March 31, 2005
EXECUTIVE SUMMARY
The Company produces revenue by the movement of freight by water to and from Puerto Rico from the continental United States through its terminal facility in Jacksonville, Florida. The Company also generates revenue from the movement of freight within the continental United States by truck when such movement complements its core business of moving freight to and from Puerto Rico. The Company's operating expenses consist of the cost of the equipment, labor, facilities, fuel and administrative support necessary to move freight to and from Puerto Rico and within the continental United States.
During the fourth quarter of 2004, the Company purchased Kadampanattu Corporation, as discussed further in Note 6 to the Financial Statements. This purchase and refinancing were immediately accretive to the Company's earnings. The Company believes the overall savings during the month of December, the first month after the transaction occurred was approximately $.2 million. The Company further believes the transaction will have a favorable annual impact of approximately $2.0 million, in 2005 and each year thereafter. This savings is primarily from a reduction in rent and annual lease payments of $11.5 million partially off set by an increase in depreciation and interest expense of approximately $9.5 million.
RESULTS OF OPERATIONS
The following table sets forth the indicated items as a percentage of net revenues for the years ended December 31, 2004, 2003 and 2002.
Operating Statement - Margin Analysis
(% of Operating Revenues)
2004 2003 2002
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Operating Revenues 100% 100% 100%
Salaries, wages, and benefits 15 18 20
Rent and purchased transportation:
Related Party 7 8 10
Other 24 28 28
Fuel 10 10 10
Operating and maintenance (exclusive of
depreciation shown separately below) 24 25 23
Taxes and licenses 0 1 1
Insurance and claims 3 3 4
Communications and utilities 1 1 1
Depreciation and amortization 3 4 4
Other operating expenses 4 4 7
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Total Operating Expenses 91 103 105
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Operating income (loss) 9 (3) (5)
Net interest expense (5) (3) (4)
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Net income (loss) 4% (6)% (9)%
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Year ended December 31, 2004 Compared to Year ended December 31, 2003
The Company operating ratio (operating expense stated as a percentage of operating revenues) decreased from 103% in 2003 to 91% in 2004. This improvement is more fully explained under operating expense caption set forth below.
Revenues
The following table sets forth by percentage and dollar, the changes in the
Company's revenue and volume by sailing route and freight carried:
Volume & Revenue Changes 2004 compared to 2003
Overall Southbound Northbound
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Volume Percent Change:
Core container & trailer 4.1% 0.2% 17.5%
Auto and other cargos 15.4% 16.0% 11.5%
SOLs 16.0% 19.2% (11.7)%
Domestic linehaul (54.3)%
Revenue Change ($millions):
Core container & trailer $ 4.2 $ 3.4 $ 0.8
Auto and other cargos 3.3 3.1 0.2
SOLs 0.4 0.4 (0.0)
Domestic linehaul (1.2)
Other Revenues 5.6
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Total Revenue Change $ 12.3
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The increase in core container and trailer revenue, auto and other revenue is due to increased vessel capacity utilization and increased rates per equivalent units.
Vessel capacity utilization on the core continental U.S. to Puerto Rico traffic lane was 96.5% during 2004, compared to 93.3% during 2003.
Domestic revenue is for moves that originate and terminate within the continental United States. The decrease in domestic line haul revenue was primarily the result of less domestic linehaul within the continental United States, because of increased demand in the Puerto Rico shipping lane. This change in demand resulted in less equipment available for Domestic linehaul.
The increase in other revenues is primarily attributable to an increase in fuel surcharges, demurrage, security charges and charterhire. The Company's fuel surcharge is included in the Company's revenues and amounted to $7.0 million in 2004 and $4.0 million in 2003. Demurrage, a charge assessed for failure to return empty freight equipment on time, is also included in the Company's revenues and amounted to $2.9 million in 2004 in comparison to $2.2 million in 2003. During 2004 total charterhire revenue amounted to $0.7 million in 2004 and $0.4 million in 2003. Charterhire is rental revenue for vessels not in use in a liner service. Security Charges are charges to cover the Company's expenses beyond the normal security required to ensure the safety of the Shipper's cargo. These charges amounted to $1.3 million in 2004 in comparison to $.3 million in 2003.
