ITEM 1. BUSINESS
Overview
We own and operate a 351-mile freight railroad along the east coast of Florida from Jacksonville to Miami. Our railroad is one of only two major freight railroads serving Florida. In 2012, we provided our services to over 500 customers, and transported over 457,000 units. We generate rail-operating revenues primarily from both the movement of freight in conventional freight cars (such products as crushed rock (aggregate), automobiles, food products and other industrial products) and intermodal shipments of containers and trailers on flatcars. We count each move of freight car, container or trailer on our line as one unit. We also generate freight revenue from dray moves (drayage is the movement of containers or trailers by truck to and from the rail yard). We generated total operating revenue and net loss of $246.8 million and $13.3 million respectively, for the year ended December 31, 2012. As of December 31, 2012, we had assets of $873.0 million.
Company Information
The Company is owned by private equity funds managed by affiliates of Fortress Investment Group LLC (“Fortress”). Upon the acquisition, Fortress acquired all of the outstanding stock of Florida East Coast Industries, Inc. (“FECI”) in 2007 and then subsequently FECI sold its rail transportation segment (the “Rail Separation”), which operated as separate legal entities. Concurrent with the Rail Separation, FECR Rail LLC and Florida East Coast Railway Corp. were formed to carry on the activities of the railway.
Florida East Coast Holdings Corp. was incorporated in Florida on January 10, 2011. In January 2011, FECR Rail LLC contributed all of its holdings of the common and preferred shares of Florida East Coast Railway Corp. to Florida East Coast Holdings Corp., whereby Florida East Coast Holdings Corp. became the direct parent of Florida East Coast Railway Corp. Our principal corporate office is located at 7411 Fullerton Street, Suite 100, Jacksonville, Florida 32256, and our telephone number at that location is 1-800-342-1131.
Business Strategy
We plan to grow our revenue, cash flow and earnings by employing the following strategies:
Continuing Conversion of over the Road Freight: We have continued our focus of converting truck and vessel business to rail. We recognize the efficiencies of rail movement as railroads are estimated to be approximately four times more fuel efficient than truck transportation while a single train can haul the equivalent of up to 280 trucks as reported by the American Association of Railroads, or AAR. Additionally, as the price of fuel has increased over the past several years, the fuel efficiency advantage of railroads as compared to other forms of freight transportation has grown.
Port Strategies: The Company is participating in major expansions at two south Florida ports which we believe will become a critical component of our strategy to grow our intermodal business in the coming years. The projects include a plan to restore freight-rail service to the Port of Miami as well as a project to build an intermodal transfer facility at Port Everglades in Fort Lauderdale.
Industrial Development: We believe that continued efforts to gain more local traffic will enable our operations to be successful in the future. We will work to increase the number of customers along our railway.
Improving our Operating Ratio: We believe with our focus on growing our existing customer base, coupled with our ability to effectively leverage our prices, as well as our cost-savings initiatives, we will improve our operating ratio. We define our operating ratio as total operating expenses divided by total operating revenues.
Freight Revenue
We generate freight revenue primarily under two different types of service: local and interchange. Local service, which represented approximately 40% of our total 2012 revenue, involves transporting freight that both originates and terminates on our rail line. Examples of local service include most crushed rock aggregates, which originate from South Florida quarries served by us and terminate at various consumption points in the middle and northern portions of the State, as well as retailers and grocers moving their goods from North Florida to retail stores in South Florida. Interchange service represented approximately 49.2% of our total 2012 revenue. Interchange services vary by customer shipping needs with freight either (i) originating at the customer’s facility on our line for transport to other destinations in the United States, Canada and Mexico via our Jacksonville interchange with CSX and Norfolk Southern (Class I Railroads) or (ii) being received at our Jacksonville interchange and hauled to a customer’s plant or port, where the freight is subsequently consumed or further distributed.
Commodities
Products hauled over our rail line include more than 6 major freight groups, such as intermodal units (containers and truck trailers), crushed rock (aggregate), automobiles, food products, chemicals and other industrial products. The chart below provides detail regarding the percentage of 2012 freight revenue that we generated from hauling various products:
Intermodal (65% of 2012 freight revenue): We transport intermodal containers and trailers (on piggy-back railcars) for major shippers including retailers, parcel delivery companies, maritime shipping companies, trucking companies, and Intermodal Marketing Companies (“IMCs”) as well as the intermodal business units of Class I railroads. We benefit from the geographic shape of Florida as a peninsula and the location of its largest consumption markets (Miami and Orlando) in the southernmost and central regions, which combine to create an imbalanced lane for the flow of goods into and out of the State. As a net consuming state, this geography makes it undesirable for trucks to transport freight southbound, only to return empty northbound. Additionally, the South Florida Highway network, including Interstate 95 and Route US-1, suffer from severe congestion and delays. Due to the challenges that the traffic flow and road congestion present to major shippers, in several instances, these shippers utilize our service as an extension of their operations to obtain a more reliable and efficient means for transporting products north and south within Florida, and in most cases, our service exceeds that of trucks.
Aggregate (16% of 2012 freight revenue): We transport aggregate (primarily crushed limestone) from quarries located in South Florida to distribution points in the middle and northern portions of the State. In most cases, we are the only railroad directly serving a particular quarry. Moreover, given the heavy weight and distance hauled of aggregate, we compete favorably with over-the-road (primarily dump trucks) distribution - one “unit train” (a dedicated train consisting entirely of one product) of aggregate can haul the maximum equivalent of approximately 480 trucks.
Food Products (5% of 2012 freight revenue): We transport three main food commodities which include fruit juice, beer products and high fructose corn sweeteners. These products interchange in our Jacksonville facility, with a Class I railroad and either originate or terminate on our line.
Automobiles (5% of 2012 freight revenue): We serve as a major conduit for transporting finished automobiles primarily from our interchange with Class I railroads in Jacksonville to points in the central and southern portions of the State. Specifically, we transport automobiles either to our own rail yards where the automobiles are then distributed by truck to nearby dealers and rental companies or to yards located on our rail line but owned directly by the Class I with whom we partner to provide total rail transportation.
Chemicals (3% of 2012 freight revenue): We transport a variety of chemical commodities including liquefied petroleum gas (LPG), ethanol and plastics. LPG and ethanol are handled in private tank cars which are then transported to wholesalers for final delivery. Plastics are delivered to manufacturers directly as well as to bulk distribution terminals for final motor carrier delivery.
All other products (6% of 2012 freight revenue): We transport a variety of other freight including building materials, waste and scrap, and petroleum products. Due to the efficiencies of rail transportation and the nature of the freight that we carry - high volumes of heavy freight shipped long distances - our service is often the most competitive mode of transportation for customers.
Customers
As of December 31, 2012, we served approximately 500 customers. In 2012, our 10 largest customers accounted for approximately 40.9% of our total freight revenue, with our largest customer accounting for approximately 7.3% of our total freight revenue.
Commercial Arrangements
A substantial portion of our freight revenue is generated under contracts and similar arrangements with either customers located on our line or the Class I railroads with which we connect. Contracts and arrangements vary in terms of duration, pricing and volume requirements. We collect the majority of our revenue from Class I railroads and other business entities. Moreover, our railroad is often integrated into a customer’s facility and serves as an important component of that customer’s supply chain. In certain circumstances, our customers have made significant capital investments in facilities on or near our railroad (as in the case of industrial plants or major warehouses) or are geographically unable to relocate (as in the case of rock quarries). We believe the quality of our customers and our level of integration with their facilities provide a stable and predictable revenue base. In addition, due to our captive drayage (local trucking) company, FEC Highway Services, L.L.C., and our alliances with the Class I railroads that we connect with in Jacksonville - Norfolk Southern and CSX - we are able to extend our reach throughout North America. Almost all commercial arrangements are subject to some form of fuel surcharge program that protects us from sudden increases in fuel costs. Commercial agreements that are not subject to a fuel surcharge program can typically be cancelled on short notice. Individual contracts and arrangements vary in terms of duration, pricing and volume requirements, but can generally be categorized as follows:
Contracts directly with customers/shippers: In many cases, we maintain a contract with the customer that we directly serve. Typically, the customer has significant rail infrastructure within its facility and is a major shipper or receiver of industrial freight. Contracts stipulate the term and pricing arrangements, and often include minimum customer volume requirements with liquidated damages paid to us to the extent volumes fall below certain levels.
Contracts directly with Class I railroads: We act as an agent for the connecting Class I railroads, with the Class I typically maintaining a contract directly with the customer/shipper for the entire length of haul. The Class I railroad pays us upon our providing the service for the portion of the total haul that occurs on our railroad, and the Class I pays us regardless of whether the customer pays the Class I which results in low credit exposure and timely payment.
Quoted rate, or tariff: In the remaining cases, our railroad generates freight revenue using a rate per unit based on the type of freight service and market environment. Rates can typically be adjusted upon 30-days notice although some of our larger customers often request a private rate that provides more price certainty over a longer period of time. While we do not serve customers under signed contracts in these cases, we have long standing relationships with our customers and, in many instances, we are the only rail service provider available to customers. Moreover, the heavy nature of the freight shipped by the customer and/or the long distances carried competitively positions us favorably versus other modes of transportation.
Non-Freight Revenue
In addition to providing freight services, we also generate non-freight revenue from other sources such as car hire and demurrage (allowing our customers and other railroads to use our railcars for storage or transportation in exchange for a daily fee), real estate and equipment lease income (including Class I railroads), ancillary dray charges, switching (managing and positioning railcars within a customer’s facility), and other transportation services.
A summary of our non-freight revenue generated during 2012 and 2011 is presented in the table below:
Employees
As of December 31, 2012, we had approximately 541 employees, of which approximately 369 employees were represented by the following labor unions: United Transportation Union (“UTU”), representing train and engine service employees, Brotherhood of Maintenance of Way Employees (“BMWE”), representing track maintenance, structures and roadway shop employees, and International Brotherhood of Electrical Workers (“IBEW”), representing agents and clerical, carmen, maintenance of equipment foreman, signals and communications, train dispatchers, electricians, machinists, sheetmetal workers and shop laborers. In total, the Company is party to 9 labor agreements. We have developed a standard template with which to negotiate with the unions and are confident of its ability to satisfy them.
In 2011 and 2012, the Company successfully ratified bargaining agreements with the UTU and BMWE. The UTU agreement was extended until the end of 2012 and the BMWE agreement was extended until the end of 2014. Each of the current agreements contain an annual general wage increase of approximately 2%, and an Incentive Compensation Plan (“ICP”) based on safety results, whereby the employee can earn up to a 6% bonus should the criteria be met.
Safety
We endeavor to conduct safe railroad operations for the benefit and protection of employees, customers and the communities we serve. Our safety program, led by our Operations management team, involves all of our employees and is administered by our safety group. Operating personnel are trained and certified in train operations, hazardous materials handling, personal safety and all other areas subject to federal regulations. Each employee involved in train operations is subject to pre-employment and random drug testing as required by federal regulation. We believe that we comply in all material respects with federal, state, and local regulations. We also participate in committees of the AAR, governmental and industry sponsored safety programs including Operation Lifesaver (the national grade crossing awareness program) and numerous American Short Line and Regional Railroad Association Committees.
Environmental Matters
We are subject to various federal, state and local laws and regulations relating to pollution and the protection of the environment. These include requirements for governing such matters as the management of wastes, the discharge of pollutants into the air and into surface and underground waters, the manufacture and disposal of regulated substances and remediation of contaminated soil and groundwater. Failure to comply with environmental requirements can result in fines and penalties, and may subject us to third party claims alleging personal injury, and/or property damage or seeking restrictions on our operations. Some environmental laws impose strict, and under some circumstances joint and several, liability for costs of investigation and remediation of contaminated sites on current and prior owners or operators of the sites. In addition, some environmental laws are imposed on entities that sent regulated materials to the sites, as well as impose liability for related damages to natural resources.
In September 2006, the Florida Department of Environmental Protection (“FDEP”) notified the Company and an adjacent property owner that they had been identified as potentially responsible parties (“PRPs”) as a result of an investigation into contaminated groundwater in Fort Pierce, Florida. As of December 31, 2012 and December 31, 2011, the Company had accrued $1.5 million, related to the alleged contamination of which $1.5 million is expected to be paid over the next year. FDEP and the Company agreed in April 2012 that the Company’s scope of testing is complete and the Company can initiate a pilot remediation of the property. The Company has completed a competitive review of remediation proposals and selected a contractor to begin the pilot in early 2013.
We believe that we operate in material compliance with current environmental laws and regulations. We estimate that any expenses incurred in maintaining compliance with current environmental laws and regulations will not have a material effect on our earnings or capital expenditures. However, there can be no assurance that new, or more stringent enforcement of existing, requirements or discovery of currently unknown conditions will not result in significant expenditures in the future.
Insurance
We maintain liability and property insurance coverage. Our primary liability policies have self-insured retentions of up to $2.0 million per occurrence. In addition, we maintain excess liability policies that provide supplemental coverage for losses in excess of our primary policy limits. Due to the location of our assets on Florida’s eastern seaboard, we also maintain windstorm coverage.
With respect to the transportation of hazardous commodities, our liability policies cover sudden releases of hazardous materials, including expenses related to evacuation, up to the same excess coverage limits and subject to the same self-insured retentions. Personal injuries associated with grade crossing accidents are also covered under liability policies.
Our employees are covered by the Federal Employers’ Liability Act (the “FELA”), a fault-based system under which claims resulting from injuries and deaths of railroad employees are settled by negotiation or litigation. FELA-related claims are covered under our liability insurance policies. Drivers of our trucking business are covered under occupational accident policies.
Our property damage policies, including windstorm coverage, provide coverage for track, infrastructure, business interruption, and all locomotives and rail cars in our custody and control. This policy provides coverage up to $25.0 million per occurrence, subject to self-insurance retention of $0.75 million per occurrence.
Industry
Introduction
The U.S. economy is dependent on the movement of freight ranging from raw materials such as coal, ores, aggregates, lumber and grain to finished goods, such as food products, paper products, automobiles and machinery. Railroads represent the largest component of the freight transportation industry in the United States, carrying more freight than any other mode of transportation. With a network of approximately 138,500 miles of track, railroads link businesses with each other domestically and with international markets through connections with ports and other international terminals. Unlike other modes of transportation, such as trucking (which uses highways, toll roads, etc.) and shipping companies (that utilize ports), railroad operators generally own their infrastructure of track, land and rights of way, and rail yards. This infrastructure, most of which was originally established over 100 years ago, represents a limited supply of assets and a difficult-to-replicate network.
Industry Structure
According to the AAR, there are 567 railroads in the United States operating approximately 138,500 miles of track. The AAR classifies railroads operating in the United States into one of three categories based on the amount of revenues and track miles. Class I railroads, those with over $433.2 million in revenues, represent approximately 94% of total rail revenues. Regional and local/short line railroads operate approximately 43,000 miles of track in the United States. The primary function of these smaller railroads is to provide feeder traffic to the Class I carriers. Regional and local/short line railroads combined account for approximately 6% of total industry rail revenues.
Source: Association of American Railroads, Railroad Facts, 2012 Edition.
Class I railroads operate across many different states and concentrate largely, though not exclusively, on long-haul, high density intercity traffic lanes. The six largest railroads in North America are BNSF Railway, Union Pacific, Norfolk Southern, CSX, Canadian National Railway, and Canadian Pacific Railroad Company. Regional railroads typically operate 400-650 miles of track and provide service to selected areas of the country, mainly connecting neighboring states and/or economic centers (including intrastate). Typically short line railroads serve as branch lines connecting customers with Class I railroads. Short line railroads have more predictable and straightforward operations as they generally perform point-to-point service over short distances, without the complex networks associated with the large Class I railroads.
Use of regional and short line railroads is largely driven by interchange traffic between carriers. Typically, a Class I railroad will transport the freight the majority of the distance, with the short line providing the final step of service directly to the customer. Most short line railroads depend on Class I traffic for a substantial portion of their revenue.
Regional and Short line Railroads
The North American short line and regional railroad industry has experienced steady growth over several decades. Short lines and regional railways have always been a part of the rail industry in North America. In the 1800’s, most North American railroads were constructed to serve a local or regional interest. Today’s Class I railroads are descended from hundreds of short lines and regionals that came together in successive waves of consolidation.
During the 1980’s, the number of regional and short line railroads increased dramatically. Deregulation of U.S. railroads simplified abandonment and sales regulations, allowing the major carriers to gain many of the savings of abandonment while preserving the traffic on the rail lines. Carriers created through this divestiture process now account for the majority of regional and short line railroads. Short line and regional railroads today serve important roles in moving freight within their service areas and function as a critical traffic “feeder” network for the Class I railroads.
Over the past decade, the number of regional and short line railroads has remained relatively constant. While some new entrants were formed through spin-offs or divestitures of Class I railroads, they have generally been offset by other existing regional and short lines either exiting the business or being merged with or acquired by other railroads. With the growth of multi-carrier holding companies, such as Genesee & Wyoming, the number of operators of regional and short line railroads has decreased. The consolidation brought on by multi-carrier holding companies has induced a number of shippers with private railroads to sell those railroads to the major short line operators. Similarly, Class I railroads sell and lease rail lines to smaller rail entities in order to address a range of issues impacting costs and productivity.
Short lines and regional railroads have a variety of ownership structures and are owned by shippers, governments, and multi-carrier holding companies.
Competition
Short line and regional railroads compete against each other and other forms of freight transportation based on cost, location and service. The cost of transporting goods and services via different forms of freight transportation is a major factor in determining which means of transportation a shipper will utilize. With respect to location, potential customers often experience geographic constraints that significantly impact the relative freight transportation costs of different alternatives. For example, a shipper can be constrained by railroad’s trackage, accessible waterways, access to pipelines, and proximity to airports. As a result, short line and regional railroad operators often evaluate the feasibility of other forms of freight transportation available to a customer when developing their rate and service offerings.
Some short line and regional railroad customers have multiple forms of freight transportation available. Depending on circumstances, truck, water, or other railroads may be competitive alternatives for a shipment. In such instances, customers will compare both the relative costs, reliability of on-time delivery and quality of service when determining what mode(s) of transport to use.
Trucking is often considered as a viable alternative to rail transport. Our intermodal freight services (trailers and containers on flat-rail cars) compete directly with trucking carriers. While trucking provides additional delivery location flexibility due to the geographic diversity of North America’s highway network relative to railway network, railroads are substantially more cost competitive along travel routes they serve. Recently, rail transport has become a more cost efficient alternative for shippers moving bulk goods over long distances, because of volatile fuel costs.
Other factors that enhance rail’s competitive advantage over trucking include:
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Capability to transport larger shipment sizes
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Higher density; ratio of product handled in a railcar to a truck is higher
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Ability to transport product over longer distances than trucks offer
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Reduced sensitivity to fast or reliable service
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Less dependent on return haul requirements compared to trucking
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Reduced environmental impact, i.e. rail is “greener”
Further, for many shipments, transport options that include alternative railroads are competitive, even where direct service by a second rail carrier is not available. Although we are often the only rail carrier directly serving our customers, we compete directly with other railroads that potentially could deliver freight to our markets and customers via different routes and use of multiple modes of transportation. Our primary rail competition for carload traffic is CSX. However, our railroad is the most direct route to Southern Florida and due to this, Florida East Coast Railway (“FECR”) is the most well tailored to handle intermodal traffic and carries CSX’s intermodal traffic.
Options to ship by water are limited geographically, but when available can be very competitive with rail. Factors that enhance rail’s competitiveness over water options include:
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Capability for rail to transport larger shipments, with higher density as water vessels are limited by water depth and size of shipment
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Railroads have a more direct route between origination and destination compared to vessels
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Rail benefits from lower loading and unloading costs
The railroad industry has increased its share of freight ton-miles compared to other forms of freight transportation over the past quarter century due to its ability to haul heavy products over long distances more efficiently and at a lower cost. Since 1980, the railroad industry has continually improved its cost competitiveness compared to other forms of freight transportation as it consumes less fuel and has lower labor costs per ton transported than other forms of freight transportation. Railroads’ cost per ton-mile has decreased as a result of significant reductions to labor and rolling stock requirements and the spinning off of less dense network segments. According to the AAR, railroads are estimated to be approximately four times more fuel efficient than truck transportation while a single train can haul the equivalent of up to 280 trucks. Additionally, as the price of fuel has increased over the past several years, the fuel efficiency advantage of railroads as compared to other forms of freight transportation has grown. In 1980, one gallon of diesel fuel moved one ton of freight by rail an average of 235 miles, versus 2009 where the equivalent gallon of fuel moved one ton of freight an average of 480 miles by rail - representing a 104% increase over 1980. As a result, the railroad industry’s share of U.S. freight ton-miles has steadily increased from 30% in 1980 to 43% in 2007.
Regulation
We are subject to various safety and other laws and regulations administered by numerous government agencies, including (1) regulation by the U.S. Department of Transportation (the “USDOT”) and the Surface Transportation Board (the “STB”), successor to the Interstate Commerce Commission, (2) labor related statutes including the Railway Labor Act, the Railroad Retirement Act, the Railroad Unemployment Insurance Act, and the FELA, and (3) some limited regulation by the State of Florida and in the states in which we do business.
The STB, established by the ICC Termination Act of 1995 (the “ICC Termination Act”), has jurisdiction over, among other matters, the construction, acquisition, or abandonment of rail lines, the consolidation or merger of railroads, the assumption of control of one railroad by another railroad, the use by one railroad of another railroad’s tracks through lease, joint use or trackage rights, the rates charged for regulated transportation services, and the service provided by rail carriers.
As a result of the 1980 Staggers Rail Act (the “Staggers Rail Act”), the rail industry is trusted with considerable rate and market flexibility including the ability to obtain wholesale exemptions from numerous provisions of the Interstate Commerce Act. The Staggers Rail Act allowed the deregulation of all containerized and truck trailer traffic handled by railroads. Requirements for the creation of new short line railroads or the expansion of existing short line railroads were substantially expedited and simplified under the exemption process. On regulated traffic, railroads and shippers are permitted to enter into contracts for rates and provision of transportation services without the need to file tariffs. Moreover, on regulated traffic, the Staggers Rail Act allows railroads considerable freedom to raise or lower rates without objection from captive shippers, although certain proposed shipper-backed legislative initiatives threaten to limit some of that pricing freedom. While the ICC Termination Act retained maximum rate regulation on traffic over which railroads have exclusive control, the new law relieved railroads from the requirements of filing tariffs and rate contracts with the STB on all traffic other than agricultural products.
The FRA regulates railroad safety and equipment standards, including track maintenance, handling of hazardous shipments, locomotive and rail car inspection and repair requirements, and operating practices and crew qualifications.
Railroad Retirement
Railroad industry personnel are covered by the Railroad Retirement System instead of Social Security. Our contributions under the Railroad Retirement System have been approximately triple those of employees in industries covered by Social Security. The Railroad Retirement System, funded primarily by payroll taxes on covered employers and employees, includes a benefit roughly equivalent to Social Security (“Tier I”), an additional benefit similar to that allowed in some private defined-benefit plans (“Tier II”), and other benefits. For 2012, the Railroad Retirement System required up to a 19.75% contribution by railroad employers on eligible wages, while the Social Security and Medicare Acts only required a 7.65% contribution on similar wage bases.
