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Executives

Jim Storey – Director, IR & Corporate Communications

Chuck Raymond -- Chairman, President & CEO

John Keenan – President, Horizon Lines

Brian Taylor – President, Horizon Logistics

Mike Avara – SVP and CFO

Analysts

Peter Wahlstrom – Goldman Sachs

Kevin Sterling – Stevens Inc.

Chaz Jones – Morgan Keegan

Horizon Lines, Inc. (HRZ) Q3 2008 Earnings Call Transcript October 24, 2008 11:00 AM ET

Operator

Good morning, ladies and gentlemen, welcome to the Horizon Lines Third Quarter 2008 Earnings Results Conference Call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator instructions). This conference is being recorded today, Friday October 24, 2008.

I would now like to turn the conference over to Jim Storey, Director of Investor Relations and Corporate Communications. Please go ahead, sir.

Jim Storey

Thank you, operator, and good morning, everyone, and welcome to Horizon Lines third quarter 2008 conference call.

With us this morning are Chuck Raymond, our Chairman, President and CEO; John Keenan, President of our Liner Company; Brian Taylor, President of our Logistics Company; and Mike Avara, our Chief Financial Officer. Also on hand with us in the room are John Handy, our Executive Vice President and Catherine Walsh, our Vice President and Control.

Our call today will be conducted in the normal manner. Chuck will provide an overview of the quarter, John will then review our shipping operations followed by Brian, who will discuss our logistics business, Mike will then walk you through the financials and Chuck will provide some further commentary before opening the call to questions.

Before we get started I would like to draw your attention to our Safe Harbor statement and remind everyone that on today's call, management will make certain forward-looking statements that it believes to be a reasonable at this point in time. Actual results could differ materially from those projected today due to known and unknown risks and uncertainties. A discussion of factors that might affect future results is provided in our filings with the SEC and we encourage you to review them.

Now let me call -- let me turn the call over to Chuck Raymond. Chuck?

Chuck Raymond

Thank you, Jim, and welcome everyone to our third quarter earnings conference call. I'll start out by providing a brief overview of the quarter, our accomplishments, our challenges and the environment that we face. By now I hope everyone's had a chance to review our third quarter press release and the attachments that detail our third quarter performance.

Despite few challenges our Horizon Lines associates continued to perform. In both our liner and logistics businesses we served our customers well, reserving a growing key relationships. We posted third quarter earnings of $0.53 per share on an adjusted basis.

We grew our revenue 3.1% during the quarter net of fuel and we generated solid cash flows, which we used in part to pay down debt, and to continue to make selective advance -- select -- selective investments in our Puerto Rico and Honolulu marine terminals and as made an advance payment on the crates that we have purchased for the future.

We ended the quarter on solid financial ground, with strong liquidity, well within the financial covenants of our revolver, and solidly positioned to continue to execute our

business in what increasingly looks to us to be an extended period of economic uncertainty.

As you know, tourism is a major driver of the Hawaiian economy. And while we expect the tourism to weaken in line with the second half slow down here and in Japan, I don't think anyone expected or projected the sudden softening that Hawaii saw in the past quarter and it continues now.

As a result, we reduced our volume expectations in that particular trade lane, certainly for the rest of the year, and probably through much of 2009 as well. And it's a key reason that we've turned a little more cautious on our outlook for the full year.

I want to make two key points about the operating environment which we find ourselves today. First, I fully expect that our countries financial dilemmas will continue to send economic shock waves not only across the United States, but throughout the globe, well into 2009, and even possibly beyond.

Secondly, one point on fuel costs. While crude prices moderated somewhat during the quarter, the average price for fuel that we use was still about 82% above what we had paid a year ago. Our per ton purchase costs of fuel are just now starting to fall.

Looking back at the third quarter, our financial results were negatively impacted by volume declines in Puerto Rico and in Hawaii. Puerto Rico's weak economy continued in the quarter and the trade lane also was impacted by five major hurricanes and several tropical storms.

Alaska held steady as did Guam. Our performance was (inaudible) by rate improvements, mixed improvements, cost controls, and exceptional schedule reliability despite the weather issues that plagued others.

Briefly, on the DOJ investigation of the carriers in the Puerto Rico trade, as you know, I can't comment specifically on this situation other than to tell you that our company will continue to cooperate as the investigation moves forward.

Today, we have a strong team in place in our Puerto Rico business unit and we're continuing to serve our customers with the high level of service that they have come to expect from Horizon Lines throughout the 50 years we've served that market.

Today, our company is well-positioned to continue serving our customers in all of our trade lanes for the following very solid reasons.

First, we've aligned ourselves with successful leading brands like Wal-Mart, Costco, Walgreens and Safeway in the retail sector, like Lowe's and Home Depot in the home improvement area and like Johnson & Johnson and Amgen in the biotech and pharmaceutical space.

We provide all of our customers with a high level of service and on time performance, which is ever so much important to them in these tough economic times. This, of course, translates into strong customer relationships and a fortified enduring brand preference for Horizon Lines.

Secondly, we're largely in the business of providing the basics within our trade lanes. We talk about food, clothing and shelter. And I said before -- I'll say it again, delivering these goods in three different geographies makes Horizon Lines not recession proof by any means, but certainly less exposed than others might be in a recessionary environment. Consumers in our trade lanes depend on us for the necessities that sustain and improve the quality of their lives.

Third, we are financially sound. I can't stress this enough. Our business generates strong cash flows. We're using these funds primarily to pay down debt and although leveraged the cost of our debt is low, and the majority is fixed. We also remain highly liquid and we have no recapitalization needs here at Horizon Lines until at least mid 2012.

Just one last point before I turn the call over to John. We managed our business for the long-term, and as I said earlier, I don't believe that this unstable economic environment will blow off us off course.

