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Horizon Lines, Inc. (HRZ)

Q1 2008 Earnings Call Transcript

April 25, 2008 11:00 am ET

Executives

Mike Avara – SVP and CFO

Chuck Raymond – Chairman, President and CEO

John Keenan – President, Horizon Lines, LLC

Brian Taylor – President, Horizon Logistics, LLC

Analysts

John Chappell – JP Morgan

Peter Wahlstrom – Goldman Sachs

Kevin Sterling – Stephens Inc.

Chaz Jones – Morgan Keegan

Operator

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Horizon Lines Q1 2008 Fiscal Year Earnings Results Conference Call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator instructions) This conference call is being recorded today, Friday, April 25th of 2008. I would now like to turn the conference over to Mike Avara, Senior VP and CFO. Please go ahead, sir.

Mike Avara

Mary, thank you. Good morning everyone and welcome to Horizon Lines' first quarter 2008 earnings release call. Thanks for joining us today. Joining me in Dallas are Chuck Raymond, our Chairman, President and CEO; John Keenan, President of our Liner Company; Brian Taylor, President of our Logistics Company, Catherine Walsh, our VP and Controller; and in Charlotte John Handy, our Executive Vice President.

Our call will be conducted today in the normal fashion. Chuck will provide an overview of the first quarter, John will review the Shipping operations, Brian will take you through our Logistics business and I will wrap up with the financial review, and we will conclude with a Q&A session.

Before we get started, I must turn your attention to our forward-looking statement on Page 3. During this call we will be making certain forward-looking statements and although we certainly believe them to be reasonable at this point in time, we obviously can provide no guarantees that they will actually come to pass. There are a number of risk factors that could cause actual results to differ materially from our projections and I suggest that you review our filings with the SEC for a description of these risk factors.

So, with that I will now turn the call over to Chuck Raymond. Chuck?

Chuck Raymond

Mike, thank you and good morning. Thank you for joining us on the call today. Our highlights for the first quarter of 2008 are the following. First of all, our business is fundamentally healthy. Revenues, as you will see from the 10-Q and from the PowerPoint presentation, are up about $32 million over the first quarter of 2008. That's about 12% increase in revenues. Now, a part of that is fuel of course, which is a major cost for us and the cost of fuel during the first quarter are up some 46% over the same quarter of 2007.

With this recession that we are in and the continuing softness in the markets, nevertheless, our business volume is close to flat to the first quarter of '07 rather over the first quarter of '07, down right around 1%. Most of that, of course, as you might imagine, in the Puerto Rico trade lane. We still earn growing volumes from our key customers. Critical brands out there to us and very renowned customers such as Walgreens, Wal-Mart, and Sam's, Costco, Lowe's, Target Stores. These are all very, very successful retailers and the businesses that make up our customer list and our volumes with these customers continue to be impressive.

During the quarter our volume was impacted by a lack of a Puerto Rico recovery and also by severe weather not only in Alaska but in the Pacific Northwest. That was an anomaly that we believe will not repeat during the next three quarters particularly in Alaska and we expect to make up a big portion of that here as we go forward.

However, the Puerto Rican economy is one that we still have some questions about and that will be dealt with more by John Keenan who has been working on that matter along with our management team. Schedule integrity and fuel conservation actions and surcharges have tempered the volatility of fuel costs in our P&L. We've had another 3% improvement in our arrivals and our on-time reliability of our fleet. That's I think is incredible, particularly with the weather we've had and with the very cautious approach we are taking on burning fuel on these vessels.

During the first quarter and throughout 2008 we will continue to invest in our terminals. Our CapEx this year, as you see, is about $28 million, probably half of that will be on our terminals, and maybe the other 40% or 50% related to our vessel fleet and containers. So the company continues to invest in the infrastructure of the entity.

Our Logistics business has scored some impressive wins over the last quarter. Heinz brands, Michelin tires, McDonald's, just to mention a few and Brian will take you through those. We are excited about that ramping up. And then finally, once again, Horizon is recognized by one of the premier shippers in this business, Wal-Mart, our 6th Carrier of the Year Award from Wal-Mart since the company came out from under CSX and Sea-Land in the year 2000.

The outlook for 2008, as I mentioned the Puerto Rican economy is recovering, but we think that is not going to recover are we are not sure it's going to recover to a level that we would have hoped, and that's reflected in our guidance going forward. We want to make sure that we are appropriately representing that. The fuel price volatility, everybody expects that to persist. We can't predict what's going to happen to fuel. Pretty much everybody believes it's going up, has been going up, and we have reflected that in our forecast as well.

In Alaska, there has been a reduction in the Pollock quota. That impacts us principally in our export volume that we handle out to Asia on Maersk line vessels. As you know, we are their agent in Alaska, so the terminal handling cost that we incur for that, the process that we built into that as well as the earnings by being Maersk's commercial agent in that state impacts us because of that Pollock quota reduction. Not a hung issue, but we thought we ought to mention it.

There in the state of Alaska as well as in Hawaii and Puerto Rico too, our business is fundamentally sound and is still poised for future growth. I believe that the vessel deployment changes that we made in 2007 are going to serve us well going forward as these markets come back.

Market diversification. You know the fact that we are in Alaska and Hawaii and Guam and Puerto Rico really is one of the company's strengths. not only from a marketing standpoint, but also because we look at Alaska today as a very solid economy, Hawaii, and Guam basically stable, not going down, not taking off like a wildfire, but still doing well. And Puerto Rico, going through difficulties there, but when you average it all out, Horizon Lines, I think we can look you straight in the eye and tell you we are recession resistant in this company, and I think our revenues and our EBITDA generation stand behind that.

