-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BoSRRD3X3AGpYzXzQrvVXrcBAo5AePh50cCZUWA96VWgNaHjKBPuoO8IMhwb6dNz 3mvcVByd5AXbgFNMB8Nszw== 0000831968-07-000034.txt : 20070327 0000831968-07-000034.hdr.sgml : 20070327 20070327150544 ACCESSION NUMBER: 0000831968-07-000034 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20061231 FILED AS OF DATE: 20070327 DATE AS OF CHANGE: 20070327 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROVIDENCE & WORCESTER RAILROAD CO/RI/ CENTRAL INDEX KEY: 0000831968 STANDARD INDUSTRIAL CLASSIFICATION: RAILROADS, LINE-HAUL OPERATING [4011] IRS NUMBER: 050344399 STATE OF INCORPORATION: RI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-12761 FILM NUMBER: 07721072 BUSINESS ADDRESS: STREET 1: 75 HAMMOND ST CITY: WORCESTER STATE: MA ZIP: 01610 BUSINESS PHONE: 5087554000 MAIL ADDRESS: STREET 1: PROVIDENCE & WORCESTER RAILROAD CO STREET 2: 75 HAMMOND STREET CITY: WORCESTER STATE: MA ZIP: 01610 10-K 1 body10k200612.txt FORM 10K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Form 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission file number 0-16704 PROVIDENCE AND WORCESTER RAILROAD COMPANY (Exact name of registrant as specified in its charter) Rhode Island 05-0344399 _____________________________ __________________________ (State or other jurisdiction of I.R.S. Employer Identification No. incorporation or organization) 75 Hammond Street, Worcester, Massachusetts 01610 _____________________________ __________________________ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code(508) 755-4000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of Each Class on which registered _____________________________ __________________________ Not Applicable Not Applicable Securities registered pursuant to Section 12(g) of the Act: Common stock, $.50 par value ________________________________________________________________ (Title of Class) ________________________________________________________________ Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No X Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No X Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (check one) Large accelerated filer Accelerated filer Non-accelerated filer X As of June 30, 2006, the aggregate market value of the voting stock held by non-affiliates of the Registrant was $70,906,096. (For this purpose, all directors of the Registrant are considered affiliates.) As of March 23, 2007, the Registrant had 4,536,431 shares of Common Stock outstanding. Documents Incorporated by Reference - - ------------------------------------- Portions of the Registrant's Proxy Statement for the 2007 Annual Meeting of Shareholders to be held on April 25, 2007, is incorporated by reference into Part III of this Form 10-K. Exhibit Index - Page III-2. PART I Item 1. Business - ---------------- Providence and Worcester Railroad Company ("P&W" or "the Company") is a class II regional freight railroad operating in Massachusetts, Rhode Island, Connecticut and New York. The Company is the only interstate freight carrier serving the State of Rhode Island and possesses the exclusive and perpetual right to conduct freight operations over the Northeast Corridor between New Haven, Connecticut and the Massachusetts/Rhode Island border. Since commencing independent operations in 1973, the Company, through a series of acquisitions of connecting lines, has grown from 45 miles of track to its current system of approximately 516 miles. P&W operates the largest double stack intermodal terminal facilities in New England in Worcester, Massachusetts, a strategic location for regional transportation and distribution enterprises. The Company transports a wide variety of commodities for its customers, including construction aggregate, iron and steel products, chemicals, lumber, scrap metals, plastic resins, cement, coal, construction and demolition debris, processed foods and edible food stuffs, such as frozen foods, corn syrup and animal and vegetable oils. Its customers include Cargill, Inc., The Dow Chemical Company, Exxon-Mobil Corporation, First Light Power Resources, Frito-Lay, Inc., International Paper Company, Northeast Utilities, Nucor Steel, Smurfit-Stone Container Corporation and Tilcon Connecticut, Inc. In 2006, P&W transported approximately 34,000 carloads of freight and 63,000 intermodal containers. The Company also generates income through sales of properties, grants of easements and licenses and leases of land and tracks. P&W's connections to multiple Class I railroads, either directly or through connections with regional and short-line carriers, provide the Company with a competitive advantage by allowing it to offer creative pricing and routing alternatives to its customers. In addition, the Company's commitment to maintaining its track and equipment to high standards enables P&W to provide fast, reliable and efficient service. Industry Overview General Railroads are divided into three classes based on operating revenues: Class I, $319.3 million or more; Class II, $25.5 million to $319.3 million; and Class III, less than $25.5 million. As a result of mergers and consolidations, there are now only seven Class I railroads in the country. The Class I railroads handle 93% of the nation's rail freight business. The rail freight industry underwent a revitalization after the passage of 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. Rail freight service became more competitive with other transportation modes with respect to both quality and price. The volume of freight moved by rail has risen dramatically since 1980 and profitability has improved significantly. One result of the revitalization of the industry has been the growth of regional (over 350 miles) and short-line railroads, which has been fueled by a trend among Class I railroads to divest 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 50 states, account for 32% of all rail track, employ 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. Over the past decade, commodity shippers have 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) in specially designed railcars, together with increasing highway traffic congestion and the shortage of long-haul truck drivers have contributed to this trend. Regional Developments There are a number of development projects underway in New England to increase port capacity along the extensive coastline and to improve the intermodal transportation and distribution infrastructure in the region. These projects present significant opportunities for the Company to increase its business. I-1 Quonset/Davisville The State of Rhode Island and the federal government are progressing with the redevelopment of a 1,000 acre portion of the former Naval facility at Quonset/Davisville to a more active port and industrial park. This facility already houses a number of rail oriented industries and an auto port. Construction of a freight rail improvement project to provide additional track capacity and double stack clearance on the Northeast Corridor between Quonset/Davisville and the connection of the Corridor to the Company's main line at Central Falls, RI commenced in 2002 at a cost of $148 million to Rhode Island and the federal government and was completed in October of 2006. Massachusetts Highway Improvement Program In 2005 work was completed on a significant expansion of the Company's bulk transload and intermodal yards in Worcester in conjunction with the Massachusetts Highway Department's $250 million project creating a direct Worcester connection to the Massachusetts Turnpike. This project adds six acres and over 4,000 feet of track storage space to the Company's transload facilities, and a major petrochemical distribution company is in the process of relocating its local plastics distribution business to Worcester in order to utilize this facility. Middletown/Hartford Line In cooperation with the state of Connecticut, the Company has been engaged in the restoration of the rail line extending from Middletown to Hartford, Connecticut. In April 2000, the state of Connecticut appropriated $1.85 million to fund their portion of the project (approx 70%). The restoration of this 11 mile segment is now complete and the line is in service. With a planned industrial park along this line and a new connection to other carriers in Hartford, the Company believes restoration of this line presents opportunities for future revenue growth. New London and Willimantic Interchanges Through its New London interchange with the New England Central Railroad ("NEC"), P&W has been able to develop significant new business with the Canadian National Railway ("CN") and the Canadian Pacific Railway ("CP"). The Company recently reactivated the Willimantic Interchange with the NEC further strengthening its connections with the CN and CP. Port of Providence The Port of Providence, in conjunction with the Company, has made investments in its infrastructure, including paving, lighting and "on dock" rail, to accommodate growth in the movement of imported coal to inland markets and to handle that product more efficiently. This is expected to be a significant source of revenue for the Company over the next few years. In October 2006, the Company initiated the rehabilitation 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. The Company expects rehabilitation to be completed in April 2007 and to see business develop from this endeavor during the second quarter of 2007. Railroad Operations The Company's rail freight system extends over approximately 516 miles of track. The Company interchanges freight traffic with CSX at Worcester, Massachusetts and at New Haven, Connecticut; with Pan Am Railways (formerly Springfield Terminal Railway Company) at Gardner, Massachusetts; with the New England Central Railroad at New London and Willimantic, Connecticut; and with the 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. It 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. I-2 By agreement with a private operator, the Company operates two approved customs intermodal yards in Worcester. A customs intermodal yard is an area containing tracks used for the loading and unloading of containers. These yards are U.S. Customs bonded, and international traffic must be inspected and approved by U.S. Customs officials. The intermodal facility serves primarily as a terminal for movement of container traffic from the Far East, Southeast Asia and Europe destined for points in New England. Several major container ship lines utilize double stack train service through this terminal. P&W works closely with the terminal operator to develop and maintain strong relationships with steamship lines involved in international intermodal transportation. Customers The Company serves approximately 165 customers in Massachusetts, Rhode Island, Connecticut and New York. The Company's 10 largest customers account for half of its operating revenues. In 2006, Tilcon Connecticut, Inc., which ships construction aggregate from three separate quarries on P&W's system to asphalt production plants in Connecticut and New York, accounted for 13.9% of the Company's operating revenues. No other customer accounted for 10% or more of its total operating revenues in 2006. Markets The Company transports a wide variety of commodities for its customers. In recent years, chemicals and plastics and construction aggregate were the two largest commodity groups transported by the Company, constituting 32% and 18%, respectively, of conventional carload freight revenues in 2006. The following table summarizes the Company's conventional carload freight revenues by commodity group as a percentage of such revenues: Commodity 2006 2005 2004 2003 2002 - --------- ---- ---- ---- ---- ---- Chemicals and plastics ............ 32% 31% 32% 33% 35% Construction aggregate ............ 18 16 15 16 20 Forest and paper products ......... 13 13 15 12 13 Food and agricultural products .... 11 11 11 12 12 Other, including coal ............. 11 10 9 8 5 Metal products .................... 10 14 11 10 7 Scrap metal and waste ............. 5 5 7 9 8 --- --- --- --- --- Total .......................... 100% 100% 100% 100% 100% === === === === === 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 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, the Company is able to offer its customers creative 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 to minimize the risk of derailments and believes its rail system is in good condition. I-3 Safety of the Company's operations is of paramount importance for the benefit and protection of the Company's employees, customers and the communities served by its rail lines. The Company and its employees have continued to make improvements in preventing injuries while at the same time increasing operations and expanding the work force. 