Description
Filed with the SEC from July 12 to July 18:
Providence & Worcester Railroad (PWX)
Gamco Investorshas 452,977 shares (9.4%) after purchasing 7,983 from June 5 through July 13 at $13.10 to $14.09 per share.
BUSINESS OVERVIEW
Industry Overview
General
Freight railroads are categorized in different classes by the STB and the AAR. As a result of mergers and consolidations, there are only seven Class I railroads in North America today. The Class I railroads account for a majority of North America’s rail freight business.
The freight rail industry underwent revitalization after the passage of the Staggers Rail Act in 1980 (the “Staggers Rail Act”) which deregulated the pricing and types of services provided by railroads. As a result, railroads were able to achieve significant productivity gains and operating cost decreases while gaining pricing flexibility. Freight rail service became more competitive with other transportation modes with respect to both quality and price. Since 1980, the volume of freight moved by rail has risen dramatically and profitability has improved significantly, with the exception of the recession.
One result of revitalization of the industry has been the growth of regional (over 350 miles) and short-line railroads, which was fueled by Class I railroads’ divestiture of certain branch lines in order to focus on their long-haul core systems. There are now more than 550 of these regional and short-line railroads. They operate in all of the 48 contiguous states comprising the continental United States, plus Alaska, account for about 30% of all rail track, employ about 11% of all rail workers and generate about 7% of all rail revenue.
Generally, freight railroads handle two types of traffic: conventional carloads and intermodal containers used in the shipment of goods via more than one mode of transportation, e.g., by ship, rail and truck. By using a hub-and-spoke approach to shipping, multiple containers can be moved by rail to and from an intermodal terminal and then either delivered to their final destinations by truck or transferred to ship for export. During the periods 1996-2007, commodity shippers increasingly turned to intermodal transportation principally as an alternative to long-haul trucking. The development of new intermodal technology, which allows containers to be moved by rail double- stacked (i.e., stacked one on top of the other) on specially designed railcars, together with increasing highway traffic congestion, contributed to this trend. Beginning with the second quarter of 2007 and continuing through 2010, the number of containers arriving in southern New England by way of landbridge (across the continental United States) declined, as containers began being routed from Far East ports directly to East Coast ports over all-water routes.
Regional Developments
Over the past decade, a number of development projects within the Company’s service area have been completed. Some have increased port capacity along the extensive coastline of southern New England and improved the intermodal transportation and distribution infrastructure in the region, while others have improved the Company’s connections to Class I carriers serving southern New England. These infrastructure improvements present the Company with multiple opportunities for increased business and routing options, enhancing its customers’ market access.
Quonset/Davisville
The State of Rhode Island with assistance from the federal government is continuing redevelopment efforts on a 1,000 acre portion of the former naval facility at Quonset/Davisville for an active port and industrial park that houses a number of rail-oriented industries and an auto port. Construction of a freight rail improvement project, providing additional track capacity and Phase 1 double-stack clearances on the Northeast Corridor between Quonset/Davisville and Boston Switch, the connection of the Northeast Corridor to the Company’s mainline at Central Falls, RI, was completed in October 2006. Shipments of automobiles by rail commenced in the fall of 2007. The Company handled 4,074 autoracks in 2011 and 3,220 autoracks in 2010.
Port of Providence
Infrastructure improvements undertaken by the Port of Providence and the Company in 2003, including the installation of paving, lighting and “on dock” rail, have accommodated the Company’s movement of imported coal to inland markets. During 2011 and 2010, the Company moved 1,488 and 3,155 carloads, respectively. The Company continues to move coal.
The Company rehabilitated a substantial portion of its South Providence yard to facilitate handling unit trains of ethanol. This commodity is being transported by rail throughout the country and is a component of the gasoline mix available at gasoline service stations throughout southern New England. Rehabilitation was completed and shipments of ethanol commenced during the third quarter of 2007. The Company moved 4,449 carloads of ethanol in 2011 and 4,168 carloads of ethanol in 2010.
