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PWX > SEC Filings for PWX > Form 10-K on 22-Mar-2013All Recent SEC Filings

Show all filings for PROVIDENCE & WORCESTER RAILROAD CO/RI/ | Request a Trial to NEW EDGAR Online Pro

Form 10-K for PROVIDENCE & WORCESTER RAILROAD CO/RI/


22-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in connection with the Company's audited financial statements and notes thereto included elsewhere in this annual report.

Critical Accounting Policies and Estimates

The Securities and Exchange Commission ("SEC") defines critical accounting policies as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The following critical accounting policies are a subset of the Company's significant accounting policies described in Note 1 of the Notes to Financial Statements. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates.

Property and Equipment

The Company's rail operations are highly capital intensive. Property and equipment, including land held for development, is stated at historical cost (including self-construction costs). Self-construction costs for track structure include material costs for ties, rail, other track materials and ballast; the cost of direct and supervisory labor, including railroad retirement taxes and employee benefits; costs for track machinery and equipment (including depreciation) and various other overhead costs. Major renewals or betterments are capitalized while routine maintenance and repairs that do not improve or extend asset lives are charged to expense when incurred. Costs are capitalized to the extent that they are incurred in connection with the replacement of track structure pursuant to a program of rehabilitation which results in significant future economic benefit or with the construction of new track structure. A program of rehabilitation or construction of new track structure generally includes ballast, rail and other track material and ties. Costs for routine maintenance are expensed. Routine maintenance items include the sporadic replacement of ties, replacement of track structure damaged in a derailment, washout or other cause or event and the costs of general upkeep of track structure to keep it in good operating condition. Costs are capitalized or expensed depending on the facts and circumstances of each specific project. The total amount of the costs to be capitalized is based on the per unit standard cost for each category of expenditure (ties, rail and other track material and ballast) and the number of equivalent units installed. Per unit costs are developed annually using costs incurred for materials, direct labor and overhead.

Properties and equipment are carried at cost and are depreciated over their useful lives. Items included in track structures with similar physical characteristics, use, date of installation and expected life are grouped together into separate asset classes and depreciated by the estimated useful life for the asset class group. Gains or losses on sales or other dispositions of property are credited or charged to other income.

The Company reviews property and equipment retirements each year in order to determine whether or not the estimated useful lives are reasonable. Since, in most instances, assets retired have been fully or substantially depreciated, the Company has not found it necessary, historically, to make any significant adjustments to their estimated useful lives. Retirements of track structures are recorded by removing the historical cost and related accumulated depreciation of its oldest track structures with the related gain or loss being charged to other income. Historically, the Company has not had any significant retirements of track infrastructure which it considers to be abnormal and not in the normal course of business.

The conclusions and ongoing evaluations of our estimated useful lives may result in future material changes in the Company's maintenance and capital spending, as well as revisions to the useful lives of property and equipment which may affect depreciation rates and expenses.

The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When circumstances indicate that assets should be evaluated for possible impairment, the Company uses an estimate of the related undiscounted future cash flows over the remaining lives of the assets in determining whether the carrying amounts of the assets are recoverable. If an impairment exists, the impairment is measured by comparing the carrying value to the fair value. No impairments were recognized in the two years presented.

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Income Taxes

Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating losses and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the dates of enactment. Valuation allowances are established when it is estimated that it is more likely than not that the deferred tax asset will not be realized.

Overview

The Company is a freight railroad operating in Massachusetts, Rhode Island, Connecticut and New York.

The Company generates operating revenues primarily from the movement of freight in both conventional freight cars and in intermodal containers on flat cars over its rail lines. Freight revenues are estimated and recorded at the time shipments move onto the Company's or the connecting carrier's track. Modest freight-related operating revenues are derived from demurrage, switching, weighing, special train and other transportation services. Other operating revenues are derived from services rendered to freight customers and other outside parties by the Company's Maintenance of Way, Communications & Signals, and Maintenance of Equipment departments. Operating revenues also include amortization of deferred grant income and rental income.

The Company's operating expenses consist of salaries and wages and related payroll taxes and employee benefits, depreciation, insurance and casualty claim expense, diesel fuel, car hire, property taxes, materials and supplies, purchased services, track usage fees and other expenses. Many of the Company's operating expenses are of a relatively fixed nature and do not increase or decrease proportionately with increases or decreases in operating revenues unless the Company's management were to take specific actions to restructure the Company's operations.

When comparing the Company's results of operations from one year to another, the following factors should be taken into consideration. First, the Company has historically experienced fluctuations in operating revenues and expenses due to unpredictable events such as one-time freight moves and customer plant expansions and shutdowns. Second, the Company's freight volumes are susceptible to increases and decreases due to changes in international, national and regional economic conditions. Third, the volume of capitalized track or recollectible projects performed by the Company's Maintenance of Way and Communications & Signals departments can vary significantly from year to year, thereby impacting total operating expenses. Fourth, diesel fuel comprises a significant portion of the Company's operating costs. As fuel prices increase the Company attempts to recover these costs through surcharges and increased fees; however, the Company's profitability can be impacted by changes in fuel prices.