ITEM 1A.
ITEM 1A. RISK FACTORS
Our operations and financial condition are subject to certain risks that could cause actual operating and financial results to differ materially from those expressed or forecast in our forward-looking statements, including the risks described below and the risks that may be identified in future documents that are filed or furnished to the SEC.
Risks Related to Our Business
Adverse macroeconomic and business conditions, particularly in the State of Florida and the southeast, have and could continue to have an adverse impact on our business.
The decline in economic activity in the United States and throughout the world over the past three years has had an adverse impact on our business. The global financial markets recently have undergone and may continue to experience significant volatility and disruption. The sustainability of an economic recovery is uncertain and additional macroeconomic, business and financial disruptions could have a material adverse effect on our operating results, financial condition and liquidity. In particular, our freight traffic is generally affected by overall economic conditions in Florida and the southeast United States, which have been severely impacted by the recent economic downturn. Our largest carload market, aggregates, is highly dependent upon the residential construction market, the commercial construction market and state and federal highway construction, each of which have been negatively affected by the recent economic conditions. The pace of residential construction as well as the level of state and federal highway and other public projects affect the amount of aggregate loadings that our customers request. During the recent economic downturn, the State of Florida has experienced an unprecedented decline in homebuilding. The condition of international economies, including the Caribbean, South America, Europe and Asian economies, can also affect our intermodal traffic.
We receive significant business from our customers who utilize the Port of Miami and Port Everglades for shipping and cargo activity. Our railroad relies on these Ports to serve cargo ships on behalf of our customers for import and export freight. The decline of imports or exports at these Ports could have a material adverse effect on our operating results, financial condition and liquidity. The Company plans to establish intermodal container rail service on its own rail line leading into the Port of Miami for an estimated cost to the Company of $9.1 million (see Note 15). In addition, the Company plans to construct a new Florida East Coast Intermodal Transfer Facility on Port Everglades, Florida for an estimated total cost of approximately $53 million, $30 million of which will be funded through a State Infrastructure Bank (SIB) loan, $18 million of which will be from a Florida Department of Transportation (FDOT) grant and $5 million from the Company’s capital budget. The Company has been awarded the entire $18 million of the FDOT grant as of December 31, 2012. These investments could be at risk should the volumes not support the investments.
In addition, certain of our customers and suppliers are directly affected by the economic downturn, are facing credit issues and could experience cash flow problems that have and could continue to give rise to payment delays, increased credit risk, bankruptcies and other financial hardships that could decrease the demand for our rail services or delay our receipt of payment from certain customers. Adverse economic conditions could also affect our costs for insurance and our ability to acquire and maintain adequate insurance coverage for risks associated with the railroad business if insurance companies experience credit downgrades or bankruptcies. In addition, changes in governmental banking, monetary and fiscal policies to stimulate the economy, restore liquidity and increase credit availability may not be effective. It is difficult to determine the depth and duration of the economic and financial market problems and the many ways in which they may impact our customers, suppliers and our business in general. Moreover, given the asset-intensive nature of our business, the economic downturn increases the risk of significant asset impairment charges since we are required to assess for potential impairment of non-current assets whenever events or changes in circumstances, including economic circumstances, indicate that the respective asset’s carrying amount may not be recoverable. This may limit our ability to sell our assets to the extent we need, or find it desirable, to do so.
Furthermore, our railroad competes directly with other modes of transportation, including motor carriers, and ship, barge and pipeline operators. If these alternative methods of transportation become more cost-effective to our customers due to macroeconomic changes, or if legislation is passed providing materially greater opportunity for motor carriers with respect to size or weight restrictions, our operating results, financial condition and liquidity could be materially adversely affected.
Continuation or further worsening of current macroeconomic, business and financial conditions, particularly in the State of Florida and the southeast United States, could have a material adverse effect on our operating results, financial condition and liquidity.
Rising fuel costs could materially adversely affect our business.
Fuel costs were approximately 12.3%, 13.5% and 10.8% of our total operating revenue for the years ended December 31, 2012, 2011, and 2010, respectively. Fuel prices and supplies are influenced significantly by international, political and economic circumstances. If fuel supply shortages or unusual price volatility were to arise for any reason, the resulting higher fuel prices would significantly increase our operating costs. Increases in fuel price may be passed along to customers through a “fuel surcharge” or otherwise, though often with delayed effect. However, there are no assurances that these surcharges will cover the entire fuel price increase for a given period, or that competitive market conditions will effectively allow us to pass along this cost.
As part of our railroad operations, we frequently transport hazardous materials, the accidental release of which could have an adverse effect on our operating results, financial condition and liquidity.
We are required to transport hazardous materials to the extent of our common carrier obligation. An accidental release of hazardous materials could result in significant loss of life and extensive property damage. The associated costs could have an adverse effect on our operating results, financial condition and liquidity. In 2012, approximately 1.0% of our moves were related to hazardous materials.
A majority of our employees belong to labor unions, and strikes or work stoppages could adversely affect our operations.
Many of our employees are union-represented. Our union employees work under collective bargaining agreements with various labor organizations. Our inability to negotiate acceptable contracts with these unions could result in, among other things, strikes, work stoppages or other slowdowns by the affected workers. If our union-represented employees were to engage in a strike, work stoppage or other slowdown, or other employees were to become unionized or their terms and conditions in future labor agreements were renegotiated, we could experience significant disruption of our operations and higher ongoing labor costs.
Because we depend on Class I railroads and certain other customers for a significant percentage of our operations, our business and financial results may be adversely affected if our relationships with Class I carriers and such customers deteriorate.
The railroad industry in the United States is dominated by a small number of Class I carriers that have substantial market control and negotiating leverage. Approximately 52.4% of our traffic for the year ended December 31, 2012 was interchanged from CSX and Norfolk Southern, each a Class I carrier, and South Central Florida Express, a regional short line railroad. In addition, approximately 48.4% of our total freight revenue for the year ended December 31, 2012 was derived from Class I traffic. Approximately 1.0% of our total freight revenue for the year ended December 31, 2012 was derived from the regional short line traffic. No single customer represented more than 10% of our total freight revenue for the year ended December 31, 2012. Our ability to provide rail service to our customers depends in large part upon our ability to maintain cooperative relationships with Class I carriers and certain other customers with respect to, among other matters, freight rates, car supply, switching, interchange, fuel surcharges and trackage rights (an arrangement where the Company that owns the line retains all rights, but allows another company to operate over certain sections of its track). In addition, loss of customers or service interruptions or delays by our Class I and other interchange partners relating to customers who ship over our track may decrease our revenue. Furthermore, the ability of Class I carriers, in particular CSX and Norfolk Southern, to market and service southbound traffic into the Florida market will affect the amount of traffic we move.
Although our operations served approximately 500 customers in 2012, freight revenue from our 10 largest freight revenue customers accounted for approximately 40.9% of our total freight revenues for the year ended December 31, 2012. In addition, we have three primary aggregate customers with operations in south Florida whose freight revenues represented approximately 12.3% of our total freight revenues for the year ended December 31, 2012 (of the three primary aggregate customers, none accounted for more than 10% of total freight revenue individually). Our revenues are affected by the demand for aggregate material, primarily in Florida, and the ability of these customers to supply this natural raw material efficiently and effectively. Substantial reduction in business with or loss of important customers could have a material adverse effect on our business and financial results.
The track maintenance tax credit was not renewed by Congress until after its expiration on December 31, 2012.
In 2011, we received approximately $2.4 million from the assignment of tax credits for certain track maintenance expenditures pursuant to Section 45G of the Internal Revenue Code. Section 45G expired at the end of 2009, but was subsequently and retroactively reinstated on December 17, 2010, when President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 into law, which included provisions that extended several tax provisions through 2010 and 2011, including Section 45G. Accordingly, the Section 45G maintenance reimbursement had been extended until December 31, 2011 to cover expenditures paid or incurred in the 2010 and 2011 taxable years. While Congress did pass an extension of the 45G maintenance reimbursement for 2012 and 2013, the extension was not passed until January 2013; and therefore, no 45G maintenance reimbursement was reflected in the 2012 financials.
We are subject to environmental and other governmental regulation of our railroad operations, which could impose significant costs.
Our operations and properties are subject to federal, state and local environmental laws and regulations that impose strict, and in certain cases joint and several, liability for such costs, including, among other things, discharge of pollutants into the air, water and soil, the generation, handling, storage, transportation, treatment and disposal of waste and other regulated materials, and the cleanup of contaminated properties and human health and safety. The failure to comply with environmental and other governmental regulations could have a material adverse effect on us. We could incur significant costs, fines and penalties as a result of any allegations or findings to the effect that we have violated or are strictly liable under these laws or regulations. We may be required to incur significant expenses to investigate and remediate environmental contamination. We are also subject to governmental regulation by a significant number of federal, state and local regulatory authorities with respect to our railroad operations and a variety of health, safety, labor, maintenance and other matters.
New legislation or regulatory changes could impact our or restrict our ability to independently negotiate prices.
Legislation passed by Congress or new regulations issued by federal agencies can significantly affect the revenues, costs and profitability of our business. For instance, in December 2009, a proposed bill called the “Surface Transportation Board Reauthorization Act of 2009” was introduced in the Senate but not advanced. In January 2011, the bill now referred to as the Surface Transportation Board Reauthorization Act of 2011 (“STB Reauthorization Bill”) was reintroduced. The STB Reauthorization Bill, if adopted, could increase government involvement in railroad pricing, service and operations. The proposed legislation also includes provisions that would reduce the ability to price at market levels, and open a carrier’s privately-owned and maintained rail network to competitors where certain conditions are met.
If adopted as proposed, this bill could significantly change the federal regulatory framework of the railroad industry. Several of the changes under consideration could have a significant negative impact on our ability to determine prices for rail services, meet service standards and could force a reduction in capital spending. Statutes imposing price constraints or affecting rail-to-rail competition could adversely affect our profitability.
Severe weather and natural disasters could disrupt normal business operations, which could result in increased costs and liabilities and decreases in revenues.
Our operating assets are located on Florida’s eastern seaboard. Severe weather conditions and other natural phenomena, including hurricanes and other severe storms, fires and floods, may cause significant damage, destruction and business interruptions and result in increased costs, increased liabilities and decreased revenue. Additionally, the operations and properties of some of our customers (especially aggregate suppliers) are also subject to natural disasters, which could significantly reduce the volumes they ship and result in decreased revenue.
We face possible catastrophic loss and liability, and our insurance may not be sufficient to cover our damages or damages to others.
The operation of any railroad carries with it an inherent risk of catastrophe, mechanical failure, collision, and property loss. In the course of our operations, spills or other environmental mishaps, cargo loss or damage, business interruption due to political developments, as well as labor disputes, strikes and adverse weather conditions, could result in a loss of revenues or increased liabilities and costs. Collisions, cargo leaks or explosions, environmental mishaps, or other accidents can cause serious bodily injury, death, and extensive property damage, particularly when such accidents occur in heavily populated areas. Additionally, our operations may be affected from time to time by natural disasters such as hurricanes and other severe storms and floods. The occurrence of a major natural disaster could have a material adverse effect on our operations and financial condition. We maintain insurance that is consistent with industry practice against the accident-related risks involved in the conduct of our business and business interruption due to natural disaster. In addition, due to the location of our assets on Florida’s eastern seaboard, we also maintain windstorm coverage. However, our insurance is subject to a number of limitations on coverage, depending on the nature of the risk insured against. This insurance may not be sufficient to cover our damages or damages to others and this insurance may not continue to be available at commercially reasonable rates. In addition, we are subject to the risk that one or more of our insurers may become insolvent and would be unable to pay a claim that may be made in the future. Even with insurance, if any catastrophic interruption of service occurs, we may not be able to restore service without a significant interruption to operations which could have an adverse effect on our financial condition.
We may face liability for casualty losses that are not covered by insurance.
We have obtained insurance coverage, including windstorm coverage, for losses sustained by our railroad arising from personal injury and for property damage in the event of derailments or other incidents. Personal injury claims made by our railroad employees are subject to the Federal Employers’ Liability Act (FELA) rather than state workers’ compensation laws. Currently, we are responsible for the first $2.0 million of expenditures per each incident under our general liability insurance policy and $0.75 million of expenditures per each incident under our property insurance policy. Severe accidents or personal injuries could cause our liability to exceed our insurance limits which might have a material adverse effect on our business and financial condition. Our annual insurance limits are $200.0 million and $25.0 million on liability and property, respectively. In addition, adverse events directly and indirectly attributable to us, including such things as derailments, accidents, discharge of toxic or hazardous materials, or other like occurrences in the industry, can be expected to result in increases in our insurance premiums or our self insured retentions and could result in limitations to the coverage under our existing policies. Furthermore, the market for windstorm coverage remains very limited and costly. It is unknown how much windstorm coverage we will purchase in the future, and it is possible that our property will experience windstorm damage and utility service interruption in excess of insurance limits.
Our inability to efficiently utilize our rail car and intermodal fleet could have an adverse effect on our operations and financial condition.
We earn per diem rents on the use of our rail car and intermodal fleet of equipment based on other railroads’ or transportation service providers’ use of the equipment. Future significant downturns in the overall U.S. economy, equipment obsolescence or reduced market demand for our car and/or intermodal fleet, or efforts by other railroads or transportation providers to improve equipment utilization practices or increase or decrease the size of their equipment fleets could affect the utilization of and per diem rents for our equipment.
Also, we, through operating agreements, currently lease approximately 3,255 rail cars from Greenbrier Leasing Corporation (“Greenbrier”), The CIT Group (formerly, Bombardier Capital) and other entities, with lease lengths generally of three, five and ten years. Under the terms of the lease, the counterparty bills us an hourly rate based upon the length of time the car is on our railroad (on-line) or on another railroad (off-line). As a car goes off-line, a per diem rent sharing arrangement goes into effect whereby we and the counterparty apportion the rent based upon the length of time the car is off-line. Certain of these leases provide that we must pay the counterparty a base rent payment if the car remains on our line for a specified number of days. As a result, if a car remains on our line beyond certain periods of time, we may be required to pay our applicable counterparty a base rent amount even though we have not received any revenue under the contract because the car has not been off our line, which would reduce our operating results. Rents from Greenbrier, CIT, and other entities received by the Company were $6.5 million, $6.5 million, and $6.8 million in 2012, 2011, and 2010, respectively. By contrast, to date, the base rent payments that we have made to counterparties-i.e., payments we have made to counterparties in excess of the amount of revenue we have generated under the applicable lease-have been minimal.
Shared use of our railroad corridor with passenger railroad operations could have an adverse effect on our ability to utilize our railway efficiently, which could impact our operations and financial condition.
In December 2007, we granted to FDG Passenger ROW Holdings LLC (“FDG Passenger”), a subsidiary of FECI, a permanent, perpetual and exclusive easement for purposes consistent with, or relating to, commuter rail and transit passenger railroad operations, subject to certain exceptions. If FDG Passenger were to commence operating a passenger railroad on our railway corridor pursuant to the right granted by the passenger rail easement, without infrastructure improvement and additional capacity on our network we could be required to reduce our levels of freight volume as a result of sharing the corridor, which could have an adverse effect on our ability to utilize our railway efficiently, which may impact our operations and financial condition. We may also incur additional liability, casualty and property risks as a result of shared use of the corridor with passenger railroad operations, which could also adversely affect our operations and financial condition.
We depend on our management and key personnel, and we may not be able to operate and grow our business effectively if we lose the services of our management or key personnel or are unable to attract qualified personnel in the future.
The success of our business is heavily dependent on the continued services and performance of our current management and other key personnel and our ability to attract and retain qualified personnel in the future. The loss of key personnel could affect our ability to run our business effectively. Competition for qualified personnel is intense, and there can be no assurance that we will be successful in attracting and retaining such personnel. Although we have entered into employment agreements with certain of our key personnel, these agreements do not ensure that our key personnel will continue in their present capacity with us for any particular period of time. The loss of any key personnel could require one or more remaining key personnel to divert immediate and substantial attention to seeking a replacement or performing the duties of the departed executive. An inability to find a suitable replacement for any departing executive officer on a timely basis could adversely affect our ability to operate and grow our business.
Future acts of terrorism or war, as well as the threat of war, may cause significant disruptions in our business operations.
Terrorist attacks, such as those that occurred on September 11, 2001, as well as the more recent attacks on the transportation systems in Madrid and London, and government response to those types of attacks and war or risk of war may adversely affect our results of operations, financial condition or liquidity. Our rail lines and facilities could be direct targets or indirect casualties of an act or acts of terror. Such acts could cause significant business interruption and result in increased costs and liabilities and decreased revenues, which could have an adverse effect on our operating results and financial condition. Such effects could be magnified where releases of hazardous materials are involved. Any act of terror, retaliatory strike, sustained military campaign or war or risk of war may have an adverse effect on our operating results and financial condition by causing or resulting in unpredictable operating or financial conditions, including disruptions of rail lines, volatility or sustained increase of fuel prices, fuel shortages, general economic decline and instability or weakness of financial markets which could restrict our ability to raise capital. In addition, insurance premiums charged for some or all of our coverage could increase dramatically or certain coverage may not be available to us in the future.
The availability of qualified personnel and an aging workforce may adversely affect our operations.
Changes in demographics, training requirements and the availability of qualified personnel, particularly train crew members, could negatively affect our service levels. Unpredictable increases in demand for rail services may exacerbate these risks and may have an adverse effect on our operating results, financial condition or liquidity.
Risks Related to Our Indebtedness
We have a substantial amount of indebtedness, which may adversely affect our cash flow and our ability to operate our business.
As of December 31, 2012, our total indebtedness was approximately $626 million, including the Senior PIK Toggle Notes and the 8 1/8% Notes, which represented approximately 71% of our total capitalization. Our substantial indebtedness could have important consequences, including:
· increasing our vulnerability to adverse economic, industry or competitive developments;
· requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;
· making it more difficult for us to satisfy our obligations with respect to the notes;
· restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;
· limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes; and
· limiting our flexibility in planning for, or reacting to, changes in our business or the industry in which we operate, placing us at a competitive disadvantage compared to our competitors who are less highly leveraged and who therefore may be able to take advantage of opportunities that our leverage prevents us from exploiting.
Holdings Corp. is a holding company and, therefore, depends on its subsidiaries to service its financial obligations.
Holdings Corp. has no operations of its own and it derives all of its revenues and cash flows from FECR Corp. and its subsidiaries. FECR Corp. is a separate and distinct legal entity and has no obligation, contingent or otherwise, to make any funds available to pay Holdings Corp., whether by dividend, distribution, loan or other payments. Holdings Corp. will depend on FECR Corp. (and any other subsidiaries that Holdings Corp. may form in the future) for dividends and other payments to generate the funds necessary to meet Holdings Corp.’s financial obligations, including payments of principal and interest on the Senior PIK Toggle Notes. Legal and contractual restrictions in agreements governing current and future indebtedness, as well as the financial condition and operating requirements of FECR Corp., may limit Holdings Corp.’s ability to obtain cash from FECR Corp. The indenture governing the 8 1/8% Notes restricts FECR Corp.’s ability to pay cash dividends and make other distributions or loans to Holdings Corp. Although Holdings Corp. is a guarantor with respect to the 8 1/8% Notes, Holdings Corp.’s dependence on its subsidiaries to service its financial obligations results in this guarantee providing little, if any, additional credit support for the 8 1/8% Notes. In addition, the earnings from, or other available assets of, FECR Corp. may not be sufficient to pay dividends or make distributions or loans to enable Holdings Corp. to make payments in respect of the Senior PIK Toggle Notes when such payments are due. Furthermore, even if such earnings were sufficient, the agreements governing the current and future indebtedness of FECR Corp. may not permit FECR Corp. to provide us with sufficient dividends, distributions or loans to fund interest and principal payments on the Senior PIK Toggle Notes when due.
Despite our substantial indebtedness level, we and our subsidiaries will still be able to incur significant additional amounts of debt, which could further exacerbate the risks associated with our substantial indebtedness.
Subject to specified limitations, the indenture governing the notes permits Holding Corp. to incur additional debt. Further, the indenture governing the Senior PIK Toggle Notes, the indenture governing the 8 1/8% Notes and the ABL Facility each permit our subsidiaries to incur additional debt. On September 26, 2012, the Company, through its subsidiaries FEC PEVT, L.L.C., as borrower, and Florida East Coast Railway L.L.C., as guarantor, entered into, the SIB Loan with FDOT. The SIB Loan required that FEC PEVT, L.L.C., post with FDOT, as additional collateral through July 1, 2017, a standby letter of credit in the amount of $3 million (the “Standby Letter of Credit Collateral”). On February 1, 2013, the Company posted the Standby Letter of Credit Collateral by accessing the letter of credit line of the ABL Facility, reducing availability under the ABL Facility to $27.0 million. If new debt is added to our or any such subsidiary’s current debt levels, the risks described above could intensify.
Inability to refinance the ABL Facility may require the Company to deliver alternative cash collateral or pay down the SIB Loan
The SIB Loan required FEC PEVT, L.L.C., as borrower, to post the $3.0 million Standby Letter of Credit with FDOT through July 1, 2017. On February 1, 2013, the Company posted the Standby Letter of Credit Collateral by accessing the letter of credit line of the ABL Facility. The ABL Facility matures on January 25, 2015. In the event the Company is not able to refinance the ABL Facility or obtain another a letter of credit facility, the Company may be required to post $3.0 million cash collateral with FDOT or pay down the SIB Loan by $3.0 million in substitution of the Standby Letter of Credit.
Our debt agreements contain restrictions that will limit our flexibility in operating our business.
The indentures governing the 8 1/8% Notes, Senior PIK Toggle Notes and our ABL Facility contain various covenants that limit our ability to engage in specified types of transactions. The indentures and the ABL Facility covenants limit our and our restricted subsidiaries’ ability to, among other things:
· incur additional indebtedness;
· pay dividends on, repurchase or make distributions in respect of our capital stock or make other restricted payments;
· make certain investments;
· sell, transfer or convey certain assets;
· create liens;
· enter into sale and leaseback transactions;
· issue or sell preferred stock;
· in the case of our restricted subsidiaries, restrict them from making dividends or other payments to us;
· in the case of our restricted subsidiaries, guarantee or secure debt;
· engage in transactions with affiliates;
· create unrestricted subsidiaries; and
· consolidate, merge, sell or otherwise dispose of all or substantially all of our assets and the assets of our subsidiaries (if any) on a consolidated basis.
These covenants could adversely affect our ability to finance our future operations or capital needs and pursue available business opportunities.
In addition, if availability under the ABL Facility is below $7.5 million, we will be subject to a minimum fixed charge coverage ratio (as defined in the ABL Facility) of 1.1 to 1.0. If this covenant becomes operative in the future, events beyond our control, including changes in general economic and business conditions, may affect our ability to meet this financial ratio test. There can be no assurance that we will meet this potential financial ratio test or that our lenders will waive any failure to meet this test.