New London and Willimantic Interchanges
Through its New London and Willimantic interchanges with the New England Central Railroad (“NECR”), P&W interchanges traffic with the Canadian National Railway (“CN”) and the Canadian Pacific Railway (“CP”). With the Company’s reactivation of the Willimantic Interchange in late 2007, across a route with improved overhead clearances to NECR, the Willimantic Branch became the primary interchange route to NECR and further strengthened the Company’s connections with CP via the Vermont Rail Systems’ Green Mountain Gateway at Bellows Falls, Vermont and CN via East Alburg, Vermont. During 2011, the Company completed rehabilitation of 14 miles of the Willimantic Branch from Willimantic, CT to Versailles, CT with new 115 lb. rail, ties and resurfacing.
In February 2012, the Company and NECR entered into a strategic alliance establishing service across the “Great Eastern Route”. The Great Eastern Route furnishes the Company with pricing authority for service to CN, through a haulage arrangement by which NECR provides haulage for the Company between East Alburg, VT and Willimantic, CT on certain contractually-agreed commodities. The route also enhances the Company’s connection with CP.
Railroad Operations
The Company’s rail freight system comprises approximately 516 miles of track. The Company interchanges freight traffic: with CSX Transportation (“CSXT”) at Worcester, Massachusetts and at New Haven, Connecticut; with Pan Am Railways at Worcester, Massachusetts; with Pan Am Southern (“PAS”) and Norfolk Southern Railways (“NS”) via PAS at Gardner, Massachusetts; with NECR at New London and Willimantic, Connecticut; with CN through the Great Eastern Route; with CP via the NECR; and with New York and Atlantic Railroad at Fresh Pond Junction on Long Island. Through its connections, P&W links more than 80 communities on its lines. The Company operates four classification yards (areas containing tracks used to group freight cars destined for a particular industry or interchange) located in Worcester, Massachusetts, Cumberland, Rhode Island, and Plainfield and New Haven, Connecticut.
The Company is dependent upon the railroads with which it interchanges freight traffic to enable it to properly service its customers at competitive rates. Failure of any of these connecting railroads to provide adequate service at reasonable rates can result in a loss of freight customers and revenues.
By agreement with private operator, the Company services an intermodal yard in Worcester, an area containing tracks used for the loading and unloading of containers. This yard is U.S. Customs-bonded, and international traffic must be inspected and approved by U.S. Customs officials. The intermodal yard serves primarily as a terminal for movement of container traffic from Canada, the Far East, Southeast Asia and Europe destined for points in New England. Container ship lines utilize double-stack train service through this terminal. Intermodel traffic declined significantly beginning in 2007 and reached its lowest traffic counts in 2009. In 2011, 10,792 containers were handled which represented an improvement of 63 containers over 2010. P&W continues to work with the terminal operator to develop relationships with steamship lines involved in international intermodal transportation. The Company and CN have entered into an Intermodal Haulage Agreement with respect to international intermodal containers to and from certain Canadian ports.
Customers
The Company serves approximately 160 customers in Massachusetts, Rhode Island, Connecticut and New York. The Company’s ten (10) largest customers account for more than half of its operating revenues. 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, accounted for more than 10% of the Company’s operating revenues.
Sales and Marketing
P&W’s sales and marketing staff of three people has substantial experience in pricing and marketing railroad services. The sales and marketing staff focuses on understanding and addressing the raw material requirements and transportation needs of its existing customers and businesses on its lines. The staff grows existing business by maintaining close working relationships with both customers and connecting carriers. The sales and marketing staff strives to generate new business for the Company through (i) targeting companies already located on P&W’s rail lines but not currently using rail services or not using them to their full capacity, (ii) working with state and local development officials, developers and real estate brokers to encourage the development of industry on the Company’s rail lines, and (iii) identifying and targeting the non-rail transportation of goods into and out of the region in which the Company operates. Unlike many other regional and short-line railroads which have access only to a single Class I connection, the Company is able to offer its customers various pricing and routing alternatives because of its multiple connections to other carriers.