Our EDGE project, which we spent a lot of time talking with you about in 2006-2007 is here and serving us well. The culture of the company has really changed, and EDGE is no more really a special project for us, it's really our culture. And the tools that we've built and developed and the approach that our people are taking with EDGE is ingrained in our spirit every day here.

I might take just a minute and comment about the Department of Justice investigations into the Puerto Rico trade. We are one of four carriers that have been asked to turn over documents there. The company has not been charged. No individual of the company has been charged with any offense. We will obviously continue to cooperate fully with DOJ on this. And we certainly don't expect any service disruptions to come about as a result of this.

Let me just take a second on Page 7 and talk to you about what we consider in the company as a season of opportunity for us. And what we have tried to do here is array on the left side kind of the convictional wisdom that companies apply in times of stress, and how Horizon is doing with these things. In today's environment of a questionable economy, rising fuel costs, and the obvious impact on trade volumes, I thought it was important to help differentiate ourselves from conventional wisdom, which, you know, most companies would say now is the time to downsize people. Our approach is not that. Our approach is to invest in people. We believe that the team we have here at Horizon, the key people right on down to the entry level folks with our company are the best in the business. And so we continue to invest in training, we continue to invest in providing those folks with the right EDGE tools that we talked about as opposed to simply laying people off.

In the area of services, many companies would take this as an opportunity to reduce their services. In our case, we are focused on increasing our service levels. You will see that by our taking on higher standards. Our on-time arrivals of our vessels. Cutting out errors. Using the EDGE projects to provide a better quality product to our customers. This is where Horizon is focused.

You might ask us to reduce vessel speeds to conserve fuel. Well, our customers can't have that. Our customers in these countries of Puerto Rico and the states of Alaska, Hawaii, and Guam rely on schedule integrity. There's not a lot of warehousing capability there and the land that would be used for warehousing is quite dear. So, we have a very strong focus on maintaining schedule authority, getting out of port on-time, getting into port on-time, and on the inland factors, making sure that our pick-up and deliveries are on schedule. In that regard, the tools that we've built in the past today serve us very, very well.

You might avoid reinvestment. We are not doing that. As I mentioned, we are reinvesting in container assets, in cranes in our key facilities, and in providing better capacity in Hawaii, Puerto Rico, and Alaska for future growth. Companies would divest weakness. What we do is address our weakness. We have built a sales pipeline of accounts that we believe will be with us. We have continued to look at our deployments and make sure that we are doing the right thing without degrading our service to the community.

Companies struggle for liquidity in tough times. In our case, we have great liquidity. We are going through a review right now of our cash flows, and as you can see from our guidance, the cash flows of this company are still very, very impressive. We did lock-in our interest rates, as you know, and we did a share repurchase in the first quarter.

People tend to distance themselves from the community. Our employees almost down to the person are very, very engaged in their local communities. They are active everywhere, and we certainly are not backing away from that obligation that we feel we have. Horizon will not retreat in this environment. We are 'Always There, Always Delivering.' We have improved reliability, and improved reputation with our shippers.

With that, let me turn this over to John Keenan who will take you through our Liner business. John?

John Keenan

Thank you, Chuck. On Page 9, Alaska economic outlook. As you know, the high oil prices in the states of Alaska buoy the economy. As a matter of fact, Alaska has some excess state revenues unlike a lot of other states in the lower 48. The job growth is projected for the 20th consecutive year about approximately a thousand new jobs in the healthcare and professional services areas. The fishing quotas, as Chuck touched on, there has been a reduction in the Pollock quota, which we have factored into our forecast going forward. In the railbelt, the construction remains strong and that construction coincides with some of our customer, the big box retailers, Lowes, Wal-Mart, and Target.

The gas pipeline, I think you've seen recently, it's the Denali Group $30 billion, a project between Conoco and BP, and there's going to be – they plan to spend $600 million over the next three years on the planning and engineering and permitting for this gas pipeline. So, we are very optimistic about the state of Alaska.

On Page 10, Hawaii, Guam, economic outlook. We have the Hawaii GSP, the growth forecasts have been trimmed from 1% down to basically flat. As a result, we have reduced our volumes 1%. That's 2.5% unemployment in the state of Hawaii, as you – the visitor arrival growth we expect to be retained at approximately 1%. Commercial and the military construction are offsetting some of the soft residential and we feel we are very well positioned with our new flat-racks that we put into the Hawaii trade to help move that materials.

And as you know, Guam continues with the military spending, about $1.5 billion annually. Increased construction, especially the project cargo in support of construction, we are well positioned with the first arrival of our vessel as well as the equipment for the Guam market.

The Puerto Rico market, as you know, Puerto Rico has experienced the combination of slow economic growth, high unemployment, rising prices since the second quarter of 2006. So as a result, we've adjusted our volumes down accordingly. We've adjusted our volumes down 2% for Puerto Rico. That being said, there's the fiscal stimulus, the IRS payments that will be coming out in May. There will be, we feel, a short term benefit. That should punch about a billion dollars into the economy. When you look at their overall gross state product, they are about 72.3 billion. We see that as a fairly significant impact. The Government of Puerto Rico has been addressing their fiscal issues, including increasing tax revenues and – as well as reducing expenses within the government. The charges against the governor increase the chance for more pro-growth administration. As you know, election years historically bring increased government spending and support as well as construction spending.