Our logistics business is a key component of our long-term growth strategy, and as Brian will share with you in a few minutes, our logistics business is serving more and diverse customers and we're seeing the business develop organically from within, which is the way we intend to grow it going forward. Acquisitions at this particular time are not on the table and probably won't be for the foreseeable future.

Now, I'll turn the call over to John Keenan who will take you through our line of business. John.

John Keenan

Thank you, Chuck, and good morning, everyone. I will be walking you through our third quarter line operations starting with review about trade lanes and taking a look at volume, unit revenue and vessel performance trends. I will conclude with updates on the labor and legislative areas affecting our business, as well as a quick review of our cost efficiency and coast wide shipping initiatives.

As a company I feel we operated very well in increasingly difficult environment during the third quarter which was impacted by the weakening overall economy. Even with this, we continued to align our sales with successful growing customers. We maintained strong on-time arrivals and we continued to identify and implement cost savings initiatives across our organization.

I am starting review of our trade lanes on Page 7 with a look at Alaska. Alaska was definitely the strongest of our free trade lanes during the third quarter. The economy in Alaska continues to be buoyed by high oil prices and recent boost in oil production taxes. This has resulted in a record budget surplus on the order of $2.6 billion this year.

Every year, Alaska pays each resident a special dividend based on oil revenues, and this year was a record payout of more than $3,200. This dividend was paid out late in the third quarter and into the fourth quarter, pumping an estimated $2 billion into the hand of the Alaska consumers who in turn have been spending it on everything from basic goods to furniture to cars and HD TVs. Another 33,000 Alaskans are expected to receive a total of about $350 million from the Exxon Valdez settlement possibly later this year. The economy certainly has received a boost and that has helped our northbound project.

The third quarter southbound (inaudible) volumes were fairly strong which is expected at this time of year. As we look out on the Horizon we continue to focus on expanding relationships with meeting, brand name, retail customers that are expanding in the state. Retail sales per square foot are very high in Alaska, about double the average in the Mainland US so it's a very attractive market for retailers.

We are also focused on on-time service and vessel utilization both to ensure timely delivery of the needed goods and staples for Alaska consumers and make sure we're serving these markets as cost efficiency (inaudible).

As we discussed in the last quarter we have purchased three new cranes with the Port of Anchorage, which is undergoing a major multi-year expansion effort. Those cranes are due to arrive in 2010 when the port is complete we expect to be able to handle more cargo more efficiently.

Turning to slide 8 on Hawaii, Hawaii certainly challenges in the third quarter, but we think it proved challenging for everyone a result of the sharp drop off in tourism that caught everybody off guard. Tourism accounts for about 1/3 of Hawaii's economy and 1/3 of its jobs it was a major economic driver.

The University of Hawaii Economic Research Organization is now projecting the number of visitors to Hawaii will drop 9% from a year ago. That's nearly double the decline projected just over three months ago. As recently as April, the number of visitors was projected to increase this year so that's quite a turned about. Newspaper headlines coming out of Hawaii are saying that Honolulu is in a recession and the state is teetering close to one.

Residential and commercial construction is softening as well, partially offset by construction related to privatized military housing. We also need to take into account that this latest downward revision of visit or expectations made in mid-September just before the global financial crisis erupted and that's a great majority of Hawaii visitors are from the US Mainland and Japan, so we believe it possibly get worst before it gets better.

We're staying as close to our customers as we can in this environment, focusing on securing high margin business with major brand name retailers. As I just mentioned one bright spot in Hawaii is construction related to the privatized military housing that we're anticipating in that.

Guam remain fairly steady in the third quarter, the big jump projected in military spending for relocation of U.S. troops from Oakland [ph] to Guam is expected to occur in 2011. But in the meantime other military projects are stable and volume in trade lane has been steady.

Looking at Puerto Rico on slide 9 the economy continues to stagnate. Unemployment and inflation are both in double-digits. Economic growth has declined in the past two years and expected to show another decline through mid-2009.

The recent turmoil in the financial markets also impacting the Puerto Rico government, which lost hundreds of millions of dollars in the market value on its investment funds during the Wall Street melt down in the past weeks.

The polls for the November elections still show the pro-business reform candidate, Louise Portelance [ph], leading by a wide margin. He is running on a platform to drive economic growth with strong support from the private sector. Despite the ongoing -- or excuse me, the outlook for ongoing economic weakness in Puerto Rico we continue to operate with strong mutual loyalty between our company and our customers in the third quarter we celebrated 50 years of service to the island.

Our new team in Puerto Rico is focused on providing reliable, on-time service while at the same time finding ways to serve the market and our customers in the most cost efficient manner. The economic environment is challenging. We're seeing some good business wins including an uptick in our export recent loads that previously moved by air.

Now I would like to review our volume starting on slide 10. Our volume declined by 3,000 containers in the third quarter from last year, that's a 4% decrease year-over-year. This was primarily due to the continuing recession in Puerto Rico and sharp slow down in Hawaii. The Puerto Rico trade lane was also hit by two tropical storms and three hurricanes during the quarter, which additionally impacted volumes there and our Trans-Pacific service was impacted by two (inaudible).

On a piece of positive news out of Puerto Rico, however, is we just completed bidding on our critical annual reefer contract in which we won 19 out of 20 contracts we were seeking, with one still pending, that's very encouraging news for us.

Alaska southbound volumes in 2008 were hurt by the 28% quota reduction in Pollack. We're expecting the 2009 quota to be released in '09 -- excuse me in early December.

Despite the third quarter volume decline we believe our overall market share held relatively steady and as noted on slide 11 we were able to achieve a 3.1% revenue increase when you exclude fuel. This 3.1% revenue increase was a combination of rate improvement and commodity mix.