Safety
An important component of the Company’s operating strategy is conducting safe railroad operations for the benefit and protection of employees, customers and the communities served by its rail lines. Since commencing active operations in 1973, the Company has committed significant resources to track maintenance and believes its rail system is in good condition. During 2011, the Company completed rehabilitation of 14 miles of the Willimantic Branch from Willimantic, CT to Versailles, CT with new 115 lb. rail, ties and resurfacing. The Company has an employee training program utilizing classroom instruction and video programs on topics including NORAC Operating Rules, Safety Rules, Rail Security Awareness plans and Hazardous Materials Awareness, as well as manufacturer-provided training materials. The Company and its employees continue to work to prevent injuries while at the same time expanding operations.
Rail Traffic
Rail traffic is classified as on-line or overhead traffic. On-line traffic is traffic that originates or terminates with shippers located on a railroad’s rights-of-way. Overhead traffic passes from one connecting carrier to another and neither originates nor terminates with shippers located on a railroad’s rights-of-way. Presently, with minor exceptions, P&W is solely an on-line carrier.
Freight rail rates can be in various forms. Generally, customers are given a “through” rate, a single amount encompassing the rail transportation of a commodity from point of origin to point of destination, regardless of the number of carriers which handle the car. Rates are developed by the carriers based on the commodity, volume, distance and competitive market considerations. The entire freight bill is paid either to the originating carrier (“prepaid”) or to the destination carrier (“collect”) and divided among all carriers which handle the move. The basis for the division varies and can be based on factors (or revenue requirements) independently established by each carrier which comprise the through rate, or on a percentage basis established by division agreements among the carriers. A carrier such as P&W, which actually places the car at the customer’s location and attends to the customer’s daily switching requirements, typically receives a share of revenue greater than an amount based simply on mileage hauled.
Employees
As of December 31, 2011, the Company had 147 full-time employees, 116 of whom are represented by three railroad labor organizations that are national in scope. The Company’s non-management employees have been represented by the same unions since the Company commenced independent operations in 1973.
The Company’s initial agreement with the United Transportation Union (“UTU”) covering trainmen was unusual in the railroad industry since it provided the Company with discretion in determining crew sizes, eliminated craft distinctions and provided a guaranteed annual wage for a maximum number of hours worked. The Company’s collective bargaining agreements have been in effect since February 1973 for trainmen, since May 1974 for clerical employees and dispatchers and since June 1974 for maintenance employees. These contracts do not expire but are subject to renegotiation after the agreed-upon moratoria. The Company signed eight year agreements with the UTU in October 2005, the Transportation Communications International Union (clerical) in August 2006 and the Brotherhood of Railroad Signalmen (maintenance) in July 2007, retroactive to prior periods. The Company considers its employee and labor relations to be good. The Company and the UTU have not yet begun contract negotiations, notwithstanding that their collective bargaining agreement is subject to renewal in 2012.
Competition
The Company is the only rail carrier serving businesses located on-line. The Company competes with other carriers, however, in the siting of new rail-oriented businesses in the region. Certain rail competitors, including CSXT, are substantially larger and better capitalized than the Company. The Company also competes with other modes of transportation, particularly long-haul trucking companies, for the transportation of commodities, and ocean-going vessels for the transportation of containers. Any improvement in the cost or quality of these alternate modes of transportation including, for example, legislation granting material increases in truck size or allowable weight, could increase competition and may materially adversely affect the Company’s business and results of operations. As a means of competing, P&W strives to offer greater convenience and better service than competing rail carriers and at costs lower than some competing non-rail carriers. The Company also competes by participating in efforts to attract new industry to its service area.
The Company believes that its ability to grow depends, in part, upon its ability to acquire additional connecting rail lines. In making acquisitions, P&W competes with other short-line and regional rail operators, some of which are larger and have greater financial resources than the Company.
