92d Congress ptjywt Session i uOJEJS/UTTitE PRlrfT U8RARY OF TH© V OF ILLINOIS THE PENN CENTRAL AND OTHER RAILROADS A REPORT TO T SENATE COMMITTEE ON COMMERCE Pffl he Direction of Honorable Warren G. Magnuson, Chairman the Use of COMMITTEE ON COMMERCE UNITED STATES SENATE DECEMBER Printed for the use of the Committee on Commerce LIBRARY OF THE UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGN 385 Un338p cop 2 The person charging this material is re- sponsible for its return to the library from which it was withdrawn on or before the Latest Date stamped below. Theft, mutilation, and underlining of books are reasons for disciplinary action and may result in dismissal from the University. UNIVERSITY OF ILLINOIS LIBRARY AT URBANA-CHAMPAIGN SEP 2i ,EP25 JAN •'•I ' ■■■■■'• FEB 2 o 19; B " APR?-* AUG 1 8 l|978 FEB 1 5 Vf 51OT 5 1989 L161 — O-1096 Digitized by the Internet Archive in 2012 with funding from University of Illinois Urbana-Champaign http://archive.org/details/penncentralotherOOunit 92d Congress j COMMITTEE PRINT 2d Session J THE PENN CENTRAL AND OTHER RAILROADS A REPORT TO THE SENATE COMMITTEE ON COMMERCE Prepared at the Direction of Honorable Warren G. Magnuson, Chairman For the Use of the COMMITTEE ON COMMERCE UNITED STATES SENATE DECEMBER 1972 Printed for the use of the Committee on Commerce U.S. government printing office 74-924 WASHINGTON : 1973 For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, D.C. 20402 - Price $8.15 domestic postpaid or $7.50 GPO Bookstore COMMITTEE ON COMMERCE WARREN G. MAGNUSON, Washington, Chairman JOHN O. PASTORE, Rhode Island NORRIS COTTON, New Hampshire VANCE HARTKE, Indiana JAMES B. PEARSON, Kansas PHILIP A. HART, Michigan ROBERT P. GRIFFIN, Michigan HOWARD W. CANNON, Nevada HOWARD H. BAKER, Jr., Tennessee RUSSELL B. LONG, Louisiana MARLOW W. COOK, Kentucky FRANK E. MOSS, Utah TED STEVENS, Alaska ERNEST F. HOLLINGS, South Carolina J. GLENN BEALL, Jr., Maryland DANIEL K. INOUYE, Hawaii LOWELL P. WEICKER, Jr., Connecticut WILLIAM B. SPONG, Jr., Virginia Frederick J. Lordan, Staff Director Michael Pertschdk, Chief Counsel A. Daniel O'Neal, Transportation Counsel John Cary, Staff Counsel Arthdr Pankopf, Jr., Minority Staff Director Malcolm Sterrett, Minority Staff Counsel SPECIAL STAFF FOR THE PENN CENTRAL INQUIRY A. Daniel O'Neal, Transportation Counsel John Cart, Staff Counsel and Report Analyst DR. Merrill J. Roberts (Graduate School of Business Administration, University of Pittsburgh), Consultant and Report Coordinator Josephine Olson, Consultant and Financial Analyst Joseph Tumbler, Financial Analyst James J. Faris, Counsel Peter M. Montague, Management Analyst B. G. Jeanne Paulonis, Financial Analyst Burton Hoffman, Editor Kenneth Brousseau, Research Assistant Robert J. Beatson, Investigator, Minority Staff Member Richard J. Barber (Richard J. Barber Associates, Inc.) Consultant Samuel P. Delisi (Attorney, Pittsburgh, Pa.), Consultant Dr. Charles A. Taff (Department of Business Administration, University of Maryland), Consultant (ID 7^ PREFACE December 28, 1972. The Senate Committee on Commerce in 1971 directed that a special staff under direction of the Committee's Transportation Counsel be formed to review the Penn Central Transportation Company. The study was to determine the reasons for the Penn Central's collapse into bankruptcy in June 1970. Further it was to explore the extent to which the malady which affected the Penn Central exists in the remainder of the rail industry. Pursuant to the Committee's direction a special staff was assembled after the special authorizing legislation, S. Res. 81, passed the Senate on May 3, 1971. The attached report, the result of the efforts by the staff, should provide the Committee with some useful information which can be applied in future Com- mittee deliberations on related matters. I wish to emphasize that the conclusions and recommendations incorpo- rated into this staff report, and which may prove to be controversial, represent the views of the members of the special staff and have neither been approved, disapproved, nor considered by the Senate Committee on Commerce. Warren G. Magnuson, Chairman, Committee on Commerce. (in) LETTER OF TRANSMITTAL December 27, 1972. Dear Mr. Chairman: Transmitted herewith is the Senate Commerce Committee Special Staff report analyzing the financial collapse of the Penn Central Transportation Company, pursuant to Senate Resolution 81, which was adopted by the Senate on May 3, 1971. While the principal objective of the Committee in approving this study was to determine the causes of the Penn Central collapse, it was clear from the beginning of the inquiry that the Penn Central could not be viewed in isolation. Rather, the most accurate pic- ture of the Penn Central would of necessity include a look at the railroad industry generally to set the stage for a more balanced view of the Penn Central. The collapse of the Perm Central focused intense public attention on the railroad and its officers. Investigations of various aspects of this most complex Corporation were undertaken by the Securities and Exchange Commission, the Interstate Commerce Commission, the House Banking and Currency Commit- tee, the House Comittee on Interstate and Foreign Comerce, and this Com- mittee. Early hearings conducted by the Senate Subcommittee on Surface Transportation and the Senate Commerce Committee provided the opening round in public scrutiny of certain activities by officers of the railroad. The personal activities of the company's officers, the possibility of insider dealings with corporate stock, the jurisdiction of the Securities and Exchange Commission versus the role of the ICC and the involvement of the financial community were aspects of the Penn Central affair which were under very intensive examination by the other Federal bodies indicated above. The principal concern of the Senate Commerce Committee is in the devel- opment of better transportation. While the Committee could have examined other facets of the Penn Central, it seemed that in view of other actions by the Federal Government, and in view of the principal concern of this Committee, it would be most instructive and useful from the Committee view to evaluate the Penn Central on the basis of its impact on transportation policy in the United States. With this in mind, therefore, a special staff was assembled and the inquiry was begun. \ The staff with the cooperation of the Penn Central Trustees in Bankruptcy examined the files of the Penn Central Transportation Company, extracted pertinent documents and assembled a file for use in drafting this report. This effort alone took approximately four months before the materials could be put in usable form. The ICC provided space for the special staff and for file materials which had been accumulated. The special staff concentrated in the main on evaluating the Penn Central itself and the transportation rail situation in the Northeast quadrant of the United States. The review of the railroad industry generally ( found in Part II of the report) was accomplished independently under a contract with a private consultant. I do not necessarily support all of the findings or recommendations. In discussions with the staff, I indicated at early stages that it would not be particularly useful to the Committee to attempt to frame answers to trans- portation problems by dwelling upon violations of the law by corporate leaders. Such activities are already circumscribed by existing law. What the Committee needs to know is what changes in Government policy toward transportation are suggested by the current condition of the railroad industry, and most particularly the condition of the Penn Central Transportation Company. (V) VI The staff is to be commended for cutting 1 away at a veil of confusion which has shrouded the Penn Central affair from the day of bankruptcy. I commend this document as part of a total effort toward understanding the job before Congress, the Administration and the Interstate Commerce Commission; the restoration of viability in rail transportation. Sincerely yours, Vance Hartke, Chairman, Subcommittee on Surface Transportation. CONTENTS Page Preface m Letter of Transmittal v Introduction xvn PART I. Penn Central Collapse: Perspective, Analysis, and Prescriptions: Foreword 3 Penn Central in Perspective 5 Findings 9 Environmental Conditions 9 Penn Central Financial Performance 11 Fiscal Policy 11 Diversification 15 Rail Operations 15 Merger — and the Road to Ruin 18 The Evidence and Analysis 21 Environmental Conditions 21 Transportation and the National Economy — Changing Perspectives 21 Eastern Regional Perspective 25 Coal 26 Manufactured Commodity Traffic Generally 27 Iron and Steel Products 27 Automobiles 28 Small Shipment Traffic 29 Divisions 29 Financial Performance 31 Operating Revenues, Expenses, and Income 31 Net Railroad Operating Income (NROI) 33 After NROI 34 Fiscal Policy 49 Constraints 49 Investment Programs 50 Investment Patterns 50 Investment Policy 51 Investment Policy Evaluation 52 Capital Structure and Financing Methods 53 Debt Burden 55 Equipment Financing 56 Post- Merger Fiscal Policy 58 Accounting Practice and PoUcy 60 Earnings Maximization 60 Dividend Policy 62 Diversification 73 The Diversification Facts 73 Rationale 74 Investment Pattern 74 Railroad Operations 79 Decision Constraints 79 Plant Investment and Maintenance 81 Labor Utilization 83 Physical Performance 85 Pricing and Marketing 87 Service Quality 92 Merger and the Road to Ruin 159 The Inception 159 Merger Planning 159 The Merger Aftermath 163 Merger Evaluation 166 Public Processes 166 Private Processes 169 Monetary Impacts 171 An Integrated View 173 Approaches to Retrospective Evaluation 173 Synthesis of the Arguments 173 Conclusions 180 Report Conclusions 181 What Happened to the Penn Central? 181 Who is to Blame? 183 Private Sector 183 Public Sector 186 (VII) VIII PART I. Penn Central Collapse: Perspective, Analysis, and Prescription — Continued P R Ke Policy Recommendations 189 Prologue.. 189 Introduction 189 Recommendations Regarding the Rail Industry Generally 189 Improved Disclosure 189 Improved Identification of Problems and Formulation of Policy 191 Annual Report 192 Rail System Report . 192 Multidisciplinary Approach 193 Revised Relationship Between the Government and the Private Sector. 194 Operational and Financial Auditor 195 Railroad in Extremis 196 Specific Areas of Concern 198 Recommendations for the Future of the Penn Central 205 PART II. The American Railroads: Posture, Problems, and Prospects: Foreword 210 Highlights and Conclusions 211 Rail Traffic and the Economy 211 Financial Condition 213 Efficiency and Service 214 Investment 215 Public Policy 217 An Introduction to "The Railroad Problem" 219 The Railroad Problem in Perspective 220 Long-Run Trends in Rail Transportation: The Shaping Forces 224 Overall Economic Growth and Transport Demand 224 Changing Composition of the Economy 226 Locational Adjustments 233 Railroad Finance and Earnings 235 Earnings 235 Capital Outlays, Overt and Disguised 243 Cash Flow 244 Working Capital 248 Investment and Productivity 251 The Character of Rail Investment 251 Adequacy of Investment 256 Productivity 256 Efficiency and Service 261 Freight Train Indicators 261 Freight Car Indicators 262 Car Utilization 266 Marketing and Traffic 269 Tonnage 269 Revenue 272 Revenue Per Ton-Mile 274 Modal Competition 276 Conclusion 279 Rail Transportation and Public Policy 280 Rate Regulation 280 Mergers 283 Holding Companies and Railroad Diversification 286 Government Financial Aid to Transportation 288 PART III. Analysis of Selected Issues: The Economy and the Railroads 293 Economic Trends 295 Analysis of Traffic Patterns 296 Coal Shipments 299 Projection of Coal Usage in Generating Electricity 300 Less-Than-Carload Service 302 Analysis of Census Data 303 Intermodal Competition 304 Selected Class I Motor Common Carriers 306 Qualitative Aspects of Rail Freight Services 307 Non-rail Service Transportation Subsidiaries 308 Passenger Traffic 309 Innovative Efforts to Stimulate Freight Traffic 310 The Penn Central Merger: A Study of Its Planning, Approval, and Result 313 The Penn Central Merger, Planning, Approval, and Result 315 Chronology of the Merger 316 Managing of the Merger: Pivotal Figures 325 The Conditions of Approval Imposed by the ICC 330 Inclusion of Other Railroads 330 Protection of Other Railroads 331 Labor Protective Provisions 331 Relationship to Other Railroads 332 Other Conditions 333 Merger Meant Consolidation 333 What Consolidation Involved 334 Preparation and Execution of the Merger 335 IX PART III. Analysis of Selected Issues — Continued The Penn Central Merger — Continued P*ee What Was Left Undone on Merger Day 337 Decision to Rush Consolidation 337 Failure to Reorganize 340 Corporate Character 342 Overview and Conclusions 345 Fiscal Policy Analysis 351 Financial Situation 353 Financial Outlook: Introduction 353 Financial Position 354 Sources of Funds 355 Financial Position : Analysis 357 Accounting Practices and Policy 358 Major Differences Between ICC and GAAP. 359 Earnings Maximization 367 Introduction . 