or facility ineligible to operate. We are also required to audit these security plans on an annual basis and, if necessary, submit amendments to the Coast Guard for its review and approval. Failure to timely submit the necessary amendments may lead to the imposition of the fines and control and compliance measures mentioned above. Failure to meet the requirements of the maritime security regulations could have a material adverse effect on our results of operations. The Transportation Security Administration and the Coast Guard have issued proposed regulations to implement the so-called Transportation Worker Identification Credential (TWIC) program. The proposed TWIC program would establish minimum standards for the issuance of biometric identification cards to all individuals who require unescorted access to secure areas of port facilities or to vessels regulated under MTSA. It is anticipated that the TWIC program could be implemented as early as the end of 2006. The costs of implementing the TWIC program could be substantial and therefore could adversely affect our results of operations.

DHS may adopt additional security-related regulations, including new requirements for screening of cargo and our reimbursement to the agency for the cost of security services. These new security-related regulations could have an adverse impact on our ability to efficiently process cargo or could increase our costs. In particular, our customers typically need quick shipping of their cargos and rely on our on-time shipping capabilities. If these regulations disrupt or impede the timing of our shipments, we may fail to meet the needs of our customers, or may increase expenses to do so.

 

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Increased inspection procedures and tighter import and export controls could increase costs and disrupt our business.

Domestic and international container shipping is subject to various security and customs inspection and related procedures, referred to herein as inspection procedures, in countries of origin and destination as well as in countries in which transshipment points are located. Inspection procedures can result in the seizure of containers or their contents, delays in the loading, offloading, transshipment or delivery of containers and the levying of customs duties, fines or other penalties against exporters or importers (and, in some cases, shipping and logistics companies such as us). Failure to comply with these procedures may result in the imposition of fines and/or the taking of control or compliance measures by the applicable governmental agency, including the denial of entry into U.S. waters.

We understand that, currently, only a small proportion of all containers delivered to the United States are physically inspected by U.S., state or local authorities prior to delivery to their destinations. The U.S. government, foreign governments, international organizations, and industry associations have been considering ways to improve and expand inspection procedures. There are numerous proposals to enhance the existing inspection procedures, which if implemented would likely affect shipping and logistics companies such as us. Such changes could impose additional financial and legal obligations on us, including additional responsibility for physically inspecting and recording the contents of containers we are shipping. In addition, changes to inspection procedures could impose additional costs and obligations on our customers and may, in certain cases, render the shipment of certain types of cargo by container uneconomical or impractical. Any such changes or developments may have a material adverse effect on our business, financial condition and results of operations.

Restrictions on foreign ownership of our vessels could limit our ability to sell off any portion of our business or result in the forfeiture of our vessels.

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. The Jones Act, therefore, restricts the foreign ownership interests in the entities that directly or indirectly own the vessels which we operate in the non-contiguous Jones Act markets. If we were to seek to sell any portion of our business that owns any of these vessels, we would have fewer potential purchasers, since some potential purchasers might be unable or unwilling to satisfy the foreign ownership restrictions described above. As a result, the sales price for that portion of our business may not attain the amount that could be obtained in an unregulated market. Furthermore, at any point Horizon Lines ceases to be controlled and 75% owned by U.S. citizens, we would become ineligible to operate in our current markets and may become subject to penalties and risk forfeiture of our vessels.

No assurance can be given that our insurance costs will not escalate.

Our protection and indemnity insurance, referred to as P&I, is provided by a mutual P&I club which is a member of the International Group of P&I Clubs. As a mutual club, it relies on member premiums, investment reserves and income, and reinsurance to manage liability risks on behalf of its members. Increased investment losses, underwriting losses, or reinsurance costs could cause international marine insurance clubs to substantially raise the cost of premiums, resulting not only in higher premium costs but also higher levels of deductibles and self-insurance retentions.

 

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Catastrophic losses and other liabilities could adversely affect our results of operations and such losses and liability may be beyond insurance coverage.

The operation of any oceangoing vessel carries with it an inherent risk of catastrophic maritime disaster, mechanical failure, collision, and loss of or damage to cargo. Also, in the course of the operation of our vessels, marine disasters, such as oil spills and other environmental mishaps, cargo loss or damage, and business interruption due to political or other developments, as well as maritime disasters not involving us, labor disputes, strikes and adverse weather conditions, could result in loss of revenue, liabilities or increased costs, personal injury, loss of life, severe damage to and destruction of property and equipment, pollution or environmental damage and suspension of operations. Damage arising from such occurrences may result in lawsuits asserting large claims.

Although we maintain insurance, including retentions and deductibles, at levels that we believe are consistent with industry norms against the risks described above, including loss of life, there can be no assurance that this insurance would be sufficient to cover the cost of damages suffered by us from the occurrence of all of the risks described above or the loss of income resulting from one or more of our vessels being removed from operation. We also cannot assure you that a claim will be paid or that we will be able to obtain insurance at commercially reasonable rates in the future. Further, if we are negligent or otherwise responsible in connection with any such event, our insurance may not cover our claim.

In the event that any of the claims arising from any of the foregoing possible events were assessed against us, all of our assets could be subject to attachment and other judicial process.

As a result of the significant insurance losses incurred in the September 11, 2001 attack and related concern regarding terrorist attacks, global insurance markets increased premiums and reduced or restricted coverage for terrorist losses generally. Accordingly, premiums payable for terrorist coverage have increased substantially and the level of terrorist coverage has been significantly reduced.

Additionally, new and stricter environmental regulations have led to higher costs for insurance covering environmental damage or pollution, and new regulations could lead to similar increases or even make this type of insurance unavailable.

Our spare vessel reserved for relief may be inadequate under extreme circumstances.

We generally keep a spare vessel in reserve available for relief if one of our vessels in active service suffers a maritime disaster or must be unexpectedly removed from service for repairs. However, this spare vessel may require several days of sailing before it can replace the other vessel, resulting in service disruptions and loss of revenue. If more than one of our vessels in active service suffers a maritime disaster or must be unexpectedly removed from service, we may have to redeploy vessels from our other trade routes, or lease one or more vessels from third parties. As there is a relatively limited supply of U.S.-built, U.S.-owned and U.S.-flagged container vessels available for short- or long-term lease, especially on short notice, we may be unable to lease any such vessels or be faced with prohibitively high lease rates. In any such case, we may suffer a material adverse effect on our business, our operating results and our financial condition.

 

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Interruption or failure of our information technology and communications systems could impair our ability to effectively provide our shipping and logistics services, especially HITS, which could damage our reputation and harm our operating results.

Our provision of our shipping and logistics services depends on the continuing operation of our information technology and communications systems, especially HITS. We have experienced brief system failures in the past and may experience brief or substantial failures in the future. Any failure of our systems could result in interruptions in our service reducing our revenue and profits and damaging our brand. Some of our systems are not fully redundant, and our disaster recovery planning does not account for all eventualities. The occurrence of a natural disaster, or other unanticipated problems at our facilities at which we maintain and operate our systems could result in lengthy interruptions or delays in our shipping and logistics services, especially HITS.

Our vessels could be arrested by maritime claimants, which could result in significant loss of earnings and cash flow.

Crew members, suppliers of goods and services to a vessel, shippers of cargo, lenders and other parties may be entitled to a maritime lien against a vessel for unsatisfied debts, claims or damages. In many jurisdictions, a claimant may enforce its lien by either arresting or attaching a vessel through foreclosure proceedings. Moreover, crew members may place liens for unpaid wages that can include significant statutory penalty wages if the unpaid wages remain overdue (e.g., double wages for every day during which the unpaid wages remain overdue). The arrest or attachment of one or more of our vessels could result in a significant loss of earnings and cash flow for the period during which the arrest or attachment is continuing.

In addition, international vessel arrest conventions and certain national jurisdictions allow so-called sister-ship arrests, which allow the arrest of vessels that are within the same legal ownership as the vessel which is subject to the claim or lien. Certain jurisdictions go further, permitting not only the arrest of vessels within the same legal ownership, but also any associated vessel. In nations with these laws, an association may be recognized when two vessels are owned by companies controlled by the same party. Consequently, a claim may be asserted against us or any of our vessels for the liability of one or more of the other vessels that we own.

We are susceptible to severe weather and natural disasters.

Our operations are vulnerable to disruption as a result of weather and natural disasters such as bad weather at sea, hurricanes, typhoons and earthquakes. Such events will interfere with our ability to provide the on-time scheduled service our customers demand resulting in increased expenses and potential loss of business associated with such events. In addition, severe weather and natural disasters can result in interference with our terminal operations, and may cause serious damage to our vessels, loss or damage to containers, cargo and other equipment and loss of life or physical injury to our employees. Terminals in the South Pacific Ocean, particularly in Guam, and terminals on the east coast of the continental U.S. and in the Caribbean are particularly susceptible to hurricanes and typhoons. In the recent past, the terminal at our port in Guam was seriously damaged by a typhoon and our terminal in Puerto Rico was seriously damaged by a hurricane. These storms resulted in damage to cranes and other equipment and closure of these facilities. Earthquakes in Anchorage and in Guam have also damaged our terminal facilities resulting in delay in terminal operations and increased expenses. Any such damage will not be fully covered by insurance.

 

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We may face new competitors.

Other established or start-up shipping operators may enter our markets to compete with us for business.

Existing non-Jones Act qualified shipping operators whose container ships sail between ports in Asia and the U.S. West Coast could add Hawaii, Guam or Alaska as additional stops on their sailing routes for non-U.S. originated or destined cargo. Shipping operators could also add Puerto Rico as a new stop on sailings of their vessels between the continental U.S. and ports in Europe, the Caribbean, and Latin America for non-U.S. originated or destined cargo. Further, shipping operators could introduce U.S.-flagged vessels into service sailing between Guam and U.S. ports, including ports on the U.S. West Coast or in Hawaii. On these routes to and from Guam no limits would apply as to the origin or destination of the cargo dropped off or picked up. In addition, current or new U.S. citizen shipping operators may order the building of new vessels by U.S. shipyards and may introduce these U.S.-built vessels into Jones Act qualified service on one or more of our trade routes. These potential competitors may have access to financial resources substantially greater than our own. The entry of a new competitor on any of our trade routes could result in a significant increase in available shipping capacity that could have a material adverse effect on our business, financial condition, results of operations and cash flows.

In early 2005, Pasha Hawaii Transport Lines, a joint venture between The Pasha Group, a California-based automobile handling and logistics company, and Strong Vessel Operators LLC, a Connecticut-based operator of a U.S.-flagged ship on a trade route between the U.S. East Coast and the Azores, began a Jones Act qualified shipping service between Hawaii and San Diego, utilizing one roll-on/roll-off vessel. Pasha Hawaii has targeted newly manufactured vehicles, including Chrysler and Honda vehicles for shipment from the U.S. West Coast to Hawaii, privately-owned vehicles for shipment between the U.S. West Coast and Hawaii and larger, rolling-stock pieces, including tractors and military vehicles and equipment for shipment between the U.S. West Coast and Hawaii. Pasha Hawaii’s service has had some effect on us through the loss of some shipments of vehicles between the U.S. West Coast and Hawaii. We have also experienced downward rate pressure, resulting in eroding margins, with respect to these types of vehicle shipments.

Delayed delivery or non-delivery of one or more of the five new U.S.-flag container vessels or default under the agreements relating to them may adversely affect our operations and financial condition.

We have entered into a series of agreements with Ship Finance International Limited and certain of its subsidiaries, referred to herein collectively as SFL, with respect to our chartering of five new U.S.-flag container vessels that are currently under construction in the Republic of Korea.

If any of the new vessels are not constructed in accordance with their respective shipbuilding contracts, such vessel(s) could be properly declined under the terms of our agreements with SFL and we would be unable to charter such vessels.

If any of the new vessels are delivered later than contemplated under the shipbuilding contracts either due to construction delays or damage during construction, or if any of the new vessels is damaged during construction such that the vessel is a total loss, the implementation of our plans to phase the new vessels into our operations and to redeploy a number of our existing vessels would be delayed or prevented. If the delivery of any of the new vessels is delayed beyond a certain date, the commitment for the bank financing for SFL’s purchase of the

 

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vessels will expire with respect to any such vessel. In the absence of replacement financing, SFL would be unable to complete the purchase of any such vessel.

If, as a result of construction cost overruns or changes to the new vessels requested by us, the purchase price for any of the vessels exceeds the maximum allowable purchase price under our agreements with SFL, it may be necessary for us to agree to cover the excess cost in order for us to charter the vessels.

If SFL were to default on its contractual obligations with the sellers of the new vessels or the financial institutions providing financing for SFL’s purchase of the vessels, including the requirement for its equity portion of the purchase price of each vessel, or if those financial institutions were to default on their contractual obligations to fund the purchases, we would be deprived of the use of such vessels, and the implementation of our plans to phase such vessels into our operations and to redeploy a number of our existing vessels on other routes would be hindered or prevented.

In the event we default under our agreements with SFL, we could be liable to SFL and its lenders for losses resulting from our default. Such losses include reimbursement to SFL of its security deposits of cash in the amount of $11.0 million and letters of credit in the amount of $25.5 million, which could be forfeited to the sellers of the new vessels, interest rate swap breakage fees, and other actual damages arising from such a default. As collateral for our obligation to reimburse SFL in respect of its letters of credit and interest rate swap breakage fees, we have provided SFL with letters of credit in the aggregate amount of $29.3 million, which have been assigned to SFL’s lenders as collateral for its obligations to them. In the event of such a default, our letters of credit would be subject to being drawn, thereby adversely affecting our financial condition, and we could be liable for the above-described additional damages.

Horizon Lines has entered into the bareboat charters for the five new vessels based on their treatment as operating leases in order to comply with certain covenants in the senior credit facility. If the bareboat charters were to be deemed capital leases, such treatment may result in a default under certain covenants in the senior credit facility unless waived by the lenders thereunder.

We may not exercise our purchase options for our chartered vessels.

We intend to exercise our purchase options for up to three of the vessels that we have chartered upon the expiration of their charters in January 2015. We have not determined whether we will exercise our scheduled purchase options for the five newly built U.S.-flag vessels that we have agreed to charter, beginning in the fourth quarter of 2006. There can be no assurance that, when these options become exercisable, the price at which these vessels may be purchased will be reasonable in light of the fair market value of these vessels at such time or that we will have the funds required to make these purchases. As a result, we may not exercise our options to purchase these vessels. If we do not exercise our options, we may need to renew our existing charters for these vessels or charter replacement vessels. There can be no assurance that our existing charters will be renewed, or, if renewed, that they will be renewed at favorable rates, or, if not renewed, that we will be able to charter replacement vessels at favorable rates.

We may face significant costs as the vessels currently in our fleet age.

We believe that each of the vessels we currently operate has an estimated useful life of approximately 45 years from the year it was built. The average age of the vessels is approximately 30 years. We expect to expend increasing expenses to operate and maintain the

 

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vessels in good condition as they age. Eventually, these vessels will need to be replaced. While we have already agreed to charter five newly built U.S.-flag vessels, beginning the fourth quarter of 2006, we may not be able to replace all of our existing vessels with new vessels based on uncertainties related to financing, timing and shipyard availability.

We may face unexpected substantial drydocking costs for our vessels.

Our vessels are drydocked periodically for repairs and renewals. The cost of repairs and renewals at each drydocking are difficult to predict with certainty and can be substantial. Our established processes have enabled us to make on average six drydockings per year over the last five years with a minimal impact on schedule. In addition, our vessels may have to be drydocked in the event of accidents or other unforeseen damage. Our insurance may not cover all of these costs. Large unpredictable drydocking expenses could significantly decrease our profits.

Loss of our key management personnel could adversely affect our business.

Our future success will depend, in significant part, upon the continued services of Charles G. Raymond, our President and Chief Executive Officer, John W. Handy, our Executive Vice President, John V. Keenan, our Senior Vice President and Chief Transportation Officer, M. Mark Urbania, our Senior Vice President—Finance and Administration and Chief Financial Officer and Brian W. Taylor, Senior Vice President, Sales and Marketing, of Horizon Lines. The loss of the services of any of these executive officers could adversely affect our future operating results because of their experience and knowledge of our business and customer relationships. If key employees depart, we may have to incur significant costs to replace them and our ability to execute our business model could be impaired if we cannot replace them in a timely manner. We do not expect to maintain key person insurance on any of our executive officers.

We are subject to, and may in the future be subject to, disputes, or legal or other proceedings, that could have a material adverse effect on us.

The nature of our business exposes us to the potential for disputes, or legal or other proceedings, from time to time relating to labor and employment matters, personal injury and property damage, environmental matters and other matters, as discussed in the other risk factors disclosed in this prospectus. In addition, as a common carrier, our tariffs, rates, rules and practices in dealing with our customers are governed by extensive and complex foreign, federal, state and local regulations which are the subject of disputes or administrative and/or judicial proceedings from time to time. These disputes, individually or collectively, could harm our business by distracting our management from the operation of our business. If these disputes develop into proceedings, these proceedings, individually or collectively, could involve significant expenditures by us or result in significant changes to our tariffs, rates, rules and practices in dealing with our customers that could have a material adverse effect on our future revenue and profitability.

We are currently subject to two actions before the Surface Transportation Board, or STB. The first action, brought by the Government of Guam in 1998 on behalf of itself and its citizens against Horizon Lines and Matson Navigation Co., seeks a ruling from the STB that Horizon Lines’ Guam shipping rates during 1996-1998 were “unreasonable” under the ICC Termination Act of 1995, and an order awarding reparations to Guam and its citizens. The second action, brought by DHX, Inc., a freight forwarder, in 1999 against Horizon Lines and Matson, challenges the reasonableness of certain rates and practices of the defendants in the Hawaii trade. DHX is seeking $11.0 million in damages. An adverse decision in either of these actions could also affect the rates that Horizon Lines would be permitted to charge on its routes and could have a material adverse effect on our future revenue and profitability. No assurance can be given that

 

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the final decision of the STB with respect to either action will be favorable to us. For additional information concerning the two actions before the STB, see “Business—Legal Proceedings,” beginning on page 103 of this prospectus.

Integrating acquisitions may be time-consuming and create costs that could reduce our net income and cash flows.

Part of our growth strategy may include pursuing acquisitions. Any integration process may be complex and time-consuming, may be disruptive to our business and may cause an interruption of, or a distraction of our management’s attention from our business as a result of a number of obstacles, including but not limited to:

 

    the loss of key customers of the acquired company;

 

    the incurrence of unexpected expenses and working capital requirements;

 

    a failure of our due diligence process to identify significant issues or contingencies;

 

    difficulties assimilating the operations and personnel of the acquired company;

 

    difficulties effectively integrating the acquired technologies with our current technologies;

 

    our inability to retain key personnel of acquired entities;

 

    a failure to maintain the quality of customer service;

 

    our inability to achieve the financial and strategic goals for the acquired and combined businesses; and

 

    difficulty in maintaining internal controls, procedures and policies.

Any of the foregoing obstacles, or a combination of them, could negatively impact our net income and cash flows.

We have not completed any acquisitions to date. We may not be able to consummate acquisitions in the future on terms acceptable to us, or at all. In addition, future acquisitions are accompanied by the risk that the obligations and liabilities of an acquired company may not be adequately reflected in the historical financial statements of that company and the risk that those historical financial statements may be based on assumptions which are incorrect or inconsistent with our assumptions or approach to accounting policies. Any of such obligations, liabilities or incorrect or inconsistent assumptions could adversely impact our results of operations.

We may be exposed to potential risks resulting from new requirements that we evaluate our internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act.

Section 404 of the Sarbanes-Oxley Act requires that publicly reporting companies cause their managements to perform annual assessments of the effectiveness of their internal controls over financial reporting and their independent auditors to prepare reports that address such assessments. The issuer and all of its subsidiaries are required to satisfy the requirements of Section 404 for the fiscal year ended December 24, 2006. We may not be able to assess our current internal controls and comply with these requirements in due time. If we are able to proceed with a complete assessment in a timely manner, we may identify deficiencies which we may not be able to remediate, may identify deficiencies which will demand significant resources to remediate or may be unable to identify existing deficiencies at all. In addition, if we fail to achieve and maintain the adequacy of our internal controls, we may not be able to conclude on

 

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an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important to helping prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors could lose confidence in our reported financial information and the trading price of our common stock could drop significantly. Our compliance with the Sarbanes-Oxley Act may require significant expenses and management resources that would need to be diverted from our other operations and could require a restructuring of our internal financial reporting. Any such expenses, time reallocations or restructuring could have a material adverse effect on our operations. The applicability of the Sarbanes-Oxley Act to us could make it more difficult and more expensive for us to obtain director and officer liability insurance, and also make it more difficult for us to attract and retain qualified individuals to serve on our boards of directors (and, particularly, our audit committee), or to serve as executive officers.

Our cash flows and capital resources may be insufficient to make required payments on our substantial indebtedness and future indebtedness.

As of June 25, 2006, on a consolidated basis, we had (i) approximately $532.5 million of outstanding long-term debt (exclusive of outstanding letters of credit with an aggregate face amount of $37.2 million), including capital lease obligations, (ii) approximately $239.5 million of aggregate trade payables, accrued liabilities and other balance sheet liabilities (other than the long-term debt referred to above) and (iii) a debt-to-equity ratio of approximately 3.5:1.0.

Because we have substantial debt, we require significant amounts of cash to fund our debt service obligations. Our ability to generate cash to meet scheduled payments or to refinance our obligations with respect to our debt depends on our financial and operating performance which, in turn, is subject to prevailing economic and competitive conditions and to the following financial and business factors, some of which may be beyond our control:

 

    operating difficulties;

 

    increased operating costs;

 

    increased fuel costs;

 

    general economic conditions;

 

    decreased demand for our services;

 

    market cyclicality;

 

    tariff rates;

 

    prices for our services;

 

    the actions of competitors;

 

    regulatory developments; and

 

    delays in implementing strategic projects.

If our cash flow and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and might be forced to reduce or delay capital expenditures, dispose of material assets or operations, seek to obtain additional equity capital, or restructure or refinance our indebtedness. Such alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In particular, in the event that we are required to dispose of material assets or operations to meet our debt service

 

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obligations, we cannot be sure as to the timing of such dispositions or the proceeds that we would realize therefrom. The value realized from such dispositions will depend on market conditions and the availability of buyers, and, consequently, any such disposition may not, among other things, result in sufficient cash proceeds to repay our indebtedness. Also, the senior credit facility and the indentures governing the 9% senior notes due 2012, referred to herein as the 9% senior notes, and the 11% senior discount notes due 2013, referred to herein as the 11% senior discount notes, contain covenants that may limit our ability to dispose of material assets or operations or to restructure or refinance our indebtedness. Further, we cannot provide assurance that we will be able to restructure or refinance any of our indebtedness or obtain additional financing, given the uncertainty of prevailing market conditions from time to time, our high levels of indebtedness and the various debt incurrence restrictions imposed by the senior credit facility and the indentures for the 9% senior notes and the 11% senior discount notes. If we are able to restructure or refinance our indebtedness or obtain additional financing, the economic terms on which such indebtedness is restructured, refinanced or obtained may not be favorable to us.

We may incur substantial indebtedness in the future. The terms of the senior credit facility and the indentures governing the 9% senior notes and the 11% senior discount notes permit us to incur or guarantee additional indebtedness under certain circumstances. As of June 25, 2006, Horizon Lines Holding and Horizon Lines had approximately $12.8 million of additional borrowing availability under the revolving credit facility, subject to compliance with the financial and other covenants and the other terms set forth therein. Our incurrence of additional indebtedness would intensify the risk that our future cash flow and capital resources may not be sufficient for payments of interest on and principal of our substantial indebtedness.

Financial and other covenants under our current and future indebtedness could significantly impair our ability to operate our business.

The senior credit facility contains covenants that, among other things, restrict the ability of Horizon Lines Holding and its subsidiaries to:

 

    dispose of assets;

 

    incur additional indebtedness, including guarantees;

 

    prepay other indebtedness or amend other debt instruments;

 

    pay dividends or make investments, loans or advances;

 

    create liens on assets;

 

    enter into sale and lease-back transactions;

 

    engage in mergers, acquisitions or consolidations;

 

    change the business conducted by them; and

 

    engage in transactions with affiliates.

In addition, under the senior credit facility, Horizon Lines Holding and its subsidiaries are required to comply with financial covenants, comprised of leverage and interest coverage ratio requirements. Their ability to comply with these covenants will depend on their ongoing financial and operating performance, which in turn will be subject to economic conditions and to financial, market and competitive factors, many of which are beyond their control, and will be substantially dependent on our financial and operating performance which, in turn, is subject to

 

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prevailing economic and competitive conditions and to various financial and business factors, including those discussed in the other risk factors disclosed in this prospectus, some of which may be beyond our control.

Under the senior credit facility, Horizon Lines and Horizon Lines Holding are required, subject to certain exceptions, to make mandatory prepayments of amounts under the senior credit facility with all or a portion of the net proceeds of certain asset sales and events of loss, certain debt issuances, certain equity issuances and a portion of their excess cash flow. Our circumstances at the time of any such prepayment, particularly our liquidity and ability to access funds, cannot be anticipated at this time. Any such prepayment could, therefore, have a material adverse effect on us. Mandatory prepayments are first applied to the outstanding term loans and, after all of the term loans are paid in full, then applied to reduce the loans under the revolving credit facility with corresponding reductions in revolving credit facility commitments.