Governmental Regulation
The Company is subject to governmental regulation by the STB, the FRA, the Transportation Security Administration (the “TSA”) and other federal, state and local regulatory authorities with respect to certain rates and railroad operations, as well as a variety of health, safety, labor, environmental and other matters, all of which could potentially affect the Company’s competitive position and profitability. Additionally, the Company is subject to STB regulation and may be required to obtain STB approval prior to its acquisition of any new railroad properties. Management believes that the regulatory freedoms granted by the Staggers Rail Act have been beneficial to the Company by affording it flexibility to adjust prices and operations to respond to market forces and industry changes. However, various interests, and certain members of the United States Congress (which has jurisdiction over federal regulation of railroads), have from time to time expressed their intention to support legislation that would eliminate or reduce significant freedoms granted by the Staggers Rail Act.
Environmental Matters
The Company’s railroad operations and real estate ownership are subject to extensive federal, state and local environmental laws and regulations concerning, among other things, emissions to the air, discharges to waters and the handling, storage, transportation and disposal of waste and other materials. The Company handles, stores, transports and disposes of petroleum and other hazardous substances and wastes. The Company also transports hazardous substances for third parties and arranges for the disposal of hazardous wastes generated by the Company. The Company believes that it is in compliance with applicable environmental laws and regulations.
Internet Address and SEC Reports
The Company maintains a website with the address www.pwrr.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission (“SEC”). We also include on our website our corporate governance guidelines and the charters for each of the major committees of our board of directors. In addition, we intend to disclose on our website any amendments to, or waivers from, our code of business conduct and ethics that are required to be publicly disclosed pursuant to rules of the SEC.
Item 2. Properties
Track
P&W’s rail system extends over approximately 516 miles of track, of which it owns approximately 163 miles. The Company has the right to use the remaining 353 miles pursuant to perpetual easements and long-term trackage rights agreements. Under certain of these agreements, the Company pays fees based on usage.
Virtually all of the mainlines on which the Company operates are in FRA class 3 condition. The Company intends to maintain the mainline tracks which it owns in such condition.
Of the approximately 516 miles that comprise the Company’s system, 306 miles, or 58.5 %, are located in Connecticut, 95 miles, or 19 %, are located in Massachusetts, 87 miles, or 17 % , are located in Rhode Island and 28 miles, or 5.5 %, are located in New York.
Rail Facilities
P&W owns land and a building with approximately 69,500 square feet of floor space in Worcester, Massachusetts. The building houses the Company’s executive and administrative offices and some of the Company’s storage space. Approximately 4,735 square feet are leased to outside tenants. In addition, the Company owns various maintenance buildings and other structures related to its railroad operations.
The Company owns and operates three principal classification yards located in Worcester, Massachusetts, Cumberland, Rhode Island and Plainfield, Connecticut and also operates a classification yard in New Haven, Connecticut. In addition, the Company has maintenance facilities in Putnam and Plainfield, Connecticut and in Worcester, Massachusetts. P&W believes that its executive and administrative office facilities, classification yards and maintenance facilities are adequate to support its current level of operations.
Other Properties
The Company owns a total of approximately 150 acres of real estate located along its principal railroad lines, including classification yards in the greater Worcester, Massachusetts area. Additionally, the Company owns or has the right to use a total of approximately 130 acres of real estate located along the principal railroad lines from downtown Providence through Pawtucket, Rhode Island. Of this acreage, P&W owns approximately eight acres in Pawtucket and has a perpetual easement for railroad purposes over the remaining 122 acres.
The Company has invested approximately $12 million in the development of the South Quay in East Providence, Rhode Island which has resulted in the creation of approximately 33 acres of waterfront land, located adjacent to a 12 acre site, also owned by the Company.
P&W actively manages its real estate assets in order to maximize revenues. The income from property management is derived from sales and leasing of properties and tracks and grants of easements to government agencies, utility companies and other parties for the installation of overhead or underground cables, pipelines and transmission wires as well as recreational uses such as bike paths.