367 Implications of Earnings Maximization 368 Effect of Earnings Maximization on Reported Income 370 General Comments on Earnings Maximization 374 Conclusion 377 Dividend Policy 378 Internal Control After Merger 381 Introduction 381 Internal Control 381 Diversification 387 Diversification Programs 388 Pennsylvania Railroad 388 New York Central 392 Penn Central Transportation Co 392 Timing 393 Magnitude 393 Source of Funds 397 Investment Pattern 401 Financial Results of Diversification Program 409 Total Diversification Investment Relative to Reinvestment in Rail Plant 411 Total Income From Diversification Program Relative to Railroad Income 414 Diversification as a Policy 415 The Specific Program — Costs and Benefits 415 Effect on Cash Shortage 415 Credit Reserves 420 Effect on Management 421 Role of the ICC 422 Powers 422 Limitations on Powers 423 Other Applicable Investigatory Powers 423 Policy of ICC Toward Diversification and Application of Existing Powers 424 Formation of Holding Company by Penn Central Transportation Company 426 Role of ICC in PCTC Diversification Program 427 Conclusions and Recommendations 427 Assessment of Relative and Absolute Weight of Diversification as a Force Leading to Bankruptcy 426 Recommendations 429 LIST OF CHARTS AND TABLES PART I Penn Central Transportation Co. — Condensed comparative statement for the period 1960-69 5 Selected factors showing influence on cash for the period 1960-69 6 Penn Central Transportation Co., statement of sources and applications of funds, for periods ended December 31, 1960-69 7, 748 Share of National income accounted for by major sectors, 1950, 1960, 1970 22 Intercity freight transportation and the national economy, selected measures, 1960 and 1969 22 Intercity freight by modes 24 Freight traffic and revenue, United States and eastern district, class I railroads and class I motor carriers, 1960-69 25 Rail transportation and minehead generation of coal 26 Percent change in rail tonnage of coal 26 Percent change in rail revenue from coal 27 Share of transport market for manufactured goods in selected production areas, railroads and for-hire motor carriers, 1963 and 1967 27 Percent change in rail tonnage of steel works and rolling mill products 28 Percent change in rail revenue from steel works and rolling mill products 28 Page Percent change in rail tonnage of motor vehicles 28 Percent change in rail revenue from motor vehicles 28 Operating revenues, 1958-70 36 Index of railway operating revenue 37 Index of freight revenue, 1960-69 38 Index of net ton-miles of freight revenue, 1 960-69 39 Average length of haul/revenue freight, 1960-69 40 Average freight revenue per ton-mile, 1960-69 41 Index of railway operating expenses, 1960-69 42 Operating ratio (operating expenses to operating revenue), 1960-69 43 Ratio of income available for fixed charges to fixed charges 44 Selected railroad performance measures — Penn Central, Pennsylvania, and New York Central (1958-70) 45 Selected measures of financial performance — Penn Central, Pennsylvania, and New York Central, 1958-70 1 46 Total maintenance expenditures, selected railroads; 1958-70 47 Equipment and joint facilities rents, selected railroads, 1958-70 47 Net expenditures for freight car leasing — Penn Central, Pennsylvania, and New York Central, 1958-69 47 Net income as a function of NROI, other income, fixed and miscellaneous charges, Penn Central, Pennsylvania, New York Central (1958-70) 48 Capital structures 5-year averages, Pennsylvania, New York Central, 1948-67 54 Capital expenditures, Pennsylvania and New York Central, 1946-67 64 Summary of capital expenditures, Pennsylvania, New York Central, 1948-67 64 Total capital expenditures as a percentage of operating revenues, selected railroads, 1960-69 65 Capital structure, Pennsylvania and New York Central; 1948-67 65 Long-term debt/equity ratio : Pennsylvania, New York Central, and Class I railroads, 1948-67 65 Ratio of income available for fixed charges to fixed charges; Pennsylvania and New York Central, 1948-67 66 Equipment financing, Penn Central, Pennsylvania, and New York Central, 1958-69. 66 Railroad net income and dividend payments, Penn Central, Pennsylvania, New York Central, and Class I railroads ; 1952-70 1 67 Consolidated net income and dividend payments, Pennsylvania and New York Central, 1952-67 67 Dividend payments per share, Pennsylvania, New York Central, 1957-67 68 Total capital expenditures per mile of track operated, selected railroads, 1960-69 — 69 Capital expenditures for equipment per mile of track operated, selected railroads, 1960-69 70 Capital expenditures for road per mile of track operated, selected railroads, 1960-69-- 71 Acquisitions post 1963 73 Sources of Net Income 74 Capital expenditures as a percent of operating revenue, Penn Central, Pennsylvania, and New York Central, 1960-69 92 Ratios of cumulative capital and maintenance expenditures to operating revenues and income, Pennsylvania and New York Central, 1958-67 93 Change in freight car fleet, Pennsylvania, 1948-67 93 Changes in freight car fleet, New "York Central, 1948-67 93 Capital expenditures per mile of track operated selected railroads, 1960-69 94 Maintenance expenditures for way and structure per million gross ton-miles, selected railroads, 1958-67 95 Freight car-maintenance selected railroads, 1959-70 95 Freight-train car utilization and bad-order ratio 95 Selected locomotive maintenance and performance measures — Penn Central, Penn- sylvania, and New York Central, 1958-70 96 Maintenance of physical emplacements — Penn Central, Pennsylvania, and New York Central, 1960-69 96 Railroad accidents per million units, selected railroads; 1960-69 96 Wages as a percentage of gross operating revenue, selected railroads 1960-69 97 Gross ton-miles per employee, selected railroads, 1 960-70 97 Gross ton-miles per service-hour, selected railroads, 1960-70 97 Gross ton-miles per dollar of compensation, selected railroads, 1960-70 97 Compensation per service-hour, selected railroads, 1960-70 98 Net ton-miles of revenue freight traffic per mile of road operated, selected railroads, 1960-69 98 Mileage per locomotive unit, selected railroads, 1 964-70 98 Car-miles per serviceable freight car-day, selected railroads, 1958-70 98 Gross ton-miles per freight train-hour, selected railroads, 1958-70 99 Percent loaded of total freight car-miles, selected railroads, 1958-70 99 Net ton-miles per loaded car-mile, selected railroads, 1958-70 99 Net ton-miles per freight car-day, selected railroads, 1958-70 99 Capital expenditures for road, per mile of track operated, 1960-61 100 Capital expenditures for equipment, per mile of track operated, 1960-69 101 Capital expenditures for road, per mile of track operated, 1960-69 102 Capital expenditures for equipment, per mile of track operated, 1960-69 103 Tons of rail laid in replacement, per mile of track operated, 1960-69 104 Crossties laid per mile of track operated, selected railroads, 1960-69 105 XI Page Miles of slow order track, Pennsylvania Railroad, 1956-67 106 Railroad accidents, per million units, 1960-69 107 Wages as a percent of gross operating revenue, selected railroads, 1960-69 108 Gross ton-miles per employee, selected railroads, 1960-69 109 Gross ton-miles per service hour, selected railroads, 1960-69 110 Gross ton-miles per dollar of compensation, selected railroads, 1960-69 111 Compensation per employee, selected railroads, 1960-69 112 Compensation per service hour, selected railroads, 1 960-69 113 Employees per mile of track operated, selected railroads, 1960-69 114 Net ton-miles of revenue freight traffic per mile of road operated, selected railroads, 1960-69 115 Average annual mileage per locomotive unit, selected railroad, 1964-70 116 Car miles per serviceable freight car day, selected railroads, 1958-70 117 Gross ton miles per freight train hour, selected railroads, 1958-70 118 Percent loaded of total freight car miles, selected railroads, 1958-70 119 Net ton-miles per loaded car mile, selected railroads, 1958-70 120 Net ton-miles per freight car day, selected railroads, 1958-70 121 Transportation ratio (transportation expenses/operating revenue, selected railroads, 1960-69 122 Bituminous coal revenues, eastern district railroads, 1965-69 123 Tons of bituminous coal moved, selected railroads, 1965-69 124 Bituminous coal average revenue per ton, selected railroads, 1965-69 125 Primary metals revenues, selected railroads, 1965-69 126 Tons of primary metals moved, selected railroads, 1965-69 127 Primary metals average revenue per ton, selected railroads, 1965-69 128 Metallic ores, revenues eastern district railroads, 1965-69 129 Tons of metallic ore moved, selected railroads, 1965-69 130 Metallic ore average revenue per ton, selected railroads, 1965-69 131 Food and kindred products revenues, selected railroads, 1965-69 132 Tons of food and kindred products, selected railroads, 1965-69 133 Food and kindred products average revenue per ton, selected railroads, 1965-69 134 Chemical revenues, selected railroads, 1965-69 135 Tons of chemicals moved, selected railroads, 1965-69 136 Chemicals average revenue per ton, selected railroads, 1965-69 137 Stone, glass, and clay products revenues, selected railroads, 1965-69 138 Tons of stone, glass, and clay products, eastern district railroads, 1965-69 139 Stone, glass, and clay products average revenue per ton, 1965-69 140 Pulp, paper, and allied products revenues, eastern district railroads, 1965-69 141 Tons of pulp, paper, and allied products, eastern district railroads, 1965-69 142 Pulp, paper, and allied products average revenue per ton, 1965-69 143 Field crops, revenues eastern district railroads, 1965-69 144 Tons of field crops, eastern district railroads, 1965-69 145 Field crops, average revenue per ton, 1965-69 146 Lumber and wood products, revenues eastern district railroads, 1965-69 147 Tons of lumber and wood products, eastern district railroads, 1965-69 148 Lumber and wood products, average revenue per ton, 1965-69 149 Motor vehicle parts and accessories, revenues eastern district railroads, 1965-69 150 Tons of motor vehicle parts and accessories, eastern district railroads, 1965-69 151 Motor vehicle parts and accessories, average revenue per ton, 1965-69 152 Petroleum, revenues eastern district railroads, 1965-69 153 Tons of petroleum moved by selected railroads, eastern district, 1965-69 154 Petroleum, average revenue per ton, 1965-69 155 Motor vehicles, revenues eastern district railroads, 1965-69 156 Tons of motor vehicles, eastern district railroads, 1965-69 157 Motor vehicles, average revenue per ton, 1965-69 158 PART II Gross national product, and intercity rail freight traffic, selected years, 1939-70 225 Relative significance of transportation in the economy, selected aggregative measures, 1950-70 226 Output by major economic sectors, based on 1958 prices, 1929-70 227 Gross national product and intercity freight traffic, by selected mode, 1947-70 228 Projected rate of growth to 1980 and distribution of gross product originating, 1965, 1968, projected to 1980, by major economic sector 229 Past and forecast rates of growth in output of major commodity sources of rail freight tonnage, 1957-80 229 Comparative growth rates for major industries, 1947-65 and projected, 1965-80 230 Output of transportation and warehousing sector required, directly and indirectly, for each dollar of delivery to final demand by various industries 232 Freight loss due to changing composition of final demand and structural change among the twenty industries with the largest total transportation requirements 233 Value added by manufacturing region as a percent of total for Nation, 1929-68 234 Percent of U.S. bituminous coal production, by selected major producing states, 1951-69 234 Operating ratio, class I railroads and selected railroads, 1960-70 236 Operating ratio, class I railroads and selected lines, 1960-70 237 Change in selected income accounts, 1960-70, class I railroads 238 Change in major items affecting ordinary income, 1960-70, class I railroads 238 XII Equipment and joint facilities rents as a percent of net operating revenue, class I P*K e railroads, 1 960-70 239 Equipment and facilities rents as a percent of net operating revenue, class I railroads and selected lines, 1 960-69 240 Annual fixed charges as a percent of net railway operating income, regional districts and selected railroads, 1964-70 241 Annual fixed charges as a percent of net railway operating income, class I railroads and selected lines, 1960-70 242 Oridinary income and cash flow, class I railroads, 1960-70 245 Cash dividends as a percent of pre-Federal income tax ordinary income, class I rail- roads and selected lines, 1960-70 247 Current assets as a percent of current liabilities, class I railroads and selected lines, 1960-70 249 Debt due within 1 year as a percent of pre-Federal income tax ordinary income, class I railroads, 1960-70 250 Gross capital expenditures and cash flow, class I railroads, 1960-70 252 Gross capital expenditures as a percent of cash flow, class I railroads and selected lines, 1960-70 253 New freight cars installed, class I railroads, 1955-70 255 Miles of new rail laid, number of ties replaced, and miles of centralized traffic control, class I railroads, 1960-70 256 Capital productivity, selected measures, class I railroads, 1960-70 257 Net investment per employee, class I railroads, 1960-70 258 Labor productivity, selected measures, class I railroads, 1960-70 258 Freight train miles and hours and trains made up for line haul, class I railroads, 1960-70 262 Loaded freight car miles, class I railroads, 1960-70 263 Average freight car load, class I railroads, 1960-70 268 Daily car mileage and time average car spends in freight trains, class I railroads, 1960-70 263 Net ton-miles per freight car day, class I railroads, regional districts, and selected railroads, 1960-70 264 Net ton-miles per freight car day, class I railroads and selected railroads, 1960-70 265 Trips per year by type of car, class I railroads, 1958-69 266 Turnaround time-days, class I railroads, selected years 266 Tonnage (originated and received), class I railroads and selected railroads, 1961-70 270 Revenue ton-miles, class I railroads, regional districts, and selected railroads, 1961-70. 271 Originated tonnage as a percent of total freight tonnage, selected railroads, 1961-70 272 Freight revenue, class I railroads, regional districts, and selected railroads, 1961-70 273 Revenue per ton-mile, class I railroads, regional districts, and selected railroads, 1960-70 274 Relationship of changes in rail traffic to changes in GNP and average revenue vield, 1960-70 274 Revenue per ton-mile, class I railroads and selected railroads, 1 960-70 275 Shipments subject to truck and rail competition 278 Involvement of the largest railroads in the current merger wave 284 Conglomerate holding companies and major railroad companies controlled as of December 31, 1970, with selected balance sheet data 286 PART III Chronology of Eastern Railroad Mergers 317 Penn Central Transportation Co. — equipment leasing and capital expenditures, 1963-69 355 Penn Central Transportation Co., asset and security dispositions — cash effect 356 Penn Central Transportation Co. — source of external financing transportation company only 356 Comparison of straight line and accelerated-depreciation methods 359 Comparison of accounting methods 363 Cost and equity method of accounting for investments in subsidiaries compared 365 Penn Central Corporation organization chart 369 Penn Central Transportation Co. (company only) effect of noncash transactions on reported net income 374 Penn Central Transportation Co. dividend payout ratio, 1963-69 378 Penn Central Co. stock ownership and stock represented by directors at December 31, 1968 meeting 380 Penn Central computation of interest cost relative to money borrowed to replace money expended through dividend payments, 1963 to June 1970 380 Penn Central Transportation Co. accounts receivable outstanding over 30 days — cash impact postmerger 382 Penn Central Transportation Co. effect of accounts receivable on interest expense and borrowings 383 Penn Central Transportation Co., analysis of delinquent accounts at December 1969 (over 10 days old) 383 Penn Central Transportation Co., an analysis of billing and collection lags, April 1970_ 384 Penn Central Transportation Co., an analysis of bad debts expense as a percent of sales 384 Investments by railroad and railroad subsidiaries (and/or predecessor companies) in selected nonrail businesses (Jan. 1 to Dec. 31, 1970) - 394 Interest and dividends paid on securities used by railroad in making selected nonrail acquisitions , 395 XIII Quarterly balances of loans and advances between railroad (PCTC and/or predecessor companies) and/or railroad subsidiaries and selected acquired nonrail subsidiaries Page (Jan. 1, 1960 to June 20, 1970) 395 Total cash funds employed by PCTC (and/or predecessor companies) and subsidiaries in regard to selected nonrail subsidiaries (on a yearly basis — Jan. 1, 1960 through June 20, 1970) 397 Disposition of Norfolk & Western Railway Co. stock held by PCTC (and/or predeces- sor companies) and subsidiaries from Jan. 1, 1960 through Dec. 31, 1970 397 Extraordinary additions to working capital of railroad (Jan. 1, 1960-June 20, 1970).