Reefer [ph] volume was flat during the quarter relative to a year ago, but our strategy on focusing on higher margin product in both reefer and dry goods container continue to payoff, evidenced in the rate improvement.

Turning to slide 12 we're very proud of our overall vessel performance in our ability to maintain 92% on-time even with seven storms during this quarter. At the same time, we're able to maintain a strict discipline of fuel consumption, on our vessels and as you recall, when we talk about on-time, we measure our ships to the minute.

In terms of maintenance and vessel availability I'll compare our ships to any in the industry, unlike many operators, we own our ships which means we take really good care of them, so our vessels are available and ready to sale at a rate of 99.9% which is consistent with our past performance.

Capacity utilization was at 66% in the quarter, down from 75% a year ago. The difference reflects both increased capacity, resulting from our addition of our TP1 vessel last year, the redeployment of our fleet we made it to those TP1 vessel and slowing volumes in some markets mostly related to the economy. In terms of capacity, we're very well positioned for future growth. We're also looking at every way possible in this economic environment to increase utilization and reduce costs.

Now let me review our EDGE initiative on page 13. The best way to describe EDGE is that it's a culture of continuous improvement that we've ingrained into our entire organization through process and system efficiency. We launched in the spring of 2006 and contributed to both financial and intangible benefits across key business functions at Horizon Lines. We're glad we implemented EDGE when we did using EDGE we have clearly placed ourselves in a better position to both manage cost through this economic slow down and to accelerate opportunities when economic conditions improve.

Turning to slide 14, our coastwise initiative continues in the planning stages. We have a team in place that is forging the strategic alliances with Lava [ph] port authorities in Marriott [ph] and building the customer pipeline necessary to profitably operate this coastal shipping program. Launching Coastwise will depend on compliance of these factors which in turn will be heavily impacted we believe by the evolving economic conditions in 2009.

On slide 15, one very positive factor regarding our coastwise shipping is we expect passage of the harbor maintenance tax exemption in 2009, that is good by part in support on capital held partly due to convergence of high fuel cost, highly congestions and environmental concerns.

Regarding Title XI funding, the Federal ship construction loan guarantee program is continuing at the $5 million level through next March. We encourage by language in a continuing resolution that direct $48 million more for the program, that's an impressive funding level which would support $750 million to $1 billion in new ship construction.

Let me give you a quick update on unionized labor as noted on slide 16 the agreement with ILWU on the west coast was completed and ratified in the third quarter. With little or no freight flow disruptions we don't have any other contracts expiring until 2010, but negotiations are expected to begin mid-December with the ILA International Longshoremen's Association covering workers on the east coast and gulf.

Before turning the call over to Brian I'd like to leave you with these closing thoughts. The challenges in our trade lanes intensified during the quarter but we operated well achieving a 3.1% revenue gain net of fuel on a combination of commodity mix and rate improvement.

Our best of long time performance remains very high despite a very challenging weather conditions. We continued to work hard to control costs, to operate our vessels efficiently, and serve our customers well regardless of the economic challenges facing us.

With that, let me turn the call over to Brian.

Brian Taylor

Thank you, John. Good morning, everyone. I'd like to begin by reviewing the progress we've made in developing our logistics brand focusing specifically on some of our business wins our infrastructure development and our future growth plans. I'll conclude with a brief review of our financial results for the division before I hand this over to Mike.

I'm now on slide 18. I'm very excited about the progress of our business. I now have a strong leadership team in place. We've created a solid infrastructure foundation. And we are seeing some nice wins with our customers. The logistics investments that we've made in people and technology over the past year have positioned us for growth without any immediate need for future acquisitions or significant capital spending going forward.

When we started Horizon Logistics in 2007 we really weren't anticipating the stiff economic head winds we have faced as this year has progressed. Throughout this challenging business client we've focused on growing our business we are now beginning to see success in terms of an increasing and more diversified customer base.

We have continued to enhance our sales platform, fine tune our infrastructure and we have further articulated a growth -- our strategic growth plan which I'll share with you shortly.

Looking at our third quarter progress on slide 19 we continued building a diversified pipeline of customers in our chosen market segments. The photograph accompanying this slide is a major solar power project the Nellis Air Force Base just outside of Las Vegas.

Earlier this year Horizon Logistics moved closed to 200 truck loads of solar panels and supporting infrastructure to this job site. We played an instrumental role in the evolution of this one project, and now have two additional solar power projects we are handling for the same customer.

From the installation of wind turbines in Times Square to the movement of a large piece of mining equipment to an open pit mine in New Mexico, our company is serving a growing diversified number of customers who depend on us to get their merchandise onsite, on-time and intact.

We recently finalized our transition to a single integrated technology platform for logistics. This change allows us to more effectively operate our business, giving supply chain visibility to our customers, and it also provides a system wide cost visibility for each shipment creating a more coordinated approach to the way we price and the margin we generate in our overall business.

Organizationally, we've continued strengthening the sales force and we recently re-located our west coast operation to new facility in Los Angeles will provide an ability to take on larger assignments for our customers.

Slide 20 provides an overview of our strategic focus over the next three years. Much of this past year has been laying the foundation for future growth, and this plan demonstrates where we are heading. What we've created four lines of business that support our vision to become a premier logistics provider leveraging our sea freight expertise and developing a North American integrated logistics offering.

Our service offerings are designed around four customer segments and the real beauty of this plan is it's purely an organic growth strategy that leverages our existing liner relationships and complements, and competencies and requires predominantly human capital investments going forward.