The indentures that govern the 9% senior notes and the 11% senior discount notes also contain restrictive covenants that, among other things, limit the ability of Horizon Lines Holding and its subsidiaries, in the case of the 9% senior notes, and H-Lines Finance Holding, in the case of the 11% senior discount notes, to:

 

    incur more debt;

 

    pay dividends, redeem stock or make other distributions;

 

    make investments;

 

    create liens;

 

    transfer or sell assets;

 

    merge or consolidate; and

 

    enter into transactions with our affiliates.

The senior credit facility and the indentures that govern the 9% senior notes and the 11% senior discount notes contain cross-default provisions that may result in nearly all of our indebtedness coming due simultaneously.

The breach of any of the covenants or restrictions contained in the senior credit facility could result in a default under the indenture governing the 9% senior notes that would permit the noteholders thereunder to declare all amounts outstanding under such indenture to be due and payable, together with accrued and unpaid interest, resulting in the acceleration of the amounts outstanding under the senior credit facility as well. Similarly, the breach of any of the covenants or restrictions contained in the indenture governing the 9% senior notes would permit the lenders under the senior credit facility to declare all amounts outstanding under such facility to be due and payable, together with accrued and unpaid interest, resulting in the acceleration of the amounts outstanding under such indenture. In the event of a breach of any of the covenants or restrictions contained in the senior credit facility or the indenture governing the 9% senior notes, the noteholders under the indenture governing the 11% senior discount notes would be permitted to declare all amounts outstanding under such indenture to be due and payable. If the indebtedness under the senior credit facility and the indentures governing the 9% senior notes and the 11% senior discount notes were all to be accelerated, the aggregate amount of indebtedness immediately due and payable as of June 25, 2006 would have been approximately $527.6 million. We do not have sufficient liquidity to repay this amount if all of such indebtedness were to be accelerated, and we may not have sufficient liquidity in the future and may not be able to borrow money from other lenders to enable us to refinance all of such indebtedness.

 

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Our substantial indebtedness and future indebtedness could significantly impair our operating and financial condition.

The required payments on our substantial indebtedness and future indebtedness, as well as the restrictive covenants contained in the senior credit facility and the indentures governing the 9% senior notes and the 11% senior discount notes, could significantly impair our operating and financial condition. For example, these required payments and restrictive covenants could:

 

    make it difficult for us to satisfy our debt obligations;

 

    make us more vulnerable to general adverse economic and industry conditions;

 

    limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions and other general corporate requirements;

 

    expose us to interest rate fluctuations because the interest rate on the debt under our revolving credit facility is variable;

 

    require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow for operations and other purposes;

 

    limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and

 

    place us at a competitive disadvantage compared to competitors that may have proportionately less debt.

We may incur substantial indebtedness in the future. Our incurrence of additional indebtedness would intensify the risks described above.

The senior credit facility exposes us to the variability of interest rates.

Horizon Lines Holding and Horizon Lines have outstanding a $245.6 million term loan, which bears interest at variable rates. Horizon Lines Holding and Horizon Lines also have a revolving credit facility which provides for borrowings of up to $50.0 million, which bears variable interest rates. The interest rates applicable to the senior credit facility vary with the prevailing corporate base rate offered by the administrative agent under the senior credit facility or with LIBOR. If these rates were to increase significantly, our ability to borrow additional funds may be reduced and the risks related to our substantial indebtedness would intensify. Each quarter point change in interest rates would result in a $0.6 million change in annual interest expense on the term loan. Accordingly, a significant rise in interest rates would adversely affect our financial results.

Risks Related to this Offering

Our stock price may be volatile, and you could lose all or part of your investment.

The following factors could cause the price of our common stock in the public market to fluctuate significantly:

 

    variations in our quarterly operating results;

 

    changes in market valuations of companies in our industry;

 

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    fluctuations in stock market prices and volumes;

 

    issuance of common stock or other securities in the future;

 

    the addition or departure of key personnel;

 

    announcements by us or our competitors of new business or trade routes, acquisitions or joint ventures; and

 

    the other factors discussed elsewhere in this prospectus.

Volatility in the market price of our common stock may prevent investors from being able to sell their common stock at or above the price an investor pays for our common stock on this offering. In the past, class action litigation has often been brought against companies following periods of volatility in the market price of those companies’ common stock. We may become involved in this type of litigation in the future. Litigation is often expensive and diverts management’s attention and company resources and could have a material effect on our business, financial condition and operating results.

Certain provisions of our charter documents and agreements and Delaware law could discourage, delay or prevent a merger or acquisition at a premium price.

Our certificate of incorporation and bylaws contain provisions that:

 

    permit us to issue, without any further vote or action by our stockholders, up to 25 million shares of preferred stock, excluding the Series A preferred stock (shares of which series are no longer issuable), in one or more series and, with respect to each series, to fix the number of shares constituting the series and the designation of the series, the voting powers (if any) of the shares of such series, and the preferences and other special rights, if any, and any qualifications, limitations or restrictions, of the shares of the series;

 

    limit the ability of stockholders to act by written consent or to call special meetings;

 

    establish a classified board of directors with staggered three-year terms;

 

    impose advance notice requirements for nominations for election to our board of directors and for stockholder proposals;

 

    limit to the incumbent members of our board the right to elect or appoint individuals to fill any newly created directorship on our board of directors that results from an increase in the number of directors (or any vacancy occurring on our board);

 

    limit the ability of stockholders who are non-U.S. citizens under applicable U.S. maritime laws to acquire significant ownership of, or significant voting power with respect to, shares of any class or series of our capital stock; and

 

    require the consent of 66 2/3% of the total voting power of all outstanding shares of stock to modify certain provisions of our certificate of incorporation.

The provisions listed above may discourage, delay or prevent a merger or acquisition at a premium price.

In addition, we are subject to Section 203 of the General Corporation Law of the State of Delaware, or the DGCL, which also imposes certain restrictions on mergers and other business combinations between us and any holder of 15% or more of our common stock. Further, certain of our future incentive plans may provide for vesting of shares of common stock and/or

 

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payments to be made to our employees in connection with a change of control, which could discourage, delay or prevent a merger or acquisition at a premium price.

If a substantial number of shares become available for sale and are sold in a short period of time, the market price of our common stock could decline.

If our existing stockholders sell substantial amounts of our common stock in the public market following this offering, the market price of our common stock could decrease significantly. The perception in the public market that our existing stockholders might sell shares of common stock could also depress our market price.

There are 33,614,170 shares of our common stock outstanding. All of the shares sold in this offering will be, and all of the shares sold in our Initial Public Offering were, freely tradable without restrictions or further registration under the Securities Act of 1933 as amended, except for shares purchased by our “affiliates” as defined in Rule 144 under the Securities Act. After giving effect to this offering, 7,326,670 shares are “restricted securities” as defined in Rule 144. These restricted securities may be sold in the future without registration under the Securities Act subject to an applicable holding period, volume limitations, manner of sale and notice requirements set forth in the applicable rules of the Securities and Exchange Commission. Subject to the provisions of Rules 144, 144(k) and 701 and, in some cases, subject to volume limitations, 6,304,345 shares of our common stock will be available for sale in the market under Rule 144 and 144(k) upon the consummation of this offering and an additional 952,325 shares of our common stock will become available for sale in the market within 90 days after the consummation of this offering. In addition, all but 70,000 of such restricted securities will, if these securities may not be sold pursuant to Rule 144 and 144(k), be subject to registration rights held by the pre-IPO stockholders under a registration rights agreement. These registration rights may, depending on the circumstances, enable these pre-IPO stockholders to sell these restricted securities under a registration statement filed under the Securities Act. For further information, see “Shares Eligible for Future Sale—Registration Rights,” beginning on page 148 of this prospectus.

The issuer and its executive officers and certain of its directors, and certain of its existing stockholders holding in the aggregate 6,578,940 shares of common stock, after giving effect to this offering, have entered into “lock-up agreements” with the underwriters whereby the issuer, these individuals and these stockholders have agreed to a “lock-up” period, meaning that such parties may not, subject to certain exceptions, issue (in the case of the issuer) or sell any of their shares of common stock without the prior written consent of Deutsche Bank Securities Inc. and J.P. Morgan Securities Inc. approximately 75 days after the date of this prospectus. Deutsche Bank Securities Inc. and J.P. Morgan Securities Inc. may, in their sole discretion, at any time or from time to time and without notice, waive the terms and conditions of these lock-up agreements. For further information, see “Underwriting,” beginning on page 161 of this prospectus.

Further, upon the consummation of this offering, all of our pre-IPO stockholders will cease to be subject to certain contractual restrictions on transfer of shares of our common stock, including rights of first offer and co-sale, set forth in a stockholders agreement. Upon the consummation of this offering, the stockholders agreement (except for the registration rights and indemnity provisions, which shall remain in full force and effect) will terminate in accordance with its terms. Consequently, 12,681,595 outstanding shares of our common stock, or 38% of our total outstanding common stock, after giving effect to this offering, will no longer be subject to contractual restrictions on transfer. For further information, see “Certain Relationships and Related Party Transactions” on page 135 of this prospectus.

 

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In addition, upon the consummation of this offering, all of our pre-IPO stockholders (other than the funds and accounts that are members of The Castle Harlan Group) will cease to be subject to a voting trust in favor of Mr. Castle under a voting trust agreement. Consequently, 5,732,041 shares of our outstanding common stock, or 17% of our outstanding common stock, after giving effect to this offering, shall cease to be subject to the provisions of the voting trust agreement and will be entitled to be voted by their record holders. For further information, see “Certain Relationships and Related Party Transactions” beginning on page 135 of this prospectus.

The market price for shares of our common stock may drop significantly when the restrictions on resale by our stockholders lapse under Rule 144 and lapse or are waived under the lock-up agreements, the stockholders agreement and the voting trust agreement, or in advance of (or in anticipation of) such lapse (or waiver). A decline in the price of shares of our common stock might impede our ability to raise capital through the issuance of additional shares of our common stock or other equity securities.

Our certificate of incorporation limits the ownership of common stock by individuals and entities that are not U.S. citizens. This may affect the liquidity of our common stock and may result in non-U.S. citizens being required to disgorge profits, sell their shares at a loss or relinquish their voting, dividend and distribution rights.

Under applicable U.S. maritime laws, at least 75% of the outstanding shares of each class or series of our capital stock must be owned and controlled by U.S. citizens within the meaning of such laws. Certain provisions of our certificate of incorporation are intended to facilitate compliance with this requirement and may have an adverse effect on holders of shares of the common stock issued and sold pursuant to this offering.

Under the provisions of our certificate of incorporation, any transfer, or attempted transfer, of any shares of our capital stock will be void if the effect of such transfer, or attempted transfer, would be to cause one or more non-U.S. citizens in the aggregate to own (of record or beneficially) shares of any class or series of our capital stock in excess of 19.9% of the outstanding shares of such class or series. However, in order for us to comply with the conditions to listing specified by the New York Stock Exchange, our certificate of incorporation provides that nothing therein, such as the foregoing restrictions regarding transfers, precludes the settlement of any transaction entered into through the facilities of the New York Stock Exchange or any other national securities exchange or automated inter-dealer quotation service so long as our stock is listed on the New York Stock Exchange. Therefore, to the extent such restrictions voiding transfers are effective, the liquidity or market value of the shares of common stock issued and sold pursuant to this offering may be adversely impacted.

In the event such restrictions voiding transfers would be ineffective for any reason, our certificate of incorporation provides that if any transfer would otherwise result in the number of shares of any class or series of our capital stock owned (of record or beneficially) by non-U.S. citizens being in excess of 19.9% of the outstanding shares of such class or series, such transfer will cause such excess shares to be automatically transferred to a trust for the exclusive benefit of one or more charitable beneficiaries that are U.S. citizens. The proposed transferee will have no rights in the shares transferred to the trust, and the trustee, who is a U.S. citizen chosen by us and unaffiliated with us or the proposed transferee, will have all voting, dividend and distribution rights associated with the shares held in the trust. The trustee will sell such excess shares to a U.S. citizen within 20 days of receiving notice from us and distribute to the proposed transferee the lesser of the price that the proposed transferee paid for such shares and the amount received from the sale, and any gain from the sale will be paid to the charitable beneficiary of the trust.

 

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These trust transfer provisions also apply to situations where ownership of a class or series of our capital stock by non-U.S. citizens in excess of 19.9% would be exceeded by a change in the status of a record or beneficial owner thereof from a U.S. citizen to a non-U.S. citizen, in which case such person will receive the lesser of the market price of the shares on the date of such status change and the amount received from the sale. In addition, our certificate of incorporation provides that if the issuance of shares of common stock in this offering would result in non-U.S. citizens owning (of record or beneficially) in excess of 19.9% of the outstanding shares of common stock, the excess shares shall be automatically transferred to a trust for disposal by a trustee in accordance with the trust transfer provisions described above. As part of the foregoing trust transfer provisions, the trustee will be deemed to have offered the excess shares in the trust to us at a price per share equal to the lesser of (i) the market price on the date we accept the offer and (ii) the price per share in the purported transfer or original issuance of shares, as described in the preceding paragraph, or the market price per share on the date of the status change, that resulted in the transfer to the trust.

As a result of the above trust transfer provisions, a proposed transferee (including a proposed transferee of shares in this offering) that is a non-U.S. citizen or a record or beneficial owner whose citizenship status change results in excess shares may not receive any return on its investment in shares it purportedly purchases or owns, as the case may be, and it may sustain a loss.

To the extent that the above trust transfer provisions would be ineffective for any reason, our certificate of incorporation provides that, if the percentage of the shares of any class or series of our capital stock owned (of record or beneficially) by non-U.S. citizens is known to us to be in excess of 19.9% for such class or series, we, in our sole discretion, shall be entitled to redeem all or any portion of such shares most recently acquired (as determined by our board of directors in accordance with guidelines that are set forth in our certificate of incorporation), including shares issued by us in this offering, by non-U.S. citizens, or owned (of record or beneficially) by non-U.S. citizens as a result of a change in citizenship status, in excess of such maximum permitted percentage for such class or series at a redemption price based on a fair market value formula that is set forth in our certificate of incorporation. Such excess shares shall not be accorded any voting, dividend or distribution rights until they have ceased to be excess shares, provided that they have not been already redeemed by us. As a result of these provisions, a stockholder who is a non-U.S. citizen may be required to sell its shares of common stock at an undesirable time or price and may not receive any return on its investment in such shares. Further, we may have to incur additional indebtedness, or use available cash (if any), to fund all or a portion of such redemption, in which case our financial condition may be materially weakened.

So that we may ensure our compliance with the applicable maritime laws, our certificate of incorporation permits us to require that any record or beneficial owner of any shares of our capital stock provide us from time to time with certain documentation concerning such owner’s citizenship and comply with certain requirements. These provisions include a requirement that every person acquiring, directly or indirectly, 5% or more of the shares of any class or series of our capital stock must provide us with specified citizenship documentation. In the event that a person does not submit such requested or required documentation to us, our certificate of incorporation provides us with certain remedies, including the suspension of the voting rights of such person’s shares of our capital stock and the payment of dividends and distributions with respect to those shares into an escrow account. As a result of non-compliance with these provisions, a record or beneficial owner of the shares of our common stock may lose significant rights associated with those shares.

 

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In addition to the risks described above, the foregoing foreign ownership restrictions could delay, defer or prevent a transaction or change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.

If non-U.S. citizens own more than 19.9% of our stock, we may not have the funds or the ability to redeem any excess shares and we could be forced to suspend our Jones Act operations.

Our certificate of incorporation contains provisions voiding transfers of shares of any class or series of our capital stock that would result in non-U.S. citizens, in the aggregate, owning in excess of 19.9% of the shares of such class or series. In the event that this transfer restriction would be ineffective, our certificate of incorporation provides for the automatic transfer of such excess shares to a trust specified therein. These trust provisions also apply to excess shares that would result from a change in the status of a record or beneficial owner of shares of our capital stock from a U.S. citizen to a non-U.S. citizen and to excess shares that would result from the issuance of shares of common stock in this offering. In the event that these trust transfer provisions would also be ineffective, our certificate of incorporation permits us to redeem such excess shares. However, we may not be able to redeem such excess shares because our operations may not have generated sufficient excess cash flow to fund such a redemption. If such a situation occurs, there is no guarantee that we will be able to obtain the funds necessary to effect such a redemption on terms satisfactory to us or at all. The terms of the senior credit facility under which two of our wholly-owned indirect subsidiaries, Horizon Lines Holding and Horizon Lines, are co-borrowers and their respective subsidiaries are guarantors, permit upstream payments from such subsidiaries, subject to exceptions, to us to fund redemptions of excess shares. However, the terms of the indentures of our subsidiaries governing the 9% senior notes and the 11% senior discount notes contain limitations on upstream payments which provide no specific exceptions to fund such redemptions of excess shares and any future indebtedness of our subsidiaries may contain similar limitations.

If, for any of the foregoing reasons or otherwise, we are unable to effect such a redemption when such ownership of shares by non-U.S. citizens is in excess of 25.0% of such class or series, or otherwise prevent non-U.S. citizens in the aggregate from owning shares in excess of 25.0% of any such class or series, or fail to exercise our redemption right because we are unaware that such ownership exceeds such percentage, we will likely be unable to comply with applicable maritime laws. If all of the citizenship-related safeguards in our certificate of incorporation fail at a time when ownership of shares of any class or series of our stock is in excess of 25.0% of such class or series, we will likely be required to suspend our Jones Act operations. Any such actions by governmental authorities would have a severely detrimental impact on our results of operations.

We may terminate our dividend payment policy.

We have adopted a dividend policy that reflects our intention to distribute a portion of the cash generated by our business in excess of operating needs, interest and principal payments on our indebtedness and capital expenditures as regular dividends to our stockholders. There can be no assurance, however, as to the amount and frequency of any such dividend or that a dividend will be paid at all or whether our dividend policy will be maintained. We have only a limited history of paying cash dividends on our common stock and we currently intend to retain a substantial portion of our future earnings, if any, to make payments of principal and interest on our substantial indebtedness and to fund the development and growth of our businesses. As a result, capital appreciation, if any, of our common stock may be your sole source of potential gain for the foreseeable future.

 

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We may not have the necessary funds to pay dividends on our common stock.

We will require continuing, significant cash flow in order for us to make payments of regular dividends to our stockholders in accordance with our dividend policy. However, we have no operations of our own and have derived, and will continue to derive, all of our revenues and cash flow from our subsidiaries. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to make funds available to us. They may not have sufficient funds or assets to permit payments to us in amounts sufficient to fund our anticipated dividend payments. Also, our subsidiaries are subject to contractual restrictions (including with their secured and unsecured creditors) that may limit their ability to upstream cash indirectly or directly to us. The senior credit facility under which two of our wholly-owned indirect subsidiaries, Horizon Lines Holding and Horizon Lines, are co-borrowers and their respective subsidiaries are guarantors, currently prohibits upstream payments to our direct wholly owned subsidiary H-Lines Finance, the direct parent of Horizon Lines Holding, if an event of default has occurred and is continuing, or would occur as a result of such upstream payments or if certain other conditions are not satisfied. In addition, the indenture governing the 9% senior notes co-issued by Horizon Lines Holding and Horizon Lines, and guaranteed by their respective subsidiaries, generally prohibits the upstreaming of funds by these co-issuers or their subsidiaries to H-Lines Finance, unless certain financial and other covenants specified therein are complied with after giving effect to such payment. The indenture governing the 11% senior discount notes issued by H-Lines Finance contains similar restrictions on the ability of H-Lines Finance to upstream to us any cash that it may receive or generate. Thus, there is a significant risk that we may not have the requisite funds to make the regular dividend payments contemplated by our the dividend policy.

Rising interest rates may adversely affect the market price of our common stock.

Because we have a dividend policy providing for the payment of regular dividends to our stockholders, interest rates may affect, at times significantly, the market price of our common stock. In general, as interest rates increase, the market price of our common stock could decline. Interest rates remain at moderate levels and, therefore, the value of our common stock may decline if interest rates rise in the future.

Our dividend policy may limit our ability to pursue growth opportunities.

Our dividend policy providing for the payment of regular dividends to our stockholders from our cash flow from our operations may significantly constrain our ability to finance any material expansion of our business or to fund our operations more than if we had retained such cash flow from our operations. In addition, our ability to pursue any material expansion of our business, including through acquisitions or increased capital spending, will depend more than it otherwise would on our ability to obtain third party financing. Such financing may not be available to us at an acceptable cost, or at all.

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This prospectus includes “forward-looking statements,” as defined by federal securities laws, with respect to our financial condition, results of operations and business. 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: our substantial debt; restrictive covenants under our debt; decreases in shipping volumes; our failure to renew our commercial agreements with Maersk; rising fuel prices; labor interruptions or strikes; job-related claims; liability under multi-employer pension plans; compliance with safety and environmental protection and other governmental requirements; new statutory and regulatory directives in the United States addressing homeland security concerns; the successful start-up of any Jones Act competitor; delayed delivery or non-delivery of our new vessels; increased inspection procedures and tight import and export controls; restrictions on foreign ownership of our vessels; repeal or substantial amendment of the Jones Act; escalation of insurance costs; catastrophic losses and other liabilities; the arrest of our vessels by maritime claimants; severe weather and natural disasters; our inability to exercise our purchase options for our chartered vessels; the aging of our vessels; unexpected substantial drydocking costs for our vessels; the loss of our key management personnel; actions by our significant stockholder; and legal or other proceedings to which we are or may become subject.

In light of these risks and uncertainties, expected results or other anticipated events or circumstances discussed in this prospectus might not occur. We undertake no obligation, and specifically decline any obligation, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

See the section entitled “Risk Factors,” beginning on page 14 of this prospectus, for a more complete discussion of these risks and uncertainties and for other risks and uncertainties. These factors and the other risk factors described in this prospectus 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.

TRADEMARKS AND SERVICE MARKS

We own or have rights to trademarks, service marks, copyrights and trade names that we use in conjunction with the operation of our business including, without limitation, Horizon Lines®.

 

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INDUSTRY AND MARKET DATA

Industry and market data used throughout this prospectus, including information relating to our relative position in the shipping and logistics industry are approximations based on the good faith estimates of our management, which are generally based on internal surveys and sources, and other publicly available information, including local port information. In addition, information relating to the Puerto Rico market is based on the good faith estimates of our management using data provided by Commonwealth Business Media, Inc., an independent service unaffiliated with any industry participants. Unless otherwise noted, financial data and industry and market data presented herein are for a period ending on March 25, 2006.

 

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USE OF PROCEEDS

All of the shares offered hereby are being offered by the selling stockholders. We will not receive any proceeds from this offering.

 

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PRICE RANGE OF COMMON STOCK

Our common stock trades on the New York Stock Exchange under the symbol “HRZ.” The following table sets forth the high and low sales price of our common stock on the New York Stock Exchange for the periods presented. Our common stock began trading on the New York Stock Exchange on September 27, 2005.

 

Period

   High    Low

2005

     

Fourth Quarter

   $ 12.99    $ 10.00

2006

     

First Quarter

   $ 13.32    $ 12.09

Second Quarter

   $ 16.02    $ 12.35

Third Quarter through August 31, 2006

   $ 16.79    $ 14.61

As of April 7, 2006, there were approximately 1,464 record holders of our common stock. On August 31, 2006, the last reported sales price of our common stock on the New York Stock Exchange was $15.93.

 

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DIVIDEND POLICY

In connection with the consummation of the Initial Public Offering, our board of directors adopted a dividend policy that reflects our intention to distribute, subject to legally available funds, a portion of the cash generated by our business in excess of operating needs, interest and principal payments on our indebtedness and capital expenditures as regular dividends to our stockholders. The aggregate annual amount of cash dividends on outstanding shares of common stock pursuant to this policy is $15.0 million (which is currently equal to $0.11 per share assuming quarterly cash dividends of equal amount based on the number of issued and outstanding shares of our common stock as of the date of this prospectus). As a result, we have a limited history of the payment of cash dividends. Since the consummation of the Initial Public Offering, we have paid cash dividends, totaling $11.1 million, to the holders of issued and outstanding shares of our common stock at the rate of $0.11 per share on each quarterly payment date.

The declaration of any future dividends and, if declared, the amount of any such dividends, will be subject to our actual future earnings, capital requirements, regulatory restrictions and to the discretion of our board of directors. Our board may take into account such matters as general business conditions, our financial results, our capital requirements, our debt service requirements, our contractual restrictions (including those imposed by our creditors), and our legal and regulatory restrictions on the payment of dividends by us to our stockholders, or by our subsidiaries to us, and such other factors as our board may deem relevant.

For a discussion of some of the risks and uncertainties associated with our adoption and maintenance of a dividend policy providing for the payment of regular dividend payments to our stockholders, and the risks and uncertainties associated with reliance thereon, see “Risk Factors—Risks Related to this Offering—We may terminate our dividend payment policy”, on page 33 of this prospectus, “—We may not have the necessary funds to pay dividends on our common stock,” on page 34, “—Rising interest rates may adversely affect the market price of our common stock,” on page 34, and “—Our dividend policy may limit our ability to pursue growth opportunities,” on page 34.

 

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CAPITALIZATION

The following table sets forth the capitalization, as of June 25, 2006, on a consolidated basis.

You should read this table together with the information in this prospectus under the captions “Use of Proceeds,” “Selected Consolidated and Combined Financial Data,” “Unaudited Pro Forma Condensed Consolidated Financial Statements,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Description of Capital Stock” and together with our consolidated and combined financial statements and related notes included elsewhere in this prospectus.