Operating expenses
Operating expenses increased by $1.2 million, or 2.1% from $89.0 million in 2003 to $90.2 million for 2004. This increase was due to volume-related increases in substantially all areas other than salaries and benefits, related party purchase transportation, other purchase transportation and taxes and licenses which decreased 3.5%, 8.5%, 4.5% and 60.0%, respectively. The decrease in salaries and benefits was due to lower driver payroll due to fewer miles driven by Company drivers. The decrease in related party purchase transportation was the result of the purchase of the Ro/Ro Barges in December. The decrease in rent of other
purchase transportation was the result of the Company purchasing equipment that was previously leased and the increased usage of rail transportation instead of truck transportation. The decrease in taxes and license is associated with a favorable legal determination in Puerto Rico, which resulted in the reversal of a $.3 million accrual recorded in 2001. Fuel expense increased $1.2 million or 13.8% primarily as a result of a $1.4 million increase in tug fuel from increased fuel prices partially offset by a decrease of $0.2 million in truck fuel expense resulting from increased use of rail transportation. Operating and maintenance expense increased $1.8 million or 8.3% due to $1.2 million in higher cargo handling costs related to increased volume; $0.3 million increase in repairs and maintenance due to a detailed survey of revenue equipment and increased dry docking and vessel maintenance expense and marine terminal expenses. Other operating expenses increased $0.8 million due to professional fees during 2004; an increase in the provision for doubtful accounts is primarily due to the increase in revenues during 2004. Depreciation expense declined $0.3 million or 10% to $3.1 million in 2004 from $3.4 million in 2003, primarily due to a change in estimated lives of depreciable property as further discussed below, partially off-set by an increase in depreciable assets. And as a result, the Company's operating ratio improved to 92% during 2004 from 103% during 2003.
The Company extended the estimated remaining life for its TBC barges by twelve years and its containers, VTMs and chassis by seven and nine years respectively, to more accurately reflect the remaining useful life of its equipment. This change in estimate was recorded prospectively and resulted in reduction in depreciation expense of approximately $409,000 or $0.03 per common share for 2004.
Interest Expense
Interest expense increased to $4.2 million in 2004 from $2.9 million in 2003 primarily due to higher interest rates on the Company's floating rate indebtedness and the write-off of approximately $0.5 million in deferred loan costs associated with the Company's prior term loan with a variable interest rate. In December of 2004, the term loan indebtedness was satisfied with the proceeds of the $85 million in senior secured debt.
Income taxes
Income taxes are calculated using the liability method specified by SFAS No. 109 "Accounting for Income Taxes". Valuation allowances are provided against deferred tax assets if it is considered "more likely than not" that some portion or the entire deferred tax asset will not be realized.
During 2004 the Company realized a reversal of approximately $1.7 million of its' deferred tax asset, from which the management has recorded approximately $21.0 million as a valuation allowance for the current year. Management is continuously evaluating the deferred tax valuation allowance, to determine what portion of the deferred tax asset, if any, may be realized in the future. Management's evaluation includes, among other things, such factors as a history of profitability, a substantial history of operations upon which to base a forecast and a history of accurately forecasting future results of operations.
As a result of the factors described above the Company reported net income of $4.4 million for 2004 compared to net loss of $5.5 million in 2003.
Preferred Stock Series "B"
Undeclared Dividends - The undeclared dividends on the preferred stock series "B" increased to $1,115,796 in 2004 from $846,385 in 2003, primarily due to increases in the contractual dividend rate from 2003. These dividends will never be paid and are recorded because they were contractual obligations.
Preferred Stock Accretion - The Preferred Stock Series "B" accretion decreased to $515,845 in 2004 from $980,745 in 2003, due to the recognition of the implied discount rate, which was applicable to the Series "B" Preferred Stock in accordance with the Staff Accounting Bulletin No. 68 "Increasing Rate Preferred Stock", through December 1, 2004.
