UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

Form 6-K

 

REPORT OF FOREIGN PRIVATE ISSUER

PURSUANT TO RULE 13a-16 OR 15d-16

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

Commission File Number 1-32591  

 

SEASPAN CORPORATION

(Exact name of Registrant as specified in its Charter)

 

Unit 2, 2nd Floor

Bupa Centre

141 Connaught Road West

Hong Kong

China

(Address of principal executive office)

 

Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F. Form 20-F  ☒    Form 40-F  ☐

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101 (b)(1).     Yes  ☐    No  ☒

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101 (b)(7).     Yes  ☐    No  ☒

 

 

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Item 1 — Information Contained in this Form 6-K Report

Attached as Exhibit I is Seaspan Corporation’s report on Form 6-K, or this Report, for the quarter ended June 30, 2018. This Report is hereby incorporated by reference into: the Registration Statement of Seaspan Corporation filed with the Securities and Exchange Commission, or the SEC, on May 30, 2008 on Form F-3D (Registration No. 333-151329), the Registration Statement of Seaspan Corporation filed with the SEC on March 31, 2011 on Form S-8 (Registration No. 333-173207), the Registration Statement of Seaspan Corporation filed with the SEC on June 20, 2013 on Form S-8 (Registration No. 333-189493), the Registration Statement of Seaspan Corporation filed with the SEC on April 24, 2012 on Form F-3 (Registration No. 333-180895), as amended on March 22, 2013, the Registration Statement of Seaspan Corporation filed with the SEC on April 29, 2014 on Form F-3 (Registration No. 333-195571), as amended on March 3, 2017 and April 19, 2017, the Registration Statement of Seaspan Corporation filed with the SEC on November 28, 2014 on Form F-3 (Registration No. 333-200639), as amended on March 3, 2017 and April 19, 2017, the Registration Statement of Seaspan Corporation filed with the SEC on November 28, 2014 on Form S-8 (Registration No. 333-200640), the Registration Statement of Seaspan Corporation filed with the SEC on March 12, 2015 on Form F-3D (Registration No. 333-202698), the Registration Statement of Seaspan Corporation filed with the SEC on May 23, 2016 on Form F-3 (Registration No. 333-211545), as amended on March 3, 2017, March 7, 2017 and April 19, 2017, the Registration Statement of Seaspan Corporation filed with the SEC on June 24, 2016 on Form S-8 (Registration No. 333-212230) and the Registration Statement of Seaspan Corporation filed with the SEC on April 13, 2018 on Form F-3D (Registration No. 333-224291), the Registration Statement of Seaspan Corporation filed with the SEC on May 3, 2018 on Form F-3/A (Registration No. 333-224288), as amended on May 7, 2018 and the Registration Statement of Seaspan Corporation filed with the SEC on June 15, 2018 on Form F-4 (Registration No. 333-225681).

SIGNATURES

Pursuant to the requirements 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.

 

 

 

 

 

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EXHIBIT I

SEASPAN CORPORATION
REPORT ON FORM 6-K FOR THE QUARTER ENDED JUNE 30, 2018

INDEX

 

 

Unless we otherwise specify, when used in this Report, the terms “Seaspan”, the “Company”, “we”, “our” and “us” refer to Seaspan Corporation and its subsidiaries. References to our “Manager” are to Seaspan Management Services Limited and its wholly-owned subsidiaries which provide us with all of our technical, administrative and strategic services.

 

References to shipbuilders are as follows:

 

 

 

 

ii

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References to customers are as follows:

 

^{_____________________}

We use the term “twenty-foot equivalent unit”, or TEU, the international standard measure of containers, in describing the capacity of our containerships, which are also referred to as our “vessels”. We identify the classes of our vessels by the approximate average TEU capacity of the vessels in each class. However, the actual TEU capacity of a vessel may differ from the approximate average TEU capacity of the vessels in such vessel’s class.

The information and the unaudited consolidated financial statements in this Report should be read in conjunction with the consolidated financial statements and related notes and the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 20-F for the year ended December 31, 2017, filed with the U.S. Securities and Exchange Commission, or the SEC, on March 6, 2018, or our 2017 Annual Report.  Unless otherwise indicated, all amounts in this Report are presented in U.S. dollars, or USD. We prepare our consolidated financial statements in accordance with United States generally accepted accounting principles, or U.S. GAAP.

 

 

 

 

iii

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SEASPAN CORPORATION

PART I — FINANCIAL INFORMATION

ITEM 1 — INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

SEASPAN CORPORATION

Interim Consolidated Balance Sheets

(Unaudited)

(Expressed in thousands of United States dollars, except number of shares and par value amounts)

 

Basis of presentation and going concern (note 1(a))

Commitments and contingencies (note 15)

Subsequent events (note 19)

See accompanying notes to interim consolidated financial statements.

 

1

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SEASPAN CORPORATION

Interim Consolidated Statements of Operations

(Unaudited)

(Expressed in thousands of United States dollars, except per share amounts)

 

 

 

See accompanying notes to interim consolidated financial statements.

 

2

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SEASPAN CORPORATION

Interim Consolidated Statements of Comprehensive Income

(Unaudited)

(Expressed in thousands of United States dollars)

 

 

 

See accompanying notes to interim consolidated financial statements.

 

 

 

3

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SEASPAN CORPORATION

Interim Consolidated Statements of Puttable Preferred Shares and Shareholders’ Equity

(Unaudited)

(Expressed in thousands of United States dollars, except number of shares)

Six months ended June 30, 2018 and year ended December 31, 2017

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

4

 

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SEASPAN CORPORATION

Interim Consolidated Statements of Puttable Preferred Shares and Shareholders’ Equity (Continued)

(Unaudited)

(Expressed in thousands of United States dollars, except number of shares)

Six months ended June 30, 2018 and year ended December 31, 2017

 

 

See accompanying notes to interim consolidated financial statements.

 

 

 

 

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SEASPAN CORPORATION

Interim Consolidated Statements of Cash Flows

(Unaudited)

(Expressed in thousands of United States dollars)

 

 

Supplemental cash flow information (note 14)

See accompanying notes to interim consolidated financial statements.

 

 

 

 

 

6

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

1.       Significant accounting policies:

These consolidated financial statements have been prepared by management on a going concern basis, which contemplates that the Company will be able to continue operations for the foreseeable future and will be able to realize its assets and settle its liabilities in the normal course of operations.

At June 30, 2018, the Company has a working capital deficiency of $532,579,000 which includes $337,925,000 of senior unsecured notes maturing in April 2019. The working capital deficiency may increase in future periods as described below. These factors indicate that a material uncertainty exists that casts substantial doubt about the Company’s ability to continue as a going concern. In order to alleviate this uncertainty, the Company will rely, in part, upon the continued financial support of Fairfax Financial Holdings Ltd. and its affiliates (“Fairfax”), which includes not exercising the debenture put right and the successful closing of the agreements described below. The Company also expects to further address this deficiency through cash generated from operations and additional sources of funds in the capital markets to the extent available.

On February 14, 2018 and March 13, 2018, the Company and Fairfax entered into agreements for a total $500,000,000 investment in debentures, $250,000,000 in each agreement, and warrants to purchase a total of 76,923,078 Class A common shares of the Company, 38,461,539 in each agreement, for an aggregate total purchase price of $500,000,000 (note 8(e)). The March 13, 2018 agreement will be funded, and the warrants issued, in January 2019 subject to closing conditions.

On May 31, 2018, the Company and Fairfax entered into agreements to invest an additional $500,000,000 of equity in the Company through the exercise of the warrants issued in February 2018 (note 11) and the warrants to be issued in January 2019 under the March 13, 2018 agreement. On July 16, 2018, Fairfax exercised 38,461,539 warrants at an exercise price of $6.50 per share from its February 14, 2018 agreement. The gross proceeds of $250,000,000 were partially used to redeem the Company’s outstanding Series F preferred shares (note 19(a) and 19(b)). Under the terms of the May 31, 2018 agreement, expected to close in January 2019, Fairfax will immediately exercise all of the warrants that are issuable under the March 13, 2018 agreement.

The May 31, 2018 agreements which closed July 16, 2018 provide Fairfax with the right to put each of the February 14, 2018 and March 13, 2018 debentures on their applicable anniversary dates subject to submitting an annual put right notice commencing 150 days and ending 120 days prior to each applicable anniversary date. As the right to put the debentures is solely within the control of Fairfax, the February 14, 2018 debentures will be reclassified from long-term liabilities to current liabilities as of July 16, 2018.  Upon funding of the March 13, 2018 debentures and exercise of the March 13, 2018 warrants upon closing in January 2019, the debentures will be classified as a current liability.

Fairfax owns 22% of the class A common shares outstanding as at August 3, 2018 and is considered a related party. Fairfax will own an additional 38,461,539 common shares if the warrants from the March 13, 2018 investment are exercised.

These consolidated financial statements do not include the adjustments to the carrying values of assets and liabilities and the reported expenses and balance sheet classifications that would be necessary were the going concern assumption inappropriate, and these adjustments could be material.

 

 

 

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

1.       Significant accounting policies (continued):

Effective January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers”, that introduced a new five-step revenue recognition model to determine how an entity should recognize revenue related to the transfer of goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services.  

The Company’s revenue is comprised primarily of time charter revenue and interest income from leasing.  The time charter revenue includes a lease element, which is evaluated under Accounting Standards Codification (“ASC”) 840 “Leases”, and a service element, which is evaluated under ASU 2014-09.  Under previous accounting standards, service revenue was recognized when the amounts were fixed or determinable, services had been rendered and collectability was reasonably assured.  Under ASU 2014-09, recognition of such service revenue occurs when the services are provided and the performance obligations are satisfied.  The Company evaluated the service revenue under ASU 2014-09 and determined that the amounts recognized and the pattern of recognition are substantially the same as the previous revenue standard. The Company adopted ASU 2014-09 using the modified retrospective method and applied the new standard only to contracts not completed as of January 1, 2018.  There is no impact on the Company’s consolidated financial statements.