- 398 New York Central Railroad 399 Pennsylvania RR. Co 399 Penn Central Transportation Co 400 Commissions and other fees paid by railroad and/or railroad subsidiaries in connection with acquisition of stock of selected nonrail subsidiaries 405 Summary of earnings of selected nonrail acquisitions 409 Percentage return on total investment by railroad (as determined by reported earnings of selected nonrail acquisitions) 410 Total cash investment in diversification program relative to total reinvestment in plant (1963-67), P.R.R. and N.Y.C 411 Total cash investment in diversification program relative to total reinvestment in plant (1963-69), P.C.T.C. and predecessor companies 412 Capital expenditures Pennsylvania and New York Central; 1946-67 412 Total maintenance expenditures selected railroads, 1958-70 412 Total reinvestment in plant, 1960-69 (capital and maintenance — road and equip- ment- — expenditures) 413 Earnings contributed by selected acquired nonrail subsidiaries to consolidated earnings of railroad (1964-69) 414 Summary of cash return on selected nonrail investments 416 Percentage cash return on selected nonrail investments 416 Dividends (interest) paid by selected acquired nonrail subsidiaries to Pennsylvania Co. 1964-70 418 Dividends (interest) paid by selected acquired nonrail subsidiaries to Penn Central Transportation Co. (and/or predecessor companies) 1964-70 418 Penn Central Transportation Co. (and/or predecessor companies) accounting for tax allocation receivable from (payable to) selected subsidiaries 418 Appendix A Intercity freight by modes, 1939-70 431 Composition of gross national product by major sectors, 1929-70 432 Income statement, class I railroads, 1960-70 433 Financial summary, class I railroads, 1960-70 435 Selected financial ratios, class I railroads, 1 960-70 437 Operating revenue, class I railroads, regional districts, and selected railroads, 1960-70- 439 Operating expenses, class I railroads, regional districts, and selected railroads, 1960-70 440 Equipment and joint facilities rent as a percent of net operating revenue, regional districts and selected railroads, 1964-70 441 Annual fixed charges as a percent of net railway operating income, class I railroads, 1960-70 441 Other income as a percent of pre-Federal income tax ordinarv income, class I railroads, 1960-70 441 Other income as a percent of pre-Federal income tax ordinary income, regional district and selected railroads, 1964-70 441 Cash flow, class I railroads and selected railroads, 1960-70 442 Ordinary income and cash flow, class I railroads, 1960-70 443 Fixed charges as a percent of cash flow, class I railroads and selected railroads, 1964-70 445 Cash flow as a percent of net worth, class I railroads and selected railroads, 1964-70. 445 Cash dividends as a percent of pre-Federal income tax ordinary income and as a percent of cash flow, class I railroads, 1960-70 445 Cash dividends as a percent of pre-Federal income tax ordinary income, selected rail- roads, 1964-70 445 Current assets as a percent of current liabilities, class I railroads, 1960-70 445 Current assets as a percent of current liabilities, selected railroads, 1964-70 446 Debt due within 1 year as a percent of pre-Federal income tax ordinary income, selected railroads, 1964-70 446 Net working capital as a percent of fixed charges, class I railroads, 1960-70 446 Net working capital as a percent of fixed charges, selected railroads, 1964-70 446 State and local taxes as a percent of pre-Federal income tax ordinarv income, class I railroads, 1960-70 446 State and local taxes as a percent of pre-Federal income tax ordinarv income, selected railroads, 1964-70 447 Output per man-hour, unit labor requirements, and related data, class I railroads, 1939-70 448 Average length of haul in miles, national rail system and selected railroads, 196 1-70 _ 449 Average length of trains, in number of cars, class I railroads and regional districts, 1960-70 449 XIV Average freight train load, class I railroads, regional districts, and selected railroads, Page 1960-70 449 Gross ton-miles per freight train hour, class I railroads and selected railroads, 1960-70. 449 Loaded car-miles as a percentage of total car-miles, selected railroads, 1961-70 449 Average freight car capacity, class I railroads, 1960-70 450 Unserviceable equipment, class I railroads, 1960-69 450 Average freight train speed, class I railroads, 1960-70 450 Time average locomotive spends in road trains, class I railroads, 1960-69 450 Percentage share of total class I rail tonnage (originated and received) for selected railroads, 1 96 1-70 450 Percentage of originated tonnage terminated, selected railroads, 1961-70 451 Percentage of received tonnage terminated, selected railroads, 1961-70 451 Percentage of total freight terminated, selected railroads, 1961 and 1970 451 Trailer on flat car carloadings as a percent of total carloadings, class I railroads and regional districts, 1960-70 451 Appendix B Gross national product or expenditure in 1958 dollars, 1929-71 453 Indexes of intercity ton-miles, industrial production, and gross national product (less services) , 1 960-70 454 Revenues of carriers and national income, 1939, 1959-70 455 Comparison of indices depicting national and regional growth patterns with railroad freight revenues generated by the Pennsylvania and New York Central Railroads. 456 Trend in tonnage originated — manufactures and miscellaneous 456 Index of tonnage originated — manufactures and miscellaneous 456 Trends in tonnage terminated — manufactures and miscellaneous 457 Index of tonnage terminated — manufactures and miscellaneous 457 Trends in revenues — manufactures and miscellaneous 457 Index of revenues — manufactures and miscellaneous 457 Trend in tonnage originated — products of mines 458 Index of tonnage originated — products of mines 458 Trend in tonnage terminated — products of mines 458 Index of tonnage terminated — products of mines 458 Trend in revenues — product of mines 459 Index of revenues — product of mines 459 Trend in tonnage originated — products of forests 459 Index of tonnage originated — products of forests 459 Trend in tonnage terminated — products of forests 460 Index of tonnage terminated — products of forests 460 Trend in revenues — products of forests 460 Index of revenues — products of forests 460 Trend in tonnage originated — LCL 461 Index of tonnage originated — LCL 461 Trend in tonnage terminated — LCL 461 Index of tonnage terminated — LCL 461 Trend in revenues — LCL 462 Index of revenues — LCL 462 Trend in tonnage originated — products of agriculture 462 Index of tonnage originated — products of agriculture 462 Trend in tonnage terminated — products of agriculture 463 Index of tonnage terminated — products of agriculture 463 Trend in revenue — products of agriculture 463 Index of revenue — products of agriculture 463 Trend in tonnage originated — Coal 464 Index of tonnage originated — Coal 464 Trend in tonnage terminated — Coal 464 Index of tonnage terminated — Coal 464 Trend in revenues — Coal „ 465 Index of revenues — Coal 465 Method of transporting bituminous coal and lignite from mines 465 Index of coal shipments by various modes 466 Participation of class I and II motor carriers of general freight in the total estimated intercity volume of regulated small shipment traffic in the United States, se- lected years, 1950-69 470 Comparison of relative changes in total tonnage generated by the 24 shipper groups and the rail share, 1963-67 - 471 Comparison of relation changes in total ton-miles generated by the 24 shipper groups and the rail share, 1963-67 471 Comparison of freight levenues generated by the various modes during the period 1954-69 472 Index of freight reyenues 472 Comparison of tonnage generated by the various modes during the period 1954-69. . 473 Index of tonnage 473 Intercity revenue growth of selected class I motor carriers 474 Merger, acquisition history of selected carriers, 1955-1970 480 Shippers evidence of service deficiencies --.---. ^^ Comparison of operating ratios achieved by intercity motor carrier subsidiaries con- trolled by the Penn Central and those achieved by all class I intercity common carriers 1965-70 482 XV Comparison of revenue growth achieved by intercity motor carrier subsidiaries con- trolled by the Penn Central and those achieved by all class I intercity common Page carriers, 1965-70 482 Comparison of operating ratios achieved by local motor carrier subsidiaries controlled by the Penn Central and those achieved by all general freight local carriers, 1965- 70 - 482 Comparison of revenue growth achieved by local motor carrier subsidiaries controlled by the Penn Central and those achieved by all general freight local carriers, 1965- 70 483 Comparison of revenues and production generated by U.S. pipelines versus Buckeye-- 483 Comparison of revenues generated by U.S. pipelines versus Buckeye 483 Comparison of barrels generated by U.S. pipelines versus Buckeye 484 Comparison of passenger revenues during the period 1953-69 484 Index of passenger revenues during the period 1953-69 484 Piggyback trailer and container terminations reported by class I railroads by plan, 1964-70 485 Appendix C North-South traffic and revenue as a share of total traffic and revenue in Official and Southern territories, 1953-69 487 Transcontinental traffic and revenue as a share of total traffic and revenue in Official and Mountain-Pacific territories, 1953-69 487 Volume and directional flow of Official-Southern traffic, 1953-69 488 Volume and directional flow of Official-Transcontinental traffic, 1953-69 488 Chronology of Southern and Transcontinental divisions cases 488 Appendix D exhibits Letter from Charles J. Hodge to David C. Bevan, July 28, 1960 493 Penn Central Will Diversify— To Spend $500,000,000 in "Variety of Fields, article, Baltimore Sun, May 14, 1968 494 Pennsy Eyes Diversification, Saunders Savs, article, Philadelphia Bulletin, Novem- ber 7, 1963 . 494 Memoranda dated May 10, 1963, from P.R.R. finance department 494 Letter from J. J. Wright to J. O. Boisi, November 8, 1963 503 Letter from J. J. Wright to A. E. Perlman, October 8, 1965 505 Memorandum of S. T. Saunders used at P.C.T.C. Board of directors meeting, June 1968 507 Letter from S. T. Saunders, to D. C. Bevan, August 14, 1968 508 Letter from David C. Bevan, to Mr. Saunders, May 28, 1968 508 Selected Subsidiaries — Analysis of Purchase of Investments — Period 1964-69. [Tables and other data submitted by railroad pursuant to request of committee's special staff] 508 News from the Pennsylvania Railroad, July 24, 1964 516 From the Pennsylvania Railroad, June 24, 1964, news release 517 Glore, Forgan & Co., interoffice memorandum, February 18, 1964 518 Minutes — N. Y. C. board of directors meeting, May 4, 1966 523 Letter from Charles J. Hodge to Alan T. Brown, March 29, 1965 524 Letter from Martha Fonner, to C. J. Hodge, September 29, 1965 and following cor- respondence pertinent thereto 525 From files of C. J. Hodge — "Pinnacle Farm Dinner — Cafe Boat," August 26, 1965_- 526 Letter from C. J. Hodge to David Bevan, October 16, 1961 526 Letter to Francis N. Rosenbaum, November 15, 1961 527 From the files of C. J. Hodge, Glore, Forgan, Wm. R. Staats & Co., October 30, 1963_ 527 Letter from files of C. J. Hodge, Chairman of Ex. Com., Glore, Forgan, Wm. R. Staats & Co., to David C. Bevan, April 6, 1965, with attachments 528 Letter from C. J. Hodge to D. C. Bevan, August 3, 1964 531 Memorandum from D. C. Bevan, chairman of the finance committee, P.R.R. to S. T. Saunders, chairman of the board, P.RR., September 28, 1964, with attachment.- 532 Letter to Charles J. Hodge, August 4, 1965 533 Letter from files of C. J. Hodge to Stuart Saunders, August 19, 1964 533 Partners memorandum from C. J. H., August 22, 1958 533 Letter from Basil Cole, to Mr. Kaier, February 18, 1969 535 Attachment to B. Cole memorandum of March 10, 1969 supra (exhibit 27) 539 Letter from S. T. Saunders to Hon. Alan S. Boyd, January 23, 1967 539 Memorandum from R. N. Carroll to A. E. Perlman, November 23, 1966 541 Letter from A. E. Perlman to Perry M. Shoemaker, May 6, 1969 544 From the files of S. T. Saunders, board memorandum, April 23, 1969 545 Memorandum from files of D.C. Bevan to S. T. Saunders, February 15, 1965 550 Letter from Jervis Langdon to S. T. Saunders, May 26, 1969, with attachments 551 Letter from William B. Johnson to Thomas M. Goodfellow, May 19, 1962 with attachments 553 Letters from D. C. Bevan to S.T.S., October 25, 1966 and November 8, 1967 554, 558 Letter from D. C. Bevan to Mr. Saunders, August 30, 1968 560 From files of S. T. Saunders, August 1964, memorandum for the directors 561 Letter from D. C. Bevan to James W. Aston, December 1, 1966 564 Letter from W. R. Gerstnecker to Charles J. Hodge, September 22, 1967 564 XVI "Conglomerates" and Public Responsibility, article from Traffic World, March 1, P a ee 1969 565 Memorandum from B. Cole to S. T. Saunders 572 Memorandum from E. K. Taylor to David C. Bevan, June 5, 1968 572 Memorandum from Basil Cole to Mr. Saunders, January 20, 1969 574 Application under sections 20a or 214, Interstate Commerce Act, for authority to issue securities, or to assume obligation or liability in respect of securities of another person 576 Norfolk & Western Railway Co. — common stock investment analysis 586 Letter from D.C.B. to J.M.S., June 21, 1954 610 Letter from D.C.B. to S.T.S., October 22, 1965 612 Equipment Lease Agreements 614 Letter from D.C.B. to S.T.S., November 21, 1966 616 (Memorandum). —"Tax Allocation Agreement Between GSC and Penn Central Co.," from William C. Baker to David C. Bevan, September 12, 1969 618 Letter from David C. Bevan to Mr. Saunders 623 Letter from Edward C. German (Labrum & Doak) to George Deller, February 15, 1972, with attachments 623 Report of trustees on reorganization planning, February 15, 1972 632 Trustees' Interim Report of October 1, 1972 655 Letter from J.P.N, to J.D.M., January 4, 1961 683 Letter from H. Large to R. G. Flannery (1740), November 24, 1969, with attachments. 