Excess Consideration Transferred to the Holders of the Preferred Stock Over the Carrying Amount - In connection with the acquisition of K-Corp on December 1, 2004, the Company redeemed the Series "B" Preferred Stock for $24 million. In connection with the redemption, the Company recorded the excess of the consideration transferred ($24 million) to the holders of the preferred stock over the carrying amount of the preferred stock, ($23.5 million), and reflected as a subtraction of $0.5 million from net earnings available to common shareholders. This transaction was recorded in accordance with Emerging Issues Task Force D-42 "The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock"
As a result of the acquisition of K-Corp and the redemption of the Series "B' Preferred Stock, the Company will not have these transactions in 2005 and subsequent years.
Vessels
Currently the Company owns five TBCs. Of these vessels two are used for liner service between San Juan, Puerto Rico and Jacksonville, Florida. In 2004 the revenue earned from these two vessels was approximately $35.3 million in comparison to $34.1 million in the prior year.
Of the remaining three vessels that were originally used in Newark, New Jersey, one was leased to an unrelated third party during the first quarter of 2005 at an approximate annual rent of $1.6 million and the remaining two vessels are available for charter. The charter agreement will expire in April of 2005 but can be renewed up until January of 2006. Management continues to evaluate the use of the two vessels and no determination has been made as to their final use. As an alternative to their current use management has considered using one vessel as a ready spare, relieving the other vessels in the fleet during periods of dry-docking in order to protect market share and keep established shipping routes open, and possibly leasing the other vessel under a similar contract to the agreement reached during 2005. Ultimately management intends to use all of these vessels on expanded trade routes throughout the American Continents and surrounding island countries, as new markets become available and are considered to be economically feasible.
It is the management's belief that based on the current cash flows derived from the TBC vessels and their current market value as determined by an independent appraiser, that the current excess capacity of the two vessels, available for charter, does not indicate an impairment.
Year ended December 31, 2003 Compared to Year ended December 31, 2002
The following table sets forth by percentage and dollar, the changes in the
Company's revenue and volume by sailing route and freight carried:
Page 14
Revenue & Volume Changes 2003 compared to 2002
Overall Southbound Northbound
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Volume Percent Change:
Core container & trailer 17.2% 18.3% 13.5%
Auto and other cargos 0.1% (1.4)% 26.2%
SOLs (3.1)% (8.5)% 54.5%
Domestic linehaul (53.9)%
Revenue Change ($millions):
Core container & trailer 7.6 7.2 0.4
Auto and other cargos 1.7 1.2 0.5
SOLs 0.4 0.3 0.1
Domestic linehaul (1.6)
Other Revenues 2.4
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Total Revenue Change 10.5
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Vessel capacity utilization on the core continental U.S. to Puerto Rico traffic lane was 92.0% during 2003, compared to 79.4% during 2002.
The Company's fuel surcharge is included in the Company's revenues and amounted to $4.0 million in 2003 and $2.6 million in 2002. The Company's demurrage is included in the Company's revenues and amounted to $2.3 million in 2003 and $1.3 million in 2002. Demurrage is a charge assessed for failure to return empty freight equipment on time. The Company's charterhire is included in the Company's revenues and amounted to $0.4 million in 2003 and $0.7 million in 2002. Charterhire is rental revenue for vessels not in use in a liner service.
The decrease in domestic line haul revenue was primarily as a result of increased southbound volumes resulting in less available domestic equipment capacity and the loss of a particular domestic linehaul customer. Domestic revenue is for moves that originate and terminate within the continental United States.
Operating expenses
Operating expenses increased $9.0 million, or 11.3% from $80.0 million in 2002 to $89.0 million for 2003. This increase was due to volume-related increases in substantially all areas other than insurance and claims, communications and utilities that decreased 1.6% and 12.0%, respectively, due primarily to lower claims volume and premiums as well as entering into a contract with a new telephone company. Salary, wages and benefits increased 4.1% due to increased workers compensation insurance premiums of $0.7 million that was partially offset by a $0.2 million decrease in salary and employee benefits. Purchased transportation other than to a related party increased $2.9 million or 13.2% primarily due to increased volume resulting in additional inland miles and increased fuel costs increasing the rate per mile. Fuel expense increased $1.6 million or 21.2% primarily as a result of a $1.3 million increase in tug fuel from increased fuel prices and an increase of $0.2 million in truck fuel expense resulting from increased fuel prices. Operation and maintenance expense increased $3.9 million or 21.9% due to $1.3 million in higher stevedoring costs related to increased volume and increased stevedoring rates in Jacksonville; $1.4 million in truck maintenance due to increased tire, parts and repair expense and increased dry docking and vessel maintenance expense and marine terminal expenses. As a result, the Company's operating ratio decreased to 103% during 2003 from 105% during 2002.