Definition of a Business

Effective January 1, 2018, the Company adopted ASU 2017-01, “Clarifying the Definition of a Business”, which provides a new framework for determining whether transactions should be accounted for as acquisitions of assets or businesses.  The Company analyzed its March 13, 2018 acquisition of Greater China Intermodal Investments LLC (“GCI”) under this standard (see note 2).

Statement of Cash Flows – Restricted Cash

Effective January 1, 2018, the Company adopted ASU 2016-18, “Statement of Cash Flows – Restricted Cash”, which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and restricted cash.  In addition, the amounts of restricted cash and nature of the restrictions are required to be disclosed.  The Company’s consolidated statements of cash flows and supplemental cash flow note reflect the changes as required.

Equity-linked financial instruments with down round features

Effective January 1, 2018, the Company elected to early adopt ASU 2017-11, which changes the classification analysis of certain equity-linked financial instruments with down round features.  When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock.  The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted.  There is no impact on the Company’s consolidated financial statements.

 

 

 

 

 

 

8

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

1.       Significant accounting policies (continued):

Leases

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02, “Leases”, which requires lessees to recognize all leases, including operating leases, with a term greater than 12 months on the balance sheet, for the rights and obligations created by those leases.  The accounting for lessors will remain largely unchanged from the existing accounting standards.  The standard is effective for fiscal years beginning after December 31, 2018, including interim periods within those fiscal years.  

Under ASU 2016-02, each lease agreement will be evaluated to identify the lease components and non-lease components at lease inception. The total consideration in the lease agreement will be allocated to the lease and non-lease components based on their relative standalone selling prices. Lessors will continue to recognize the lease revenue component using an approach that is substantially equivalent to existing guidance for operating leases (straight-line basis). Sale-type and direct financing leases will be accounted for as financing transactions with the lease payments being allocated to principal and interest utilizing the effective interest rate method.

In July 2018, the FASB issued ASU 2018-11, “Leases – Targeted Improvements” that allows lessors to elect, as a practical expedient, to not separate lease and non-lease components and allows these components to be accounted for as a single lease component if both (i) the timing and pattern of transfer to the lessee of the lease component and the related non-lease component are the same and (ii) the lease component, if accounted for separately, would be classified as an operating lease.  In addition, a company is permitted to use its effective date as the date of initial application.  Therefore, a company electing this option will not restate comparative period financial information, will not make the new required lease disclosures in comparative periods beginning before the effective date and will recognize its cumulative effect transition adjustment as of the effective date.  Under the practical expedient mentioned above, it is expected that time charter revenue and service revenue will be presented under a single lease component presentation. The amendments have the same effective date as ASC 2016-02.

The Company intends to adopt ASU 2016-02 on January 1, 2019 whereby a cumulative effect adjustment will be made as of that day with no retrospective effect.  The Company also intends to elect to apply the package of practical expedients such that for any expired or existing leases it will not reassess lease classification, initial direct costs or whether any expired or existing contracts are or contain leases.

The adoption of ASU 2016-02 will result in a change in the accounting method for certain of the Company’s sale-leaseback transactions and office leases.  Under ASU 2016-02, the Company will recognize a right-of-use asset and a lease liability on the balance sheet for these sale-leaseback transactions and office leases based on the present value of the future minimum lease payments, whereas currently no right-of-use asset or lease liability is recognized.  The existing deferred gain related to the sale-leaseback transactions will be eliminated through a credit directly to retained earnings.  The impact on the Company’s consolidated financial statements will be an increase to its assets and liabilities. The Company is currently determining the impact on its statement of operations.

 

 

 

 

 

 

9

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

1.       Significant accounting policies (continued):

The adoption of ASU 2016-02 will require the Company to complete its lease classification assessment at lease commencement rather than when a lease is entered into.  Historically, for charters that were negotiated concurrently with the construction of the related vessels, the fair value of the constructed asset was presumed to be its newbuilding cost. If such charters were classified as direct financing leases at the time the lease was entered into, no gain or loss was recognized subsequently on commencement of the charter.  On adoption of ASU 2016-02, the fair value of the vessel will be determined based on information available at the lease commencement date, rather than lease inception date, and any difference in the fair value of the vessel upon commencement of the charter and its carrying value will be recognized as a gain or loss upon commencement of the charter.

2.       Acquisition of Greater China Intermodal Investments LLC:

On March 13, 2018, the Company acquired the remaining 89.2% that it did not own of GCI from affiliates of The Carlyle Group and the minority owners of GCI. GCI’s fleet of 18 containerships, including two newbuilds, was comprised of 10000 TEU and 14000 TEU eco-class vessels.  

The aggregate purchase price was $498,050,000, comprised of:

Under the Agreement and Plan of Merger (the “Merger Agreement”), $10,000,000 was deposited in escrow for settlement of potential indemnifiable damages.  If there are no claims for indemnification, the escrowed amount will be released within two business days after March 13, 2019.

The value of the Company’s Series D preferred shares and Class A common shares was determined based on the closing market price of those shares on March 13, 2018, which was the date the acquisition closed. As the initial holders of the 1,986,449 Series D preferred shares have a right commencing on September 13, 2019 and ending on October 13, 2019 to cause the Company to repurchase any of these shares they hold at that time for a price of $24.84 per share, these Series D preferred shares are recorded as temporary equity.

The Company incurred $1,910,000 of acquisition-related costs that have been capitalized as a cost of the net assets acquired.

The Company accounted for the transaction as an asset acquisition as substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable group of similar identifiable assets.

Accordingly, the consideration has been allocated on a relative fair value basis to the assets acquired and liabilities assumed.  

 

 

 

 

 

10

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

2.       Acquisition of Greater China Intermodal Investments LLC (continued):

The following table summarizes the fair value of the identifiable assets acquired and liabilities assumed;

 

The Company purchased identifiable intangible assets (time charters) with an estimated useful life of 5.3 years and is recorded in Other Assets.

3.       Related party transactions:

The Company had $293,000 (December 31, 2017 – $318,500) due from other related parties included in accounts receivable

 

The income or expenses with related parties relate to amounts paid to or received from individuals or entities that are associated with the Company or the Company’s directors or officers and these transactions are governed by pre-arranged contracts.

In February 2018, the Company issued to certain affiliates of Fairfax, in a private placement, $250,000,000 aggregate principal of 5.50% senior notes due 2025 (“Fairfax Notes”) and warrants (“Fairfax Warrants”) (note 11) to purchase 38,461,539 of the Company’s Class A common shares for an aggregate issue price of $250,000,000. The Fairfax Notes are guaranteed by certain of the Company’s subsidiaries. The proceeds of the Fairfax Notes and Fairfax Warrants were allocated to each security on a relative fair value basis.  The indenture relating to the Fairfax Notes provides that, subject to certain limitations, the Fairfax investors will have the right to designate a maximum of two members to our board of directors.  Fairfax became a related party as a result of this private placement.  Interest expense relates to interest expense on the Fairfax Notes.

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

3.       Related party transactions (continued):

In 2017, transaction fees were paid to the Company’s former chief executive officer (“former CEO”) in connection with services he provided related to new build contracts and purchase or sale contracts, and these fees were capitalized to vessels. Transaction fees were paid in the Company’s common shares, certain of which were paid in 2018 and contractually entered into while he was employed by the Company (note 13(b)). The former CEO’s employment ended on December 31, 2017 and as of that date he was no longer a related party.

Interest income was earned on loans to affiliate, prior to March 13, 2018. Management fees were earned from GCI for the management of GCI’s vessels, prior to March 13, 2018, and are included in revenue.

 

4.       Gross investment in lease:

 

In April 2015, the Company entered into an agreement with MSC to bareboat charter five 11000 TEU vessels for a 17-year term, beginning from the vessel delivery dates. Pursuant to the Company’s right of first refusal agreement with GCI, the Company retained three of the vessels and GCI acquired the remaining two vessels. In June 2016, two of the five 11000 TEU vessels and associated bareboat charter contracts were acquired by the Company from GCI. At the end of each 17-year bareboat charter term, MSC has agreed to purchase each vessel for $32,000,000. Each transaction is considered a direct financing lease and accounted for as a disposition of vessels upon delivery of each vessel.

In 2017, four of the five 11000 TEU vessels delivered and commenced their 17-year bareboat charters. In January 2018, the fifth 11000 TEU vessel delivered and commenced its 17-year bareboat charter.

 

5.      Vessels:

 

 

 

During the three and six months ended June 30, 2018, the Company capitalized interest costs of $256,000 and $769,000, respectively, (June 30, 2017 - $2,926,000 and $5,786,000) to vessels under construction.

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

6.     Deferred charges:

 

 

7.      Deferred revenue:

 

 

 

8.      Long-term debt:

 

In February 2018, the Company cancelled its $120,000,000 364-day, unsecured revolving loan facility, which had not been drawn.

At June 30, 2018, the one month average LIBOR was 2.1% (December 31, 2017 – 1.5%) and the margins ranged between 0.5% and 0.9% (December 31, 2017 – 0.5% and 1.4%) for revolving credit facilities. The weighted average rate of interest, including the margin, for our revolving credit facilities was 2.7% at June 30, 2018 (December 31, 2017 – 2.2%). Interest payments are made monthly.

 

 

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

8.       Long-term debt (continued):

In March 2018, the Company entered into a secured term loan facility for $100,000,000 which bears interest at LIBOR plus a margin.  The facility is secured by 11 vessels currently owned by the Company which were previously unencumbered.

As part of the acquisition of GCI on March 13, 2018, the Company assumed long-term debt which was recorded at its fair value of $1,038,081,000 (see note 2).  The assumed long-term debt consists primarily of 12 term loans to finance the 16 operating vessels.  The term loans bear interest at LIBOR plus a margin.  

In April 2018, the Company entered into a secured term loan facility for up to $120,000,000 to finance two 10000 TEU vessels that were delivered in May 2018.  The loan bears interest at LIBOR plus a margin.