The Company also generates other income through sales of properties, grants of easements and licenses. Other income or loss from the sale, condemnation, disposal of property and equipment and grants of permanent easements is recorded at the time the transaction is consummated and collectability is assured. Other income varies significantly from year to year.

One of the Company's customers, which ships construction aggregates from three separate quarries on the Company's rail system to locations in Connecticut and New York, accounted for 10.8% of the Company's freight operating revenues in 2012. Though no single customer accounted for 10% or more of its total operating revenues in 2011, revenues attributable to individual shippers served by Motiva Enterprises LLC, which operates a petroleum blending and storage terminal located in Providence, Rhode Island on the Company's lines, accounted for more than 10% of the Company's operating revenues. The Company does not believe that these customers will cease to be rail shippers in the foreseeable future.

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Results of Operations

The following table sets forth the Company's operating revenues, exclusive of rental revenues, by category in dollars and as a percentage of operating revenues:

                                               Years Ended December 31,
                                            2012                       2011
                                          (in thousands, except percentages)
         Freight Revenues:
         Conventional carloads      $  26,669        90.7 %    $ 28,692        90.5 %
         Containers                     1,178         4.0           751         2.4
         Other freight-related            888         3.0           872         2.7
         Other operating revenues         670         2.3         1,383         4.4

         Total                      $  29,405       100.0 %    $ 31,698       100.0 %

The following table sets forth conventional carload freight revenues by commodity group in dollars and as a percentage of such revenues:

                                                        Years Ended December 31,
                                                     2012                       2011
                                                   (in thousands, except percentages)
Automobiles                                  $   2,800        10.5 %    $  2,841         9.9 %
Chemicals and plastics (including ethanol)      10,428        39.1        12,452        43.4
Construction aggregates                          4,454        16.7         4,619        16.1
Coal                                               640         2.4           717         2.5
Metal products                                   2,347         8.8         2,841         9.9
Food and agricultural products                   1,573         5.9         1,578         5.5
Forest and paper products                        2,587         9.7         2,267         7.9
Other                                            1,840         6.9         1,377         4.8

Total                                        $  26,669       100.0 %    $ 28,692       100.0 %

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The following table sets forth a comparison of the Company's operating expenses expressed in dollars and as a percentage of operating revenues, exclusive of rental revenues:

                                                                Years Ended December 31,
                                                            2012                        2011
                                                           (in thousands, except percentages)
Salaries, wages, payroll taxes and employee
benefits                                           $  16,539         56.2 %     $ 16,160         51.0 %
Casualties and insurance                               1,075          3.7          1,279          4.0
Depreciation                                           3,403         11.6          3,274         10.3
Diesel fuel                                            3,446         11.7          3,990         12.6
Car hire, net                                            957          3.3          1,063          3.4
Purchased services, including legal and
professional fees                                      2,364          8.0          2,909          9.2
Repairs and maintenance of equipment                   1,767          6.0          1,114          3.5
Track and signal materials                             1,972          6.7          1,166          3.7
Track usage fees                                         971          3.3          1,169          3.7
Other materials and supplies                           1,252          4.3          1,221          3.9
Other                                                  2,284          7.8          2,227          7.0

Total                                                 36,030        122.6         35,572        112.3
Less capitalized and recovered costs, including
amounts relating to the Amtrak Agreement1              8,551         29.1          3,677         11.6

Total                                              $  27,479         93.5 %     $ 31,895        100.7 %

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Operating Revenues

Operating Revenues decreased $2.3 million, or 7.3%, to $29.4 million in 2012 from $31.7 million in 2011. This decrease is the net result of a $2.0 million (7.1%) decrease in conventional freight revenues, a $427 thousand (56.9%) increase in container freight revenues, a $16 thousand (1.8%) increase in other freight-related revenues and a $713 thousand (51.6%) decrease in other operating revenues.

The decrease in conventional freight revenues is attributable to an 11.5% decrease in traffic volume, offset by a 5.9% increase in the average revenue received per carloading. In 2012, the Company's conventional carloadings decreased by 4,126 to 31,725 from 35,851 in 2011. Shipments of metal and chemicals and plastics (including ethanol) decreased during the year ended December 31, 2012 by approximately 38.5% and 23.9%, respectively, over prior year levels due to changing shipping patterns of ethanol on account of drought conditions during summer 2012 and the 2012 bankruptcy of an on-line scrap customer. The increase in the average revenue received per conventional carloading is largely attributable to price increases.