Equipment
P&W has a digital touch control dispatching system at its Worcester operations center permitting two-way radio contact with every train crew and maintenance vehicle on its lines and a computer-based manual block dispatching system with safety overrides to enhance dispatching and safety. The Company maintains a computer facility in Worcester with back-up computer facilities in Putnam, Connecticut to assure the Company’s ability to operate in the event of disruption of service in Worcester. The Company also has automatic train defect detectors at strategic locations which inspect passing trains and audibly communicate the results to train crews and dispatchers in order to protect against equipment failure en route.
The Company maintains a fleet of track maintenance equipment and aggressively pursues available opportunities to work with federal and state agencies for the rehabilitation of bridges, grade crossings and track. The Company’s locomotives which operate on the Northeast Corridor are equipped with cab signal technology, automatic civil speed enforcement systems and positive train control.
The Company, at its Worcester Engine House, has a fifty-ton drop table to facilitate the efficient exchange of wheels on locomotives and railcars by lowering the wheels beneath the level of the Engine House floor and across to an adjacent track where exchange with a second wheel set is made. The Company has performed contracted services for other railroads and the Massachusetts Bay Transportation Authority.
Item 3. Legal Proceedings
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 who 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 the Site, or that its activities caused contamination at the Site, the Company paid $45 thousand to settle this suit in March 2006.
CEO BACKGROUND
Richard W. Anderson, Director. Mr. Anderson has been a Director of the Company since 1998. He is President and Chief Investment Officer of Massachusetts Capital Resource Company (“MCRC”), a private investment firm funded by major Massachusetts-based life insurance companies providing high risk growth capital to Massachusetts businesses. He began working at MCRC in 1981, serving as Vice President through 1985, and Senior Vice President from 1986 until he was appointed to his current position. Mr. Anderson is also a director of Polar Corp., a manufacturer and distributor of beverage products. Until its sale in January 2012, Mr. Anderson was a director of Valpey Fisher Corporation, where he served as chairman of the Audit Committee. Mr. Anderson’s extensive experience in evaluating companies and their financial performance provides the Board with financial expertise in evaluating the Company’s capital and liquidity needs.
Frank W. Barrett, Director. Mr. Barrett has been a Director of the Company since 1995 and retired from TD Bank (f/k/a TD Bank North, N.A.) as Executive Vice President in 2006 after working in the banking industry for over forty years. Mr. Barrett’s years of banking experience provide the Board with valuable insights to its existing and potential alternative banking relationships as well as serving as the Company’s designated financial expert.
Roger N. Begin , Nominee. Mr. Begin has been Sales Director of BNY Mellon Wealth Management since 2007. He worked at Bank of America (or its predecessor entity, Fleet Bank, N.A.) from 1993 to 2007, serving as: Vice President, Institutional Sales, Fleet Investment Management (Fleet Bank, N.A.) from 1993 to 2002; Director, Institutional Sales & Client Service from 2002 to 2004 (Fleet Bank, N.A.); and, as Private Client Advisor, Private Bank from 2005 to 2007. Prior thereto, he served as General Treasurer of the State of Rhode Island from 1985 through 1988 and as Lieutenant Governor of the State of Rhode Island from 1989 through 1993. Mr. Begin’s depth of relationships with senior Rhode Island government officials established through his prior service as General Treasurer and his understanding of financial reporting and financial matters in general provides the Board with a valuable resource in government relations in Rhode Island and the financial sector as a whole.
P. Scott Conti, President, Chief Operating Officer and Director . Mr. Conti is the Company’s President and Chief Operating Officer, and has been a Director of the Company since 2006. Prior to his election as President, Mr. Conti served as Vice President Engineering from March 1999 and, prior thereto, in other capacities since joining the Company in 1988. As Chief Operating Officer of the Company, Mr. Conti advises the Board on the operational issues confronting the Company and opportunities for improvement.