683 Letter from T. B. Graves, Jr. to J. R. Sullivan, October 13, 1970 684 Letter from George R. Wallace to J. R. Sullivan (1534) 684 Trustees' plan for reorganization (April 1, 1972) 686 Letter from H. W. L. to B. J. R., January 30, 1967 701 Letter from H. W. Large to Mr. Saunders, November 14, 1969 701 Letter from Basil Cole to F. L. Kattan, August 30, 1965 702 April 6, 1970, Interim Report-President's Task Force 702 Letter from David E. Smucker to Mr. Saunders, November 13, 1969 704 Letter from Peat, Marwick, Mitchell & Co. to C. S. Hill, December 22, 1969, with attachment 705 Letter from Nicholas deB. Katzenbach to Stuart Saunders, September 4, 1964, with attachments 714 Letter from R. G. Flannerv to J. H. Burdakin, E. P. Frasher, R. C. Harrison, F. S. King, R. F. Lawson, J*. M. McGuigan, W. B. Salter, G. M. Smith, K. E. Smith, "Master Operating Plan Progress Appraisal", October 14, 1969 716 Letter from Stuart T. Saunders to Robert L. Oswald, May 15, 1972 with attachments. 717 Minutes of meeting held Mav 21, 1963 (finance committee, board of directors of P.R.R. Co.) 730 Letter from D.C.B. to S.T.S., August 31, 1966 731 Letter from W. S. Cook to D.C. Bevan, October 5, 1967 732 Letter from S. T. Saunders to D. C. Bevan, June 2, 1969 733 Interstate Commerce Commission, Docket No. 35291, verified statement 11, exhibit NPE 8, memo in working papers of Peat, Marwick, Mitchell & Co 733 Memorandum of finance committee board meeting, P.R.R. Co., May 13, 1969 735 Board memorandum, Tuesday, May 13, 1969 with attachments 735 Board memorandum, Wednesday, June 25, 1969 with attachments 737 Interstate Commerce Commission, Docket No. 35291 verified statement 4, exhibit DD 7 743 Letter from Basil Cole, regarding proposal to reform SEPTA board 745 Letter from Henry A. Guinn, to Stuart T. Saunders, June 3, 1969 746 Table of sources and applications for funds, December 31, 1960 to December 31, 1969. 7, 748 INTRODUCTION The Pennsylvania Railroad was organized in 1846 primarily with local capital to protect the commercial interests of Philadelphia by maintaining trade channels through Pennsylvania. Founded largely on civic pride, this economic enterprise was m the center of the Philadelphia social establishment, a position it maintained throughout its history. The city's western suburbs were developed from railroad land adjacent to its mainline right-of-way. Its presidents right up through its last president, Stuart T. Saunders, were often politically skilled and influential beyond the borders of the State of Pennsylvania. The Pennsyl- vania, which grew to be the largest railroad in the United States, survived the depression intact and remained a substantial force in the business community of the Nation. Its corporate personality reflected its social standing and was characterized by gentility, tradition, and feelings of superiority toward other railroads. The company's management was traditionally divided into several, somewhat independent spheres of influence, each contending for Board approval of its policies, with the chief executive officer primarily mediating conflict rather than establishing his own independent course. The character of the New York Central offers sharp contrast. It did not possess a secure connection to its community and to the past. Although also a railroad giant and a potent force in the Nation's commerce, it seemed in later years to be a lone wolf, cut off from its peers. Robert Young's takeover in 1954 disturbed its long association with the New York banks and drastically changed its management profile by bringing in, as president, Alfred Perlman who placed young college graduates into responsible positions, and encouraged inno- vation in railroad operations and marketing policies. The Central's chief executive played a dominant role in the company so that the Central was not composed of independent fief doms as was the Pennsylvania. Despite the radically different backgrounds and philosophies of the two railroads, the late 1950's and early 1960's found them with very much in com- mon, both having lost firm control over their own destinies. Plagued by declin- ing markets and growing truck and water competition, both were financially exhausted. Accepting the prevailing view of merger as the panacea for the rail- roads' financial problems, they anxiously got into the merger parade, but even here they had lost control as others set the merger pace — first the C&O and B&O and then a combine under the Norfolk & Western which appeared to further threaten their security. These earlier merger proposals left the Pennsylvania and New York Cen- tral with no other merger partners in the Northeast except each other. And the potentially stronger competition from the resulting roads made the Penn- sylvania and New York Central fearful that they would not be able to survive alone. Despite the essentially negative impetus for their merger, however, it was widely hailed as a forward step. Optimistic press agentry, confident assertions by merger architects, and financial analyses that concentrated only on the bene- fits expected from the merger resulted in the general belief that the Penn Cen- tral would not only be the Nation's largest railroad, but also a newly strength- ened pillar of the Nation's economy. Stuart Saunders, generally given most of the credit for bringing the merger to pass, was named businessman of the year for 1968. The Penn Central's stock price shot up shortly after the merger to unrealistic heights. It appeared to many observers that the problems of the Northeast's major railroads had been solved. Against this background it is not surprising that the Penn Central's collapse caught the Nation unaware. Warning signals of trouble had been suppressed or sugar coated. Its end approached with uncommon speed after the auspicious culmination of the merger. (xvn) XVIII Reality contrasted sharply with the rosy picture presented to the public and generally accepted by most observers. The ICC had presided over a complete reordering of the Northeastern railroad system in a short period of just six years. The debacle which would soon arise following the shotgun marriage of the Pennsylvania and the New York Central demonstrated, however, that a merged railroad is not necessarily superior to its parts. A combination of two weak, cash short railroads, with the smaller and even weaker New Haven added to it, produced a much larger but still weaker enterprise. So on June 21, 1970, two years after the merger, the ostensibly mighty Penn Central Transportation Company came to its ignominious end in a Federal bankruptcy court in Philadelphia. Two large, proud and once robust companies were reduced to penury by a combination of adverse circumstances and internal weaknesses. They were at once similar and diverse — similar as to geographic sources of support ; diverse as to philosophy, organization, approaches to railroading, and business in gen- eral. Accordingly they were both logical and unlikely merger partners. Finan- cial difficulties both drove them together and made them unfit for each other. As would be expected of such a behemoth, the Penn Central's death throes were agonizing. After money borrowed from banks dried up, an attempt in May 1970 to raise $100 million through a public debt offering failed. In late May the Board forced out its Chairman (Stuart Saunders) and its chief financial officer (David Bevan) and the President (Paul Gorman) assumed complete charge. The company openly sought Federal government assistance under the Defense Production Act. The Secretary of Transportation responded by holding a num- ber of "off the record" meetings with House and Senate leaders. However, the Chairmen of the House Banking and Currency Committee and the Senate Sub- committee on Surface Transportation, among others, were vocally skeptical of using existing s f atutes as a source of help and indicated their probable opposi- tion to any new bills to provide assistance. Administration officials prepared to sign papers authorizing a loan guarantee by the Federal government of $200 million for the Penn Central but this approach was abandoned on Friday, June 19, in view of growing congressional opposition. After a last gasp effort on Saturday, June 20, failed to change views of key congressional leaders, the Penn Central filed a voluntary petition for railroad reorganization under section 77 of the Federal Bankruptcy Act. (Section 77 is a special section designed to keep bankrupt railroads operating while resolving the claims of creditors and equity investors.) Although the Penn Central's collapse shook the financial world, its failure was not the major transportation disaster expected by some. The element of surprise, together with the Penn Central's default on commercial paper and other obligations, reverberated throughout the financial community and re- quired special action by Federal agencies to dampen the consequences. How- ever, bankruptcy did not require shutting down the railroad. It continued to operate as well, if not better, under the supervision of the court as it had before. The Senate Commerce Committee commenced hearings three days after the bankruptcy petition was filed to consider Administration proposed legisla- tion which would have authorized the Federal government to guarantee $750 million in loans for the Penn Central Railroad. But more questions developed than could be answered immediately and the hearings continued through July and August, with two final days in November. 1 The hearings produced a plethora of information about the Penn Central Railroad which hitherto had not been generally known: even by interested agencies of government such as the Interstate Commerce Commission and the Department of Transportation. Many members of the Committee found it diffi- cult to comprehend that a corporation with assets of an estimated value between $4 billion and $7 billion could come to its financial end without gross culpability in either management or government. There was concern that the extensive non- railroad holdings of the corporation not only failed to help the railroad but actually siphoned off funds which should have been used for improving the k, « 1 , H ^ rlngs bef °re Senate Committee on Commerce, Failing Railroads, Parts 1, 2, and 3, Serial No. 91-90, Ninety First Congress, Second Sess. xrx railroad's facilities and service. The diversification issue thus loomed large, and it was compounded by numerous indications of improprieties as well as pos- sible conflicts of interest and law violations as the Committee exposed to public view the private investments of some corporate officers. These private ventures were intertwined with and otherwise closely involved with questionable ven- tures by the Penn Central Transportation Company, such as its investment in Executive Jet Aviation. Indications of important management objectives other than providing transportation service led to further investigations into man- agement conduct by the House Banking and Currency Committee. 2 Meanwhile numerous private suits were filed against management, the board of directors, accountants, and others who could conceivably have played a part in the Penn Central's failure. The Securities and Exchange Commission investigated ques- tions of insider trading, criminal actions were brought in Pennsylvania against the railroad, and the trustees in bankruptcy of the railroad brought their own action against the prior management. The ICC finally began an inquiry into the state of affairs, while the House Interstate and Foreign Commerce Com- mittee staff considered the question of jurisdictional overlap and gaps between regulation by the ICC and the SEC 3 But while this flurry of activity was developing, the question of transporta- tion service in the Northeast continued to plague the Congress. The Senate Commerce Committee rejected any thought of immediate aid to the Penn Central and continued to review the situation until the trustees of the railroad sought a hearing before the Committee in November 1970. The November hearings convinced Committee members that, without assistance from the Federal government, the Perm Central might indeed be forced to shut down its operations and stop providing essential rail services. The numerous condi- tions which the committee attached to a legislative proposal to aid the Penn Central were indicative of the Committee's reluctance to pour Federal assistance into what appeared to be an almost hopeless financial situation. But, on the other hand, the Penn Central was the nation's largest transportation company at that time, with some 20,000 miles of railroad spread throughout 16 states, the District of Columbia and two provinces in Canada. The area served included 55 percent of America's manufacturing plants and 60 percent of its manufacturing employees. It moved about 1 million tons of freight and 300,000 passengers every 24 hours. Twenty-one percent of all freight cars loaded in the United States passed over the Penn Central. Over 70 percent of the Penn Central's traffic involved other railroads. There was hardly a major commodity produced in the United States or imported that the Penn Central did not handle at one time or another. It was the leading railroad for the movement of automobiles, chemicals, metals and manufactured consumer products and the second largest grain hauler among the nation's rails. The Penn Central exclusively served 34 U.S. Army installations, depots, arsenals and plants, 13 naval bases, stations and centers, 12 Air Force bases and other defense facilities. It was at that time the largest single carrier of mail in the United States. According to the in- formation available to the Committee, termination of operations by the Penn Central would have been a drastic blow to the economy — regionally and na- tionally. The Department of Transportation estimated that total economic activity in 17 Northeastern states would be reduced by 3 percent in the fifth week and 5 percent in the eighth week following termination of the Penn Cen- tral's services. For the nation as a whole there would be a 3 percent decrease in gross national product by the eighth week, unemployment would rise 5 per- cent in the eastern district and 3 percent nationally. These effects were regarded as unacceptable and hence, in the Committee's view, congressional action had to be taken. * „ See e.g. The Penn Central Failure and the Role of Financial Institutions, Part II, "Case Studv of Penn Central Subsidiary," Executive Jet Aviation, Staff Report of the Committee on Banking and Currency, Dec. 21, 1970, U.S. House of Representatives, 91st Cong., 2d Sess. s Inadequacies of Protections for Investors in Penn Central and Other ICC-Regulated Companies. Staff Study, Special Subcommittee on Investigations, Committee on Interstate and Foreign Commerce House of Representatives, July 27. 