At June 30, 2018, the one month, three month and six month average LIBOR was 2.1%, 2.3% and 2.4%, respectively (December 31, 2017 – 1.6%, 1.5% and 1.5%, respectively) and the margins ranged between 0.4% and 4.8% (December 31, 2017 – 0.4% and 4.8%) for term loan credit facilities.

For certain of our term loan credit facilities with a total principal outstanding of $71,901,000, interest is calculated based on the Export-Import Bank of Korea (KEXIM) rate plus 0.7% per annum.

For one of our unsecured term loan facilities with a total principal outstanding of $29,000,000, interest is a fixed rate of 7.0%.

The weighted average rate of interest, including the margin, was 4.6% at June 30, 2018 (December 31, 2017 – 3.6%) for term loan credit facilities. Interest payments are made in monthly, quarterly or semi-annual payments.

Waivers

For one of the Company’s term loan credit facilities, the Company initially obtained a waiver from the lender extending the grace period for securing acceptable replacement charters for two of the vessels to the fourth quarter of 2017. In September 2017, the Company received another waiver from the lender which extends the grace period for securing replacement charters to October 2020. If either of the vessels remains unemployed for a consecutive period of more than 90 days, then the waiver will be terminated.  For four GCI vessels financed by the same lender, a similar waiver was received by GCI.

For another one of the Company’s term loan credit facilities, the Company entered into a supplement to the loan agreement with the lender for one vessel, extending the grace period for securing an acceptable replacement charter for the vessel to the fourth quarter of 2018. In March 2018, the Company entered into another supplement to the loan agreement with the lender to remove the requirement to secure an acceptable replacement charter by the fourth quarter of 2018. In connection with this supplement to the loan agreement the Company prepaid $10,000,000 of the loan balance in March 2018. The final maturity of this facility is December 2022.

 

As of June 30, 2018, our credit facilities, including those of GCI, are secured by first-priority mortgages granted on 76 of our vessels, together with other related security, such as assignments of shipbuilding contracts and refund guarantees for the vessels, assignments of time charters and earnings for the vessels, assignments of insurances for the vessels and assignments of management agreements for the vessels.

 

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

8.       Long-term debt (continued):

The Company may prepay certain amounts outstanding without penalty, other than breakage costs in certain circumstances. In certain circumstances a prepayment may be required as a result of certain events, including the sale or loss of a vessel, a termination or expiration of a charter (and the inability to enter into a charter suitable to lenders within a period of time).  The amount that must be prepaid may be calculated based on the loan to market value. In these circumstances, valuations of our vessels are conducted on a “without charter” basis as required under the credit facility agreement.

Each credit facility, other than credit facilities of GCI’s subsidiaries, contains financial covenants requiring the Company to maintain minimum liquidity, tangible net worth, interest coverage ratios, interest and principal coverage ratios, and debt-to-assets ratios, as defined. For GCI, each borrower under each facility is a special purpose entity and subsidiary of GCI.  Each facility is guaranteed by GCI and as the guarantor, GCI must meet certain consolidated financial covenants under these term loan facilities including maintaining certain minimum tangible net worth, cash requirements and debt to asset ratios.  Some of the facilities also have an interest and principal coverage ratio requirement for the subsidiary borrower.  The Company was in compliance with these covenants at June 30, 2018.

In March 2017, the Company entered into a repurchase plan for up to $10,000,000 of its senior unsecured notes which mature in April 2019.  During the six months ended June 30, 2018, the Company did not repurchase any senior unsecured notes.

In February 2018, the Company issued to certain affiliates of Fairfax, in a private placement, $250,000,000 aggregate principal of 5.50% senior notes due 2025 and warrants (note 11) to purchase 38,461,539 of the Company’s Class A common shares for an aggregate issue price of $250,000,000. The Fairfax Notes are guaranteed by certain of the Company’s subsidiaries. The proceeds of the Fairfax Notes and Fairfax Warrants were allocated to each security on a relative fair value basis.

In March 2018, the Company entered into a subscription agreement with Fairfax pursuant to which the Company will sell and Fairfax will purchase $250,000,000 aggregate principal of 5.50% interest bearing debentures and warrants to purchase 38,461,539 Class A common shares of the Company for an aggregate purchase price of $250,000,000 (the “Second Fairfax Investment”). The Second Fairfax Investment is expected to close in January 2019, subject to customary closing conditions.

 

9.      Long-term obligations under capital lease:

 

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

10.      Other long-term liabilities:

 

 

11.      Puttable preferred shares and share capital:

Common shares:

At its April 2018 annual general meeting, the Company amended its number of authorized Class A common shares from 200,000,000 to 400,000,000 common shares.

In November 2017, the Company entered into a second equity distribution agreement under which the Company may, from time to time, issue Class A common shares in ATM offerings for up to $100,000,000. During the three and six months ended June 30, 2018, the Company did not issue any Class A common shares under the ATM offerings.

Preferred shares:

At June 30, 2018, the Company had the following preferred shares outstanding:

 

      __________

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

11.     Puttable preferred shares and share capital (continued):

Dividends:

In June 2018, the Company declared a quarterly dividend of $0.125 per common share. The dividend was paid on July 30, 2018 to all shareholders of record as of July 10, 2018.

The Company also declared quarterly dividends of $0.496875, $0.515625, $0.65625, $0.512500 and $0.492188 per Series D, Series E, Series F, Series G and Series H preferred share, respectively, representing a total distribution of $18,395,000. The dividends were paid on July 30, 2018 to all shareholders of record on July 27, 2018.

Warrants:

The Fairfax Warrants entitle the holder to purchase one share of the Company’s Class A common shares          at an exercise price of $6.50.   Each warrant is exercisable within seven years and the exercise price of the Fairfax Warrants is subject to customary anti-dilution adjustments.  The Company can elect to require early exercise of the warrants, at any time after February 14, 2022, if the volume weighted average price of the Company’s Class A common shares, averaged over a 20-day period, equals or exceeds twice the exercise price of the Fairfax Warrants at that time.  The proceeds of the Fairfax Notes and Fairfax Warrants were allocated to each security on a relative fair value basis.

 

12.     Earnings per share (“EPS”):

 

 

 

17

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

12.     Earnings per share (“EPS”) (continued):

 

 

 

13.     Share-based compensation:

A summary of the Company’s outstanding restricted shares, phantom share units, stock appreciation rights (“SARs”) and restricted stock units as of and for the six months ended June 30, 2018 is presented below:

 

In January 2018, the Company granted the Chief Executive Officer (“CEO”) stock options to acquire 500,000 Class A common shares at an exercise price of $7.20 per share. The stock options vest equally on each of the first five anniversaries of the CEO’s start date in January 2018 and expire on January 8, 2028.

During the three and six months ended June 30, 2018, the Company amortized $808,000 and $1,435,000 respectively (June 30, 2017 - $1,922,000 and $3,766,000) in share-based compensation expense related to the above share-based compensation awards.

 

18

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

13.      Share-based compensation (continued):

At June 30, 2018, there was (i) $2,333,000 (December 31, 2017 – $4,178,000) of total unamortized compensation costs relating to unvested share-based compensation awards, which are expected to be recognized over a weighted-average period of 23 months and (ii) 2,041,846 (December 31, 2017 – 2,952,896) shares remaining for issuance under the Company’s Stock Incentive Plan, as amended.

Class A common shares are issued on a one-for-one basis in exchange for the cancellation of vested restricted shares and phantom share units. The restricted shares generally vest over one year and the phantom share units generally vest over three years. During the six months ended June 30, 2018, the fair value of restricted shares vested was $1,018,000 (June 30, 2017 – $880,000).

As vested outstanding phantom share units are only exchanged for common shares upon written notice from the holder, the phantom share units that are exchanged for common shares may include units that vested in prior periods. At June 30, 2018, 650,335 (December 31, 2017 – 587,001) of the outstanding phantom share units were vested and available for exchange by the holder.

During the three and six months ended June 30, 2018, the Company incurred no arrangement fees. During the three and six months ended June 30, 2017, the Company incurred arrangement fees of $1,872,000 and $1,872,000, respectively, all of which were paid in Class A common shares.

During the three and six months ended June 30, 2018, the Company incurred $1,758,000 and $2,325,000, respectively, (June 30, 2017 – $989,000 and $1,054,000) in transaction fees that were capitalized to vessels, all of which were paid in Class A common shares. The number of shares issued under each of these arrangements is based on volume weighted-average share prices as defined in the underlying agreements.  

 

 

19

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

14.      Supplemental cash flow information:

 

 

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the consolidated balance sheets that sum to the amounts shown in the consolidated statements of cash flows:

Restricted cash included in other assets represents amounts required to be set aside by contractual agreement for two of the Company’s capital leases. The restriction will be removed on termination of the charter agreements.

 

20

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

15.      Commitments and contingencies:

 

 

The minimum future revenues are based on 100% utilization, relate to committed time-charter party agreements currently in effect and assume no renewals or extensions.

 

 

16.      Concentrations:

The Company’s revenue is derived from the following customers:

 

 

 

21

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

17.     Financial instruments:

The carrying values of cash and cash equivalents, short-term investments, restricted cash, accounts receivable, loans to affiliate and accounts payable and accrued liabilities approximate their fair values because of their short term to maturity. As of June 30, 2018, the fair value of the Company’s revolving and term loan credit facilities, excluding deferred financing fees is $3,190,000,000 (December 31, 2017 - $1,940,215,000) and the carrying value is $3,279,000,000 (December 31, 2017 - $2,050,137,000). As of June 30, 2018, the fair value of the Company’s long-term obligations under capital lease, excluding deferred financing fees, is $683,449,000 (December 31, 2017 - $653,007,000) and the carrying value is $672,496,000 (December 31, 2017 - $648,840,000). The fair value of the revolving and term loan credit facilities and long-term obligations under capital lease, excluding deferred financing fees, are estimated based on expected principal repayments and interest, discounted by relevant forward rates plus a margin appropriate to the credit risk of the Company. Therefore, the Company has categorized the fair value of these financial instruments as Level 3 in the fair value hierarchy.