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. Overhead traffic passes from one connecting carrier to another and neither originates nor terminates with shippers located on a railroad. Presently, P&W is solely an on-line carrier but may provide overhead service in the future for certain rail traffic to and from Long Island. Rail freight rates can be in various forms. Generally, customers are given a "through" rate, a single figure 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 between 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, receives revenue greater than an amount based simply on mileage hauled. Employees As of December 31, 2006, the Company had 149 full-time employees, 117 of whom are represented by three railroad labor organizations that are national in scope. The Company's employees have been represented by unions since the Company commenced independent operations in 1973. The Company's initial agreement with the United Transportation Union covering the 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 re-negotiation after the agreed-upon moratoria. The Company signed eight year agreements with the United Transportation Union (trainmen) in October 2005 and the Transportation Communications Union (clerical) in August 2006. Negotiations with the Brotherhood of Railroad Signalmen (maintenance) are currently underway. The Company considers its employee and labor relations to be good. Competition The Company is the only rail carrier serving businesses located on-line. However, the Company competes with other carriers in the location of new rail-oriented businesses in the region. Certain rail competitors, including CSX Transportation and Norfolk Southern, are 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. Any improvement in the cost or quality of these alternate modes of transportation, 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 the areas which it serves. 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. I-4 Governmental Regulation The Company is subject to governmental regulation by the United States Surface Transportation Board ("the STB"), the Federal Railroad Administration ("the FRA") 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 competitive position and profitability of the Company. 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 of the Company believes that the regulatory freedoms granted by the Staggers Rail Act have been beneficial to the Company by giving 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 material compliance with applicable environmental laws and regulations. Internet Address and SEC Reports We maintain 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. 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 1A. Risk Factors - --------------------- Fluctuations in Operating Revenues Historically, the Company's operating revenues have been tied to national and regional economic conditions, especially those impacting the manufacturing sector, while the Company's expenses have been relatively inelastic. Increasingly, the Company's business is impacted by global economic events. A downturn in general economic conditions could materially adversely affect the Company's business and results of operations. In addition, shifts in the New England economy between manufacturing and service sectors could materially affect the Company's performance. The Company's operating revenues and expenses have also fluctuated due to unpredictable events, such as adverse weather conditions and customer plant closings. While generally the Company has been able to replace revenues lost due to plant closings through expansion of existing business or replacement with new customers, there can be no assurance that it could do so in the future. The occurrence of such unpredictable events in the future could cause further fluctuations in operating revenues and expenses and materially adversely affect the Company's financial performance. Availability of Acquisition and Growth Opportunities and Associated Risks The Company believes that its ability to grow depends, in part, upon its ability to acquire additional connecting rail lines. There are a limited number of acquisition targets in the Company's market. In addition, in making acquisitions, the Company competes with other short-line and regional rail operators, some of which are larger and have greater financial resources than the Company. The growing competition for such acquisitions may cause an increase in acquisition prices and related costs, resulting in fewer attractive acquisition opportunities, which could materially adversely affect the Company's growth. No assurance can be given that the Company will be able to acquire I-5 suitable additional rail lines or that, if acquired, the Company would be able to successfully operate such additional rail lines. Acquisitions of additional rail lines may be subject to regulatory review and approval by the Surface Transportation Board. The Company is a Class II railroad and acquisitions made by Class II railroads are subject to a requirement that employees affected by an acquisition be paid up to one year severance. Competition For customers located directly on line, which constitute the majority of the Company's freight business, the Company is the only rail carrier providing direct service. However, the Company competes with other freight railroads in the location of new businesses in the region. The Company also competes with other modes of transportation, particularly long-haul trucking companies. Any improvement in the cost or quality of these alternate modes of transportation, for example, legislation granting increases in truck size or allowable weight, could increase this competition and materially affect the Company's business and results of operations. Customer Concentration The Company's ten largest customers accounted for approximately 50% of the Company's operating revenues for 2006 with one customer accounting for more than 13%. The Company's business could be materially adversely affected if any of these customers reduces shipments of commodities transported by the Company. Although in the past the Company has been able to replace revenues lost due to a reduction in existing customers' rail service requirements, no assurance can be given that it could do so in the future. Labor Issues Substantially all of the Company's non-management employees are represented by national railroad labor organizations. The Company's inability to satisfactorily conclude negotiations with unions could materially adversely affect the Company's operations and financial performance. Similarly, any protracted work stoppages against the Company's connecting railroads could materially adversely affect the Company's business and results of operations. Historically, Congress has intervened in such events to avoid disruptions in interstate commerce, but there can be no assurance that it would do so in the future. All railroad industry employees are covered by the Railroad Retirement Act and the Railroad Unemployment Insurance Act in lieu of Social Security and other federal and state unemployment insurance programs, and the Federal Employers Liability Act in lieu of state workers' compensation. Significant increases in the taxes payable pursuant to the Railroad Retirement Act would increase the Company's costs of operations. Relationships with Other Railroads The railroad industry in the United States is dominated by a small number of large Class I carriers that have substantial market control and negotiating leverage. A majority of the Company's carloadings is interchanged with a Class I carrier, CSX Transportation. A decision by CSX Transportation to discontinue serving routes or transporting certain commodities could materially adversely affect the Company's business. The Company's ability to provide rail service to its customers depends in large part upon its ability to maintain cooperative relationships with all its connecting carriers with respect to, among other matters, freight rates, car supply, interchange and trackage rights. A deterioration in the operating relationships with or service provided by those connecting carriers could materially adversely affect the Company's business. Rail Infrastructure and Availability of Government Programs Certain of the Company's growth opportunities are contingent upon anticipated improvements to P&W's existing rail infrastructure. No assurance can be given that the Company will be able to complete such projects as planned. Unforeseen delays or other problems which prevent completion of such improvements could materially adversely affect the Company's business and results of operations. In addition, the Company has worked with federal and state agencies to improve its rail infrastructure and has been effective in I-6 obtaining federal and state financial support for such projects. However, there can be no assurance that such federal and state programs or funds will be available in the future or that the Company will be eligible to participate in such programs. Failure to participate in federal and state programs or to receive federal or state funding for rail infrastructure improvements would cause the Company to incur the full cost of rail infrastructure improvements and significantly increase its costs of rail maintenance. Potential for Increased Governmental Regulation and Mandated Upgrade to Property The Company is subject to governmental regulation by the Surface Transportation Board, the Federal Railroad Administration 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 competitive position and profitability of the Company. Management of the Company believes that the regulatory freedoms granted by the Staggers Rail Act of 1980 (the "Staggers Rail Act") have been beneficial to the Company by giving 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 House of Representatives and Senate (which have jurisdiction over the 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. If enacted, these proposals, or court or administrative rulings to the same effect under current law, could materially adversely affect the Company's business and results of operations. Casualty Losses The Company has obtained insurance coverage for losses arising from personal injury and for property damage in the event of derailments or other accidents or occurrences. The Company believes that its insurance coverage is adequate based on its experience. However, under catastrophic circumstances such as accidents involving passenger trains or spillage of hazardous materials, the Company's liability could exceed its insurance limits. The Company transports hazardous chemicals throughout its system and conducts operations on the Northeast Corridor on which there is heavy passenger traffic. Insurance is available from only a limited number of insurers, and there can be no assurance that insurance protection at the Company's current levels will continue to be available or, if available, will be obtainable on terms acceptable to the Company. Losses or other liabilities incurred by the Company which are not covered by insurance or which exceed the Company's insurance limits could materially adversely affect the Company's financial condition, liquidity and results of operation. 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 transports hazardous materials and periodically uses hazardous material in its operations. While the Company believes it is in substantial compliance with all applicable environmental laws and regulations, any allegations or findings to the effect that the Company had violated such laws or regulations could materially adversely affect the Company's business and results of operations. The Company operates on properties that have been used for rail operations for over a century. There can be no assurance that historic releases of hazardous waste or materials will not be discovered, requiring remediation of Company properties, and that the cost of such remediation would not be material. Item 1B. Unresolved Staff Comments - ---------------------------------- None 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. I-7 Virtually all of the main lines on which the Company operates are in FRA class 3 condition (allowing 40 m.p.h. speeds) or better. The Company intends to maintain the main line tracks which it owns in such excellent condition. Of the approximately 516 miles of the Company's system, 306 miles, or 59%, 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%, 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 2,600 square feet are leased to outside tenants. 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 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 amount, 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 nearly $12 million in the development of the South Quay, which is adjacent to 12 acres of land owned by the Company. This investment has resulted in the creation of approximately 33 acres of waterfront land which is being held for future development. 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. Rolling Stock The following schedule sets forth the rolling stock owned by the Company as of December 31, 2006: Description Number ----------- ------ Locomotive .................................................. 31 Gondola ..................................................... 77 Flat Car .................................................... 5 Ballast Car ................................................. 