1 For an explanation of the Amtrak Agreement, see Note 10 on page II-25

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The increase in container freight revenues is the result of increased traffic volume and a 6.8% increase in the average revenue received per container. Container volume increased by 5,321 containers to 16,113 in 2012 from 10,792 in 2011. The increase in container traffic is primarily a result of the terminal operator located on the Company's line obtaining an additional customer. This increase in traffic, along with improved economic conditions, contributed to the increase in the average revenue received per container.

Other operating revenues include billings for siding maintenance, signal maintenance, flagging and other services rendered to freight customers and other outside parties. The 2012 decrease was due to decreased maintenance department billings for signal maintenance.

Other Income

Other income increased by $1.3 million to $2.7 million in 2012 from $1.4 million in 2011. The Company received $2.6 million for the grant of permanent easement and $1.2 million in settlement of certain legal proceedings and with respect to the granting of a permanent easement during 2012 and 2011, respectively.

Operating Expenses

Operating expenses decreased by $4.4 million, or 13.8%, to $27.5 million in 2012 from $31.9 million in 2011. Decreases in diesel fuel expense and car hire due to decreased traffic volume resulting in reduced diesel fuel consumption, and decreases in purchased services and other expenses, accounted for $1.4 million of this decrease. Personnel costs increased due to contractually-required increases in pay rates and health care premium increases (totaling $379 thousand). Repairs and maintenance and track and signal materials increased by $1.5 million due mainly to reduced scrap material offsets and increased material demand in connection with recoverable projects. These increases were offset by $3.6 million of recoveries due to the Amtrak Agreement executed in 2012, $751 thousand of increased capital projects performed by Company personnel and $523 thousand of recoveries for primarily signal related projects.

Interest Expense

Interest expense was $202 thousand in 2012 and $110 in 2011. The increase was due to the long term debt carried by the Company for the full year of 2012. Additionally, in 2011, $70 thousand of interest expense was capitalized in conjunction with the Willimantic Branch rehabilitation project.

Provision for Income Taxes (Benefit)

The Company's federal income tax provision for 2012 was $1.5 million. This amount approximates the Company's expected tax rate plus a decrease in the Company's valuation allowance against its deferred tax assets of $293 thousand (6% of the total effective tax rate).

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Liquidity and Capital Resources

During 2012 and 2011, the Company generated $2.4 million and $5.9 million, respectively, of cash from operating activities.

During 2012, the Company's cash flows used in investing activities were $943 thousand. Capital expenditures were $3.6 million, partially offset by proceeds from the sale of property, equipment and easements of $2.6 million. The Company's expenditures for track structure replacement net of grants for the past two years were:

                              Net Expenditures for Track Structure
                                          Replacements
               December 31,              (In Thousands)
               2011           $                               7,188
               2012           $                               2,855

Substantially the entire mainline track owned by the Company meets FRA Class 3 standards, and the Company intends to continue to maintain this track at this level. The Company expended $2.8 million and $7.2 million for additions and improvements to its track structure in 2012 and 2011, respectively. During 2011, the Company rehabilitated 14 track miles of the Willimantic Branch from Versailles, CT to Willimantic, CT. The Company expects that on average it will continue to spend between $2 million and $3 million per year for capitalized track improvements adjusted annually for inflation. Improvements to the Company's track structure are made, for the most part, by the Company's Maintenance of Way Department personnel.

During 2012, the Company utilized $4.4 million of cash for financing activities. For 2012, the primary drivers of cash flows utilized in financing activities were $3.9 million for the retirement of the Company's long term debt and $778 thousand for the payment of dividends partially offset by $75 thousand from the exercise of stock options and employee stock purchases and by $245 of deferred grant income.

In 2012, the Company paid dividends in the amount of $5 per share, aggregating $3.2 thousand, on its outstanding noncumulative preferred stock and $0.16 per share, aggregating $775 thousand, on its outstanding common stock. In January 2013, the Company declared a preferred stock dividend of $5 per share ($3.2 thousand) and a $.04 dividend per common share ($193 thousand). Continued payment of such dividends is contingent upon the Company's continuing to have the necessary financial resources.

The Company's revolving line of credit of $5.0 million with a commercial bank was extended through June 2015 with the same bank under the same terms and conditions. Borrowings under this line of credit are unsecured, due on demand and bear interest at either the bank's prime rate or one and three-quarters percent over the thirty, sixty or ninety day London Interbank Offered Rate ("LIBOR") with a LIBOR floor of one and one-quarter percent. The Company pays no commitment fee on this line and has no compensating balance requirements. The Company had no amounts outstanding under the line of credit as of December 31, 2012.