As you'll see on slide 21, entering the international NVOCC business has become a key part of this strategy. First, it allows us to feed our logistics infrastructure with little investment in additional physical assets. Second, it allows us to leverage our core competencies including our existing customer relationships and our sales expertise. And third, it expands our growth opportunities to a global trade environment that is driving demand for multi-modal international service providers.

Through our existing infrastructure much of the required back office support and technology is already in place. I think it's important that I stress the asset light nature of this venture. It really requires no investment in ships, containers, chassis or other equipment. We're third party international freight holder, which means we can participate in this space while avoiding many of the pricing battles initiated by asset base international carriers trying to fill their capacity.

In late September, we received our FMC license as an international NVOCC. Since then we've recruited some new leadership talent, established a relationship with a significant offshore agent and we're targeting a December '08 launch for the service.

Looking at our results for the third quarter on slide 22 you can see we generated $50 million in revenue, EBITDA negative for the quarter. Like most other transportation providers we have experienced some softening in demand due largely to the economy, but we are also growing in more diversified base of customers and expect to continue seeing nice wins in our chosen customer segments going forward.

In summary, we're upbeat about the future prospects for our logistics business. We see the potential inherent in our truck brokerage operation and the developing international NVOCC business. While we know we must continue to content with the softening economy we remain confident we have a strategic platform in place to move forward with our organic growth plans.

With that I'll turn this over to Mike.

Mike Avara

Thank you, Brian, and good morning, everyone. I'll start with on page 24. Revenue for the third quarter grew nicely, up $31.5 million or 9.8% over 2007. Operating revenue for the first nine months jumped by $99 million, or 11.1% versus last year.

Page 25 provides more information on the factors that drove the increase in revenue. In the third quarter revenue for container grew by $441 or 12%. That's reflect in both higher fuel cost recovery and rate mix improvement, totaling $31.5 million.

Aero Logistics and Hawaii (inaudible) contributed a net $5.9 million for increased revenue from these two acquisitions back in 2007. These positive factors more than offset the $11.1 million adverse impact of a decline in volume of about 3,000 loads or 4%, primarily in Hawaii, Guam and Puerto Rico.

For the nine months, rate per box increased by $371 or 10.2%. And it's again reflected in both improved fuel surcharges and higher rates, totaling $71.8 million. Acquisitions accounted for $26.5 million of the $99 million revenue increase, a $19.8 million volume decline of about 5,500 loads, or 2.5%, Puerto Rico, and Hawaii, Guam, partially offset these revenue gains.

Operating income results on page 26 are adjusted to exclude anti-trust related legal fees of $4.6 million in the quarter, and $7 million through nine months. The nine months numbers also exclude the severance expense of $800,000 that you may recall from the second quarter.

Adjusted operating income declined by $8 million or 25.2% in the third quarter, largely due to the volume decline that we have spoken about, $10 million impact from that, and a higher shortfall on our fuel recoveries $6.5 million negative. Now these two factors were partially offset by the rate net of fuel increase that we referenced and that added $7.4 million to operating income.

Nine months adjusted operating income fell by $16.8 million or 22.5%, primarily as a result of the volume decline, about a $12.2 million impact from that. That's the lease expense from our five new ships for full year, $8.2 million higher, mitigated somewhat by the rate net of fuel improvement for nine months also totaling $3.5 million.

Adjusted EBITDA reflects on Page 27 declined $8.6 million for the third quarter and $19.1 million for nine months, now the same factors in testing adjusted operating income also affected adjusted EBITDA.

Turning to net income in order to present results on a comparable basis net income has also been adjusted on page 28 to exclude the antitrust legal fees and severance expense in 2008 that I referred to, as well as in 2007 a loss on extinguishment of debt of $38 million in the quarter, and $38.5 million for nine months. A deferred tax evaluation benefit of $4.8 million in the third quarter and $7.3 million through September 2007, which also excluded to present the results on a comparable apples-to-apples basis.

Adjusted net income of $16.2 million in the third quarter was $4.5 million lower than 2007. That's a $2.3 million interest expense savings partially offset the $8.9 million decline in adjusted operating income. Our refinancing last August combined with falling interest rates and debt repayments have enabled us to reduce our lending cost of debt from 8.8% last year before the refinancing to 4.3% over the last year.

Nine months adjusted net income of $28.1 million with $7.1 million behind that of last year. The adjusted operating income short falls $16.8 million, more than offset the savings from a lower interest expense, which totaled about $8 million.

Adjusted diluted EPS on page 29 declined $0.08 or 13.2%. When reduced net income I just referenced but also benefitted from lower share count. As a result of the 3.8 million shares repurchased between August of 2007 and January of this year, our average diluted shares outstanding have declined to 30.2 million shares from 33.8 million shares in the third quarter of 2007. Adjusted diluted EPS fell by $0.11 or 10.7% for the nine months as the lower net income more than offset the reduced shares outstanding.

Pre-cash flow presented on page 30 of $6.8 million, for the nine months was $58.1 million improved over the first nine months of 2007, and let me walk you some of those primary factors. First of all, last year, we did two acquisitions, HSI and Aero Logistics, added $32.1 million total purchase price.

We also have lower vessel lease payments this year, about $21 million. You might recall that we had a $40 million mid-term balloon payment on our three Alaska vessels in January 2007 which was about double the normal payment we made on January 1st of this year.

Working capital consumption was improved by $15.6 million, primarily as a result of a focus on accounts receivable. It yielded the majority of the savings. And you might recall in 2008, in January, we paid a bonus payment to the bonus earned in 2006, that is not in the numbers this time, so that added a positive $10.5 million. Now all these positive factors were mitigated somewhat by the EBITDA shortfall of $19.2 million.