Robert H. Eder, Chairman of the Board and Chief Executive Officer. Mr. Eder was President of the Company from 1966 through 1980. He has been Chairman of the Board of Directors and Chief Executive Officer since 1980. He is also (with his wife) beneficial or direct owner of a majority of the stock of Capital Properties, Inc., a real estate holding company, of which he is also President, Chief Executive Officer and Chairman of the Board of Directors. Mr. Eder was admitted to practice law in Rhode Island and New York. Mr. Eder led the Company in its efforts to resume independent operations and is directly involved with all major strategic developments of the Company. Mr. Eder’s history with the Company and education as a lawyer results in his having extensive and specific knowledge as to the Company’s operations, and an overall grasp of the Company’s strategic opportunities and challenges.
James C. Garvey, Director . Mr. Garvey has been a Director of the Company since 2005. Mr. Garvey is President and Chief Executive Officer of Borel Private Bank & Trust Company, a division of Boston Private Bank & Trust Company in San Mateo, California. Mr. Garvey was President and Chief Executive Officer of Borel Private Bank’s private banking affiliate, Charter Private Bank, in Bellevue, Washington from 2009 to 2010. He was President and CEO of Worcester-based Flagship Bank & Trust Company from 2001 to 2009. Mr. Garvey’s long experience as a commercial banker provides the Board with insight into current conditions in the banking industry including potential availability of credit to the Company.
John J. Healy, Director. Mr. Healy has been a Director of the Company since 1991. Mr. Healy is Director of the Manufacturing Advancement Center and Director of Operations for the Massachusetts Manufacturing Extension Partnership, an independent consulting organization dedicated to assisting small manufacturing enterprises in becoming globally competitive. Mr. Healy’s involvement with the Manufacturing Advancement Center provides the Board with valuable insights into economic development in Massachusetts which is critical to the Company’s development of its market.
David J. McQuade, Director. Mr. McQuade has been a Director of the Company since 2011. Mr. McQuade has been senior Government Affairs Consultant with Murtha, Cullina LLP in Hartford, Connecticut since 1994. He was the Chief of Staff to a former Senate President Pro Tempore of the State of Connecticut and, prior thereto, was the Chief of Staff to a former governor of Connecticut. Mr. McQuade’s political and government experience in the State of Connecticut provide the Board with valuable insight into government relations which have a bearing on the Company’s operations within Connecticut.
Paul F. Titterton, Director. Mr. Titterton has been a Director of the Company since 2008. Mr. Titterton is Vice President and Group Executive, Fleet Management, Marketing and Government Affairs of GATX Corporation. Prior to his appointment as Vice President and Group Executive, Mr. Titterton held a variety of increasingly responsible jobs in the areas of structured transactions, fleet portfolio management, strategic growth, marketing and government affairs since joining GATX in 1997. Mr. Titterton’s experience as a Vice President of GATX provides the Board valuable insights into the railroad industry in the United States.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
The Company is a regional 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 recorded at the time delivery is made to the customer or the connecting carrier. 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.
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 income through sales of properties, grants of easements and licenses, and leases of land and tracks. Income or loss from sale, condemnation and disposal of property and equipment and grants of easements is recorded at the time the transaction is consummated and collectability is assured. This income varies significantly from year to year.
Though no single customer accounted for 10% or more of its total operating revenues in 2011 or 2010, 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 or will substantially decrease their freight volumes in the foreseeable future. Should these customers cease or substantially reduce their rail freight operations and no replacement shippers were to emerge, management believes that the Company could restructure its operations to reduce operating costs by an amount sufficient to offset significantly the decrease in operating revenues.
Operating Revenues
Operating Revenues increased $3.0 million, or 10.5%, to $31.7 million in 2011 from $28.7 million in 2010. This increase is the net result of a $2.1 million (7.7%) increase in conventional freight revenues, a $44 thousand (6.2%) increase in container freight revenues, a $250 thousand (40.2%) increase in other freight-related revenues and a $622 thousand (81.7%) increase in other operating revenues.