30 Passenger Equipment ......................................... 7 Caboose ..................................................... 2 ------ Total .................................................. 152 ====== The 30 diesel electric locomotives, which include nine pre-owned 3,900 horsepower GE B39-8 locomotives acquired in 2002 and 2003 and three pre-owned GE B40-8 locomotives acquired in 2004 and 2005, are used on a daily basis, are maintained to a high standard, comply with all FRA and Association of American Railroads rules and regulations and are adequate for the needs of the Company's freight operations. The gondolas and flat cars are considered modern rail cars and are used by certain P&W customers. Other rail freight customers use their own freight cars or obtain such equipment from other sources. The ballast cars are used in track maintenance. From time to time, the Company has leased ballast cars to other adjoining railroads. The passenger equipment and caboose are not utilized in P&W's rail freight operations but are used on an occasional basis for Company functions, excursions and charter trips. I-8 Equipment P&W has a state-of-the-art 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. The system also enables each train crew to maintain radio contact with other crew members. The Company maintains a computer facility in Worcester with back-up computer facilities in Worcester and Plainfield, Connecticut to assure the Company's ability to operate in the event of disruption of service in Worcester. The Company also has state-of-the-art 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 modern 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 are equipped with the cab signal technology necessary for operations on the Northeast Corridor and are equipped with automatic civil speed enforcement systems which were required by the introduction of high speed passenger service on the Northeast Corridor. 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 $762,000) 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 will take approximately two or more years to complete. 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. ss. 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 $45,000 to settle this suit in March 2006. Item 4. Submission of Matters to a Vote of Security Holders - ----------------------------------------------------------- Not applicable. I-9 Part II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters and - -------------------------------------------------------------------------------- Issuer Purchases of Equity Securities ------------------------------------- The Common Stock is quoted on the American Stock Exchange ("AMEX") under the trading symbol "PWX". The following table sets forth, for the periods indicated, the high and low sale prices per share for the Common Stock as reported on the AMEX. Also included are dividends paid per share of Preferred Stock and Common Stock during these quarterly periods. Common Stock ------------ Trading Prices Dividends Paid -------------- -------------- High Low Preferred Common ---- --- --------- ------ 2005 - ---- First Quarter ........ $16.16 $12.10 $5.00 $ .04 Second Quarter ....... 14.97 12.50 -0- .04 Third Quarter ........ 15.20 13.20 -0- .04 Fourth Quarter ....... 15.40 12.52 -0- .04 2006 - ---- First Quarter ........ $16.99 $14.71 $5.00 $ .04 Second Quarter ....... 20.80 15.75 -0- .04 Third Quarter ........ 21.00 16.50 -0- .04 Fourth Quarter ....... 21.84 18.51 -0- .04 As of March 2, 2007, there were approximately 688 holders of record of the Company's common stock. The declaration of cash dividends on both the preferred and the common stock is made at the discretion of the Board of Directors based on the Company's earnings, financial condition, capital requirements and other relevant factors and restrictions. II-1 PERFORMANCE GRAPH PREPARED BY BURNHAM SECURITIES INC. FOR PROVIDENCE AND WORCESTER RAILROAD COMPANY. 5 - Year Return Providence and Worcester Railroad Company, U.S. Railroad Index and Russell 2000(R) Index [GRAPHIC OMITTED] [GRAPHIC OMITTED] Fiscal Years Ended December 31 ------------------------------ 2001 2002 2003 2004 2005 2006 - -------------------------- ----- ----- ----- ----- ----- ----- - -------------------------- ----- ----- ----- ----- ----- ----- PWX 97.0 119.9 121.9 162.5 120.2 143.1 U.S. Railroad Index 68.3 70.9 83.0 91.5 118.7 130.9 S&P Industrials 96.8 75.9 110.3 129.1 139.2 161.2 - -------------------------- ----- ----- ----- ----- ----- ----- The Russell 2000(R) Index measures the performance of small capitalization US companies by measuring the performance of the 2,000 smallest securities in the Russell 3000(R) Index. The U.S. Railroad Index is compiled by Burnham Securities Inc. and includes 10 railroad-operating companies. The Board of Directors recognizes that the market price of stock is influenced by many factors, only one of which is issuer performance. The Company's stock price may also be influenced by market perception, economic conditions and government regulation. The stock price performance shown in the graph is not necessarily an indicator of future price performance. II-2 Item 6. Selected Financial Data - ------------------------------- The selected financial data set forth below has been derived from the Company's audited financial statements. The data should be read in conjunction with the Company's audited financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the other information included elsewhere in this annual report on Form 10-K. As described in Note 2 to the financial statements included elsewhere in this annual report on Form 10-K the Company has restated its retained earnings as of January 1, 2004 and its net income for 2004 and 2005 to reflect its liability for accrued compensated time off and payroll taxes reduced by the related deferred income tax benefit. Years Ended December 31, 2006 2005 2004 2003 2002 (1) (1) (1) (1) ------- ------- ------- ------- ------- (in thousands, except per share amounts) Income Statement Data: Operating revenues .......... $28,451 $26,734 $24,943 $23,961 $22,868 Other income ................ 1,373 1,208 1,547 661 877 ------- ------- ------- ------- ------- Total Revenues .............. 29,824 27,942 26,490 24,622 23,745 Operating expenses .......... 28,222 26,114 24,854 23,592 23,725 ------- ------- ------- ------- ------- Income before income taxes... 1,602 1,828 1,636 1,030 20 Provision for income taxes... 560 615 631 387 15 ------- ------- ------- ------- ------- Net income .................. 1,042 1,213 1,005 643 5 Preferred Stock dividend .... 3 3 3 3 3 ------- ------- ------- ------- ------- Net income available to common shareholders ........ $ 1,039 $ 1,210 $ 1,002 $ 640 $ 2 ======= ======= ======= ======= ======= Basic and diluted income per common share ............... $ .23 $ .27 $ .22 $ .14 $ -- ======= ======= ======= ======= ======= Weighted average shares-basic ............... 4,523 4,496 4,470 4,449 4,429 ======= ======= ======= ======= ======= Weighted average shares-diluted ............. 4,602 4,574 4,548 4,516 4,497 ======= ======= ======= ======= ======= Cash dividends per share of Common Stock ............... $ 0.16 $ 0.16 $ 0.16 $ 0.16 $ 0.16 ======= ======= ======= ======= ======= December 31, 2006 2005 2004 2003 2002 (1) (1) (1) (1) ------- ------- ------- ------- ------- (in thousands) Balance Sheet Data: Total assets ................ $95,024 $93,484 $91,582 $90,711 $90,579 Shareholders' equity ........ 70,624 69,845 69,027 68,523 68,498 (1) Subsequent to the issuance of the 2005 financial statements, the Company determined that a liability for compensated time off had not been recorded. See Note 2 to the financial statements. The Company has restated its financial statements for all periods prior to September 30, 2006. The effect of this restatement increased operating expenses for the years ended December 31, 2005, 2004, 2003 and 2002 by $70, $52, $38 and $27, respectively, and decreased net income by $45, $33, $22 and $17 for the same periods, respectively. II-3 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. The statements contained in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MDA") which are not historical are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent the Company's present expectations or beliefs concerning future events. The Company cautions, however, that actual results could differ materially from those indicated in the MDA. Critical Accounting Policies 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. The Company's significant accounting policies are 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. Management believes that the Company's policy for the evaluation of long-lived asset impairment meets the SEC definition of critical. 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 factors 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. 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 shut-downs. 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. II-4 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 collectibility is assured. This income varies significantly from year to year. One of the Company's customers, Tilcon Connecticut, Inc., which ships construction aggregate from three separate quarries on the Company's rail system to asphalt production plants in Connecticut and New York, accounted for 13.9%, 13.3% and 12.6% of its operating revenues in 2006, 2005 and 2004, respectively. The Company does not believe that this customer will cease to be a rail shipper or will significantly decrease its freight volume in the foreseeable future. In the event that this customer should cease or significantly reduce its rail freight operations, management believes that the Company could restructure its operations to reduce operating costs by an amount sufficient to substantially offset the decrease in operating revenues. As described in Note 2 to the financial statements the Company has restated its statements of income for 2005 and 2004 to reflect its liability for accrued compensated time off and related payroll taxes. The impact of this restatement was to increase operating expenses (salaries, wages, payroll taxes and employee benefits) by $70,000 for 2005 and $52,000 for 2004 and to decrease the provision for income taxes by $25,000 for 2005 and $19,000 for 2004. Because the effects of the restatement are not material to any quarter, the Company does not anticipate amending its quarterly reports on Form 10Q for any period. Results of Operations The following table sets forth the Company's operating revenues by category in dollars and as a percentage of operating revenues: Years Ended December 31, ----------------------------------------------- 2006 2005 2004 ------------- -------------- ------------- (in thousands, except percentages) Freight Revenues: Conventional carloads ....... $23,443 82.4% $22,082 82.6% $20,705 83.0% Containers .................. 3,572 12.5 3,201 12.0 2,778 11.1 Other freight related ....... 876 3.1 850 3.2 836 3.4 Other operating revenues...... 560 2.0 601 2.2 624 2.5 ------- ----- ------- ----- ------- ----- Total ...................... $28,451 100.0% $26,734 100.0% $24,943 100.0% ======= ===== ======= ===== ======= ===== 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, ----------------------------------------------- 2006 2005 2004 ------------- -------------- ------------- (in thousands, except percentages) Chemicals and plastics ....... $ 7,455 31.8% $ 6,923 31.4% $ 6,684 32.3% Construction aggregate ....... 4,173 17.8 3,485 15.8 3,102 15.0 Forest and paper products..... 3,047 13.0 2,917 13.2 3,036 14.7 Food and agricultural products 2,649 11.3 2,391 10.8 2,325 11.2 Coal and other................ 2,462 10.5 2,219 10.0 1,868 9.0 Metal products................ 2,391 10.2 2,985 13.5 2,222 10.7 Scrap metal and waste......... 1,266 5.4 1,162 5.3 1,468 7.1 ------- ----- ------- ----- ------- ----- Total ...................... $23,443 100.0% $22,082 100.0% $20,705 100.0% ======= ===== ======= ===== ======= ===== II-5 The following table sets forth a comparison of the Company's operating expenses expressed in dollars and as a percentage of operating revenues: Years Ended December 31, ----------------------------------------------- 2006 2005 2004 ------------- -------------- ------------- (in thousands, except percentages) Salaries, wages, payroll taxes and employee benefits ....... $14,945 52.5% $14,471 54.1% $13,810 55.4% Casualties and insurance ..... 956 3.4 1,084 4.1 1,409 5.6 Depreciation ................. 2,829 9.9 2,764 10.3 2,764 11.1 Diesel fuel .................. 2,495 8.8 2,014 7.5 1,348 5.4 Car hire, net ................ 1,096 3.9 1,123 4.2 954 3.8 Purchased services, including legal and professional fees . 1,947 6.8 1,564 5.9 1,357 5.4 Repairs and maintenance of equipment ................... 1,943 6.8 1,280 4.8 1,046 4.2 Track and signal materials ... 2,949 10.4 2,428 9.1 1,862 7.5 Track usage fees ............. 829 2.9 827 3.1 899 3.6 Other materials and supplies . 1,239 4.4 1,016 3.8 1,060 4.3 Other ........................ 