A breach of any of these covenants or any other restrictive covenants contained in FECR Corp.’s ABL Facility or the indenture governing the Senior PIK Toggle Notes and the indenture governing the 8 1/8% Notes could result in an event of default. If an event of default under FECR Corp.’s ABL Facility, the indenture governing the Senior PIK Toggle Notes or the indenture governing the 8 1/8% Notes occurs, the holders of the affected indebtedness could declare all amounts outstanding, together with accrued interest, to be immediately due and payable, which, in turn, could cause the default and acceleration of the maturity of our or FECR Corp.’s other indebtedness. If we were unable to pay such amounts, the lenders under FECR Corp.’s ABL Facility and noteholders of the 8 1/8% Notes could proceed against the collateral pledged to them.
The SIB Loan contains covenants and conditions that could restrict our ability to draw funds under the SIB Loan.
The SIB Loan contains covenants and conditions to disbursements customarily contained in construction loans and loans from governmental entities. The SIB Loan requires FEC PEVT, L.L.C., the borrower under the SIB Loan, to undergo annual audits by the State of Florida as required by Florida law. In addition, FDOT has the right to annul the SIB Loan if FEC PEVT, L.L.C. does not make a request for disbursement within six months of the first scheduled disbursement (October 1, 2012) or, at anytime, suspend or terminate FDOT’s remaining obligations under the SIB Loan if FEC PEVT, L.L.C. abandons the ICTF construction project or if the ICTF construction project is rendered improbable, infeasible, impossible, or illegal. FDOT also has the right to unilaterally cancel the SIB Loan in the event the Company refuses to allow public access to all documents, papers, letters or other materials subject to the provisions of Chapter 119, Florida Statutes, and made or received in conjunction with the SIB Loan. FDOT’s obligation to make advances under the SIB Loan is contingent upon the annual appropriation of the Florida legislature and there is no assurance that the Florida legislature will make such appropriations.
A default under the SIB Loan may adversely affect the 8 1/8% Notes.
The SIB Loan contains customary events of default, including, failure to make a loan payment when due for more than 5 days, a warranty or representation of FEC PEVT, L.L.C., as borrower, or Florida East Coast Railway, L.L.C., as guarantor, is found to be untrue in any material respect, a bankruptcy or insolvency of FEC PEVT, L.L.C., as borrower, or Florida East Coast Railway, L.L.C., as guarantor, failure to provide or restore the Standby Letter of Credit Collateral, or a material covenant breach or failure to provide notice of a material covenant breach within the times periods set forth in the SIB Loan. As a condition to making the SIB Loan, FDOT required and was granted a first priority lien on certain fixtures (including rail trackage) and equipment included in the collateral securing 8 1/8% Notes. A default under the SIB Loan may result in the seizure of collateral securing the 8 1/8% Notes and default under the indenture governing the 8 1/8% Notes.
We may not be able to generate sufficient cash to service the 8 1/8% Notes, the SIB Loan or our other indebtedness, and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on the notes or our other indebtedness. Any payments we make directly or indirectly to our parent companies would reduce the level of cash available to us to make the scheduled payments in respect of the 8 1/8% Notes, the SIB Loan and other indebtedness.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance the 8 1/8% Notes or our other indebtedness. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of the indenture governing the 8 1/8% Notes and existing or future debt instruments may restrict us from adopting some of these alternatives. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Track and Equipment
Track
We own a railroad right-of-way, generally 100-feet wide, along the east coast of Florida extending for 351 miles from Jacksonville to Miami, used for our railroad operations. We also own/lease and operate approximately 235 miles of branch, switching and other secondary track, 115 miles of yard track, various rail car marshalling yards, trailer/container and automobile loading and unloading facilities, signaling system facilities, and a number of operating offices, shops and service house buildings.
The mainline is, in general, constructed of 136-pound per yard continuous welded rail supported on concrete cross-ties. The facilities provide a reliable infrastructure for rail operations suited to the business demands of our customers, including unrestricted movement of double-stacked containers, tri-level automobiles and heavier rail axle cars. The branch mainlines, way switching and yard tracks are, for the most part, constructed of 115-pound per yard materials supported by wood ties.
Locomotives and Railcars (“Rolling Stock”)
As of December 31, 2012, the Company owned or leased 59 diesel electric locomotives, 4,766 freight cars, 1,357 trailers, containers and chassis for highway revenue service, numerous pieces of rail-mounted work equipment and numerous automobiles used in maintenance and transportation operations. Generally, the Company’s equipment is in good physical condition, considering its years of service and operating utilization.
A summary of the rolling stock owned and leased by us at the end of 2012 is presented in the table below:
The average age of our locomotives is 28 years as compared to a depreciable life of 60 years for new locomotives. The average of our railcars is 23 years as compared to depreciable life of 55 years for a new railcar.
In addition to the rolling stock that the Company owns, the Company currently manages 3,255 rail cars from Greenbrier Leasing Corporation and other entities, with lease lengths generally of three, five and ten years. The lease terms call for the Company to be billed an hourly rate based upon the length of time the car is on the Company’s railroad (on-line) or on another railroad (off-line). As a car goes off-line, a per diem rent sharing arrangement goes into effect whereby Greenbrier and the Company apportion the rent based upon the length of the time the car is off-line. Rents from Greenbrier and other entities received by the Company were $6.5 million, $6.5 million, and $6.8 million in 2012, 2011, and 2010, respectively.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We have been, and may from time to time, be involved in litigation and claims incidental to the conduct of our business in the ordinary course. Our industry is also subject to scrutiny by governmental regulators, which could result in enforcement proceedings or litigation related to regulatory compliance matters. We maintain insurance policies in amounts and with the coverage and deductibles we believe are adequate, based on the nature and risks of our business, historical experience and industry standards. As of the date of this Annual Report on Form 10-K, we are not a party to any material legal or adverse regulatory proceedings.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
FECR Rail Holdings, LLC, our ultimate parent, an entity wholly owned by private equity funds managed by affiliates of Fortress, owns approximately 99.2% of our outstanding common stock. There is no established public trading market for our common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following tables summarize selected historical consolidated financial information for our business. You should read these tables along with “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Business”, and our consolidated historical financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. The historical results are not necessarily indicative of the results of operations to be expected in the future.
The Company is owned by private equity funds managed by affiliates of Fortress Investment Group LLC (“Fortress”). Upon the acquisition, Fortress acquired all of the outstanding stock of Florida East Coast Industries, Inc. (“FECI”) in 2007 and then subsequently FECI sold its rail transportation segment (the “Rail Separation”), which operated as separate legal entities. Concurrent with the Rail Separation, FECR Rail LLC and Florida East Coast Railway Corp. were formed to carry on the activities of the railway. In January 2011, FECR Rail LLC contributed all of its holdings of the Company’s common and preferred shares to Florida East Coast Holdings Corp. (“Holdings Corp.”), whereby Holdings Corp. became the immediate parent of FECR Corp.
The selected historical consolidated financial data for the years ended December 31, 2008 through 2012, have been derived from the audited historical Consolidated Financial Statements of FECR.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements that involve risks and uncertainties. You should read the following discussion in conjunction with our historical consolidated financial statements included in this Annual Report on Form 10-K. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed under “Risk Factors.”
Holdings Corp. was incorporated on January 10, 2011. In January 2011, all of the equity interests in FECR Corp. were transferred from FECR Rail LLC to Holdings Corp., whereby Holdings Corp. became the immediate parent of FECR Corp. Holdings Corp. is a holding company and has no direct operations or material assets other than its wholly owned interest in FECR Corp. All of Holdings Corp.’s operations are conducted through its subsidiaries. The only material differences between Holdings Corp. and FECR Corp. are Holdings Corp.’s separate debt obligations and related accounts, including deferred financing costs, amortization, and payment of interest. Reclassifications in common stock and additional paid-in-capital have been made to the Consolidated Financial Statements to reflect the capital structure for Holdings Corp. for the year ended December 31, 2011.
Overview
We own and operate a 351-mile freight railroad along the east coast of Florida from Jacksonville to Miami. Our railroad is one of only two major freight railroads serving Florida. We operate at a high level of density, which means that we carry a high number of units per track mile. In 2012, we carried approximately 1,304 units per mainline track mile, which we believe is more than any of the Class I railroads in the United States.
In 2012, we transported over 457,000 units on our railroad comprising various types of freight for over 500 customers. We transport products such as intermodal containers and trailers, crushed rock (aggregate), automobiles, food, and other industrial products. We are a major hauler of aggregate in the State of Florida and a key conduit for the transportation of automobiles into South Florida.
We provide a direct route through some of the most highly congested regions of the State of Florida, and we believe that we are able to haul freight often more quickly and more cost effectively than other modes of transportation, such as trucking, as one train can haul the equivalent of up to 280 trucks.
We have direct access to the major south Florida ports of Miami, Everglades (Fort Lauderdale) and Palm Beach through which we transport intermodal containers. We believe that our unique positioning to these ports will help us continue our volume growth of intermodal containers.
Our Business
We generate rail-operating revenues primarily from both the movement of freight in conventional freight cars and intermodal shipments of containers and trailers on flatcars. We count each move of a freight car, container or trailer on our line as one unit. We also generate revenue from dray moves (drayage is the movement of containers or trailers by truck to and from the rail yard). Non-freight operating revenues are derived from car hire and demurrage (allowing our customers and other railroads to use our railcars for storage or transportation in exchange for a daily fee), real estate and equipment lease income, ancillary dray charges, switching (managing and positioning railcars within a customer’s facility), and other transportation services.
Our operating expenses consist of salaries (approximately 70% of our work force is covered by collective bargaining agreements), related payroll taxes and employee benefits, depreciation (primarily reflecting our capital requirements for maintaining current operations), insurance and casualty claim expenses, diesel fuel, repairs billed to/from others (generally, a net credit received from repairs of foreign cars on our line less repairs paid by us for our cars on a foreign line), property taxes, material and supplies, purchased services (contract labor and professional services), and other expenses.
Managing Business Performance
We manage our business performance by attempting to (i) grow our freight and non-freight revenue, (ii) drive financial improvements through a variety of cost-savings initiatives, and (iii) continued focus on safety to lower the costs and risks associated with operating our business.
Changes in units and revenue per unit (“RPU”) have a direct impact on freight revenue. We continue to implement more effective pricing by carefully analyzing pricing decisions to improve our freight revenue per unit. As a consequence, our operating ratio, which we define as total operating expenses divided by total operating revenues, continues to be a key metric which we evaluate. We deem operating ratio as an important metric to measure our operational performance, however, operating ratio is not a measure as defined under U.S. GAAP.
Non-freight services offered to our rail customers include switching (or managing and positioning railcars within a customer’s facility), car hire and demurrage (allowing our customers and other railroads to use our railcars for storage or transportation in exchange for a daily fee), realty and equipment lease rentals, and dray ancillary charges (detention, lumper, and other). Each of these services leverages our existing customer relationships and generates additional revenue with minimal capital investment.
Highlights for the Years ended December 31, 2012 and 2011
·
Operating revenue for the year ended December 31, 2012 was $246.8 million, compared with $213.3 million for the year ended December 31, 2011. The primary driver of this $33.5 million increase was an increase in both intermodal volume and rates, as well as increased carload volumes, partially offset by a decrease in non-freight revenues.
·
Freight revenues increased $35.0 million, or 18.0%, for the year ended December 31, 2012, compared with the year ended December 31, 2011, primarily due to an increase in intermodal volumes, negotiated intermodal rate increases and increased fuel surcharge recovery, as well as increased carload volumes. Non-freight revenues decreased $1.5 million, or 8.1%, for the year ended December 31, 2012, compared with the year ended December 31, 2011, primarily due to the sale of locomotives previously under lease.
·
Net loss for the year ended December 31, 2012 was $13.3 million, compared with a net loss of $37.3 million for the year ended December 31, 2011. Operating income for the year ended December 31, 2012 was $53.0 million, compared with $34.9 million for the year ended December 31, 2011.
·
Our operating ratio was 78.5% for the year ended December 31, 2012, compared with an operating ratio of 83.6% for the year ended December 31, 2011. This improvement was primarily due to higher revenue combined with continued productivity improvements.
·
During the year ended December 31, 2012, we generated $33.5 million in cash from our operating activities, purchased $22.4 million in property and equipment, received $0.6 million for assets sold and used $2.2 million in financing activities.
·
Our income tax expense was $7.6 million for the year ended December 31, 2012 which was a non-cash item, compared to income tax expense of $14.9 million for the year ended December 31, 2011. We believe that it is more likely than not that our net operating losses will expire unused for the years ended December 31, 2012 and 2011.
Highlights for the Years ended December 31, 2011 and 2010
·
Operating revenue for the year ended December 31, 2011 was $213.3 million, compared with $200.0 million for the year ended December 31, 2010. The primary driver of this $13.3 million increase was an increase in intermodal volumes, negotiated rate increases and increased fuel surcharge recovery, offset by decreased carload revenues.
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Freight revenues increased $13.9 million, or 7.7%, for the year ended December 31, 2011, compared with the year ended December 31, 2010, primarily due to an increase was an increase in intermodal volumes, negotiated rate increases and increased fuel surcharge recovery, offset by decreased carload revenues. Non-freight revenues decreased $0.6 million, or 3.1%, for the year ended December 31, 2011, compared with the year ended December 31, 2010, primarily due to the sale of locomotives previously under lease.
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Net loss for the year ended December 31, 2011 was $37.3 million, compared with a net loss of $23.6 million for the year ended December 31, 2010. Operating income for the year ended December 31, 2011 was $34.9 million, compared with $43.0 million for the year ended December 31, 2010.
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Our operating ratio was 83.6% for the year ended December 31, 2011, compared with an operating ratio of 78.5% for the year ended December 31, 2010. This increase was primarily due to a change in mix to lower margin intermodal business from carload, costs incurred related to strategic initiatives and increased rail yard rent.
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During the year ended December 31, 2011, we generated $35.5 million in cash from our operating activities, purchased $25.7 million in property and equipment, received $9.9 million for assets sold and paid $18.0 million for financing costs.
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Our income tax expense was $14.9 million for the year ended December 31, 2011 which was a non-cash item. There was zero income tax expense for the year ended December 31, 2010. We believe that it is more likely than not that our net operating losses will expire unused for the year ended December 31, 2011, whereas for the year ended December 31, 2010, we expected to fully utilize our net operating losses.
Results of Operations
Comparison of Operating Results for the Year Ended December 31, 2012 and 2011
Operating Revenue
Operating revenues increased $33.5 million, or 15.7%, to $246.8 million for the year ended December 31, 2012 from $213.3 million for the year ended December 31, 2011. The net increase was primarily due to higher intermodal and carload freight revenues, partially offset by decreased non-freight revenues.
Freight revenues increased $35.0 million, or 18.0%, to $229.6 million for the year ended December 31, 2012 from $194.5 million for the year ended December 31, 2011. The increase was primarily due to an increase in intermodal volumes, negotiated intermodal rate increases and increased fuel surcharge recovery, as well as increased carload volumes. Total units increased 6.9% to 457,686 for the year ended December 31, 2012, from 428,120 for the year ended December 31, 2011.
The increase in average revenue per unit to $502 for the year ended December 31, 2012 from $454 for the year ended December 31, 2011 was due to an increase in intermodal price and fuel surcharge recovery.
The following table compares freight revenues, units, and average freight revenue per unit for the year ended December 31, 2012 and 2011:
* The units for 2011 have been restated to conform to the 2012 presentation. In June 2012, the Company made a policy change and began charging for certain Intermodal revenue empties; the year ended December 31, 2012 includes 7,378 units related to this change. Excluding the volumes, Intermodal revenue per unit would have been $428.
Intermodal revenues increased $19.9 million (Rate/Mix increase-$18.3 million; Volume increase-$1.6 million) for the year ended December 31, 2012, compared to the year ended December 31, 2011. Rate/Mix represents the change in price per unit charged to the customer as well as the change in price per unit due to the mix in traffic as the rate per unit may vary per the commodity handled and the length of the haul. Our Rate/Mix increase was primarily driven by an increase in actual price, as well as a favorable change in mix.
Carload revenues for the year ended December 31, 2012 increased $15.1 million (Rate/Mix decrease-$6.2 million; offset by Volume increase-$21.3 million) compared to the year ended December 31, 2011. Overall, carload shipments increased 32.5%, or 25,159 units, for the year ended December 31, 2012 compared to the year ended December 31, 2011. This increase in carload revenue was primarily due to the net effect of the following:
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Crushed Stone (Aggregate) revenues increased $10.5 million, or 40.7% primarily due to increases in infrastructure projects in Florida and the expansion of the Fort Lauderdale airport.
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Food Products revenues increased $2.1 million, or 20.4%. This increase was driven by a customer’s manufacturing facility coming back online at the beginning of 2012.
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Motor Vehicles & Equipment revenues increased $2.9 million, or 32.8%. This increase was due to continued volume recovery from the earthquakes in Japan during 2011, and increased volumes for other car manufacturers, as well as price improvements.
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Chemicals revenues remained relatively consistent for the comparable periods.
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Other revenues decreased $0.5 million, or 3.3%. This decrease is primarily due to lower housing related shipments.
Non-freight revenues decreased $1.5 million, or 8.1%, to $17.2 million for the year ended December 31, 2012 from $18.7 million for the year ended December 31, 2011. The primary decrease in non-freight revenues was due to the sale of locomotives that were previously under lease.
Operating Expenses
The following table sets forth the operating revenue and expenses for our consolidated operations for the periods indicated (dollars in thousands):
Operating expenses increased to $193.8 million for the year ended December 31, 2012, from $178.3 million for the year ended December 31, 2011, an increase of $15.5 million, or 8.7%. The operating ratio was 78.5% for the year ended December 31, 2012 compared to 83.6% for the year ended December 31, 2011. Set forth below is additional detail regarding changes in our operating expenses:
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Labor and benefits increased $2.0 million, or 4.2%, to $48.6 million, due to general wage inflation and higher health and welfare costs.
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Equipment rents increased $1.8 million, or 15.6%, to $13.4 million. This increase was due to higher car hire expense related to increased volumes. In addition, in March 2012, the Company cancelled a haulage agreement which caused the car hire expense to become a Company obligation.
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Purchased services increased $8.8 million, or 24.5%, to $44.8 million. This increase was mainly due to purchased rail services.
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Diesel fuel increased $1.7 million, or 5.8% to $30.4 million. As a percentage of revenue, diesel fuel decreased to 12.3% for the year ended December 31, 2012, as compared to 13.5% for the year ended December 31, 2011. The increase in diesel fuel was primarily due to an increase in the average price of fuel. The average price of fuel was $3.41per gallon for the year ended December 31, 2012 compared to the average price per gallon of $3.26 for the year ended December 31, 2011. The increase in fuel cost was partially offset by efficiencies in fuel usage for the comparable periods.
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Net loss on sale and impairment of assets increased $1.5 million, or 75.8%, to $3.4 million. The increase was due to the impairment loss of $3.3 million related to hopper cars in 2012.
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Depreciation and amortization remained relatively consistent for the comparable periods.
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Other expenses remained relatively consistent for the comparable periods.
Other Income (Expense)
Interest Expense (net of interest income). Interest expense increased $1.4 million, or 2.4%, to $58.8 million for the year ended December 31, 2012 from $57.4 million for the year ended December 31, 2011. The increase in interest expense is due to increased debt related to the interest on the Senior PIK Toggle Notes which were paid in kind, and the timing of the issuance of the Senior PIK Toggle Notes.
Other Income (Loss). Other income (loss) remained relatively consistent for the comparable periods.
Provision for Income Taxes. For the year ended December 31, 2012, we believe that it is more likely than not that our net operating losses expected to be generated by the Company in 2012 will expire unused. Accordingly, we recognized tax expense in the amount of $7.6 million for the year ended December 31, 2012. For the year ended December 31, 2011, recognized tax expense in the amount of $14.9 million.
Comparison of Operating Results for the Year Ended December 31, 2011 and 2010
Operating Revenue
Operating revenues increased $13.3 million, or 6.6%, to $213.3 million for the year ended December 31, 2011 from $200.0 million for the year ended December 31, 2010. The net increase was primarily due to an increase in intermodal revenues, negotiated rate increases, and increased fuel surcharge recovery, partially offset by decreased carload revenues.
Freight revenues increased $13.9 million, or 7.7%, to $194.5 million for the year ended December 31, 2011 from $180.7 million for the year ended December 31, 2010. The increase was primarily due to increased negotiated rates and volumes (intermodal volume increases were offset by a decrease in carload volumes), as well as increased fuel surcharge recovery. Total units increased 1.0% to 428,120 for the year ended December 31, 2011, from 421,801 for the year ended December 31, 2010.
The increase in average revenue per unit to $454 for the year ended December 31, 2011 from $428 for the year ended December 31, 2010 was due to an increase in price and fuel surcharge recovery, offset by a decrease related to traffic mix. Carload traffic, which has a higher average revenue per unit, was 18.1% of the traffic in 2011 as compared to 20.2% in 2010.
The following table compares freight revenues, units, and average freight revenue per unit for the year ended December 31, 2011 and 2010:
*The units for 2011and 2010 have been restated to conform to the 2012 presentation. In June 2012, the Company made a policy change and began charging for certain Intermodal revenue empties; for the years ended December 31, 2011 and 2010 includes 15,329 and 11,705 units, respectively. Excluding the volumes, Intermodal revenue per unit would have been $385 and $347 for the years ended December 31, 2011 and 2010, respectively.
Intermodal revenues increased $16.3 million (Rate/Mix increase-$11.6 million; Volume increase-$4.7 million) for the year ended December 31, 2011, compared to the year ended December 31, 2010. Rate/Mix represents the change in price per unit charged to the customer as well as the change in price per unit due to the mix in traffic as the rate per unit may vary per the commodity handled and the length of the haul. Our Rate/Mix increase was driven by an increase in actual price offset by a change in mix. Overall, Intermodal shipments increased 4.2% or 14,106 units for the year ended December 31, 2011, compared to the year ended December 31, 2010. This growth was attributable to our international business (which primarily includes our customers that ship freight through maritime ports), freight with our Class I partners, as well as conversion of truckload traffic to rail.
Carload revenues for the year ended December 31, 2011 decreased $2.4 million (Rate/Mix increase-$3.8 million; offset by Volume decrease-$6.2 million) compared to the year ended December 31, 2010. Overall, carload shipments declined 9.1%, or 7,787 units, for the year ended December 31, 2011 compared to the year ended December 31, 2010. This decrease in carload revenue was primarily due to the net effect of the following:
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Crushed Stone (Aggregate) revenues decreased $1.3 million, or 4.9% primarily due to continued volume declines in the residential and road construction market in Florida.
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Food Products revenues decreased $1.5 million, or 12.8%. This decrease was driven by a decline in volumes of 16.1% that was primarily due to a temporary shift as one of our customers is retooling their manufacturing facility that we serve.