Interest Expense
Interest expense decreased to $2.9 million in 2003 from $3.1 million in 2002 primarily due to lower interest rates on the Company's floating rate indebtedness and lower loan balances.
Income taxes
Income taxes are calculated using the liability method specified by SFAS No. 109 "Accounting for Income Taxes". Valuation allowances are provided against deferred tax assets if it is considered "more likely than not" that some portion or the entire deferred tax asset will not be realized.
During 2003 the Company realized an increase of approximately $2.0 million of its' deferred tax asset, from which the management has recorded approximately $22.7 million as a valuation allowance for the current year.
As a result of the factors described above the Company reported a net loss of $5.5 million for 2003 compared to net loss of $7.1 million in 2002.
DIVIDENDS
The Company has not declared or paid dividends on its common stock during the past five years.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operations was $3.1 million in 2004 compared to net cash provided by operations of $.9 million in 2003. This represented an increase of $2.1 million from 2003. $9.9 million of the improvement was attributable to increased net income. Increases in accounts receivable and decreases in accounts payable offset this amount by $6.4 million. The trade receivable balance increased $4.6 due to revenue earned in the fourth quarter of 2004 in comparison with the revenue earned in the fourth quarter of 2003. The increase in revenue was primarily the result of higher volume and higher yields. The revenue in the fourth quarter of 2004 and 2003 was $27.8 million and $22.1 million, respectively. The decrease in accounts payable was facilitated by the Company's improved profitability. Net cash used in investing activities was $23.6 million in 2004 compared to net cash provided by investing activity in 2003 of $.1 million in 2003. This represented a decrease of $23.7 million from 2003. $19.8 million of the decrease is directly related to the purchase of equipment primarily the Ro/Ro vessels and revenue equipment from the proceeds of the senior secured notes in December 2004. $2.0 million of the decrease is result of a required contractual deposit related to the Ship Financing Bonds and the Notes, Title XI debt. Net cash provided in financing activities was $26.2 million in 2004 compared to net cash used by financing activities of $2.6 million in 2003 representing an increase of $28.8 million. Net cash provided in financing activities consisted primarily of activity related to the sale of senior secured notes of $85.0 million which was used to acquire K-Corp for $32.0 million and assumed $9.1 million worth of debt which was paid off on December 1, 2004, repay the Company's credit facility for $20.2 million, exercise equipment purchase options for $11.8 million, provide an increase of working capital of $6.0 million and the remainder of which went to fees and expenses of $3.5 million associated with the senior secured notes. At December 31, 2004, cash amounted to $6.2 million, working capital was a $10.4 million, and stockholders' equity was a deficit of $7.1 million.
During the period between 1998 and 2002, the Company operated in a trade
lane that was characterized by significant over capacity and fierce
competition. This over capacity and competition resulted in significant and
prolonged rate decreases throughout that period. Similarly, the Company's
ability to pass on certain expenses to customers, through surcharges and other
customer charges was severely hampered due to competition. As a result, during
the years ended December 31, 2003 and 2002, the Company incurred net losses
applicable to common shares of $7,282,220 and $7,746,644 respectively and had
cash flows provided
(used) by operating activities of $860,093 and $(3,704,325) respectively as
well
as a working capital deficiency of $2,040,623 and $6,451,866 at December 31, 2003 and 2002 respectively.