1,891 6.6 1,680 6.3 1,628 6.5 ------- ----- ------- ----- ------- ----- Total ....................... 33,119 116.4 30,251 113.2 28,137 112.8 Less capitalized and recovered costs ............ 4,897 17.2 4,137 15.5 3,283 13.2 ------- ----- ------- ----- ------- ----- Total ...................... $28,222 99.2% $26,114 97.7% $24,854 99.6% ======= ===== ======= ===== ======= ===== Year Ended December 31, 2006 Compared to Year Ended December 31, 2005 Operating Revenues Operating Revenues increased $1.7 million, or 6.4%, to $28.4 million in 2006 from $26.7 million in 2005. This increase was the result of a $1.4 million (6.2%) increase in conventional freight revenues, a $371,000 (11.6%) increase in container freight revenues and a $26,000 (3.1%) increase in other freight related revenues, slightly offset by a $41,000 (6.8%) decrease in other operating revenues. The increase in conventional freight revenues results from a 1.7% increase in traffic volume and a 4.3% increase in the average revenue received per carloading. The Company's conventional carloadings increased by 577 to 33,780 in 2006 from 33,203 in 2005. Rate increases, including diesel fuel surcharges, as well as a shift in the mix of commodities hauled account for the increase in the average revenue per carloading. The increase in container freight revenues results from an 11.1% increase in the average revenue received per container and a small (.4%) increase in traffic volume. Intermodal containers handled increased by 278 to 63,183 in 2006 from 62,905 in 2005. The increase in the average revenue received per container is attributable to contractual rate adjustments based upon railroad industry cost indices, as well as a shift in the mix of traffic toward higher rated containers. The increase in other freight related revenues results from increased billings for demurrage and secondary switching services. The decrease in other operating revenues reflects a decrease in maintenance department billings. Revenues of this type vary from year to year depending upon the needs of freight customers and other outside parties. Other Income Other income increased by $165,000 to $1.4 million in 2006 from $1.2 million in 2005. This increase is the result of increased gains from the sale of property and equipment, rentals and interest income. II-6 Operating Expenses Operating expenses increased $2.1 million, or 8.1%, to $28.2 million in 2006 from $26.1 million in 2005. Operating expenses amounted to 99.2% of operating revenues in 2006 compared to 97.7% in 2005. Increased costs of diesel fuel, equipment repairs and maintenance and personnel expense account for a substantial portion of this increase. Provision for Income Taxes The Company's income tax provision for 2006 amounts to 35% of income before Income taxes compared to 34% in 2005. Railroad tax maintenance credits in the amount of $36.000 were utilized to reduce the 2006 provision compared to $65,000 in 2005. Year Ended December 31, 2005 Compared to Year Ended December 31, 2004 Operating Revenues Operating revenues increased $1.8 million, or 7.2%, to $26.7 million in 2005 from $24.9 million in 2004. This increase was the result of a $1.4 million (6.7%) increase in conventional freight revenues, a $423,000 (15.2%) increase in container freight revenues and a $14,000 (1.7%) increase in other freight related revenues partially offset by a $23,000 (3.7%) decrease in other operating revenues. The increase in conventional freight revenues results from a 6.8% increase in the average revenue received per conventional carload. Conventional traffic volume decreased slightly (.1%) between years. The Company's conventional carloadings decreased by 41 to 33,203 in 2005 from 33,244 in 2004. Rate increases, including diesel fuel surcharges, and a shift in the mix of commodities hauled account for the increase in the average rate received per conventional carload. Increases in carloadings of metal products and coal were largely offset by smaller decreases in carloadings of various other commodities. The increase in container freight revenues results from an 18.7% increase in the average revenue received per container partially offset by a 3.0% decrease in container traffic volume. Intermodal containers handled during 2005 decreased by 1,913 to 62,905 from 64,818 in 2004. The increase in the average revenue received per container is attributable to contractual rate adjustments as well as a shift in the mix of containers handled. The increase in other freight related revenues results from increased demurrage billings largely offset by decreases in secondary switching and other charges. This increased demurrage revenue offsets the increased car hire expense incurred during the year. The decrease in other operating revenues results from an overall reduction in maintenance department billings. Other Income Other income decreased by $339,000 to $1.2 million in 2005 from $1.5 million in 2004. The decrease results from the fact that 2004 includes a $948,000 gain realized on the disposal of a portion of a branch line which the Commonwealth of Massachusetts acquired by eminent domain during the year, whereas 2005 did not include any gains of that magnitude. Revenues of this nature typically vary from year to year. Operating Expenses Operating expenses increased by $1.3 million, or 5.1%, to $26.1 million in 2005 from $24.8 million in 2004. Expressed as a percentage of operating revenues, however, operating expenses decreased to 97.7% in 2005 compared to 99.6% in 2004. Diesel fuel expense for the year increased by $666,000 reflecting the high cost of petroleum products in effect in 2005. Car hire expense increased by $169,000 during the year which costs were largely offset by increased demurrage revenue as previously discussed. Provision for Income Taxes The Company's income tax provision for 2005 amounts to 34% of income before income taxes compared to 39% in 2004. The largest component of this decrease is $65,000 of railroad tax maintenance credits which the Company was able to utilize in 2005 to reduce its current income tax provision. II-7 Liquidity and Capital Resources The Company generated $3.8 million, $4.9 million and $3.1 million of cash from operations in 2006, 2005 and 2004, respectively. The Company's total cash and cash equivalents decreased by $810,000 in 2006 and increased by $328,000 in 2005 and $503,000 in 2004. The principal utilization of cash during the three year period was for expenditures for property and equipment acquisitions and payment of dividends. During 2006, 2005 and 2004 the Company generated $863,000, $691,000 and $1.5 million, respectively, from the sales and disposals of properties not considered essential for railroad operations and from the granting of easements and licenses. The Company holds various properties which could be made available for sale, lease or grants of easements and licenses. Revenues from sales of properties, easements and licenses can vary significantly from year to year. In August 2006, the Company's principal bank increased the Company's revolving line of credit to $5.0 million through May 31, 2007. Borrowings under this line are unsecured and bear interest at either the prime rate or one and one half per cent over either the one or three month London Interbank Offered Rates. The Company does not pay any commitment fee on this line and has no compensating balance requirements. The Company had no advances against this line of credit during 2006 and 2005. Substantially all of the mainline track owned by the Company meets FRA Class 3 standards (permitting freight train speeds of 40 miles per hour), and the Company intends to continue to maintain this track at this level. The Company expended $4.1 million, $3.1 million and $2.5 million for track structure and bridge improvements in 2006, 2005 and 2004, respectively. Deferred grant income of $121,000 in 2006, $411,000 in 2005 and $39,000 in 2004 financed a portion of these improvements. Management estimates that $3.0 million to $4.0 million of improvements to the Company's track structure and bridges will be made in 2007, provided that sufficient funds, including grant proceeds, are available. Improvements to the Company's track structure are made, for the most part, by the Company's Maintenance of Way Department personnel. In 2006, the Company paid dividends in the amount of $5.00 per share, aggregating $3,000, on its outstanding noncumulative preferred stock and $0.16 per share, aggregating $723,000, on its outstanding common stock. Continued payment of such dividends is contingent upon the Company's continuing to have the necessary financial resources available. 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 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 $762,000) 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 will take approximately two or more years to complete. 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. II-8 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. ss. 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 $45,000 to settle this suit in March 2006. Land Held for Development 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"). The permits for the property, both of which have been extended to 2009, also allow for construction of a dock along the west face of the South Quay. The property, which has a carrying value of $12.0 million, is adjacent to a 12 acre site also owned by the Company. The property is located a half mile from I-195. In 2006, the Rhode Island Department of Transportation awarded a contract for roadway improvements to provide direct vehicular access from the interstate highway system to the South Quay. The project is anticipated to be substantially complete by the end of 2007. 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. Selected Quarterly Financial Data Historically the Company has experienced lower operating revenues in the first quarter of the year. The following table sets forth selected financial data for each quarter of 2006 and 2005. The information for each of these quarters is unaudited but includes all normal recurring adjustments that the Company considers necessary for a fair presentation. These results, however, are not necessarily indicative of results for any future period. Results for the first three quarters of 2006 and all four quarters of 2005 have been restated to reflect the recording of the Company's liability for accrued compensated time off and payroll taxes reduced by the related income tax benefit as described in Note 2 to the financial statements. II-9 Year Ended December 31, 2006 -------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter (as restated, see Note 2 to the financial statements) ------- ------- ------- ------- (in thousands, except per share amounts) Operating Revenues .................... $ 6,607 $ 7,243 $ 7,786 $ 6,815 Other income .......................... 180 244 682 267 ------- ------- ------- ------- Total revenues ........................ 6,787 7,487 8,468 7,082 Operating expenses .................... 7,188 7,080 7,134 6,820 ------- ------- ------- ------- Income (loss) before income taxes (benefit) ............................ (401) 407 1,334 262 Provision for income taxes (benefit) ............................ (132) 148 425 119 ------- ------- ------- ------- Net income (loss) ..................... $ (269) $ 259 $ 909 $ 143 ------- ------- ------- ------- Basic and diluted income (loss) per common share ......................... $ (.06) $ .06 $ .20 $ .03 ------- ------- ------- ------- As originally reported: Operating expenses .................... $ 7,162 $ 7,052 $ 7,106 Income (loss) before income taxes (benefit) ............................ (375) 435 1,362 Provision for income taxes (benefit) ............................ (123) 158 435 Net income (loss) ..................... (252) 277 927 Year Ended December 31, 2005 -------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter (as restated, see Note 2 to the financial statements) ------- ------- ------- ------- (in thousands, except per share amounts) Operating Revenues .................... $ 5,640 $ 6,588 $ 7,449 $ 7,057 Other income ........................ 195 164 133 716 ------- ------- ------- ------- Total revenues ........................ 5,835 6,752 7,582 7,773 Operating expenses .................... 6,221 6,433 6,493 6,947 ------- ------- ------- ------- Income (loss) before income taxes (benefits) ........................... (386) 299 1,089 826 Provision for income taxes (benefits) ........................... (120) 103 398 234 ------- ------- ------- ------- Net income (loss) ..................... $ (266) $ 196 $ 691 $ 592 ------- ------- ------- ------- Basic and diluted income (loss) per common share ......................... $ (.06) $ .05 $ .15 $ .13 ------- ------- ------- ------- As originally reported: Operating expenses .................... $ 6,205 $ 6,435 $ 6,475 $ 6,929 Income (loss) before income taxes (benefit) ............................ (370) 317 1,107 844 Provision for income taxes (benefits) ........................... (120) 110 405 240 Net income (loss) ..................... (255) 207 702 604 Basic and diluted income (loss) per common share ......................... $ (.06) $ .05 $ .16 $ .13 Inflation In recent years, inflation has not had a significant impact on the Company's operations. II-10 Seasonality Historically, the Company's operating revenues are lowest for the first quarter due to the absence of construction aggregate shipments during this period and to winter weather conditions. Recent Accounting Pronouncements In July 2006, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), an interpretation of Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes. FIN 48 clarifies the accounting for uncertainty in tax positions and requires that the impact of tax positions be recorded in the financial statements, if it is more likely than not that such position will be sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for the Company beginning January 1, 2007. The Company does not expect that the adoption of FIN 48 will have a material effect on the Company's financial position or results of operations. In September 2006, the FASB issued SFAS 157, Fair Value Measurements, which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. The provisions of SFAS 157 are effective for the Company beginning January 1, 2008. The Company has not yet adopted this pronouncement and is currently evaluating the expected impact that the adoption of SFAS 157 will have on its financial position and results of operations. In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits companies to elect to measure certain eligible items at fair value. Subsequent unrealized gains and losses on those items will be reported in earnings. Upfront costs and fees related to those items will be reported in earnings as incurred and not deferred. SFAS 159 is effective for the Company beginning January 1, 2008. If a company elects to apply the provisions of the statement to eligible items existing at that date, the effect of the remeasurement to fair value will be reported as a cumulative effect adjustment to the opening balance of retained earnings. Retrospective application will not be permitted. The Company is currently assessing whether it will elect to use the fair value option for any of the eligible items. Item 7A. Quantitative and Qualitative Disclosures About Market Risk - ------------------------------------------------------------------- Cash and Cash Equivalents As of December 31, 2006, the Company is exposed to market risks which primarily include changes in U.S. interest rates. The Company invests cash balances in excess of operating requirements in short-term securities, generally with maturities of 90 days or less. In addition, the Company's revolving line of credit agreement provides for borrowings which bear interest at variable rates based on either prime rate or one and one half percent over either the one or three month London Interbank Offered Rates. The Company had no borrowings outstanding pursuant to the revolving line of credit agreement at December 31, 2006. The Company believes that the effect, if any, of reasonably possible near-term changes in interest rates on the Company's financial position, results of operations, and cash flows should not be material. II-11 Item 8. Financial Statements and Supplementary Data - --------------------------------------------------- PROVIDENCE AND WORCESTER RAILROAD COMPANY INDEX TO FINANCIAL STATEMENTS Page ---- Report of Independent Registered Public Accounting Firm................................................ II-12 Balance Sheets as of December 31, 2006 and 2005...... II-13 Statements of Income for the Years Ended December 31, 2006, 2005 and 2004................................. II-14 Statements of Shareholders' Equity for the Years Ended December 31, 2006, 2005 and 2004.................... II-15 Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004.................... II-16 Notes to Financial Statements........................ II-17 II-12 Report of Independent Registered Public Accounting Firm - ------------------------------------------------------- To the Board of Directors and Shareholders of Providence and Worcester Railroad Company Worcester, Massachusetts We have audited the accompanying balance sheets of Providence and Worcester Railroad Company (the "Company") as of December 31, 2006 and 2005, and the related statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness on the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Providence and Worcester Railroad Company as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 2 to the financial statements, the accompanying 2005 and 2004 financial statements have been restated. /s/ Deloitte & Touche LLP Boston, Massachusetts March 23, 2007 II-13 PROVIDENCE AND WORCESTER RAILROAD COMPANY BALANCE SHEETS (Dollars in Thousands Except Per Share Amounts) December 31, 2006 2005 (as restated, see Note 2) ------- ------- ASSETS Current Assets: Cash and cash equivalents ........................... $ 1,253 $ 2,063 Accounts receivable, net of allowance for doubtful accounts of $175 in 2006 and 2005 ......... 3,244 3,202 Materials and supplies .............................. 1,483 1,654 Prepaid expenses and other current assets ........... 148 152 Deferred income taxes ............................... 347 329 ------- ------- Total Current Assets ............................... 6,475 7,400 Property and Equipment, net .......................... 76,591 74,126 Land Held for Development ............................ 11,958 11,958 ------- ------- Total Assets ......................................... $95,024 $93,484 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable .................................... $ 2,717 $ 1,905 Accrued expenses .................................... 1,433 1,853 ------- ------- Total Current Liabilities .......................... 4,150 3,758 ------- ------- Profit-Sharing Plan Contribution ..................... 178 211 ------- ------- Deferred Income Taxes ................................ 12,051 11,530 ------- ------- Deferred Grant Income ................................ 8,021 8,140 ------- ------- Commitments and Contingent Liabilities (Note 10)...... Shareholders' Equity: Preferred stock, 10% noncumulative, $50 par value; authorized, issued and outstanding 640 shares in 2006 and 645 shares in 2005 .............. 32 32 Common stock, $.50 par value; authorized 15,000,000 shares; issued and outstanding 4,534,056 shares in 2006 and 4,507,056 shares in 2005 ............................................ 2,267 2,254 Additional paid-in capital .......................... 30,680 30,230 Retained earnings ................................... 37,645 37,329 ------- ------- Total Shareholders' Equity ......................... 70,624 69,845 ------- ------- Total Liabilities and Shareholders' Equity ........... $95,024 $93,484 ======= ======= The accompanying notes are an integral part of the financial statements. II-14 PROVIDENCE AND WORCESTER RAILROAD COMPANY STATEMENTS OF INCOME (Dollars in Thousands Except Per Share Amounts) Years Ended December 31, 2006 2005 2004 (as restated,(as restated, see Note 2) see Note 2) -------- -------- -------- Revenues: Operating Revenues ........................... $28,451 $26,734 $24,943 Other Income ................................. 1,373 1,208 1,547 -------- -------- -------- Total Revenues ............................. 29,824 27,942 26,490 -------- -------- -------- Expenses: Operating: Maintenance of way and structures ........... 3,971 3,776 3,414 Maintenance of equipment .................... 3,692 2,908 2,661 Transportation .............................. 8,555 7,892 7,335 General and administrative .................. 4,544 4,333 4,205 Depreciation ................................ 2,829 2,764 2,764 Taxes, other than income taxes .............. 2,299 2,056 2,217 Car hire, net ............................... 1,095 1,123 954 Employee retirement plans ................... 408 435 405 Track usage fees ............................ 829 827 899 -------- -------- -------- Total Operating Expenses ................... 28,222 26,114 24,854 -------- -------- -------- Income before Income Taxes .................... 1,602 1,828 1,636 Provision for Income Taxes .................... 560 615 631 -------- -------- -------- Net Income .................................... 1,042 1,213 1,005 Preferred Stock Dividends ..................... 3 3 3 -------- -------- -------- Net Income Available to Common Shareholders ... $ 1,039 $ 1,210 $ 1,002 ======= ======= ======= Basic and Diluted Income Per Common Share ..... $ .23 $ .27 $ .22 ======= ======= ======= The accompanying notes are an integral part of the financial statements. II-15 PROVIDENCE AND WORCESTER RAILROAD COMPANY STATEMENTS OF SHAREHOLDERS' EQUITY (Dollars in Thousands Except Per Share Amounts) Years Ended December 31, 2006, 2005 and 2004 Additional Share- Preferred Common Paid-in Retained holders' Stock Stock Capital Earnings Equity ------- ------- ------- ------- ------- Balance, January 1, 2004 as previously reported... $ 32 $ 2,229 $29,709 $36,721 $68,691 Prior period corrections (See Note 2) ............ -- -- -- (168) (168) ------- ------- ------- ------- ------- Balance, January 1, 2004 (as restated,see Note 2). $ 32 $ 2,229 $29,709 $36,553 $68,523 Issuance of 12,628 common shares to fund the Company's 2003 profit sharing plan contribution ............ 6 113 119 Issuance of 10,885 common shares for stock options exercised, employee stock purchases, and other .... 6 92 98 Dividends paid: Preferred stock, $5.00 per share .................. (3) (3) Common stock, $.16 per share (715) (715) Net income for the year (as restated,see Note 2). 1,005 1,005 ------- ------- ------- ------- ------- Balance, December 31, 2004 (as restated,see Note 2). 32 2,241 29,914 36,840 69,027 Issuance of 13,980 common shares to fund the Company's 2004 profit sharing plan contribution ............ 7 181 188 Issuance of 12,069 common shares for stock options exercised, employee stock purchases, and other .... 6 135 141 Dividends paid: Preferred stock, $5.00 per share .................. (3) (3) Common stock, $.16 per share (721) (721) Net income for the year (as restated,see Note 2). 1,213 1,213 ------- ------- ------- ------- ------- Balance, December 31, 2005 (as restated,see Note 2). 32 2,254 30,230 37,329 69,845 Issuance of 13,011 common shares to fund the Company's 2005 profit sharing plan contribution ............ 6 205 211 Issuance of 13,489 common shares for stock options exercised, employee stock purchases, and other .... 7 158 165 Conversion of 5 shares of preferred stock into 500 shares of common stock .. -- -- -- Share-based compensation 87 87 Dividends paid: Preferred stock, $5.00 per share .................. (3) (3) Common stock, $.16 per share (723) (723) Net income for the year .. 1,042 1,042 ------- ------- ------- ------- ------- Balance, December 31, 2006. $ 32 $ 2,267 $30,680 $37,645 $70,624 ======= ======= ======= ======= ======= The accompanying notes are an integral part of the financial statements. II-16 PROVIDENCE AND WORCESTER RAILROAD COMPANY STATEMENTS OF CASH FLOWS (Dollars in Thousands) Years Ended December 31, 2006 2005 2004 (as restated,(as restated, see Note 2) see Note 2) ------- ------- ------- Cash Flows from Operating Activities: Net income ................................... $ 1,042 $ 1,213 $ 1,005 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation ............................... 2,829 2,764 2,764 Amortization of deferred grant income ...... (240) (234) (229) Profit-sharing plan contribution to be funded with common stock ................. 178 211 188 Gains from sale, condemnation and disposal of property, equipment and easements, net ........................... (766) (691) (1,081) Deferred income taxes ...................... 503 395 831 Share-based compensation ................... 115 29 3 Increase (decrease) in cash and cash equivalents from: Accounts receivable ...................... (127) 425 122 Materials and supplies ................... 171 235 (118) Prepaid expenses and other ............... 4 87 -- Accounts payable and accrued expenses .... 77 475 (344) ------- ------- ------- Net cash flows from operating activities ..... 3,786 4,909 3,141 ------- ------- ------- Cash Flows from Investing Activities: Purchase of property and equipment ........... (5,077) (5,011) (3,659) Proceeds from sale and condemnation of property, equipment and easements ........... 863 691 1,488 ------- ------- ------- Net cash flows used in investing activities (4,214) (4,320) (2,171) ------- ------- ------- Cash Flows from Financing Activities: Dividends paid ............................... (726) (724) (718) Issuance of common shares for stock options exercised and employee stock purchases ...... 137 112 95 Proceeds from deferred grant income........... 207 351 156 ------- ------- ------- Net cash flows used in financing activities .. (382) (261) (467) ------- ------- ------- Increase (Decrease) in Cash and Cash Equivalents .................................. (810) 328 503 Cash and Cash Equivalents, Beginning of Year .. 2,063 1,735 1,232 ------- ------- ------- Cash and Cash Equivalents, End of Year ........ $ 1,253 $ 2,063 $ 1,735 ======= ======= ======= Supplemental Disclosures: Cash paid during year for income taxes ....... $ 136 $ -- $ -- ======= ======= ======= The accompanying notes are an integral part of the financial statements. II-17 PROVIDENCE AND WORCESTER RAILROAD COMPANY NOTES TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 (Dollars in Thousands Except Per Share Amounts) 1. Description of Business and Summary of Significant Accounting Policies Description of Business ----------------------- Providence and Worcester Railroad Company (the "Company") is an interstate freight carrier conducting railroad operations in Massachusetts, Rhode Island, Connecticut and New York. Through its connecting carriers, it services customers located throughout North America. One customer accounted for 13.9%, 13.3% and 12.6% of the Company's operating revenues in 2006, 2005 and 2004, respectively, and this customer accounted for 13.9% and .7% of total accounts receivable at December 31, 2006 and 2005, respectively. Cash and Cash Equivalents ------------------------- The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents for purposes of classification in the balance sheets and statements of cash flows. Cash equivalents are stated at cost, which approximates fair market value. Materials and Supplies ---------------------- Materials and supplies, which consist of items for the improvement and maintenance of track structure and equipment, are stated at cost, determined on a first-in, first-out basis, and are charged to expense or added to the cost of property and equipment when used. Property and Equipment ---------------------- Property and equipment, including land held for development, is stated at historical cost (including self-construction costs). Acquired railroad property is recorded at the purchased cost. Major renewals or betterments are capitalized while routine maintenance and repairs, which do not improve or extend asset lives, are charged to expense when incurred. Gains or losses on sales or other dispositions are credited or charged to income. Depreciation is provided using the straight-line method over the estimated useful lives of the assets as follows: Track structure 20 to 67 years Buildings and other structures 33 to 45 years Equipment, including rolling stock 4 to 25 years 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 factors 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 it is measured by comparing the carrying value to the fair value. Deferred Grant Income --------------------- The Company has availed itself of various federal and state programs administered by the states of Connecticut, Massachusetts and Rhode Island for reimbursement of expenditures for capital improvements. In order to receive reimbursement, the Company must submit requests for the projects, including cost estimates. The Company receives from 70% to 100% of the costs of such projects, which have included bridges, track structure and public improvements. To the extent that such grant proceeds are used to fund capital improvements to bridges and track structure, they are recorded as deferred grant income and amortized into operating revenues on a straight-line basis over the estimated useful lives of the related improvements ($240 in 2006, $234 in 2005 and $229 in 2004). II-18 Grant proceeds utilized to finance public improvements, such as grade crossings and signals, are recorded as a direct offset to the cost of the improvements, which are not capitalized. Revenue Recognition ------------------- Freight revenues are recorded at the time delivery is made to the customer or the connecting carrier. Other freight related revenues and other operating revenues are recorded at the time the services are rendered to the customer. Gain or loss from sale, condemnation and disposal of property and equipment and easements is recorded at the time the transaction is consummated and collectibility is assured. Income Taxes ------------ Deferred income taxes are recorded based on the differences between the financial statement and tax basis of assets and liabilities. Such deferred income taxes are also adjusted to reflect changes in the U.S. tax laws when enacted and changes in state tax rates. Valuation allowances are recorded against deferred tax assets that are not expected to be realized. Income per Common Share ----------------------- Basic income per common share is computed using the weighted average number of common shares outstanding during each year. Diluted income per common share reflects the effect of the Company's outstanding convertible preferred stock (using the if-converted method) and options (using the treasury stock method), except where such items would be antidilutive. A reconciliation of weighted average shares used for the basic computation and that used for the diluted computation is as follows: Years Ended December 31, 2006 2005 2004 --------- --------- --------- Weighted average shares for basic ...... 4,522,763 4,495,683 4,470,332 Dilutive effect of convertible preferred stock and options ..................... 79,603 77,975 77,278 --------- --------- --------- Weighted average shares for diluted .... 4,602,366 4,573,658 4,547,610 ========= ========= ========= Options to purchase 3,731, 5,029 and 11,110 shares of common stock were outstanding during 2006, 2005 and 2004, respectively, but were not included in the computation of diluted earnings per common share because their effect would be antidilutive. Use of Estimates ---------------- The preparation of the Company's financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. The Company's principal estimates include the allowance for doubtful accounts, useful lives of properties, accrued liabilities including health insurance claims and legal and other contingencies, and income taxes. o The Company had a self funded medical plan with stop-loss insurance which covered all of its full time employees. Medical claims were paid from a claims fund which the Company contributed to monthly. The estimated liability for unpaid claims incurred was adjusted at the end II-19 of each reporting period based upon historical experience modified by actual claim payments made through the date the financial statements were issued. This plan was discontinued in 2006 and replaced by insured plans for which the Company has no liability for unpaid claims. o Liabilities for casualty claims, legal judgments and other loss contingencies are recorded when it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. The Company does not accrue estimated legal fees for appeals of legal judgments since we do not believe that such costs meet the definition of a liability and thus are accruable only at such time as legal services have been provided. Comprehensive Income -------------------- Comprehensive Income equals net income for 2006, 2005 and 2004. Segment Reporting ----------------- The Company organizes itself as one segment reporting to the chief operating decision maker. Products and services consist primarily of interstate freight rail services. These include the movement of freight in both conventional freight cars and in intermodal containers on flat cars over the Company's rail lines, as well as freight related services such as switching, weighing and special trains and other services rendered to freight customers and other outside parties by the Company's Maintenance of Way, Communications & Signals and Maintenance of Equipment Departments. Recently Issued Financial Accounting Standards ---------------------------------------------- In July 2006, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), an interpretation of Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes. FIN 48 clarifies the accounting for uncertainty in tax positions and requires that the impact of tax positions be recorded in the financial statements, if it is more likely than not that such position will be sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for the Company beginning January 1, 2007. The Company does not expect that the adoption of FIN 48 will have a material effect on the Company's financial position or results of operations. In September 2006, the FASB issued SFAS 157, Fair Value Measurements, which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. The provisions of SFAS 157 are effective for the Company beginning January 1, 2008. The Company has not yet adopted this pronouncement and is currently evaluating the expected impact that the adoption of SFAS 157 will have on its financial position and results of operations. In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits companies to elect to measure certain eligible items at fair value. Subsequent unrealized gains and losses on those items will be reported in earnings. Upfront costs and fees related to those items will be reported in earnings as incurred and not deferred. SFAS 159 is effective for the Company beginning January 1, 2008. If a company elects to apply the provisions of the statement to eligible items existing at that date, the effect of the remeasurement to fair value will be reported as a cumulative effect adjustment to the opening balance of retained earnings. Retrospective application will not be permitted. The Company is currently assessing whether we will elect to use the fair value option for any of the eligible items. II-20 2. Restatement of Previously Issued Financial Statements Subsequent to the issuance of the 2005 financial statements, the Company determined that its liability for accrued compensated time off had not been recorded. The Company's contracts with the labor unions representing its union employees require the Company to provide employees with accrued compensated time off at the rate of one or one and one half hours, as applicable, for each hour worked in excess of eight hours per day (for a five-day work week) or forty hours per week. The Company did not accrue any liability for such compensation and related payroll taxes in the past. The misstatements, although not material to the annual periods, were considered material to the fourth quarter of 2006 and therefore the Company has restated its financial statements as follows: o Retained earnings as of January 1, 2004 has been reduced by $168 as a result of a liability of $260 for accrued payroll and payroll taxes reduced by the related deferred income tax benefit of $92. The accrued payroll and payroll taxes liability increased to $382 and $312 at December 31, 2005 and 2004, respectively. o Salaries and wages and the related payroll taxes included in operating expenses increased by $70 and $52 for the years ended December 31, 2005 and 2004, respectively. o Net income has been reduced by $45 ($.01 per Common Share) and by $33 ($.01 per Common Share) for 2005 and 2004, respectively. In addition, the Company has reclassified the proceeds from deferred grant income in the statements of cash flows from investing activities to financing activities. The proceeds from deferred grant income totaled $351 and $156 in the years ended December 31, 2005 and 2004, respectively. The effects of the restatement adjustments on the Balance Sheet, Statements of Income and Statements of Cash Flows are summarized as follows: II-21 2005 2004 ------------------------ ------------------------ As As Previously Adjust- As Previously Adjust- As Reported ment Restated Reported ment Restated ------------------------ ------------------------ Balance Sheet at December 31: Deferred income taxes..... $ 193 $ 136 $ 329 Total Current Assets..... 7,264 136 7,400 Total Assets ............. 93,348 136 93,484 Accrued expenses ......... 1,471 382 1,853 Total Current Liabilities ............. 3,376 382 3,758 Retained earnings ........ 37,575 (246) 37,329 Total Liabilities and Shareholders' Equity..... 93,348 136 93,484 Statement of Income for the year ended December 31: Operating Expenses: Maintenance of Way and structures ............ $ 3,739 $ 37 $ 3,776 $ 3,404 $ 10 $ 3,414 Maintenance of equipment ............. 2,886 22 2,908 2,627 34 2,661 Taxes, other than income taxes .......... 2,045 11 2,056 2,209 8 2,217 Total Operating Expenses ............... 26,044 70 26,114 24,802 52 24,854 Income before Income Taxes .................. 1,898 (70) 1,828 1,688 (52) 1,636 Provision for Income Taxes .................. 640 (25) 615 650 (19) 631 Net Income .............. 1,258 (45) 1,213 1,038 (33) 1,005 Net Income Available to Common Shareholders .... 1,255 (45) 1,210 1,035 (33) 1,002 Basic and diluted Income per share ....... $ 0.28 $(0.01) $ 0.27 $ 0.23 $(0.01) $ 0.22 Statements of Cash Flows for the year ended December 31: Cash flows from operating activities: Net income ............. $ 1,258 $ (45) $ 1,213 $ 1,038 $ (33) $ 1,005 Deferred income taxes .. 420 (25) 395 850 (19) 831 Accounts payable and accrued expenses ...... 405 70 475 (396) 52 (344) Net cash flows from operating activities .. 