If you look at some of the biomedical investments, there's over 200 million. Look at St. Jude alone it's 200 million over five years. They intend to spend in a creation of over 1200 jobs for that one biomedical investment alone. So, I think on that we see some positive indications of industry and government working together to provide incentives for new investments as well as business expansion.

On Page 12, a little bit about our volume updates in our business. If you look at the bar chart there, you'll see that our container volumes first quarter year-over-year are down 1%. That 1% is driven primarily by contracting volumes in the Puerto Rico trade lane, some of the extreme cold in Alaska that Chuck mentioned earlier tempered otherwise our solid demand that we typically see in the Alaska trade. Our schedule integrity supported the strength of the Hawaii volumes, and I'll touch on that schedule integrity in a minute. And our Guam service was impacted by reductions in the Saipan garment shipments which we had previously in our plan.

On 13, when you look at our rate per container, if you look at the unit revenue, or revenue per box, our unit revenue is up 8.9% year-over-year, quarter over quarter, and about 5% of that, just so you are aware it, is attributed to fuel, but the other increases are general rate increase and contract renewal rate increases that have driven that revenue growth as well as our cargo mix improvement.

When you move to Slide 14 and look at our vessel performance, again we are very proud of this. The vessel on-time arrival, as you know, we time this to the minute. There is not many other carriers in the industry that can say that. From 2007 to 2008, our on-time arrival has improved 3%; we're at 81%. The major improvement in this area has been Hawaii Guam trade lane where year-over-year with our new TP1 vessels we've seen a 30% improvement on our on-time arrivals and schedule integrity.

Our vessel availability basically is unchanged year-over-year, and our utilization has dropped from 84% to 83%, and that really correlates to the volume reductions that you have seen and I've discussed on earlier slides.

On Page 15, the investment that we made in our container fleet, you will see that it continues primarily with our dry boxes. In the second quarter of this year, we'll see 1800 new dry boxes. These are high-cube boxes that will continue as part of our fleet enhancement program come into service. And that helps when you look at the numbers below that, the maintenance cost per load, where you see the dramatic improvement. This is a cost comparison for repairing the box, old versus new, and I think the key takeaway here is the reinvestment in our equipment results in obviously lower maintenance expenses going forward. In addition, we have seen a 7% improvement year-over-year of our maintenance expense, which is really driven by a lot of our EDGE processes and our corporate maintenance processes.

As Chuck touched earlier, on the awards and recognition, Page 16, we are awarded one more time the Wal-Mart Jones Act Carrier of the Year, which we are extremely proud of. We have also received the Lloyd's List 2008 Award. That's based on Horizon Falcon. That's our vessel operating in our trans-pacific service, and they received an award for rescue of the Chinese seafarers in 2007, and Horizon Lines joins the SmartWay Transportation Partnership and we earned this highest fuel efficiency as well as environmental performance ratings from the EPA.

On our EDGE update, our first quarter accomplishments, we continue to focus on the top two bullets there. We see the public segmentation, sales tactical planning tools, yield tools, these all translate into better cargo mix, better ability to segment and to serve our key customer groups. We have achieved greater fuel efficiencies and allowed [ph] us with our onboard technology programs that we put on our vessels. As you know, we burn predominantly low sulfur fuel, or fuel that's in the 2% to 2.5% sulfur range below the IMO standards that exist today.

We have reduced crew overtime with our onboard management controls and our EDGE processes, worked on our optimization with our inland empty miles and reducing miles as well as reducing chassis. And I think the key takeaway on this slide is our EDGE processes are ingrained in every aspect in key work stream of our businesses.

Onto our coastwise shipping solution, I think what you see here is our product offering. And if you look at the slide you'll see some networks on the up and down and East Coast and into the Gulf, and our targeted customers here are some of the large liners, large international liner companies that we've targeted as well as domestic markets served by truck and rail, and to offer alternate service options. We show one of our vessels here. As you know, this is one of our vessels that has been freed up based on our TP1 deployment next year, and some of our next step is to finalize the discussions with international carriers and our target customers. Secure passage of the Harbor Maintenance Tax. Negotiate with the ship-board unions and shore-side labor groups and port authorities to come up with favorable economics to hopefully implement this sometime in the near future.

As you are aware, from a labor relations update perspective, we are – we utilized the ILWU on the west coast. The current contract that's due to expire July 1st, we commenced bargaining on March 17th of this year; we started early. We believe that the contract will be renewed with minimal impact, and as well as the IBT. We had our negotiations with the IBT. We are signatory to the National Master Freight Agreement which was ratified, and I think the key takeaway on this slides is that we anticipate no business interruption with both of these agreements and these bargaining units.

So with that, I'll thank you and turn it over to Brian Taylor.

Brian Taylor

John, thank you very much. I'm going to provide you with a quick update on the status of the Logistics Company now that we are seven months into the operation of this new business unit. Slide 21. Where are we today? Aero Logistics, our August '07 acquisition is now really fully integrated into the Horizon Logistics network. 95% of all of the integration work that needs to be done within the organization is now complete. Our newly-formed integrated truck brokerage network is now up and running. We are beginning to see some nice solid wins from this new service offering. Full technology integration is well underway and on track as we expected it to be. We have refocused the technology team really on the development of integrated logistic solutions versus some of the core technology services that we were focused on previously.

Slide 22. Our growth model really remains unchanged from the last time when we spoke. We are obviously continuing to leverage our expertise to deliver value-added services to existing and new customers. We are using the existing expertise that we have in logistics within this organization and we are adding new skills and new resources that are really helping us create greater value for our customers.