The increase in conventional freight revenues is attributable to a .5% increase in traffic volume and a 7.8% increase in the average revenue received per carloading. In 2011, the Company’s conventional carloadings increased by 161 to 35,851 from 35,690 in 2010. Shipments of automobiles and construction aggregates increased during the year-ended December 31, 2011 by approximately 26.5% and 11.7%, respectively, over prior year levels. These increases were offset by an approximately 53% decrease in coal shipments. The increase in the average revenue received per conventional carloading is largely attributable to a shift in commodity mix.
The increase in container freight revenues is the result of stable traffic volume and a 4.8% increase in the average revenue received per container. Container traffic volume increased by 63 containers to 10,792 in 2011 from 10,729 in 2010. This stabilization of traffic volume halts a decline which began in 2007 in which cross-country container traffic to the East Coast had shifted from rail to all water routes.
The increase in other freight-related revenues results primarily from an increase in excursion revenues (43% increase over 2010 levels) and demurrage revenues (180% increase over 2010 levels).
Other operating revenues include maintenance department billings for siding maintenance, signal maintenance, flagging and other services rendered to freight customers and other outside parties. The 2011 increase was due to increased maintenance department billings for signal maintenance.
Other Income
Other income increased by $900 thousand to $2.0 million in 2011 from $1.1 million in 2010. The Company received $1.2 million during 2011 in settlement of certain legal proceedings and with respect to the granting of a permanent easement which accounted for the majority of the increase. In addition, the Company recognized a $350 thousand loss on the sale of three EMD locomotives in 2010.
Operating Expenses
Operating expenses increased by $2.1 million, or 7.0%, to $31.9 million in 2011 from $29.8 million in 2010. Increases in diesel fuel expense, car hire and track usage fees due to increases attributable to increased diesel fuel costs, additional car hire expense primarily due to the increase in automotive traffic and operating rights relating to changes in the traffic patterns of certain of the Company’s traffic, accounted for $1.8 million of this increase. Personnel costs increased due to contractually-required increases in pay rates and health care premium increases (totaling $701 thousand). Casualty and insurance increased by $315 thousand, $295 thousand of which related to the settlement of a judgment against the Company for an automobile accident involving a Company-owned vehicle. These increases were offset by increases in the amounts of capitalized and recovered costs due to additional Section 45G of the Internal Revenue Code of 1986 (“45G”) tax credits of $795 thousand and $443 thousand of grant reimbursements for state projects offset by a decrease in capital projects performed by Company personnel of $368 thousand versus 2010. Increases in other operating expenses were partially offset by a decrease in costs incurred for repairs and maintenance and track and signal material.
Interest Expense
Interest expense was $110 thousand in 2011. The increase was mainly due to the impact of long term debt first incurred by the Company in 2011. This was offset in part by reduced line of credit interest resulting from the Company’s payment of the amounts outstanding under the line of credit during 2011.
Provision for Income Taxes (Benefit)
The Company’s federal income tax provision for 2011 was $753 thousand. This amount approximates the Company’s expected rate plus an increase in the Company’s valuation allowance against its deferred tax assets of $119 thousand (8% of the total effective tax rate).
Liquidity and Capital Resources
During 2011 and 2010, the Company generated $5.9 million and $2.7 million, respectively, of cash from operating activities. The Company received deferred revenue for a 25 year license in the amount of $2.8 million in 2011.
During 2011, the Company’s cash flows used in investing activities were $5.9 million. Capital expenditures were $8.3 million, partially offset by proceeds from the sale of property, equipment and easements of $2.0 million and the satisfaction of a note receivable for $384 thousand.
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 $7.2 million and $1.5 million for additions and improvements to its track structure in 2011 and 2010, 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 2011 the Company generated $2.4 million of cash from financing activities. For 2011, the primary drivers of cash flows generated from financing activities were $4.0 million received from borrowings under the Company’s long term debt and $100 thousand from the exercise of stock options and employee stock purchases, partially offset by $775 thousand for the payment of dividends, $900 thousand for payment on its line of credit and $59 thousand of payments on the Company’s long term debt.