As of June 30, 2018, the fair value of the Company’s senior unsecured notes is $424,314,000 (December 31, 2017 – $423,184,000) and the carrying value is $417,925,000 (December 31, 2017 – $417,925,000). The fair value of senior unsecured notes is calculated based on a quoted price that is readily and regularly available in an active market. Therefore, the Company has categorized the fair value of these financial instruments as Level 1 in the fair value hierarchy.

As of June 30, 2018, the fair value and carrying value of the Company’s senior notes due 2025 is $174,335,000 (December 31, 2017 – nil). The fair value of senior notes due 2025 is based on the relative fair values of the senior notes and the related warrants. Therefore, the Company has categorized the fair value of these financial instruments as Level 3 in the fair value hierarchy.

The Company’s interest rate derivative financial instruments are re-measured to fair value at the end of each reporting period. The fair values of the interest rate derivative financial instruments have been calculated by discounting the future cash flow of both the fixed rate and variable rate interest rate payments. The discount rate was derived from a yield curve created by nationally recognized financial institutions adjusted for the associated credit risk. The fair values of the interest rate derivative financial instruments are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets. Therefore, the Company has categorized the fair value of these derivative financial instruments as Level 2 in the fair value hierarchy.

 

 

 

 

 

 

 

 

 

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

17.     Financial instruments (continued):

As of June 30, 2018, the Company had the following outstanding interest rate derivatives:

 

 

If interest rates remain at their current levels, the Company expects that $30,565,000 would be settled in cash in the next 12 months on interest rate swaps maturing after June 30, 2018. The amount of the actual settlement may be different depending on the interest rate in effect at the time settlements are made.  

The following provides information about the Company’s derivatives:

 

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

 

17.     Financial instruments (continued):

The following table provides information about gains and losses included in net earnings and reclassified from accumulated other comprehensive loss (“AOCL”) into earnings:

 

 

The estimated amount of AOCL expected to be reclassified to net earnings within the next 12 months is approximately $1,072,000.

 

 

24

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.     Guarantor financial information:    

The Fairfax Notes are guaranteed by the following wholly owned subsidiaries of the Company, each a “Guarantor”:

 

The guarantees are full and unconditional and joint and several, subject to certain customary release provisions including (1) the sale, exchange or transfer of a Guarantor in accordance with the terms of the Fairfax Notes (2) upon the legal defeasance or covenant defeasance or discharge of obligations under the Fairfax Notes and (3) merger or consolidation of a Guarantor with Seaspan Corporation or another Guarantor   For the purposes of the following footnote, Seaspan Corporation is referred to as “Issuer”.  The following supplemental combining and condensed consolidating financial information reflects the Issuer’s separate account, the combined accounts of the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries, the combining and consolidating adjustments and eliminations and the Issuer’s consolidated
accounts for the dates and periods indicated.  For purposes of the following combining and consolidating information, the Issuer’s investment in its subsidiaries and the Guarantor subsidiaries’ investments in their subsidiaries include their proportionate interest in the net assets of the subsidiaries.

 

The following tables present consolidated financial information related to the guarantees of the Fairfax Notes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):  

 

26

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

 

27

---

SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

 

28

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

 

 

 

 

29

---

SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

 

 

30

---

SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

 

 

 

31

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

 

32

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

33

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

 

34

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

 

35

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

18.      Guarantor financial information (continued):

 

 

 

36

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SEASPAN CORPORATION

Notes to Interim Consolidated Financial Statements

For the three and six months ended June 30, 2018 and 2017

(Unaudited)

(Tabular amounts in thousands of United States dollars, except per share amount and number of shares)

 

 

19.      Subsequent events:

 

 

 

 

 

 

 

 

 

 

 

 

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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Overview

We are a leading independent charter owner and manager of containerships, which we charter primarily pursuant to long-term, fixed-rate time charters with major container liner companies. As of June 30, 2018, we operated a fleet of 112 containerships. As of June 30, 2018, the average age of the 112 vessels in our operating fleet was approximately five years, on a TEU-weighted basis.

We primarily deploy our vessels on long-term, fixed-rate time charters to take advantage of the stable cash flow and high utilization rates that are typically associated with long-term time charters. As of June 30, 2018, the charters on the 112 vessels in our operating fleet had an average remaining term of approximately five years, on a TEU-weighted basis, excluding the effect of any charterers’ options to extend certain time charters.

Customers for our operating fleet as at June 30, 2018 were as follows:

 

Our primary objective is to continue to grow our business through accretive vessel acquisitions as market conditions allow. Please read “Our Fleet” for more information about our vessels and time-charter contracts. Most of our customers’ containership business revenues are derived from the shipment of goods from the Asia Pacific region, primarily China, to various overseas export markets in the United States and in Europe.

 

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Significant Developments

Vessel Acquisitions and Deliveries

In January 2018, we accepted delivery of MSC Yashi B, an 11000 TEU vessel. This vessel was constructed at HHIC – PHIL Inc. and commenced a 17-year fixed-rate bareboat charter with MSC. Upon completion of the bareboat charter period, MSC is obligated to purchase the vessels for a pre-determined amount.

In February 2018, we purchased two second-hand 2006-built geared 2500 TEU vessels and entered into fixed-rate time charters with Maersk.  The time charters are for a term of four years with options to extend up to an additional two years at increasing charter rates.

In May 2018, we accepted delivery of four 10000 TEU vessels, the CMA CGM Mundra, CMA CGM Cochin, CMA CGM Mumbai, and CMA CGM Chennai. These vessels were constructed at New Jiangsu and Jiangsu Xinfu. Upon delivery, each vessel commenced a three-year fixed rate time charter with CMA CGM with an option to extend for up to an additional three years.

Fairfax Investment

On February 14, 2018, we issued to affiliates of Fairfax Financial Holdings Limited (collectively, “Fairfax”), in a private placement for an aggregate purchase price of $250.0 million, an aggregate principal amount of our 5.50% interest bearing, debentures due 2025 (the “Fairfax Notes”), and 38,461,539 warrants, each exercisable for one share of our Class A common shares at an exercise price of $6.50 per share. Each warrant is exercisable within seven years. We can elect to require early exercise of the warrants, at any time after February 14, 2022, if the volume weighted average price of our common shares, averaged over a 20-day period, equals or exceeds twice the exercise price of the Fairfax warrants at that time. For additional information about this private placement, please read our Reports on Form 6-K furnished to the SEC on February 15, 2018 and February 22, 2018.

On March 13, 2018, we entered into a subscription agreement with Fairfax pursuant to which we will sell and Fairfax will purchase $250.0 million aggregate principal of 5.50% interest bearing debentures and warrants to purchase 38,461,539 Class A common shares of the Company at an exercise price of $6.50 per share for an aggregate purchase price of $250,000,000 (the “Second Fairfax Investment”). The Second Fairfax Investment is expected to close in January 2019, subject to customary closing conditions.

In May 2018, Fairfax entered into agreements to invest an additional $500.0 million of equity in Seaspan.  The agreements provide that on July 16, 2018, the date the agreements are expected to close, Fairfax will exercise all of the warrants issued to Fairfax on February 14, 2018, to acquire approximately 38.5 million Class A common shares at an exercise price of $6.50 per share. In addition, Fairfax agreed that in January 2019, it will immediately exercise all of the warrants that are issued to Fairfax in connection with the closing of the Second Fairfax Investment. Upon exercise of the warrants in January 2019, Fairfax will acquire approximately 38.5 million Class A common shares at an exercise price of $6.50 per share, for a total equity investment of $500.0 million

In consideration for Fairfax exercising these warrants in advance of their seven year terms, 2025 and 2026 expirations, Seaspan will issue Fairfax seven year warrants to acquire 25.0 million Class A common shares at an exercise price of $8.05 per share and amend the terms of the debentures that were issued on February 14, 2018 and are expected to be issued January 2019 to allow Fairfax to call for early redemption of some or all of those debentures on each respective anniversary date of issuance to the respective seven year maturity date.

Upon the full exercise of both tranches of warrants and the January 2019 subscription for $250.0 million of debentures, Fairfax’s total investment in Seaspan will increase to $1.0 billion, consisting of $500.0 million of Class A common shares and $500.0 million in debentures.

Acquisition of GCI

On March 13, 2018, we acquired the remaining 89.2% that we did not own of Greater China Intermodal Investments LLC (“GCI”) from affiliates of The Carlyle Group and the minority owners of GCI. GCI’s fleet of 18 modern containerships, including two newbuilding containerships, is comprised of 10000 TEU and 14000 TEU eco-class vessels. For additional information about the acquisition please read our Report on Form 6-K furnished to the SEC, on March 14, 2018.

 

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The aggregate purchase price of $498.1 million includes the following:

 

 

Debt Financing

In March 2018, we closed and drew on a secured credit facility for $100.0 million at an interest rate of LIBOR plus a margin. The facility is secured by 11 previously unencumbered vessels currently owned by us.

Vessel Financing

In April 2018, we entered into a secured term loan facility for up to $120.0 million to finance the CMA CGM Chennai and CMA CGM Cochin, and drew on that facility in May 2018 for the full $120.0 million on the respective delivery dates of those vessels.

Dividends

On June 28, 2018, our board of directors declared the following quarterly cash dividends on our common and preferred shares for a total distribution of $31.9 million on July 30, 2018.

 

^{_____________________}

 

Washington Family Participation in Dividend Reinvestment Plan

 

Following the additional investments from Fairfax, which do not participate in the dividend reinvestment plan in respect of its equity holdings, the Board of Directors offered the Washington family the option to discontinue its participation in such plan. After considering this proposal, the Washington family members and their various affiliated entities, who hold shares in us, informed the Board of the Directors that they intend to cease participation in the our dividend reinvestment plan after the second quarter dividend payment date of July 30, 2018.