The liner customers that we have, have been demanding these services. They have been asking us for these solutions and now in the first six months of the operation of this business we are in a position where we are now starting to deliver some of those solutions. Clearly focused on further integration into our customer supply chains, we are creating some long-lasting relationships and stickiness with existing customers and looking at many new customers to add to the portfolio. Our growth will be driven by obviously some organic growth, but we are well aware that our – a good portion of our growth moving forward will be through future acquisitions.

Just quickly on the acquisition front, it will be a key growth component for us. We have created a team inside of this organization that is helping us refine an acquisition methodology and helping us finalize a list of potential targets that we want to look at going forward. Some of the key criteria that's been identified, obviously, functional alignment with the services that we already have inside of the organization and culture; size and scope of some of the potential targets we may look at; and obviously sticking very close to an asset light model. We are engaging some investment banks and key industry contacts and we are using their expertise to help us round out the list of targets and help us make sure we have the most refined acquisition process to ensure success.

On Slide 24, we have told you early on and talked about really the two distinct sales channels that we have inside of this business. None of that has changed. We are continuing to work on these distinct sales channels and we've added resources in all areas, sales and operations, to position the organization for solid growth. Chuck mentioned early on some of the wins that we have seen. We feel very confident right at the moment that we have a robust pipeline of potential customers that are going to add significant value to this business in '08 and beyond.

One of the key focus areas that we have touched on previously is the area of warehousing and distribution. We have made a great deal of progress in developing our capability in this segment. One of the key facilities that we focused on in the last four months is our facility in Lexington, North Carolina. This is a facility that now is a key raw materials consolidation center for several textile and apparel customers. We have built out a truck brokerage and consolidation business that is really helping us grow our truck volumes in some key specific lanes. We've added technology and support resources to this operation, and we are creating greater economies of scale that are allowing us to take on more business, and helping us build a model that will create sustainable value and also be able to be moved to other locations in the future. Our GPS equipped trailers that we use for this facility as well as the proprietary warehouse system that we've implemented in our network is really helping provide our customers with some real-time visibility and encouraging them to give us an opportunity to handle more of their supply chain process.

One other component that we talked about as a key focus point for us in '08 is our Mexico freight services. Clearly we are expanding our offering in Mexico and over a short period of time we really feel that this initiative is beginning to gain some traction. Our land-based transportation services use the same dedicated GPS equipment fleet that I have touched on earlier. We have moved into a new state-of-the-art 60,000 square foot facility that is secure, safe, and giving us the ability to offer enhanced distribution and even supplier managed inventory processes for our customers. We are positioned to provide the services that really are allowing us to manage the entire Mexico supply chain process for the customers that are working with Horizon Logistics.

Slide 27. Quarter one is traditionally the slowest quarter in our business. Recent economic moderations clearly have impacted our growth with a couple of our main retail customers. You may remember I mentioned to you early on, on the last earnings call that we did intend to add additional resources methodically, add additional resources that would help us support and position this business for future growth. We will see the benefit of those resource additions going forward. Clearly, it's important for us to invest in the resources that are required to build this business out, the people, the technology, the operating resources to serve our customers in the way they expect to be served. At this point, we are very excited about where this business is at, and feel that we can take this company very far in 2008 and beyond.

With that, I'm going to turn this over to Mike to review the financial results. Mike?

Mike Avara

Brian, thank you. I'll start on Page 29 with operating revenue. You can see that revenue was up nicely during the quarter, $32.2 million, or 11.8% over 2007. This is largely driven by the strength of our Hawaii-Guam trade as well as revenue from acquisitions.

Turning to Page 30, a little more color on the $32.2 million increase I just referred to. Revenue per container grew by $320, or 8.9%, and is reflected in both the higher fuel cost recovery as well as the rate improvement that you see here. Our 2000 acquisitions Aero Logistics and Hawaii Stevedores contributed a combined $10.1 million additional revenue during the quarter. These positive factors were offset slightly by the 1% decline in revenue loads primarily in Puerto Rico that John referenced earlier.

Turning to Page 31, you can see that operating income declined by $4.9 million in the first quarter. The increase in operating expenses led by higher fuel expense of $9.4 million and higher vessel lease expense of $6.2 million more than offset the healthy growth in revenue that I referenced earlier. The vessel lease expense, should I recall that we have the five new vessels in place now versus only one in the first quarter of 2007 that we were incurring lease expense on.

EBITDA reflected on Page 32 declined by $6.4 million from the first quarter of 2007. The same factors impacting operating income that I referenced also affected EBITDA.

Looking at adjusted net income, net income declined $2.4 million during the quarter after adjustment to exclude the $2.6 million deferred tax revaluation benefit that was included in the results for 2007. Interest expense, benefiting from our restructuring of our debt, was down $2.2 million over 2007, and also falling interest rates, which we have strategically taken advantage of. Over the last nine months, we've been able to reduce our blended cost of debt to 8.8% to 4.6%, to cut that almost in half. Our fixed-to-floating debt ratio is now at 72% fixed to 28% variable after the execution of our $122 million interest rate swap on March 31st of this year. And that interest rate swap effectively locked in the current $122 million portion of our term loan through August 8th, 2012 maturity at 4.52% with the 3.02% fixed swap rate in our current LIBOR spread of 1.5%.

Turning to EPS, our diluted EPS of $0.07 declined $0.06 from 2007, again, after adjustments removed the one-time deferred tax revaluation benefit of $2.6 million from the 2007 results. We did have two share repurchase programs. You might remember, we acquired 1 million shares as part of our refinancing, and 2.8 million shares during our $50 million repurchase program at $17.82 per share. Those combined repurchases have allowed us to reduce shares outstanding by about 10%, down to 30.8 million shares outstanding this quarter versus 34.1 million shares in 2007.