 

     June 25, 2006  
     ($ in thousands)  

Cash and cash equivalents

   $ 44,187  
        

Debt:

  

Term loan facility

   $ 245,625  

Revolving credit facility(1)

     —    

9% senior notes

     197,014  

11% senior discount notes

     84,925  

Notes from owner trustees

     4,513  

Capital lease obligation

     423  
        

Total debt

     532,500  
        

Stockholders’ equity:

  

Common stock, $.01 par value: 50,000,000 shares authorized, 33,614,170 shares issued and outstanding

     336  

Additional paid in capital

     179,753  

Accumulated other comprehensive loss

     (226 )

Retained deficit

     (26,852 )
        

Total stockholders’ equity

     153,011  
        

Total capitalization

   $ 685,511  
        

(1)   Horizon Lines Holding and its subsidiaries are parties to a $50.0 million revolving credit facility. At June 25, 2006, letters of credit with an aggregate face amount of $37.2 million were outstanding.

 

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UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following unaudited pro forma condensed consolidated financial statements have been derived by the application of pro forma adjustments to our historical consolidated financial statements and those of our predecessors. The unaudited pro forma condensed consolidated statement of operations for the year ended December 25, 2005 gives effect to the Initial Public Offering-Related Transactions as if they had occurred as of December 27, 2004. The unaudited pro forma financial statements do not purport to represent what our results of operations or financial position would have been if the Initial Public Offering-Related Transactions had occurred on the dates indicated and are not intended to project our results of operations or financial position for any future period or date. For an explanation of the Initial Public Offering-Related Transactions, see “Historical Transactions” beginning on page 129 of this prospectus.

The unaudited pro forma adjustments are based on available information and certain assumptions that we believe are reasonable. The pro forma adjustments and primary assumptions are described in the accompanying notes. Other information included under this heading has been presented to provide additional analysis.

The issuer was formed in connection with the Acquisition-Related Transactions and has no independent operations. Consequently, financial data for the period (or any portion thereof) from February 27, 2003 through July 6, 2004 reflect Horizon Lines Holding on a consolidated basis. Financial data for the period (or any portion thereof) from July 7, 2004 through June 25, 2006 reflect the issuer on a consolidated basis. All unaudited pro forma condensed financial data for each other period (or portion thereof) reflects Horizon Lines Holding on a combined and consolidated basis with the entities reflected in the combined and consolidated financial data from which such unaudited pro forma condensed financial data was derived.

You should read our unaudited pro forma condensed consolidated financial statements and the related notes hereto in conjunction with our historical consolidated and combined financial statements and the related notes thereto and other information contained in “Selected Consolidated and Combined Financial Data” on page 45 of this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 51 of this prospectus.

Certain prior period balances have been reclassified to conform with the current period presentations.

 

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Horizon Lines, Inc.

Unaudited Pro Forma Condensed Consolidated Statement of Operations

For the Year Ended December 25, 2005

($ in thousands, except share and per share amounts)

 

     Historical    

Initial Public

Offering-
Related
Transactions
Adjustments

    Pro Forma
Consolidated
 

Operating revenue

   $ 1,096,156     $ —       $ 1,096,156  

Operating expense

     867,307       —         867,307  

Depreciation and amortization

     51,141       —         51,141  

Amortization of vessel drydocking

     15,766       —         15,766  

Selling, general and administrative

     114,639       (30,394 )(1)     84,245  

Miscellaneous expense, net

     649       —         649  
                        

Total operating expense

     1,049,502       (30,394 )     1,019,108  

Operating income

     46,654       30,394       77,048  

Interest expense, net

     51,357       (8,780 )(2)     42,577  

Loss on early extinguishment of debt

     13,154       —         13,154  

Other expense, net

     26       —         26  
                        

Income (loss) before income taxes

     (17,883 )     39,174       21,291  

Income tax expense

     438       8,086 (3)     8,524  
                        

Net income (loss)

     (18,321 )     31,088       12,767  

Less: accretion of preferred stock

     5,073       (5,073 )(4)     —    
                        

Net income (loss) available to common stockholders

   $ (23,394 )   $ 36,161     $ 12,767  
                        

Net income (loss) per common share:

      

Basic

   $ (1.05 )     $ 0.38  

Diluted

   $ (1.05 )     $ 0.38  

Number of common shares:

      

Basic

     22,376,797         33,544,170 (5)

Diluted

     22,381,756         33,570,364 (5)

See accompanying Notes to Unaudited Pro Forma Condensed Consolidated Statements of Operations For the Year Ended December 25, 2005

 

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Horizon Lines, Inc.

Notes to Unaudited Pro Forma Condensed Consolidated Statement of Operations

For the Year Ended December 25, 2005

($ in thousands)

Initial Public Offering-Related Transactions Adjustments:

 

(1)   Adjustments reflect the following:

 

Elimination of management fees

   $ 9,698

Elimination of non-employee directors, stock compensation and executive restricted stock compensation

     18,953

Elimination of other transaction-related expenses

     1,743
      
   $ 30,394
      

 

(2)   Reflects the change in interest expense as a result of early payments of $53.0 million on the outstanding 9% senior notes and $43.2 million on the outstanding 11% senior discount notes. This adjustment also represents a change in interest expense attributable to a 0.25% reduction in the margin applicable to outstanding amounts under the senior secured term loan facility. These changes in interest expense are detailed below:

 

Reduction of interest expense on early payment of 9% senior notes

   $ 4,172

Reduction of interest expense on early payment of 11% senior discount notes

     3,793

Reduction of amortization of deferred finance costs

     350

Reduction of term loan interest expense from reduction of interest rate by 0.25%

     465
      

Total pro forma adjustment to interest expense

   $ 8,780
      

 

(3)   Reflects income tax expense based upon an effective tax rate of 20.6% on a pretax income, calculated as follows:

 

Adjustments to net income before income taxes

   $ 39,174  

Effective tax rate

     20.6 %
        

Pro forma income tax expense

   $ 8,086  
        

 

(4)   Represents the elimination of the accretion of the Series A preferred stock. As part of the Initial Public Offering-Related Transactions, $62.2 million of the proceeds of the Initial Public Offering were utilized to redeem our outstanding shares of Series A preferred stock.

 

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(5)   The following table provides a reconciliation between the number of common shares on a basic and diluted basis to give effect to the consummation of the Initial Public Offering—Related Transactions, as if, in each case, such transactions occurred as of December 27, 2004:

 

     For the year
ended
December 25,
2005

Reconciliation of number of common shares:

  

Basic-actual

   22,376,797

Adjustments:

  

Issuance of non-employee directors stock compensation and executive restricted stock compensation (a)

   104,476

Issuance of shares in conjunction with common stock offering as if issued on December 27, 2004 (b)

   9,557,760

Issuance of shares in conjunction with exercise of underwriter’s option as if issued on December 27, 2004 (c)

   1,505,137
    

Basic-pro forma

   33,544,170

Assumed exercise of employee stock options (d)

   26,194
    

Diluted-pro forma

   33,570,364
    

 

(a)   Represents incremental impact as if 1,854,671 restricted shares had been issued on December 27, 2004.

 

(b)   Represents incremental impact as if 12,500,000 common shares had been issued on December 27, 2004.

 

(c)   Represents incremental impact as if 1,875,000 common shares had been issued on December 27, 2004.

 

(d)   On September 27, 2005, the company granted nonqualified stock options under its equity incentive plan to members of management to purchase up to 705,100 shares in the aggregate of the company’s common stock at a price per share equal to the Initial Public Offering price per share.

 

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SELECTED CONSOLIDATED AND COMBINED FINANCIAL DATA

The selected consolidated and combined financial data should be read in conjunction with, and is qualified by reference to, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, beginning on page 51 of the prospectus, and our combined and consolidated financial statements and the related notes appearing elsewhere in this prospectus. The combined and consolidated statement of operations data for the periods from December 23, 2002 through February 26, 2003 and from February 27, 2003 through December 21, 2003 and the periods from December 22, 2003 through July 6, 2004 and from July 7, 2004 through December 26, 2004 and the consolidated balance sheet data as of December 25, 2005, December 26, 2004 are derived from our audited combined and consolidated financial statements appearing elsewhere in this prospectus. The combined statements of operations data for the years ended December 22, 2002 and December 23, 2001 and the combined balance sheet data as of December 23, 2001, and December 22, 2002 and December 21, 2003 are derived from our audited consolidated financial statements not appearing in this prospectus. The consolidated statement of operations data for the six months ended June 25, 2006 and June 26, 2005 and the consolidated balance sheet data as of June 25, 2006 and June 26, 2005 presented below have been derived from the unaudited financial statements contained in this prospectus. We have prepared the unaudited information on the same basis as the audited consolidated financial statements appearing elsewhere in this prospectus and have included, in our opinion, all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of the financial information set forth in those statements. The historical results are not necessarily indicative of the results to be expected in any future period.

The information for the twelve months ended December 21, 2003 and December 26, 2004 presented below has been combined to present more meaningful information on a comparative period basis. The combined and consolidated statement of operations data for the twelve months ended December 21, 2003 is derived by combining the statement of operations data for the period December 23, 2002 through February 26, 2003 with the data for the period from February 27, 2003 through December 21, 2003. The combined and consolidated statement of operations data for the twelve months ended December 26, 2004 is derived by combining the statement of operations data for the period December 22, 2003 through July 6, 2004 with the data for the period from July 7, 2004 through December 26, 2004. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—History and Transactions” on page 52 of this prospectus for a description of the transactions during the periods presented below that may impact period to period comparability of the data presented.

The company was formed in connection with the Acquisition-Related Transactions and has no independent operations. All financial data for the period (or any portion thereof) from December 27, 1999 through February 26, 2003 reflect the combined company CSX Lines, LLC and its wholly owned subsidiaries, CSX Lines of Puerto Rico, Inc., and the Domestic Liner Business of SL Service, Inc. (formerly known as Sea-Land Service, Inc.), all of which were stand-alone wholly owned entities of CSX Corporation. All financial data for the period (or any portion thereof) from February 27, 2003 through July 6, 2004 reflect Horizon Lines Holding on a consolidated basis. All financial data for the period (or any portion thereof) from July 7, 2004 through June 25, 2006 reflect the issuer on a consolidated basis.

Certain prior period balances have been reclassified to conform with the current period presentation.

 

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SELECTED CONSOLIDATED AND COMBINED FINANCIAL DATA—CONTINUED

 

     Predecessor B          Predecessor A                                
     Years Ended
December
 

Period from
December 23,
2002 through
February 26,

2003

        

Period from
February 27,
2003 through
December 21,

2003

 

Twelve
Months
Ended
December 21,

2003

 

Period from
December 22,
2003 through
July 6,

2004

     

Period from
July 7, 2004
through
  December 26,

2004

   

Twelve
Months

Ended
December 26,

2004

 

Year Ended
December 25,

2005

   

Six Months
Ended
June 26,
2005

   

Six Months
Ended
June 25,

2006

 
     2001     2002                      
     ($ in thousands, except share
and per share amounts)
      ($ in thousands, except share
and per share amounts)
 

Statement of Operations Data:

                                    

Operating revenue

  $ 714,653     $ 804,424   $ 138,411          $ 747,567   $ 885,978   $ 498,430     $ 481,898     $ 980,328   $ 1,096,156     $ 528,106     $ 564,781  

Operating expense

    597,770       658,053     121,862            596,369     718,231     402,875       377,468       780,343     867,307       422,469       444,347  

Depreciation and amortization

    23,502       17,977     3,053            26,901     29,954     20,937       24,633       45,570     51,141       25,441       25,095  

Amortization of vessel drydocking

    10,181       14,988     3,221            13,122     16,343     8,743       7,118       15,861     15,766       8,544       7,971  

Selling, general and administrative

    62,183       75,174     11,861            68,203     80,064     43,323       41,482       84,805     114,639       54,634       47,694  

Miscellaneous expense (income), net(1)

    (11,184 )     824     935            2,238     3,173     1,891       269       2,160     649       1,220       1,383  
                                                                                      

Total operating expenses

    682,452       767,016     140,932            706,833     847,765     477,769       450,970       928,739     1,049,502       512,308       526,490  
                                                                                      

Operating income (loss)

    32,201       37,408     (2,521 )          40,734     38,213     20,661       30,928       51,589     46,654       15,798       38,291  

Interest expense, net(2)

    3,774       1,908     421            8,519     8,940     5,111       21,770       26,881     51,357       26,238       24,024  

Interest expense—preferred units of subsidiary

    —         —       —              4,477     4,477     2,686       —         2,686     —         —         —    

Loss on early extinguishment of debt

    —         —       —              —       —       —         —         —       13,154       —         —    

Other expense, net

    183       42     68            —       68     7       15       22     26       1       (186 )
                                                                                      

Income (loss) before income taxes

    28,244       35,458     (3,010 )          27,738     24,728     12,857       9,143       22,000     (17,883 )     (10,441 )     14,453  

Income tax expense (benefit)

    9,816       13,707     (961 )          10,576     9,615     4,896       3,543       8,439     438       226       5,686  
                                                                                      

Net income (loss)

    18,428       21,751     (2,049 )          17,162     15,113     7,961       5,600       13,561     (18,321 )     (10,667 )     8,767  

Less: accretion of preferred stock

    —         —       —              —       —       —         6,756       6,756     5,073       3,122       —    
                                                                                      

Net income (loss) available to common stockholders

  $ 18,428     $ 21,751   $ (2,049 )        $ 17,162   $ 15,113   $ 7,961     $ (1,156 )   $ 6,805   $ (23,394 )   $ (13,789 )   $ 8,767  
                                                                                      

Net income (loss) per common share:

                                    

Basic

    *       *     *          $ 21.45     *   $ 9.95     $ (0.07 )     *   $ (1.05 )   $ (0.73 )   $ 0.26  

Diluted

    *       *     *          $ 19.57     *   $ 8.94     $ (0.07 )     *   $ (1.05 )   $ (0.73 )   $ 0.26  

Number of common shares used in calculation:

                                    

Basic

    *       *     *            800,000     *     800,000       15,585,322       *     22,376,797       18,912,639       33,544,170  

Diluted

    *       *     *            876,805     *     890,138       15,585,322       *     22,381,756       18,912,639       33,586,992  

Dividends declared per common share

    —         —       —              —       —       —         —         —     $ 0.11       —       $ 0.22  

* For periods ended February 26, 2003 and prior, owners’ equity consisted of parent’s net investment, and thus no income (loss) per share has been calculated. The twelve months ended December 21, 2003 and December 26, 2004 are derived by combining data from different entities and thus no net income per share has been calculated.

 

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SELECTED CONSOLIDATED AND COMBINED FINANCIAL DATA—CONTINUED

 

    December 23,
2001
    December 22,
2002
  December 21,
2003
  December 26,
2004
  December 25,
2005
  June 26,
2005
  June 25,
2006
    ($ in thousands)

Balance Sheet Data:

             

Cash and cash equivalents

  $ 47,087     $ 40,342   $ 41,811   $ 56,766   $ 41,450   $ 61,440   $ 44,187

Working capital (deficit)

    (51,757 )     25,301     46,192     67,252     67,111     88,323     83,184

Total assets

    505,716       321,129     492,554     937,792     927,319     1,017,067     925,034

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

    132,128       —       165,417     610,201     527,905     615,049     529,821

Total debt, including capital lease obligations(2)

    153,330       —       165,570     612,862     530,575     617,710     532,500

Series A redeemable preferred stock(3)

    —         —       —       56,708     —       60,202     —  

Stockholders’ equity

    70,154       113,985     96,860     25,608     151,760     22,756     153,011

 

    Years Ended
December
   

Twelve
Months
Ended
December 21,

2003

   

Twelve
Months
Ended
December 26,

2004

    Year Ended
December 25,
2005
    Six
Months
Ended
June 26,
2005
    Six
Months
Ended
June 25,
2006
 
    2001     2002            
    ($ in thousands)  

Other Financial Data:

             

EBITDA(4)

  $ 65,701     $ 70,331     $ 84,442     $ 112,998     $ 100,381     $ 49,782     $ 71,543  

Capital expenditures(5)

    10,637       19,298       35,150       32,889       41,234       2,217       7,218  

Vessel drydocking payments

    13,900       15,905       16,536       12,273       16,038       9,991       12,129  

Cash flows provided by (used in):

             

Operating activities

    66,426       (1,840 )     44,048       69,869       70,881       8,395       19,391  

Investing activities(6)

    (5,364 )     (4,905 )     (350,666 )     (694,563 )     (38,817 )     (1,804 )     (5,663 )

Financing activities(3)(6)

    (13,977 )     —         305,687       657,805       (47,380 )     (1,917 )     (10,991 )

Ratio of earnings to fixed charges(7)

    1.65x       2.05x       1.65x       1.35x       —         —         1.40x  

(1)   Miscellaneous expense (income), net generally consists of bad debt expense, accounts payable discounts taken, gain or loss on the sale of assets, and various other miscellaneous income and expense items. During 2001 we recorded bad debt expense of $(0.1) million in addition to $(11.1) million related to accounts payable discounts and accounting reserve adjustments. These accounting reserve adjustments were unusual in nature and primarily a result of changes in estimates.
(2)  

During 2001 and 2002 we incurred interest charges totaling $13.9 million and $7.1 million, respectively, on outstanding debt that had been borrowed in prior years to fund vessel construction costs of our Alaska D-7 vessels and equipment purchases. To fund principal and interest payments on this debt we held investments from which we earned interest income. Interest income from these investments, as well as other investments, totaled $10.2 million and $5.2 million during fiscal years ended 2001 and 2002, respectively. During the year ended December 22, 2002, substantially all of the $84.8 million of Collateralized Extendible Notes and $68.5 million of other long-term debt and capital lease obligations of the combined company CSX Lines LLC and its wholly-owned subsidiaries, CSX Lines of Puerto Rico, Inc. and the Domestic Liner Business of SL Service, Inc. were either repaid or assumed by CSX Corporation, resulting in no total debt outstanding as of December 22, 2002. During 2003 we incurred interest charges totaling $8.9 million on the outstanding debt borrowed to finance the February 27, 2003 purchase transaction, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 51 of this prospectus. Debt outstanding as of December 21, 2003 was repaid in connection with the Acquisition-Related Transactions. The period from February 27, 2003 through December 21, 2003 and the period from December 22, 2003 through July 6, 2004 include interest expense-preferred units of subsidiary of $4.5 million and $2.7 million, respectively. On July 7, 2004, as part of the Acquisition-Related Transactions, $250.0 million original principal amount of 9% senior notes were issued, $250.0 million was borrowed under the senior secured term loan facility, $6.0 million was borrowed under the revolving credit facility and interest began to accrue thereon. On December 10, 2004, 11% senior discount notes with an initial accreted value of $112.3 million were issued and the accreted value thereof began to increase. During the fourth quarter of 2005, utilizing proceeds from the Initial Public Offering, the company repurchased $53.0 million of the 9% senior notes and $43.2 million of

 

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SELECTED CONSOLIDATED AND COMBINED FINANCIAL DATA—CONTINUED

 

 

accreted value of the 11% senior discount notes, respectively. As of June 25, 2006, $197.0 million principal amount of 9% senior notes, $245.6 million of borrowing under the term loan facility, the 11% senior discount notes with an accreted value of $84.9 million, $4.5 million of notes issued by owner trustees, and capital lease obligations with a carrying value of $0.4 million were outstanding.

(3)   In connection with the financing of the Acquisition-Related Transactions, we issued and sold 8,391,180 shares of our Series A preferred stock in July 2004. No dividends accrued on these shares. We recorded these shares on our books and records at their fair value in accordance with FAS No. 141 “Business Combinations.” As these shares had no dividend rate, we determined that a 10% discount rate was appropriate. The issuer classified the value of these shares outside the equity section of the balance sheet. During October 2004, an additional 1,898,730 Series A preferred shares were issued and sold. During December 2004, 5,315,912 Series A preferred shares were redeemed for $53.2 million. During January 2005, we repurchased 53,520 Series A preferred shares with an aggregate stated value of $0.5 million. Also, during January 2005, we sold 45,416 Series A preferred shares and 130,051 common shares for $0.5 million. In connection with the Initial Public Offering, the issuer redeemed all shares of its non-voting $.01 par value Series A preferred stock for $62.2 million. During 2005, the company recorded $5.1 million of accretion of its Series A preferred stock.
(4)   EBITDA is defined as net income plus interest expense (net of interest income), income taxes, depreciation and amortization. We believe that GAAP-based financial information for highly leveraged businesses, such as ours, should be supplemented by EBITDA so that investors better understand our financial information in connection with their analysis of our business. The following demonstrates and forms the basis for such belief: (i) EBITDA is a component of the measure used by our board of directors and management team to evaluate our operating performance, (ii) the senior credit facility contains covenants that require Horizon Lines Holding and its subsidiaries to maintain certain interest expense coverage and leverage ratios, which contain EBITDA as a component, and restrict upstream cash payments if certain ratios are not met, subject to certain exclusions, and our management team uses EBITDA to monitor compliance with such covenants, (iii) EBITDA is a component of the measure used by our management team to make day-to-day operating decisions, (iv) EBITDA is a component 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 (v) the payment of discretionary bonuses to certain members of our management is contingent upon, among other things, the satisfaction by Horizon Lines of certain targets, which contain EBITDA as a component. We acknowledge that there are limitations when using EBITDA. EBITDA is not a recognized term under GAAP and does 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 is 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 may not be comparable to other similarly titled measures of other companies. A reconciliation of net income (loss) to EBITDA is included below:

 

    Years Ended
December
 

Twelve
Months
Ended
December 21,

2003

 

Twelve
Months
Ended
December 26,

2004

 

Year Ended
December 25,

2005

   

Six
Months
Ended
June 26,

2005

   

Six
Months
Ended
June 25,

2006

    2001   2002          
    ($ in thousands)

Net income (loss)

  $ 18,428   $ 21,751   $ 15,113   $ 13,561   $ (18,321 )   $ (10,667 )   $ 8,767

Interest expense, net

    3,774     1,908     13,417     29,567     51,357       26,238       24,024

Income tax expense

    9,816     13,707     9,615     8,439     438       226       5,686

Depreciation and amortization

    33,683     32,965     46,297     61,431     66,907       33,985       33,066
                                             

EBITDA

  $ 65,701   $ 70,331   $ 84,442   $ 112,998   $ 100,381     $ 49,782     $ 71,543
                                             

 

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SELECTED CONSOLIDATED AND COMBINED FINANCIAL DATA—CONTINUED

 

The EBITDA amounts presented above contain certain charges that are not anticipated to recur regularly in the ordinary course of business following the consummation of this offering, as described in the following table:

 

    Years Ended
December,
 

Twelve

Months
Ended
December 21,

2003

 

Twelve

Months
Ended
December 26,

2004

 

Year Ended
December 25,

2005

 

Six
Months

Ended

June 26,

2005

 

Six
Months

Ended
June 25,

2006

    2001     2002          
    ($ in thousands)

Merger related expenses(a)

  $ —       $ —     $   4,287   $ 2,934   $ 457   $ —     $   —  

Management fees(b)

    —         —       250     2,204     9,698     1,500     —  

Equipment lease—Maersk(c)

    (6,400 )     —       —       —       —       —       —  

Compensation charges(d)

    —         —       —       —       18,953     10,412     —  

Transaction Related Expenses

    —         —       —       —       1,743     189     858

Loss on extinguishment of debt

    —         —       —       —       13,154     —       —  

  (a)   As a result of the February 27, 2003 purchase transaction, we incurred $1.7 million of severance costs related to the departure of three of our executives, $0.8 million of expenses related to the renaming and rebranding of vessels and equipment with the Horizon Lines name, and $1.8 million in professional fees. Professional fees include legal fees related to the re-documentation of our vessels, registration of trademarks and other intellectual property, establishment of various employee benefit plans, and costs associated with moving our technology data center and establishing our financial system software license on a standalone basis. Adjustments also include legal fees incurred in connection with an arbitration case regarding trucking services provided to a third party in Long Beach, California. We incurred $2.9 million in expenses related to the Acquisition-Related Transactions on July 7, 2004.
  (b)   The adjustment represents management fees paid to Castle Harlan and to an entity that was associated with the party that was the primary stockholder of Horizon Lines Holding prior to the Acquisition-Related Transactions. Upon the completion of the Acquisition-Related Transactions, the company, Horizon Lines and Horizon Lines Holding entered into a new management agreement with Castle Harlan. On September 7, 2005, as a result of an amendment of such agreement and a related payment to Castle Harlan of $7.5 million under such amended agreement, the provisions of such agreement were terminated, except as to expense reimbursement and indemnification and related obligations of the company, Horizon Lines and Horizon Lines Holding. See “Certain Relationships and Related Party Transactions—Management Agreement” beginning on page 135 of this prospectus.
  (c)   The adjustment represents equipment lease income on container equipment leased to Maersk. This equipment was transferred to CSX Corporation in 2002 resulting in the elimination of this lease income after 2001.
  (d)   The adjustment represents non-cash stock-based compensation charges which we incurred during the year ended December 25, 2005 related to the issuance and sale of common stock, including restricted common stock, to non-employee directors and to members of management. All of these shares vested in full upon the consummation of the Initial Public Offering.
(5)   Includes the acquisition of the rights and beneficial interests of the sole owner-participant in two separate trusts, the assets of which consist of two vessels, for $25.2 million during the year ended December 25, 2005. Includes vessel purchases of $5.5 million, $21.9 million and $19.6 million for the years ended December 22, 2002, December 21, 2003, and December 26, 2004, respectively.
(6)  

During 2003, the amounts in cash flows provided by (used in) investing and financing activities primarily represent the accounting for the February 27, 2003 purchase transaction. Investing activities related to the February 27, 2003 purchase transaction included the purchase price of $296.2 million and spending for transaction costs of $18.8 million. Financing activities related to the February 27, 2003 purchase transaction included the initial capitalization of $80.0 million and borrowings under the term loan facility of $175.0 million and the issuance of preferred and common units to CSX Corporation and its affiliates with an aggregate original cost totaling $60.0 million. During 2004, the amounts in cash flows provided by (used in) investing primarily represent the accounting for the Acquisition-Related Transactions and financing activities primarily represent the accounting for the Acquisition-Related Transactions and subsequent financing transactions, which are described in “Historical Transactions” on page 129. Investing activities related to the Acquisition-Related Transactions included the acquisition consideration and spending for transaction costs of $663.3 million. Financing activities related to the Acquisition-Related Transactions included a capital contribution of $87.0 million, the issuance of the 13% promissory notes, in the aggregate original principal amount of $70.0 million, $250.0 million borrowed under the term loan facility, $6.0 million borrowed under the revolving credit facility, and the issuance of the 9% senior notes in the aggregate original principal amount of $250.0 million. Subsequent financing transactions included the issuance of common shares and Series A preferred shares for gross proceeds of $20.7 million, and the repayment of $20.0 million of the outstanding principal amount of the 13% promissory notes, plus accrued interest of $0.7 million thereon, the

 

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SELECTED CONSOLIDATED AND COMBINED FINANCIAL DATA—CONTINUED

 

 

issuance of $160.0 million in aggregate principal amount at maturity of 11% senior discount notes, the repayment of $52.9 million of the outstanding principal amount, together with accrued but unpaid interest thereon, of the 13% promissory notes, and the repurchase of a portion of the outstanding Series A preferred shares having an aggregate original stated value of $53.2 million. Financing activities during 2005 included the proceeds from the Initial Public Offering and the use of proceeds therefrom. The proceeds of $143.8 million and $40.0 million of cash generated from operations were used to redeem $62.2 million of the Series A preferred shares, $53.0 million principal amount of the 9% senior notes, $43.2 million in accreted value of the 11% senior discount notes, and to pay associated redemption premiums and related transaction expenses. Financing activities during the six months ended June 25, 2006 include dividends of $7.4 million to stockholders and are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financing Activities,” beginning on page 73.