1971, 92d Congress. XX A bill was developed which would authorize a Federal guarantee of $125 million in private loans to railroads upon sat isfaction of several conditions. The principal condition was that any recipient had to be in bankruptcy and there- fore subject to the jurisdiction of a Federal court. The Committee stated in its report to the Senate: "The financial system that prevails in the United States recognizes that business failures will occur and so long as the Nation's entire financial structure is not seriously endangered such failure should be accepted. A competitive system will produce both successes and failures and theoretically within the proper framework the general public gains by having a choice available. "The Committee is chary about setting any precedent for general relief to businesses which experience financial difficulties. Accordingly the legislation reported herewith is designed to let the laws of the marketplace pertain to rail- roads as to any other business until there is demonstrable evidence that termina- ton of services by the railroad is imminent and that such termination will endanger the public welfare." The Committee went on to say that in its view, therefore, the railroad like any other business should be required to use the Bankruptcy Act. 4 But in approving the legislation the Committee was aware that it was only emergency legislation, that it probably would not solve the dilemma of the Penn Central nor would it solve the massive transportation problems endemic to the Northeast. Subsequently the Chairman of the Surface Transportation Subcom- mittee, the Subcommittee which is directly concerned with surface transporta- tion problems, proposed that the Committee commission a study to determine the cause of the Penn Central collapse, to isolate those factors which woidd be responsive to government action, and to propose solutions. Accordingly the Committee approved and in May 1971, the Senate authorized a special study of the Penn Central collapse to be carried out by the Commerce Committee. The Committee Chairman directed the Committee's Transportation Counsel to di- rect a special staff study. The Chairman of the Surface Transportation Sub- committee would oversee the staff efforts on behalf of the Committee. The Committee's principal interest in this matter related to the quality of transportation service in the United States. It was determined therefore that the study should isolate and, insofar as practical, quantify the causes of the Penn Central collapse. It should place the Penn Central in perspective within the industry generally and it should place the asserted causes of bankruptcy in perspective. The study should reach conclusions and should propose solu- tions. It should not place undue emphasis on areas only incidentally of interest or areas which were being examined or had been examined by other government entities unless such additional examination was necessary because of the impact upon the provision of transportation services. As a consequence the staff did not devote substantial efforts to uncovering violations of the law after it became apparent that such violations were not major contributors to the railroad's collapse. In addition prosecutions at the State level had begun at an early date and Federal agencies have carried on their own inquiries. "While not engaged in criminal investigation itself, the staff has endeavored to coop- erate with law enforcement agencies at both the Federal and local level. Nor did the staff concentrate on the insider trading issue — the Securities and Exchange Commission having undertaken a thorough review of that area and apparently having taken steps to prosecute discovered violations. Similarly the study does not dwell on the misconduct of officers — having determined that, while reprehensible, misconduct was not an important cause of the collapse. From a strictly legislative viewpoint, the aforementioned areas, although of great interest and perhaps even some significance insofar as the railroad's col- lapse was concerned, were not likely to produce much guidance for improving government policy toward transportation. Much of the information for the study was gathered directly from files of the Penn Central Transportation Company, from some creditors of that com- * See Senate Report 91-1510 of the 91st Congress accompanying S. 4595 which became P.L. 91-633 on January 8, 1971. XXI pany, from investment houses, from the Association of American Railroads and the rail industry generally, from the Securities and Exchange Commission, and from the Interstate Commerce Commission. The ICC made available vast amounts of information, including some very helpful verified statements by its investigative employees. It should be added that all of these sources and par- ticularly the ICC, which provided working space for the special staff as Avell as information, have been most cooperative with the Committee staff. The report resulting from this special study is divided into three major portions. Part I, a distillation of the fundamental forces underlying the Penn Central bankruptcy, begins with a piece entitled "Penn Central in Perspective" which states in as few words as possible the principle lessons and proposals supported by the report. The body of Part I starts with a look at the eco- nomic situation facing all transportation and in particular the Eastern rail- roads. The next chapter deals with Penn Central's Financial Performance. Then the chapter on Fiscal Policy describes the investment activities of the management in the years prior to the merger and during the two years of merger. While diversification is really a part of Fiscal Policy it is treated separately in its own chapter because of the great importance which has been attached to it. Then the railroad's operations are assessed. And finally, the Merger is reviewed. The final chapter of the analysis segment of Part I, entitled "An Integrated View," draws together in one place the general impli- cations of the analysis. As an aid to the users of this report, immediately following the "Perspective" will be found the report's Findings organized to correspond with the structure of the "Evidence and Analysis" in Part I. The conclusions which follow the analysis were extracted from the Findings to answer questions about what happened to the Penn Central and who is to blame. Following that are the Policy Recommendations which seek to respond to the question of what the government should do about the problems identified by this study. Part II is entitled "American Railroads: Posture, Problems and Prospects." It is this work which provides a review of the rail industry generally and which supplies an industry-wide background for the Penn Central inquiry itself. Part III is composed of more detailed background studies which generally provided the basis for the Part I analysis. An important objective of any study should be to critically review past actions. Often this process produces sharp criticism of conduct which at the time of performance, given the environment, might qualify as reasonable con- duct in a court of law. This study does not purport to make any findings about legal culpability. Rather, it represents an effort to evaluate prior events in the light of today's standards for the purpose of improving future policy formula- tions. Hindsight is an invaluable tool for correcting past mistakes. But while using hindsight, the study group did strive for perspective in analyzing the various forces at work. And a determined effort was made to produce a balanced report, to provide practical guidelines for future action by the Congress, the Department of Transportation, the ICC, and the industry, in coping with the transportation crisis which now confronts the Northeastern part of the country and which may spread to other portions of the United States. Part I Penn Central Collapse: Perspective, Analysis, and Prescriptions FOREWORD Part I is intended to provide an analysis of the Penn Central and to extract lessons arising therefrom. It is the heart of the report. Several sections of Part I were drawn from the more detailed analyses found in Part III. Part I repre- sents a distillation of the information available to the study group. The objec- tive was to condense the relevant information as much as possible in Part I, leaving Part III for those interested in pursuing some of the individual subjects in more depth and using Part II to provide perspective for the Penn Central in a larger rail transport context. Part I begins with a very brief synopsis, entitled "Perspective," designed to relate, in as few words as possible, the message transmitted by the Penn Cen- tral experience. The "Findings'' immediately follow the synopsis; the "Find- ings" are essentially a list of principal facts arranged to correspond with the organization of the "Evidence and Analysis." The "Analysis" begins with a review of the National and regional economic environment in which the Penn Central found itself. The next section "Finan- cial Performance" describes the outward financial manifestations of the Penn Central's condition for the decade prior to bankruptcy. It should be noted that much of the Financial Performance analysis and succeeding sections utilize "pro forma" data which is merely the combination of various data for convenient use. Usually it involved the combining of Pennsyl- vania Railroad and New York Central Railroad data prior to merger producing "pro forma" information about the Penn Central in premerger years. The section entitled "Fiscal Policy" is an analysis of the company's finan- cial management excluding diversification which was placed in a separate sec- tion immediately following "Fiscal Policy." Following "Diversification" is the analysis of operations' management in the section entitled "Railroad Operations." "Merger and the Road to Ruin" reviews the merger event and assigns its role in the demise. "An Integrated View" seeks to draw together into one section the themes suggested by the prior analyses. The "Conclusions," and "Policy Recommendations" refine the process fur- ther. The "Conclusions" are drawn from the "Findings" and the "Policy Rec- ommendations" are the suggestions for future policy supported by the report. Following each section are pertinent tables and charts supporting the text where necessary. (3) PENN CENTRAL IN PERSPECTIVE The story of the Perm Central collapse has many facets and implications. But the most important conclusion of this report is that there was no singular reason for the Penn Centrals financial failure. It will perhaps be disappoint- ing to those expecting the root cause to be found in a litany of sordid events to learn that the railroad's failure cannot be written off as resulting from evil men's schemes. Rather the major contributors were much broader in scope : changing and more hostile environment in the Northeast, the declining con- dition of the national economy, management and industry response to those changes, and the failure of public policy toward transportation. The Penn Cen- tral's financial difficulties and the state of most other rail transportation in the Northeast flowed from a critical combination of those factors. The causes are to be found, then, in the failure of men, institutions and laws. The wrongdoers are being prosecuted and sued. But if we are to avoid a repetition and if the nation is to strengthen its transport system, changes must be made on many fronts ; in laws, and institutions, as well as in the attitudes of men. This report makes a number of recommendations for such changes. To assist in quantifying the contributors to the failure of the Penn Central, the following is offered to show the effect of various factors on available cash : PENN CENTRAL TRANSPORTATION CO.-CONOENSED COMPARATIVE STATEMENT FOR THE PERIOD 1960-69 [In millions) 1 1960-69 (millions) Percentage Railway operating revenues. Less: Operating expenses. Net revenues from railway operations Less: Joint facility rents, taxes, etc Net railway operating income _ Plus: Other income Less: Other expenses Income available for fixed charges Fixed charges Net income.. 150.4 1.0 ' 1960-67 pro forma. (5) $15,210.8 12,478.9 100.0 82.0 2,731.9 2,408.2 18.0 15.8 323.7 789.0 103.8 2.2 5.2 .8 1,008.9 858.5 6.6 5.6 6 Selected factors showing influence on cash for the period 1960-69 In thousands Dividend payments (1960-69) $307,111.2 Passenger losses — Solely related 1 (1964-70) (On a fully allocated basis, the losses were $609,127.) 198,451.2 Excessive bad debt expense post-merger 31,511.9 Inter-territorial division settlement 11,550.1 Merger-related expenses : Capital improvements $90, 200. Excessive per diem 15, 000. Labor protection 64, 600. Purchases 18, 600. New Haven inclusion : Rehabilitation costs 31, 000. Advances 14,000.0 Total, merger-related expenses 233,400.0 Subtotal 782, 024. 4 Investments in subsidiaries and affiliates — Cash outlay only 8 203,203.0 Total 985, 227. 3 Interest 3 expense on dividends paid (1963-69) $67, 673. Interest 3 expense on cash investment in subsidiaries 56, 903. 3 Interest cost on borrowings necessitated by increase in accounts receivable (1968-June 1970) 3, 554. 6 128, 132. 9 Total 1, 113, 360. 2 1 Includes New York, New Haven and Hartford RR. for 1968-70. 2 Primarily by the Pennsylvania Co. Net cash outflow for diversification from 1963 through 1970 was approximately $41 million. 