Turning to free cash flow, even in these difficult times you can see that free cash flow has improved by $14.4 million in the first quarter of 2008. We were helped by the absence of the bonus payment and the vessel lease mid-term balloon payment on our ships in Alaska that you might remember last year of about $25 million. And that more than offset the lower EBITDA. Some increased working capital consumption that will get here and the rest of the year and higher cash interest payments in 2008.

You also note that net cash flow actually improved by $46.8 million for the quarter. The free cash flow increase of $14.4 million contributed to this of course as well as debt borrowings net of repayments of $56.4 million that were utilized to fund our share repurchase program.

Our financial guidance is reflected on Page 36. You will recall that we transitioned to providing annual guidance in the fourth quarter of 2007 really for a couple of reasons. It's better aligned with our long-term approach to running the business and eliminates seasonal and timing difference distortions that sometimes fall into quarterly guidance. So we are reducing our 2008 guidance in reflection of the growing problems in the U.S. economy, continued weakness in Puerto Rico that Chuck touched on, and reduced growth assumptions in some of our other trades that John referenced. Record high oil prices also are having an impact and causing the revision that you see here.

So, based on current market conditions, what are we projecting? Operating revenue at $1.315 billion to $1.350 billion; EBITDA at $145 million to $160 million; diluted EPS of $1.30 to $1.69; and free cash flow of $72 million to $87 million. We have taken our guidance range and expanded it a little bit from our usual range of about $10 million to $15 million to better reflect some of these increased uncertainties in the economy and fuel prices.

On Page 37 we have our segment breakdown of our 2008 projections. Using the mid-point of the guidance you'll see Liner EBITDA forecast at $148.5 million, Logistics at $4 million, and recall that the $176 million revenue elimination reflects services that the Logistics business currently provides to the Liner at point of cost basis.

I thought it was important to walk you through some of our major assumptions in our budgets and forecast and guidance, and you can see the trend has continued from November through April. We've had to reflect obviously on our volumes and to our rates, the change and the deterioration in the U.S. economy and some softening, quite frankly, in our trades. We have engaged in what I consider a very and thorough and robust [ph] forecast process. We have challenged the assumption all of our trade lanes, we've conducted this under various scenarios and Page 38 reflects the resulting forecast assumptions. We are confident that this revised guidance is achievable under at least any reasonably foreseeable circumstances.

So, let me just take a minute and wrap up and try to put things in perspective here. As Chuck mentioned, our business is financially very sound. Our recession-resistant business model is being evidenced by 2008 projection even at these reduced levels close or equal to our 2007 $160 million of EBITDA despite significantly worse economic conditions and higher fuel prices. Horizon EDGE, which Chuck had the foresight and John Handy and the rest of the team to put it back in 2006 when we were operating on all eight cylinders, has really served its intended purpose, it has helped us out here on the cost side when things have been difficult on the revenue side.

We continue to generate very strong free cash flows, both in absolute terms and especially in context for our market cap, and we are poised for future growth when market conditions improve, which they will, with our vessel capacity additions that John referenced. And Brian's Logistics business will, in the future, increasingly contribute to our earnings and our cash flows. So with that, I'll turn the call back to Mary. Mary?

Question-and-Answer Session

Operator

Thank your. Ladies and gentlemen, at this time, we will begin the question-and-answer session. (Operator instructions) And our first question comes from John Chappell with JP Morgan. Please go ahead.

John Chappell – JP Morgan

Thank you. Good morning, guys.

Chuck Raymond

Good morning, John.

John Chappell – JP Morgan

Chuck, I assume that you can't say a whole lot about this price investigation in the Puerto Rico market, but I do have a couple of broad questions on that. First of all, as I'm sure you saw, Alexander & Baldwin put out a press release on last Friday saying that they have been told by the Department of Justice that they'll receive subpoenas for their Hawaii trade. Have you received any notice about potential subpoenas or investigations on the Hawaii and/or the Alaska trades?

Chuck Raymond

John, we've not heard anything about Hawaii or Alaska.

John Chappell – JP Morgan

The other thing is, and I know this is going to be – we are in the very early stages of this, but as you kind of think about best case and worst-case scenarios or the way that this finally plays out, what's really the kind of the worst-case scenario? Are you going to give the numbers, fines, whatever, I know that's too early and you can't tell on that, but is there any way that this investigation could lead to an opening up of competition in some of the trade lanes, the Jones Act trade lanes?

Chuck Raymond

John, I just can't speculate on that, and I wouldn't, I'm sorry.

John Chappell – JP Morgan

Okay. No problem. Question about cash flow use. As Mike said, this cash flow is still pretty strong. You went through your whole buyback program. The stock is about $6 lower than what you purchased it at. Would you look to re-op share buybacks in this type of credit environment as debt repayment become the top priority of uses of cash, or do you maybe want to keep some back for unforeseen events?

Chuck Raymond

Well, John, you know, share repurchase is always something we keep on our radar screen. Clearly, with the stock down where it is right now, we have a much more compelling case for a share buyback. When you look at the cost of our debt and the yield that we would save on this thing, it probably makes sense. But, on the other hand, we've got opportunities to grow this business that are a good long term opportunities, and think that we'll take a good hard look at it. Are we considering a buy back right now? The answer is no. We haven't come to that conclusion. But we will certainly keep that alive as an option.