(7)   For the purposes of calculating the ratio of earnings to fixed charges, earnings represent income before income taxes plus fixed charges. Fixed charges consist of interest expense, including amortization of net discount or premium and financing costs and the portion of operating rental expense (33%) which management believes is representative of the interest component of rent expense. For the year ended December 25, 2005, and the six months ended June 26, 2005, earnings were insufficient to cover fixed charges by $17.9 million and $10.4 million, respectively. The calculation of the ratio of earnings to fixed charges is noted below:

 

    Years Ended
December,
   

Twelve
Months
Ended
December 21,

2003

   

Twelve
Months
Ended
December 26,

2004

   

Year Ended
December 25,

2005

   

Six
Months
Ended
June
26,
2005

   

Six
Months
Ended
June
25,
2006

    2001     2002            
    ($ in thousands)

Pretax income (loss)

  $ 28,244     $ 35,458     $ 24,728     $ 22,000     $ (17,883 )   $ (10,441 )   $ 14,453

Interest expense

    13,924       7,133       13,593       29,829       53,057       29,689       24,737

Preferred stock accretion

    —         —         —         6,756       5,073       3,122       —  

Rentals

    29,412       26,674       26,662       26,193       24,530       12,562       11,759
                                                     

Total fixed charges

  $ 43,336     $ 33,807     $ 40,255     $ 62,778     $ 82,660     $ 45,373     $ 36,496
                                                     

Pretax earnings plus fixed charges

  $ 71,580     $ 69,265     $ 64,983     $ 84,778     $ 64,777     $ 34,932     $ 50,949

Ratio of earnings to fixed charges

    1.65 x     2.05 x     1.65 x     1.35 x     —         —         1.40x

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with Selected Consolidated and Combined Financial Data and our annual audited and quarterly unaudited consolidated and combined financial statements and related notes thereto included elsewhere in this prospectus. The following discussion includes forward-looking statements that involve certain risks and uncertainties. See “Cautionary Statement Regarding Forward-Looking Statements” on page 35 of this prospectus.

Executive Overview

 

     Six Months
Ended
June 25,
2006
    Six Months
Ended
June 26,
2005
    Year
Ended
December 25,
2005
    Twelve Months
Ended
December 26,
2004
    Twelve Months
Ended
December 21,
2003
 
     ($ in thousands)  

Operating revenue

   $ 564,781     $ 528,106     $ 1,096,156     $ 980,328     $ 885,978  

Operating expense

     526,490       512,308       1,049,502       928,739       847,765  
                                        

Operating income

   $ 38,291     $ 15,798     $ 46,654     $ 51,589     $ 38,213  
                                        

Operating ratio

     93.2 %     97.0 %     95.7 %     94.7 %     95.7 %

Revenue containers (units)

     147,205       153,025       307,895       308,485       289,360  

Operating revenue increased by $36.7 million or 6.9% from the six months ended June 26, 2005 to the six months ended June 25, 2006. This revenue growth is primarily attributable to rate improvements resulting from favorable changes in cargo mix and general rate increases, increased bunker and intermodal fuel surcharges, and revenue increases from non-transportation and other revenue services.

Operating expense increased by $14.2 million or 2.8% from the six months ended June 26, 2005 to the six months ended June 25, 2006, primarily as a result of higher vessel fuel costs and higher rail and truck transportation costs as a result of higher fuel prices, and an increase in rolling stock rent due to new container fleet leases. These increases are offset by a decrease in selling, general, and administrative expenses due to lower stock-based compensation charges, and a decrease in variable operating costs as a result of lower revenue container volumes shipped during the six months ended June 25, 2006 as compared to the six months ended June 26, 2005.

Operating income increased by $22.5 million or 142.4% from the six months ended June 26, 2005 to the six months ended June 25, 2006. This increase in operating income is primarily due to revenue growth in excess of operating expense growth as well as a reduction in selling, general, and administrative expenses due to lower stock-based compensation charges.

Operating revenue increased by $115.9 million or 11.8% from the twelve months ended December 26, 2004 to the year ended December 25, 2005. This revenue growth is primarily attributable to rate improvements resulting from favorable changes in cargo mix, general rate increases, increased bunker and intermodal fuel surcharges to help offset significant increases in fuel costs, and revenue increases from non-transportation and other revenue services. This revenue increase is offset slightly by lower container volumes due to 53 weeks in the twelve months ended December 26, 2004 compared to 52 weeks in the year ended December 25, 2005.

Operating expenses increased by $120.8 million or 13.0% from the twelve months ended December 26, 2004 to the year ended December 25, 2005. Factors contributing to the increase in

 

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operating expense include significant increases in vessel fuel expense and rail and truck transportation costs as a result of increases in fuel prices, and higher depreciation and amortization costs due to the purchase price accounting step-up in basis of customer contracts and trademarks related to the consummation on July 7, 2004 of the Acquisition-Related Transactions. Increases also include a $17.3 million increase in non-cash stock compensation charges as well as charges related to the Initial Public Offering which was completed in the fourth quarter of 2005. Charges associated with the Initial Public Offering include a $7.5 million charge related to the termination of the ongoing management services and related fee provisions of a management agreement with Castle Harlan among other items.

Operating income decreased by $4.9 million or 9.6% from the twelve months ended December 26, 2004 to the year ended December 25, 2005. This decrease in operating income can be attributed to an increase in non-cash stock compensation charges of $17.3 million and a $7.5 million charge related to the termination of the ongoing management services and related fee provisions of a management agreement with Castle Harlan during the year ended December 25, 2005.

Operating revenue increased by $94.3 million or 10.6% from the twelve months ended December 21, 2003 to the twelve months ended December 26, 2004. This revenue growth is primarily attributable to revenue container growth, mostly driven by market growth, in addition to increases in bunker and intermodal fuel surcharges to help offset increases in fuel costs, general rate increases, and increases from non-transportation and other revenue services.

Operating expense increased by $81.0 million or 9.6% from the twelve months ended December 21, 2003 to the twelve months ended December 26, 2004. This increase was due in part to the inclusion of 53 weeks in the twelve months ended December 26, 2004. Other factors contributing to this increase were higher total revenue container volume, increased charges from rail and truck service providers, and fuel price increases.

Operating income improved by $13.4 million or 35.0% from the twelve months ended December 21, 2003 to the twelve months ended December 26, 2004, generating an improvement in operating ratio from 95.7% during the twelve months ended December 21, 2003 to 94.7% during the twelve months ended December 26, 2004.

General

We believe that we are the nation’s leading Jones Act container shipping and integrated logistics company, accounting for approximately 36% of total U.S. marine container shipments from the continental U.S. to Alaska, Puerto Rico and Hawaii, constituting the three non-contiguous Jones Act markets, and to Guam. Under the Jones Act, all vessels transporting cargo between U.S. ports must, subject to limited exceptions, be built in the U.S., registered under the U.S. flag, manned by predominantly U.S. crews, and owned and operated by U.S.-organized companies that are controlled and 75% owned by U.S. citizens. We operate the largest Jones Act containership fleet with 16 vessels and approximately 23,900 cargo containers. We provide comprehensive shipping and 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 our seven ports in the continental U.S. and in our ports in Guam, Hong Kong and Taiwan.

History and Transactions

Our long operating history dates back to 1956, when Sea-Land Service, Inc. pioneered the marine container shipping industry and established our business. In 1958, we introduced

 

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container shipping to the Puerto Rico market and in 1964 we pioneered container shipping in Alaska with the first year-round scheduled vessel service. In 1987, we began providing container shipping services between the U.S. West Coast and Hawaii and Guam through our acquisition from an existing carrier of all of its vessels and certain other assets that were already serving that market. Today, as the only Jones Act vessel operator with an integrated organization serving Alaska, Puerto Rico, and Hawaii, we are uniquely positioned to serve our customers that require shipping and logistics services in more than one of these markets.

On February 27, 2003, Horizon Lines Holding (which at the time was indirectly majority-owned by Carlyle-Horizon Partners, L.P.) acquired from CSX Corporation (referred to herein as CSX), which was the successor to Sea-Land, 84.5% of CSX Lines, LLC (referred to herein as the Predecessor Company), and 100% of CSX Lines of Puerto Rico, Inc. (referred to herein as the Predecessor Puerto Rico Entity), which together constitute our business today. This transaction is referred to in this prospectus as the February 27, 2003 purchase transaction. CSX Lines, LLC is now known as Horizon Lines, LLC and CSX Lines of Puerto Rico, Inc. is now known as Horizon Lines of Puerto Rico, Inc.

Our current ownership and corporate structure relates to our acquisition of Horizon Lines Holding on July 7, 2004. The foregoing acquisition and related financing and other transactions, referred to in this prospectus collectively as the “Acquisition-Related Transactions,” included a merger, whereby Horizon Lines Holding became our direct wholly-owned subsidiary. We were formed at the direction of Castle Harlan, which provided a substantial portion of our equity financing and bridge financing in connection with the Acquisition-Related Transactions.

The consideration that was paid in the Acquisition-Related Transactions consisted of approximately $663.3 million in cash, net of purchase price adjustments, but including transaction costs. This amount was used to repay certain indebtedness of Horizon Lines Holding and its subsidiaries, to pay the equity holders of Horizon Lines Holding for their equity interests in Horizon Lines Holding, and to pay certain other equity holders for their minority equity interests in Horizon Lines, the principal operating subsidiary of Horizon Lines Holding.

In connection with the Acquisition-Related Transactions, Castle Harlan and its associates and affiliates invested approximately $157.0 million in the company, of which approximately $87.0 million was in the form of shares of common stock and Series A redeemable preferred shares, or Series A preferred shares of the company and $70.0 million was in the form of 13% promissory notes of the company, which were convertible into shares of common stock and Series A preferred shares. In addition, as part of the Acquisition-Related Transactions, management converted a portion of its equity interest in Horizon Lines Holding, valued at the time of the merger at approximately $13.0 million, into equity of the company.

On July 7, 2004, as part of the Acquisition-Related Transactions, H-Lines Subcorp., a wholly-owned subsidiary of the issuer, merged with and into Horizon Lines Holding, with the latter entity as the survivor of such merger. As a result, Horizon Lines Holding became a wholly-owned subsidiary of the issuer.

On September 30, 2005, we issued and sold 12,500,000 of our common stock in the Initial Public Offering, at a price of $10.00 per share, less the underwriters’ discount of 7% per share. On October 14, 2005, we issued and sold an additional 1,875,000 shares of our common stock to the underwriters of its Initial Public Offering at a price of $10.00 per share, representing the Initial Public Offering price to the public, less the underwriters discount of 7% per share. These additional shares were issued and sold pursuant to the exercise in full by the underwriters of their option to purchase additional shares from the company granted to

 

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them with respect to the Initial Public Offering. The company used the proceeds to repurchase certain indebtedness, pay related debt redemption premiums, redeem its outstanding preferred stock, and pay related transaction expenses. In conjunction with the consummation of the Initial Public Offering, on September 30, 2005, the margin applicable to the term loan facility decreased to 1.25% and 2.25% from 1.50% and 2.50%, for base rate loans and LIBOR loans respectively.

On June 16, 2006, we completed a secondary offering of 6,612,500 outstanding shares of our common stock, including 862,500 shares of our common stock pursuant to the exercise in full of the underwriters’ option to purchase additional shares that was granted in connection with the offering. We did not receive any proceeds from the sale of such stock.

Basis of Presentation

The issuer was formed in connection with the Acquisition-Related Transactions, and has no independent operations. Consequently, the accompanying consolidated financial statements include the consolidated accounts of the issuer as of June 25, 2006, December 25, 2005, June 26, 2005 and December 26, 2004 and for the period from December 26, 2005 through June 25, 2006, the year ended December 25, 2005 and from July 7, 2004 through December 26, 2004 and of Horizon Lines Holding for the periods from February 27, 2003 through December 21, 2003 and from December 22, 2003 through July 6, 2004. For dates prior to February 27, 2003, the combined financial statements include the accounts of the Predecessor Company and its wholly-owned subsidiaries, the Predecessor Puerto Rico Entity, and the Domestic Liner Business of SL Service, Inc. (formerly known as Sea-Land Service, Inc.), all of which were stand-alone wholly-owned entities of CSX.

The financial statements for periods prior to February 27, 2003 have been prepared using CSX’s basis in the assets and liabilities presented as of the dates specified therein and the historical results of operations for such periods. The financial statements for periods subsequent to February 26, 2003 but prior to July 7, 2004 have been prepared using Horizon Lines Holding’s basis in the assets and liabilities acquired in the February 27, 2003 purchase transaction, determined by applying the purchase method of accounting to such transaction, and the assets and liabilities so acquired were valued on Horizon Lines Holding’s books at Horizon Lines Holding’s assessment of their fair market value. The financial statements for periods subsequent to July 6, 2004 have been prepared using the basis of the issuer in the assets and liabilities deemed acquired by the issuer in the Acquisition-Related Transactions, determined by applying the purchase method of accounting to such transactions, and the assets and liabilities so acquired were valued on the issuer’s books at the issuer’s assessment of their fair market value. The consolidated financial information included in this prospectus may not necessarily reflect the consolidated financial position, operating results, changes in stockholders’ equity, and cash flows of the issuer in the future or what they would have been had we been a separate, stand-alone entity during the periods preceding February 27, 2003.

The information for the twelve months ended December 21, 2003 and December 26, 2004 discussed below represents the combined financial information for the appropriate pre-acquisition and post-acquisition periods to present more meaningful information on a comparative annual basis.

Certain prior period balances have been reclassified to conform with the current period presentation. This change reflects the reclassification of the purchase by Maersk, an

 

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international shipping company, and certain of our Jones Act competitors, of container space on our vessels to operating revenue from the prior classification thereof as an offset to operating expense. The effect of this reclassification on our operating revenue was an increase of $60.2 million and $54.3 million for the twelve months ended December 26, 2004 and December 21, 2003, respectively. For each of these twelve-month periods, the impact of this change was an increase in operating revenue and an increase of equal amount in operating expense.

Fiscal Year

We have a 52- or 53-week (every sixth or seventh year) fiscal year that ends on the Sunday before the last Friday in December. The fiscal year ended December 25, 2005 and the twelve months ended December 21, 2003 each consisted of 52 weeks. The twelve months ended December 26, 2004 consisted of 53 weeks.

Critical Accounting Policies

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions in the reported amounts of revenues and expenses during the reporting period and in reporting the amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of our financial statements. Since many of these estimates and assumptions are based on future events which cannot be determined with certainty, the actual results could differ from these estimates.

We believe that the application of our critical accounting policies, and the estimates and assumptions inherent in those policies, are reasonable. These accounting policies and estimates are constantly 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 our critical accounting policies during the six months ended June 25, 2006.

Revenue Recognition

We account for transportation revenue based upon method two under Emerging Issues Task Force No. 91-9 “Revenue and Expense Recognition for Freight Services in Process.” Under this method we record transportation revenue for the cargo when shipped and an expense accrual for the corresponding costs to complete delivery when the cargo first sails from its point of origin. We believe that this method of revenue recognition does not result in a material difference in reported net income on an annual or quarterly basis as compared to recording transportation revenue between accounting periods based upon the relative transit time within each respective period with expenses recognized as incurred.

Terminal and other service revenue and related costs of sales are recognized as services are performed.

Allowance for Credits and Doubtful Accounts

We record an allowance for doubtful accounts based upon a number of factors, including historical uncollectible amounts, ongoing credit evaluations of customers, customer markets and overall economic conditions. Historical trends are continually reviewed with adjustments

 

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made to the allowance for doubtful accounts as appropriate. If the financial condition of our customers were to deteriorate resulting in a perceived impairment of their ability to make payments, specific allowances might be taken. In addition, we maintain allowances for credits issued to customers, which are recorded as a reduction to revenue.

Casualty Claims

We purchase insurance coverage for a portion of our exposure related to certain employee injuries (workers’ compensation and compensation under the Longshore and Harbor Workers’ Compensation Act), vehicular and vessel collision, accidents and personal injury and cargo claims. Most insurance arrangements include a level of self-insurance (self-retention or deductible) applicable to each claim or vessel voyage, but provide an umbrella policy to limit our exposure to catastrophic claim costs. The amounts of self-insurance coverage change from time to time. Our current insurance coverage specifies that the self-insured limit on claims ranges from $2,500 to $1,000,000. Our safety and claims personnel work directly with representatives from our insurance companies to continually update the anticipated residual exposure for each claim. In establishing accruals and reserves for claims and insurance expenses, we evaluate and monitor each claim individually, and we use factors such as historical experience, known trends and third-party estimates to determine the appropriate reserves for potential liability. Changes in the perceived severity of previously reported claims, significant changes in medical costs and legislative changes affecting the administration of our plans could significantly impact the determination of appropriate reserves.

Goodwill, Purchase Costs and Other Identifiable Intangible Assets

Under SFAS No. 142 “Goodwill and Other Intangible Assets,” previously recorded goodwill and other intangible assets with indefinite lives are not amortized but are subject to annual undiscounted cash flow impairment tests. If there is an apparent impairment, a new fair value of the reporting unit would be determined. If the new fair value is less than the carrying amount, an impairment loss would be recognized.

Customer contracts and trademarks were valued on July 7, 2004, as part of the Acquisition-Related Transactions, by an independent third-party valuation company using the income appraisal methodology. The income appraisal methodology includes a determination of the present value of future monetary benefits to be derived from the anticipated income, or ownership, of the subject asset. The value of our customer contracts includes the value expected to be realized from existing contracts as well as from expected renewals of such contracts and is calculated using unweighted and weighted total undiscounted cash flows as part of the income appraisal methodology. The value of our trademarks and service marks is based on various factors including the strength of the trade or service name in terms of recognition and generation of pricing premiums and enhanced margins. We amortize customer contracts and trademarks and service marks on a straight-line method over the estimated useful life of eight to fifteen years. We evaluate these assets annually for potential impairment in accordance with SFAS No. 142.

Shipping Rates

We publish tariffs with fixed rates for all three of our Jones Act trade routes. These rates are subject to regulation by the STB. However, in the case of our Puerto Rico and Alaska trade routes, we primarily ship containers on the basis of confidential negotiated transportation service contracts that are not subject to rate regulation by the STB.

 

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Vessel Drydocking

Under U.S. Coast Guard Rules, administered through the American Bureau of Shipping’s alternative compliance program, all vessels must meet specified seaworthiness standards to remain in service carrying cargo between U.S. marine terminals. Vessels must undergo regular inspection, monitoring and maintenance, referred to as drydocking, to maintain the required operating certificates. These drydockings generally occur every two and a half years, or twice every five years. Because drydockings enable the vessel to continue operating in compliance with U.S. Coast Guard requirements, the costs of these scheduled drydockings are customarily deferred and amortized until the next regularly scheduled drydocking period.

We also take advantage of these vessel drydockings to perform normal repair and maintenance procedures on our vessels. These routine vessel maintenance and repair procedures are expensed as incurred. In addition, we will occasionally, during a vessel drydocking, replace vessel machinery or equipment and perform procedures that materially enhance capabilities or extend the useful life of a vessel. In these circumstances, the expenditures are capitalized and depreciated over the estimated useful lives.

Deferred Tax Assets

Deferred tax items represent expenses recognized for financial reporting purposes that may result in tax deductions in the future. Certain judgments, assumptions and estimates may affect the carrying value of the valuation allowance and income tax expense in the consolidated financial statements. We record an income tax valuation allowance when the realization of certain deferred tax assets, net operating losses and capital loss carryforwards is not likely.

Union Plans

We contribute to multiemployer health, welfare and pension plans for employees covered by collective bargaining agreements. The amounts of these contributions, absent a termination, withdrawal or determination by the Internal Revenue Service, are determined in accordance with these agreements. Our health and welfare plans provide health care and disability benefits to active employees and retirees. The pension plans provide defined benefits to retired participants. We recognize as net pension cost the required contribution for the applicable period and recognize as a liability any contributions due and unpaid. We contributed to such multiemployer plans $10.0 million for the year ended December 25, 2005, $10.2 million for the twelve months ended December 26, 2004, and $10.5 million for the year ended December 21, 2003.

We have a noncontributory pension plan that covered 27 union employees as of December 25, 2005. Costs of the plan are charged to current operations and consist of several components of net periodic pension cost based on various actuarial assumptions regarding future experience of the plans. In addition, certain other union employees are covered by plans provided by their respective union organizations. We expense amounts as paid in accordance with the applicable union agreements. Amounts recorded for the pension plan covering the 27 union employees reflect estimates related to future interest rates, investment returns and employee turnover. We review all assumptions and estimates on an ongoing basis. We record an additional minimum pension liability adjustment, when necessary, for the amount of underfunded accumulated pension obligations in excess of accrued pension costs.

Property and Equipment

We capitalize property and equipment as permitted or required by applicable accounting standards, including replacements and improvements when costs incurred for those purposes extend the useful life of the asset. We charge maintenance and repairs to expense as incurred.

 

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Depreciation on capital assets is computed using the straight-line method and ranges from 3 to 40 years. Our management makes assumptions regarding future conditions in determining estimated useful lives and potential salvage values. These assumptions impact the amount of depreciation expense recognized in the period and any gain or loss once the asset is disposed.

We evaluate each of our long-lived assets for impairment using undiscounted future cash flows relating to those assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When undiscounted future cash flows are not expected to be sufficient to recover the carrying amount of an asset, the asset is written down to its fair value.

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123R (revised 2004), “Share-Based Payments” (SFAS 123R), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and its interpretations, and amends SFAS No. 95 “Statement of Cash Flows.” FASB 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based upon their fair values beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation costs and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. The company adopted SFAS 123R in the fourth quarter of 2005 with respect to newly issued stock options.

In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” an interpretation of FASB Statement No. 109 (“FASB 109”), “Accounting for Income Taxes.” FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 applies to all tax positions related to income taxes subject to FASB 109. FIN 48 is effective for fiscal years beginning after December 15, 2006. Differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption should be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We do not believe that the adoption of FIN 48 will have a material impact on the consolidated financial statements.

Results of Operations

Operating Revenue Overview

We derive our revenue primarily from providing comprehensive shipping and logistics services to and from the continental U.S. and Alaska, Puerto Rico, Hawaii and Guam. We charge our customers on a per load basis and price our services based 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. At times, there is 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 insufficient recovery of our fuel costs during sharp hikes in the price of fuel and recoveries in excess of our fuel costs when fuel prices level off or decline.

 

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Over 90% of our revenues are generated from our shipping and logistics services in markets where the marine trade is subject to the Jones Act or other U.S. maritime laws. The balance of our revenue is derived from (i) vessel loading and unloading services that we provide for vessel operators at our terminals, (ii) agency services that we provide for third-party shippers lacking administrative presences in our markets, (iii) vessel space charter income from third parties in trade lanes not subject to the Jones Act, (iv) management of vessels owned by third parties, (v) trucking and warehousing services for third-parties, and (vi) other non-transportation services.

As used in this prospectus, the term “revenue containers” represents containers that are transported for a charge (as opposed to empty containers).