Turning to liquidity, credit facility compliance and capital structure on page 31. We were in a fortunate position having ample liquidity. We are very comfortably in compliance with our credit facility. Financial covenants have a low interest rate on our debt, and no recapitalization needs until August of 2012.

We've had nearly $90 million liquidity at the end of the third quarter. A voluntary additional revolver payment of $12.5 million was made during the third quarter. You might recall that we made a similar payment of $10 million in second quarter. Already in the third quarter, we've made an additional voluntary payment of $5 million on our revolver, so we continue to pay down debt.

Credit facility compliance, our interest coverage ratio of 4.47 times was significantly higher than required 3.5 times minimum at the end of the third quarter. Our senior security leverage ratio at 1.99 times was well under the 3 times maximum.

Turning to capital structure, our opportunistic refinancing last August and timely interest rate swap on our term-loan this April has resulted in an excellent capital structure. 74% of our debt is fixed through maturity in 2012 and a small piece in 2013, and again our average interest rate is below 4.4%.

Our 2008 financial guidance is reflected on page 32. We're reducing our guidance due to the historic financial crisis and resulting increasingly difficult economic environment, which has adversely impacted volumes in both Puerto Rico and especially Hawaii.

We've decided to retain a larger than typical $10 million EBITDA range for this time of the year. We feel that it's prudent in light of the extremely difficult and rapidly changing economic environment to allow for some production on the downside just in case things are even worse than currently expected and we do have the current expectations reflected in these numbers.

So we are hopeful that we can come in at or near the high end of the range but we thought it was appropriate to build in some downside protection because of the historic and uncertain times we're going through. I would remind you guidance is adjusted to exclude an estimated $10 million in antitrust legal fees in 2008.

Just quickly on page 33, you see the liner, EBITDA of $127.4 million, big contributor. Logistics, Brian touched on a negative $2.4 million projection for 2008.

I want to walk you through some of the major assumptions that we utilized in our guidance and as John spoke to many of these have changed drastically in just a couple months, two or three months since we last spoke to you.

You will note that we have significantly tempered our volume assumption in light of the deteriorating US economy, significant downturn in Hawaii due to a sharp contraction in visitors and a weak construction sector and a lack recovery in Puerto Rico from (inaudible) recession is now approaching three years.

Total volume is now projected to slip to 3.1% versus 0.4% that we had expected back in July. However, unit revenue, net of fuel is a good news story. This improved by 0.6% to 2.2% for the year as we secure some higher payment freight in the fourth quarter.

We've also included projections on a trade lane drivers that we evaluate. Alaska GST remains very healthy at a 5% increase. Hawaii visit revivers have declined sharply, and Puerto Rico GDP had slipped further. Alaska [ph] prices are estimated at $515 per ton in the fourth quarter and you should remember that we actually expense fuel that we purchased in the previous months so we're not enjoying in the fourth quarter in terms of expense, all the reduction in bunker prices that have occurred at this point in time.

I just want to quickly remind you on page 35 with some new accounting win convertible notes. Basically, the new accounting requires that the interest rate existing on other non-convertible debts, this would be other than our convertible notes at the time the issuance of the convertible notes be reflected in the income statement.

Now this of course is higher or was higher back in August of 2007, somewhere in the neighborhood of about 8%. So convertible debt is recorded on the balance sheet under this new accounting at a discount, reflecting the lower coupon rate that accretive up to par value using the higher non-convertible borrowing rate so almost like your home mortgage amortization. The announcement is effective for fiscal year 2009 and must be retrospectively applied to prior periods.

Page 36 provides the retrospective and prospect impact required new accounting for convertible notes. Again, I would remind you that the additional interest expense is non-cash and does not at all impact true economic of the convertible notes nor are very successful refinancing last August.

To wrap up we delivered good results in the face of a growing financial crisis of really historic proportions we haven't seen such a tough time probably since the '30s and resulting in increasingly difficult economic environment. The compound matters, fuel prices were highly volatile during the quarter with oil prices first rising to historic high and retreating sharply. However, bunker prices were very slow to react to the falling oil from its peak when bunker finally did fall we promptly reduced our fuel surcharges in the cost.

We are intensely managing costs, searching for opportunities to selectively grow revenue, conserving cash and paying down debt. Although the severity and duration of the (inaudible) prices and economic turmoil cannot be predicted Horizon Lines stands well positioned to weather the storm. Going into 2009, we're expecting a deep and protracted U shape recession and preparing a quarterly, while of course, hoping for a shallow and quicker typical V shaped recession.

So with that I'll turn the call back to Chuck Raymond to wrap up. Chuck.

Chuck Raymond

Thanks, Mike. And kind of building on some of the points that John made and then Brian made here, on the economy, and on our business, first of all, our company is in the midst of a very challenging economic environment and it's impacting everyone.

As I think about it, and what's very clear from this discussion is that we're very well-positioned both financially and operationally to continue to make progress despite this environment. And while at the same time positioning our company for the long-term value creation that we have been able to provide in the past.

Secondly, our plan in this environment is to intensely focus on what we do best. And that's to provide excellent service to our customers, preserve our brand reputation, and to build our business for the long-term and generate solid cash flows. Again, so that we are positioning to capitalize on growth opportunities when economic conditions do improve.

And then lastly, the fundamental investment considerations for our company really haven't changed. We remain a leading domestic ocean shipping company, serving as a economic lifeline, linking Puerto Rico, Alaska, Hawaii and Guam to the continental U.S.

We continue to cultivate durable lasting partnership with the nation's leading brands, protecting strong market shares, and the related cash flows that are derived from that. And our logistics platform, as Brian mentioned, offers us a very sound platform for organic expansion, and long-term growth of our company.

And with that, we're ready to take questions.