3 Imputed interest on cash paid out. Also of interest is the following general table showing the source of funds and the application of funds for the Penn Central over the period 1960 through 1969: PENN CENTRAL TRANSPORTATION CO. (COMPANY ONLY) STATEMENT OF SOURCES AND APPLICATIONS OF FUNDS, FOR PERIODS ENDED DEC. 31, 1960 TO DEC. 31, 1969' [In thousands of dollars] 1960-69 totals 1960-69 totals Sources: Net income(loss) 149,900 Plus depreciation 95 1 , 700 Less identified noncash transactions.. (132,000) Total 969,600 Increase in capital stock (principally options). 8,600 Sale of capital assets 343,300 Sale of investments and miscellaneous properties 322,800 Sale of investments to Pennsylvania Co 29,500 Equipment financing: CSA 670,900 ETC... . . 117,100 Leasing _ 546,900 Total equipment financing 1,334,900 Other borrowings and advances __ 799,100 Total sources 3,807,800 1 For more complete table, see Appendix D, Exhibit 81, p. 748. Applications of funds: Dividends _ 307, 100 Capital expenditures: Road... 571,900 Equipment 1,056,500 Leasing 546,900 Total 2,715,300 Other capital expenditures 36, 000 Debt reduction 1, 141,400 Investments and advances 5,800 Increase in special funds, expenditures charged to merger reserve.. _. 36, 300 Miscellaneous 31,400 Total applications 3,733,300 Increase (decrease) in net working capital... (81, 700) 8 The lessons for policy are particularly pressing because many of the factors that contributed to the bankruptcy of the Penn Central are at work in other parts of the Nation's rail system. Kail service is seriously impaired throughout the East and is less than adequate in other sections as well. It is important to keep in mind, however, that the definition of the railroad problem is com- monly oversimplified. It is in reality highly complex, with manifestations varying in character and severity among regions and raihoads. Examining the railroad system in the aggregate hides the significant relationships. For some railroads, traffic is growing steadily; for others, the outlook is bleak. Despite the strength of some roads, the deficiencies of the system and the Penn- Central experience offer a stern warning with far reaching lessons for carriers, transportation users, taxpayers, and government. It is unlikely, however, that mere modification of traditional policies would provide a setting conducive to a fiscally and operationally viable system. Spe- cifically, long-neglected problems such as functional obsolescence of the rail plant attributable to decades of fiscal starvation, locational obsolescence at- tributable to the dynamics of the economy, and archaic management attitudes, must be dealt with. Effective treatment requires sharp changes in the premises of public policy and organic restructuring of the industry. The challenge is to devise a combination of public and private programs that will insure a railroad system appropriate for present and future transport markets and public needs. Although much can be done by individual carriers to improve their efficiency and provide more reliable service, the industry as a whole must willingly seek to enhance individual efforts and, more importantly, to improve system performance. We cannot lose sight of the fact that the rail- roads must function as a system ; one railroad cannot function in isolation from others. Beyond private remedies, the answer appears to be in a reasoned sys- tems' approach identifying and addressing fundamental system deficiencies, taking into consideration social, environmental and economic factors. The recommendations found at the end of Part I of this report begin with the need to improve public disclosure of financial, physical, and operating conditions of railroads. Improved identification of problems and the formulation of policy can occur if the Department of Transportation helps to monitor the rail system, and determines the nation's needs for rail service; and if the executive branch focuses attention on the illness. The government's involvement in rail affairs must begin before facilities deteriorate to the point where the public interest is adversely affected. While protecting the rights of protagonists, the Commission must develop guidelines for speedier decision-making on issues involving diversification, rates, abandonment, and merger policy. Service failures, maintenance neglect and freight car utilization are other matters specifically requiring more attention by government. Government assistance should be addressed specifically to the needs of the public and trans- port users for better service. The Penn Central and most other railroads in the Northeast appear to have declined to the point where drastic action is necessary. Various suggestions have been made. One suggestion of great interest proposes the establishment of a Northeastern Transportation Authority with appropriate local. State, and Federal representation. The Authority would determine what is necessary in terms of rail service for the Northeast. If it subsequently found that such service could not be provided by the existing transportation network, given its financial problems, then either the Authority or a quasi public corporation would take over the operating authority of all bankrupt railroads in the North- east, issuing government guaranteed debentures to the trustees in bankruptcy, and placing stock in escrow for later sale to the public if and when feasible. Free from investor imposed constraints, the authority would have sufficient power to improve the service capability from a systems vantage point and, hopefully, would eventually restore a revitalized rail system to private owner- ship and control at little cost to the Federal government. FINDINGS Environmental Conditions The market and general economic environment for the Pennsylvania and New York Central Railroad was particularly hostile and grew increas- ingly so during the 1960's and throughout the merger gestation period. (1) Changing nature of the national economy During the 1960's the role of transportation in the American economy, while still expanding in absolute terms, deteriorated somewhat in a reflection of less- ened emphasis on goods production. Freight transportation is concerned with the movement of physical things such as minerals, agricultural products and manufactured goods which for many years were at the core of domestic eco- nomic activity. Recently, however, the services, finance, trade and government sectors of the economy have been growing most rapidly. In terms of the share of the Gross National Product they represent, agriculture, mining and non- durable goods have begun to diminish while the share represented by the serv- ices, finance and trade categories have expanded considerably. From a transport standpoint, these "service" sectors generate relatively little demand for freight transportation. Environmental and related social considerations have also had an affect on transportation. For example, coal has come under general disfavor as a source of energy (although recent fuel supply problems promise to revise the trend outside the Northeast), hurting the railroads as a group. The impact has been most severe in the case of restrictions on higher sulfur content coal, which is the kind of coal mined in most of the coal fields served by the Penn Central. In view of these trends it is not surprising to find that freight transport indicia have been shrinking in relation to aggregate economic expansion. {2) Technological changes The shifts in the composition of the economy have been accompanied by changes in technology. The use of lighter weight materials, for example, has re- duced the demand for transportation capable of moving large, heavy materials. There has been a general trend toward locating factories and other production facilities closer to consuming markets, further reducing the demand for trans- portation. Coal, once burned almost entirely at electric generating stations lo- cated in the using market after being hauled by rail from the mine, is now con- sumed in large quantities for electric power generation at the minehead. (3) Cyclical economic patterns The cyclical pattern of the economy has a pronounced impact on transpor- tation and especially on the railroads. Rail traffic closely tracks the ups and downs of the economy. During the 1960's this had acute significance for all the railroads and particularly for the Penn Central in the decade's last years. Re- cessions took place in the* beginning of the decade. 1960 to 1961, and at the end from 1968 (when the Penn Central merger was consummated) until 1970 (when the Penn Central petitioned for bankruptcy). The almost continuous decline of the economy at merger time set the stage for hard times for the new Penn Central. (Jf) Uneven impact of change on the modes The forces of change have permitted other modes of transportation to gain ground on railroads. The rail share of intercity freight traffic has been sub- stantially reduced, to the benefit of the other modes — trucks (with their greatest penetration coming in general commodities) , barges, and pipelines (de- livering substantial amounts of bulk traffic). In 1960 railroads accounted for O) 10 44 percent of the nation's intercity freight transportation, but by 1969 the rail share slipped to 41 percent. The rail share of freight revenues 'declined from 28 percent to 22 percent. Bv contrast the trucks increased their revenue sharply during this period, doubling their tonnage and doing even better in their profits. (5) Northeast region In the Penn Central region these factors were an even greater negative force. The Penn Central territory has lost ground relative to the rest of the nation. Its percentage of the population has dropped since 1950, as has its share, of the nation's personal income. Even more pronounced is the decline in manufacturing (from 65 percent of the total in 1950 to 54 percent in 1969). In absolute terms of course. States making up the Penn Central territory con- tinued to bulk large in the national economy. But the region's relative rate of expansion clearly lagged behind most other areas. To see how all these forces have come together and affected the Penn Central it is helpful to look at the key traffic sectors — coal, manufactured goods, and smaller shipment movements. Coal — By 1970, only 15 percent of the Penn Central's revenue was derived from the transportation of coal as coal production in the region dropped from 71 percent in 1957 to 62 percent in 1970 of the total coal produced in the nation and there was an increased tendency for mine head use of coal (by 1970 nearly three times as much coal was being consumed for power generation at the mine head than was being transported by rail). At the same time the Eastern market was declining, Penn Central's share of the market dropped even more (while Eastern roads generally reported a 5 percent increase in coal revenue between 1965 and 1970, Penn Central coal revenue was off more than 11 percent). Manufactured goods traffic — The railroads lost ground in transporting high rated manufactured goods to other modes, especially to the trucks. In the East- ern district the rail share dropped by about 3 percent between 1963 and 1967 while in New York City, for example, the trucks increased their share from 50 percent to 73 percent. Of significance here too are the railroads' successful ef- forts to regain automobile transport traffic which had been lost in the 1940's and 1950's. Their fight to regain this traffic in the early 1960's caused tonnage to rise by 164 percent, while revenue, revealing the downward rate adjustment that had been put into effect, increased by 93 percent. The Eastern roads did better than the industry with this traffic. However, the Penn Central, while improving, did not do as well as the other Eastern roads. The resurgence of auto traffic suggests that railroads are capable of highly effective competition in higher valued man- ufactured goods traffic. Small shipment traffic — In the late 1940's and early 1950's, railroads vir- tually abandoned hauling goods in less than carload lots, and today handle only a very inconsequential volume of such shipments. These small parcels (50 to 10,000 pound category) represent 95 percent of all shipments by for hire truck- ers. In 1970. they represented about 79 million tons of freight. This is high value freight with high rates and high yields. With its coal traffic down sharply and with the loss of substantial manufactured goods traffic to the trucks, the Penn Central (and it was not alone in this respect) was caught in pincers. Railroads are slowly making an effort to reenter this market with TOFC (trailer on fiat car) or COFC (container on flat car) service. (G) 1 nterterritorlal divisions When two or more railroads participate in a joint rate shipment there must be a division of the resulting revenue. Considering that billions of dollars ($4 billion in 1969) are subject to divisions each year, it becomes apparent that very 11 small percentage shifts in the shai*e to be allocated are of substantial economic importance. The Northeastern (Official Territory) carriers have in recent years argued for readjustments. The Penn Central alone claims that division adjust- ments could increase its revenues by $46 million. Major division cases are hotly contested affecting as they do the economic condition of every region in the country. Equitable resolution of such disputes are important but at the same time difficult to achieve. Penn Central Financial Performance The hostile environment was reflected in extreme financial stringency for the Penn Central, with the railroad operations incurring chronic deficits as traffic dropped off and expenses shot up even while revenues and rates increased. (7) Revenues Operating revenues for both the New York Central and the Pennsylvania Railroad were generally unfavorable in the late 1950's. reaching a low point in 1961. After some hesitation in 1961 to 1963, their combined revenue advanced rather firmly through 1966. The favorable revenue trends through 1966 resulted entirely from increases in volume; significantly this increased revenue occurred with no important change in haul patterns and with reduced rates. After 1966 modest revenue growth was achieved despite a consistent drop in traffic volume (a force which cannot long be countered by compensating factors). Post 1966 revenue growth for the Penn Central partners was similar, but lagged far be- hind the performance of other railroads in the East. Other railroads' traffic re- vived after the 1966-1967 downturn while Penn Central traffic continued to fall. (8) Costs The generally upward revenue movement during the 1960\s suggests that the company was not done in by a revenue collapse in absolute terms. It appears that rising costs were more damaging than softening revenues