Operating Expense Overview

Our operating expenses consist primarily of marine operating costs, inland transportation costs, vessel operating costs, land costs and rolling stock rent. 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 vessel operating costs consist primarily of crew payroll costs and benefits, vessel fuel costs, 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 vessel fuel consumption has been generally constant for corresponding years or corresponding interim periods, since the number of active vessels, voyages and destinations have generally been the same for corresponding years or corresponding interim periods. 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.

Six Months Ended June 25, 2006 Compared with Six Months Ended June 26, 2005

 

     Six Months
Ended
June 25,
2006
    Six Months
Ended
June 26,
2005
    %
Change
 
     ($ in thousands)        

Operating revenue

   $ 564,781     $ 528,106     6.9 %

Operating expense:

      

Vessel

     160,429       144,433     11.1 %

Marine

     95,217       97,272     (2.1 )%

Inland

     97,591       90,429     7.9 %

Land

     68,206       68,905     (1.0 )%

Rolling stock rent

     22,904       21,430     6.9 %
                  

Operating expense

     444,347       422,469     5.2 %

Selling, general and administrative

     47,694       54,634     (12.7 )%

Depreciation and amortization

     25,095       25,441     (1.4 )%

Amortization of vessel drydocking

     7,971       8,544     (6.7 )%

Miscellaneous expense, net

     1,383       1,220     13.4 %
                  

Total operating expenses

     526,490       512,308     2.8 %
                  

Operating income

   $ 38,291     $ 15,798     142.4 %
                  

Operating ratio

     93.2 %     97.0 %   3.8 %

Revenue containers (units)

     147,205       153,025     (3.8 )%

 

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Operating Revenue. Operating revenue increased to $564.8 million for the six months ended June 25, 2006 compared to $528.1 million for the six months ended June 26, 2005, an increase of $36.7 million, or 6.9%. This revenue increase can be attributed to the following factors ($ in thousands):

 

Revenue container volume decrease

   $ (17,817 )

More favorable cargo mix and general rate increases

     22,326  

Bunker and intermodal fuel surcharges included in rates to offset rising fuel costs

     27,723  

Growth in other non-transportation services

     4,443  
        

Total operating revenue increase

   $ 36,675  
        

The decreased revenue due to revenue container volume declines for the six months ended June 25, 2006 compared to the six months ended June 26, 2005 is primarily due to overall soft market conditions in Puerto Rico as well as a strategic shift away from lower margin automobile cargo towards more refrigerated cargo and other higher margin freight. This revenue container volume decrease is offset by higher margin cargo mix in addition to general rate increases. Bunker and intermodal fuel surcharges, which are included in our transportation revenue, accounted for approximately 12% of total revenue in the six months ended June 25, 2006 and approximately 7% of total revenue in the six months ended June 26, 2005. We increased our bunker and intermodal fuel surcharges several times throughout 2005 and in the first six months of 2006 as a result of significant increases in the cost of fuel for our vessels in addition to fuel increases passed on to us by our truck, rail and barge carriers. 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 growth in other non-transportation services is primarily due to increases in terminal services provided to third parties and an increase in vessel space charter revenue not included in transportation revenue.

Operating Expense. Operating expense increased to $444.3 million for the six months ended June 25, 2006 compared to $422.5 million for the six months ended June 26, 2005, an increase of $21.9 million or 5.2%. The increase in operating expense primarily reflects the effect of rising fuel prices, offset by lower expenses associated with lower container volumes. Vessel expense, which is not primarily driven by revenue container volume, increased to $160.4 million for the six months ended June 25, 2006 from $144.4 million for the six months ended June 26, 2005, an increase of $16.0 million or 11.1%. This $16.0 million increase can be attributed to the following factors ($ in thousands):

 

Increased vessel fuel costs

   $ 20,858  

Reduction of vessel lease expense from vessel purchases

     (3,524 )

Labor and other vessel operating increases

     (1,338 )
        

Total vessel expense increase

   $ 15,996  
        

The $20.9 million increase in fuel costs is attributable to a 47.5% increase in fuel prices, slightly offset by lower fuel consumption primarily due to having one less vessel in service in Puerto Rico. In addition, vessel fuel costs were favorably impacted in the six months ended June 25, 2006 by delayed timing in deploying our spare vessel for service in Alaska. We typically deploy our spare vessel in our Alaska market during the busy summer months. The $1.3 million decrease in vessel operating costs is primarily due to having one less vessel in service in Puerto Rico during the six months ended June 25, 2006 offset by higher labor and other vessel operating increases.

 

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Marine expense is comprised of the costs incurred to bring vessels into and out of port, and to load and unload containers. The types of costs included in marine expense are stevedoring and benefits, pilotage fees, tug fees, government fees, wharfage fees, dockage fees, and line handler fees. Marine expense decreased to $95.2 million for the six months ended June 25, 2006 from $97.3 million for six months ended June 26, 2005, a decrease of $2.1 million or 2.1%. This decrease in marine expenses can be attributed to a 3.8% decrease in total revenue container volume period over period, offset by contractual labor cost increases.

Inland expense increased to $97.6 million for the six months ended June 25, 2006 from $90.4 million for the six months ended June 26, 2005, an increase of $7.2 million or 7.9%. Approximately $4.0 million of this increase is due to higher fuel costs, as rail, truck and barge carriers have substantially increased their fuel surcharges period over period. Horizon Lines intermodal agreement with CSX Intermodal, Inc. expired on February 28, 2006. On March 1, 2006, Horizon Lines entered into a similar agreement with CSX Intermodal, Inc. Although the company expects to require at least the same volume of services previously provided by CSX Intermodal, Inc, Horizon Lines has entered into agreements for services with multiple providers. As a result, the level of services provided directly by CSX Intermodal, Inc. is expected to decrease.

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. Land expense decreased to $68.2 million for the six months ended June 25, 2006 from $68.9 million for the six months ended June 26, 2005, a decrease of $0.7 million, or 1.0%. Non-vessel related maintenance expenses decreased by approximately $0.8 million for the six months ended June 25, 2006 from the six months ended June 26, 2005, primarily due to a decrease in maintenance expenses associated with the new refrigerated container equipment added to our fleet during 2005. Yard and gate expense is comprised of the costs associated with moving cargo into and out of the terminal facility and the costs associated with the storage of equipment and revenue loads in the terminal facility. Yard and gate expenses decreased approximately $0.2 million, or 1.8%, for the six months ended June 25, 2006 from the six months ended June 26, 2005, primarily due to decreased revenue container volumes. Warehouse expense decreased by $0.4 million, or 9.1%, for the six months ended June 25, 2006 from the six months ended June 26, 2005, primarily due to lower automobile volumes shipped.

 

     Six Months
Ended
June 25,
2006
  

Six Months

Ended
June 26,
2005

   %
Change
 
     ($ in thousands)       

Land expense:

        

Maintenance

   $ 26,443    $ 27,262    (3.0 )%

Terminal overhead

     24,616      23,857    3.2 %

Yard and gate

     13,166      13,406    (1.8 )%

Warehouse

     3,981      4,380    (9.1 )%
                

Total land expense

   $ 68,206    $ 68,905    (1.0 )%
                

During the quarter ended September 25, 2005 we acquired the rights and beneficial interests of the sole owner participant in two separate trusts, the assets of which consist primarily of the Horizon Enterprise and the Horizon Pacific, leading to a decrease in vessel lease expense of $3.5 million for the six months ended June 25, 2006 compared to the six months ended June 26, 2005. The decrease in vessel lease expense was partially offset by the resulting increase in depreciation and amortization from those acquired vessels.

 

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     Six Months
Ended
June 25,
2006
   Six Months
Ended
June 26,
2005
   %
Change
 
     ($ in thousands)       

Depreciation and amortization:

        

Depreciation—owned vessels

   $ 5,438    $ 4,392    23.8 %

Depreciation and amortization—other

     9,877      11,269    (12.4 )%

Amortization of intangible assets

     9,780      9,780    0.0 %
                

Total depreciation and amortization

   $ 25,095    $ 25,441    (1.4 )%
                

Amortization of vessel drydocking

   $ 7,971    $ 8,544    (6.7 )%
                

Depreciation and Amortization. Depreciation and amortization costs decreased to $25.1 million for the six months ended June 25, 2006 from $25.4 million for the six months ended June 26, 2005, a decrease of $0.3 million, or 1.4%. Depreciation of owned vessels increased by $1.0 million from the six months ended June 26, 2005 to the six months ended June 25, 2006. This increase is due to the acquisition of the rights and beneficial interest of the sole owner participant in two separate trusts, the assets of which consist primarily of the Horizon Enterprise and the Horizon Pacific in the third quarter of fiscal year 2005. The $1.4 million decrease in depreciation and amortization—other is primarily due to a decrease in the depreciation of containers, leasehold improvements, and capitalized software. The decrease in depreciation of containers is due to the sale of approximately 1,800 containers during the twelve-month period ended June 25, 2006. The decrease in leasehold improvements is due to the write-off of certain leasehold improvements made prior to the acquisition of the rights and beneficial interests in the aforementioned trusts in September 2005.

Amortization of Vessel Drydocking. Amortization of vessel drydocking decreased $0.6 million, or 6.7%, to $8.0 million for the six months ended June 25, 2006 from $8.5 million in the six months ended June 26, 2005 due to lower overall costs on recent drydockings.

Selling, General and Administrative. Selling, general and administrative costs decreased to $47.7 million for the six months ended June 25, 2006 compared to $54.6 million for the six months ended June 26, 2005, a decrease of $6.9 million or 12.7%. This decrease is comprised of a $10.0 million decrease in stock-based compensation expense, offset by approximately $0.9 million of fees incurred in connection with the Company’s June 2006 secondary offering, approximately $1.0 million in higher legal and professional fees, and $2.7 million of other expenses, including insurance and labor related expenses. The stock-based compensation charges in the 2005 period related to the restricted stock issued in January 2005. In addition, the six months ended June 26, 2005 included $1.5 million in expenses related to the fee provisions of a management agreement with Castle Harlan. Such fee provisions were terminated in conjunction with the Initial Public Offering in September 2005.

Miscellaneous Expense, Net. Miscellaneous expense increased to $1.4 million for the six months ended June 25, 2006 compared to $1.2 million for the six months ended June 26, 2005, an increase of $0.2 million, or 13.4%. This increase is primarily due to an increase in bad debt expense offset by an increase on the gain on the sale of fixed assets, primarily containers, during the six months ended June 25, 2006.

Interest Expense, Net. Interest expense decreased to $24.0 million for the six months ended June 25, 2006 compared to $26.2 million for the six months ended June 26, 2005, a decrease of $2.2 million, or 8.4%. This decrease is comprised of a $4.0 million decrease attributable to the redemption of $53.0 million of the principal amount of the 9% senior notes and $56.0 million principal amount of the 11% senior discount notes utilizing proceeds from the Initial Public Offering in September 2005. This decrease is offset by a $2.0 million increase in interest

 

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expense under our senior credit facility due to a 150 basis point increase in the LIBOR rate in the six months ended June 25, 2006 as compared to the six months ended June 26, 2005 and $0.2 million in interest expense related to our notes issued by the owner trustees of the owner trusts and which are secured by mortgages on the vessels owned by such trusts. In addition, interest income increased by approximately $0.4 million in the six months ended June 25, 2006 compared to the six months ended June 26, 2005.

Income tax expense. Income tax expense was $5.7 million and $0.2 million for the six months ended June 25, 2006 and June 26, 2005, respectively, which represent effective annual tax rates of 39.4% and (2.2%), respectively. The difference between the combined federal and state statutory tax rates and the overall effective tax rate during the six months ended June 26, 2005 is due to permanent differences relating from stock-based compensation.

Year Ended December 25, 2005 Compared With Twelve Months Ended December 26, 2004

 

     Year Ended
December 25,
2005
    Twelve Months
Ended
December 26,
2004
    %
Change
 
     ($ in thousands)        

Operating revenue

   $ 1,096,156     $ 980,328     11.8 %

Operating expense:

      

Vessel

     300,324       247,314     21.4 %

Marine

     195,279       190,554     2.5 %

Inland

     190,205       170,443     11.6 %

Land

     138,320       131,044     5.6 %

Rolling stock rent

     43,179       40,988     5.3 %
                  

Operating expense

     867,307       780,343     11.1 %
                  

Depreciation and amortization

     51,141       45,570     12.2 %

Amortization of vessel drydocking

     15,766       15,861     (0.6 )%

Selling, general and administrative

     114,639       84,805     35.2 %

Miscellaneous expense, net

     649       2,160     (70.0 )%
                  

Total operating expenses

     1,049,502       928,739     13.0 %
                  

Operating income

   $ 46,654     $ 51,589     (9.6 )%
                  

Operating ratio

     95.7 %     94.7 %   (1.0 )%

Revenue containers (units)

     307,895       308,435     (0.2 )%

Operating Revenue. Operating revenue increased to $1,096.2 million for the year ended December 25, 2005 from $980.3 million for the twelve months ended December 26, 2004, an increase of $115.8 million, or 11.8%. This revenue increase can be attributed to the following factors ($ in thousands):

 

Revenue container volume decrease

   $ (1,567 )

More favorable cargo mix and general rate increases

     42,345  

Bunker and intermodal fuel surcharges included in rates to offset rising fuel costs

     33,166  

Management contract to manage seven oceanographic vessels for the U.S. Government and management contract to manage two Ready Reserve Fleet vessels

     21,671  

Growth in other non-transportation services

     20,213  
        

Total operating revenue increase

   $ 115,828  
        

 

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The decreased revenue due to lower container volume for the year ended December 25, 2005 compared to the twelve months ended December 26, 2004 is primarily a result of a 52 week accounting year in 2005 compared to a 53 week accounting year in 2004 and a strategic shift away from lower margin automobile cargo towards more refrigerated cargo and other higher margin freight. This decreased volume was mostly offset by strong market demand for transportation services in the markets we serve, particularly in the Alaska market. Bunker and intermodal fuel surcharges, which are included in our transportation revenue, accounted for approximately 8% of total revenue in the year ended December 25, 2005 and approximately 6% of total revenue in the year ended December 26, 2004. We increased our bunker and intermodal fuel surcharges several times throughout 2005 as a result of significant increases in the cost of fuel for our vessels in addition to fuel increases passed on to us by our truck, rail, and barge carriers. 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 management contract to manage seven oceanographic vessels was awarded to us in the fourth quarter of the twelve month period ended December 26, 2004 and the management contract to manage two Ready Reserve Fleet vessels was awarded to us in the third quarter of fiscal year 2005. The growth in other non-transportation services includes increases in agency and terminal services provided to third parties, other ancillary services, and space charter revenue not included in transportation revenue.

Operating Expense. Operating expense increased to $867.3 million for the year ended December 25, 2005 from $780.3 million for the twelve months ended December 26, 2004, an increase of $87.0 million or 11.1%. The increase in operating expense primarily reflects the effect of rising fuel prices, increases in labor and other inflationary costs, and additional costs associated with the growth in our non-transportation and other revenue. Vessel expense, which is not primarily driven by revenue container volume, increased to $300.3 million for the year ended December 25, 2005 from $247.3 million for the twelve months ended December 26, 2004, an increase of $53.0 million or 21.4%. This $53.0 million increase can be attributed to the following factors ($ in thousands):

 

Increased vessel fuel costs

   $ 30,371  

Vessel operating costs from vessel management contracts

     20,465  

Reduction of vessel lease expense from vessel purchases

     (5,143 )

Vessel space purchases from other carriers

     2,164  

Labor and other vessel operating increases including operating the Horizon Fairbanks in Alaska during summer months

     5,153  
        

Total vessel expense increase

   $ 53,010  
        

Marine expense is comprised of the costs incurred to bring vessels into and out of port, and to load and unload containers. The types of costs included in marine expense are stevedoring and benefits, pilotage fees, tug fees, government fees, wharfage fees, dockage fees, and line handler fees. Marine expenses increased to $195.3 million for the year ended December 25, 2005 from $190.6 million for the twelve months ended December 26, 2004, an increase of $4.7 million or 2.5%. This increase can be attributed to contractual labor cost increases as expenses related to revenue container volumes were nearly flat from year to year.

Inland expense increased to $190.2 million for the year ended December 25, 2005 from $170.4 million for the twelve months ended December 26, 2004, an increase of $19.8 million or 11.6%. This increase is a result of a higher percentage of inland moves versus port to port moves performed for our revenue containers shipped, and a substantial increase in fuel surcharges passed onto us by rail, truck, and barge carriers, in addition to normal contractual labor increases.

 

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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. Land expense increased to $138.3 million for the year ended December 25, 2005 from $131.0 million for the twelve months ended December 26, 2004, an increase of $7.3 million or 5.6%. Higher non-vessel related maintenance expenses can primarily be attributed to higher fuel costs to power our refrigerated containers in addition to an increase in refrigerated cargo moves. Yard and gate expenses increased year over year due to additional grounding moves in our yards due to yard congestion and increased labor costs due to normal contractual rate increase. Warehouse expenses declined in 2005 as a result of lower automobile volumes shipped.

 

     Year Ended
December 25,
2005
   Twelve Months
Ended
December 26,
2004
   %
Change
 
     ($ in thousands)       

Land expense:

        

Maintenance

   $ 54,343    $ 52,236    4.0 %

Terminal overhead

     48,027      45,460    5.6 %

Yard and gate

     27,397      22,722    20.6 %

Warehouse

     8,553      10,626    (19.5 )%
                

Total land expense

   $ 138,320    $ 131,044    5.6 %
                

The purchase of two vessels in 2004, the Horizon Navigator and Horizon Trader, in addition to the acquisition in 2005 of the rights and beneficial interests of the sole owner participant in two separate trusts, the assets of which consist primarily of the Horizon Pacific and Horizon Enterprise, all of which were previously operated by us under operating leases led to a decrease in vessel lease expense of $5.1 million for the year ended December 25, 2005 compared to the twelve months ended December 26, 2004. The decrease in vessel lease expense was partially offset by the resulting increase in depreciation and amortization from those vessels.

 

     Year Ended
December 25,
2005
   Twelve Months
Ended
December 26,
2004
   %
Change
 
     ($ in thousands)       

Depreciation and amortization:

        

Depreciation—owned vessels

   $ 9,303    $ 8,060    15.4 %

Depreciation and amortization—other

     22,277      26,557    (16.1 )%

Amortization of intangible assets

     19,561      10,953    78.6 %
                

Total depreciation and amortization

   $ 51,141    $ 45,570    12.2 %
                

Amortization of vessel drydocking

   $ 15,766    $ 15,861    (0.6 )%
                

Depreciation and Amortization. Depreciation and amortization costs increased to $51.1 million for the year ended December 25, 2005 from $45.6 million for the twelve months ended December 26, 2004, an increase of $5.6 million or 12.2%. The increase in depreciation and amortization is primarily due to the purchase price accounting step-up in basis of customer contracts and trademarks related to the Acquisition-Related Transactions. Amortization costs related to customer contracts and trademarks increased by $8.6 million from the twelve months ended December 26, 2004 to the year ended December 25, 2005. Depreciation of owned vessels increased by $1.2 million, or 15.4%, as a result of purchasing vessels previously under operating leases. These increases were partially offset by a decrease in other depreciation and amortization, primarily due to a decrease in depreciation of vessel leasehold improvements.

 

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Amortization of Vessel Drydocking. Amortization of vessel drydocking remained relatively flat at $15.8 million for the year ended December 25, 2005 and the twelve months ended December 26, 2004.

Selling, General and Administrative. Selling, general and administrative costs increased to $114.6 million for the year ended December 25, 2005 from $84.8 million for the twelve months ended December 26, 2004, an increase of $29.8 million or 35.2%. Approximately $17.3 million of this year over year increase is a result of higher non-cash stock based compensation expense recorded in the year ended December 25, 2005. The termination of the fee provisions of a management agreement with Castle Harlan resulted in a $7.5 million increase in expense for the year ended December 25, 2005. The remaining increase in selling, general and administrative expenses can be attributed to expenses related to the Initial Public Offering, additional management bonus expense, higher professional fees, and labor and other inflationary increases.

Miscellaneous Expense, Net. Miscellaneous expense decreased to $0.6 million for the year ended December 25, 2005 from $2.2 million for the twelve months ended December 26, 2004, a decrease of $1.5 million or 70.0%. This reduction is primarily a result of lower bad debt expense recorded for the year ended December 25, 2005 in addition to recognized gains on the sale of equipment.

Interest Expense, Net. Interest expense increased to $51.4 million for the year ended December 25, 2005 from $26.9 million for the year ended December 26, 2004, an increase of $24.5 million or 91.1%. This increase can be attributable to the incurrence of approximately $410.0 million of additional debt in conjunction with the Acquisition-Related Transactions, the issuance of the 11% senior discount notes on December 10, 2004, and an increasing LIBOR rate throughout 2005 impacting our outstanding term debt. With a portion of the proceeds from the Initial Public Offering on September 30, 2005, the subsequent exercise on October 14, 2005, of the underwriters’ option to purchase additional shares from the company granted to them in connection with the Initial Public Offering and cash flows generated from operations, $40.0 million and $13.0 million of outstanding 9% senior notes and $52.3 million and $3.7 million of the original principal amount at maturity of the 11% senior discount notes were redeemed on November 2, 2005 and November 21, 2005, respectively.

Loss on Early Extinguishment of Debt. A $13.2 million loss on early extinguishment of debt was incurred during the year ended December 25, 2005 due to redemption premiums and the write-off of deferred financing costs associated with the early retirement of a portion of our 9% senior notes and 11% senior discount notes.

Interest Expense—Preferred Units of Subsidiary. Interest expense—preferred units of subsidiary decreased to $0.0 for the year ended December 25, 2005 from $2.7 million for the twelve months ended December 26, 2004. The preferred units were issued in conjunction with the closing of the February 27, 2003 purchase transaction and began accreting interest at 10%. The preferred units were redeemed in conjunction with the closing of the Acquisition-Related Transactions on July 7, 2004.

Income Tax Expense. Income tax expense was $0.4 million and $8.4 million for the year ended December 25, 2005 and for the twelve months ended December 26, 2004, respectively, which represent effective annual tax rates of (2.4)% and 38.4%, respectively. The difference between the combined Federal and state statutory tax rates and the overall effective tax rate for the year ended December 25, 2005 is related primarily to permanent differences resulting from stock-based compensation.

 

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Twelve Months Ended December 26, 2004 Compared with Twelve Months Ended December 21, 2003

 

     Twelve Months
Ended
December 26,
2004
    Twelve Months
Ended
December 21,
2003
    %
Change
 
     ($ in thousands)        

Operating revenue

   $ 980,328     $ 885,978     10.6 %

Operating expense:

      

Vessel

     247,314       236,025     4.8 %

Marine

     190,554       176,664     7.9 %

Inland

     170,443       147,626     15.5 %

Land

     131,044       116,835     12.2 %

Rolling stock rent

     40,988       41,081     (0.2 )%
                  

Operating expense

     780,343       718,231     8.6 %
                  

Depreciation and amortization

     45,570       29,954     52.1 %

Amortization of vessel drydocking

     15,861       16,343     (2.9 )%

Selling, general and administrative

     84,805       80,064     5.9 %

Miscellaneous expense

     2,160       3,173     (31.9 )%
                  

Total operating expenses

     928,739       847,765     9.6 %
                  

Operating income

   $ 51,589     $ 38,213     35.0 %
                  

Operating ratio

     94.7 %     95.7 %   1.0 %

Revenue containers (units)

     308,435       289,360     6.6 %

The twelve months ended December 26, 2004 consisted of 53 weeks. The twelve months ended December 21, 2003 consisted of 52 weeks.

Operating Revenue. Operating revenue increased to $980.3 million for the twelve months ended December 26, 2004 from $886.0 million for the twelve months ended December 21, 2003, an increase of $94.3 million or 10.6%. This revenue increase can be attributed to the following factors ($ in thousands):

 

Revenue container volume growth

   $ 53,351

More favorable cargo mix and general rate increases

     16,700

Bunker and intermodal fuel surcharges included in rates to offset rising fuel costs

     15,576

Growth in other non-transportation services

     8,723
      

Total operating revenue increase

   $ 94,350
      

The increase in revenue container volume growth is primarily a result of 53 weeks being included in the twelve months ended December 26, 2004 compared to 52 weeks being included in the twelve months ended December 21, 2003, in addition to increased demand for transportation services in our markets. Rate improvements from 2003 to 2004 are a result of general rate increases and mix improvements as a result of focusing less on lower rated automobile cargo and more towards refrigerated cargo and other higher margin freight. Bunker and intermodal fuel surcharges, which are included in our transportation revenue, accounted for approximately 6% of total revenue in the twelve months ended December 26, 2004 and approximately 5% of total revenue in the twelve months ended December 21, 2003. 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 growth in

 

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other non-transportation services includes increases in agency and terminal services provided to third parties, other ancillary services, and space charter revenue not included in transportation revenue.

Operating Expense. Operating expense increased to $780.3 million for the twelve months ended December 26, 2004 from $718.2 million for the twelve months ended December 21, 2003, an increase of $62.1 million or 8.6%. By contrast, operating revenue increased by 10.6%. The decrease in operating expense as a percentage of operating revenue is attributable to our continued ability to leverage our existing cost structure. The increase in operating expense from the twelve months ended December 21, 2003 to the twelve months ended December 26, 2004 primarily reflects the increase in revenue container volumes. Vessel expense, which is not primarily driven by revenue container volume, increased to $247.3 million for the twelve months ended December 26, 2004 from $236.0 million for the twelve months ended December 21, 2003, an increase of $11.3 million or 4.8%. Approximately $7.4 million of this increase in vessel expense is attributable to additional bunker fuel expenses with the remaining increase primarily a result of higher labor costs for our vessel crews.