Also during this period, one of the trade lane's largest participants filed bankruptcy and, after operating in bankruptcy for approximately 18 months, sold its vessel assets to another competitor in the trade. With a realignment of capacity and demand in the trade lane, 2003 resulted in a redistribution of freight volume among the remaining four participants, which resulted in increased volume and capacity utilization. During the fourth quarter of 2003, the Company began to implement increases in customer rates and surcharges. In addition to the revenue increases, the Company also implemented several changes to reduce cost. This increase in rates and utilization of capacity helped the Company improve its operating position for the current year. For the year ended December 31, 2004 earnings available to common shareholders were $2,352,672 and as of December 31, 2004, working capital was $10,422,542.The most notable changes for 2004 were made in purchased transportation, healthcare costs and tug fuel consumption. During the fourth quarter of 2003, the Company began utilizing lower cost rail transportation in certain lanes effectively lowering the unit cost per mile of inland transportation. In January 2004, the Company implemented a change in policy and healthcare providers, reducing benefit costs and started chartering tugs with more fuel-efficient engines. The Company has also entered into written contracts with customers that reflect increased rates and additional surcharges as market conditions have improved. Based upon the foregoing, the Company believes that it will be able to maintain the increased vessel capacity utilization at these increased rates over the foreseeable future. The trade lane in which the Company operates in is protected by a number of barriers to entry, the most formidable of which is the Jones Act that requires that vessels serving the trade lane be built in the United States, operated by United States citizens and crewed by United States citizens. Other barriers to entry include limited port space in San Juan. Both act as major constraints to the addition of new capacity.
At December 31, 2003, The Company had $13.1 million due to a bank under its senior credit facility, which expired January 31, 2004. In addition, the Company had $6.3 million due to related parties, all of which was scheduled to be paid in 2004. In April 2004, after receiving extensions from its then existing senior lender, the Company refinanced this bank debt with a new senior lender. This bank debt in turn was fully paid down with the proceeds of its $85.0 million note offering completed December 1, 2004. As of December 31, 2004, the Company had an unused and available line of credit of $10 million secured by current eligible receivables with interest at prime plus 1.5% that may only be drawn upon if certain conditions are satisfied. Additionally, with the proceeds of the $85.0 million senior secured notes, the Company paid $5.3 million of its debt payable to related parties, deferring approximately $2.5 million until January of 2005. This debt is scheduled to be repaid in 36 monthly payments to the Estate of M. P. McLean. The Company's Chief Executive Officer, John McCown, personally guarantees approximately $0.1 million of this debt. All other amounts owed to affiliates were repaid with a portion of the proceeds of the $85.0 million note offering completed December 1, 2004. This restructure of debt, along with increased rates and vessel utilization are expected to allow us to meet our working capital requirements through December 31, 2005. During previous years, due to overcapacity and hyper competitiveness in the United States / Puerto Rico trade lane in which the Company operates, it had significant negative cash flow from operations. The conditions in the United States / Puerto Rico trade lane have changed significantly and the Company now has significant positive cash flow from operations which is expected to continue over the foreseeable future. Our business plan does not require or anticipate any utilization of the revolving credit facility.
The Company has issued two series of Ship Financing Bonds designated as its 7.07% Sinking Fund Bonds Due September 30, 2022 and 6.52% Sinking Fund Bonds Due March 30, 2023. These bonds are guaranteed by the U.S. government under Title XI of the Merchant Marine Act of 1936, as amended. The Company refers to these bonds as the "Title XI Bonds." During 2003, with the consent of the holders of the Title XI Bonds, the Company deferred the semi-annual principal payments on the Title XI Bonds and in 2004 the Company spread those deferred principal payments over the remaining maturity. The Company has therefore rescheduled the principal payments of $232,022 and $372,429 due each semi-annual period until
fully paid on September 30, 2022 and March 30, 2023, respectively. The aggregate principal amount of the Title XI Bonds outstanding at December 31, 2004 was $22.1 million. In addition, in connection with obtaining the consent of the Secretary of Transportation of the United States of America to offer and sell the notes, in December 2004 the Company deposited approximately $2.0 million into a reserve fund that secures the Title XI Bonds.
As of December 31, 2004, the Company was restricted from performing certain financial activities due to it not being in compliance with Title XI debt covenants. The provisions of the Title XI covenants provide that, in the event of noncompliance with the covenants, the Company is restricted from conducting certain financial activities without obtaining the written permission of the Secretary of Transportation of the United States (the "Secretary "). If such permission is not obtained and the Company enters into any of the following actions it will be considered to be in default of the Title XI covenants and the lender will have the right to call the debt. These actions are as follows: (1) acquire any fixed assets other than those required for the normal maintenance of . . .