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Motor Vehicles & Equipment revenues increased $0.5 million, or 5.9%. This increase was due to price increases and fuel recovery which was slightly offset by a volume decrease. The reduction in volumes was due to the earthquakes in Japan during the first quarter of 2011.
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Chemicals revenues decreased $1.0 million, or 12.8%. This decrease was due to a reduction in ethanol shipments.
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Other revenues increased $0.9 million, or 7.1%. This increase is primarily due to an increase in volume of the lumber commodity.
Non-freight revenues decreased $0.6 million, or 3.1%, to $18.8 million for the year ended December 31, 2011 from $19.4 million for the year ended December 31, 2010. The primary decrease in non-freight revenues was due to the sale of locomotives that were previously under lease.
Operating Expenses
The following table sets forth the operating revenue and expenses for our consolidated operations for the periods indicated (dollars in thousands):
Operating expenses increased to $178.3 million for the year ended December 31, 2011, from $157.0 million for the year ended December 31, 2010, an increase of $21.3 million, or 13.6%. The operating ratio was 83.6% for the year ended December 31, 2011 compared to 78.5% for the year ended December 31, 2010. Set forth below is additional detail regarding changes in our operating expenses:
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Labor and benefits increased $4.3 million, or 10.2%, to $46.6 million. As a percentage of operating revenue, labor and benefits increased 0.7 points. The increase in labor and benefits was mainly due to an increase in headcount resulting from assembling an executive team in the first quarter of 2011, as well as stipulated wage increases for union contracts.
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Equipment rents remained relatively consistent for the comparable periods.
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Purchased services increased $2.8 million, or 8.3%, to $36.0 million. This increase was mainly due to consulting services related to strategic initiatives, increased lift costs and increased volumes.
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Diesel fuel increased $7.1 million, or 32.8% to $28.8 million. As a percentage of revenue, diesel fuel increased to 13.5% for the year ended December 31, 2011, as compared to 10.8% for the year ended December 31, 2010. The increase in diesel fuel was primarily due to an increase in the average price of fuel. The average price of fuel was $3.26 per gallon for the year ended December 31, 2011 compared to the average price per gallon of $2.41 for the year ended December 31, 2010. The increase in fuel cost was partially offset by efficiencies in fuel usage for the comparable periods.
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Depreciation and amortization remained relatively consistent for the comparable periods.
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Other expenses increased $5.2 million, or 24.7%, to $26.2 million primarily due to increased rent of $3.0 million related to the Hialeah yard as a result of the amended lease agreement, increased rent expense $0.8 million, as well as increases in other expenses of $1.3 million.
Other Income (Expense)
Interest Expense (net of interest income). Interest expense decreased $8.9 million, or 13.3%, to $57.4 million for the year ended December 31, 2011 from $66.3 million for the year ended December 31, 2010. The decrease was primarily due to a change in the combined interest rates in connection with refinancing the $1.656 billion Senior Secured Credit Facility (the “Old Facility”) with proceeds of $475.0 million from the sale of the 8 1/8% Notes (9.75% interest rate on the Old Facility as compared to a rate of 8.125% on the 8 1/8% Notes), as well as the $130.0 million gross proceeds from the sale of the Senior PIK Toggle Notes (interest rate on the Senior PIK Toggle Notes is 10 ½% / 11 ¼%).
Other Income (Loss). Other income (loss) remained relatively consistent for the comparable periods.
Provision for Income Taxes. For the year ended December 31, 2011, we believe that it is more likely than not that our net operating losses expected to be generated by the Company in 2011 will expire unused. Accordingly, we recognized tax expense in the amount of $14.9 million for the year ended December 31, 2011. For the year ended December 31, 2010, we expected that our net operating losses would be fully utilized.
Liquidity and Capital Resources
The discussion of liquidity and capital resources that follows reflects our consolidated results and includes all of our subsidiaries. We have historically met our liquidity requirements primarily from cash generated from operations and borrowings under our credit agreements which are used to fund capital expenditures and debt service requirements. For the year ended December 31, 2012 and 2011, there was a net cash inflow from operations of $33.6 million and $35.5 million, respectively, primarily related to cash flow generated by operations.
We meet our liquidity requirements primarily from the following sources:
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Operating revenues generated from freight and non-freight revenues. Freight revenues include revenues derived from intermodal transports and carload shipments of a variety of goods such as aggregates (crushed stones), motor vehicles and food products. Non-freight revenues include car hire and demurrage, real estate and equipment lease income, ancillary dray charges, switching, administration fees and other transportation services.
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Borrowings and lines of credits, under which $475.0 million was outstanding on the Senior Secured 8 1/8% Notes, $151.0 million was outstanding for the Senior PIK Toggle Notes, and $30.0 million was available for borrowing under the ABL Facility as of December 31, 2012. As of December 31, 2012 and 2011, $626.0 million and $609.8 million, respectively, were outstanding and there were no funds drawn on the ABL for both periods.
We expect that our cash flows from operations and existing credit facilities will be sufficient to meet our ongoing operating requirements, to fund capital expenditures for property, plant and equipment, and to satisfy our debt requirements. In addition, we closed the $30 million State Infrastructure Bank loan (the “SIB Loan”) on September 26, 2012. The purpose of the SIB Loan is to fund, in part, the costs associated with the Company’s construction of a new Florida East Coast Intermodal Transfer Facility (the “ICTF”) at Port Everglades which will serve the Company’s domestic and international segments. The ICTF is expected to cost $53 million to complete. Proceeds of the SIB Loan will be advanced by the Florida Department of Transportation (“FDOT”) as construction proceeds on the ICTF. The total construction costs of the ICTF are expected to be $53 million, $30 million of which will be funded by the SIB Loan, $18 million of which will be funded by a grant from FDOT, and the balance of $5 million from the Company’s capital budget. Our current projections of cash flows from operations and the availability of funds under our ABL Facility (as further described below) are expected to be sufficient to fund our maturing debt and contractual obligations in the next several years. No assurance can be made that we will be able to meet our financing and liquidity needs as currently contemplated. See “Risk Factors-Risks Related to Our Indebtedness.”
Holdings Corp. is a holding company and, therefore, depends upon the performance of and distributions from our subsidiaries to meet its debt service obligations (including interest payments) under the Senior PIK Toggle Notes. Legal and contractual restrictions in agreements governing current and future indebtedness, as well as the financial condition and operating requirements of our direct subsidiary, FECR Corp., may limit Holdings Corp.’s ability to obtain cash from FECR Corp. The indenture governing the 8 1/8% Notes and the ABL Facility contain covenants that restrict FECR Corp.’s ability to pay cash dividends and make other distributions or loans to Holdings Corp. The earnings from, or other available assets of, FECR Corp. may not be sufficient to pay dividends or make distributions or loans to enable Holdings Corp. to make payments in respect of the notes when such payments are due. In addition, even if such earnings were sufficient, we cannot assure you that the agreements governing the current and future indebtedness of FECR Corp. will permit FECR Corp. to provide us with sufficient dividends, distributions or loans to fund interest and principal payments on the notes when due. Holdings Corp. will be forced to accrue interest on a “paid-in-kind” basis, to the extent that distributions from FECR Corp. are not sufficient to fulfill the interest obligations under the notes. Any interest accrued on a “paid-in-kind” basis will increase the overall cost of Holdings Corp.’s borrowings, as well as the cash ultimately required to fully satisfy Holdings Corp.’s obligations, under the Senior PIK Toggle Notes.
We have implemented capital spending programs designed to assure the ability to provide safe, efficient and reliable transportation services. In 2012, we spent $22.5 million of capital of which approximately 79.5% was used to sustain the core infrastructure. We funded these capital investments through cash generated from operations.
The remaining capital expenditures were for locomotives, freight cars, technology and high return growth or productivity investments such as the planned intermodal container rail service on our own rail line leading into the port of Miami. This project will enable cargo to be moved directly from the port’s facility to an inland distribution center and alleviate traffic congestion in and around the port. We estimate the total costs to be $50.0 million, of which we have contributed an estimated $9.1 million.
We are continually evaluating market and regulatory conditions that could affect our ability to generate sufficient returns on capital investments. We may revise our future estimates for capital spending as a result of changes in business conditions, tax legislation or the enactment of new laws or regulations. Although new legislation or regulations could have a material adverse effect on our operations and financial performance in the future, we cannot predict the manner or severity of such impact. However, we continue to take steps and explore opportunities to reduce the impact of our operations on the environment, including investments in new technologies, reducing fuel consumption and increasing fuel efficiency and lowering emissions.
Cash Flow Information for the Years ended December 31, 2012, 2011, and 2010
Operating Activities
Cash generated by operating activities was $33.5 million for the year ended December 31, 2012 compared to cash provided by operating activities of $35.5 million for the year ended December 31, 2011. The decrease in cash provided by operating activities of $2.0 million was primarily due to changes in working capital for the corresponding periods.
Cash generated by operating activities was $35.5 million and $21.9 million for the years ended December 31, 2011 and 2010, respectively. The increase in cash from operating activities for the year ended December 31, 2011 in comparison to 2010 of $13.6 million was primarily related to changes in working capital off-set by lower interest costs.
Investing Activities
Cash used in investing activities was $21.8 million for the year ended December 31, 2012 compared to cash used in investing activities of $11.8 million for the year ended December 31, 2011. The increase in cash used by investing activities of $10.0 million was primarily related to the release of the interest reserve account of $4.0 million related to the 2011 Refinancing as well as a reduction in proceeds from the sale of assets of $9.3 million off-set by a reduction in purchases of property of $3.2 million.
Cash used in investing activities was $11.8 million and $19.6 million for the years ended December 31, 2011 and 2010, respectively. The decrease in cash used by investing activities of $7.8 million was primarily related to the release of the interest reserve account related to the 2011 Refinancing as well as proceeds from the sale of assets off-set by an increase of capital expenditures.
Financing Activities
Cash used in financing activities was $2.2 million and $2.1 million for the years ended December 31, 2012, and 2011, respectively.
Cash used in financing activities was $2.1 million for the year ended December 31, 2011. The cash used for financing activities was $1.2 million for the year ended December 31, 2010. The increase of $0.9 million was primarily related to the refinancing including transaction costs of the Rail Term Loan and the equity contribution from our parent company, FECR Rail LLC of $16.0 million.
Long-term Debt
In connection with the Acquisition, FECR Corp., along with FECI, entered into the $1.656 billion Old Facility. The Old Facility consisted of:
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a $992.8 million Property Term Loan;
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a $600.0 million Rail Term Loan;
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a $13.2 million Delayed Draw Property Term Loan; and
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a $50.0 million Revolving Credit Facility.
As a result of the Rail Separation, the $600.0 million Rail Term Loan was assumed by FECR Corp. and FECR Rail LLC. The $50 million Revolving Credit Facility remained in place for FECI and FECR Corp. after the Rail Separation. Prior to December 31, 2007, all amounts outstanding under the Revolving Credit Facility were drawn by and were the obligation of FECI. All obligations outstanding under the Old Facility were cross-guaranteed by FECI and FECR Corp.’s respective subsidiaries.
The Company’s outstanding balances of the amended Old Facility were $601.2 million as of December 31, 2010. The weighted-average interest rate on the amended Old Facility was 9.66% for the year ended December 31, 2010. The aggregate outstanding balance on the amended Old Facility, which included the Company’s outstanding balance of $601.2 million, was $799.1 million as of December 31, 2010.
All outstanding amounts under the amended Old Facility were paid in January 2011 (as described in “Refinancing” below).
Refinancing
On January 25, 2011, FECR Corp. sold $475.0 million of 8 1/8% Senior Secured Notes due 2017 (“Senior Secured Notes” or “8 1/8% Notes”) in a private offering, for gross proceeds of $475.0 million.
In connection with the issuance of the Senior Secured Notes, FECR Corp. and certain of its subsidiaries also entered into the Asset-Based Lending (“ABL”) Facility. The ABL Facility matures on January 25, 2015 and bears interest at FECR Corp.’s option of: (a) a base rate determined in the greater of (1) the prime rate of the administrative agent, (2) federal funds effective rate plus 1 / 2 of 1%, or (b) a LIBOR rate determined by reference to the cost of funds for U.S. dollar deposits in London interbank market for the interest period relevant to such borrowing. The applicable margin with respect to (a) base rate borrowings will be 2.25%, and (b) LIBOR borrowings will be 3.25%. Obligations under the ABL Facility are secured by a first-priority lien on the ABL Collateral.
The Senior Secured Notes are secured by first-priority liens on substantially all of the tangible and intangible assets of FECR Corp. and its subsidiary guarantors’ (other than the ABL collateral securing the ABL Facility) and a second-priority lien on ABL collateral. The guarantors are defined primarily as existing and future wholly owned domestic restricted subsidiaries. FECR Corp. may redeem up to 10% of the aggregate principal amount of the Senior Secured Notes issued during any 12-month period commencing on the issue date and ending on the third anniversary thereof at a price equal to 103% of the principal amount thereof plus accrued and unpaid interest, if any. FECR Corp. may also redeem some or all of the Senior Secured Notes at any time before February 2014 at a price equal to 100% of the aggregate principal amount thereof plus a make-whole premium. In addition, prior to February 1, 2014, FECR Corp. may redeem up to 35% of the Senior Secured Notes at a redemption price of 108.125% of the aggregate principal amount thereof with the proceeds from an equity offering. Subsequent to February 1, 2014, FECR Corp. may redeem the Senior Secured Notes at 104.063% of their principal amount. The premium then reduces to 102.031% commencing on February 1, 2015 and then 100% on February 1, 2016 and thereafter.
The ABL Facility and indenture governing the Senior Secured Notes contain various covenants and restrictions that limits FECR Corp. and its restricted subsidiaries’ ability to incur additional indebtedness, pay dividends, make certain investments, sell or transfer certain assets, create liens, designate subsidiaries as unrestricted subsidiaries, consolidate, merge or sell substantially all the assets, and enter into certain transactions with affiliates. It is anticipated that proceeds from any future borrowings will be used for general corporate purposes.
State Infrastructure Bank Loan
On September 26, 2012, FEC PEVT, L.L.C., as borrower, and Florida East Coast Railway, L.L.C., as guarantor, each a wholly owned subsidiary of the Company, entered into a SIB Loan with FDOT. The SIB Loan provides for a loan of $30 million to fund, in part, the costs associated with the construction of a new Florida East Coast ICTF in Port Everglades which will serve the Company’s domestic and international business segments. Proceeds of the SIB Loan will be advanced by FDOT as construction proceeds on the ICTF. The total cost of the ICTF construction project is approximately $53 million, $30 million of which will be funded through the SIB Loan, $18 million of which will be from a FDOT grant (the “FDOT Grant”) and the balance of $5 million from the Company’s capital budget. The Company has been awarded the entire $18 million of the FDOT Grant as of December 31, 2012.
Interest will accrue on the advanced principal amount of the SIB Loan at the rate of 3.50% per annum, compounded annually, using an actual-days-elapsed/365 day counting convention. Both principal and interest payments are payable in annual installments as follows: interest payments commence on the SIB Loan on October 1, 2013, and principal repayments commence on the SIB Loan on October 1, 2015. The SIB Loan will be amortized over 20 years.
The SIB Loan is fully and unconditionally guaranteed by the Florida East Coast Railway, L.L.C. In addition, as a condition to making the SIB Loan, FDOT required a first priority lien on certain fixtures (including rail trackage) and equipment included in the collateral securing the Senior Secured Notes. The SIB Loan specifically excludes land, rail equipment and motor vehicles from its lien. As a condition to FDOT making the first loan disbursement under the SIB Loan, FEC PEVT, L.L.C. was required to post as additional collateral through July 1, 2017, a standby letter of credit in the amount of $3.0 million payable to FDOT, as beneficiary (the “Standby Letter of Credit Collateral”). On February 1, 2013, the Company posted the Standby Letter of Credit Collateral by accessing the letter of credit line of the ABL Facility, reducing availability under the ABL Facility to $27.0 million. The SIB Loan permits FEC PEVT, L.L.C, in lieu of posting the Standby Letter of Credit Collateral, at any time upon prior notice, to either pay down the principal of the SIB Loan by $3 million or substitute cash collateral.
Sale and Issuance of Series B Perpetual Preferred Stock
On January 25, 2011, the Company completed the sale and issuance of its Series B Perpetual Preferred Stock, par value $0.01 per share (“Series B Perpetual Preferred Stock”) for an aggregate consideration of $125.0 million to an affiliate of FECI commonly owned by affiliates of Fortress. The Series B Perpetual Preferred Stock carried interest cumulatively at the amount of 20% per annum.
Shareholder Contribution of FECR Rail LLC
In January and February 2011, FECR Rail LLC contributed an aggregate $16.0 million to the Company.
The proceeds of the sale of the Series B Perpetual Preferred Stock and $15.0 million of the FECR Rail LLC contribution to the Company were further contributed to FECR Corp. This contribution of $140.0 million together with the proceeds of the issuance of the Senior Secured Notes were used to repay outstanding debt of approximately $601.2 million, to pay certain fees and expenses incurred in connection with the offering of the 8 1/8% Notes, and for general corporate purposes.
Senior PIK Toggle Notes
On February 11, 2011, Holdings Corp. sold $130.0 million of 10 1 / 2 % / 11 1 / 4 % Senior Payment in Kind Toggle Notes due 2017 (the “Senior PIK Toggle Notes”) in a private offering, for net proceeds of $127.7 million. The Senior PIK Toggle Notes are senior unsecured obligations that are not guaranteed by any of Holdings Corp.’s subsidiaries.
Holdings Corp. may redeem the notes in whole or in part at a redemption price of 107.5%, 105%, 102.5%, and 100%, plus accrued and unpaid interest thereon for the subsequent periods after August 1, 2012 as follows: August 1, 2012 through January 31, 2013; February 1, 2013 through January 31, 2014; February 1, 2014 through January 31, 2015; and February 1, 2015 and thereafter, respectively.
The Senior PIK Toggle Notes will pay interest semi-annually in arrears on each February 1 and August 1, commencing on August 1, 2011. Thereafter and up to February 1, 2016, Holdings Corp. may elect to pay interest on the Senior PIK Toggle Notes (1) entirely in cash at a rate of 10.5% , (2) entirely by increasing the principal amount of the note or by issuing new notes for the entire amount of the interest payment, at a rate per annum equal to the cash interest rate of 10.5% plus 75 basis points (in each case, PIK interest), or (3) 50% as cash interest and 50% as PIK interest. After February 1, 2016, interest will be payable entirely in cash.
The Company could be subject to certain interest deduction limitations if the Senior PIK Toggle Notes were treated as “applicable high yield discount obligations” within the meaning of Section 163(i)(1) of the Internal Revenue Code, as amended. In order to avoid such treatment, the Company would be required to redeem for cash a portion of each Senior PIK Toggle Note then outstanding at the end of the accrual period ending August 1, 2016. The portion of a Senior PIK Toggle Note required to be redeemed is an amount equal to the excess of the accrued original issue discount as of the end of such accrual period, less the amount of interest paid in cash on or before such date, less the first-year yield (the issue price of the debt instrument multiplied by its yield to maturity). The redemption price for the portion of each Senior PIK Toggle Note so redeemed would be 100% of the principal amount of such portion plus any accrued interest on the date of redemption.
The net proceeds of the issuance of the Senior PIK Toggle Notes were used to redeem the Company’s Series B Perpetual Preferred Stock for the carrying value of $125.0 million and accrued interest of $1.1 million. As a result, none of the Series B Perpetual Preferred Stock were further issued and outstanding.
Covenants
The indentures governing the Senior PIK Toggle Notes, the 8 1/8% Notes and our ABL Facility contain certain covenants that limits and restricts us, and our restricted subsidiaries’ ability to, among other things, incur additional indebtedness; issue preferred and disqualified stock; purchase or redeem capital stock; make certain investments; pay dividends or make other payments on loans or transfer property; sell assets; enter into certain types of transactions with affiliates involving consideration in excess of $5.0 million; create liens on certain assets; and sell all, or substantially all, of our assets or merge with or into another company. In addition, if availability under the ABL Facility is below $7.5 million during any future period, FECR Corp. will be subject to a minimum fixed charge coverage ratio (as defined in the ABL Facility) of 1.1 to 1.0. As of December 31, 2012, the Company was in compliance with all debt covenants.
Contractual Obligations
The following table represents the minimum future payments on our long-term debt and our existing lease obligations as of December 31, 2012 (in thousands).
(1)
The long-term debt balance includes PIK interest payment that we have elected to PIK on February 1, 2013 of approximately $8.6 million, as well as the unamortized original issue discount of $1.8 million.
(2)
The semi-annual interest payment of the 8 1/8% Senior Secured Notes has been paid through January 31, 2013. The remaining interest payments are due on February 1 and August 1 of each year, through and including February 1, 2017.
The first, second and third semi-annual interest payments on the Senior PIK Toggle Notes were paid in kind on August 1, 2011, February 1, 2012, and August 1, 2012, respectively. In addition, the Company has elected to pay in kind the interest payment due on February 1, 2013. The remaining interest payments are due on February 1 and August 1 of each year, through and including August 1, 2017. We may elect to pay interest on the Senior PIK Toggle Notes (1) entirely in cash, at a rate of 10.5%, (2) entirely by increasing the principal amount of the note or by issuing new notes for the entire amount of the interest payment, at a rate per annum equal to the cash interest rate of 10.5% plus 75 basis points (in each case, PIK interest), or (3) 50% as cash interest and 50% as PIK interest up to February 1, 2016. After February 1, 2016, interest will be payable entirely in cash. If we were to elect to pay all remaining interest payments in cash, with the exception of the first, second and third payments on August 1, 2011, February 1, 2012, and August 1, 2012, respectively, the interest would be as reflected in the table above. Our ability to pay the Senior PIK Toggle Notes interest payments will be governed by net cash flows provided by operating activities each applicable year.
(3)
The cancellable rail yard lease agreement is included in the operating lease obligations in the table above.
The rail yard lease agreement was amended and restated on January 24, 2011. Under the restated agreement, base rent commenced on January 1, 2011 at $4.5 million per annum with a 2.5% escalation clause per year for 25 years and will automatically renew for additional five year periods. Under the amended agreement, we may terminate the agreement after five years (as reflected in the table above) upon a two year notice to terminate, and we have the option to purchase the property at fair market value upon written notice of such intent and the payment of a non-refundable 3% deposit.
(4)
There were no material purchase obligations outstanding as of December 31, 2012.
Critical Accounting Policies
Our Consolidated Financial Statements have been prepared in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. We base our estimates on historical experiences and assumptions believed to be reasonable under the circumstances and re-evaluate them on an ongoing basis. Those estimates form the basis for our judgments that affect the amounts reported in the Consolidated Financial Statements. Actual results could differ from our estimates under different assumptions or conditions. Our significant accounting policies, which may be affected by our estimates and assumptions, are more fully described in Note 2 “Summary of Significant Accounting Policies” in our audited Consolidated Financial Statements.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Although we believe the policies summarized below to be the most critical, other accounting policies also have significant effect on our financial statements and certain of these policies also require the use of estimates and assumptions.