Marine expense is comprised of the costs incurred to bring vessels into and out of port and to load and unload containers. The types of costs included in marine expense are stevedoring and benefits, pilotage fees, tug fees, government fees, wharfage fees, dockage fees, and line handler fees. Marine expenses increased to $190.6 million for the twelve months ended December 26, 2004 from $176.7 million for the twelve months ended December 21, 2003, an increase of $13.9 million or 7.9%. This increase is primarily a result of additional revenue container volume and contractual labor increases.

Land expense is comprised of the costs included within the terminal for the handling, maintenance and storage of containers, including yard and gate operations, maintenance, warehouse and terminal overhead. Land expense increased to $131.0 million for the twelve months ended December 26, 2004 from $116.8 million for the twelve months ended December 21, 2003, an increase of $14.2 million or 12.2%. This increase can be attributed to additional revenue container volume, higher non-vessel related maintenance expenses due to higher fuel costs to power our refrigerated containers, and normal contractual labor increases.

 

     Twelve Months
Ended
December 26,
2004
   Twelve Months
Ended
December 21,
2003
   %
Change
 
     ($ in thousands)       

Land expense:

        

Maintenance

   $ 52,236    $ 44,134    18.4 %

Terminal overhead

     45,460      40,665    11.8 %

Yard and gate

     22,722      22,085    2.9 %

Warehouse

     10,626      9,951    6.8 %
                

Total land expense

   $ 131,044    $ 116,835    12.2 %
                

 

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The purchase of four vessels in our fleet that we held under operating leases, namely the Horizon Hawaii in December 2003, the Horizon Fairbanks in January 2004, the Horizon Navigator in April 2004 and the Horizon Trader in October 2004, led to a decrease in vessel lease expense of $4.2 million for the twelve months ended December 26, 2004. This decrease in operating expense was partially offset by the resulting increase in depreciation and amortization.

 

     Twelve Months
Ended
December 26,
2004
   Twelve Months
Ended
December 21,
2003
   %
Change
 
     ($ in thousands)       

Depreciation and amortization:

        

Depreciation—owned vessels

   $ 8,060    $ 3,726    116.3 %

Depreciation and amortization—other

     26,557      23,578    12.6 %

Amortization of intangible assets

     10,953      2,650    313.3 %
                

Total depreciation and amortization

   $ 45,570    $ 29,954    52.1 %
                

Amortization of vessel drydocking

   $ 15,861    $ 16,343    (2.9 )%
                

Depreciation and Amortization. Depreciation and amortization increased to $45.6 million for the twelve months ended December 26, 2004 from $30.0 million for the twelve months ended December 21, 2003, an increase of $15.6 million or 52.1%. The increase in depreciation and amortization is largely due to the step-up in basis of customer contracts and trademarks related to the consummation of the Acquisition-Related Transactions on July 7, 2004. Amortization of customer contracts, trademarks and service marks increased by $8.3 million from the twelve months ended December 21, 2003 to the twelve months ended December 26, 2004. The acquisition of four vessels previously under operating leases and the step-up in basis of property and equipment from historical costs to fair market value after the closing of the Acquisition-Related Transactions on July 7, 2004 accounted for the remaining increase in depreciation and amortization.

Amortization of Vessel Drydocking. Amortization of vessel drydocking decreased to $15.9 million for the twelve months ended December 26, 2004 from $16.3 million for the twelve months ended December 21, 2003, a decrease of $0.5 million or 2.9%.

Selling, General and Administrative. Selling, general and administrative costs increased to $84.8 million for the twelve months ended December 26, 2004 compared to $80.1 million for the twelve months ended December 21, 2003, an increase of $4.7 million or 5.9%. Approximately $2.9 million of this increase is due to costs associated with the closing of the Acquisition-Related Transactions on July 7, 2004. Incentive-based compensation costs increased by $1.6 million and management fees charged by equity sponsors increased by $2.0 million for the twelve months ended December 26, 2004 from the twelve months ended December 21, 2003. We were able to reduce IT data center charges by $1.0 million for the twelve months ended December 26, 2004 from the twelve months ended December 21, 2003.

Miscellaneous Expense, Net. Miscellaneous expense decreased to $2.2 million for the twelve months ended December 26, 2004 from $3.2 million for the twelve months ended December 21, 2003, a decrease of $1.0 million or 31.9%. Miscellaneous expense primarily consists of bad debt expense, gain or loss on disposal of equipment, and accounts payable discounts. We were able to reduce bad debt charges by $0.5 million during the twelve months ended December 26, 2004 from the twelve months ended December 21, 2003.

Interest Expense, Net. Interest expense increased to $26.9 million for the twelve months ended December 26, 2004 from $9.0 million for the twelve months ended December 21, 2003, an

 

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increase of $17.9 million or 199.1%. The increase is due to the higher levels of outstanding debt during the twelve months ended December 26, 2004, as a result of the closing of the Acquisition-Related Transactions on July 7, 2004.

Interest Expense—Preferred Units of Subsidiary. Interest expense—preferred units of subsidiary totaled $2.7 million for the twelve months ended December 26, 2004. The preferred units were issued in conjunction with the closing of the February 27, 2003 purchase transaction and began accreting interest at 10%. The preferred units were redeemed in conjunction with the closing of the Acquisition-Related Transactions on July 7, 2004.

Income Tax Expense. Income taxes for the twelve months ended December 26, 2004 and December 21, 2003 totaled $8.4 million and $9.6 million, respectively, which represents effective annual tax rates of 38.4% and 38.9%, respectively. The differences between the federal statutory rates and the effective annual tax rates are primarily due to state income taxes.

Uncertainty Related to Renewal of Our Arrangements with Maersk

Our commercial agreements with Maersk, an international shipping company, encompass terminal services, equipment sharing, cargo space charters, sales agency services, and trucking services. These agreements generally are scheduled to expire at the end of 2007, but we believe that they will be extended through 2010. If we are unable to renew or extend these agreements or to enter into substitute agreements with third parties, or if we enter into substitute agreements with third parties on terms and conditions significantly less favorable to us than those of our existing agreements with Maersk, we may have to make changes to our operations, which may cause disruptions to our business, which could be significant, and may result in reduced revenue and in additional costs and expenses. See “Risk Factors—Risks Related to Our Business—Our failure to renew our commercial agreements with Maersk in the future could have a material adverse effect on our business,” beginning on page 14 of this prospectus.

Liquidity and Capital Resources

Our principal sources of funds have been earnings before non-cash charges, borrowings under debt arrangements, and equity capitalization. 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 drydocking expenditures, (iii) the purchase of vessels upon expiration of operating leases, (iv) working capital consumption, (v) principal and interest payments on our existing indebtedness, and (vi) dividend payments to our common stockholders. Cash and cash equivalents totaled $44.2 million at June 25, 2006. As of June 25, 2006, $12.8 million was available for borrowing by certain subsidiaries of the issuer under the existing $50.0 million revolving credit facility, after taking into account $37.2 million utilized for outstanding letters of credit.

 

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Operating Activities

 

    Six
Months
Ended
June 25,
2006
    Six
Months
Ended
June 26,
2005
    Year
Ended
December 25,
2005
    Twelve Months
Ended
December 26,
2004
    Twelve Months
Ended
December 21,
2003
 
    ($ in thousands)  

Cash flows provided by operating activities

         

Net income (loss)

  $ 8,767     $ (10,667 )   $ (18,321 )   $ 13,561     $ 15,113  

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

         

Depreciation

    15,314       15,660       31,580       34,572       27,308  

Amortization of other intangible assets

    9,781       9,781       19,561       10,998       2,646  

Amortization of vessel drydocking

    7,971       8,544       15,766       15,861       16,343  

Amortization of deferred financing costs

    1,596       1,677       3,363       1,853       438  

Loss on extinguishment of debt

    —         —         3,632       —         —    

Deferred income taxes

    5,220       226       (7,394 )     7,612       2,740  

Stock-based compensation

    384       10,412       19,052       1,765       —    

Tax benefit from exercise of stock options

    —         —         5,495       9,494       —    

Accretion of interest on 11% senior discount notes

    4,489       6,191       12,057       549       —    

Accretion of preferred units of subsidiary

    —         —         —         2,686       4,477  
                                       

Subtotal

    44,755       52,491       103,112       85,390       53,952  
                                       

Earnings adjusted for non-cash charges

    53,522       41,824       84,791       98,951       69,065  
                                       

Changes in operating assets and liabilities:

         

Accounts receivable

    (14,781 )     (16,980 )     (9,037 )     (5,045 )     11,689  

Materials and supplies

    1,613       (1,624 )     (5,309 )     (3,181 )     (1,250 )

Other current assets

    (766 )     1,422       9,846       (14,542 )     (1,913 )

Accounts payable

    980       (4,035 )     (2,907 )     (3,003 )     4,803  

Accrued liabilities

    (3,713 )     (1,135 )     3,470       12,927       (10,656 )

Other assets / liabilities

    (4,870 )     (972 )     (2,464 )     (3,849 )     (11,080 )
                                       

Subtotal

    (21,537 )     (23,324 )     (6,401 )     (16,693 )     (8,407 )
                                       

Gain on equipment disposals

    (465 )     (114 )     (993 )     (116 )     (74 )

Redemption premiums

    —         —         9,522       —         —    

Vessel drydocking payments

    (12,129 )     (9,991 )     (16,038 )     (12,273 )     (16,536 )
                                       

Net cash provided by operating activities

  $ 19,391     $ 8,395     $ 70,881     $ 69,869     $ 44,048  
                                       

Operating Activities

Net cash provided by operating activities increased by $11.0 million to $19.4 million for the six months ended June 25, 2006 compared to $8.4 million of net cash provided by operating activities for the six months ended June 26, 2005. This increase is primarily driven by improved

 

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profitability after non-cash charges. Net earnings adjusted for depreciation, amortization, deferred income taxes, accretion and other non-cash operating activities resulted in cash flow generation of $53.5 million for the six months ended June 25, 2006 compared to $41.8 million for the six months ended June 26, 2005. Changes in working capital resulted in a use of cash of $21.5 million for the six months ended June 25, 2006 compared to a use of cash of $23.3 million for the six months ended June 26, 2005. The accrued liabilities working capital use is primarily due to vessel lease payments and management bonus payments. $15.6 million and $15.8 million in vessel lease payments were made during the six months ended June 25, 2006 and June 26, 2005, respectively. Our vessel lease payments, which are made in January and July of each year, are not straight lined throughout the lease terms. In addition, we paid management bonuses of $8.7 million and $10.5 million in the six months ended June 25, 2006 and June 26, 2005, respectively. During the year, we accrue management bonuses based on our satisfaction of certain financial targets, and such bonuses are paid the first quarter of each year. The increase in accounts receivable balances in the first six months of 2006 and 2005 is due to seasonality within the business. The accounts receivable balance typically rises during the first three quarters of the year, and decreases to its lowest balance in the fourth quarter. The other assets/liabilities working capital use is primarily due to $3.0 million of costs associated with our contracted arrangements with SFL.

Net cash provided by operating activities increased by $1.0 million to $70.9 million for the year ended December 25, 2005 from $69.9 million of net cash provided by operating activities for the twelve months ended December 26, 2004. Net earnings adjusted for depreciation, amortization, deferred income taxes, accretion and other non-cash operating activities, which includes non-cash stock based compensation expense, resulted in cash flow generation of $84.8 million for the year ended December 25, 2005 compared to $99.0 million for the twelve months ended December 26, 2004, a decrease of $14.2 million. This decrease is primarily driven by cash charges related to the Initial Public Offering, including redemption premiums from the early retirement of debt, in addition to a $7.5 million cash charge related to the termination of the fee provisions of a management agreement with Castle Harlan. Changes in working capital resulted in a use of cash of $6.4 million for the year ended December 25, 2005 compared to a use of cash of $16.7 million for the year ended December 26, 2004. This working capital use of cash in 2005 is primarily due to (i) higher accounts receivables as a result of higher revenues and (ii) higher materials and supplies, which is largely due to significantly higher fuel prices during 2005. This is offset by a source of cash from other current assets primarily due to the collection of a $7.3 million income tax receivable during the year ended December 25, 2005.

Net cash provided by operating activities increased by $25.8 million to $69.9 million for the twelve months ended December 26, 2004 from $44.1 million of net cash provided by operating activities for the twelve months ended December 21, 2003. This increase is primarily a result of improved profitability before non-cash charges for depreciation and amortization, deferred income taxes, accretion and other non-cash operating activities. Net earnings adjusted for non-cash operating activities resulted in cash flow generation of $99.0 million in 2004 versus $69.1 million in 2003, an improvement of $29.9 million. Changes in working capital resulted in an $8.3 million use of cash year over year as operating assets and liabilities consumed cash of $16.7 million in 2004 versus $8.4 million in 2003. This $8.3 million increase in working capital was largely driven by the recording of an income tax receivable of $9.4 million in 2004. The income tax receivable was recorded primarily due to deductions available to us arising from the exercise of stock options by senior management in conjunction with the July 7, 2004 Acquisition-Related Transactions.

Investing Activities

Net cash used in investing activities increased by $3.9 million to $5.7 million for the six months ended June 25, 2006 compared to $1.8 million for the six months ended June 26, 2005.

 

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The $3.9 million increase is due to a $5.0 million increase in capital expenditures, primarily due to the acquisition of containers, a container handler and various other operating equipment in the six months ended June 25, 2006, offset by an increase of $1.1 million in proceeds from the sale of equipment.

Net cash used in investing activities, excluding the Acquisition-Related Transactions, increased by $7.5 million to $38.8 million for the year ended December 25, 2005 from $31.3 million for the twelve months ended December 26, 2004. These amounts exclude $663.3 million of acquisition expenditures related to the July 7, 2004 Acquisition-Related Transactions. The $7.5 million increase in cash used in investing activities is primarily a result of $25.2 million of cash used in 2005 for the acquisition of the rights and beneficial interests of the sole owner participant in two separate trusts, the assets of which consists primarily of the Horizon Enterprise and the Horizon Pacific, compared to $19.6 million of cash used in 2004 to purchase three vessels, the Horizon Navigator, the Horizon Fairbanks and the Horizon Trader, all of which were previously under operating leases.

Net cash used in investing activities, excluding the Acquisition-Related Transactions, decreased by $4.4 million to $31.3 million for the twelve months ended December 26, 2004 from $35.7 million for the twelve months ended December 21, 2003. These amounts exclude the $663.3 million acquisition expenditures related to the July 7, 2004 Acquisition-Related Transactions, and the February 27, 2003 purchase transaction, which totaled $315.0 million. We purchased the Horizon Navigator, the Horizon Fairbanks and the Horizon Trader during the twelve months ended December 26, 2004 for $19.6 million, and we purchased the Horizon Spirit in February 2003 and the Horizon Hawaii in December 2003 for a total of $21.9 million.

Financing Activities

Net cash used for financing activities during the six months ended June 25, 2006 was $11.0 million compared to $1.9 million for the six months ended June 26, 2005. The net cash used for financing activities during the six months ended June 25, 2006 includes $7.4 million in dividends to common stockholders, the payment of $0.8 million in fees associated with obtaining amendments to our senior credit facility, and a $1.3 million open market purchase of H-Lines Finance’s 11% senior discount notes.

Net cash used in financing activities, excluding those activities associated with our Initial Public Offering described below under “Initial Public Offering”, was $7.0 million for the year ended December 25, 2005 compared to $6.8 million of net cash used in financing activities for the twelve months ended December 26, 2004, excluding financing activities related to the July 7, 2004 Acquisition-Related Transactions and subsequent 2004 financing transactions. The $7.0 million net cash used for financing activities for the year ended December 25, 2005 primarily includes $1.8 million in fees related to exchange offers for the 9% senior notes and the 11% senior discount notes, $2.5 million of principal payments on long-term debt, and a $3.7 million dividend paid to stockholders on December 15, 2005.

Net cash used in financing activities for the twelve months ended December 26, 2004, excluding financing activities related to the July 7, 2004 Acquisition-Related Transactions and subsequent 2004 financing transactions, totaled $6.8 million. This amount reflects a $6.0 million repayment of outstanding borrowings under the revolving loan facility, $0.6 million principal payments on long-term debt, and $0.2 million payments on capital lease obligations. Financing activities related to the July 7, 2004 Acquisition-Related Transactions included a capital contribution of $87.0 million, the issuance of the $70.0 million of 13% promissory notes, $250.0 million borrowed under the term loan facility, $6.0 million borrowed under the revolving credit facility, and the issuance of the 9% senior notes in the aggregate original principal amount of

 

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$250.0 million. Financing activities related to the subsequent 2004 financing transactions included the issuance of common shares and Series A preferred shares for gross proceeds of $20.7 million and the repayment of $20.0 million of outstanding principal amount, together with accrued but unpaid interest thereon, of the 13% promissory notes. Other subsequent 2004 financing activities included the issuance of $160.0 million in aggregate original principal amount at maturity of 11% senior discount notes, the repayment of $50.0 million of the outstanding principal amount, together with accrued but unpaid interest thereon, of the 13% promissory notes, and the repurchase of a portion of the outstanding Series A preferred shares having an aggregate original stated value of $53.2 million.

Net cash used in financing activities during the twelve months ended December 21, 2003, excluding the capital infusion and borrowings related to the February 27, 2003 purchase transaction, totaled $9.3 million. This amount reflects a distribution to the holders of the preferred stock of Horizon Lines totaling $15.0 million, principal payments on long-term debt totaling $10.3 million and capital contributed by CSX Corporation totaling $16.0 million, during the period under CSX ownership. The capital infusion and borrowing related to the February 27, 2003 purchase transaction consisted of contributed capital of $80.0 million and term debt borrowings of $175.0 million and the issuance of $60.0 million in common and preferred units by Horizon Lines to CSX Corporation and its affiliates.

Public Offerings

Total gross proceeds from the Initial Public Offering of $143.8 million, along with $40.0 million of cash generated from operations, were used (i) to fully redeem $62.2 million of Series A preferred stock, (ii) to redeem $53.0 million principal amount of the 9% senior notes, plus related redemption premiums of $4.8 million, (iii) to redeem $43.2 million accreted value of the 11% senior discount notes, plus related redemption premiums of $4.8 million and (iv) to pay related transaction expenses of approximately $15.8 million. The redemption premiums of $9.5 million as well as the write-off of $3.6 million of deferred financing fees associated with the early redemptions, were recorded as a loss on early extinguishment of debt in the fourth quarter of 2005. In addition, we recorded transaction related fees of approximately $15.8 million as a reduction to additional paid in capital.

On June 16, 2006, we completed a secondary offering of 6,612,500 outstanding shares of our common stock, including 862,500 shares of our common stock pursuant to the exercise in full of the underwriters’ option to purchase additional shares that was granted in connection with the offering. We did not receive any proceeds from the sale of such stock. We incurred approximately $0.9 million in fees associated with these transactions during the quarter ended June 25, 2006. Such fees are included within selling, general, and administrative expenses in the consolidated statement of operations.

Capital Requirements

Our current and future capital needs relate primarily to debt service, maintenance, and improvement of our vessel fleet, including entering into lease transactions for new vessels, purchasing vessels upon expiration of vessel operating leases, and providing for other necessary equipment acquisitions. Cash to be used for investing activities, including purchases of property and equipment, for the next 12 months are expected to total approximately $20.0 million. In addition, expenditures for vessel drydocking payments are estimated at $20.0 million for the next 12 months.

 

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Three of our vessels, the Horizon Anchorage, Horizon Tacoma and Horizon Kodiak, are leased, or chartered. The charter periods for these vessels are due to expire in January 2015. The charters for these vessels permit us to purchase the applicable vessel at the expiration of the charter period for a fair market value specified in the relevant charter that is determined through a pre-agreed appraisal procedure. During 2005, we expended $25.2 million in cash to purchase owner participant interests in two vessels, the Horizon Pacific and the Horizon Enterprise, that were operating solely under lease agreements. During 2004 and 2003, we purchased four vessels, Horizon Fairbanks, Horizon Hawaii, Horizon Navigator and Horizon Trader, at the expiration of their charter periods, utilizing similar fair market value purchase option arrangements. The purchase prices of the four vessels ranged from $3.8 million to $8.2 million per vessel. The fair market values of the vessels currently under charter at the expiration of their charters cannot be predicted with any certainty.

Contractual Obligations and Off-balance Sheet Arrangements

Contractual obligations as of June 25, 2006(1) are as follows ($ in thousands):

 

    Total
Obligations
  Remaining
2006
  2007   2008   2009   2010   After
2010

Principal obligations:

             

Senior credit facility

  $ 245,625   $ 1,250   $ 2,500   $ 2,500   $ 2,500   $ 60,625   $ 176,250

Notes issued by owner trustees

    4,513     —       4,513     —       —       —       —  

9% senior notes

    197,014     —       —       —       —       —       197,014

11% senior discount notes

    102,505     —       —       —       —       —       102,505

Operating leases

    344,318     26,074     78,975     36,803     36,515     35,129     130,822

Capital lease obligations

    423     86     180     157     —       —       —  
                                         

Subtotal

    894,398     27,410     86,168     39,460     39,015     95,754     606,591
                                         

Interest obligations:

             

Senior credit facility

    91,495     6,820     20,007     19,567     19,212     18,746     7,143

Notes issued by owner trustees

    480     240     240     —       —       —       —  

9% senior notes

    112,297     8,866     17,731     17,731     17,731     17,731     32,507

11% senior discount notes

    53,560     —       —       5,638     11,276     11,276     25,370
                                         

Subtotal

    257,832     15,926     37,978     42,936     48,219     47,753     65,020
                                         

Total principal and interest

  $ 1,152,230   $ 43,336   $ 124,146   $ 82,396   $ 87,234   $ 143,507   $ 671,611
                                         

Other commercial commitments:

             

Standby letters of credit(2) 

  $ 37,209   $ —     $ 29,338   $ —     $ 7,871   $ —     $ —  

Surety bonds(3) 

    8,614     8,610     1     —       3     —    
                                         

Other commercial commitments

  $ 45,823   $ 8,610   $ 29,339   $ —     $ 7,874   $ —     $ —  
                                         

(1)  

Included in contractual obligations are scheduled interest payments. Interest payments on the senior credit facility are variable and are based as of June 25, 2006, upon the London Inter-Bank Offering Rate (LIBOR) plus 2.25%. The three-month LIBOR / swap curve has been

 

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utilized to estimate interest payments on the senior credit facility. Interest on the 9% senior notes is fixed and is paid semi-annually on May 1 and November 1 of each year until maturity on November 1, 2012. Interest on the 11% senior discount notes is fixed. However, no cash interest will accrue prior to April 1, 2008. Thereafter, cash interest will accrue at a rate of 11.0% per annum and be payable on April 1 and October 1 of each year, commencing on October 1, 2008 and continuing until maturity on April 1, 2013.

(2)   The standby letters of credit include $29.3 million in letters of credit that serve as collateral related to the SFL agreements, $4.6 million in letters of credit that serve as collateral on state workers compensation and auto liability policies, and $3.3 million in letters of credit that serve as security for all bonds excluding US Customs bonds.
(3)   $6.3 million are customs bonds, $1.1 million are bonds for payment of taxes levied under the Excise Tax Act of the Commonwealth of Puerto Rico of 1987, and the remaining $1.2 million are utility or lease bonds. The company has the financial ability and intention to satisfy its obligations.

SFL Agreements

Although Horizon Lines is not the primary beneficiary of the variable interest entities created in conjunction with the April 2006 transactions with SFL, Horizon Lines has an interest in the variable interest entities now. Certain contractual obligations and off-balance sheet obligations arising from this transaction are as follows ($ in millions):

 

Annual operating lease obligations(a)

   $ 32.0

Letters of credit(b)

   $ 29.3

Residual guarantee(c)

   $ 3.8

Security deposits guarantee(d)

   $ 0.2

(a)   These operating lease obligations will commence during 2007 as the vessels are delivered from the shipyard to certain subsidiaries of SFL (the “SFL shipowners”) and the bareboat charters commence. The annual operating lease obligations represent a full twelve month period. The initial term of each of the bareboat charters is twelve years from the date of delivery of the related vessel. The estimated aggregate annual charter hire for the vessels under the bareboat charters with the SFL shipowners are based on certain assumptions with respect to final vessel purchase price and swap interest rates that will be adjusted on the date of the delivery of the particular vessel. The SFL shipowners have entered into forward starting swaps to lock in the interest rate on the underlying bank loan with a syndicate of banks led by Fortis Capital Corp., or Fortis. However, if a particular vessel’s delivery date or its construction cost changes, the related forward starting swap agreements will need to be adjusted. If the swap interest rate is changed due to any of the above reasons, the aggregate annual charter hire will also change accordingly.
(b)   The letters of credit were issued in April 2006 to secure certain obligations under the Reimbursement Agreement. To obtain the letters of credit, Horizon Lines amended its senior credit facility by, among other things, (i) increasing the aggregate amount of letters of credit permitted under the senior credit facility from $20.0 million to $41.0 million and (ii) permitting Horizon Lines or any of its subsidiaries to guarantee, directly or indirectly, up to $42.5 million of the obligations of SFL and/or any of its subsidiaries or affiliates in connection with the charter by Horizon Lines of the vessels from the SFL shipowners.
(c)   If Horizon Lines elects not to purchase the vessels at the end of the initial twelve-year charter period and the SFL shipowners sell the vessels for less than a specified amount, Horizon Lines is responsible for paying the amount of such shortfall, up to $3.8 million per vessel. Such residual guarantee will be recorded at its fair value of approximately $0.2 million as a liability on our balance sheet upon commencement of the bareboat charters.