 

Purchase of Class A Common Shares

 

In June 2018, David Sokol, chairman of the Board of Directors, purchased 375,057 Class A common shares in the open market at an average price of $8.50 per share, bringing his total shareholdings to 3,387,121 Class A common shares at June 30, 2018.  

 

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Change in Senior Management  

In April 2018, David Spivak, our Chief Financial Officer (“CFO”), gave notice that he was exercising his right to terminate his employment with us effective June 29, 2018 to pursue other opportunities. Mr. Spivak remained CFO until May 5, 2018, after which Mr. Ryan Courson was appointed CFO.  Mr. Spivak continued with us as Special Advisor to the President and Chief Executive Officer until the end of June 2018.

In April 2018, Mark Chu, our Chief Operating Officer, General Counsel and Corporate Secretary gave notice that he plans to terminate employment with us effective August 31, 2018 to pursue other opportunities. Mr. Chu will remain in his current roles until successors are appointed, and will continue with us through to the end of August to help facilitate a seamless transition.

Amendment to Restated and Amended Articles of Incorporation

At our April 27, 2018 annual general meeting shareholders approved a resolution to amend our articles of incorporation to increase the number of authorized Class A common shares from 200,000,000 to 400,000,000, with corresponding increases in the number of authorized common shares from 225,000,100 to 425,000,100 and in the number of authorized shares of capital stock from 375,000,100 to 575,000,100.

Amendment to Bylaws

On February 22, 2018, our Board of Directors approved an amendment to Section 4.2 of our bylaws to revise the structure of the standing committees of the Board of Directors, such amendment to be effective April 27, 2018 (the “Bylaw Amendment”).  Pursuant to the Bylaw Amendment, the Board of Directors shall have the following standing committees: Audit Committee, Compensation and Governance Committee and Executive Committee.

Recent Developments

Fairfax Investments

On July 16, 2018, in accordance with the agreement signed May 31, 2018, Fairfax exercised 38.5 million warrants at an exercise price of $6.50 per share resulting in us receiving $250.0 million in proceeds. Also in accordance with the May 2018 agreement, we issued Fairfax warrants to acquire 25.0 million Class A common shares at an exercise price of $8.05 per share and the terms of the debentures issued in February 2018 and to be issued in January 2019 were amended to allow Fairfax to call for an early redemption of some or all of the debentures on each anniversary date of issuance. As the right to put the debentures is solely within the control of Fairfax, the outstanding debentures will be reclassified from long-term liabilities to current liabilities as of July 16, 2018.  Upon funding of the additional debentures and exercise of the additional warrants upon closing in January 2019, the additional debentures will also be classified as a current liability.

  Redemption of Series F Preferred Shares

On July 23, 2018, we redeemed all of our outstanding 10.5% Series F preferred shares for $140.0 million plus $3.4 million of accrued dividends.

Controls and Procedures

During the preparation of the interim financial statements for the quarter ended June 30, 2018, the Company’s management identified a material weakness in our internal controls over financial reporting relating to the timely recording of dividends declared and approved by our Board of Directors, which resulted in a $35.6 million understatement of current liabilities and deficit in our earnings press release dated August 1, 2018 (the “Earnings Release”).  A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis.

The control deficiency did not result in a misstatement of our previously issued annual or quarterly consolidated financial statements, or of other unrelated financial information contained in the Earnings Release.  The dividend accrual has been correctly recorded in our June 30, 2018 financial statements presented in this Form 6-K, and in the corrected earnings press release dated August 6, 2018.

 

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Management is committed to remediating the identified material weakness in a timely manner, with appropriate oversight from our Audit Committee.  Management has immediately initiated compensating controls, is assessing the root cause and will be enhancing and revising the design of existing controls and procedures to ensure dividend transactions are recorded on a timely basis and reported accurately in our published financial statements and earnings press releases.  The identified material weakness will not be considered remediated until the applicable remedial controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that remediation of this material weakness will be completed prior to the end of fiscal year 2018.

Except as noted above, there has been no change in the Company's internal control over financial reporting as of August 6, 2018, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

 

 

 

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Our Fleet

Our Current Fleet

The following table summarizes key facts regarding our 112 operating vessels as of June 30, 2018:

 

 

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44

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^{_____________________}

 

45

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The following table indicates the estimated number of owned, leased and managed vessels in our fleet as of June 30, 2018:

 

^{____________________}

 

Three and Six Months Ended June 30, 2018 Compared with Three and Six Months Ended June 30, 2017

The following is a discussion of our financial condition and results of operations for the three and six months ended June 30, 2018. The following provides information about our fleet as of June 30, 2018:

 

 

Our consolidated financial results for the three and six months ended June 30, 2018 and 2017 are summarized below:

 

 

Ownership Days, Operating Days and Vessel Utilization

 

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Ownership days are the number of days a vessel is owned and available for charter. Operating days are the number of days a vessel is available to the charterer for use.

 

The primary driver of ownership days are the increases or decreases in number of vessels we own, while the drivers of operating days are the ownership days and the number of days the vessels are off-hire. Ownership and operating days for the three and six months ended June 30, 2018 and 2017 were as follows:  

 

^{____________________}

 

Ownership days increased by 1,509 days primarily due to the addition of 16 vessels acquired through the GCI acquisition, which contributed 1,456 days. The remainder of the increase was due to 2018 vessel deliveries and acquisitions and partially offset by vessel disposals.

 

Vessel utilization represents the number of days a vessel is used (operating days) as a percentage of the total days a vessel is available for charter (ownership days).

 

The following table summarizes our vessel utilization by quarter and for the six months ended June 30, 2018 and 2017:

 

^{____________________}

Vessel utilization increased for the three and six months ended June 30, 2018, compared to the same periods in 2017, primarily due to higher utilization of vessels acquired from GCI and the 2018 deliveries and acquisitions. The increase in utilization for the six months ended June 30, 2018 was also due to a decrease in off-charter days. During the six months ended June 30, 2018, we completed dry-dockings for five 2500 TEU vessels, one 3500 TEU vessel and one 4250 TEU vessel, one of which occurred while the vessel was off-charter.

Revenue

Revenue increased by 37.7% to $281.7 million and by 24.8% to $506.4 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. The increases in revenue were primarily due to the additional operating days from the vessel deliveries and acquisition of vessels from the GCI transaction.

The increase in operating days and the related financial impact thereof for the three and six months ended June 30, 2018, relative to the same periods in 2017, is attributable to the following:

 

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Ship Operating Expense

Ship operating expense increased by 31.1% to $58.8 million and by 19.8% to $108.3 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. The increases were primarily due to an increase in ownership days from the increase in the number of vessels in our fleet, higher bulk purchasing of vessel stores and spare parts, and an increase in planned maintenance required for certain vessels less than 8500 TEU in size.

Depreciation and Amortization Expense

Depreciation and amortization expense increased by 24.7% to $62.1 million and by 16.3% to $116.0 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017.  The increases were primarily due to an increase in ownership days from the increase in the number of vessels in our fleet.

General and Administrative Expense

General and administrative expense increased by 21.2% to $9.1 million and by 9.2% to $16.3 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. The increases were primarily due to transition payments to the former CFO, and additional general and administrative expense related to the acquisition of GCI, partially offset by a decrease in stock-based compensation related to the former chief executive officer.

Operating Lease Expense

Operating lease expense increased by 14.9% to $32.3 million and 16.2% to $63.5 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. The increases were primarily due to an increase in LIBOR and the delivery of one vessel in 2017 that was financed through a sale-leaseback transaction.

Interest Expense and Amortization of Deferred Financing Fees

The following table summarizes our borrowings:

 

 

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Interest expense and amortization of deferred financing fees increased by $29.0 million and $39.5 million to $57.3 million and $96.2 million for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. The increases were primarily due to the debt assumed as part of the acquisition of GCI, an increase in operating debt for delivered vessels, the issuance of the debentures to Fairfax and an increase in LIBOR.

Change in Fair Value of Financial Instruments

The change in fair value of financial instruments resulted in a gain of $5.9 million and $25.2 million for the three and six months ended June 30, 2018, respectively. The gains for these periods were primarily due to the impact of swap settlements and increase in the forward LIBOR curve.

The fair value of interest rate swaps is subject to change based on our company-specific credit risk and that of the counterparty included in the discount factor and the interest rate implied by the current swap curve, including its relative steepness. In determining the fair value, these factors are based on current information available to us. These factors are expected to change through the life of the instruments, causing the fair value to fluctuate significantly due to the large notional amounts and long-term nature of our derivative instruments. As these factors may change, the fair value of the instruments is an estimate and may deviate significantly from the actual cash settlements realized during the term of the instruments. Our valuation techniques have not changed and remain consistent with those followed by other valuation practitioners.

The fair value of our interest rate swaps is most significantly impacted by changes in the yield curve. Based on the current notional amount and tenor of our interest rate swap portfolio, a one percent parallel shift in the overall yield curve would be expected to result in a change in the fair value of our interest rate swaps by approximately $43.0 million. Actual changes in the yield curve are not expected to occur equally at all points and changes to the curve may be isolated to periods of time. This steepening or flattening of the yield curve may result in greater or lesser changes to the fair value of our financial instruments in a particular period than would occur had the entire yield curve changed equally at all points.

The fair value of our interest rate swaps is also impacted by changes in our company-specific credit risk included in the discount factor. We discount our derivative instruments with reference to publicly-traded bond yields for our comparator group in the shipping industry and composite Bloomberg industry yield curves. Based on the current notional amount and tenor of our swap portfolio, a one percent change in the discount factor is expected to result in a change in the fair value of our interest rate swaps of approximately $3.0 million.

All of our interest rate swap agreements were marked-to-market with all changes in the fair value of these instruments recorded in “Change in fair value of financial instruments” in the Statement of Operations.

Please read “Item 11. Quantitative and Qualitative Disclosures About Market Risk” in our 2017 Annual Report for additional information.