John Chappell – JP Morgan

Okay. One last one, and then I'll turn it over. As I look at the last slide here, the guidance assumptions and the big dropdowns, 2% every time on Puerto Rico, would you categorize this negative 2% volume growth as basically kitchen sinking Puerto Rico? I mean is this the absolute worst-case scenario, or do you think that still the U.S. economy doesn't bounce back, that there's still some potential downside to this market in a worst-case scenario?

Chuck Raymond

You know, I think we are – you characterize it as the kitchen sink. I think we are close to that. You know, if you go back and kind of review the bidding here for the last year or so, about a year ago, we started to speculate that 2008 could be a turning point for us in Puerto Rico because of the elections. They are still, of course, scheduled for November. There's been a little bit of change down there politically in the sense as I think John mentioned that the sitting governor more than likely will not run for reelection now, so it's likely that you're going to see a new governor in the Porta Lisa [ph].

There is the combination of some excitement about new industrial incentives down there which the legislature and private enterprise have been working very diligently on now for the last several months. Our intelligence is that later this week, or early next week, the legislature will roll out a new industrial incentives up package for Puerto Rico, and I think that's very, very necessary. Also, with something also John mentioned that perhaps people have not heard, is that as a part of the federal stimulus program, the economic stimulus program that was signed into law back in February, that the taxpayers in Puerto Rico, even though they do not pay federal income tax, are all going to get a federal income tax refund, fairly substantial, which will average in a range of I think it's $1200 to $1600 per family. That had occurred before, back in 1991, much smaller at that time, but it had a rather dramatic impact. So if you look at the ledger, on the positive side of the ledger you've got, I think, a very strong coalition between politicians and business people now, very seriously addressing what needs to be done to grow the local economy, married up with some one-time incentives that will help get us through 2008. So there's a little bit of good light there for this year as well as for the future. You know, on the negative side of that ledger is we've sort of seen Puerto Rico slide, slide, slide, and they've had 16% inflation in 2006, something very close to that last year. Those subsidies that caused the inflation have gone away, and the government is addressing the fact that their electricity, $0.24 a kilowatt hour, for example, is just a very, very difficult thing, so they've got to look at things like privatizing their electrical power authority and other state-owned entities in Puerto Rico. So, at the end of the day, this 4 million people down there, a lot of business. We've got a great service reputation there. We've got a tremendous array of assets in that trade, and, again, we want to be very, very cautious on this call because the last thing we want to do is miss this guidance, and so I would say – repeat what you said is, we've just about got to the kitchen sink here.

John Chappell – JP Morgan

All right, thanks a lot, Chuck.

Chuck Raymond

I hope that helps.

Operator

Thank your. Your next question comes from Peter Wahlstrom with Goldman Sachs. Please go ahead.

Peter Wahlstrom – Goldman Sachs

Good morning.

Chuck Raymond

Good morning, Pete.

Peter Wahlstrom – Goldman Sachs

We saw the gross state product assumptions for Hawaii and Alaska. Do you have one for Puerto Rico that you can share just to help us frame that 2% expected decline in volumes?

John Keenan

Pete, I think the most recent information that we've seen from – out of Puerto Rico is zero.

Peter Wahlstrom – Goldman Sachs

Okay. And staying on that same slide, over the last couple of quarters, we've seen downward revision in Alaska, Guam, and Puerto Rico, and this time we have Hawaii stable at 1%. Could you go into a little bit more detail on why you feel more comfortable in this geographic region?

John Keenan

Well, Peter, we feel more comfortable based on what we are seeing and reading and we are hearing from our customer base in Hawaii, Guam. As I mentioned in Hawaii, we feel we are very well positioned with the new equipment that we put in, the flat-racks, the new refrigerated containers, and our alignment with the right customers into Hawaii, although you see a lot of the residential construction is down, the commercial construction as well as the military construction is up. So we are still – that's our position with Hawaii. We still see about a 1%. Now, Alaska, we had forecasted reductions in the Pollock quota, and we are seeing that, and what we are seeing in Alaska is the, as Chuck mentioned, we have terminal services revenue that we generate from our terminal in Dutch Harbor. And based on that Pollock quota and the reductions, we are seeing a reduction in our terminal services revenue, which will show as other revenue, however, the volume growth to Alaska is still strong, it's robust. We hope to see Alaska very consistent.

Peter Wahlstrom – Goldman Sachs

Okay. And actually staying on that Alaska topic, could you give us a sense as to whether it's volume or financial impact related to the weather in the Alaska quarter?

John Keenan

For the first quarter, it was just volume, it's freight that just didn't move in the first period.

Peter Wahlstrom – Goldman Sachs

And can you help us get a – gauge that a little bit? Is it 10 containers, 100 container?

John Keenan

I think the softening is probably more in the neighborhood of 100 containers over the quarter.

Peter Wahlstrom – Goldman Sachs

Okay. And–

John Keenan

I think the –

Chuck Raymond

Just to add on that, this is Chuck, as John and I just finished going through this last night was that we had that softness in the first quarter in our headhaul business to Alaska. We expect to pretty be in our plan in terms of shipments up to Alaska for the rest of the year. Again, the adjustment in our forecast is related specifically to the export fish [ph] that moves on Maersk line. We are the agent for Maersk out there, and this isn't related to our core business.

Peter Wahlstrom – Goldman Sachs

Okay. Shifting quickly to Logistics, Brian, are you still targeting basically a doubling revenue for the next couple of years, and have you seen acquisition multiples coming down?