 

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(d)   Pursuant to the Agreement to Acquire and Charter and the Reimbursement Agreement, Horizon Lines has agreed to reimburse SFL, SFL Holdings and the SFL shipowners for their respective losses if there is a default by SFL Holdings as the buyer under the Memoranda of Agreement except under certain circumstances. The losses covered include forfeiture of SFL Holdings’ security deposits, any damage claims made against SFL Holdings by the sellers under the Memoranda of Agreement (to the extent such claims exceed SFL’s security deposits), any liabilities of SFL and the SFL shipowners to Fortis for any draws on the letters of credit, any interest due under Fortis’s credit agreement with the SFL shipowners as a result of any such draws, and any interest-rate swap breakage fees. In addition, SFL Holdings has the right to require Horizon Lines to assume its obligations to the sellers under the Memoranda of Agreement in the event that (i) Horizon Lines is in material default under the terms of any of the transaction documents with the SFL parties with respect to any vessel that has not yet been delivered to the relevant SFL shipowner, (ii) the company or Horizon Lines becomes insolvent or bankrupt, or (iii) the company’s guarantee issued in favor of the SFL shipowners of Horizon Lines’ obligations under certain of the transaction documents with the SFL parties ceases to be in full force and effect.

Long-Term Debt

The senior credit facility consists of (i) a $50.0 million revolving credit facility and (ii) a $250.0 million term loan facility. We expect that the subsidiaries of the issuer that are the borrowers under the senior credit facility will be permitted to incur up to an additional $50.0 million of senior secured debt in the form of term loans at the option of the participating lenders under the term loan facility, provided that no default or event of default under the senior credit facility has occurred or would occur after giving effect to such incurrence and certain other conditions are satisfied. The term loan matures on July 7, 2011 and the revolving credit facility matures on July 7, 2009. No amounts were outstanding under the revolving credit facility as of June 25, 2006 or December 25, 2005. However, $37.2 million and $6.9 million of availability under the revolving credit facility were utilized for outstanding letters of credit as of June 25, 2006 and December 25, 2005, respectively.

Principal payments of approximately $0.6 million are due quarterly on the term loan facility through June 30, 2010, at which point quarterly payments increase to $58.8 million until final maturity on July 7, 2011. Borrowings under the term loan facility bear interest at Horizon Lines and Horizon Lines Holding’s choice of LIBOR or the base rate, in each case, plus an applicable margin. The margin applicable to the term loan facility is equal to 1.25% for base rate loans and 2.25% for LIBOR loans. The interest rate at June 25, 2006 approximated 7.3%. Horizon Lines and Horizon Lines Holding are also charged a commitment fee on the daily unused amount of the revolving credit facility during the availability period based upon a rate of 0.50%.

The senior credit facility requires the subsidiaries of the issuer that are the borrowers thereunder to meet a minimum interest coverage ratio and a maximum leverage ratio. In addition, the senior credit facility contains restrictive covenants which will, among other things, limit the incurrence of additional indebtedness, capital expenditures, investments, dividends, transactions with affiliates, asset sales, acquisitions, mergers and consolidations, prepayments of other indebtedness, liens and encumbrances and other matters customarily restricted in such agreements. It also contains certain customary events of default, subject to grace periods, as appropriate. Horizon Lines and Horizon Lines Holding believe that they were in compliance with all such covenants as of June 25, 2006. The senior credit facility is secured by the assets of Horizon Lines and Horizon Lines Holding. The 9% senior notes and the 11% senior discount notes also contain restrictive covenants including, limiting incurrence of additional indebtedness, dividends and restrictions customary in such agreements.

 

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On July 7, 2004, Horizon Lines and Horizon Lines Holding completed an offering of $250.0 million in principal amount of 9% senior notes. The 9% senior notes mature on November 1, 2012. Interest on the 9% senior notes accrues at the rate of 9% per annum and is payable in cash semi-annually on May 1 and November 1 of each year. The 9% senior notes are the general unsecured obligations of Horizon Lines and Horizon Lines Holding and rank equally with the existing and future unsecured indebtedness and other obligations of Horizon Lines and Horizon Lines Holding that are not, by their terms, expressly subordinated in right of payment to the 9% senior notes and senior in right to any future subordinated debt. Horizon Lines and Horizon Lines Holding used $57.8 million of the proceeds of the Initial Public Offering to redeem $53.0 million of the principal amount of the 9% senior notes and pay associated redemption premiums of $4.8 million.

On December 10, 2004, H-Lines Finance completed an offering of $160.0 million in principal amount of 11% senior discount notes. The 11% senior discount notes were issued at a discount from their principal amount at maturity and generated gross proceeds of approximately $112.3 million. The 11% senior discount notes mature on April 1, 2013. Until April 1, 2008, the notes will accrete at the rate of 11% per annum, compounded semiannually on April 1 and October 1 of each year, beginning October 1, 2005, to but not including April 1, 2008. Beginning on April 1, 2008, cash interest will accrue at the rate of 11% per annum and will be payable in cash semi-annually in arrears on each April 1 and October 1, commencing October 1, 2008. The 11% senior discount notes are the general unsecured obligations of Horizon Lines Holding and rank equally with the existing and future unsecured indebtedness and other obligations of Horizon Lines Holding that are not, by their terms, expressly subordinated in right of payment to the 11% senior discount notes and senior in right to any future subordinated debt. Horizon Lines Holding used $48.0 million of the proceeds of the Initial Public Offering to redeem $56.0 million of the original principal amount at maturity, or $43.2 million in accreted value, of the 11% senior discount notes and pay associated redemption premiums of $4.8 million. During the quarter ended June 25, 2006, Horizon Lines made a $1.3 million open market purchase of 11% senior discount notes, which represented a $46,000 premium to the accreted value thereof at the date of purchase.

We intend to fund our ongoing operations through cash generated by operations and availability under the senior credit facility.

Future principal debt payments are expected to be paid out of cash flows from operations, borrowings under the senior credit facility, and future refinancings of our debt.

Our ability to make scheduled payments of principal, or to pay the interest, if any, on, or to refinance our indebtedness, to make dividend payments to our common stockholders, or to fund planned capital expenditures will depend on our future performance, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.

Based upon the current level of operations and certain anticipated improvements, we believe that cash flow from operations and available cash, together with borrowings available under the senior credit facility, will be adequate to meet our future liquidity needs for the next twelve months. There can be no assurance that we will generate sufficient cash flow from operations, that anticipated revenue growth and operating improvements will be realized or that future borrowings will be available under the senior credit facility in an amount sufficient to enable us to service our indebtedness or to fund other liquidity needs. In addition, there can be no assurance that we will be able to effect any future refinancing of our debt on commercially reasonable terms or at all.

 

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Interest Rate Risk

Our primary interest rate exposure relates to the senior credit facility. As of June 25, 2006, the company and Horizon Lines have outstanding a $245.6 million term loan, which bears interest at variable rates. Each quarter point change in interest rates would result in a $0.6 million change in annual interest expense on the term loan. Horizon Lines Holding and Horizon Lines also have a revolving credit facility which provides for borrowings of up to $50.0 million. As of June 25, 2006, no amounts were outstanding under the revolving credit facility.

Credit Ratings

As of June 25, 2006, Moody’s Investors Service and Standard and Poor’s Rating Services assigned the following credit ratings to our outstanding debt:

Debt/Rating Outlook:

 

     Moody’s    Standard
& Poor’s

Senior secured credit facility

   B2    B

9% senior notes due 2012

   B3    CCC+

11% senior discount notes due 2013

   Caa2    CCC+

Rating outlook

   Stable    Positive

Ratio of Earnings to Fixed Charges

Our ratio of earnings to fixed charges for the six months ended June 25, 2006 is as follows ($ in thousands):

 

    

For the

Six Months
Ended
June 25,
2006

 

Pretax income

   $ 14,453  

Interest expense

     24,737  

Rentals

     11,759  
        

Total fixed charges

     36,496  
        

Pretax earnings plus fixed charges

   $ 50,549  
        

Ratio of earnings to fixed charges

     1.40 x

For the purposes of calculating the ratio of earnings to fixed charges, earnings represent income before income taxes plus fixed charges. Fixed charges consists of interest expense, including amortization of net discount or premium and financing costs and the portion of operating rental expense (33%) which our management believes is representative of interest component of rent expense.

 

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BUSINESS

Our Company

We believe that we are the nation’s leading Jones Act container shipping and integrated logistics company, accounting for approximately 36% of total U.S. marine container shipments from the continental U.S. to the three non-contiguous Jones Act markets, Alaska, Hawaii and Puerto Rico, and to Guam. We are the only Jones Act container shipping and logistics company with an integrated organization operating in all three non-contiguous Jones Act markets. With 16 vessels and approximately 23,900 cargo containers, we operate the largest Jones Act containership fleet, providing comprehensive shipping and sophisticated logistics services to our markets. We have long-term access to terminal facilities in each of our ports, operating our own terminals in Alaska, Hawaii, and Puerto Rico and contracting for terminal services in our seven ports in the continental U.S. and in our ports in Guam, Hong Kong and Taiwan. We also offer extensive inland cargo trucking and logistics for our customers through our relationships with third-party truckers, railroads, and barge operators in our market and our own trucking operations on the U.S. West Coast. Over 90% of our revenue is generated from our shipping and logistics services in markets where the marine trade is subject to the Jones Act or other U.S. maritime laws.

Our long operating history dates back to 1956, when Sea-Land Service, Inc. pioneered the marine container shipping industry and established our business. In 1958 we introduced container shipping to the Puerto Rico market, and in 1964 we pioneered container shipping in Alaska with the first year-round scheduled vessel service. In 1987, we began providing container shipping services between the U.S. West Coast and Hawaii and Guam through our acquisition from an existing carrier of all of its vessels and certain other assets that were already serving that market. Today, as the only Jones Act vessel operator with 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.

For the fiscal year ended December 25, 2005, we generated revenue of $1,096 million, EBITDA of $100.4 million, and net loss available to common stockholders of $23.4 million. For the six months ended June 25, 2006, we generated revenue of $564.8 million, EBITDA of $71.5 million, and net income available to common stockholders of $8.8 million. For the twelve months ended December 25, 2005, we generated pro forma EBITDA of $130.8 million and pro forma net income available to common stockholders of $12.8 million, after giving effect to certain adjustments, and based upon certain assumptions, as more fully described in “Unaudited Pro Forma Condensed Consolidated Financial Statements,” beginning on page 41 of this prospectus. For the definition of EBITDA and its reconciliation to net income, see footnote 4 to the table under “Summary Consolidated, Combined and Unaudited Pro Forma Financial Data,” beginning on page 9 of this prospectus.

On April 11, 2006, we concluded a series of agreements to charter five newly built U.S.-flag container vessels, each with a capacity of 2,824 twenty-foot equivalent units, or TEUs, and a potential service speed of 23 knots. These five container vessels of the same class are currently being built in Korea and are scheduled to be delivered over a seven-month period starting in the fourth quarter of 2006. The charter term for each vessel will be twelve years from the date of delivery of the vessel, with a three-year renewal option exercisable by us for each charter. In addition, we will have an option to purchase all of the vessels following the five-, eight-, twelve- and, if applicable, fifteen- year anniversaries of the first date of delivery of the vessels at pre-agreed purchase prices. Upon the delivery of these five vessels by the end of the first half of 2007, the average age of our active vessels that are deployed in our markets, referred to herein as our active vessels, will be reduced from 31 years to 20 years.

 

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This initiative will allow us to use the new vessels for our non-Jones Act routes between the U.S. West Coast and Guam and Asia in a very capital efficient manner, at approximately one third the cost of comparable U.S.-built vessels. The deployment of these new vessels will enable us to provide Maersk with additional capacity on the transpacific route where we currently provide vessel container space to Maersk on a take or pay basis. In addition, our larger Jones Act vessels currently operating in the transpacific service will be redeployed to our Hawaii and Puerto Rico markets resulting in additional capacity to meet market growth requirements and an improved network cost structure.

Our vessels are maintained according to our own strict maintenance procedures, which meet or exceed U.S. government requirements. We also offer extensive inland cargo trucking and logistics for our customers through our own trucking operations on the U.S. West Coast and our relationships with third-party truckers, railroads, and barge operators in our markets. We book and monitor all of our shipping and logistics services with our customers through HITS, our industry-leading ocean shipping and logistics information technology system, which is a key feature of our complete shipping logistics solutions. Our focus is on maintaining our reputation for service and operational excellence by emphasizing strict vessel maintenance, employing experienced vessel crews, expanding and improving our national sales presence, and employing industry-leading information technology as part of our complete logistics solutions.

As the only Jones Act container shipping and logistics company with integrated organization operating in all three non-contiguous Jones Act markets, we believe that we have a stronger competitive position in our markets, serve more effectively our national customers with shipping and logistics needs across one or more of these markets, spread our fixed costs over a larger revenue base, achieve greater network operating efficiencies and negotiate larger volume discounts from our inland shipping providers.

We transport a wide spectrum of consumer and industrial items used everyday in the markets we serve, ranging from foodstuffs (refrigerated and nonrefrigerated) to household goods and auto parts to building materials and various materials used in manufacturing. Many of these cargos are consumer goods vital to the expanding populations in our markets, thereby providing us with a stable base of growing demand for our shipping and logistics services. We have approximately two thousand customers and have many long-standing customer relationships, including large consumer and industrial products companies and several agencies of the U.S. government. Our customer base is broad and diversified, with our top ten customers accounting for approximately 32% of revenue and our largest customer accounting for approximately 7% of revenue in 2005. Approximately 51% of our revenue in 2005 was derived from customers shipping with us in more than one of our geographic markets and approximately 29% of our revenue in 2005 was derived from customers shipping with us in all of our geographic markets.

We focus on maintaining our reputation for service and operational excellence by emphasizing strict vessel maintenance, employing experienced vessel crews, expanding and improving our national sales presence, and employing industry-leading information technology as part of our complete logistics solutions:

 

   

We operate the largest Jones Act containership fleet, currently consisting of 16 vessels, and we will expand our fleet to include five new non-Jones Act vessels currently under construction, which we will take delivery of beginning in the fourth quarter of 2006. Typically, 15 of the vessels currently in our fleet are actively deployed at any given time, with one spare vessel reserved for relief during another vessel’s drydocking period. We

 

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maintain our vessels according to our own strict maintenance procedures, which meet or exceed U.S. government requirements. All of our vessels are regulated pursuant to rigorous standards promulgated by the U.S. Coast Guard and are subject to periodic inspection and certification, for compliance with these standards, by the American Bureau of Shipping, on behalf of the U.S. Coast Guard. Our procedures protect and preserve our fleet to the highest standards in our industry and enable us to preserve the usefulness of our ships. In addition, the senior officers on our vessels (masters and chief engineers) have an average tenure with us of over 16 years.

 

    We manage a sales and marketing team of approximately 120 employees strategically located in our various ports, as well as in seven regional offices across the continental U.S., from our headquarters in Charlotte, North Carolina. Senior sales and marketing professionals in Charlotte are responsible for developing sales and marketing strategies and are closely involved in servicing our largest customers. All pricing activities are centrally coordinated from Charlotte and Tacoma, Washington, enabling us to better manage our customer relationships.

 

    We book and monitor all of our shipping and logistics services through HITS, our industry-leading ocean shipping and logistics information technology system and a key feature of our complete shipping logistics solutions. This system encompasses an extensive database of information relevant to the shipment of containerized cargo and captures all critical aspects of every shipment booked with us, including cargo booking, tracking and tracing and the production of bills of lading, customs documents and invoicing. Since the launch of HITS in 2000, we have migrated our customers to the on-line interfaces of HITS, with on-line bookings totaling approximately 50% of our total bookings. We believe that HITS’ functionality and ability to generate cost savings for our customers build strong customer loyalty for our services and enhance our customer relationships. We believe that HITS differentiates us from our competitors as it better positions us to serve higher-margin customers with sophisticated shipping and logistics requirements.

The Jones Act

The Jones Act is a long-standing cornerstone of U.S. maritime policy. 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. U.S.-flagged vessels are generally required to be maintained at higher standards than foreign-flagged vessels and are supervised by, as well as subject to rigorous inspections by, or on behalf of the U.S. Coast Guard, which requires appropriate certifications and background checks of the crew members. Our trade routes between Alaska, Hawaii and Puerto Rico and the continental U.S. represent the three non-contiguous Jones Act markets. Vessels operating on these trade routes are required to be fully qualified Jones Act vessels. Other U.S. maritime laws require vessels operating on the trade routes between Guam, a U.S. territory, and U.S. ports to be U.S.-flagged and predominantly U.S.-crewed, but not U.S.-built.

Cabotage laws, which reserve the right to ship cargo between domestic ports to domestic vessels, are not unique to the United States; similar laws are common around the world and exist in over 40 countries. In general, all interstate and intrastate marine commerce within the U.S. falls under the Jones Act, which is a cabotage law. The Jones Act enjoys broad support from both major political parties. During the 2004 presidential election, both major political parties supported the retention of the Jones Act as currently in effect. In addition, the Jones Act has historically enjoyed strong congressional support. We believe that the ongoing war on

 

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terrorism has further solidified political support for the Jones Act, as a vital and dedicated U.S. merchant marine is a cornerstone for a strong homeland defense, as well as a critical source of trained U.S. mariners for wartime support.

Market Overview

The Jones Act distinguishes the U.S. domestic shipping market from international shipping markets by making the U.S. domestic shipping market the exclusive domain of Jones Act qualified vessels. Given the limited number of existing Jones Act qualified vessels, the relatively high capital investment and long delivery lead times associated with building a new containership in the U.S., the substantial investment required in infrastructure and the need to develop a broad base of customer relationships, the markets in which we operate have been less prone to overcapacity and volatility than international shipping markets. Since 1995, Alaska, Hawaii and Guam and Puerto Rico have experienced low average rate volatility of 0.4%, 1.7% and 3.8% per annum while the major transpacific and transatlantic trade routes have experienced average rate volatility of 23.7% and 9.4% per annum.

Although the U.S. container shipping industry is affected by general economic conditions, the industry does not tend to be as cyclical as other sectors within the shipping industry. Specifically, most of the cargos shipped via container vessels consist of a wide range of consumer and industrial items as well as military and postal loads. Since many of these types of cargos are consumer goods vital to the expanding populations in our markets, they provide us with a stable base of growing demand for our shipping and logistics services.

The Jones Act markets are not as fragmented as international shipping markets. In particular, the three non-contiguous Jones Act markets and Guam are currently served predominantly by four shipping companies, including Horizon Lines, Matson Navigation Company, Inc., Crowley Maritime Corporation, and Totem Ocean Trailer Express, Inc., or TOTE. Horizon Lines and Matson serve the Hawaii and Guam market. Pasha Hawaii Transport Lines LLC operates a vessel with roll-on/roll-off service, shipping vehicles between the U.S. West Coast and Hawaii. Horizon Lines and TOTE serve the Alaska market. The Puerto Rico market is currently served by two containership companies, Horizon Lines and Sea Star Lines, which is an independently operated company majority-owned by an affiliate of TOTE. Two barge operators, Crowley and Trailer Bridge, Inc., also currently serve the Puerto Rico market.

The U.S. container shipping industry as a whole is experiencing rising customer expectations for real-time shipment status information and the on-time pick-up and delivery of cargo, as customers seek to optimize efficiency through greater management of the delivery process of their products. Commercial and governmental customers are increasingly requiring the tracking of the location and status of their shipments at all times and have developed a strong preference to retrieve information and communicate using the Internet. To ensure on-time pick-up and delivery of cargo, shipping companies must maintain strict vessel schedules and efficient terminal operations for expediting the movement of containers in and out of terminal facilities.

The departure and arrival of vessels on schedule is heavily influenced by both vessel maintenance standards (i.e., minimizing mechanical breakdowns) and terminal operating discipline. Marine terminal gate and yard efficiency can be enhanced by efficient yard layout, high-quality information systems, and streamlined gate processes.

 

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Our Competitive Strengths

We believe that our competitive strengths include:

Leading Jones Act container shipping and logistics company. We are the only container vessel operator with an integrated organization serving all three non-contiguous Jones Act markets and have a number-one or a number-two market position within each of our markets. We are one of only two major marine container shipping operators currently serving the Alaska market, one of two marine container shipping companies currently serving the Hawaii and Guam markets and the largest of four marine container shipping companies currently serving the Puerto Rico market. As a result, we are able to serve the needs of customers shipping to individual markets as well as the needs of large customers that require shipping and sophisticated logistics services across more than one of these markets. Approximately 51% of our revenue in 2005 was derived from customers shipping with us in more than one of our geographic markets and approximately 29% of our revenue in 2005 was derived from customers shipping with us in all of our geographic markets. In addition to enabling us to effectively serve a long-standing customer base, our presence in all of these geographic markets mitigates our geographic exposure to any one particular market.

Favorable industry dynamics. Given the requirements of the Jones Act, the level of services already provided by us and our existing competitors in our markets and the increasing requirements of customers in our markets, any future viable competitor would not only have to make substantial investments in vessels and infrastructure but also establish regularity of service, develop customer relationships, develop inland cargo shipping and logistics solutions and acquire or build infrastructure at ports that are currently limited in space, berths and water depth.

Stable and growing revenue base. We have achieved five consecutive years of revenue growth. Our revenue base is stable and growing due to our presence across three geographic markets, the breadth of our customer base served and the diversity of our cargos shipped, all of which better protect us against external events that may adversely affect any of our markets. We ship a diverse mix of cargos, and benefit from serving substantial and growing customers with sophisticated container shipping and logistics requirements across two or more geographic markets that we serve. In addition, many of the cargos we ship are consumer goods which are vital to the expanding populations in our markets, thereby providing us with a stable base of growing demand for our shipping and logistics services. Also, our presence across multiple geographic markets, along with our expertise in supply chain management and our sophisticated on-line shipping and logistics information technology, enables us to be the shipping and logistics solution of choice in these markets for many of our national customers. As a result, we participate in economic and demographic growth trends in each of these markets at a relatively early stage. For example when Lowe’s opened two new retail stores in Alaska, Lowe’s expanded our relationship by selecting us to provide the shipping and logistics services required to stock these stores upon their opening and thereafter. When Lowe’s opened one new retail store in Hawaii, Lowe’s again selected us to provide these services. In addition, our use of non-exclusive customer contracts, with durations ranging from one to six years, generates most of our revenue and provides us with stable revenue streams.

Long-standing relationships with leading, established customers. We serve a diverse base of long-standing, established customers consisting of many of the world’s largest consumer and industrial products companies, as well as a variety of smaller and middle-market customers. Our customers include Costco Wholesale Corporation, Johnson & Johnson, Lowe’s Companies, Inc., Safeway, Inc, Toyota Motor Corporation and Wal-Mart Stores, Inc. In addition, we serve several agencies of the U.S. government, including the Department of Defense and the Postal

 

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Service. We have a long- standing history of service to our customer base, with some of our customer relationships extending back over 40 years and our relationships with our top ten customers averaging 28 years. In addition, during 2005, we experienced a retention rate of approximately 99% with respect to customers who generate more than $100,000 in revenue during such year. For 2005, no customer accounted for more than approximately 7% of our total revenue during 2005 and nearly all of our customer relationships are based on non-exclusive contracts.

Customer-oriented sales and marketing presence. Our approximately 120-person national and regional sales and marketing presence enables us to forge and maintain close customer relationships. Our sales headquarters is based in Charlotte, North Carolina and we also maintain a regional sales presence strategically located in our various ports as well as in seven regional offices across the continental U.S. Our national and regional presence, combined with our operational excellence, results in high levels of repeat business from our diverse customer base.

Operational excellence. As the leading Jones Act shipping and integrated logistics company, we pride ourselves on our operational excellence and our ability to provide consistent, high quality service. The quality of our vessels as well as the expertise of our vessel crews and engineering resources help us to maintain highly reliable and consistent dock-to-dock on-time arrival performance. Our track record of service and operational excellence continues to be widely recognized by some of the most demanding customers in the world. Wal-Mart once again named us as its 2005 Jones Act Carrier of the Year (the fifth time which we have received this award over the last six years for which the award has been given), Lowe’s awarded us with its 2005 Gold Carrier Award for the fifth straight year, and Toyota recognized us with its Logistics Excellence for On Time Performance award for the seventh consecutive year and with its Logistics Excellence Award for Customer Service for 2005.

Experienced management with strong culture of commitment to service and operational excellence. Our senior management, headed by Charles G. Raymond, is comprised of seasoned leaders in the shipping and logistics industry with an average of 25 years of experience in the industry. Our senior management has a long history of working together as a team, with four of our eight most senior managers having worked together at Horizon Lines or our predecessors for over 22 years. Furthermore, as of the date hereof, after giving effect to this offering, our management team, including family members, continues to own approximately 11% of our common equity on a fully diluted basis.