Liquidity and Capital Resources

Working Capital

At June 30, 2018, we have a working capital deficiency of $532.6 million which includes $337.9 million of senior unsecured notes maturing in April 2019. The working capital deficiency may increase in future periods.  In order to alleviate this deficiency, we will rely, in part, upon the continued financial support of Fairfax, which includes not exercising the debenture put right and the successful closing of the agreements described below. We also expect to further address this working capital deficiency through cash generated from operations and additional sources of funds in the capital markets to the extent available.

On February 14, 2018 and March 13, 2018, we and Fairfax entered into agreements for a total $500.0 million investment in debentures, $250.0 million in each agreement, and warrants to purchase a total of 76,923,078 of our Class A common shares, 38,461,539 in each agreement, for an aggregate total purchase price of $500.0 million. The March 13, 2018 agreement will be funded, and the warrants issued, in January 2019 subject to closing conditions.

 

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On May 31, 2018, we and Fairfax entered into agreements to invest an additional $500.0 million of equity through the exercise of the warrants issued in February 2018 and the warrants to be issued in January 2019 under the March 13, 2018 agreement. On July 16, 2018, Fairfax exercised 38,461,539 warrants at an exercise price of $6.50 per share from its February 14, 2018 agreement. The gross proceeds of $250.0 million were partially used to redeem our outstanding Series F preferred shares. Under the terms of the May 31, 2018 agreement, upon closing in January 2019, Fairfax will immediately exercise all of the warrants that are issuable under the March 13, 2018 agreement.

The May 31, 2018 agreements which closed July 16, 2018 provide Fairfax with the right to put each of the February 14, 2018 and March 13, 2018 debentures on their applicable anniversary dates subject to submitting an annual put right notice commencing 150 days and ending 120 days prior to each applicable anniversary date. As the right to put the debentures is solely within the control of Fairfax, the February 14, 2018 debentures will be reclassified from long-term liabilities to current liabilities as of July 16, 2018.  Upon funding of the March 13, 2018 debentures and exercise of the March 13, 2018 warrants upon closing in January 2019, the debentures will also be classified as a current liability.

Liquidity

At June 30, 2018, our cash and cash equivalents and short-term investments totaled $271.5 million and our restricted cash totaled $14.1 million. Our primary short-term liquidity needs are to fund our operating expenses, debt repayments, lease payments, payment of our quarterly dividends, repayment of our 6.375% senior unsecured notes which mature in April 2019 (“2019 Notes”) and potential early redemption of the Fairfax Notes. Our medium-term liquidity needs primarily relate to debt repayments, lease payments, potential early redemption of the Fairfax Notes and the redemption of our puttable preferred shares. Our long-term liquidity needs primarily relate to potential future acquisitions, lease payments, debt repayments including repayment of our 7.125% senior unsecured notes due 2027 (“2027 Notes”) and the Fairfax Notes, and the future potential redemption of our preferred shares.

Our Series D preferred shares have an annual dividend rate of 7.95% per $25.00 of liquidation preference per share and our Series D preferred shares are redeemable by us at any time on or after January 30, 2018. Our Series E preferred shares have an annual dividend rate of 8.25% per $25.00 of liquidation preference per share and our Series E preferred shares are redeemable by us at any time on or after February 13, 2019. Our Series F preferred shares have an annual dividend rate of 10.5% per $25.00 of liquidation preference per share and were fully redeemed on July 23, 2018. Our Series G preferred shares have an annual dividend rate of 8.20% per $25.00 of liquidation preference per share and our Series G preferred shares are redeemable by us at any time on or after June 16, 2021. Our Series H preferred shares have an annual dividend rate of 7.875% per $25.00 of liquidation preference per share and our Series H preferred shares are redeemable by us at any time on or after August 11, 2021.

We anticipate that our primary sources of funds for our short-term liquidity needs will be cash, cash from operations, new credit facilities, proceeds from Fairfax’s exercise of the 38.5 million February 2018 warrants on July 16, 2018, proceeds from the issuance of $250.0 million aggregate principal of 5.50% interest bearing debentures to Fairfax and proceeds from Fairfax’s exercise of the 38.5 million January 2019 warrants, both of which are expected to occur in January 2019. We anticipate our medium and long-term sources of funds will be from cash from operations, new credit and lease facilities and capital markets financings.

 

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The following table summarizes our long-term debt and lease obligations as of June 30, 2018:

 

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Our Long-Term Debt

As of June 30, 2018, our revolving credit facilities, term loan credit facilities, our 2019 Notes, our 2027 Notes, and our Fairfax Notes provided for borrowings of up to approximately $3.9 billion, all of which was outstanding. We primarily use our credit facilities to finance the construction and acquisition of vessels.

Revolving Credit Facilities

In February 2018, we cancelled our $120.0 million 364-day, unsecured revolving loan facility which had not been drawn.

Interest payments on our revolving credit facilities are based on LIBOR plus margins, which ranged between 0.5% and 0.9% as of June 30, 2018.

Term Loan Credit Facilities

As part of the acquisition of GCI on March 13, 2018, we assumed long-term debt which was recorded at its fair value of $1.0 billion.  The assumed long-term debt consists primarily of 12 term loan credit facilities to finance the 16 operating vessels.  

In March 2018, we entered into a secured term loan facility for $100.0 million which bears interest at LIBOR plus a margin.  The facility is secured by 11 previously unencumbered vessels currently owned by us.

In April 2018, we entered into a secured term loan facility for up to $120.0 million to finance two 10000 TEU vessels which delivered in the second quarter of 2018.  The loan bears interest at LIBOR plus a margin.

Interest payments on our term loan credit facilities are based on either LIBOR plus margins, which ranged between 0.4% and 4.8% as of June 30, 2018.  For a portion of one of our term loans, interest is calculated based on the reference rate of KEXIM plus a margin, which was 0.7% as of June 30, 2018.  For one of our unsecured term loan facilities, interest is a fixed rate of 7.0%.

 

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Waivers

For one of our term loan credit facilities, we initially obtained a waiver from the lender extending the grace period for securing acceptable replacement charters for two vessels to the fourth quarter of 2017. In September 2017, we received another waiver from the lender which extends the grace period for securing replacement charters to October 2020. If either of the vessels remains unemployed for a consecutive period of more than 90 days, then the waiver will be terminated.  For four GCI vessels financed by the same lender, a similar waiver was received by GCI.

For another one of our term loan credit facilities, we entered into a supplement to the loan agreement with the lender for one vessel, extending the grace period for securing an acceptable replacement charter for the vessel to the fourth quarter of 2018. In March 2018, we entered into another supplement to the loan agreement with the lender to remove the requirement to secure an acceptable replacement charter by the fourth quarter of 2018. In connection with this supplement to the loan agreement we prepaid $10.0 million of the loan balance in March 2018. The final maturity of this facility is December 2022.

General

As of June 30, 2018, our credit facilities are secured by first-priority mortgages granted on 76 of our vessels, together with other related security, such as assignments of shipbuilding contracts and refund guarantees for the vessels, assignments of time charters and earnings for the vessels, assignments of insurances for the vessels and assignments of management agreements for the vessels.

We may prepay certain amounts outstanding without penalty, other than breakage costs in certain circumstances. In certain circumstances a prepayment may be required as a result of certain events, including the sale or loss of a vessel, a termination or expiration of a charter (and the inability to enter into a charter suitable to lenders within a period of time).  The amount that must be prepaid may be calculated based on the loan to market value. In these circumstances, valuations of our vessels are conducted on a “without charter” basis as required under the credit facility agreement.

Each credit facility, other than credit facilities of GCI’s subsidiaries, contains financial covenants requiring us to maintain minimum liquidity, tangible net worth, interest coverage ratios, interest and principal coverage ratios, and debt-to-assets ratios, as defined. For GCI, each borrower under each facility is a special purpose entity and subsidiary of GCI.  Each facility is guaranteed by GCI and as the guarantor, GCI must meet certain consolidated financial covenants under these term loan facilities including maintaining certain minimum tangible net worth, cash requirements and debt to asset ratios.  Some of the facilities also have an interest and principal coverage ratio requirement for the subsidiary borrower. We were in compliance with these covenants at June 30, 2018.

Our Notes

Our 2019 Notes mature on April 30, 2019 and bear interest at a fixed rate of 6.375% per year, payable quarterly in arrears. Our 2027 Notes mature on October 30, 2027 and bear interest at a fixed rate of 7.125% per year, payable quarterly in arrears.  Our 2027 Notes are callable at par plus accrued and unpaid interest, if any, any time after October 10, 2020. Our Fairfax Notes, issued in February 2018, mature on February 14, 2025 and bear interest at a fixed rate of 5.50% per year, payable quarterly in arrears.  Our Fairfax Notes are guaranteed by certain of our subsidiaries.  In the event of certain changes in withholding taxes, at our option, we may redeem our 2019 Notes, 2027 Notes and/or our Fairfax Notes, in each case in whole, but not in part, at a redemption price equal to 100% of the outstanding principal amount, plus accrued and unpaid interest, if any. Upon the occurrence of a Change of Control (as defined in the applicable Notes), each holder of such Notes will have the right to require the Company to purchase all or a portion of such holder’s Notes at a purchase price equal to 101% of the principal amount thereof plus accrued and unpaid interest, if any, to but excluding the date of purchase. On or after February 14, 2023, we may, at our option at any time, redeem all or any portion of the Fairfax Notes. The redemption price will equal 100% of the principal amount of the Fairfax Notes being redeemed, plus accrued and unpaid interest, if any, to the redemption date and any certain additional amounts.  

 

 

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Our Lease Facilities

We use our lease facilities to finance the construction and acquisition of vessels. Our lease facilities, which do not include our operating leases, are provided by bank financial leasing owners who own our 10 leased vessels. These banks are also granted other related security, such as assignments of time charters and earnings for the vessels, assignments of insurances for the vessels and assignments of management agreements for the vessels.