The critical financial statement accounts that are subject to significant estimation are reserves for litigation, casualty and environmental matters, deferred income taxes and property, plant and equipment depreciation methods.
In accordance with FASB Contingencies Topic, an accrual for a loss contingency is established if information available prior to the issuance of the financial statements indicates that it is probable that a liability has been incurred or an asset has been impaired and can be reasonably estimated. These estimates have been developed in consultation with outside counsel handling our defense in these matters and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. Subsequent to changes to those estimates are reflected in our statements of operations in the period of change.
Deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical taxable income, future taxable income, and the expected timing of the reversals of existing temporary differences. If we are unable to generate sufficient future taxable income, or there is a material change in the statutory tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to establish an additional valuation allowance against a portion of our deferred tax asset, resulting in an increase in our effective tax rate and adverse effect on earnings. Additionally, changes in our estimates regarding the statutory tax rates to be applied to the reversal of deferred tax assets and liabilities could materially affect our effective tax rate.
Property, plant and equipment comprised 88.7% of our total assets as of December 31, 2012. These assets are stated at cost, less accumulated depreciation. We utilize the group-life method to classify, depreciate and retire the majority of our assets. Under the group-life method, assets with similar characteristics and intended use are assigned an asset class with a specific life. Assets are either recorded individually (locomotives, freight cars, vehicles, etc.) or as a “mass” asset (rail, ties, ballast, etc.) at the time of capitalization. All depreciable assets use the straight line method for depreciation based on an average life of the asset class.
We determine the estimated service lives of depreciable railroad property by means of depreciation studies. Our depreciation studies take into account the following factors:
·
Statistical analysis of historical patterns of use and retirements of each of our asset classes;
·
Evaluation of any expected changes in current operations and the outlook for the continued use of the assets;
·
Evaluation of technological advances and changes to maintenance practices; and
·
Comparison of asset groups to the same asset groups with peer companies.
Our policy is to perform life studies approximately every eight years. Estimated service lives of depreciable railroad property may vary over time due to changes in physical use, technology, asset strategies, and other factors that will have an impact on the retirement profiles of our assets. Historically, depreciation expense has not materially changed based on the results of our life studies. If recent changes in the mix of our traffic from heavier cargo (stone, gravel and aggregates) to lighter cargo (intermodal containers) are sustained, future life studies may result in an increase in the life of our track assets. Changes in asset lives due to the results of the life studies are applied on a prospective basis and could significantly impact future periods’ depreciation expense, and thus, the results of operations.
We completed life studies for our rolling stock assets during the year ended December 31, 2012. The life study indicated that the actual lives of certain rolling stock assets were different than the estimated useful lives used for depreciation purposes in our financial statements. As such, we changed our estimates of the useful lives of certain rolling stock assets to better reflect the estimated periods during which these assets will remain in service. The effect of this change in estimate during the year ended was to reduce depreciation expense by $0.6 million. Changes in asset lives due to the results of the life studies are applied on a prospective basis and could significantly impact future periods’ depreciation expense, and thus, our results of operations. Annually, depreciation expense is expected to be reduced by approximately $1.7 million.
Under normal retirements or sale of assets, no gain or loss is recorded. The net asset value (cost less accumulated depreciation minus any proceeds) for a retirement or sale of asset is charged back to accumulated depreciation, and the net asset value is amortized over the remaining life of its assigned asset class. Expenditures that increase asset value or extend the useful life are capitalized. Repair and maintenance expenditures (track inspections, locomotive running repairs, repair of broken rail, rail grinding, etc.) are charged to expense when the work is performed. For the year ended December 31, 2012, repairs and maintenance expenditures charged to operating expenses represented approximately 24.9% of our total spend (including capitalized expenditures) for track and related assets. We review the carrying value of our property for impairment whenever an event or changes in circumstances indicate the carrying value of an asset or asset grouping may not be recoverable from the undiscounted cash flows expected to be generated over its remaining useful life.
For a complete description of our accounting policies, see Note 2 “Summary of Significant Accounting Policies” to our audited Consolidated Financial Statements included elsewhere in this Form 10-K.
Recent Accounting Pronouncements
In 2011, the FASB issued Accounting Standards Update 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income (“ASU 2011-05”) and Accounting Standards Update No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation and Reclassifications of Items Out of Accumulated Other Comprehensive Income (“ASU 2011-12”). ASU 2011-5 improves the comparability, consistency and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. ASU 2011-5 is effective for interim and annual periods beginning after December 31, 2011. As ASU 2011-5 relates specifically to presentation and disclosures the adoption of these provisions did not have any other impact on our consolidated financial statements. The main purpose of ASU 2011-12 was to defer the effective date pertaining to reclassification adjustments out of accumulated other comprehensive income in ASU 2011-5; therefore it did not have an impact on the Company’s consolidated financial statements. In accordance with the new guidance, the Company has selected the single continuous statement presentation.
Off Balance Sheet Arrangements
We currently have no off balance sheet arrangements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks from changing interest rates and diesel fuel prices. Changes in these factors could cause fluctuations in earnings and cash flows.
Interest Rates. Our 8 1/8% Notes issued on January 25, 2011 are fixed rate instruments, and therefore, would not be impacted by changes in interest rates. Our potential interest rate risk results from our ABL Facility as an increase in interest rates would result in lower earnings and increased cash outflows. We do not have any outstanding balances under the ABL Facility, but if we were to draw upon it, we would be subject to changes in interest rates.
Diesel Fuel. We are exposed to fluctuations in diesel fuel prices. Fuel costs represented 12.3% of total operating revenues during the year ended December 31, 2012. We participate in fuel surcharge programs which provide additional revenue to help offset the increase in fuel expenses. We utilize the Department of Energy’s Retail Diesel Fuel Price index to calculate the fuel surcharges that are charged to our customers. The fuel surcharges fluctuate with the price of diesel fuel with a lag of less than one month. Therefore, we believe that we have reduced the risk of fluctuating diesel fuel prices to a low level. We are continuing to optimize our fuel surcharge programs to reduce our risk to the lowest level possible.
Customer Concentration Risk. Although our operations served approximately 500 customers in 2012, freight revenue from our 10 largest customers accounted for approximately 41% of our total freight revenues for the year ended December 31, 2012 with no single customer representing more than 10% of our total freight revenue. In addition, the top three aggregate customers with operations in south Florida whose freight revenues represented approximately 11% of our total freight revenues for the year ended December 31, 2012. Our revenues are affected by the demand for aggregate material, primarily in Florida, and the ability of these customers to supply this natural raw material efficiently and effectively. Substantial reduction in business with or loss of an important customer could have a material adverse effect on our business and financial results.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Florida East Coast Holdings Corp., the accompanying notes thereto and the report of the independent registered certified public accounting firm are included as part of this Annual Report on Form 10-K and immediately follow the signature page of this Annual Report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Based on an evaluation by our management, with the participation of our chief executive officer and chief financial officer, as of the end of the period covered by this report, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) are effective to ensure that information required to be disclosed by us in this Annual Report on Form 10-K was recorded, processed, summarized, and reported within the time periods specified in SEC’s rules and forms and that such information was accumulated and communicated to our management, including our chief executive and chief financial officers, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework included in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the COSO framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2012.
Changes in Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal year covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth the name, age and position of our directors and executive officers, as of December 31, 2012.
Wesley R. Edens, has served on the Board of Florida East Coast Railway Corp. since 2008 and serves as the Chairman. Mr. Edens is founding principal and Co-Chairman of the board of directors of Fortress and has been a principal and the Chairman of the Management Committee of Fortress since co-founding the same in May 1998. Previously, Mr. Edens served as Chief Executive Officer of Fortress from inception to August 2009. Mr. Edens has primary investment oversight of Fortress private equity and publicly traded alternative businesses. Mr. Edens is Chairman of the board of directors of each of the following companies: Aircastle Limited, Brookdale Senior Living Inc., Eurocastle Investment Limited, GateHouse Media, Inc., Mapeley Limited, and Newcastle Investment Corp. and a director of GAGFAH S.A. and Penn National Gaming Inc. Mr. Edens was Chief Executive Officer of Global Signal Inc. from February 2004 to April 2006 and Chairman of the board of directors from October 2002 to January 2007. Mr. Edens serves in various capacities in the following two registered investment companies: Chairman, Chief Executive Officer and Trustee of Fortress Registered Investment Trust and Fortress Investment Trust II. Mr. Edens previously served on the boards of the following publicly traded company and registered investment companies: Crown Castle Investment Corp. (merged with Global Signal Inc.) from January 2007 to July 2007; Fortress Brookdale Investment Fund LLC, from August 13, 2000 (deregistered with the SEC in March 2009); Fortress Pinnacle Investment Fund, from July 24, 2002 (deregistered with the SEC in March 2008); and RIC Coinvestment Fund LP, from May 10, 2006 (deregistered with the SEC in June 2009). Prior to forming Fortress, Mr. Edens was a partner and managing director of BlackRock Financial Management Inc., where he headed BlackRock Asset Investors, a private equity fund. In addition, Mr. Edens was formerly a partner and managing director of Lehman Brothers. Mr. Edens received a B.S. in Finance from Oregon State University.
Mr. Edens brings strong leadership, extensive business and managerial experience, and a tremendous knowledge of our Company and the transportation-related industry, to the Board. In addition, Mr. Edens brings his broad strategic vision to our Company and the Board. Further, his experience on the boards of other public companies, including serving as chairman of the board, provides our Board with insights into how boards at other companies address issues similar to those faced by the Company.
Joseph P. Adams, Jr., has served on the Board of Florida East Coast Railway Corp. since 2008. Mr. Adams is Managing Director at Fortress, within the Private Equity Group. He serves as Deputy Chairman of Aircastle Limited and has been a member of its board since August 2, 2006. Previously, Mr. Adams was a partner at Brera Capital Partners and at Donaldson, Lufkin & Jenrette where he was in the transportation industry group. In 2002, Mr. Adams served as the first Executive Director of the Air Transportation Stabilization Board. Mr. Adams received a BS in Engineering from the University of Cincinnati and an MBA from the Harvard Business School.
Mr. Adam’s experience, including his role serving as Deputy Chairman on a number of boards for portfolio companies of Fortress, provides the Board with insights into how boards at other companies address issues similar to those faced by the Company. In addition, his experience as a private equity investor and investment and merchant banker provides the Board with valuable insights on financial, strategic planning and investor relations matters, particularly as it relates to transportation-related industries.
Randal A. Nardone , has served on the Board of Florida East Coast Railway Corp. since 2008. Mr. Nardone is a director of Alea Group Holdings (Bermuda) Ltd., GAGFAH S.A. and Eurocastle Investment Limited. Mr. Nardone was previously a managing director of UBS from May 1997 to May 1998. Prior to joining UBS in 1997, Mr. Nardone was a principal of BlackRock Financial Management, Inc. Prior to joining BlackRock, Mr. Nardone was a partner and a member of the executive committee at the law firm of Thacher Proffitt & Wood. Mr. Nardone received a B.A. in English and Biology from the University of Connecticut and a J.D. from Boston University School of Law.
As a result of his past experiences, Mr. Nardone has extensive credit, private equity finance and management expertise, extensive experience as an officer and director of public companies and a deep familiarity with our Company, all of which provide him the qualifications and skills to serve as a director.
James Hertwig, has served as President and Chief Executive Officer of Florida East Coast Railway Corp. since July 2010. Mr. Hertwig brings his 40 years of freight transportation experience to this position. Prior to joining Florida East Coast Railway Corp., Mr. Hertwig served as President of CSX Intermodal, Inc., a leading supplier of rail-based freight transportation in North America based in Jacksonville, Florida. Prior to joining CSX Intermodal, Inc., Mr. Hertwig spent nearly 9 years as President of Landstar Logistics, a transportation services company, and one of the largest truckload carriers in North America. During 1994 and 1995, Mr. Hertwig served as President and CEO of Carolina Freight Carriers Corporation and also as Chairman and CEO of Red Arrow Freight Lines, two large regional LTL carriers. Prior to 1994, Mr. Hertwig spent 8 years as President and CEO of Con-Way Intermodal, a multimodal truckload service provider and international non vessel operating common carrier (NVOCC). Mr. Hertwig also spent 13 years holding key management positions at CF Motor Freight, a nationwide LTL carrier. Mr. Hertwig began his carrier in the transportation industry in 1971 as a dock foreman with Associated Transport in Erie, Pennsylvania. Mr. Hertwig has served on the Board of Directors for the Florida Trucking Association and the Executive Committee of the Transportation Research Board. Mr. Hertwig also serves on the Board of Directors of the Intermodal Transportation Institute at the University of Denver and is beginning his third term on the Board of Directors for the Intermodal Association of North America.
John Brenholt, has served as Executive Vice President and Chief Financial Officer of Florida East Coast Railway Corp. since November 2010 and has over 20 years experience in the distribution and transportation industries. Prior to joining the Company, from 2007 to 2010, Mr. Brenholt was the Executive Vice President and Chief Financial Officer for Schneider National, Inc., a provider of truckload, logistics and intermodal services headquartered in Green Bay, Wisconsin. Mr. Brenholt also served as Senior Vice President and Chief Financial Officer for Vistar Corporation and Corporate Express, Inc. Mr. Brenholt has also held finance positions of progressively greater responsibility at Terex Corporation and Deloitte & Touche. Mr. Brenholt received his B.B.A from the University of Wisconsin-Milwaukee in 1986.
Joel Haka, has served as Executive Vice President and Chief Operating Officer of Florida East Coast Railway Corp. since February 2011. Prior to joining the Company, from 2005 to 2011, Mr. Haka was Senior Vice President and Chief Operating Officer for CMA CGM (America) LLC, a large container shipping company based in Norfolk, Virginia. Mr. Haka was responsible for CMA CGM’s North American marine, terminal and inland operations, and has a 30-year track record in the maritime operations and transportation industry. Prior to joining CMA CGM, Mr. Haka was Senior Vice President of Corporate Operations for P&O Nedlloyd, an ocean-going container shipping company where his responsibilities included terminal operations, intermodal, and truck operations. Mr. Haka has worked ashore since 1988 in varying operating capacities in Guam, Long Beach, Chicago, Dallas, New Jersey, and Norfolk for companies such as, Sea-Land Service, CSX Intermodal, Maersk Sealand, and Maersk Logistics. Mr. Haka graduated in 1980 from the United States Merchant Marine Academy at Kings Point, New York, after which he spent 8 years at sea as a merchant officer. Mr. Haka also holds a Master’s license for United States merchant vessels and is a retired Commander in the U.S. Naval Reserve.
Kim Cooper, has served as Vice President and Corporate Controller of Florida East Coast Railway Corp since 2010. Ms. Cooper joined the Company in January 2005, with over 26 years of experience in corporate finance and public accounting. Ms. Cooper’s experience includes working at Convergys Corporation as a Financial Director, Johnson & Johnson also as a Finance Director in a variety of positions, and IBAX Healthcare Systems as an Accounting Manager. Ms. Cooper began her career in public accounting with Touche Ross & Co. (before its merger with Deloitte & Touche), where she served on the audit staff and also achieved manager level. Ms. Cooper received her B.S.B.A. from Grand Valley State in 1984 and her MBA from the University of Central Florida in 1989.
Robert Ledoux, has served as Vice President, General Counsel and Corporate Secretary of Florida East Coast Railway Corp. since July 2011. Mr. Ledoux has more than 25 years of legal and management experience in corporate law and business and transportation transactions. Prior to joining the Company, Mr. Ledoux worked at CSX Transportation, Inc. for 9 years in various legal positions, including Assistant General Counsel for public project initiatives, engineering, passenger services, and Intermodal. Mr. Ledoux graduated with a BS degree in Business Administration from the University of New Hampshire, a JD degree from George Mason University, and an MBA from Virginia Tech. Mr. Ledoux is affiliated with the Virginia State Bar, the Maryland State Bar, the Florida State Bar and the American Corporate Counsel Association.
Thomas R. Ballas serves as vice president, human resources for Florida East Coast Railway. Mr. Ballas re-joined the Company in 2011, having previously worked with FEC for over thirty-five years. During his absence, Mr. Ballas provided human resource and rail labor relations consulting services. He is responsible for all human resource functions for the company including recruiting, performance management, labor relations and health and welfare benefits. Mr. Ballas holds a Bachelor of Arts degree in Psychology from the University of North Florida and has received his Professional in Human Resources and Senior Professional in Human Resources Certificates from the Society of Human Resource Management.
Robert Stevens serves as vice president and chief engineer of Florida East Coast Railway. Mr. Stevens joined the Company in 2007. Mr. Stevens has over 35 years of experience in railroad infrastructure maintenance and operations. Mr. Stevens began his career in 1976 with Consolidated Rail Corp. as field manager and held various engineering field and staff positions. In 1998, Mr. Stevens joined CSX Transportation where he held a number of engineering positions, including assistant chief engineer for system production gangs. Mr. Stevens is a graduate of Eastern College.
Board of Directors
Our bylaws provide that our board shall consist of not less than one and not more than fifteen directors as the board of directors may from time to time determine. Our board of directors consists of three directors. Directors are elected by a plurality of the votes cast at the annual meetings of stockholders.
Our bylaws do not provide for cumulative voting in the election of directors, which means that the holders of a majority of the issued and outstanding common shares can elect all of the directors standing for election, and the holders of the remaining shares will not be able to elect any directors.
Committees of the Board of Directors
The Board of Directors may designate one or more committees, each committee to consist of one or more of the directors of the Company. Presently no such committees have been established.
Board of Directors Interlocks and Insider Participation
As discussed below in “Executive Compensation - Compensation Discussion and Analysis - Role of Executives in Establishing Compensation,” our CEO regularly advises our board of directors in determining the compensation of our other executive officers (besides himself). Our board of directors has the discretion to consider our CEO’s recommendations in making such compensation determinations.
Compensation of Directors
Our directors receive no payment in their capacity as such, though they are eligible for reimbursement of any expenses incurred as a director (including costs of attendance at board of directors meetings).
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
Set out below is a discussion and analysis of the 2012 compensation program for our Chief Executive Officer (the “CEO”), our Chief Financial Officer, and the three other most highly compensated executive officers who were serving as such at December 31, 2012 (and with respect to whom we are required to provide compensation disclosure under SEC rules). This discussion and analysis should be read together with the Summary Compensation Table below and the additional narrative and tables that follow and support it.
Compensation Objectives and Philosophy
Our primary compensation goals for our named executive officers are to attract, motivate and retain the most talented and dedicated executives and to align annual and long-term incentives for those executives with enhancing shareholder value. To achieve these goals, our compensation program:
· Delivers a mix of fixed and at-risk compensation through a combination of base salary, an annual bonus opportunity and restricted stock unit grants; and
· Balances short-term and long-term goals by delivering a substantial portion of total compensation through restricted stock unit grants, the value of which is directly related to our performance.
Our board of directors evaluates our performance, including achievement of key investment and capital raising goals, and the individual performance of each named executive officer with a goal of setting overall compensation at levels that it believes are appropriate. The board of directors does not engage in “benchmarking” or compare the compensation of our named executive officers to a peer group of companies. Nor have we or our board of directors retained a compensation consultant to review our policies and procedures with respect to executive compensation, although the board of directors may elect in the future to retain a compensation consultant if it determines that doing so would assist it in implementing and maintaining our compensation programs.
Employment Agreements
Each of our presently employed named executive officers (Messrs. Hertwig, Brenholt, Haka, Ledoux and Stevens) is party to an employment agreement with us (and/or Florida East Coast Railway, L.L.C.) that governs the terms and conditions of their employment.
The agreements with Messrs. Hertwig, Brenholt, and Haka became effective July 1, 2010, November 8, 2010, and February 21, 2011, respectively. Messrs. Hertwig and Brenholt each had an initial two-year term that expired July 1, 2012 and November 8, 2012, respectively, and that automatically renews for successive one-year terms absent 60 days’ notice. Mr. Haka’s initial term was from his effective date until December 31, 2011 and renews for successive one-year terms absent 60 days’ notice. The agreements provide for:
· An annual base salary $400,000 for Mr. Hertwig and $350,000 for each of Messrs. Brenholt and Haka that may be increased (but not decreased) in the discretion of Mr. Hertwig (or, in the case of the agreement with Mr. Hertwig, in the discretion of our board of directors);
· An annual bonus opportunity of 50% of base salary (with a maximum of 150% of base salary for Mr. Hertwig and 100% for each of Messrs. Brenholt and Haka) payable based on our strategic and financial performance as a whole, as well as the contribution of the executive to that performance, as determined in our sole discretion, with up to 50% of any realized bonus payable in our discretion in the form of restricted stock units vesting in three equal installments over a period of three years following grant;
· An initial grant of restricted stock units with a value of $1,000,000, $750,000 and $500,000 for Messrs. Hertwig, Brenholt and Haka, respectively, vesting in three annual installments commencing January 1, 2012 and;
· Additional annual restricted stock unit grants for three years commencing in 2011 (each with a value of $500,000, $350,000 and $300,000 for Messrs. Hertwig, Brenholt and Haka, respectively) with vesting dependent upon attainment of specified EBITDA goals for the year of grant.
The agreements with each of Messrs. Hertwig, Brenholt and Haka also include certain restrictive covenants (including a one-year nonsolicitation obligation and nondisparagement and confidentiality obligations).
The agreements with each of Messrs. Stevens and Ledoux became effective on December 3, 2010 and June 27, 2011, respectively. Each agreement is for an indefinite term of at-will employment without severance entitlement and provides for:
· An annual base salary of $160,000 (which was increased to $190,000 effective April 1, 2012) for Mr. Stevens and $190,000 (which was increased to $200,000 effective April 1, 2012) for Mr. Ledoux.
· An annual bonus opportunity beginning in 2011 of 35% of base salary as determined in our sole discretion payable in cash or in a mix of cash and restricted stock units vesting in three equal installments over a period of three years following grant; and
· Annual restricted stock unit grants for three years commencing in 2011 (each with a value of $100,000) with vesting dependent upon attainment of specified EBITDA goals for the year of grant.
The severance provisions of the various employment agreements are described under “Severance/Change in Control Benefits” below.
Role of Executives in Establishing Compensation
Our named executive officers are not in any way directly responsible for determining our CEO’s compensation, although they may provide information to the board of directors that will be relevant to its evaluation of our CEO’s compensation (for instance, in terms of our performance). By contrast, the CEO plays a more active role in determining the compensation of the other named executive officers, who are his subordinates. He regularly advises the board of directors of his own evaluation of their job performance and, from time to time, offers for consideration by the board of directors his own recommendations for their compensation levels. The board of directors has the discretion to consider these recommendations in making compensation determinations. As noted above, the CEO has the authority (in consultation with the board of directors) under the employment agreements with each of Messrs. Brenholt and Haka to increase (but not decrease) their compensation.
Elements of Compensation
Our compensation program for our employees relies principally on base salary, an annual bonus and restricted stock unit grants. Base salaries are intended to complement the at-risk components of our compensation program (annual bonus and restricted stock unit grants) by assuring that the executives will receive an appropriate minimum level of compensation. Other benefits-such as a 401(k) plan and welfare benefits-are provided on a basis that are no more favorable to the executives than other salaried employees. We do not view perquisites as a significant element of our compensation program.