4,909 -- 4,909 3,141 -- 3,141 Net cash flows used in investing activities... (3,969) (351) (4,320) (2,015) (156) (2,171) Net cash flows used in financing activities .. (612) 351 (261) (623) 156 (467) II-22 3. Share-Based Compensation The Company has a non-qualified stock option plan ("SOP") covering all management personnel who have a minimum of one year of service with the Company and who are not holders of a majority of either its outstanding common stock or its outstanding preferred stock. In addition, the Company's outside directors are eligible to participate in the SOP. The Company's stockholders have authorized 5% of the shares of common stock outstanding, (226,703 shares at December 31, 2006) for issuance under the SOP. Options granted under the SOP, which are fully vested when granted, are exercisable over a ten year period at the market price for the Company's common stock as of the date the options are granted. Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), "Share-Based Payment," (SFAS No. 123(R)) using the modified prospective method. This method requires that companies recognize compensation expense for new stock option grants and the unvested portion of prior stock option grants at their fair value on the grant date and recognize this expense over the requisite service period for awards expected to vest. All of the Company's stock options granted prior to January 1, 2006 were 100% vested and as a result did not impact the amount of expense recorded during 2006. The prior years' financial statements have not been restated for the effects of adopting SFAS No. 123(R). As a result of adopting SFAS No. 123(R), stock-based employee compensation expense, net of income taxes, in the amount of $56, has been charged against income in 2006, for stock options granted during that year. The Company's policy is to estimate the fair market value of each option granted on the date of grant, the first business day in January of each year, using the Black-Scholes option pricing model, and record the compensation expense on a straight-line basis over the year in which the grant was made. The Company issues new common stock to satisfy stock options exercised. The following table illustrates the effect on the net income and net income per share for 2005 and 2004 as if the fair value based method of SFAS No. 123, "Accounting for Stock-Based Compensation," had been applied for all outstanding awards for periods prior to the adoption of SFAS No. 123(R). 2005 2004 ------- ------- Net income............................. $ 1,213 $ 1,005 Preferred stock dividends.............. 3 3 ------- ------- Net income available to common shareholders as reported .............. $ 1,210 $ 1,002 Less impact of stock option expense ............................... 42 40 ------- ------- Pro forma .............................. $ 1,168 $ 962 ======= ======= Basic and diluted income per share as reported ........................... $ .27 $ .22 Less impact of stock option expense ..... .01 .01 ------- ------- Pro forma .............................. $ .26 $ .21 ======= ======= Key assumptions used to apply the Black-Scholes option pricing model are set forth below: 2006 2005 2004 --------- --------- --------- Average risk-free interest rate 4.32% 3.94% 3.90% Expected life of option grants 7.0 years 7.0 years 7.0 years Expected volatility of underlying stock 88% 65% 70% Expected dividend payment rate, as a percentage of the share price on the date of grant 1.07% 1.19% 1.80% Weighted average grant date fair value $10.70 $ 8.02 $ 5.24 II-23 The following table illustrates the effect on the net income and net income per share for 2005 and 2004 as if the fair value based method of SFAS No. 123, "Accounting for Stock-Based Compensation," had been applied for all outstanding awards for periods prior to the adoption of SFAS No. 123(R). The following table summarizes the stock option activity under the Company's plan for 2004, 2005 and 2006: Weighted Average ---------------- Number of Exercise Fair Options Price Value ------ ------ ------ Outstanding and exercisable at January 1,2004 ................... 51,306 $ 9.32 Granted ........................... 8,340 8.89 $ 5.24 Exercised ......................... (3,242) 8.04 Expired ........................... (10,181) 8.68 ------ ------ ------ Outstanding and exercisable at December 31, 2004 ................ 46,223 9.47 Granted ........................... 8,260 13.49 $ 8.02 Exercised ......................... (4,006) 10.35 Expired ........................... (5,809) 8.95 ------ ------ ------ Outstanding and exercisable at December 31, 2005 ................ 44,668 10.20 Granted ........................... 8,140 14.90 $ 10.70 Exercised ......................... (7,338) 9.11 Expired ........................... (4,326) 11.61 ------ ------ ------ Outstanding and exercisable at December 31, 2006 ................ 41,144 $11.18 ====== ====== ====== The following table sets forth information regarding options as of December 31, 2006: Weighted Average Range of Number ---------------- Number Exercise Currently Exercise Remaining of Options Prices Exercisable Price Life (in years) --------- ---------- ---------- ---------- ----------- 20,750 $6.75 - 8.89 20,750 $ 7.74 6 20,394 12.38 - 18.38 20,394 14.68 6 ------- ------- 41,144 41,144 ====== ====== The total intrinsic value of options exercised for the year ended December 31, 2006 totaled approximately $50, and cash proceeds from the exercise of stock options totaled approximately $67 for the year ended December 31, 2006. The income tax benefits realized from the exercise of stock options was not material for the periods presented. The aggregate intrinsic value of the stock options outstanding, based on the closing stock price of the Company's common stock as of December 31, 2006, totaled approximately $243. Common Stock Awards The Company has awarded certain of its employees common stock under stock award plans. During the years ended December 31, 2006, 2005 and 2004, the Company awarded 1,775, 2,135 and 204 shares, respectively. The compensation expense recorded for these awards was $28, $29 and $3 for 2006, 2005 and 2004, respectively. II-24 4. Property and Equipment Property and equipment consists of the following: December 31, 2006 2005 ------- ------- Land and improvements, excluding land held for development .......................... $11,458 $10,938 Track structure .......................... 74,572 70,445 Buildings and other structures ........... 8,372 8,363 Equipment ................................ 26,295 26,052 ------- ------- 120,697 115,798 Less accumulated depreciation ............ 44,106 41,672 ------- ------- Total property and equipment, net ........ $76,591 $74,126 ======= ======= 5. Land Held for Development 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"). The permits for the property, both of which have been extended to 2009, also allow for construction of a dock along the west face of the South Quay. The property, which has a carrying value of $11,958, is adjacent to a 12 acre site also owned by the Company. The property is located a half mile from I-195. In 2006, the Rhode Island Department of Transportation awarded a contract for roadway improvements to provide direct vehicular access from the interstate highway system to the South Quay. The project is anticipated to be substantially complete by the end of 2007. 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. 6. Revolving Line of Credit The Company has a revolving line of credit with its principal bank in the amount of $5,000 expiring May 31, 2007. Borrowings under this line of credit are unsecured, due on demand and bear interest at either the bank's prime rate or one and one half percent over either the one or three month London Interbank Offered Rates. The Company pays no commitment fee on this line and has no compensating balance requirements. There were no loans outstanding under the line at any time during 2006 or 2005. II-25 7. Accrued Expenses Accrued expenses consist of the following: December 31, 2006 2005 ------- ------- Salaries and wages, including accrued compensated time off ..................... $ 535 $ 434 Payroll taxes ............................ 154 132 Simplified employee pension plan contributions ............................ 212 229 Health insurance plan claims ............. -- 375 Casualty loss claims ..................... 310 370 Other .................................... 222 313 ------- ------- $ 1,433 $ 1,853 ======= ======= 8. Other Income Other income consists of the following: Years Ended December 31, 2006 2005 2004 ------ ------ ------ Gains from sale, condemnation and disposal of property, equipment and easements, net ...................... $ 766 $ 691 $1,081 Rentals and license fees under various operating leases .................... 547 486 454 Interest ............................. 60 31 12 ------ ------ ------ $1,373 $1,208 $1,547 ====== ====== ====== Gains from sale, condemnation and disposal of property, equipment and easements for 2004 includes a $948 gain realized on the disposal of a portion of a branch line which the Commonwealth of Massachusetts acquired by eminent domain. 9. Income Taxes The provision for income taxes consists of the following: Years Ended December 31, 2006 2005 2004 ------ ------ ------ Current: Federal .......................... $ 51 $ 202 $(210) State ............................ 6 18 10 ------ ------ ------ 57 220 (200) Deferred, Federal and State ....... 503 395 831 ------ ------ ------ $ 560 $ 615 $ 631 ====== ====== ====== II-26 The following summarizes the estimated tax effect of temporary differences that are included in the net deferred income tax provision: Years Ended December 31, 2006 2005 2004 ----- ----- ----- Depreciation ........................... $ 508 $ 462 $ 462 Deferred grant income .................. 42 (63) 68 Gains from sale, condemnation and disposal of property and equipment .... -- -- 348 Accrued casualty and other claims ...... 21 37 (14) Accrued compensated time off and related payroll taxes ......................... (39) (25) (19) Share based compensation ............... (31) -- -- Other .................................. 2 (16) (14) ----- ----- ----- $ 503 $ 395 $ 831 ===== ===== ===== In 2006 and 2005 the Company generated Railroad Track Maintenance Credits in the amount of $3,136. These credits may be utilized, subject to certain limitations, to offset the Company's current federal income tax liability. Any credits not utilized in the year earned may be carried forward to offset future income tax liabilities for a period of 20 years. The Company utilized $36 of these credits to reduce its current federal income tax provision in 2006 and $74 to reduce its federal income tax liability in 2005. The unused credits, in the amount of $2,136 constitute deferred income tax assets. Such assets, however, have been fully reserved since their future realization is not assured. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of significant items comprising the Company's net deferred income tax liability as of December 31, 2006 and 2005 are as follows: December 31, 2006 2005 ------- ------- Deferred income tax liabilities - Differences between book and tax basis of property and equipment ....................... $14,928 $14,420 ------- ------- Deferred income tax assets: Deferred grant income ........................... 2,848 2,890 Accrued casualty and other claims ............... 110 131 Accrued compensated time off and related payroll taxes .................................. 174 136 Share based compensation ........................ 31 -- Allowance for doubtful accounts and other........ 61 62 ------- ------- 3,224 3,083 ------- ------- Net deferred income tax liability ................ $11,704 $11,201 ======= ======= II-27 A reconciliation of the U.S. federal statutory rate to the effective tax rate is as follows: Years Ended December 31, 2006 2005 2004 ---- ---- ---- Federal statutory rate ....................... 34% 34% 34% Depreciation of properties acquired from bankrupt railroads having a tax basis in excess of cost ........................... (1) (1) (2) Railroad track maintenance credits ........... (2) (3) -- Non deductible expenses, state income taxes, etc .................................. 4 4 7 ---- ---- ---- Effective tax rate ........................... 35% 34% 39% ==== ==== ==== 10. Commitments and Contingent Liabilities: 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 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) 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 will take approximately two or more years to complete. 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. ss. 