During 2012, the Company entered into an agreement with an unrelated third-party shipping customer. Under the agreement, the customer agreed to pay for certain qualified railroad track maintenance expenditures, including capital additions to the Company's track structure. In return the Company agreed to assign railroad track miles to the shipping customer which would enable that customer to claim certain track maintenance credits pursuant to Section 45G of the Internal Revenue Code ("45G"). The Company received $1.8 million (net of related commissions and fees) for its assignment of railroad track miles under 45G for its 2012 credits. 45G was extended through December 31, 2013 and should 45G not be extended or reauthorized subsequent to 2013, the Company would no longer be able to assign its railroad track miles under 45G.

Diesel fuel comprises a significant portion of the Company's operating costs. As fuel prices increase the Company attempts to recover these costs through surcharges and increased fees; however, the Company's profitability can be adversely impacted by increases in fuel prices.

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Table of Contents

Contractual Obligations and Commitments

The Company is a defendant in certain lawsuits relating to casualty losses, many of which are covered by insurance subject to a deductible. The Company believes that adequate provision has been made in the financial statements for any expected liabilities which may result from disposition of such lawsuits.

On January 29, 2002, the Company received a "Notice of Potential Liability" from the United States Environmental Protection Agency ("EPA") regarding an existing Superfund Site (the "Site") that includes the J.M. Mills Landfill in Cumberland, Rhode Island. EPA sends these "Notice" letters to potentially responsible parties ("PRPs") under the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA"). EPA identified the Company as a PRP based on its status as an owner and/or operator because its railroad property traverses the Site. Via these Notice letters, EPA makes a demand for payment of past costs (identified in the letter as $762 thousand) and future costs associated with the response actions taken to address the contamination at the Site, and requests PRPs to indicate their willingness to participate and resolve their potential liability at the Site. The Company has responded to EPA by stating that it does not believe it has any liability for this Site, but that it is interested in cooperating with EPA to address issues concerning liability at the Site. At this point, two other parties have already committed via a consent order with EPA to pay for the Remedial Investigation/Feasibility Study ("RI/FS") phase of the clean-up at the Site, which has not yet been completed. After that, EPA will likely seek to negotiate the cost of the Remedial Design and implementation of the remedy at the Site with the PRPs it has identified via these Notice Letters (which presently includes over sixty parties, and is likely to increase after EPA completes its investigation of the identity of PRPs). On December 15, 2003, the EPA issued a second "Notice of Potential Liability" letter to the Company regarding the Site. EPA again identified the Company as a PRP, this time because EPA "believes that [the Company] accepted hazardous substance for transport to disposal or treatment facilities and selected the site for disposal." The Company responded again to EPA stating that it is interested in cooperating with EPA but that it does not believe it has engaged in any activities that caused contamination at the Site. The Company believes that none of its activities caused contamination at the Site, and will contest this claim by EPA and therefore no liability has been accrued for this matter.

In connection with the EPA claim described above, the two parties which have committed to conduct the RI/FS at the Site filed a complaint in the U.S. District Court of Rhode Island against the Company, in an action entitled CCL Custom Manufacturing, Inc. v. Arkwright Incorporated, et al (consolidated with Unilever Bestfoods v. American Steel & Aluminum Corp. et al), C.A. No. 01-496/L, on December 18, 2002. The Company was one of about sixty parties named by Plaintiffs in this suit, to recover response costs incurred in investigating and responding to the releases of hazardous substances at the Site. Plaintiffs alleged that the Company is liable under 42 U.S.C. 961(a) (3) of CERCLA as an "arranger" or "generator" of waste that ended up at the Site. The Company entered into a Generator Cooperation Agreement with other defendants to allocate costs in responding to this suit, and to share technical costs and information in evaluating the Plaintiffs' claims. Although the Company does not believe it generated any waste that ended up at this Site, or that its activities caused contamination at the Site, the Company paid $45 thousand to settle this suit in March 2006.

Pursuant to permits issued by the United States Department of the Army Corps of Engineers and the Rhode Island Coastal Resources Management Council, the Company created 33 acres of waterfront land in East Providence, Rhode Island ("South Quay") investing nearly $12 million in its development. The permits for the property, which have been extended to December 2014 and December 2013, respectively, also allow for construction of a dock along the west face of the South Quay. The property is adjacent to a 12 acre site, also owned by the Company.

The property is located one-half mile from Interstate 195. In 2006, the Rhode Island Department of Transportation ("RIDOT") awarded a contract to construct Waterfront Drive, which provides direct vehicular access from the interstate highway system to the South Quay, which project was completed in 2007. In fall 2012, the extension of Waterfront Drive northward toward an industrial area, where the Company owns two additional waterfront parcels comprising 11 acres, creating direct access to such property, was completed. RIDOT is now working to improve access from Waterfront Drive to Interstate 195.

The City of East Providence has created a waterfront redevelopment area with a zoning overlay to encourage development of offices, hotels, restaurants, shops, marinas, apartments and other "clean" employment. The Company has been . . .

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