Question-and-Answer Session

Operator

Thank you, sir. We'll now begin the question-and-answer session. (Operator instructions). And our first question comes from the line of Peter Wahlstrom with Goldman Sachs. Please go ahead, sir.

Peter Wahlstrom -- Goldman Sachs

Good morning.

Mike Avara

Good morning.

Chuck Raymond

Morning, Peter.

Peter Wahlstrom -- Goldman Sachs

Given kind of your outlook for slowing US economy, have you considered adjusting your ships schedule more temporarily taken vessels out of service in any of these markets to really better align capacity with near-term demand?

John Keenan

Yes, Peter, good morning, this is John Keenan. Yes, we have. As we constantly look at our markets as well as our vessel utilization. We've evaluated specifically in Puerto Rico. We've looked at our service, our gaks [ph] vessel and our gak service and at this time we still think it's a right, right time to keep that vessel in, however, we put in place triggers and areas where we figured if or see that if the volumes fall below a certain level, that we'll, we'll implement a change in that service. We've also evaluated our Hawaii service, and have looked at the two major strings that we operate. The peck string and a search [ph] string, and look at we've changed departure schedules to have better fuel conservation and reduce some of our costs as well our cost in our terminals. So we are looking at that and put in place some triggers if the volumes continue to deteriorate.

Peter Wahlstrom -- Goldman Sachs

Okay. And following up on that, can you give us a broad sense of what sort of magnitude volumes might have to drop before you consider taking vessel out?

John Keenan

I think, if you look at Puerto Rico, Peter, the gulf is our smaller market there, so in that market, I would say, the volumes have to drop at least probably 15% before we pull a vessel out, and in Hawaii, we're still evaluating that.

Peter Wahlstrom -- Goldman Sachs

Okay. Fair enough. I realize that you're facing near-term challenges in Hawaii market. But taking a step back and looking may be at prior cycles, does Hawaii tends to lag at U.S. economic recovery, or does history or maybe your experience in this region show otherwise?

Brian Taylor

I'll be happy to take that one. This is Brian Taylor speaking. Peter, I believe that the Hawaiian economy tends to lag the U.S. economy, and historically, as we look at what happened back in the '90s in 2,000, the impact to the Hawaiian economy tend to follow what happened in the US Mainland. So we'll probably see this continue a little bit beyond the recovery that we might see in the US Mainland.

Peter Wahlstrom -- Goldman Sachs

Okay. Thanks. And then quickly, you provided a fairly bleak realistic outlook for 2008, for the fourth quarter where operating margins could come close to, if not become zero. How much of this cost should we really attribute to seasonality in the quarter versus general weakness, and the end markets as we kind of think ahead to 2009 and a tack on to that is, in your fourth quarter guidance range from an EBITDA standpoint what's implied in terms of volume on the low-end and also the high-end for the quarter? Thanks.

Mike Avara

Hey, Peter, this is Mike, good morning. I'll take that for you. As you recall, our fourth quarter is, one of our weaker quarters, first quarter is our weakest. We had good volumes going into the, say, first half, till right around Thanksgiving time then they drop off pretty rapidly as things obviously get difficult in Alaska. So we do have a lot of seasonal costs and reduce volumes that hit us in the second half of the year -- second half of the quarter, I'm sorry. But really the reason for reduction and the guidance and the broad range and the 125 in the point of the range is just the uncertainty out there right now. We haven't looked at things changing very, very rapidly where in historic times we just really thought it's prudent to give a broader range and more downside protection. In terms of the volume assumptions, we had on the low-end 7% down and on the high-end probably about a 5% down on an overall combined basis from our current projections.

Peter Wahlstrom -- Goldman Sachs

Okay. Thank you very much.

Mike Avara

Thank you.

Operator

Our next question comes from the line of Kevin Sterling with Stevens Incorporated. Please go ahead.

Kevin Sterling -- Stevens Inc.

Good morning, gentlemen.

Mike Avara

Good morning, Kevin.

Chuck Raymond

Good morning, Kevin.

Kevin Sterling -- Stevens Inc.

Just probably a question for Chuck, and the rest of you guys, it seems like you're committed to using your free cash flow to pay down debt, which is a good thing. But would you consider buying back your stock at current levels?

Chuck Raymond

Well, that's a good question. And as we had done some stock buy backs in the past. At this point in time we think it's more prudent to pay down debt, and continue to pay down debt. And then that will be our focus for the next, let's say 90 days to 120 days as we kind of see our way through this current economic dilemma that we have, Kevin.

Mike Avara

Kevin, I would just add to that. As a reminder the way we pay down debt we're paying our revolver, so if things turnaround, and improve significantly, we always have the ability to borrow, actually the next thing on the revolver, and to potentially do other things.

Kevin Sterling -- Stevens Inc.

Okay. Thanks a lot. And just kind of following up about 2009, and I know you guys probably can't give specifics, but I was wondering if you can talk a little bit about how you're thinking about next year, and I realize you may not be able to go into much detail, but if you offer some color I think that would be helpful.

Chuck Raymond

Let me take that. Kevin, we're going to be cautious about 2009. We don't like the fact that we have missed our guidance here on a couple of times in the past year or so. And I believe we're going to be very comfortable within our guidance for the fourth quarter. So you're probably going to see us be a little more cautious with regard to our forecast going forward, but this is the way we're looking at it. Number one is that we're going to have an intense focus on cost in our company. We're going back using the EDGE tools and examining everything we do and we're doing that today.

Secondly, we're going to continue to have a very strong focus on our vessel assets. The question was asked by Peter Whalstrom, would we take capacity out of one of our trades, that's clearly an opportunity we have. We have not removed capacity in our Puerto Rico trade as an example in the last six years. And, in fact, we've added a little bit of capacity with the new vessels we have in that trade. That being said, we have about a 66% utilization there, so should that market come back and when it comes back, and it will, we've got the operating leverage to improve. But in the short run, we've got the ability to pull tonnage out should we need to do so.