Effective October 15, 2012, we adopted an unfunded, nonqualified deferred compensation plan for the purpose of providing a select group of our management and independent contractors, including our named executive officers, with the opportunity to voluntarily defer receipt of a portion of their compensation (including base salary, performance-based compensation, and commissions). The Company also has the discretion to make contributions to the plan on behalf of participants. All amounts deferred by participants are notionally invested in investment funds as directed by the executive. Deferred compensation under the plan is payable in cash in a lump sum payment, or, in certain circumstances, in annual installments over a term equal to or less than 15 years, as determined by each participant at the time of enrollment.
Determinations regarding any one element of compensation will affect determinations regarding each other element of compensation because our goal is to set overall compensation for our named executive officers at an appropriate level. In this regard, the board of directors takes into account the extent to which different compensation elements are at risk. Accordingly, for example, the amount of salary paid to a named executive officer is considered in determining the amount of any bonus award, though we do not expect the relationship among the elements to be formulaic because of the need to balance the likelihood that the at-risk components of the compensation will actually be paid at any particular level.
As described above, the compensation levels of the named executive officers are largely determined by the terms of their respective employment agreements. Those terms were established for each executive based upon the scope of his or her respective responsibilities, the competition for qualified executives and, as applicable, compensation levels at recent prior employment.
The Company generally awards discretionary annual bonuses to our named executive officers. The annual incentive bonuses are intended to compensate our named executive officers for our overall financial performance and for achieving important milestones as well as for individual performance. Bonus levels will vary depending on the individual executive and generally will include such factors as our overall financial performance, quality and amount of new investments, improving our operations and progress on strategic operations. Short-term cash incentives are designed to advance the interests of the Company by providing incentives in the form of periodic bonus awards to certain key employees who contribute significantly to the strategic and long-term performance objectives and growth of the Company. For 2012, Mr. Hertwig’s bonus of $600,000 (representing 150% of his annual base salary) was based upon a determination by our board of directors that Mr. Hertwig played a key role in the overall management and performance of the Company. The 2012 bonus for Messrs. Brenholt, Haka, Ledoux and Stevens of $350,000, $262,500, $140,000 and $133,000, respectively, was based upon the determination by our board of directors and input from Mr. Hertwig.
Severance/Change in Control Benefits
The employment agreements for Messrs. Hertwig, Brenholt, and Haka provide that, subject to the execution of a release of claims, upon termination of the respective officer’s employment by us without “cause” or by the officer for “good reason” (each as defined in the applicable employment agreement), (i) the officer is entitled to receive severance payments equal to one year of the executive’s then-current base salary, paid in equal installments over the one-year period following the executive’s termination, (ii) if the termination does not occur within one year following a change in control of the Company, any restricted stock units scheduled to vest on the next regular vesting date will vest, and (iii) if the termination occurs within one year following a change of control, all restricted stock units will vest in full. However, in no event will such severance payments or accelerated vesting be provided to the extent it would cause us to be unable to claim a federal income tax deduction by reason of the “golden parachute” limitations set forth in Section 280G of the Internal Revenue Code.
The restricted stock unit agreements for Messrs. Ledoux and Stevens provide that, subject to the execution of a release of claims, upon termination of the officer’s employment by us without “cause” or by the officer for “good reason” (each as defined in the applicable award agreement), (i) the restricted stock units scheduled to vest on the next regular vesting date will vest if the termination does not occur within one year following a change in control of the Company and (ii) all restricted stock units will vest in full if the termination occurs within one year following a change of control. Messrs. Ledoux and Stevens are not otherwise entitled to severance payments.
Tax/Accounting Considerations
We generally develop our compensation programs such that our compensation is fully deductible for federal income tax purposes. However, in certain situations, we may approve compensation that will not meet these requirements in order to ensure competitive levels of total compensation for our executive officers. Likewise, we are aware of the financial accounting treatment of our compensation programs and decisions, but accounting considerations do not determine the amount or types of compensation we pay or the timing of its payment.
Board of Directors Report
The Board of Directors of Florida East Coast Holdings Corp. has reviewed and discussed with the Company’s management the section entitled “Compensation Discussion and Analysis” to be included in the Company’s 2013 annual report on Form 10-K. Based on the review and discussion referred to above, the Board of Directors has approved such section to be included in the Company’s 2013 annual report on Form 10-K.
Wesley R. Edens, Chairman
Joseph Adams, Jr.
Randal A. Nardone
2012 Compensation of our Named Executive Officers
Set forth below is information concerning the cash and non-cash compensation earned by, awarded to or paid to our named executive officers for 2012.
Summary Compensation Table for 2012
Notes:
(1) Amounts in this column reflect the aggregate grant date fair value of restricted stock units granted to each of our named executive officers on March 9, 2012, computed in accordance with applicable accounting guidance. For a discussion of the assumptions made in the valuation of the restricted stock unit awards reported in this column, see Note 10 to the Consolidated Financial Statements.
(2) For all, amounts are attributable to the Company’s match of their 2012 401(k) contribution, cell phone stipends, and company paid life insurance. Include in the “All Other Compensation” column and this footnote the amount of any Company contributions under the Florida East Coast Railway Deferred Compensation Plan.
(3) Mr. Stevens retired in February, 2013.
Grants of Plan Based Awards for 2012
Notes:
(1) Pursuant to the applicable Restricted Stock Unit Award Agreement, as amended, upon vesting, each restricted stock unit entitles the holder thereof to a number of shares of Holdings Corp. having a fair market value at the time of settlement equal to the value of one common unit of FECR Rail Holding, LLC (a “FECR Rail Holding, LLC Interest”) (or, if Holdings Corp. is prohibited at the relevant time from issuing equity securities to the holder, one FECR Rail Holding, LLC Interest). Dividend equivalents are payable on each unvested restricted stock unit in an amount equal to the dividends paid with respect to one FECR Rail Holding, LLC Interest.
(2) These shares vest 33% on January 1, 2013, 33% on January 1, 2014 and 34% on January 1, 2015.
Outstanding Equity Awards at Fiscal Year End for 2012
Notes:
(1) These shares vest 33% on January 1, 2012, 33% on January 1, 2013 and 34% on January 1, 2014.
(2) These shares vest 33% on March 1, 2012, 33% on March 1, 2013 and 34% on March 1, 2014.
(3) These shares vest 33% on January 1, 2013, 33% on January 1, 2014 and 34% on January 1, 2015.
(4) Based on a value per share of Company stock of $2,072.63 as of December 31, 2012.
Stock Vested for 2012
Notes:
(1) Based on a value per share of Company stock of $1,333.47 as of the time of vesting.
Nonqualified Deferred Compensation for 2012
Notes:
(1) Each named executive officer’s contribution is included in such named executive officer’s salary and/or bonus for 2012, as reported in the Summary Compensation Table.
Florida East Coast Railway Deferred Compensation Plan. Our Deferred Compensation Plan provides a select group of our management and independent contractors, including our named executive officers, with the opportunity to voluntarily defer receipt of a portion of their compensation (including base salary, performance-based compensation, and commissions). Under the terms of the plan, participants can elect to defer, on a pre-tax basis, up to 90% of their base salary, and up to 100% of any performance based compensation or commissions. The Company may also make discretionary contributions to the plan, as well as certain other contributions to plan in an amount determined by the Company in its sole discretion for each plan year.
Participants are always 100% vested in their own deferral contributions and in Company discretionary contributions, but certain other Company contributions vest 20% per year of service with the Company. However, even participants with less than five years of service become fully vested in any other Company contributions upon death, disability, retirement at age 65 or older, or a “change in control event” as defined in the plan. If a participant’s deferred compensation account is not otherwise fully vested on the date of such participant’s separation from service, the portion of such account that is not fully vested will be forfeited.
Each participant’s deferred compensation account, including any Company contributions, are credited with investment returns determined as if such account were invested in one or more investment funds made available by the plan administrator. Each participant elects the investment funds in which the participant’s deferred compensation account is deemed to be invested. In the event a participant fails for any reason to make an effective election of the investment return to be credited to the participant’s account, the investment return credited to such participant’s account will be determined by the plan administrator.
Participants in the plan, or their beneficiaries, may receive distributions from the plan in the event of a qualifying separation from service, death, disability, or unforeseeable emergencies. A change in control event, however, is not a qualifying distribution event.
Potential Payments Upon Termination or Change in Control
As described above in “Executive Compensation-Compensation Discussion and Analysis-Severance/Change in Control Benefits,” we make certain severance and change in control benefits available to our named executive officers. The following chart sets forth the payments the respective named executive officers would have received had the requisite triggering event occurred as of December 31, 2012; the value shown in respect of the accelerated vesting of the restricted stock units is based upon a value per share of Company stock of $2,072.63 as of December 31, 2012. In addition to the benefits shown below, each of our named executive officers are entitled to a death benefit equal to their base salary (but not in excess of $150,000).
Notes:
(1) These amounts do not reflect any cutback in cash severance or accelerated vesting of restricted stock units by reason of the “golden parachute” limitations set forth in Section 280G of the Internal Revenue Code.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the total number of shares of common stock beneficially owned, and the percent so owned. Holdings Corp. was incorporated on January 10, 2011. On January 25, 2011, FECR Rail LLC contributed all of its holdings of FECR Corp’s common and preferred shares in exchange for 250,555 newly issued common shares of Holdings Corp. As a result, FECR Rail LLC became the direct parent of Holdings Corp., whereas Holdings Corp. became the direct parent of FECR Corp. The percentage of beneficial ownership of our common stock is based on 252,106 shares of common stock of Holdings Corp. issued and outstanding as of March 13, 2013.
* Less than 1%.
Notes:
(1) Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Shares of common stock subject to options or warrants currently exercisable, or exercisable within 60 days of the date hereof, are deemed outstanding for computing the percentage ownership of the person holding such options or warrants but are not deemed outstanding for computing the percentage of any other person. Except in cases where community property laws apply we believe that each stockholder possesses sole voting and investment power over all shares of common stock shown as beneficially owned by the stockholder. The beneficial owners listed in this table do not, individually or as a group, have the right to acquire beneficial ownership over any other shares of our common stock.
(2) The address of each officer or director listed in this table is: c/o Florida East Coast Railway Corp., 7411 Fullerton Street, Suite 100, Jacksonville, Florida 32256.
(3) FECR Rail Holding, LLC, which is our ultimate parent, is owned by the following: (i) each of Fortress Investment Fund IV (Fund A) L.P., Fortress Investment Fund IV (Fund B) L.P., Fortress Investment Fund IV (Fund C) L.P., Fortress Investment Fund IV (Fund D) L.P., Fortress Investment Fund IV (Fund E) L.P., Fortress Investment Fund IV (Fund F) L.P., Fortress Investment Fund IV (Fund G) L.P., Fortress Investment Fund IV (Coinvestment Fund A) L.P., Fortress Investment Fund IV (Coinvestment Fund B) L.P., Fortress Investment Fund IV (Coinvestment Fund C) L.P., Fortress Investment Fund IV (Coinvestment Fund D) L.P., Fortress Investment Fund IV (Coinvestment Fund F) L.P. and Fortress Investment Fund IV (Coinvestment Fund G) L.P. (collectively, the “Fund IV Fund”); (ii) each of Fortress Investment Fund V Co. (Fund A) L.P., Fortress Investment Fund V Co. (Fund B) L.P., Fortress Investment Fund V Co. (Fund C) L.P., Fortress Investment Fund V Co. (Fund D) L.P., Fortress Investment Fund V Co. (Fund F) L.P., and (iii) Fortress Florida Coinvestment Fund LP (“FFCF LP”).
Each of the Fortress Fund IV Fund and Fortress Fund V Fund is party to a management agreement with FIG LLC, which is wholly owned by Fortress Operating Entity I LP (“FOE I”). FFCF LP’s general partner is Fortress Florida Coinvestment Fund GP LLC and its managing member is Principal Holdings I LP (“PH I”). FOE I’s general partner is FIG Corp. PH I’s general partner is FIG Asset Co. LLC. Each of FIG Corp. and FIG Asset Co. LLC is a wholly owned subsidiary of Fortress Investment Group LLC (“Fortress”). As of December 31, 2010, Wesley R. Edens owned approximately 14.14% of Fortress. By virtue of his ownership interest in Fortress and certain of its affiliates, Mr. Edens has voting or investment power with respect to all outstanding shares of FECR Rail Holding, LLC and may be deemed to beneficially own such shares. Mr. Edens disclaims beneficial ownership of such shares except to the extent of his pecuniary interest therein. The address of all entities listed above is c/o Fortress Investment Group LLC, 1345 Avenue of the Americas, New York, New York 10105.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Lease Agreements
We, through our wholly owned indirect subsidiary Florida East Coast Railway, L.L.C., began leasing our Hialeah rail yard in December 2007 from FDG Hialeah LLC, an entity owned by investment funds managed by affiliates of Fortress. On January 24, 2011, we entered into an amended and restated lease, which, among other things: extends the date to vacate to December 31, 2035 (unless we elect not to renew the lease); provides for an annual rental fee of $4.5 million a year (subject to a 2.5% annual increase); provides us the right to purchase certain land from FDG Hialeah LLC at a mutually determined fair market value; provides FDG Hialeah LLC the right to require us to relocate (at its expense) from such land to comparable property with competitive rental rates. The amended and restated lease is cancellable after five years with a two year notice requirement. The Railway paid $5.1 million, $6.0 million, and $2.9 million, for the rail yard base rent for the years ended December 31, 2012, 2011, and 2010, respectively.
Through Florida East Coast Railway, L.L.C., we lease space for our headquarters from Flagler Development Company, L.L.C. through 2018. For the years ended December 31, 2012, 2011 and 2010, we paid $0.7 million, $2.2 million and $1.3 million in rent, respectively. A portion of this office space is being sublet to RailAmerica, an entity partially owned by investment funds managed by affiliates of Fortress. Under the sublease agreement, which is subject to the terms and conditions of the corporate headquarters agreement with Flagler Development Company, L.L.C., we billed RailAmerica $1.0 million, $2.6 million and $3.8 million for the years ended December 31, 2012, 2011 and 2010, respectively. The amounts above include fees for management services during the transition period subsequent to the Rail Separation, as well as management services related to our right-of-way for the corresponding periods.
In addition, during the year ended December 31, 2011, the Company received proceeds of $4.5 million from the sale of locomotives that had previously been under lease to RailAmerica. The Company had a net receivable from RailAmerica of zero and $0.1 million as of December 31, 2012, and 2011, respectively. Subsequent to October 1, 2012, RailAmerica is no longer considered a related party, due to a change in ownership.
During 2011, the Company entered into an agreement with RailAmerica’s wholly-owned subsidiary, Atlas Road Construction, L.L.C., to provide engineering and construction services for the Port of Miami project. The Company incurred net charges of $2.2 million and $9.6 million, for the years ended December 31, 2012, and 2011, respectively, and zero for the year ended December 31, 2010. As of December 31, 2012, and 2011, we had an outstanding payable balance of zero, and $0.6 million, respectively.
The Company rents chassis equipment for ordinary business operations from TRAC Intermodal, an entity owned by funds managed by affiliates of Fortress. These rents are based on current market rates for similar assets. During the years ended December 31, 2012, 2011 and 2010, the Company paid rents in the amount of $0.7 million, $0.6 million and $0.7 million, respectively.
Other Agreements/Transactions
In January 2011, we contributed $140.0 million to FECR Corp. to repay a portion of the amounts outstanding under the existing debt. In addition, in January and February 2011, we received a contribution of $16.0 million from FECR Rail LLC.
We also completed the sale and issuance of our Series B Perpetual Preferred Stock, par value $0.01 in January 2011 for an aggregate consideration of $125.0 million to an affiliate of FECI commonly owned by affiliates of Fortress. The Series B Perpetual Preferred Stock carried an interest cumulatively at an amount of 20% per annum. In February 2011, we executed our Refinancing and redeemed the Series B Perpetual Preferred Stock for the carrying value of $125.0 and accrued interest of $1.1 million.
Review, Approval or Ratification of Transactions with Related Persons
Given the ownership structure and management of the Company, we have not adopted policies and procedures for the review, approval, or ratification of transactions required to be reported pursuant to Item 404(a) of Regulation S-K.
Director Independence
We have no securities listed for trading on a national securities exchange or in an automated inter-dealer quotation system of a national securities association, which has requirements that a majority of our board of directors be independent. For purposes of complying with the disclosure requirements of the SEC we have adopted the definition of independence used by the New York Stock Exchange. Under the New York Stock Exchange’s definition of independence, none of our directors are independent.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets forth the aggregate fees billed and expected to be billed to the Company by Ernst & Young LLP for professional services during years 2012 and 2011, as well as out-of-pocket costs included in connection with these services (in thousands):
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The financial statements filed as part of this report are listed separately in the Index of Consolidated Financial Statements on page of this Annual Report on Form 10-K.
(b) Exhibits.
Exhibit
No.
Description
3.1
Certificate of Incorporation of Florida East Coast Holdings Corp., incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-4 (Registration No. 333-174112) filed on May 10, 2011.
3.2
By-laws of Florida East Coast Holdings Corp., incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-4 (Registration No. 333-174112) filed on May 10, 2011.
4.1
Indenture, dated as of February 11, 2011, between Florida East Coast Holdings Corp. and Wells Fargo Bank, National Association, incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-4 (Registration No. 333-174112) filed on May 10, 2011.
4.2
Indenture, dated as of January 25, 2011, by and among, Florida East Coast Railway Corp., the guarantors named therein and Wells Fargo Bank, National Association, incorporated by reference to Exhibit 4.1 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 333-173954) filed on May 5, 2011.
4.3
Form of 10 1 / 2 % / 11 1 / 4 % Senior PIK Toggle Notes due 2017 (included as part of Exhibit 4.1), incorporated by reference to Exhibit 4.5 to the Company’s Registration Statement on Form S-4 (Registration No. 333-174112) filed on May 10, 2011.
Exhibit
No.
Description
4.4
Form of 8 1/8% Senior Secured Notes due 2017 (included as part of Exhibit 4.2), incorporated by reference to Exhibit 4.3 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 333-173954) filed on May 5, 2011.
4.5
First Supplemental Indenture, dated as of March 14, 2012, by and among, Florida East Coast Holdings Corp., Florida East Coast Railway Corp., the existing guarantors named therein, and Wells Fargo Bank, National Association, incorporated by reference to Exhibit 4.5 to Florida East Coast Holdings Corp.’s Annual Report on Form 10-K (Registration No. 333-174112) filed on March 15, 2012.
10.1
Credit Agreement, dated as of January 25, 2011, by and among, Florida East Coast Railway Corp., Bank of America, N.A., as administrative agent, and Merrill Lynch, Pierce, Fenner, & Smith Incorporated, as sole lead arranger and sole bookrunner, and a syndicate of financial institutions and institutional lenders, incorporated by reference to Exhibit 10.1 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4/A (Registration No. 333-173954) filed on August 2, 2011.
10.2
Assumption Agreement, dated as of March 15, 2011, by and between Miami Dade County and Florida East Coast Railway, L.L.C, incorporated by reference to Exhibit 10.2 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 333-173954) filed on May 5, 2011.
10.3
Amended and Restated Lease Agreement, dated as of January 1, 2011, by and between FDG Hialeah LLC and Florida East Coast Railway, L.L.C., incorporated by reference to Exhibit 10.3 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 333-173954) filed on May 5, 2011.
10.4**
Employment Agreement, dated as of May 24, 2011, by and among Florida East Coast Railway L.L.C., FECR Rail Corp. and James R. Hertwig, incorporated by reference to Exhibit 10.4 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 333-173954) filed on May 5, 2011.
10.5**
Employment Agreement, dated as of November 8, 2010, by and among Florida East Coast Railway L.L.C., FECR Rail Corp. and John A. Brenholt, incorporated by reference to Exhibit 10.5 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 033-173954) filed on May 5, 2011.
10.6**
Employment Agreement, dated as of December 3, 2010, by and among Florida East Coast Railway L.L.C., FECR Rail Corp. and Robert Stevens.
10.7**
Employment Agreement, dated as of December 6, 2011, by and among Florida East Coast Railway L.L.C., FECR Rail Corp. and Joel Haka., incorporated by reference to Exhibit 10.6 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 333-173954) filed on May 5, 2011.
10.8**
Employment Agreement, dated as of June 17, 2011, by and among Florida East Coast Railway L.L.C., FECR Rail Corp. and Robert Ledoux.
10.9**
Summary of Employment Terms, dated January 6, 2011, between Florida East Coast Railway L.L.C. and Kim Cooper, incorporated by reference to Exhibit 10.8 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 333-173954) filed on May 5, 2011.
10.10**
Form of Consulting Agreement, incorporated by reference to Exhibit 10.9 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 333-173954) filed on May 5, 2011.
10.11**
Form of Restricted Stock Unit Award Agreement, incorporated by reference to Exhibit 10.10 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4 (Registration No. 333-173954) filed on May 5, 2011.
10.12
Employee Services Agreement, effective as of January 1, 2010, by and between Florida East Coast Railway, L.L.C. and RailAmerica, Inc., incorporated by reference to Exhibit 10.13 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4/A (Registration No. 333-173954) filed on June 14, 2011.
10.13**
Form of Amendment to Restricted Stock Unit Award Agreement, incorporated by reference to Exhibit 10.14 to Florida East Coast Railway Corp.’s Registration Statement on Form S-4/A (Registration No. 333-173954) filed on August 2, 2011.
10.14**
The Executive Nonqualified Excess Plan Adoption Agreement, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 18, 2012.
10.15**
The Executive Nonqualified Excess Plan Document, incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on October 18, 2012.
10.16
State-Funded State Infrastructure Bank Loan Agreement, effective as of September 26, 2012, among the State of Florida Department of Transportation, FEC PEVT, LLC, the Borrower, and Florida East Coast Railway, L.L.C., the Guarantor, incorporated by reference to Exhibit 10.1 to Florida East Coast Holdings Corp.’s Form 8-K filed on October 2, 2012.
10.17
Port Everglades Intermodal Container Transfer Facility Lease and Operating Agreement, dated January 31, 2012, between Broward County, Florida, as lessor, and Florida East Coast Railway, L.L.C. and Assignment and Assumption of Lease, dated September 26, 2012 made by Florida East Coast Railway, L.L.C., as assignor, and FEC PEVT, LLC, as assignee, incorporated by reference to Exhibit 10.2 to Florida East Coast Holdings Corp.’s Form 8-K filed on October 2, 2012.
21.1*
Subsidiaries of the Registrant.
Exhibit
No.
Description
31.1*
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2*
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1*
Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
32.2*
Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
101.INS XBRL Instance Document.
101.SCH XBRL Taxonomy Extension Schema Document.
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB XBRL Taxonomy Extension Label Linkbase Document.
101.PRE  XBRL Taxonomy Extension Presentation Linkbase Document.
* Filed herewith.