As of June 30, 2018, our lease facilities provided for borrowings of approximately $672.5 million. Under our lease agreements, we may voluntarily terminate a lease agreement, subject to payment of a termination fee in certain circumstances. We are also required to prepay rental amounts, broken funding costs and other costs to the lessor in certain circumstances, such as a termination or expiry of a charter (where we do not enter into a charter suitable to the lessors within a required period of time). If we default under our lease facilities, our lessors could declare all outstanding amounts to be immediately due and payable and realize on the security granted under the lease facilities.

For additional information about our credit and lease facilities, including, among other things, a description of certain related covenants, please read “Item 5. Operating and Financial Review and Prospects—C. Liquidity and Capital Resources” in our 2017 Annual Report.

Cash Flows

The following table summarizes our sources and uses of cash for the periods presented:

 

Operating Cash Flows

Net cash flows from operating activities were $113.2 million and $182.8 million, for the three and six months ended June 30, 2018, an increase of $50.9 million and $43.5 million, respectively, compared to the same periods in 2017. The increase in net cash flows from operating activities for the three and six months ended June 30, 2018, compared to the same periods in 2017, was primarily due to an increase in net earnings excluding non-cash items of $36.3 million and $45.2 million, respectively, and an increase in cash related to changes in working capital of $14.6 million and a decrease of $1.7 million, respectively. The changes in cash related to changes in working capital resulted primarily from non-cash timing differences, which are in the normal course of our operations. The increase in net earnings excluding non-cash items was primarily due to increases in revenue. For further discussion of changes in revenue, operating expenses and interest expense and amortization of deferred financing fees, please read “― Three and Six Months Ended June 30, 2018 Compared with the Three and Six Months Ended June 30, 2017”.

Financing Cash Flows

Net cash flows from financing activities were $106.3 million and $397.6 million for the three and six months ended June 30, 2018, an increase of $91.8 million and $517.0 million in cash from financing activities, respectively, compared to the same periods in 2017.

The increase in cash from financing activities for the three months ended June 30, 2018, compared to the same period of 2017, was primarily due to the proceeds received on the draws on credit facilities partially offset by a reduction in proceeds received from the issuance of common shares and a sale-leaseback financing.

The increase in cash from financing activities for the six months ended June 30, 2018, compared to the same period of 2017, was primarily due to the proceeds received from draws on credit facilities and long-term obligations under capital lease and the issuance of Fairfax notes and Fairfax warrants. These increases were partially offset by increases in financing fees, repayments made on long-term obligations under capital lease and lower cash dividends on our common shares as well as a reduction in proceeds received from the issuance of common shares and a sale-leaseback financing.

 

 

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Investing Cash Flows

Net cash flows used in investing activities were $283.6 million and $564.5 million for the three and six months ended June 30, 2018, an increase of $216.4 million and $488.1 million in cash used, respectively, compared to the same periods in 2017.

The increases in cash from investing activities for the three and six months ended June 30, 2018 were primarily due to higher expenditures incurred for vessels. For the six months ended June 30, 2018, the increase was also due to the acquisition of GCI.

Ongoing Capital Expenditures and Dividends

Ongoing Capital Expenditures

The average age of the vessels in our operating fleet is approximately five years, on a TEU-weighted basis. Capital expenditures primarily relate to our regularly scheduled dry-dockings. During the six months ending June 30, 2018, we completed seven dry-dockings. For the remainder of 2018, we expect two additional vessels to undergo dry-docking.

We must make substantial capital expenditures over the long-term to preserve our capital base, which is comprised of our net assets, in order to continue to refinance our indebtedness and to maintain our dividends. We will likely need to retain additional funds at some time in the future to provide reasonable assurance of maintaining our capital base over the long-term. We believe it is not possible to determine now, with any reasonable degree of certainty, how much of our operating cash flow we should retain in our business and when it should be retained to preserve our capital base. Factors that will impact our decisions regarding the amount of funds to be retained in our business to preserve our capital base, include the following:

Please read “Item 3. Key Information – D. Risk Factors” in our 2017 Annual Report for factors that may affect our future capital expenditures and results.

 

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Dividends

The following table reflects dividends paid or accrued by us for the periods indicated:

 

On June 28, 2018, the board of directors declared the cash dividends on our common and preferred shares as indicated above under “Significant Developments—Dividends”.

Critical Accounting Estimates

We prepare our consolidated financial statements in accordance with U.S. GAAP, which requires us to make estimates in the application of our accounting policies based on our best assumptions, judgments and opinions. Our estimates affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures. We base our estimates on historical experience and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. For more information about our critical accounting estimates, please read “Item 5. Operating and Financial Review and Prospects—D. Critical Accounting Policies and Estimates” in our 2017 Annual Report.

Recent Accounting Developments

    Leases

In February 2016, the Financial Accounting Standards Board, or FASB,  issued Accounting Standards Update, or ASU, 2016-02, “Leases”, which requires lessees to recognize all leases, including operating leases, with a term greater than 12 months on the balance sheet, for the rights and obligations created by those leases.  The accounting for lessors will remain largely unchanged from the existing accounting standards.  The standard is effective for fiscal years beginning after December 31, 2018, including interim periods within those fiscal years.  

Under ASU 2016-02, each lease agreement will be evaluated to identify the lease components and non-lease components at lease inception. The total consideration in the lease agreement will be allocated to the lease and non-lease components based on their relative standalone selling prices. Lessors will continue to recognize the lease revenue component using an approach that is substantially equivalent to existing guidance for operating leases (straight-line basis). Sale-type and direct financing leases will be accounted for as financing transactions with the lease payments being allocated to principal and interest utilizing the effective interest rate method.

 

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In July 2018, the FASB issued ASU 2018-11, “Leases – Targeted Improvements” that allows lessors to elect, as a practical expedient, to not separate lease and non-lease components and allows these components to be accounted for as a single lease component if both (i) the timing and pattern of transfer to the lessee of the lease component and the related non-lease component are the same and (ii) the lease component, if accounted for separately, would be classified as an operating lease.  In addition, a company is permitted to use its effective date as the date of initial application.  Therefore, a company electing this option will not restate comparative period financial information, will not make the new required lease disclosures in comparative periods beginning before the effective date and will recognize its cumulative effect transition adjustment as of the effective date.  Under the practical expedient mentioned above, it is expected that time charter revenue and service revenue will be presented under a single lease component presentation. The amendments have the same effective date as ASU 2016-02.

The Company intends to adopt ASU 2016-02 on January 1, 2019 whereby a cumulative effect adjustment will be made as of that day with no retrospective effect.  The Company also intends to elect to apply the package of practical expedients such that for any expired or existing leases it will not reassess lease classification, initial direct costs or whether any expired or existing contracts are or contain leases.

The adoption of ASU 2016-02 will result in a change in the accounting method for the certain of the Company’s sale-leaseback transactions and office leases.  Under ASU 2016-02, the Company will recognize a right-of-use asset and a lease liability on the balance sheet for these sale-leaseback transactions and office leases based on the present value of the future minimum lease payments, whereas currently no right-of-use asset or lease liability is recognized.  The existing deferred gain related to the sale-leaseback transactions will be eliminated through a credit directly to retained earnings.  The impact on the Company’s consolidated financial statements will be an increase to its assets and liabilities.  The Company is currently determining the impact on its statement of operations.

The adoption of ASU 2016-02 will require the Company to complete its lease classification assessment at lease commencement rather than when a lease is entered into.  Historically, for charters that were negotiated concurrently with the construction of the related vessels, the fair value of the constructed asset was presumed to be its newbuilding cost. If such charters were classified as direct financing leases at the time the lease was entered into, no gain or loss was recognized subsequently on commencement of the charter.  On adoption of ASU 2016-02, the fair value of the vessel will be determined based on information available at the lease commencement date, rather than lease inception date, and any difference in the fair value of the vessel upon commencement of the charter and its carrying value will be recognized as a gain or loss upon commencement of the charter.

Off-Balance Sheet Arrangements

At June 30, 2018, we had no off-balance sheet arrangements that have or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

 

 

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FORWARD-LOOKING STATEMENTS

This Report on Form 6-K for the quarter ended June 30, 2018, contains forward-looking statements (as such term is defined in Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act) concerning our operations, cash flows, and financial position, including, in particular, the likelihood of our success in developing and expanding our business. Statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “continue,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “projects,” “forecasts,” “will,” “may,” “potential,” “should” and similar expressions are forward‑looking statements. These forward-looking statements represent our estimates and assumptions only as of the date of this Report and are not intended to give any assurance as to future results. As a result, you are cautioned not to rely on any forward-looking statements. Forward-looking statements appear in a number of places in this Report. Although these statements are based upon assumptions we believe to be reasonable based upon available information, they are subject to risks and uncertainties. These risks and uncertainties include, but are not limited to:

 

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Forward-looking statements in this Report are estimates and assumptions reflecting the judgment of senior management and involve known and unknown risks and uncertainties. These forward-looking statements are based upon a number of assumptions and estimates that are inherently subject to significant uncertainties and contingencies, many of which are beyond our control. Actual results may differ materially from those expressed or implied by such forward-looking statements. Accordingly, these forward-looking statements should be considered in light of various important factors listed above and including, but not limited to, those set forth in “Part II – Other Information – Item 1A – Risk Factors” and “Item 3. Key Information—D. Risk Factors” in our 2017 Annual Report.

We do not intend to revise any forward-looking statements in order to reflect any change in our expectations or events or circumstances that may subsequently arise. We expressly disclaim any obligation to update or revise any of these forward-looking statements, whether because of future events, new information, a change in our views or expectations, or otherwise. You should carefully review and consider the various disclosures included in this Annual Report and in our other filings made with the SEC that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations.

 

 

 

 

 

 

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ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk from changes in interest rates and foreign currency fluctuations. We use interest rate swaps to manage interest rate price risks. We do not use interest rate swaps for trading or speculative purposes.

Interest Rate Risk

As of June 30, 2018, our variable-rate credit facilities totaled $3.2 billion, of which we had entered into interest rate swap agreements to fix the rates on a notional principal amount of $1.3 billion. These interest rate swaps have a fair value of $123.7 million in the counterparties’ favor and $0.3 million in our favor.