I think also that in terms of, of customer service, you're going to see us intensely focused on servicing our customers. Here's the reason why. In this economic environment, they demand that. We have to help them get their materials from the distribution centers in the U.S. to the shelves of the stores in the markets that we're serving. And they want reliable, on-time service. So they can reduce the cost of their inventory in transit that ties up their working capital and as we know right now, working capital is something very hard to borrow, if you do, you have to borrow it at very, very high expenses. So our approach in going to -- in summary is going to be excellent service to our customers, watch our cost and preserve our free cash, make sure we have a good cushion so we wouldn't run into any economic extremities.

Kevin Sterling -- Stevens Inc.

Thanks, Chuck. That was some good color. Let me -- you talked about utilization on your ships at 66% in Puerto Rico, is there a threshold where it has to tip below where you would pull out one of your vessels?

John Keenan

Kevin, as you know, that 66% number, we put it, put two ships in the Puerto Rico service which we knew had excess capacity when we did our TP1 implementation, we put the two CAs, we also put some 48-foot capability on those ships, so those two ships are the backbone of the service, it's more the gulf service that we would look at and perhaps the northeast, but right now, the utilization on the services are where we expect them to be and they are contributing to our profitability.

Kevin Sterling -- Stevens Inc.

Good. Thanks John. When looking at your military business particularly out of Guam, is this, is it still fairly steady for you guys?

John Keenan

Kevin, yes, it is. As I indicated on the call earlier, that the Guam volumes are steady, you would see are the building materials move and a lot of the material in support of the build up coming to the move, where they move from the marine coming from (inaudible) in 2011, so it's Guam has been steady.

Chuck Raymond

Kevin, I just also build on that and say that we'll probably see a little slopping in the tourism in Guam same as we're seeing in Hawaii, so overall that market is going to be down a little bit. But notary [ph] construction and that construction is associated with the military build up is going to help tremendously to offset that weakness.

Kevin Sterling -- Stevens Inc.

Okay. Thanks. And on one last question, do you guys expect any antitrust legal fees in 2009?

Mike Avara

Kevin, we do. Most current estimate that we have from our attorneys is somewhere in the neighborhood of what we have projected for 2008 of $10 million. And obviously, managed those prudently, make sure that all the -- the work is being done, but we of course, get guidance from that work and manage those cost closely.

Kevin Sterling -- Stevens Inc. Okay. Thanks, Mike. Gentlemen, thanks so much for your time today.

Mike Avara

Thank you, Kevin.

Operator

Thank you. Our next question comes from the line of Chaz Jones with Morgan Keegan. Please go ahead.

Chaz Jones – Morgan Keegan

Hey, good morning, everyone.

Mike Avara

Morning, Chaz.

Chaz Jones – Morgan Keegan

I wanted to ask about pricing just in terms of, it seems like, given your guidance that, that volumes are falling, pretty rapidly here. Could you maybe give us some kind of sense for what type of volume fall off we would need to see for pricing to turn negative? I mean, considering that it's still positive at this point?

Chuck Raymond

Well, let me take that one for a minute, if you would. This business has been in the past one where there have been a couple of companies that have struggled and have gone out of business. The most recent one of course, was back in 19 -- rather 2002 would now be as in Puerto Rico. I think the carriers in the trades today realize that going out in a, in a defined market, and slashing rates to try to earn more volume is really a zero sum gain, so I don't think that people would do the irresponsible things there. That being said, there could be a little decline in rates as costs come down. I mean, we know that fuel right now is turning down and this morning, crude oil was done at $63 or $64 a barrel. It's about half of what it was four months ago. And of course, surcharges are going to come down, and vessels will be more efficient as a result. So there could be some tempering of rates as a result of that. We are however seeing rates hold up.

John mentioned the Puerto Rico trade and our reefer contracts that we've negotiated for 2009, and I believe John if I'm not mistaken we've got rate increases in every one of those contracts, so we haven't seen that phenomenon and we don't expect to see it. However, should that happen, we do have the ability to pull tonnage out, and as John mentioned, just the cost of one vessel in the Puerto Rico trade is in the range of $22 to $24 million a year to operate, so we have an ability to respond to that. On the other hand, if we had to get into a, into a battle to fight for market share, we've got plenty of time on a capacity to fight that battle, so on balance I think we're in pretty good shape there. I don't see any indications that we're going to end up in a rate war here.

Chaz Jones – Morgan Keegan

Okay, that's helpful, Chuck. Thanks. And then lastly, I just when I back into the guidance, and I know you guys don't give specific fourth quarter guidance, but obviously we can do the math with, with the full year guidance, just kind of the back of the envelope calling for a $0.25 loss to roughly $0.03 in EPS, obviously, I understand, we're in a very challenging environment. Seasonally, it's a weaker type quarter, but also the fact, my sense is the first quarter, you're probably not going to get much of a change in terms of seasonality or that type of outlook, so I guess my question is, I recognize on slide 31 you guys put a lot of effort into explaining the liquidity situation. I mean, if we were to over the next several quarters get into a type of environment where you come in at the low end of that guidance. Are you going to be able to continue since those metrics on 31 are on a trailing 12-month basis to maintain that, that liquidity in those debt covenants if we kind of hit this worse case scenario?