** Management contract or compensatory plans and arrangements for executives and others.
 XBRL (eXtensible Business Reporting Language) information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Signature
Title
Date
/s/ James R. Hertwig
President and Chief Executive Officer (Principal Executive
March 13, 2013
James R. Hertwig
Officer)
/s/ John Brenholt
Executive Vice President and Chief Financial Officer (Principal
March 13, 2013
John Brenholt
Financial Officer and Principal Accounting Officer)
/s/ Wesley R. Edens
Director
March 13, 2013
Wesley R. Edens
/s/ Joseph Adams, Jr.
Director
March 13, 2013
Joseph Adams, Jr.
/s/ Randal A. Nardone
Director
March 13, 2013
Randal A. Nardone
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FLORIDA EAST COAST HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firm.
Consolidated Balance Sheets as of December 31, 2012 and 2011.
Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2012, 2011, and 2010.
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2012, 2011, and 2010.
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011, and 2010.
Notes to Consolidated Financial Statements.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Florida East Coast Holdings Corp. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Florida East Coast Holdings Corp. and Subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations and comprehensive loss, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Florida East Coast Holdings Corp. and Subsidiaries at December 31, 2012 and 2011, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
Independent Certified Public Accountants
March 13, 2013
Jacksonville, Florida
FLORIDA EAST COAST HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except for share amounts)
The accompanying notes are an integral part of the Consolidated Financial Statements.
FLORIDA EAST COAST HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands)
The accompanying notes are an integral part of the Consolidated Financial Statements.
FLORIDA EAST COAST HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands, except for share amounts)
The accompanying notes are an integral part of the Consolidated Financial Statements.
FLORIDA EAST COAST HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of the Consolidated Financial Statements.
FLORIDA EAST COAST HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of the Business and Basis of Presentation
The accompanying Consolidated Financial Statements of Florida East Coast Holdings Corp. and its subsidiaries (the “Company” or “Holdings Corp.”) have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The Company’s rail transportation operations are conducted through its direct wholly owned subsidiary Florida East Coast Railway Corp. (“FECR Corp.”), and its indirect wholly owned subsidiaries, Florida East Coast Railway, L.L.C. and FEC Highway Services, L.L.C. (collectively, the “Railway”). The Railway operates a Class II railroad along 351 miles of mainline track between Jacksonville and Miami, Florida, serving some of the most densely populated areas of Florida. Additionally, the Railway owns and operates approximately 270 miles of branch, switching and other secondary track and 115 miles of yard track, all within Florida. The Railway has the only private coastal right-of-way between Jacksonville and Miami and is the exclusive rail-service provider to the Port of Palm Beach, Port Everglades (Fort Lauderdale), and the Port of Miami.
Fortress Acquisition
On July 26, 2007, private equity funds managed by affiliates of Fortress Investment Group LLC (collectively, “Fortress”) acquired all of the outstanding stock of Florida East Coast Industries, Inc. (“FECI”), a then publicly held company. As part of the acquisition of FECI (herein referred to as the “Fortress Acquisition”), Fortress assumed a portion of FECI’s long-term debt and repaid the remaining outstanding debt and took FECI private.
Rail Separation
On December 31, 2007, FECI’s rail transportation segment was transferred to private equity funds managed by affiliates of Fortress (the “Rail Separation”). Concurrent with the Rail Separation, FECR Rail LLC and FECR Corp. were formed to carry on the activities of FECI’s rail transportation segment. As a result of the Rail Separation, FECR Rail LLC became the immediate parent of FECR Corp., which in turn became the immediate parent of the Railway.
Formation of Florida East Coast Holdings Corp.
Florida East Coast Holdings Corp., was incorporated in Florida on January 10, 2011 to hold the investments of the Company.
On January 25, 2011, FECR Rail LLC contributed all of its holdings of FECR Corp.’s common and preferred shares in exchange for 250,555 newly issued common shares of Holdings Corp. As a result, FECR Rail LLC became the immediate parent of Holdings Corp., whereas Holdings Corp. became the immediate parent of FECR Corp.
The following is a summary of entities included in the Consolidated Financial Statements:
· Florida East Coast Holdings Corp. (a wholly owned subsidiary of FECR Rail LLC)
· Florida East Coast Railway Corp. (also known as “Railway”) (a wholly owned subsidiary of Florida East Coast Holdings Corp.):
· Florida East Coast Railway, L.L.C., and its subsidiaries;
· FEC Highway Services, L.L.C.
FEC PEVT L.L.C. and FEC PEVT Corporation
On September 26, 2012, the Company, through its wholly owned subsidiaries, FEC PEVT, L.L.C., as borrower, and Florida East Coast Railway, L.L.C., as guarantor, entered into a State Infrastructure Bank loan (the “SIB Loan”) with the Florida Department of Transportation (“FDOT”), as lender, (see additional information in Footnotes 7 and 15). In conjunction with the SIB Loan, the Company formed FEC PEVT Corporation and FEC PEVT L.L.C. FEC PEVT L.L.C. is owned by Florida East Coast Railway, L.L.C. (99%) and FEC PEVT Corporation (1%). FEC PEVT Corporation is a wholly owned subsidiary of Florida East Coast Railway Corp. The newly formed entities are included in the Consolidated Financial Statements as discussed above.
2. Summary of Significant Accounting Policies
Principles of Consolidated Financial Statements
The accompanying Consolidated Financial Statements of the Company include all wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the Consolidated Financial Statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.
Reclassification
Certain prior year amounts have been reclassified to conform to the current year presentation.
Cash and Cash Equivalents
The Company considers all highly liquid instruments purchased with a maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents include cash on hand, bank demand accounts, money market accounts and overnight repurchase agreements having original maturities of less than three months.
Restricted Cash
Restricted cash consists of cash that is held by the Company in interest reserve accounts to hold the cash collateral related to the Company’s credit facility, letters of credit, and to hold cash in escrow accounts for long-term incentive cash awards for employees.
Allowance for Doubtful Accounts
Allowance for doubtful accounts are recorded by management based on the Company’s historical experience of bad debts to sales, analysis of accounts receivable aging, and specific identification of customers in financial distress, e.g., bankruptcy or poor payment record. Management reviews material past due balances on a monthly basis. Account balances are charged against the allowance when management determines it is probable that the receivable will not be recovered. Activity in the Company’s allowance for doubtful accounts was as follows:
Materials and Supplies
Materials and supplies are stated principally at average cost, which is not in excess of replacement cost. Materials are stated at an amount that does not exceed estimated realizable value.
Property, Plant and Equipment
Railway Properties
Railway properties are stated at cost, and are depreciated and amortized on a straight-line method over the useful life.
The following describes the depreciation methodologies applied for the significant asset groups of the Company:
a) Track and Related Assets
For track and related assets, the Company uses the group method of depreciation under which a single depreciation rate is applied to the gross investment. The Company reevaluated the useful lives of its track and related assets and established new depreciable lives based on a life study performed by valuation experts (as further described below) during 2004 through 2006 for bridges and 2005 for other track assets. The assets were also reviewed by valuation experts in connection with the Fortress Acquisition in 2007.
b) Rolling Stock
For rolling stock (such as locomotives and freight cars), the Company uses the group method of depreciation. Assets are specifically identified and utilize straight-line depreciation methods on a per asset basis based on the depreciation rate for the average life for the respective asset class. The Company reevaluated the useful lives of its rolling stock and established new depreciable lives based on a life study (as further described below) performed by valuation experts during 2004. The assets were also reviewed by valuation experts in connection with the Fortress Acquisition in 2007, as well as in 2012 (see below for further discussion).
Under the group method, the service lives and salvage values for each group of assets are determined by completing periodic life studies and applying management’s assumptions regarding the service lives of its properties. A life study is the periodic review of asset lives for group assets conducted and analyzed by the Company’s management with the assistance of a third-party expert. The results of the life study process determine the service lives for each asset group under the group method. There are several factors taken into account during the life study and they include statistical analysis of historical life, retirements and salvage data for each group of property, evaluation of current operations, review of the previous assessment of the condition of the assets and the outlook for their continued use, consideration of technological advances and maintenance schedules and comparison of asset groups to peer companies.
The Company’s policy is to perform life studies approximately every eight years. During the third quarter of 2012, the Company performed a life study over its rolling stock. The life study indicated that the actual lives of certain rolling stock assets were different than the estimated useful lives used for depreciation purposes in the Company’s financial statements. As a result, the Company changed its estimates of the useful lives of certain rolling stock assets to better reflect the estimated periods during which these assets will remain in service. The effect of this change in estimate during the year ended December 31, 2012 was to reduce depreciation expense by $0.6 million. Changes in asset lives due to the results of the life studies are applied on a prospective basis and will impact future periods’ depreciation expense, and thus, the Company’s results of operations. The Company estimates the annual impact on depreciation will be a reduction to depreciation expense by approximately $1.7 million.
Real Estate Properties
Real estate properties are stated at historical cost (such as land, building and building improvements) and are specifically identified. The Company reevaluated the useful lives of its building and improvements and established new depreciable lives on reviews performed by valuation experts in connection with the Fortress Acquisition in 2007.
Capital Expenditures
Rail operations are capital intensive and the Company accounts for these costs in accordance with U.S. GAAP. Routine repairs and maintenance costs, for all asset categories, are expensed as incurred. The Company self-constructs portions of its track structure and rebuilds certain of its rolling stock. In addition to direct labor and material, certain indirect costs are capitalized. The Company defines capital projects as any purchase of an asset that has an expected useful life greater than one year. Additionally, any expenditure which significantly increases an asset’s value or extends its useful life is capitalized.
The majority of the Company’s capital expenditures are related to track and rolling stock. Annual program work for rail, turnouts, surfacing, undercutting, bridges, locomotive and freight car overhauls are capitalized. Normal repairs, inspections, and maintenance costs are expensed as incurred, which includes track inspections, locomotive running repairs, repair of broken rail, and rail grinding. The Company incurs certain direct labor, contract service and other costs associated with the development and installation of internal-use computer software. Costs for newly developed software or significant enhancements to existing software are capitalized. Research, preliminary project planning, operations, maintenance and training costs are charged to operating expense when the work is performed.
Disposals and Retirements
Railroad Properties
Upon normal sale or retirement of track assets and rolling stock, costs less net salvage value are charged to accumulated depreciation and no gain or loss is recognized. As part of the life studies performed, an assessment will be made of the recorded amount of accumulated depreciation. Any deficiency (or excess), including any deferred gains or losses, will be amortized as a component of depreciation expense over the remaining useful life of the asset group until the next required life study. Since the overall assumption with group method is that the assets within the group on average have the same life and characteristics, it is therefore concluded that the deferred gains and losses offset over time.
The Company utilizes a first-in, first-out approach to track assets and related asset retirements. Generally, the Company estimates the historical cost of the replaced assets using historical accounting records and/or inflation indices published by the Bureau of Labor Statistics which are applied to the replacement value based on the age of the retired asset. These indices closely correlate with the major cost of the materials comprising the applicable road assets.
In the event that large groups of assets are removed from service as a result of unusual acts or sales, resulting gains and losses are recognized immediately. These acts are not considered to be in the normal course of business and are therefore recognized when incurred. Examples of such acts would be the major destruction of assets due to significant storm damage (e.g., major hurricanes) and the sale, disposal or abandonment of a rail line segment.
Real Estate Properties
Upon retirement or disposal of any of the land, land improvements, building and building improvements, and other fixed assets, resulting gains and losses are recognized in earnings.
Impairment of Long-Lived Assets
The Company reviews the carrying value of its property for impairment whenever events or changes in circumstances indicate that the carrying value of an asset or asset grouping may not be recoverable from the undiscounted future net cash flows expected to be generated over its remaining useful life. If impairment is identified, a loss would be reported to the extent that the carrying value of the related assets exceeds the fair value of those assets as determined by valuation techniques applicable in the circumstances. Losses from impairment of assets are charged to net loss on sale and impairment of assets within operating expenses.
Comprehensive Income (Loss)
Comprehensive income (loss) is the changes in equity of an enterprise except those resulting from shareholder transactions. Accumulated other comprehensive income (loss) consists of the following (in thousands):
Share-Based Compensation
Certain key employees and executives of the Company are the recipients of employment agreements that have restricted share benefits. Furthermore, the Company granted restricted share benefits to non-employees (executives of affiliates of the Company, herein referred to as “consultants”) to provide strategic consulting services to the Company. Share-based compensation is accounted for using the fair value based method prescribed by ASC 718, Compensation-Stock Compensation. Management determines fair value based on valuations performed by Fortress. Generally, the fair value of restricted shares is based on a valuation approach including the market-based approach using current market multiples as well as the income approach utilizing a discounted cash flow analysis, performed on a quarterly basis. For share-based awards issued to employees, a compensation charge is recorded against earnings based on the grant date fair value of the award. The Company uses a straight-line method of accounting for compensation costs related to share-based payment awards that contain pro rata vesting provisions. For transactions with consultants in which services are performed in exchange for the Company’s common stock or other equity instruments, the transactions are recorded on the basis of the fair value of the service received or the fair value of the equity instruments issued, whichever is more readily measurable at the date performance is complete or service is provided.
Income Taxes
The Company follows the asset and liability method of accounting for income taxes, as such, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Future tax benefits, such as net operating loss carry forwards and alternative minimum tax credit carry forwards, are recognized to the extent that realization of these benefits is considered to be more likely than not.
As of and during the periods ended December 31, 2012, 2011, and 2010, the Company did not have any uncertain tax positions.
Revenue Recognition
The Company recognizes freight revenue after the freight has been moved from origin to destination, which is not materially different from the recognition of revenue as shipments progress due to the relatively short length of the Company’s railroads. Other revenue, which includes car hire, storage fees, and fuel surcharge on dray moves, is recognized when the service is performed.
Disclosures about Fair Value of Financial Instruments
ASC 825, Financial Instruments, requires disclosure of the fair value of certain financial instruments. Various inputs are considered when determining the fair value of financial instruments. These inputs are summarized below:
· Level 1 - observable market inputs that are unadjusted quoted prices for identical assets or liabilities in active markets.
· Level 2 - other significant observable inputs (including quoted prices for similar securities, interest rates, credit risk, etc.).
· Level 3 - significant unobservable inputs (including the Company’s own assumptions in determining the fair value of financial instruments.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments held by the Company:
· Current assets and current liabilities: cash and cash equivalents, accounts receivable, as well as accounts payable and accrued expenses, as reflected in the consolidated balance sheets, approximate fair value because of the short-term maturity of these instruments.
· Long-term debt: the fair value of the Company’s Senior Secured Notes and Senior PIK Toggle Notes is based on secondary market indicators.
The carrying amounts and estimated fair values of the Company’s financial instruments were as follows (in thousands):
Environmental Remediation and Compliance
Costs associated with environmental compliance and preventing future contamination that are estimable and probable are accrued and expensed, or capitalized as appropriate. Expected remediation and monitoring costs relating to the remediation of an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are accrued and expensed in the period that such costs become estimable. Liabilities are recognized for remedial activities when they are probable and the remediation cost can be reasonably estimated.
Contingencies
The Company’s policy is to reserve for certain contingencies consisting primarily of various claims and lawsuits resulting from its operations in accordance with ASC 450, Contingencies . In the opinion of management, appropriate reserves have been made for the estimated liability that is probable of resulting from disposition of such matters. Management’s opinion, and ultimately, the reserve recorded in the financial statements, is based on known facts and circumstances. In certain circumstances, management uses the services of outside counsel and experts to help evaluate the facts and circumstances and considers their professional judgment in establishing the appropriate reserve. The ultimate resolution of these contingencies may be for an amount greater or less than the amount estimated by management.
3. Recent Accounting Pronouncements
In 2011, the FASB issued Accounting Standards Update 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income (“ASU 2011-05”) and Accounting Standards Update No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation and Reclassifications of Items Out of Accumulated Other Comprehensive Income (“ASU 2011-12”). ASU 2011-5 improves the comparability, consistency and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. ASU 2011-5 is effective for interim and annual periods beginning after December 31, 2011. As ASU 2011-5 relates specifically to presentation and disclosures the adoption of these provisions did not have any other impact on our consolidated financial statements. The main purpose of ASU 2011-12 was to defer the effective date pertaining to reclassification adjustments out of accumulated other comprehensive income in ASU 2011-5; therefore it did not have an impact on the Company’s consolidated financial statements. In accordance with the new guidance, the Company has selected the single continuous statement presentation.
4. Related-Party Transactions
Management and facility and equipment rents
The Company incurred net charges of $0.7 million, $2.2 million, and $1.3 million for management services and facility rents to affiliates of FECI for the years ended December 31, 2012, 2011, and 2010, respectively. The net charges include management services incurred during the transition period subsequent to the Rail Separation, as well as management services related to our right-of-way and rents for space leased from FECI for office space. As of December 31, 2012, and 2011, respectively, the Company did not have an outstanding net receivable or payable from or to FECI.
In addition, the Company allocated net proceeds of $1.0 million, $2.6 million, and $3.8 million for management services, and facility and equipment rents to affiliates of RailAmerica, Inc. (“RailAmerica”) for the years ended December 31, 2012, 2011, and 2010, respectively. RailAmerica is an entity partially owned by investment funds managed by affiliates of Fortress. The net charges include expenses for services provided from time to time for certain reciprocal administrative services, including finance, accounting, human resources, information technology, purchasing and legal, for fees received related to leased locomotives rented to RailAmerica’s affiliated companies and for office space sub-leased to RailAmerica. In addition, during the year ended December 31, 2011, the Company received proceeds of $4.5 million from the sale of locomotives that had previously been under lease to RailAmerica. The Company had a net receivable from RailAmerica of zero and $0.1 million as of December 31, 2012, and 2011, respectively. Subsequent to October 1, 2012, RailAmerica is no longer considered a related party, due to a change in ownership.
Effective June 1, 2011, the Company entered into an agreement with RailAmerica’s wholly-owned subsidiary, Atlas Road Construction, L.L.C., to provide engineering and construction services for the Port of Miami project (see Note 15). The Company incurred net charges of $2.2 million, and $9.6 million for the years ended December 31, 2012 and 2011, respectively, and zero for year ended December 31, 2010, respectively. As of December 31, 2012, and 2011 the Company had an outstanding payable of zero, and $6.0 million, respectively.
The Company rents chassis equipment for ordinary business operations from TRAC Intermodal, an entity indirectly owned by funds managed by affiliates of Fortress. These rents are based on current market rates for similar assets. During the years ended December 31, 2012, 2011, and 2010, the Company paid rents at the amounts of $0.7 million, $0.6 million, and $0.7 million, respectively. As of December 31, 2012 and 2011, the Company had an outstanding payable of $0.1 million and $0.1 million, respectively.
Lease of FECI’s rail yard
On January 24, 2011, the Company entered into an amended and restated rail yard lease, which, among other things: extends the date to vacate to December 31, 2035 (unless the Company elects not to renew the lease); commencing on January 1, 2011, provides for an annual rental fee of $4.5 million a year (subject to a 2.5% annual increase); provides the Company the right to purchase certain land from FECI at a mutually determined fair market value; provides FECI with the right to relocate the Company (at its expense) from such land to comparable property with competitive rental rates. The lease is cancellable after five years with a two year notice requirement. The Railway paid $5.1 million, $6.0 million and $2.9 million for the rail yard base rent for the years ended December 31, 2012, 2011, and 2010, respectively.
5. Property, Plant and Equipment
Property, plant and equipment consist of the following:
(a) Includes Grading, Grade Crossings, Fences, and Signs.
(b) Includes Roadway Machines, Shop Machinery, Work Equipment, Computer Equipment, Cranes, Packers & Ramps, and Automobiles.
(c) The estimated useful lives of the property, plant and equipment includes both the assets acquired at the “Rail Separation” and the assets purchased subsequently. The estimated lives are derived from the most recent life studies performed (see Note 2).
(a) Includes Grading, Grade Crossings, Fences, and Signs.
(b) Includes Roadway Machines, Shop Machinery, Work Equipment, Computer Equipment, Cranes, Packers & Ramps, and Automobiles.
(c) The estimated useful lives of the property, plant and equipment includes both the assets acquired at the “Rail Separation” and the assets purchased subsequently. The estimated lives are derived from the most recent life studies performed (see Note 2).
Depreciation expenses, including assets recorded under capital leases, were $27.0 million, $27.2 million, and $27.6 million for the years ended December 31, 2012, 2011, and 2010, respectively.
6. Income Taxes
For the years ended December 31, 2012, and 2011 the Company recorded deferred income tax expense of $7.6 million, and $14.9 million, respectively. For the year ended December 31, 2010, there was no current or deferred income tax expense. Income tax expenses differed from the amounts computed by applying the statutory federal income tax rate to pretax income as a result of the following:
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities were as follows:
A valuation allowance against deferred tax assets is required if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Company established a valuation allowance of $52.5 million, $42.6 million and $18.7 million as of December 31, 2012, 2011 and 2010, respectively, to reduce deferred tax assets to their expected realizable value at December 31, 2012.
The Company has net operating loss carryforwards as of December 31, 2012, as follows:
· U. S.-$281.2 million (expiration periods: 2028-2034)
· Florida-$292.4 million (expiration periods: 2028-2034)
The Company recognizes interest and penalties related to uncertain tax positions in its provision for income taxes. As of December 31, 2012 and 2011, the Company did not believe that it had any uncertain tax positions. As of December 31, 2012, the U.S. taxing jurisdiction remains open to examination for the years 2011, 2010, and 2009.
7. Long-Term Debt
Debt consisted of the following:
Interest expense was $41.6 million on the Senior Secured Notes and $17.2 million on the PIK Toggle Notes for the year ended December 31, 2012. Interest expense was $43.6 million on the Senior Secured Notes and $13.9 million on the PIK Toggle Notes for the year ended December 31, 2011. Interest expense on the Rail Term Loan was $66.3 million for the year ended December 31, 2010.
On January 25, 2011, FECR Corp. sold $475.0 million of 8 1/8% Senior Secured Notes due 2017 (“Senior Secured Notes” or “8 1/8% Notes”) in a private offering, for gross proceeds of $475.0 million.
In connection with the issuance of the Senior Secured Notes, FECR Corp. and certain of its subsidiaries also entered into the Asset-Based Lending (“ABL”) Facility. The ABL Facility matures on January 25, 2015 and bears interest at FECR Corp.’s option of: (a) a base rate determined in the greater of (1) the prime rate of the administrative agent, (2) federal funds effective rate plus 1 / 2 of 1%, or (b) a LIBOR rate determined by reference to the cost of funds for U.S. dollar deposits in London interbank market for the interest period relevant to such borrowing. The applicable margin with respect to (a) base rate borrowings will be 2.25%, and (b) LIBOR borrowings will be 3.25%. Obligations under the ABL Facility are secured by a first-priority lien on the ABL Collateral. There have been no borrowings under this facility.