The tables below provide information about our financial instruments at June 30, 2018 that are sensitive to changes in interest rates. In addition to the disclosures in this interim report, please read notes 10 and 11 to our consolidated financial statements included in our 2017 Annual Report, which provide additional information with respect to our existing credit and lease facilities.

 

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As of June 30, 2018, we had the following interest rate swaps outstanding:

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Counterparties to these financial instruments may expose us to credit-related losses in the event of non-performance. As of June 30, 2018, these financial instruments are primarily in the counterparties’ favor. We have considered and reflected the risk of non-performance by us and our counterparties in the fair value of our financial instruments as of June 30, 2018. As part of our consideration of non-performance risk, we perform evaluations of

 

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our counterparties for credit risk through ongoing monitoring of their financial health and risk profiles to identify funding risk or changes in their credit ratings.

Counterparties to these agreements are major financial institutions, and we consider the risk of loss due to non-performance to be minimal. We do not require collateral from these institutions. We do not hold and will not issue interest rate swaps for trading purposes.

 

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PART II — OTHER INFORMATION

Item 1 — Legal Proceedings

None.

Item 1A — Risk Factors

The accompanying financial statements have been prepared assuming that we will continue as a going concern.

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of operations. As of June 30, 2018, we had a working capital deficiency of $532.6 million which includes $337.9 million of senior unsecured notes maturing in April 2019. The working capital deficiency may increase in future periods because of the reclassification of the February 14, 2018 Fairfax debentures from long-term liabilities to current liabilities as a result of the put right in such debentures that is described in the notes to our consolidated financial statements for the three and six months ended June 30, 2018. Upon funding of the March 13, 2018 debentures expected in January 2019, these debentures will also be classified as a current liability. Our working capital deficiency indicates that a material uncertainty exists that casts substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern and repay our liabilities is dependent on our ability to generate profitable business operations in the future and/or obtain financing to meet our obligations, including financing through previously disclosed investments by Fairfax and in the capital markets to the extent available.

We have identified a material weakness in our internal controls over financial reporting and cannot assure you that management will be able to remediate the material weakness in a timely manner.

During the preparation of the interim financial statements for the quarter ended June 30, 2018, the Company’s management identified a material weakness in our internal controls over financial reporting relating to the timely recording of dividends declared and approved by our Board of Directors, which resulted in a $35.6 million understatement of current liabilities and deficit in our earnings press release dated August 1, 2018. See Part I – Financial Information—Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations—Controls and Procedures in this Form 6-K for additional information.

Although management has already initiated compensating controls, is assessing the root cause and will be enhancing and revising the design of existing controls and procedures related to dividend transactions, there can be no assurance that management will be able to remediate the material weakness in a timely manner, which could adversely affect our business and the timeliness and accuracy of our financial reporting. Material weaknesses in internal controls over financial reporting could also cause investors to lose confidence in our publicly reported consolidated financial statements, which could have an adverse effect on the trading price of our securities and our ability to raise capital.

Our substantial debt levels and vessel lease obligations may limit our flexibility in obtaining additional financing and in pursuing other business opportunities.

As of June 30, 2018, we had approximately $3.9 billion in aggregate principal amount of debt outstanding under our credit facilities, our 6.375% senior unsecured notes due 2019, our 7.125% senior unsecured notes due 2027 and our 5.50% senior notes due 2025 (collectively, our “Notes”), and capital lease obligations of approximately $672.5 million.

On March 13, 2018, we also entered into a subscription agreement with Odyssey Reinsurance Company, Allied World Assurance Company, Ltd., Northbridge General Insurance Corporation, United States Fire Insurance Company, Zenith Insurance Company and Riverstone Insurance Limited (collectively, the “Fairfax Investors”) for

 

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an additional investment of $250 million in our 5.50% senior notes due 2026 to be issued in January 2019 in a private placement with the Fairfax Investors.

Our level of debt and vessel lease obligations could have important consequences to us, including the following:

Our ability to service our debt and vessel lease obligations will depend upon, among other things, our financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control. If our results of operations are not sufficient to service our current or future indebtedness and vessel lease obligations, we will be forced to take actions such as reducing or delaying our business activities, acquisitions, investments or capital expenditures, selling assets, restructuring or refinancing our debt, or seeking additional equity capital or bankruptcy protection. We may not be able to effect any of these remedies on satisfactory terms, or at all.

We may not be able to timely repay or be able to refinance amounts incurred under our credit facilities, Notes and capital and operating lease arrangements.

We have financed a substantial portion of our fleet and acquisitions with indebtedness incurred under our existing credit facilities, Notes and capital and operating lease arrangements. We have significant normal course payment obligations under our credit facilities, our Notes and capital and vessel operating lease arrangements, both prior to and at maturity, including as of June 30, 2018 and including the assumption of debt in connection with the acquisition of GCI, of approximately $320.9 million in 2018 and an additional $5.4 billion through 2027. In addition, under our credit facilities and capital and operating lease arrangements, a payment may be required in certain circumstances as a result of events such as the sale or loss of a vessel, a termination or expiration of a charter (where we do not enter into a replacement charter acceptable to the lenders within a required period of time) or termination of a shipbuilding contract. The amount that must be paid may be calculated based on the loan to market value ratio or some other ratio that takes into account the market value of the relevant vessel (with the repayment amount increasing if vessel values decrease), or may be the entire amount of the financing in regard to a credit facility or a pre-determined termination sum in the case of a capital or operating lease.

If we are not able to refinance outstanding amounts at an interest rate or on terms acceptable to us, or at all, we will have to dedicate a significant portion of our cash flow from operations to repay such amounts, which could reduce our ability to satisfy payment obligations related to our securities, our credit facilities, Notes and capital and operating lease arrangements or may require us to delay certain business activities or capital expenditures or cease paying dividends. If we are not able to satisfy these obligations (whether or not refinanced) under our credit facilities, Notes or capital or operating lease arrangements with cash flow from operations, we may have to seek to restructure our indebtedness and lease arrangements, undertake alternative financing plans (such as additional debt or equity capital) or sell assets, which may not be available on terms attractive to us or at all. If we are unable to meet our debt or lease obligations, or if we otherwise default under our credit facilities, Notes or capital or operating lease arrangements, the holders of such debt or lessors could declare all outstanding indebtedness to be immediately due and payable and in the case of (i) our credit facilities and capital or operating lease arrangements, foreclose on the vessels securing such indebtedness and (ii) in the 2025 Notes, foreclose on the equity of GCI, which entity is an intermediate holding company that owns the equity of a number of our indirect vessel owning subsidiaries. Additionally, most of our debt instruments contain cross-default provisions, which generally cause a default or event of default under each instrument upon a qualifying default or event of default under any other debt instrument. If we are unable to repay outstanding borrowings when due, holders of our secured debt also have the right to proceed against the collateral granted to them that secures the indebtedness. The market values of our vessels, which fluctuate with market conditions, will also affect our ability to obtain financing or refinancing, as our

 

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vessels serve as collateral for loans. Lower vessel values at the time of any financing or refinancing may reduce the amounts of funds we may borrow.

A decrease in the level of export of goods or an increase in trade protectionism will harm our customers’ business and, in turn, harm our business, results of operations and financial condition.

Most of our customers’ containership business revenue is derived from the shipment of goods from the Asia Pacific region, primarily China, to various overseas export markets, including the United States and Europe. Any reduction in or hindrance to the output of China-based exporters could negatively affect the growth rate of China’s exports and our customers’ business. For instance, the government of China has implemented economic policies aimed at increasing domestic consumption of Chinese-made goods. This may reduce the supply of goods available for export and may, in turn, result in a decrease in shipping demand.

Our international operations expose us to the risk that increased trade protectionism will harm our business. If global economic challenges exist, governments may turn to trade barriers to protect their domestic industries against foreign imports, thereby depressing shipping demand. In particular, the current U.S. administration recently proposed tariffs on a variety of products exported by China.  China has responded in kind which has resulted in further proposals by the current administration to impose tariffs on other Chinese products.  In addition, the current U.S. administration has stated that it may seek to implement more protective trade measures not just with respect to China but with respect to other countries in the Asia Pacific region as well.  Increasing trade protectionism in the markets that our customers serve has caused and may continue to cause an increase in (a) the cost of goods exported from Asia Pacific, (b) the length of time required to deliver goods from the region and (c) the risks associated with exporting goods from the region. Such increases may also affect the quantity of goods to be shipped, shipping time schedules, voyage costs and other associated costs.

Any increased trade barriers or restrictions on global trade, especially trade with China, would harm our customers’ business, results of operations and financial condition and could thereby affect their ability to make timely charter hire payments to us and to renew and increase the number of their time charters with us. This could harm our business, results of operations and financial condition.  

Our continuing compliance with the requirements of the Sarbanes-Oxley Act of 2002 will depend, in part, on our ability to integrate effectively the internal controls and procedures of GCI with our own.

In connection with the acquisition of GCI, we may be required to assess and make any necessary adjustments to GCI’s internal controls and procedures in order to maintain the overall effectiveness of our internal controls and procedures, to ensure that we continue to deliver accurate and timely financial information and to ensure ongoing compliance with Section 404 of the Sarbanes-Oxley Act of 2002. We have not yet completed our evaluation of GCI’s internal controls. Our failure to accomplish this on a timely basis or at all could compromise our compliance with the Sarbanes-Oxley Act of 2002 and the timeliness and accuracy of our financial reporting, which could reduce investor confidence in our publicly reported consolidated financial statements.

We may experience disruption as a result of the recent and pending departures of a number of members of our senior management.

We have recently experienced a number of changes in our senior management. 

 

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Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds

Not Applicable.

Item 3 — Defaults Upon Senior Securities

Not Applicable.

Item 4 — Mine Safety Disclosures

Not Applicable.

Item 5 — Other Information

 

Not Applicable.

Item 6 — Exhibits

 

None.

 

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