Brian Taylor

Yes, we believe that it is possible for us, given the right acquisitions, that we could double the size of this business within the next three to five years, Peter. And of course as you know right now with economic conditions as they are there are a lot of opportunities out there for businesses to be identified as attractive acquisition candidates for us based on current multiples.

Peter Wahlstrom – Goldman Sachs

Okay, thanks. And last question for you. With regard to the EDGE program, can you just confirm that it's still on track? And can you share your financial benchmark, whether it's – what has been achieved to date and still remind us of your targets for the run rate by the end of '08?

John Keenan

Peter, this is John, let me take that. When you look at our EDGE forecast, we see some softness in volumes and a piece of our EDGE savings was tied into our sales and marketing, and it was revenue driven. We are very confident we are going to achieve our operational savings that were tied in to our EDGE forecast, which is in the neighborhood of 8.5 million-9 million. The revenue component of that is reflected in our forward-looking guidance.

Peter Wahlstrom – Goldman Sachs

Okay. And by the end of the year then of '08 I think you had talked about 25 million and maybe achieving kind of half of that?

John Keenan

No, I think on this year we were talking about 12 million to 13 million.

Peter Wahlstrom – Goldman Sachs

Right.

John Keenan

Right. And I think that that's – I would say that's closer to 9 million.

Peter Wahlstrom – Goldman Sachs

Okay. Thanks. That's very helpful.

Operator

Thank you. Your next question comes from the line of Kevin Sterling with Stephens Inc. Please go ahead.

Kevin Sterling – Stephens Inc.

Good morning, gentlemen.

Chuck Raymond

Kevin, good morning.

Kevin Sterling – Stephens Inc.

Chuck, you started your prepared remarks by saying you felt Horizon Lines was recession-resistant. What do you mean by that when after – when you just lowered your earnings guidance about 35%? Maybe you could help walk through kind of how you define recession-resistant?

Chuck Raymond

Yeah, thanks – thank you, Kevin. Well, when I look at the why we adjusted our guidance, when you take these chunks of issues that we just talked about, essentially the Hawaii-Guam trade lane looks pretty good to us. Alaska is – basically because we had some weather going up there during the first quarter and the fish quota in one particular gender, that Pollock that goes out to Asia, is not related to the economy, frankly. Puerto Rico, that country has staged [ph] inflation in its rear-view mirror now for over 26 months. And yet our earnings in Puerto Rico are pretty much flat on an EBITDA basis. If you go back to 2005, 2006, 2007, and I recognize that we don't publish those by trade lane because we do have a lot of inter-usable assets there but the way we allocate it out, it's fairly accurate. The volumes are only down like 1%. So even though you are in a recession, the core business that's flowing through our machine here is continuing. And then there's the impact of fuel. This is an anomaly that we have not had in previous recessions in the U.S., is the dynamic impact of fuel and that's a compounding factor for us, Kevin.

Kevin Sterling – Stephens Inc.

Okay. Keeping on, I guess, down that path, Chuck, on February 1st, you guys you raised your guidance to $2.01, to $2.26, and now less than two months later, you significantly hair cut it. We know fuel has always been an issue. It's been rising this year, so that shouldn't have come out of the blue. As you mentioned, Puerto Rico has been in the tank. Is that – is it much worse now within less than two months since you last spoke on February 1st? Maybe you could help kind of understand what's changed in about a six-week period significantly damn your outlook for the rest of this year.

Chuck Raymond

Very, very good question, and obviously something that needs to be explained. The February adjustment was because of the share repurchase and only that. At that point, we didn't know enough about the year in the first quarter to be able to say, hey, look, this plan really needed to be adjusted a little bit, and we were only a couple of weeks into the year, actually.

Kevin Sterling – Stephens Inc.

All right. Could you talk a little bit about some of the trends that you've seen so far in April? Maybe you could break it down by trade lane in terms of volumes? Are we seeing any pick up at all as we sit here near the end of April?

Chuck Raymond

Well, I'm going to let John characterize that. You know, we don't break out our earnings month by month. All I can say is that March was stronger than February, and February was stronger than January, so this is not a business that's going into the tank. I mean, we're still operating very efficiently, and our volumes versus our original plan are looking pretty good. I think that our share of the Puerto Rico market is up a little bit in April. I think it's probably very stable in Alaska and maybe up just very slightly in Hawaii. And, John, do you want to add to that?

John Keenan

Yeah, I would agree. I think, Kevin, the best answer to that is it's consistent with our forecast what we are seeing. I can tell you that we've had good volumes in all three – in especially the West Coast trades the last month and in – as Chuck indicated in Puerto Rico, we've seen a slight uptick, and that's based on a little bit of our positioning in the market, and a desire to take back a little bit of market share. So it's – again, it's consistent with our forecast and our guidance.

Kevin Sterling – Stephens Inc.

Consistent with your new forecast of lower 2% volumes, or your –

John Keenan

That's correct.

Kevin Sterling – Stephens Inc.

Okay. Consistent with your new forecast. Last question here, and then I'll let someone else get in the queue. It's probably more for Mike. Your debt level has increased this quarter. Maybe could you help explain what drove this? Because I would have thought we would have seen those reduced with some of your cash flow generation that you are able to generate. So maybe you could talk a little bit about the reason why we've seen debt levels increase this quarter on a sequential basis.

Mike Avara

Sure, Kevin. In this quarter, we have really in the first quarter our biggest payments. We had $24 million of lease payments on the D-7 vessels. In addition, we did fund $29.8 million of our share repurchase program. So those two big disbursements in addition to our normal weakest free cash flow quarter really caused additional borrowings under our revolver,. Now, free cash flow will rebound start now and grow significantly during the rest of the year and we will generate the free cash flow targets that we just laid out here for you.