Our Business Strategy

Our financial and operational success has largely been driven by providing customers with reliable shipping and logistics solutions, supported by consistent and value-added service and expertise. Our goal is to continue to provide high-quality service while pursuing continued strong revenue and earnings growth both in our core markets and in other selected non-Jones Act shipping markets through the principal strategies outlined below. There are many uncertainties associated with the risks of the implementation of our business strategy. These uncertainties relate to economic, competitive, energy cost, operational, regulation, catastrophic loss and other factors that are discussed on pages 14-28, many of which are beyond our control.

Continue to organically grow our revenue. We intend to achieve ongoing revenue growth in each of our markets by focusing our national and regional sales force on acquiring business from new customers, growing business with existing customers continuing to focus on increasing the share of our revenue that is derived from our customers’ higher margin cargo and through the continued economic growth within our geographic markets. These higher rate

 

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cargos include high-value cargos, time-sensitive cargos and cargos that require complete door-to-door logistics solutions and supply chain management and through the continued growth of our geographic markets.

Expand our services and logistics solutions. We seek to build on our market-leading logistics platform and operational expertise by providing new services and integrated logistics solutions. These services and solutions include delivery planning and comprehensive shipping and logistics. In particular on the U.S. West Coast, we supplement our vessel services with proprietary trucking services, as well as the door-to-door logistics and shipping solutions we offer across our markets. Timing of shipments is crucial to our customers, and our ability to provide these combined offerings has enabled us to expand our business with our customers. By offering a wider range of services and logistics solutions, we believe that we can strengthen our franchise and further grow our revenues and profits.

Expand and enhance our customer relationships. We seek to leverage our capabilities to serve a broad and growing range of customers across varied industries and geographies of different size and growth profiles. In order to enhance our overall cargo mix, we place a strong emphasis on the development and expansion of our relationships with customers which meet high credit standards and have sophisticated container shipping and logistics requirements across more than one of the geographic markets that we serve. This strategy has resulted in our long-term and successful relationships with customers who are growing their operations in our markets.

Reduce operating costs. We continually seek to identify opportunities to reduce our operating costs, and our continued examination of unit cost economics is a critical part of our culture. In May, 2006, we formed a dedicated team of employees to develop and implement a program, referred to as “Horizon Edge”, over the next two and a half years, with the combined goals of reducing operating costs and enhancing customer focus and service efficiency. With the assistance of outside advisors, we are targeting improvements in maintenance management, marine productivity, supply chain management, and information technology.

Leverage our brand. We actively promote, through our sales and marketing efforts, the broad recognition that Horizon Lines has a long and successful history of service to customers in the three non-contiguous Jones Act trades and in Guam. We believe that Horizon’s brand Always There. Always Delivering.® is synonymous with quality and operational excellence and we intend to continue to build and leverage our brand in order to further enhance our business.

Maintain leading information technology. We are focused on maintaining HITS as an industry-leading ocean shipping and logistics information technology system with cargo booking, tracking and tracing capabilities more advanced than those of any system employed by our competitors. All orders that we receive through any medium are booked and processed through HITS, which has electronic data interface capabilities, including an Internet portal, which enables us to achieve operating efficiencies. Since the launch of HITS in 2000, we have migrated our customers to the on-line interfaces of HITS, with on-line bookings via HITS totaling approximately 50% of our total bookings. We have also made available to our customers, through HITS, automated cargo booking, tracking and tracing so our customers can reduce their labor time and costs with respect to these activities. We routinely incorporate additional enhancements into HITS to meet the changing needs of our business and further differentiate us from our competitors. For example, we recently integrated our customer rate information into HITS, which allows us to produce bills in less time and reduces billing errors. We believe that HITS’ functionality and cost savings potential for our customers produce strong loyalty.

 

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Our Growth Initiatives

Our management team has a demonstrated track record of delivering revenue and earnings growth for our stockholders. Going forward, we intend to actively pursue new business opportunities as well as grow our core business by improving our cargo mix and operating margins in each of our core markets. In order to achieve this growth in our business, we plan to execute the following initiatives:

Optimize fleet deployment. In April 2006, we entered into a series of agreements to charter five newly built U.S.-flag container vessels, each with a capacity of 2,824 TEUs, over an initial period of twelve years beginning in the fourth quarter of 2006. We plan to deploy these new U.S.-flag non-Jones Act vessels, beginning in the first quarter of 2007, on our non-Jones Act trade routes between the U.S. West Coast and Guam and Asia. The new vessels will increase our weekly effective capacity on this route by approximately 20%, allowing us to expand our service to Guam and to offer additional space to Maersk on a take or pay basis eastbound from Asia. We will redeploy the Jones Act vessels currently serving on this route into Hawaii and Puerto Rico, thereby increasing our effective weekly capacity to Hawaii to satisfy growing demand, and allowing us to serve Puerto Rico with a more cost efficient fleet configuration. We expect that these vessels will enhance our service quality as a result of faster service speeds and enhanced reliability and will operate on a more cost efficient basis with lower fuel consumption and maintenance costs than the current vessels serving these markets.

Upside revenue potential for inactive Jones Act vessels. As a result of our initiative to optimize our fleet deployment, we will have four inactive Jones Act vessels available to provide us with surge capacity during peak shipping volume seasons as well as to serve as relief vessels during drydockings of active vessels while also enabling us to pursue other Jones Act trade routes, new contracts and vessel charter opportunities.

Additional government and military business. We plan to increase our U.S. government and military cargo business. In 2004, we secured a contract to manage seven oceanographic vessels for the U.S. government. The recent addition to our senior management team of General John W. Handy, a retired four-star Air Force general who most recently served as head of air, land and sea transportation for the U.S. Department of Defense, will further position us to pursue additional government and military cargo opportunities.

Expand Operating Platform. We believe that there are significant new and expansion opportunities available for us within the overall shipping and logistics markets under the Jones Act or other U.S. maritime laws. We intend to identify and pursue strategic acquisitions within these markets on a financially disciplined basis with the goal of expanding our operating platform to increase our penetration of these markets.

Sales and Marketing

We manage a sales and marketing team of approximately 120 employees strategically located in our various ports, as well as in seven regional offices across the continental U.S., from our headquarters in Charlotte, North Carolina. Senior sales and marketing professionals in Charlotte are responsible for developing sales and marketing strategies and are closely involved in servicing our largest customers. All pricing activities are also centrally coordinated from Charlotte and from Tacoma, Washington, enabling us to manage our customer relationships. The marketing team located in Charlotte is responsible for providing appropriate market intelligence and direction to the Puerto Rico sales organization. The marketing team located in Tacoma is responsible for providing appropriate market intelligence and direction to the members of the team who focus on the Hawaii, Guam and Alaska markets.

 

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Our regional sales and marketing presence ensures close and direct interaction with customers on a daily basis. Many of our regional sales professionals have been servicing the same customers for over ten years. We believe that we have the largest sales force of all container shipping and logistics companies active in the major non-contiguous Jones Act markets. Unlike our competitors, our sales force cross-sells our shipping and logistics services across all of these markets. We believe that the breadth and depth of our relationships with our customers is the principal driver of repeat business from our customers. We further believe that our long-standing customer relationships and our cross-selling efforts enable us to forge customer relationships which provide us with a distinct competitive advantage.

Customers

We serve a diverse base of long-standing, established customers consisting of many of the world’s largest consumer and industrial products companies. Such customers include Costco Wholesale Corporation, Johnson & Johnson, Lowe’s Companies, Inc., Safeway, Inc., Toyota Motor Corporation and Wal-Mart Stores, Inc. In addition, we serve several agencies of the U.S. government, including the Department of Defense and the U.S. Postal Service.

We believe that we are uniquely positioned to serve these and other large national customers due to our position as the only shipping and logistics company serving all three non-contiguous Jones Act markets and Guam. Approximately 51% of our transportation revenue in 2005 was derived from customers shipping with us in more than one of our markets with approximately 29% of our transportation revenue in 2005 being derived from customers shipping with us in all three markets.

We generate most of our revenue through non-exclusive customer contracts with pre-specified rates and volumes and with durations ranging from one to six years, providing stable revenue streams. In addition, our relationships with our customers extend far beyond the length of any given contract. For example, some of our customer relationships extend back over 40 years and our top ten customer relationships average 28 years.

We serve customers in numerous industries and carry a wide variety of cargos, mitigating our dependence upon any single customer or single type of cargo. Our customer base is broad with no significant concentration by customer or type of cargo shipped. During 2005, our ten largest customers comprised approximately 32% of total revenue, with our largest customer accounting for approximately 7% of total revenue. Total revenue includes transportation, non-transportation and other revenue.

Business Operations

Operations Overview

We oversee our operations in all three non-contiguous Jones Act markets and Guam from our headquarters in Charlotte, North Carolina. Our operations in these markets share corporate and administrative functions such as finance, information technology and sales and marketing. Centralized functions are performed primarily at our headquarters and at our administrative facility in Dallas, Texas.

We book and monitor all of our shipping and logistics services with our customers through HITS, our proprietary ocean shipping and logistics information technology system, which provides a platform to accomplish a shipping transaction from start to finish in a cost-effective, streamlined manner. HITS provides an extensive database of information relevant to the shipment of containerized cargo and captures all critical aspects of every shipment booked with

 

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us. In a typical transaction, our customers go on-line to make a booking or call, fax or e-mail our customer service department. Once applicable shipping information is input into the booking system, a booking number is generated. The booking information then downloads into other systems used by our dispatch team, terminal personnel, vessel planners, documentation team, logistics team and other teams and personnel who work together to produce a seamless transaction for our customers.

Our dispatch team coordinates truck and/or rail shipping from inland locations to the port on intermodal bookings. We currently purchase all of our required rail services directly from the railroads providing such services through confidential transportation service contracts, other than in the case of services provided by CSX Transportation, which are obtained through our contract with CSX Intermodal, an affiliate of CSX Transportation. Our terminal personnel schedule equipment availability for containers picked up at the port. Our vessel planners develop stowage plans and our documentation teams process the cargo bill. Our logistics team reviews space availability and informs our other teams and personnel when additional bookings are needed and when bookings need to be changed or pushed to the next vessel. After containers arrive at the port of loading, they are loaded on board the vessel. Once the containers are loaded and are at sea, our destination terminal staff initiates their process of receiving and releasing containers to our customers. Customers accessing HITS via our internet portal have the option to receive e-mail alerts as specific events take place throughout this process. All of our customers have the option to call our customer service department or to access HITS via our Internet portal, 24 hours a day, seven days a week, to track and trace shipments. Customers may also view their payment histories and make payments on-line.

Operational Excellence

As the leading Jones Act shipping and logistics company, we pride ourselves on our operational excellence and ability to provide high-quality service. Highlights of our operational excellence and high-quality service include:

Effective Vessel Maintenance Strategy. Our management team adheres to an effective strategy for the maintenance of our vessels. Early in our nearly 50-year operating history, when we pioneered Jones Act container shipping, we recognized the vital importance of maintaining our valuable Jones Act qualified vessels. Led by a retired Coast Guard senior officer, our on-shore vessel management team carefully manages all of our ongoing regular maintenance and drydocking activity. We maintain our vessels according to our own strict maintenance procedures, which meet or exceed U.S. government requirements. All of our vessels are regulated pursuant to rigorous standards promulgated by the U.S. Coast Guard and subject to periodic inspection and certification, for compliance with these standards, by the American Bureau of Shipping, on behalf of the U.S. Coast Guard. Our procedures protect and preserve our fleet to the highest standards in our industry and enable us to preserve the usefulness of our ships.

Vessel Maintenance and Operating Expertise. The quality and performance of our vessels is driven by the expertise of our on-shore vessel management team and vessel crews. The 22 senior members of our on-shore vessel management team responsible for all of our ongoing regular vessel maintenance and drydocking activity have an average of over 10 years of experience with us or our predecessors and have an average of 28 years of experience in the marine industry. Twelve members of this team are licensed chief engineers, and, of the six members of this team who are responsible for assessing the severity of a vessel problem, four are retired U.S. Coast Guard officers who spent their earlier careers in commercial shipping safety and two are members of the American Bureau of Shipping. The senior officers on our vessels (masters and chief engineers) have an average tenure of over 16 years and we actively

 

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share best practices among our vessel crews to ensure consistently high standards throughout our organization. During each of the last four years, our vessels have been in operational condition, ready to sail, over 99.8% of the time when they were required to be ready to sail.

Terminal Operation Efficiency. We have substantial terminal management expertise, as reflected by our rapid turn around time for the drop-off and/or pick-up of containers by truckers, at the terminals which we operate. This efficient terminal management results in lower costs per container load. Rapid vessel turns also result in higher customer satisfaction by ensuring timely pick up and delivery of cargo. We operate our own terminals in Alaska, Hawaii and Puerto Rico and contract for terminal services in our seven continental U.S. ports and in Guam.

Inland Shipping Expertise. We have extensive capabilities for the dispatch of empty containers to customer sites and the movement of loaded containers by rail or truck between customer locations and terminals. This expertise enables us to cost-effectively fulfill customer expectations with regard to equipment availability, transit time and cargo pick-up and delivery. In addition to inland rail and trucking, we offer comprehensive warehousing and logistics services through our proprietary trucking operations in Long Beach/Los Angeles, Oakland and Tacoma and our relationships with third-party truckers and railroads.

Information Technology Capabilities. All of our shipping and logistics services are booked, tracked and traced through HITS, our industry-leading ocean shipping and logistics information technology system with cargo booking, tracking and tracing capabilities significantly beyond those of the systems employed by our competitors. HITS has its roots in a global shipping and logistics information technology system developed in the late 1990s to support the global shipping and logistics operations of Sea-Land, which, until the sale by CSX Corporation of its international ocean shipping business, was a global leader in the shipping industry. Following that sale, we focused on the further refinement and development of the portions of this technology that were integral to our Jones Act shipping and logistics services. HITS is the product of these efforts.

HITS is a client/server based application accessible through the Internet that is designed to capture detailed cargo information at the time of booking through the creation of a detailed tracking and tracing plan which is established based on cargo movement identified at the time of booking. Through multi-carrier/operator connectivity, operational shipment data is then updated into the tracking tool on a real-time basis. This provides 100% visibility to comprehensive cargo information thereby enabling decision-making related to a shipment. HITS has a built-in alert engine that is used by shippers and internal associates to alert users of deviations from the original trip plan to allow for proactive correction to ensure timely shipment deliverables.

HITS incorporates what we believe to be best-in-class technology and supports global standards. HITS allows us to extend our applications to our customers. For example, if a customer wants our sailing schedules on its website, it can directly obtain them, eliminating the need to manually obtain or update such information. In addition, we can extend all of our applications in a similar manner from booking though invoicing of freight. This ability will eventually allow us to replace a significant portion of the electronic data interchange that occurs with our customers today. This extension of our applications allows us to become tightly integrated within commercial supply chains of companies that are building the next generation of planning, procurement and just-in-time inventory systems. We believe this capability can position us as a leading transportation, logistics and information provider in the future. The new technology embodied in HITS also allows us to react more quickly to our changing business needs and those of our customers. We can respond to these constantly evolving requirements at a significantly lower cost than had our applications been built in a legacy environment.

 

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We believe this system compares favorably to other systems in the industry, which tend to be based on legacy applications that do not offer HITS’ level of sophistication. Further, HITS adheres to domestic and international standards for data transfer and translation and has been developed on a platform that follows generally accepted industry and technology standards. HITS is fully scalable to handle current business plus volumes much greater than we manage today. HITS can accommodate all major channels of communication, (i.e. telephone, Internet, voice response, radio frequency identification devices (referred to as RFID), electronic data interchange (referred to as EDI), wireless, etc.). We have also made available to our customers, through HITS, automated cargo booking, tracking and tracing so our customers can reduce their labor time and costs with respect to these activities. Our competitors do not have a comparable cargo booking, tracking and tracing system for their customers.

Customer Recognition and Awards. Our track record of service and operational excellence has been widely recognized by some of the most demanding customers in the world. For example, Wal-Mart named us as its 2005 Jones Act Carrier of the Year (the fifth time we have received this award over the last six years for which the award has been given), Lowe’s awarded us with its 2005 Gold Carrier Award for the fifth straight year, and Toyota recognized us with its Logistics Excellence for On Time Performance award for the seventh consecutive year and with its Logistics Excellence Award for Customer Service for 2005. These and numerous other accolades reflect our commitment to serving customers in a professional and timely fashion.

Vessel Fleet

The table below lists our vessel fleet, which is the largest containership fleet within the Jones Act markets, as of June 25, 2006. Our vessel fleet currently consists of 16 vessels of varying classes and specification, 15 of which are actively deployed, with one spare vessel typically available for dry-dock relief.

 

Vessel Name

  

Market

  

Year

Built

   TEU(1)   

Reefer

Capacity(2)

  

Max.

Speed

   Owned/
Chartered
  

Charter

Expiration

Horizon Anchorage

   Alaska    1987    1,668    280    20.0 kts    Chartered    2-Jan-15

Horizon Tacoma

   Alaska    1987    1,668    280    20.0 kts    Chartered    2-Jan-15

Horizon Kodiak

   Alaska    1987    1,668    280    20.0 kts    Chartered    2-Jan-15

Horizon Fairbanks(3)

   Alaska    1973    1,476    140    22.5 kts    Owned    —  

Horizon Navigator

   Hawaii & Guam    1972    2,386    100    21.0 kts    Owned    —  

Horizon Trader

   Hawaii & Guam    1972    2,386    100    21.0 kts    Owned    —  

Horizon Pacific

   Hawaii & Guam    1980    2,407    100    21.0 kts    Owned    —  

Horizon Enterprise

   Hawaii & Guam    1980    2,407    150    21.0 kts    Owned    —  

Horizon Consumer

   Hawaii & Guam    1973    1,751    170    22.0 kts    Owned    —  

Horizon Spirit

   Hawaii & Guam    1980    2,653    100    22.0 kts    Owned    —  

Horizon Reliance

   Hawaii & Guam    1980    2,653    100    22.0 kts    Owned    —  

Horizon Producer

   Puerto Rico    1974    1,751    170    22.0 kts    Owned    —  

Horizon Challenger

   Puerto Rico    1968    1,424    71    21.2 kts    Owned    —  

Horizon Discovery

   Puerto Rico    1968    1,442    70    21.2 kts    Owned    —  

Horizon Crusader

   Puerto Rico    1969    1,376    70    21.2 kts    Owned    —  

Horizon Hawaii

   Puerto Rico    1973    1,420    170    22.5 kts    Owned    —  

(1)   Twenty-foot equivalent unit, or TEU, is a standard measure of cargo volume correlated to the volume of a standard 20-foot dry cargo container.
(2)   Reefer capacity, or refrigerated container capacity, refers to the total number of 40-foot equivalent units, or FEUs, which the vessel can hold. The FEU is a standard measure of refrigerated cargo volume correlated to the volume of a standard 40-foot reefer, or refrigerated cargo container.
(3)   Formerly known as the Horizon Expedition. Serves as a spare vessel available for deployment in any of our markets.

 

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On September 12, 2005, Horizon Lines acquired with available cash, for $25.2 million, the rights and beneficial interests of the sole owner participant in two separate trusts, the assets of which consist primarily of the Horizon Enterprise and the Horizon Pacific, and the charters related thereto under which Horizon Lines operates such vessels. Title to each of the two vessels is held by the respective owner trustee of the relevant trust for the use and benefit of the owner participant and the vessels are subject to a mortgage securing non-recourse indebtedness of the respective owner trustees. Horizon Lines charters each vessel from the relevant owner trustee. By acquiring the beneficial interests of the owner participant of each trust estate, Horizon Lines obtained the right to the corpus of such estate remaining after required payments on the aforementioned indebtedness are made. Further, upon the repayment of such indebtedness at maturity on January 1, 2007 Horizon Lines will be able to obtain title to the two vessels from the respective owner trustees and terminate the charter. The outstanding indebtedness secured by a mortgage on the Horizon Enterprise is $2.3 million and on the Horizon Pacific is $2.2 million. Under U.S. generally accepted accounting principles, the effect of Horizon Lines’ purchase of the beneficial interests of the owner participant is that the vessels are reflected as assets on Horizon Lines’ books and records and the related indebtedness is reflected as a liability thereon. Hence, for purposes of this prospectus we have often referred to such vessels as owned. Charter payments that repay such indebtedness are reflected as interest expense or a reduction in liabilities, as applicable, depending upon whether such payments reduce principal or interest on the indebtedness.

New Vessels and Related Agreements

In April 2006, we completed a series of agreements with SFL, and certain of its subsidiaries that will enable us to charter five new non-Jones Act qualified container vessels, each with a capacity of 2,824 TEUs, and capable of a service speed of up to 23 knots, and referred to herein as a “new vessel.” The new vessels are currently being built in a South Korean shipyard pursuant to contracts between the shipyard and various third parties, referred to herein as the new vessel “sellers”. We expect to take delivery of these new vessels as follows:

 

Vessel

       

Expected
Delivery Date

Horizon Hunter

   November 2006(1)

Horizon Hawk

   March 2007

Horizon Tiger

   March 2007

Horizon Eagle

   April 2007

Horizon Falcon

   May 2007
  
  (1)   Upon delivery, this vessel will be sub-charted to a third party pending the implementation of our vessel deployment plan starting in the first quarter of 2007.

These new vessels are expected to be deployed, over a five-month period starting in the first quarter of 2007, on our trade routes between the U.S. West Coast and Asia and Guam. This deployment will enable us to redeploy Jones Act qualified active vessels to certain capacity constrained routes, such as our routes between the continental U.S. and Puerto Rico. The greater TEU size of the new vessels relative to the vessels in our current fleet is expected to result in significant operating efficiencies. Upon the deployment of the new vessels over the above five-month period, the redeployment of such Jones Act qualified vessels, and the shifting of certain older vessels to our standby fleet, the average age of an active vessel in our fleet, will be reduced from 31 years to 20 years.

Our contractual arrangements with SFL and its subsidiaries include an Agreement to Acquire and Charter to which Horizon Lines is a party and pursuant to which SFL and its

 

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subsidiaries are required to acquire the new vessels from the sellers and then charter them to Horizon Lines. SFL Holdings has entered into five separate memoranda of agreement with the sellers pursuant to which the new vessels will be acquired from the sellers following their completion. Upon the delivery of each vessel to SFL Holdings by the applicable seller, SFL Holdings will transfer the vessel to one of its wholly owned subsidiaries, each of which is referred to herein as a “SFL shipowner.” In connection with each such transfer, the transferred vessel will be reflagged as a U.S. vessel and bareboat chartered by the applicable SFL shipowner to Horizon Lines.

The bareboat charter for each new vessel is a “hell or high water” charter, and the obligation of Horizon Lines to pay charter hire thereunder for the vessel is absolute and unconditional. The estimated aggregate annual charter hire for all of the five new vessels is approximately $32.0 million, based on certain assumptions with respect to final vessel price and applicable interest rates, which will be adjusted on the delivery date of each vessel. Under the charters, Horizon Lines is responsible for crewing, insuring, maintaining and repairing each vessel, as well as for all other operating costs with respect to each vessel. The term of each charter is twelve years from the date of delivery of the related vessel, with a three-year renewal option exercisable by Horizon Lines. In addition, Horizon Lines has the option to purchase all of the new vessels following the five-, eight-, twelve- and, if applicable, fifteen- year anniversaries of the date of delivery at pre-agreed purchase prices. If Horizon Lines elects to purchase all of the vessels after the five- or eight-year anniversary date, it will have the right to assume the outstanding debt under the Fortis credit facility (which is described below), and the amount of debt so assumed will be credited against the purchase price paid by it for the vessels.

In order to facilitate our charter of the new vessels, our contractual arrangements with SFL and its subsidiaries include various agreements that support the obligations of SFL and its subsidiaries to the sellers under the memoranda of agreement and the syndicate of bank lenders led by Fortis Capital Corp. that is providing the debt financing for the acquisition. In order for SFL Holdings to partially secure its performance obligations, during the pre-delivery period, to the sellers arising under the memoranda of agreement, SFL Holdings has delivered to the sellers security deposits consisting of $11.0 million in cash (from sources other than us) and letters of credit (from sources other than us) in an aggregate amount of $25.5 million. The letters of credit have been issued pursuant to a credit facility provided by the syndicate of bank lenders to the SFL shipowners to finance, in part, the acquisition of the new vessels, which facility is referred to herein as the “Fortis credit facility.”

Pursuant to the Agreement to Acquire and Charter and the Reimbursement Agreement, we have agreed to reimburse SFL, SFL Holdings and the SFL shipowners for all their respective losses if SFL Holdings, as the buyer, defaults under the memoranda of agreement, except for losses that result from (i) an event of default by any of the SFL parties under the transaction documents among the SFL parties and Horizon Lines, (ii) the gross negligence or willful misconduct of any of the SFL parties, or (iii) a failure by any of the SFL parties to satisfy any term or condition of the Fortis credit facility relating to them or to matters within their control, unless such default or failure is due to an act or omission of Horizon Lines. The losses subject to such reimbursement are not limited and would include the forfeiture of the security deposits made by SFL Holdings pursuant to the memoranda of agreement, the amounts of any damage claims made by the sellers against SFL Holdings under the related memoranda of agreement (to the extent that such claims exceed the related security deposits), the reimbursement obligations of SFL and its subsidiaries with respect to any draws under the letters of credit issued under the Fortis credit facility (as well as any interest or other liabilities related to such letters of credit thereunder), and any interest-rate swap breakage fees that arise in connection with the Fortis credit facility. SFL Holdings also has the right, under the Agreement to Acquire and Charter, to

 

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