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 to settle this suit in March 2006. II-28 11. Employee Benefit Plans Defined Contribution Retirement Plans ------------------------------------- The Company has a deferred profit-sharing plan ("Plan") which covers all of its employees who are members of its collective bargaining units. Contributions to the Plan are required in years in which the Company has income from "railroad operations" as defined in the Plan. Contributions are to be equal to at least 10% but not more than 15% of the greater of income before income taxes or income from railroad operations subject to a maximum contribution of $3.5 per eligible employee. Contributions to the Plan may be made in cash or in shares of the Company's common stock valued at the closing market price on the day contributed. Contributions accrued under this Plan amounted to $178 in 2006, $211 in 2005 and $188 in 2004. The Company made its 2004 and 2005 contributions and intends to make its 2006 contribution in newly issued shares of its common stock. The Company also has a Simplified Employee Pension Plan ("SEP") which covers substantially all employees who are not members of one of its collective bargaining units. Contributions to the SEP are discretionary and are determined annually as a percentage of each covered employee's compensation up to the maximum amount allowable by law. Contributions accrued under the SEP amounted to $212 in 2006, $208 in 2005 and $203 in 2004 which, in each year, was less than the maximum amount allowable by law. Employee Stock Purchase Plan ---------------------------- The Company has an Employee Stock Purchase Plan ("ESPP") under which eligible employees may purchase registered shares of common stock at 85% of the market price for such shares. An aggregate of 200,000 shares of common stock are authorized for issuance under the ESPP which was established in 1997. Any shares purchased under the ESPP are subject to a two year lock-up. ESPP purchases amounted to 4,376 shares in 2006, 5,928 shares in 2005 and 7,439 shares in 2004. 12. Preferred Stock The Company's $50 par value preferred stock is convertible at any time at the option of the holder of the preferred stock into 100 shares of common stock. The noncumulative stock dividend is fixed by the Company's Charter at an annual rate of $5.00 per share, out of funds legally available for the payment of dividends. The holders of preferred stock and holders of common stock are entitled to one vote per share, voting as separate classes, upon matters voted on by shareholders. The holders of common stock elect one third of the Board of Directors; the voters of preferred stock elect the remainder of the Board. II-29 Item 9. Changes in and Disagreements with Accountants on Accounting and - -------------------------------------------------------------------------------- Financial Disclosure - -------------------- None. Item 9A. Controls and Procedures - -------------------------------- As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Company carried out an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the year covered by this annual report. This evaluation was carried out under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and the Company's Treasurer. Based upon that evaluation, the Chief Executive Officer and the Treasurer concluded that the Company's disclosure controls and procedures were ineffective as of December 31, 2006 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. In February 2007, the Company identified a failure to account for accrued compensated time off related to a contract with one of its labor unions, which resulted in a restatement of its financial statements. The financial statement accounts affected were accrued liabilities, operating expenses and deferred income taxes. The Company's controls related to ensuring the completeness of payroll accruals were not operating effectively. There was no significant change in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to affect, the Company's internal control over financial reporting. In February 2007, management implemented additional controls and procedures related to capturing and recording accrued compensated time off. Item 9B. Other Information - -------------------------- None. II-30 PART III Item 10. Directors and Executive Officers of the Registrant - ----------------------------------------------------------- For information with respect to the directors of the Company, see Pages 2 through 7 and 10 of the Company's definitive proxy statement for the 2007 annual meeting of its shareholders, which pages are incorporated herein by reference. The following are the executive officers of the Company: Date of First Name Age Position Election to Office - ---- --- -------- ------------------ Robert H. Eder 74 Chairman 1980 P. Scott Conti 49 President 2005 David F. Fitzgerald 56 Vice President 2005 Frank K. Rogers 45 Vice President 2005 Robert J. Easton 63 Treasurer 1988 Mary A. Tanona 49 Secretary 2000 Any officer elected or appointed by the Company's Board of Directors may be removed at any time by the affirmative vote of a majority of the Board of Directors. Mr. Conti served as Vice President from 1999 until his election as President in 2005. Prior to that, he served first as Engineering Manager and then Chief Engineer after joining the Company in 1988. Mr. Fitzgerald joined the Company in 1973 and served as Superintendent of Transportation prior to his election as Vice President in 2005. Mr. Rogers joined the Company in 1994 and served as Director of Marketing prior to his election as Vice President in 2005. Ms. Tanona joined the Company as Assistant General Counsel and Assistant Secretary in 1999 and was named Secretary and General Counsel in 2000. Prior to joining the Company she was Associate General Counsel of Arbor National Commercial Mortgage Corporation in Boston. The Company has adopted a written code of ethics that applies to all of its employees including its Chief Executive Officer and its Chief Financial Officer. A copy of the Company's code of ethics, entitled "Business Conduct Policy," is available on the Company's website at http://www.pwrr.com, and/ or may be obtained without charge by contacting: Investor Relations Attention: Wendy Lavely Providence and Worcester Railroad Company 75 Hammond Street Worcester, Massachusetts 01610 (800) 447-2003 Internet Address: http://www.pwrr.com; wlavely@pwrr.com Item 11. Executive Compensation - ------------------------------- See pages 6 and 7 and 10 through 17 of the Company's definitive proxy statement for the 2007 annual meeting of its shareholders, which pages are incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and - --------------------------------------------------------------------------- Related Stockholder Matters - --------------------------- See pages 8 and 9 of the Company's definitive proxy statement for the 2007 annual meeting of its shareholders, which pages are incorporated herein by reference. III-1 The following table sets forth information as of the end of the Company's most recently completed fiscal year with respect to compensation plans (including individual compensation arrangements) under which equity securities of the Company are authorized for issuance. Number of Securities Number of To be Issued Upon Weighted Average Securities Exercise of Exercise Price of Remaining Outstanding Options Outstanding Options Available For Plan Category Warrants and Rights Warrants and Rights Future Issuance ------------- -------------------- ------------------- --------------- Equity compensation plans approved by security holders .. 41,144 $ 11.18 311,765 Equity compensation plans not approved by security holders ..... N/A N/A 182,420 Total ................ 41,144 $ 11.18 494,185 Item 13. Certain Relationships and Related Transactions - ------------------------------------------------------- See pages 2 and 17 of the Company's definitive proxy statement for the 2007 annual meeting of its shareholders which pages are incorporated herein by reference. Item 14. Principal Accountant Fees and Services - ----------------------------------------------- For information with respect to the directors of the Company, see Pages 2 through 7 and 10 of the Company's definitive proxy statement for the 2007 annual meeting of its shareholders, which pages are incorporated herein by reference. Item 15. Exhibits and Financial Statement Schedules - --------------------------------------------------- (a) (1) All financial statements: An index of financial statements is included in Item 8, page II- 12 of this annual report (2) Financial Statement schedule: Schedule II Valuation and Qualifying Accounts........Page III-4 All other schedules are omitted because they are not applicable or not required, or because the required information is shown either in the financial statements or the notes thereto. (3) Listing of Exhibits. (10A) Material Contracts (incorporated by reference to Exhibit 10 to the registration statement of the Registrant on Form 10, to the Non-Qualified Stock Option Plan and Employee Stock Purchase Plan of the Registrant on Forms S-8 and to the registration statements of the Registrant on Form S-1). (23) Consent of Independent Registered Public Accounting Firm (31) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (32) Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Not applicable. (c) Exhibits (annexed). Financial Statement Schedule. See item (a) (2) above. III-2 SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PROVIDENCE AND WORCESTER RAILROAD COMPANY /s/ Robert H. Eder ------------------ By Robert H. Eder Chief Executive Officer Dated: March 26, 2007 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: Signature Title Date --------- ----- ---- /s/ Robert H. Eder ________________________ Chief Executive March 26, 2007 Robert H. Eder Officer and Chairman (Principal Executive Officer) /s/ P. Scott Conti ________________________ President and March 26, 2007 P. Scott Conti Director (Chief Operating Officer) /s/ Robert J. Easton ________________________ Treasurer March 26, 2007 Robert J. Easton (Principal financial officer and principal accounting officer) /s/ Richard W. Anderson ________________________ Director March 26, 2007 Richard W. Anderson /s/ Frank W. Barrett ________________________ Director March 26, 2007 Frank W. Barrett /s/ J. Joseph Garrahy ________________________ Director March 26, 2007 J. Joseph Garrahy III-3 SCHEDULE II PROVIDENCE AND WORCESTER RAILROAD COMPANY VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004 (IN THOUSAND DOLLARS) Column A Column B Column C Additions Column D Column E -------- -------- ------------------ -------- -------- (1) (2) Balance Charged to Charged to Balance at costs and other at end Description beginning expenses accounts Deductions of of period describe (A) period Allowance for doubtful accounts: Year ended December 31, 2006..... $175 $ 0 $ 0 $175 ==== ==== ==== ==== Year ended December 31, 2005..... $125 $ 50 $ 0 $175 ==== ==== ==== ==== Year ended December 31, 2004..... $125 $ 8 $ 8 $125 ==== ==== ==== ==== (A) Bad debts written off. III-4 EXHIBIT 23 Consent of Independent Registered Public Accounting Firm We consent to the incorporation by reference in Registration Statement Nos. 333-65937, 333-65949, and 333-21617 of Providence and Worcester Railroad Company on Form S-8 of our report dated March 23, 2007 relating to the financial statements and financial statement schedule of Providence and Worcester Railroad Company (which report expresses an unqualified opinion and includes an explanatory paragraph relating to a restatement of the Company's 2005 and 2004 financial statements), appearing in this Annual Report on Form 10-K of Providence and Worcester Railroad Company for the year ended December 31, 2006. /s/ Deloitte & Touche LLP Boston, Massachusetts March 23, 2007 EXHIBIT 31.1 Providence and Worcester Railroad Company Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, ROBERT H. EDER, certify that: 1. I have reviewed this annual report on Form 10-K of Providence and Worcester Railroad Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on our evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors: a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. DATE: March 26, 2007 /s/ Robert H. Eder By: ______________________________ Robert H. Eder Chairman of the Board and Chief Executive Officer EXHIBIT 31.2 Providence and Worcester Railroad Company Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, ROBERT J. EASTON certify that: 1. I have reviewed this annual report on Form 10-K of Providence and Worcester Railroad Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on our evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors: a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. DATE: March 26, 2007 /s/ Robert J. Easton By: ______________________________ Robert J. Easton Treasurer and Principal Financial Officer EXHIBIT 32 PROVIDENCE AND WORCESTER RAILROAD COMPANY CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Providence and Worcester Railroad Company (the Company) on form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Robert H. Eder, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13 (a) or 15 (d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Robert H. Eder _____________________________ Robert H. Eder, Chairman of the Board and Chief Executive Officer March 26, 2007 In connection with the Annual Report of Providence and Worcester Railroad Company (the Company) on form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Robert J. Easton, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15 (d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Robert J. Easton _____________________________ Robert J. Easton, Treasurer and Chief Financial Officer March 26, 2007 -----END PRIVACY-ENHANCED MESSAGE-----