The Senior Secured Notes are secured by first-priority liens on substantially all of the tangible and intangible assets of FECR Corp. and its subsidiary guarantors’ (other than the ABL collateral securing the ABL Facility) and a second-priority lien on ABL collateral. The guarantors are defined primarily as existing and future wholly owned domestic restricted subsidiaries. FECR Corp. may redeem up to 10% of the aggregate principal amount of the Senior Secured Notes issued during any 12-month period commencing on the issue date and ending on the third anniversary thereof at a price equal to 103% of the principal amount thereof plus accrued and unpaid interest, if any. FECR Corp. may also redeem some or all of the Senior Secured Notes at any time before February, 2014 at a price equal to 100% of the aggregate principal amount thereof plus a make-whole premium. In addition, prior to February 1, 2014, FECR Corp. may redeem up to 35% of the Senior Secured Notes at a redemption price of 108.125% of the aggregate principal amount thereof with the proceeds from an equity offering. Subsequent to February 1, 2014, FECR Corp. may redeem the Senior Secured Notes at 104.063% of their principal amount. The premium then reduces to 102.031% commencing on February 1, 2015 and then 100% on February 1, 2016 and thereafter.
The ABL Facility and indenture governing the Senior Secured Notes contain various covenants and restrictions that limits FECR Corp. and its restricted subsidiaries’ ability to incur additional indebtedness, pay dividends, make certain investments, sell or transfer certain assets, create liens, designate subsidiaries as unrestricted subsidiaries, consolidate, merge or sell substantially all the assets, and enter into certain transactions with affiliates. It is anticipated that proceeds from any future borrowings will be used for general corporate purposes.
Sale and Issuance of Series B Perpetual Preferred Stock
On January 25, 2011, the Company completed the sale and issuance of its Series B Perpetual Preferred Stock, par value $0.01 per share (“Series B Perpetual Preferred Stock”) for an aggregate consideration of $125.0 million to an affiliate of FECI commonly owned by affiliates of Fortress. The Series B Perpetual Preferred Stock carried interest cumulatively at the amount of 20% per annum.
Shareholder Contribution of FECR Rail LLC
In January and February 2011, FECR Rail LLC contributed an aggregate $16.0 million to the Company.
The proceeds of the sale of the Series B Perpetual Preferred Stock and $15.0 million of the FECR Rail LLC contribution to the Company were further contributed to FECR Corp. This contribution of $140.0 million together with the proceeds of the issuance of the Senior Secured Notes were used to repay outstanding debt of approximately $601.2 million, to pay certain fees and expenses incurred in connection with the offering of the 8 1/8% Notes, and for general corporate purposes.
PIK Toggle Notes
On February 11, 2011, Holdings Corp. sold $130.0 million of 10 ½ / 11 ¼% Senior Payment in Kind Toggle Notes due 2017 (the “Senior PIK Toggle Notes”) in a private offering, for net proceeds of $127.7 million. The Senior PIK Toggle Notes are senior unsecured obligations that are not guaranteed by any of Holdings Corp.’s subsidiaries.
Holdings Corp. may redeem the notes in whole or in part at a redemption price of 107.5%, 105%, 102.5%, and 100%, plus accrued and unpaid interest thereon for the subsequent periods after August 1, 2012 as follows: August 1, 2012 through January 31, 2013; February 1, 2013 through January 31, 2014; February 1, 2014 through January 31, 2015; and February 1, 2015 and thereafter, respectively.
The Senior PIK Toggle Notes will pay interest semi-annually in arrears on each February 1 and August 1, commencing on August 1, 2011. Thereafter and up to February 1, 2016, Holdings Corp. may elect to pay interest on the Senior PIK Toggle Notes (1) entirely in cash at a rate of 10.5% , (2) entirely by increasing the principal amount of the note or by issuing new notes for the entire amount of the interest payment, at a rate per annum equal to the cash interest rate of 10.5% plus 75 basis points (in each case, PIK interest), or (3) 50% as cash interest and 50% as PIK interest. After February 1, 2016, interest will be payable entirely in cash.
The Company could be subject to certain interest deduction limitations if the Senior PIK Toggle Notes were treated as “applicable high yield discount obligations” within the meaning of Section 163(i)(1) of the Internal Revenue Code, as amended. In order to avoid such treatment, the Company would be required to redeem for cash a portion of each Senior PIK Toggle Note then outstanding at the end of the accrual period ending August 1, 2016. The portion of a Senior PIK Toggle Note required to be redeemed is an amount equal to the excess of the accrued original issue discount as of the end of such accrual period, less the amount of interest paid in cash on or before such date, less the first-year yield (the issue price of the debt instrument multiplied by its yield to maturity). The redemption price for the portion of each Senior PIK Toggle Note so redeemed would be 100% of the principal amount of such portion plus any accrued interest on the date of redemption.
The net proceeds of the issuance of the Senior PIK Toggle Notes were used to redeem the Company’s Series B Perpetual Preferred Stock for the carrying value of $125.0 million and accrued interest of $1.1 million. As a result, none of the Series B Perpetual Preferred Stock were further issued and outstanding.
SIB Loan
On September 26, 2012, FEC PEVT, L.L.C., as borrower, and Florida East Coast Railway, L.L.C., as guarantor, each a wholly owned subsidiary of the Company, entered into the SIB Loan with FDOT. The SIB Loan provides for a loan of $30 million to fund, in part, the costs associated with the construction of a new Florida East Coast Intermodal Container Transfer Facility (the “ICTF”) in Port Everglades, Florida, which will serve the Company’s domestic and international business segments. Proceeds from the SIB Loan will be advanced by FDOT as construction proceeds on the ICTF. There have been no borrowings under the SIB Loan. The total construction cost of the ICTF construction project is approximately $53 million, $30 million of which will be funded through the SIB Loan, $18 million of which will be from a FDOT grant (the “FDOT Grant”) and the balance of $5 million from the Company’s capital budget. The Company has been awarded the entire FDOT Grant of $18 million as of December 31, 2012.
Interest will accrue on the advanced principal amount of the SIB Loan at the rate of 3.50% per annum, compounded annually, using an actual-days-elapsed/365 day counting convention. Both principal and interest payments are payable in annual installments as follows: interest payments commence on the SIB Loan on October 1, 2013, and principal repayments commence on the SIB Loan on October 1, 2015. The SIB Loan will be amortized over 20 years.
The SIB Loan is fully and unconditionally guaranteed by the Florida East Coast Railway, L.L.C. In addition, as a condition to making the SIB Loan, FDOT required a first priority lien on certain fixtures (including rail trackage) and equipment included in the collateral securing the Senior Secured Notes. The SIB Loan specifically excludes land, rail equipment and motor vehicles from its lien. As a condition to FDOT making the first loan disbursement under the SIB Loan, FEC PEVT, L.L.C. was required to post as additional collateral through July 1, 2017, a standby letter of credit in the amount of $3.0 million payable to FDOT, as beneficiary (the “Standby Letter of Credit Collateral”). On February 1, 2013, the Company posted the Standby Letter of Credit Collateral by accessing the letter of credit line of the ABL Facility, reducing availability under the ABL Facility to $27.0 million. The SIB Loan permits FEC PEVT, L.L.C, in lieu of posting the Standby Letter of Credit Collateral, at any time upon prior notice, to either pay down the principal of the SIB Loan by $3 million or substitute cash collateral (see Note 16).
8. Pension and other Benefit Programs
The Company sponsors two 401(k) plans, which are available to the Company’s employees. Contributions are at the employee’s discretion, subject to maximum limits imposed by the IRS (generally, $17,000 for 2012 and $16,500 for 2011and 2010), and an additional contribution up to 10% of after-tax compensation, also subject to maximum limits imposed by the IRS. Total contributions in 2012, 2011, and 2010, including the Company’s match if any, were limited by IRS regulations to $50,000 per participant for 2012, and $49,000 per participant for 2011 and 2010.
The 401(k) Plan for Salaried Employees -In accordance with the terms of the plan, the Company matched the employee’s contributions up to the first $1,200 contributed by the employee. For employee contributions in excess of $1,200, the Company matched $0.25 for every $1.00 in pretax employee contributions up to the IRS maximum limits. The amounts of matching contributions by the Company were $0.3 million, $0.2 million, and $0.2 million, for the years ended December 31, 2012, 2011, and 2010, respectively.
401(k) Plan for Hourly Wage Employees and/or Employees Covered by Collective Bargaining Agreement -This is a limited contributory plan that was instituted in April 1995. In 2002, train and engine hourly employees became eligible for a Company matching contribution of $0.20 for every $1.00 of employee contributions up to $200 annually. In 2006, boilermakers, electricians, machinists, shop laborers, and signal and communication workers also became eligible for the same matching contributions. In 2009, the International Brotherhood of Electrical Workers (“IBEW”), carmen, agents, clerical workers, dispatchers, and foreman also became eligible for the same matching contributions. The amounts of matching contributions for the years ended December 31, 2012, 2011, and 2010 were immaterial.
Pension Plan -The Company adopted an unfunded defined benefit plan covering previous officers of the Company in 1998. The benefits are based on years of service and the employee’s compensation during the five years before retirement. The Company curtailed this plan in 1999, causing no additional benefits to accrue to covered officers. The following chart summarizes the benefit obligations and includes rate assumptions associated with the defined benefit plan for the years ended December 31, 2012, 2011, and 2010:
As of December 31, 2012 and 2011, the total accrued liability related to the benefit obligation was $3.7 million and $3.7 million, respectively. Of the total liability, $3.2 million and $3.2 million were classified in other long-term liabilities in the consolidated balance sheet as of December 31, 2012 and 2011, respectively. The remaining balance of $0.5 million and $0.5 million, for the years ended December 31, 2012 and 2011, respectively, was presented as other current liabilities in the consolidated balance sheet. As of December 31, 2012 and 2011, accumulated other comprehensive income (loss) included $1.1 million and $0.9 million, respectively, of unrealized losses related to the benefit plan. Assuming no change in participation, the Company expects to incur benefit payments of $0.2 million per year over the next five years.
9. Preferred Stock
On January 19, 2011, the Company amended the articles of its certificate of incorporation related to all of its outstanding Series A Redeemable Preferred Stock (the “preferred shares”) whereby the preferred shares were no longer subject to redemption. Upon the execution of the amendment, the Company reclassified all of its outstanding 19,809 preferred shares, including its accumulated preferred yield of 15%, or $4.3 million, from liability to stockholders’ equity. Dividends continue to be cumulative at the rate of 15% per annum, subject to limitations on distributions by the Company imposed by the terms of any financing, swap, or other agreement. The Company was able to redeem in whole or in part the preferred share units at any time.
As of December 31, 2012 and 2011, the total unpaid preferred yield was $7.5 million, and $3.4 million (for the period from January 20, 2011 through December 31, 2011), respectively, on the then 19,809 preferred share units with a carrying value of $19.8 million for both years.
10. Share-Based Compensation
A summary of the fair value of nonvested shares is as follows:
Share-based compensation expenses related to restricted stock grants for the years ended December 31, 2012, 2011, and 2010, were $1.7 million, $1.8 million, $0.8 million, respectively.
Effective September 15, 2012, we terminated all consulting agreements with nonemployees who received restricted stock awards. In accordance with a termination without cause under the terms of their consulting agreements, each consultant was entitled to accelerated vesting of the tranche of his restricted stock units next scheduled to vest under the terms of his restricted stock unit award agreement. As part of the termination, 575 shares were accelerated and vested. All remaining shares under the agreements were forfeited.
Effective August 31, 2012, we accepted voluntary resignations from employment without “good reason” (as defined in their employment agreements) from executives as they began employment with another affiliate managed by funds owned by Fortress. Due to their resignations without “good reason,” neither executive was entitled to severance payments or equity acceleration upon termination of their employment agreements. Any unvested shares were forfeited.
As of December 31, 2012, there was $1.1 million of unrecognized compensation expense related to unvested restricted share compensation arrangements, which is expected to be recognized over a weighted average period of 1.1 years. The total fair value of shares vested during the years December 31, 2012, 2011, and 2010 was $1.4 million, $1.0 million, and $0.5 million, respectively.
11. Commitments and Contingencies
The Company is the defendant and plaintiff in various lawsuits resulting from its operations. In the opinion of management, appropriate provisions have been made in the Consolidated Financial Statements for the estimated liability that is probable of resulting from disposition of such matters. The Company maintains comprehensive liability insurance for bodily injury and property claims, but is self-insured or maintains a significant self-insured retention (i.e., deductible) for these exposures.
In September 2006, the Florida Department of Environmental Protection (“FDEP”) notified the Company and an adjacent property owner that they had been identified as potentially responsible parties (“PRPs”) as a result of an investigation into contaminated groundwater in Fort Pierce, Florida. As of December 31, 2012, and 2011, the Company had accrued $1.5 million related to the alleged contamination of which $1.5 million is expected to be paid over the next year. During the years ended December 31, 2012 and December 31, 2011, $0.1 and $0.2 million, respectively, were paid out for testing and site assessment. FDEP and the Company agreed in April 2012 that the Company’s scope of testing is complete and the Company can initiate a pilot remediation of the property. The Company has completed a competitive review of remediation proposals and selected a contractor to begin the pilot in early 2013.
In addition to the above site, the Company monitors a small number of other sites leased to others, or acquired by the Company or its subsidiaries. Based on management’s ongoing review and monitoring of these sites, and the ability to seek contribution or indemnification from the PRPs, the Company does not expect to incur material additional costs.
It is difficult to quantify future environmental costs as many issues relate to actions by third parties or changes in environmental regulations. However, based on information presently available, management believes that the ultimate disposition of currently known matters will not have a material effect on the financial position, liquidity, or results of operations of the Company.
In addition, the Company had accrued approximately $0.6 million and $0.2 million related to various other environmental incidents as of December 31, 2012 and 2011, respectively.
The Company is obligated under several noncancellable operating leases covering its facilities and equipment (primarily locomotives, trailers, and office and computer equipment). The lease terms are from one to ten years.
Future minimum payments under the leases, including applicable sales tax, are as follows (in thousands):
As previously described in Note 4, on January 24, 2011, the Company entered into an amended and restated rail yard lease, which, among other things, extends the date to vacate to December 31, 2035 (unless the Company elects to terminate the lease or purchase the land), provides for an annual rental fee of $4.5 million a year (subject to a 2.5% annual increase), provides the Company with the right to purchase certain land from FECI’s affiliate at a mutually determined fair market value, and provides FECI’s affiliate with the right to relocate the Company (at its expense) from such land to comparable property with competitive rental rates. The lease is cancellable after five years, with a two-year notice requirement.
12. Customers
The Company’s aggregate business represents approximately 15% of total revenues for the year ended December 31, 2012. The top three aggregate customers represent approximately 11%, 11% and 13% of the Railway’s total revenues for the years ended December 31, 2012, 2011 and 2010, respectively. The Railway’s revenues are affected by the demand for aggregate material, primarily in Florida, and the ability of these customers to supply, efficiently and effectively, this natural raw material. In addition, outside of the three primary aggregate customers, one customer represents approximately 11% and 10% of total revenues for the years ended December 31, 2011, and 2010, respectively. No single customer represented more than 10% of total revenues for the year ended December 31, 2012.
In January 2010, the U.S. Court of Appeals for the Eleventh Circuit upheld a decision to cancel all 2002 issued mining permits for certain quarries in the Lake Belt area of Miami-Dade County. Following this decision by the Court, the U.S. Army Corps of Engineers has signed a Record of Decision (“ROD”) for rock mining in the Lake Belt Area and issued a specific permit to Cemex Construction Materials Florida for FEC Quarry.
After extensive study and coordination with the public and other state and federal agencies, the ROD found that the discharge of fill material into 10,044 acres of Waters of the U.S. for mining in the Lake Belt area is not contrary to the public interest and is in compliance with the Section 404 of the Clean Water Act 404(b)(1) guidelines subject to certain permit conditions. Of the total impacts, 2,717 acres of wetlands were impacted under the 2002 permits, prior to the permits being vacated. The 7,327 acres of “new” authorized impacts are separated into two geographic areas: Section 1 (4,591 acres) and Section II (2,736 acres).
While there are no assurances, the Railway’s customers expect to have adequate reserves of minable aggregate material to satisfy demand in the foreseeable future. For the years ended December 31, 2012, 2011, and 2010, aggregate loads accounted for approximately $36.2 million, $25.7 million, and $27.1 million of freight revenue, respectively, or 16%, 13%, and 15%, respectively, of the Railway’s freight revenues.
13. Impairment of Assets
During the second quarter of 2011, the Company entered into a plan to dispose of certain locomotives that were under lease with RailAmerica. The Company had determined that these surplus locomotives were not expected to be placed back into service. As a result, the Company recorded a charge of $2.8 million to adjust their carrying value to their fair value based on recent sales and current market conditions (level 2 fair value measurement). The Company executed the sale in the third quarter of 2011 and received proceeds of $4.5 million. There were no significant gains or losses since the recognition of impairment.
During the fourth quarter of 2011, the Company recorded additional impairment charges of $0.1 million related to trailers that were held for sale as of December 31, 2011.
During the fourth quarter of 2012, the Company reviewed the serviceable status of the hopper car fleet. As a result of the review, the Company identified 227 hoppers that will no longer be used. As a result, the Company recorded an impairment charge of $3.5 million to adjust their carrying value to their fair value (level 2 fair value measurement) based on current scrap value obtained from third-party price quotations. Subsequent to year end, the Company received a formal release from applicable liens, however, has not yet disposed of the cars. As a result, the Company classified these hopper cars as held for sale at December 31, 2012.
14. Track Maintenance Agreement
In the first quarter of 2011, the Company entered into a Track Maintenance Agreement with an unrelated third-party customer (the “Shipper”). Under the agreement, the Shipper paid for qualified railroad track maintenance expenditures during 2011 in exchange for the assignment of railroad track miles, which permits the Shipper to claim certain tax credits pursuant to Section 45G of the Internal Revenue Code. The Shipper paid $2.4 million for each of the two years ended December 31, 2011 and 2010, respectively, of maintenance expenditures. This amount is included in other expenses as a reduction to expense in the Consolidated Statement of Operations. The track maintenance tax credit was not renewed by tax credit reimbursement for 2012 and 2013. However, as the extension was not passed until January 2013; no 45G maintenance reimbursement was reflected in the 2012 financial statements (see Note 16).
15. Port Activity
In October 2010, Miami-Dade County, owner of the Port of Miami, was awarded a $22.8 million federal grant under the U.S. Department of Transportation’s Transportation Investment Generating Economic Recovery II (“TIGER”) program to rehabilitate the port’s rail bridge and construct new rail facilities on port property (“on-port project”). These projects will enable cargo to be moved directly from the port’s facility to an inland distribution center and alleviate traffic congestion in and around the port. The Company plans to establish intermodal container rail service on its own rail line leading into the port at an estimated total cost of $18.3 million (“off-port project”). The Company signed an agreement with FDOT on January 24, 2011, in which FDOT will participate in funding of the “off-port project” and will reimburse the Company an estimated $9.1 million of the total cost. As of December 31, 2012, the Company had incurred approximately $18.3 million of capital expenditures project to date related to the Port Miami off-port project. Of this amount, the Company has reduced this capital expenditure by $9.1 million of grant proceeds. As of December 31, 2011, the Company had incurred approximately $14.4 million of capital expenditures project to date related to the Port Miami off-port project. Of this amount, the Company has reduced this capital expenditure by $7.2 million of grant proceeds.
On September 20, 2011, Miami-Dade County entered into a Rail Bridge Construction Agreement with the Company. Under this agreement, the Company is responsible for the administration of the construction work for the Bascule Bridge over Biscayne Bay which connects the Company’s Port Lead to the Port of Miami with spending not to exceed $6.6 million. The Company is reimbursed for all of the costs incurred. For the years ended December 31, 2012 and 2011, the Company incurred costs of $5.2 million and zero, respectively. As of December 31, 2012, the Company had an outstanding receivable of $2.7 million.
On January 31, 2012, the Company entered into a Port Everglades Intermodal Container Transfer Facility Lease and Operating Agreement with Broward County. The agreement was ratified by Broward County on March 20, 2012. The term of the agreement is 30 years with two 10-year options. The Agreement was subject to the closing of the SIB Loan with FDOT. The SIB Loan closed on September 26, 2012. The Agreement provides the Company the land needed for the Company to construct an intermodal facility to serve its domestic and international business segments. The total construction cost is approximately $53 million, $30 million of which will be funded through the SIB Loan, $18 million of which will be from a FDOT grant and the balance of $5 million from the Company’s capital budget. The Company has been awarded the entire $18 million FDOT grant as of December 31, 2012. Upon project commencement, the Company will be reimbursed for half of the corresponding expenditures, not to exceed the $18 million FDOT grant.
16. Subsequent Events
As discussed above in the Long-Term Debt note above, (Note 7), the Standby Letter of Credit Collateral was issued on February 1, 2013 and reduced the ABL Availability to $27.0 million.
In fiscal 2011 and 2010, the Company had entered into a Track Maintenance Agreement with an unrelated third-party customer (the “Shippers”). Under the agreement, the Shipper paid for qualified railroad tax maintenance expenditures during 2011 and 2010 in exchange for the assignment of railroad track miles, which permit the Shipper to claim certain tax credits pursuant to Section 45G of the Internal Revenue Code. The Section 45G tax credit expired in 2012, subsequent to year-end, Congress extended the Section 45G tax credit for 2012 and 2013. The Company reached an agreement with a third-party Shipper subsequent to year end to be reimbursed for $2.4 million of maintenance expenditures. This amount will be included in other expenses as a reduction to expense in the Consolidated Statement of Operations in the first quarter of 2013.
17. Guarantor Condensed Consolidated Financial Statements
Holdings Corp. was incorporated on January 10, 2011. In January 2011, all of the equity interests in FECR Corp. were transferred from FECR Rail LLC to Holdings Corp., whereby Holdings Corp. became the direct parent of FECR Corp. Holdings Corp. is a holding company and has no direct operations or material assets other than its wholly owned interest in FECR Corp. All of Holdings Corp.’s operations are conducted through its subsidiaries. The only material differences between Holdings Corp. and FECR Corp. are the separate Senior PIK Toggle Notes issued by Holdings Corp. and its related accounts, including deferred financing costs, amortization, payment of interest and payment of taxes. Where information or an explanation is provided that is substantially the same for each company, such information or explanation has been combined. Where information or an explanation is not substantially the same for each company, we have provided separate information and explanation.
The Consolidating Financial Statements herein present consolidating financial data for Holdings Corp. (on a parent only basis), FECR Corp. (on an issuer only basis), an elimination column for adjustments to arrive at the information for the parent company and subsidiaries on a consolidated basis and the parent company and subsidiaries on a consolidated basis as of December 31, 2012 and 2011 and for each of the three years ended December 31, 2012.
Condensed consolidating balance sheets as of December 31, 2012.
Condensed consolidating balance sheets as of December 31, 2011.
Condensed consolidating statement of operations for the year ended December 31, 2012.
Condensed consolidating statement of operations for the year ended December 31, 2011.
Condensed consolidating statement of operations for the year ended December 31, 2010.
Condensed consolidating statement of cash flows for the year ended December 31, 2012.
Condensed consolidating statement of cash flows for the year ended December 31, 2011.
Condensed consolidating statement of cash flows for the year ended December 31, 2010.