since operat- ing expense for 196!) and 1970 was up about $400 million. The operating ratio (ratio of expenses to revenues) of the partners declined steadily through 1966 (to 78.8) and thereafter rose sharply going completely out of sight (to 92.1) after merger. The increased expenses came largely from rentals which jumped dramatically from 1964 to 1970. During the same period, fixed charges (interest payments) rose substantially. This presented a particularly lethal combination. Over the entire 1958 to 1970 period under review, the railroads generated positive net railroad operating income of only $164.5 million (re- moval of the merger period increases this by some $300 million) and incurred fixed charges of $1,180.5 million. Fiscal Policy Financial stringency was a cornerstone of fiscal policy. For the Penn- sylvania and later the Penn Central it was matched by concern for credit standing. The resulting ad hoc policy of compromising conflict presided over a deteriorating physical plant while earnings were overstated and ex- cessive dividends continued to be paid. (9) Constraints There were numerous constraints on the railroad's fiscal policy. The most important were: (1) inherited — fixed charges (interest) and capital structure 74-924 O - 73 - 3 12 (debt) from postwar investments; (2) merger induced — agreement to limit the amount of debt increase (initially $100 million, later $195 million), and agreement to maintain slock ratio between the companies of 1.3 (NYC) to 1 (PRR) made more significant by the excessive delay in consummating the merger; (3) outside factors — severely limited earnings potential of the two companies, restricting range of investments and means of financing, financial market conditions, financial market assessments of credit worthiness and secu- rity values, and finally stockholder pressure. (10) Investment programs and patterns During World War II these railroads along with many others were used very intensively with inadequate repair and replacements, leading to the de- terioration of roadway and equipment. The two companies fell behind the system as a whole and individual companies throughout the country in reha- bilitating and improving the physical plant. For the 20 year period prior to merger the Pennsylvania Railroad invested $2.19 billion in the plant and the New York Central $1.45 billion or a grand total of $3.6 billion. During the years 1959-1967 over $1.5 billion was put back into the two companies that were able to generate only $472.5 million of net railway operating income. (This investment represented nearly 10 times the amount put into diversifica- tion during the period 1963-1970.) As a percentage of revenues the record was far below the achievement of many other major roads including Penn Central's regional neighbors, Norfolk and Western and Chesapeake and Ohio as well as the Southern Pacific and even the Chicago and Northwestern. For maintenance expenditures the pattern shows little change over the 20 years prior to 1968, varying between 41 percent and 46 percent of the total invest- ment. After merger the capital investment program remained modest, but ex- traordinary maintenance expenditures increased from $421 million in 1967 to $551 million in 1970. Coupled with this were miscalculations in merger-related capital expenditures which were projected to reach a total of $74.7 million over four years but were $90.2 million in just the first two years. (11) Investment Policy Investments for the Pennsylvania, particularly, and later the Penn Central, reflected policies which attempted to compromise the conflicting pressures and criteria imposed by concern for fiscal measures and fiscal performance to sup- port the company's credit standing and those imposed by operating require- ments for plant improvement. Credit standing was also of prime importance to stockholders not wishing to see further decline in stock prices. In 1963 the Pennsylvania Railroad financial officer enunciated a policy allowing increased capital investment in the railroad only if it produced a 30 percent return as a minimum or a $50 million operating profit. Operations officei-s argued the need for more plant investment and complained that the financial officers were more concerned about non-railroad investments or a decrease in "our Moody's rating" than in improving railroad operation. By 1967, just prior to the merger, the financial officer had no road capital budget for the ensuing year and the status of the equipment budget was still up in the air. In addition, a stop had been or- dered to all future railroad projects that did not show a 50 percent return on investment unless required for safety or for industrial development purposes. It is also important to note the influence of ICC accounting rules which actually provide a deterrent to major maintenance expenditures in track and roadbed requiring the bulk of such expenditures to be charged to expense when made. (At the same time it results in overstatement of net income because depreciation is not allowed on track and roadbed. ) ( See also finding 16. ) (12) Investment Policy Evaluation^ Investment patterns showed the absence of any coherent capital budgeting process. Instead, the avowed policy of the Pennsylvania Railroad was "middle of the road." shifting as pressures changed. It might be described as a non- policy with no consistent corporate goals, or even an ad hoc system of compro- mising conflict. While tin* railroad investment program for 1964 through 1966 13 was considered a failure by the financing officer, questions arise about the ra- tionale of the criteria and the stringent payoff period expected for rail invest- ment, but not for non-rail investments. In the final analysis it is difficult to evaluate the budgeting process because of the absence of any clearly defined goals. Furthermore, the system had no integrity, no one believed estimates, and measurements of performance were of doubtful utility as evidenced by the fi- nancial officer's questionable guidelines. (13) Capital Structure arid Debt Burden There was a major postwar buildup in debt, a debt reduction program to 1964, and then a Pennsylvania buildup in conjunction with a Central plateau. Total increase between 1964 and bankruptcy was over $700 million (to $721 million for the Pennsylvania, and $666 million for the Central). Since railroad earnings tend to be volatile, a safety margin is needed for successful debt management to insure annual income sufficient to cover fixed charges and to provide flow of funds, including depreciation accruals, to meet maturities. Not having these essentials, debt management for the Pennsylvania and the Central was precarious. With heavy maturities coming due ($52.9 million in 1965 and $84.7 million in 1968) the Pennsylvania had big problems. The Central escaped the debt problem for a while by holding down capital expenditures and deferring ma- turities until the 1970's. The Pennsylvania expected relief under the merger because of the Central's favorable debt structure which made the combined capitalization superior to either one individually and quite acceptable to invest- ment analysts. The programs of debt reduction for both companies reflected expectations that future revenues would be inadequate to meet obligations, and were accomplished by paring down capital commitments to rail operations and greatly curtailing maintenance. (1 4-) Equipment Financing Equipment financing constitutes the major component of any railroad's plant investment. Such investment is explicitly encouraged by the more ready availability of investment funds because of more favorable financing methods. Of the three general methods of financing (sale of equipment trust certificates, conditional sales financing, and leasing), leasing requires a smaller down pay- ment and leaves title in the lessor giving the lessor greater security. These, fac- tors make leasing attractive to railroads with financial difficulties. Because the lease payment is treated as an operating expense rather than a fixed charge (in- terest payment) it can give the illusion of a reduction in the railroads' long term debt and fixed charges. The Pennsylvania Railroad had begun concentrating on leasing as early as 1957 and the New York Central used leasing starting m 1962. After 1962, leasing provided a means to circumvent the merger agreement on debt limitation and was therefore important to the merger partners. A cor- ollary effort was the capitalization of major overhaul expenses. The ICC Bu- reau of Accounts has argued that even when rebuilding is involved, capitaliza- tion is improper and the costs involved should be written off as maintenance expenses for the year of rebuilding. Nevertheless, in years just prior to merger the Pennsylvania Railroad shifted to a capitalization basis which, in the short run at least, reduced reported maintenance expenses and thus increased reported net income. Coupled with a program of selling cars to "straw parties" and leas- ing them back, the railroad showed smaller cash drains in the year of repair although it might mean larger cash drains in following years. It also permitted the Pennsylvania Railroad to use the investment tax credit indirectly through the third parties which repaired the equipment and leased it back. (15) Postmerger Fiscal Policy Like other railroads the Perm Central partners rarely used equity financ- ing, even in those instances where it was most certainly suggested by the cir- cumstance. Soon after the merger was consummated and a period of rising inter- est rates and tight money was at hand, the Penn Central management, in great need of financial assistance, went the route of short term debt, putting it in greater jeopardy than if long-term financing had been arranged at the time of 14 the merger. But if ever equity financing were appropriate, it was at the time of the merger when the price earnings ratio was very high because of ex- pectations about merger savings. Also a stock offering at that time would have been less expensive than usual. By providing the railroad with substantial funds and not increasing debt it would have given the railroad a much needed margin of safety. There seems to be no good reason why a stock offering was not made in this, particular instance, nor why railroads shun stock offerings in general. (16) Accounting Practice and Policy The existing ICC position on "betterment accounting," deferred income taxes, accounting of investments in subsidiaries, and financial disclosure re- quirements does not in all cases reflect the increased complexity of the major common carriers' operations and the need for more relevant financial informa- tion by analysts and investors. The ICC's regulations lack precise requirements for certification of financial statements by independent accountants and stand- ardized disclosure requirements for prospectuses. These regulations fail to obviate the sort of loose accounting practices evinced by the Penn Central Company's treatment of transactions designed primarily to inflate reported income on both a consolidated and nonconsolidated basis. (See also finding 11.) (17) Earnings Maximization Earnings maximization, or earnings inflation, was employed by the Penn- sylvania Railroad and the Penn Central (it was not pursued extensively by the Central). This technique was not concerned with the realities of income or cash flow, but was an effort to pretend that earnings were larger than they really were by inflating them. Earnings maximization, a practice in deteriorating com- panies, was pushed to extremes by the desire of management to protect the 1.3 to 1 stock exchange ratio agreed upon in 1962. If the New York Central is rela- tive value were increased, the share of earnings going to former Pennsylvania Railroad shareholders would be less and renegotiation caused by an altered earnings picture might delay the merger. The policy was continued after merger, even though the ratio was no longer relevant, reportedly to maintain the credit position of the railroad. As the practice continued there developed less and less relation between cash flow and reported income. Devices used included requiring subsidiaries to inflate reported earnings and declare large dividends; repoi'ting as much income as possible as ordinary rather than extraordinary; restricting maintenance and capital expenditure budgets; capitalizing equip- ment refurbishing (as described in finding 14) ; and treating as many ordinary expenses as possible as "extraordinary expenses." These practices did not gen- erate any new cash ; they only seemed to. Although the Penn Central was an illiquid company where cash management would seem to be a major area of management concern, the generation of cash was secondary to the attempt to inflate, and thus distort, reported net. Accounting theory, which stresses con- servatism and consistency, was either ignored or adhered to solely when consist- ent with the principle objective of delusion. (18) Diridends Policy While dividend payments for all Class I railroads are probably too high, dividends paid by the Pennsylvania Railroad and the New York Central in the 1960-1967 periodwere extraordinarily high. Starting in 1962 (when the merger agreement required maintenance of the 1.3 ratio for dividend payments) the two railroads actually increased their dividends each year, very carefully main- taining the 1.3 ratio. From 1960 through 1969, dividends totaled $307.5 million ($282 million of which was paid after 1963.) After merger, dividends paid in 1968 were $55.4 million while the Penn Central Railroad lost $2.8 mil- lion. The 1969 dividends were $43.4 million while the railroad had a deficit of $82.8 million and a consolidated income of $4.4 million. Considering the severe financial straits, Penn Central's management evidenced a cavalier attitude to- ward the declaration of dividends. Penn Central management later argued that the dividends kept up the price of stock and gave the railroad a better credit rating. But it is difficult to justify efforts to prop up stock prices in a crisis when no stock issue was ever contemplated. It is also important to note 15 that since dividends were greater than available cash resources, the Penn Cen- tral had to borrow money to pay them. This meant higher interest costs in terms of millions of dollars more than the railroad needed to pay. Such high dividends could not be justified. Any favorable consideration the Penn Central might have received as a result of its steady dividend payments could hardly have offset the cash drain of more than $130 million in dividends and related interest payments after the merger. Diversification A specialized aspect of fiscal policy, diversification, resulted in a net cash drain which, while relatively small, could be ill afforded at the time. As part of the overall fiscal policy, it contributed to the company's illusory credit standing. (19) Cash Flow Historically both the Pennsylvania Railroad and the New York Central had substantial interests in nonrailroad investments. The diversification pro- gram of interest here and which has generated so much discussion began in 1963 shortly after the Pennsylvania's sale of its large Norfolk and Western railroad holdings became imminent. Of particular interest, because we are con- cerned with illiquid roads, is the cash flow involved. While the total acquisitions were valued at $320 million the cash outlay was $203.2 million. Of that the Pennsylvania Railroad paid out $172.1 million, the Central $21.