Mike Avara

Hey, Chaz, it's Mike. I'll take that one. As you might imagine, we have done a lot of contingency planning as we look at the situation. And obviously hoping for the best here, would have prepared for the worst so we have a series of actions that we would undertake if necessary to maintain liquidity and conserve cash. I mentioned before for the third quarter in a row now, already in the fourth quarter we have paid down $5 million of revolver debt, that helps us a couple ways. It helps us on the amount of debt outstanding on the leverage ratio and also reduces interest expense, so it helps us on a coverage ratio. We hope to be able to pay down some more debt in the fourth quarter. So we're keenly aware of these measures, we track them almost every day. We still have plenty of room at this point in time, and we'll take all steps necessary if things turn even further south to protect them.

Chaz Jones – Morgan Keegan

Okay. No, that's helpful. And I figure that's where you guys are making that kind of commentary that you are about holding on to cash. I guess is there a scenario, if it plays out like I had just mentioned over the next couple quarters, kind of a worst case scenario, it would seem to me that it would be difficult for you guys to remain free cash flow positive in that environment. Am I looking at that wrong or could you help me out on that at all?

Mike Avara

Free cash flow in the first quarter is usually low as you know. But we start to build cash very quickly starting around April, and that continues through November. When we do our 2009 budget, and we are in the midst of that season, we'll carefully look at all of our measures at each of the quarter reflection points and have, like I said, plans ready to takeoff the shelf if we need to protect liquidity and those ratios.

Chuck Raymond

I just had a couple comments on that, Chaz, as color, and of course, we do have a rather aggressive CapEx program that we've been pursuing over the last few years, so we have the discretionary ability to cut back on that in almost all the areas where we're investing right now. Secondly, of course, we are paying a dividend and we intend to continue to pay a dividend, that's an outlay of about $3.3 million per quarter if I got that right. And then also if we have a sustained economic dilemma here, I think you can expect a couple of things that will happen. Number one is I believe that you'll see a further stimulus program come out of the house in a sense and we'll be testing the law that as you know last time did include Puerto Rico so that might help one of our markets. I believe that if we have a continued economic problems that fuel will continue to moderate down in price, and of course, that's a very large portion of our variable expense. And we've done a very good job of managing that, but because of high fuel costs of managing all the other costs in our company. So I think we're pretty well positioned in the event that the economy does come down, our costs come down along with it.

We talked a little bit about the Exxon Valdez settlement up in Alaska which is a help. I'd also caution people not to worry too much about the impact of low at well fuel cost in Alaska. The dividend payment that John Keenan mentioned on this year is calculated on the basis of a five-year running average so we have the year 2008 in that formula now going forward for the next four years, so the outlays from that fund will continue to be fairly extraordinary. And then lastly, as we mentioned we can pull ships out. We can pull them out of service, we also have five idle vessels right now, which in worst of cases we can turnaround and scrap if we had to. So there are a lot of alternatives that we had. We had done that contingency planning. We feel very comfortable with that. In fact, that's why we feel comfortable showing you a little lower guidance, even though it might cause you a little concern. We want you to know that we can deal with that, and honestly, we're not going to fall outside of our guidance, so let me just wrap it up by telling you that.

Chaz Jones – Morgan Keegan

Okay. Great. I appreciate all the commentary guys and nice performance there in the third quarter.

Chuck Raymond

Thanks, Chaz.

Operator

Thank you. Our next question is a follow-up question from the line of Peter Wahlstrom with Goldman Sachs. Please go ahead, sir.

Peter Wahlstrom -- Goldman Sachs

Thanks very much. Could you actually share a little bit more about maybe your container mix and which areas continue to hold up well, such as maybe reefers and others that remain under pressure?

Mike Avara

Yes, Pete. Earlier in the presentation I described our overall rate improvement about 3.1%. Okay. And we said that our reefer volumes had remained flat year-over-year, and that's the reefer volumes maintained flat despite declining volumes in two of our trades, predominantly in Hawaii and Puerto Rico, so our reefer mix is good which we continue to focus on higher margin cargo, but the volume fall off of 3,000 containers that we discussed earlier is predominantly made up of Hawaii and Puerto Rico, with Puerto Rico being the lion share of that.

Peter Wahlstrom -- Goldman Sachs

And I'm sorry. I'm also thinking about it from maybe a content of the container perspective maybe it's from housing or I know that autos are pretty (inaudible).

Mike Avara

-- segments.

Peter Wahlstrom -- Goldman Sachs

Yes, exactly.

Mike Avara

Okay. If you look at the housing segment that's softening in all three markets, so you see the housing, predominantly housing and consolidated are two major segments that fell off, Peter.

Peter Wahlstrom -- Goldman Sachs

Okay. And lastly what sort of visibility do you have into your freight forwarders and third party business segments, is there meaningful margin difference for your freight forwarding business?

Mike Avara

Well, Peter, we have fair visibility. It's not perfect, but I don't think anybody has perfect visibility right now in this economic environment. We have a sales team is actively engaged with our customers and out on the street and working through our forecast with us. And obviously our forecasts are only as good as our consolidated agents telling us, but we continue to try to work on ways to improve that visibility. That being said, with the consolidated we feel we have very good visibility from our retailer, the big box guys.

Peter Wahlstrom -- Goldman Sachs

Okay.

John Keenan

The other thing to, to recall, Peter, is we don't move automotives. We move very few autos and I know everyone else in the market is seeing that segment down significantly. We're fairly isolated from that automotive sector.

Peter Wahlstrom -- Goldman Sachs

Okay. Thanks.

Operator

Thank you. I do not show any further questions at this time. Please continue.

Chuck Raymond

Okay, gentlemen, thank you very much. And we will look forward to visiting with you again on January 30th, which is the date we intend to have our fourth quarter earnings release at this time. I wish you a good day and let's hope that the, let's hope the market returns here --

Operator

Ladies and gentlemen, this concludes the Horizon Lines, Inc. third quarter 2008 earnings results conference call. You may now disconnect.

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