Kevin Sterling – Stephens Inc.

Okay. Well one quick followup to that. Do you have an idea of how much debt you want to pay down for the rest of the year?

Mike Avara

As we look at our free cash flow deployment, we certainly will use some of our free cash flow to pay down debt. That will also have to play into any acquisitions opportunities that we may have.

Kevin Sterling – Stephens Inc.

Okay. Thanks for your time today.

Mike Avara

Thank you, Kevin.

Operator

Thank you. And we have time for a final question, and our final question comes from the line of Chaz Jones with Morgan Keegan. Please go ahead.

Chaz Jones – Morgan Keegan

Hey, good morning, guys.

Chuck Raymond

Good morning, Chaz.

Chaz Jones – Morgan Keegan

I kind of get the explanation for the decreased outlook in volumes, but I guess one thing we haven't touched on here is kind of the rate environment – pretty substantial reduction from two six to one five. Obviously in the first quarter, you were well above that, even when you back out fuel. Could you maybe help us understand that? Is that lower rate expectation, is it due to volume slowdown, is it due to capacity maybe coming a little more in excess into the market, or is there anything else there from a fuel standpoint that's maybe keeping rates in check?

John Keenan

I think, Chaz, this is John Keenan, let me take that. I think when you look at the overall rate impact, first of all, you see where we've reduced our volumes as well as our rates out of Guam. If you look at Guam (inaudible) it's a backhaul, which is very high revenue per box, so that's certainly an impact when you look at the overall rate lever. In the other trades, I would say in Alaska, our volumes, as you see, are basically consistent with what we've had. Our rates have been moderate, and I think it's just a sign of in each of the three markets the – not only the competitive land escape, but the state of the markets where we're just choosing to be less aggressive on the rate lever. And you do have, as you know, the fuel, with the fuel increases, and you're seeing fuel as approximately – when you look at our rate increase year-over-year, about 5% of that is tied into fuel, so if you take the balance, it's a little less than 3%.

Chaz Jones – Morgan Keegan

Right. And maybe just on the – switching back over the expense side of the equation, it looks like you kept D&A fairly constant from a guidance standpoint, obviously, higher fuels baked into OpEx. You mentioned the EDGE program. Is there anything else there on the expense front that maybe has crept up here since the last call that is driving some higher expectations on the expense side?

Mike Avara

Chaz, this is Mike. I think you've captured everything correctly. Nothing other than the items you mentioned.

Chaz Jones – Morgan Keegan

Okay. And then just maybe a couple of quick ones here. It doesn't sound like from the commentary on Alaska, despite the weather disruptions, is there any type of catch-up from those lost volumes in the second quarter?

John Keenan

No, Chaz, we don't expect that.

Chaz Jones – Morgan Keegan

Okay. And the CapEx was raised modestly. It looks like you guys went from 21 to 28. Anything happened there that you can share with us?

John Keenan

Yeah, Chaz, again, this is John. That is a purchase of Guam cranes that we've added to our CapEx that we are doing a joint venture with Matson to put three additional cranes into Guam to help continue to service that market.

Chaz Jones – Morgan Keegan

Okay. Good. And last one here, the Logistics segment actually lost some money from an EBIT standpoint it looks like in the first quarter. I don't think you have given guidance on the Logistics front, but if I could ask, was that in line with where you kind of expected that segment, or could you give us any visibility there?

Brian Taylor

Hey, Chaz, this is Brian. That was in line with our expectations as we have continued to build up this business and put support resources into it to position it for growth. We had expected certainly in the first quarter, given the softness, that we would typically see in first quarter volumes, that that would be a quarter that would not deliver up a positive result for us, so it is pretty much in line with what we saw for the first quarter.

Chuck Raymond

Yeah, and I might add that that that's a business we are growing. And if you look at that variance versus plan, that's basically an investment we made in people. We've added resources in into Logistics to expand our brand awareness and to expand our customer base, and you'll see the returns from that investment later on in the year.

Chaz Jones – Morgan Keegan

Okay. Great. Thanks, guys, for the commentary.

Operator

Thank you. Mr. Raymond, at this time, we'll turn it to you for closing comments.

Chuck Raymond

Thank you very much, Mary. Well, listen, folks, again, thank you. Let me just hit a couple of points here. Many of you have been with us for several years here, and I think you recognize that Horizon is the premier brand in our business sector. Our customer support today is strong, and growing. Despite these, what we call recessionary times, the company still generates good earnings and strong cash flows, and we are going to use those cash flows as investments to make this company stronger and to bring strong future returns to shareholders.

Clearly, we believe we're doing the right thing by adjusting our guidance for 2008 being cautious there to make sure that we give you the right kind of sense of where we see this business going in the short run while we have these uncertainties.

And then finally, you have to look at the stock price today, and say to yourself this really represents a compelling investing opportunity. And we will reinvigorate our efforts to generate those kinds of returns to our investors and shareholders going forward. We will talk to you on the earnings call that we'll have at the end of the second quarter, which will be in late July. We thank you for your time today, and look forward to smoother sailing ahead. Thank you.

Operator

Thank you. Ladies and gentlemen, that will conclude today's teleconference. We do thank you again for your participation, and thank you for using ACT Conferencing. You may now disconnect.

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Source: Horizon Lines, Inc. Q1 2008 Earnings Call Transcript
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