In 2011, 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 $772 thousand, on its outstanding common stock. In January 2012, 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 extended its revolving line of credit of $5.0 million with its principal bank, through June 2013. 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 against this line as of December 31, 2011.
Certain of the Company’s automobile traffic is subject to periodic competitive bid. A shipper that accounts for approximately 50% of the Company’s automotive shipments is rebidding its contract during 2012 for a 2013 award. The Company has no assurances it will be awarded a contract for this traffic through the rebidding process.
During 2011, 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 45G. The Company received $1.8 million for its assignment of railroad track miles under 45G. 45G expired December 31, 2011 and should 45G not be extended or reauthorized, 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.
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 I-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. The planned extension by RIDOT of Waterfront Drive northward toward an industrial area, in which the Company owns two additional waterfront parcels comprising 11 acres, creating direct access to such property, is underway, with construction expected to be completed in the spring of 2013.
The City of East Providence has created a waterfront redevelopment area with a zoning overlay that would encourage development of offices, hotels, restaurants, shops, marinas, apartments and other “clean” employment. The Company has been cooperating with the City of East Providence in these efforts.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Operating Revenues:
Operating revenues decreased $191 thousand, or 2.8%, to $6.66 million in the first quarter of 2012 from $6.85 million in the first quarter of 2011. This decrease is a result of $183 thousand (50.0%) decrease in other operating revenues, mainly reimbursable contract revenue.
The slight decrease in conventional freight revenues is attributable to a 4.7% decrease in traffic volume, offset by a 3.5% increase in the average revenue received per conventional carloading. The Company’s conventional carloadings decreased by 333 to 6,691 in the first quarter of 2012 from 7,024 in 2011.
Shipments of most commodities were flat during the first quarter of 2012, as compared to the first quarter of 2011, offset by a decrease in the Company’s ethanol and plastic business due to changes in the consumption patterns of the end users. The increase in the average revenue received per conventional carloading is due mainly to rate changes.
The increase in container freight revenues is the result of a 41% increase in traffic volume and a 6.8% increase in the average revenue received per container. Container traffic volume increased by 1,040 containers to 3,574 in the first quarter of 2012 from 2,534 in 2011. This increase in traffic is attributable to the terminal operator located on the Company’s line obtaining an additional customer.
The slight decrease in other freight-related revenues is the result of the decrease in both demurrage income and switching income, offset by slight increases in weighing revenue.
Other Income:
The net change in other income is primarily due to the $50 thousand decrease in rental income.
Operating Expenses:
Operating expenses for the first quarter of 2012 decreased by $600 thousand, or 6.9%, to $8.1 million from $8.7 million in the first quarter of 2011. The decrease consists of a $218 thousand decrease in fuel consumed offset in part by an increase in the average price per gallon, $182 thousand in purchased services relating to projects in 2011 and not in 2012, $168 thousand in repairs and maintenance equipment relating to the purchase of parts and supplies, $100 thousand in other relating mainly to utility expenditures, and an increase of $259 thousand in capitalized track expenditures and recovered costs, offset by increases of $137 thousand in payroll and related costs due to contractual wage increases and related costs, $41 thousand in depreciation due mainly to the improvements and purchases being reflected in depreciation in 2012 and not in 2011, $45 thousand in track usage fee due to increased traffic along routes for which the Company pays track usage fees, and $116 thousand in casualties and insurance.
Income Tax Provision/Benefit:
The income tax (provision)/benefit for the first quarter of 2012 and 2011 is approximately 36% and (28%) of the pre-tax loss, respectively. The current rate is impacted by a variety of factors, including estimated future taxable income and possible tax planning strategies. The Company will continue to evaluate its provision for income taxes. The 2011 income tax rate represented the effective tax benefit which the Company expected to realize at that time, including provision for an increase to the Company’s valuation allowance against its deferred tax assets.
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Fund Letters