-4 million, and the Penn Central $9.8 million. While the '"changing and novel" reporting pro- cedures, which substantially separated accounting entries from reality and cash flows, indicated substantial return on investment, if measured in cash terms only the average cash return was about 5.5 percent. After offsetting the cash re- ceived from the Norfolk and Western and Long Island liquidations, it reduces to a final net outflow of $41.8 million. This is an important sum in absolute terms but not of great significance by itself. As noted earlier, from 1959 through 1967 $1.5 billion was reinvested in the railroad; nearly 10 times the amount put into diversification during 1963 through 1970. (20) Policy Implications Of perhaps greatest relevance, keeping in mind the cash needs of the rail- road, is the inappropriate nature of the diversification investments of this 1963- 1970 period. Investments in real estate ventures such as Great Southwest Cor- poration, Arvida, and Macco Realty required external financing from Penn Central because funds were tied up in unsold properties for future development and because of a high rate of receivables, principally in the form of second trust notes. These absorbed all funds generated internally and permitted small divi- dends at best. The infamous Executive Jet Aviation investment gave very little hope of an immediate or even near term return on investment in either report- able earnings or, more certainly, in cash dividends. Like the real estate com- panies acquired, EJA was a poor investment in light of the railroad needs. The financial officer's stringent payoff requirements for railroad investments were not applied to non-rail investments. The major contribution of the non-rail in- vestments was the dubious one of helping to distort earnings made possible by paper profits generated in real estate transactions. Rail Operations Fiscal policy conditioned other aspects of management performance, contributing to the railroad's poor physical condition and low quality of service. Management utilization of existing resources also contributed to poor performance, demonstrating a lack of mutual supportive relation- ships among critical policy areas embracing production, pricing, market- ing, and financing. Differences in managerial approaches did not yield noticeably different results. (21) Relative management performance Similarity in revenue patterns indicate-; that any differences in the two companies — in philosophy or policy — were not great enough to significantly 16 influence operating revenue trends; both railroads were apparently influenced far more by other common forces. Constraints on operations For the merger partners it is vital in evaluating management decisions to recognize that the Penn Central and its predecessor companies were in a de- pressed industry in a region of the country where economic expansion had slowed. Other restrictions affecting the railroads included rate regulation, rela- tions with other companies in the industry, and customer influence, particularly large customers. Restrictions on the abandonment of service, often pointed to as a major constraint, are of uncertain importance. The savings claimed are not particularly impressive and it appears that several factors currently not quantified may deserve greater attention. The fruits of the fiscal policy (another constraint on operations) are found in the relatively small amounts of money which had been put into the plant in capital and maintenance as measured by other railroads. But in terms of available resources, performance was no worse than mediocre in recent years in that capital expenditures as a percent of operating revenues approximated the national average. Still, the investment by both railroads in freight cars, as measured by freight car units in operation, de- clined in the 20 years prior to the merger. By 1966 the New York Central had a rent deficit (interline payments) increase by 109 percent while the Pennsyl- vania Railroad had a whopping 367 percent. So the railroads were saving capi- tal expenditures in the short run but were creating much greater expense in the long run and were endangering service quality. {23) Physical condition The low rate of physical replacement had unfavorable operating conse- quences. Pennsylvania Railroad had an outlandish accident rate, and incredible amounts of track subject to slow orders. The New York Central's accident rate and slow order track also increased but was well below the regional level. The condition of the railroads' equipment was also very poor although the Pennsyl- vania's was much the worse of the two (even though its cars were iised less in- tensively). A bad order ratio of 5 percent is regarded as the maximum tolerable limit. The Central did reduce its ratio from 10.7 percent in 1960 to 3.5 percent by 1967. The Pennsylvania's Avas over 15 percent in 1963 and still 9.0 percent in 1967. Locomotives were also in bad condition. The Pennsylvania at one time had nearly one of every five locomotives in unserviceable condition. While the Penn- sylvania Railroad spent more money for equipment maintenance than New York Central, it had a lower per car average, except for locomotives, than the Central. The Penn Central companies Avere fairly representative in terms of their plant maintenance and investment outlays relative to net railway operating income. They lagged further behind, however, in terms of commitments rela- tive to physical plant units. As a result their composite and merged plants were not adequately supported, as was manifested by unfavorable operating con- sequences. In absolute amounts and in terms of available net income the Penn- sylvania outdid its partner in plant support, particularly with respect to equipment, which compared favorably with other railroads. But it was not successful in producing results visible from these comparisons. In slighting roadway and favoring equipment, the Pennsylvania seems to have gotten the worst of both ends of the bargain. It gained no real payoff in the equipment commitment but suffered directly and severely from the roadway neglect. The operating consequences in unserviceable equipment and unsafe track hit with particular severity. (#4) Labor utilization Available indicators point to relatively inefficient labor utilization by the two companies that got even further out of control after the merger. Since wage rates are relatively standardized, high labor costs relative to other rail- roads are a symptom of an unfavorable labor mix or inefficient utilization. Because the Penn Central partners ran significantly behind other railroads in their region in productivity there is indication that labor control was inef- 17 fective. Gross ton miles per employee was very unfavorable. Gross ton miles per dollar of compensation also paints a dismal picture. Indications are that the Penn Central partners had an employee mix that was relatively expensive and becoming increasingly so. The Penn Central had a superior performance for compensation per service hour over compensation for employees, suggest- ing that the unfavorable elements were associated with employees who were not operating trains. There is no question that the wage bill for the Penn Central was and is quite high, representing more than one-half its gross operating rev- enue. While there was some inflation of wage cost at merger times, apparently because of the recall of previously furloughed employees, seriously unfavorable patterns solidified well before then. The cause is largely to be found in high em- ployment ratio per gross ton mile, or in relatively high salaries of supervisory personnel. Evidence of employment excesses is suggested by the sharp post bankruptcy declines and by prebankruptcy management statements about force reductions that it expected to accomplish. It appears that there was really labor slippage primarily attributable to inadequate management control. It must be noted here, however, that the Penn Central partners provided nearly 40 per- cent of the rail passenger service in the United States prior to the time when AMTRAK (the National Rail Passenger Corporation) assumed control in 1971. Since passenger service tends to be much more labor intensive than freight service, this may account for much of the unfavorable situation for the Penn Central relative to other railroads. (25) Physical performance The Pennsylvania Railroad enjoyed higher traffic densities than its com- panion and ranked in the middle of comparison railroads. On the basis of traffic density, good equipment utilization would be expected. However the Pennsylvania ran behind the New York Central in equipment utilization and both fell well below the standard of other railroads. Transferring the measure- ments to monetary terms, the transportation ratios (measuring transportation expenses as a percentage of rail operating revenue) of the Penn Central com- panies were higher than their neighbors (interestingly Pennsylvania main- tained a consistently lower ratio than the Central) . The Penn Central performed poorly. In assessing management performance, however, comparisons between the partners are significant. (26) Pricing Pricing in the railroad industry has always been difficult. One primary reason is the industry's inability to precisely determine and allocate cost. An- other is that no carrier or set of carriers controls a critical collection of the pieces that go into making up the railroad rate structures. And a change in one collec- tion inevitably has serious ramifications in others. This suggests that any form of rate structure adjustment will require a joint industry-government effort. The railroads often face a dilemma in making a case for rate increases. The conflict is personified by the Penn Central partners. The Pennsylvania Railroad felt that across the board percentage rate increases were essential, not so much be- cause of the merits of such an approach, but because more railroads support that approach. Reaching industry agreement on a commodity by commodity basis would delay presentation of the proposal to the Commission. The New York Central took an adamant position in favor of restructuring rates and proposing selective decreases as well as increases. The Central finally accepted the view that it was impossible to get what was best and decided to go along with the other railroads and at least get what was possible, with the understand- ing that the Pennsylvania and other roads would support a rate restructuring program at a later separate proceeding. The industry through 1971 continued to seek, and the Commission continued to approve, across the board increases. (27) Marketing and cost information In attempting to develop an innovative approach to marketing, the New York Central used available cost data. How strong a foundation the data pro- vided lias been questioned because such data was based upon ICC formulas which have been criticized in some circles. Pennsylvania, on the other hand, 18 traditionally gave little emphasis to individual commodity profitability. Mov- ing from the traditional economic thesis of high fixed costs for railroads, the Pennsylvania believed railroads should be primarily concerned with increasing traffic volumes to reduce unit costs and thereby assure profitability. It was oriented to the steel industry and profitable bulk commodities like coal. The merged road had poor information as to its costs : A top traffic official of the merged company recognized after merger that "there is no question about the shortcomings of our existing cost data." (28) Marketing techniques The Pennsylvania Railroad and the New York Central had dramatically different approaches to marketing. At the Pennsylvania marketing was a staff function while at the New York Central it carried line authority. The differences were deep seated and considered critical by the participants. The New York Central commodity marketing oriented approach reflected industrial marketing practices and was explicitly designed to replace the traditional practices epito- mized by the Pennsylvania Railroad approach. Indications are that merits of the two approaches are sufficiently mixed and other forces so strong that marketing innovations did not seem to be a critical determinant of the financial fate of the railroads. The Penn Central needed a unified policy approach of either type to avoid the organizational paralysis that set in. (29) Quality of service One of the most difficult measures of management performance is the qual- ity of the service that a railroad provides to its shippers. Typically, shippers' satisfaction with carrier service is reflected in complaints filed with the carrier. If there are not improvements to correct serious deficiencies, the shipper may turn to competitive for-hire modes of transportation or supply his own trans- portation in the form of truck or barge service. Serious deficiencies include such things as car shortages, uncooperative and inefficient labor, excessive transit times, bad ordered cars, poor switching service, inadequate road bed maintenance and lack of motor power. Prior to bankruptcy Penn Central was a favorite target of shipper complaints. (30) Management goals and mutual support A prime failure of management was the nonexistence of overriding cor- porate goals and the lack of any organized effort to achieve goals. The separate units of the corporation in some cases had mutually exclusive objectives. The only commonly supported objective seemed to be the merger. Without for the moment considering the myriad problems associated with the merger, it can be said that management of the Penn Central seemed to show a lack of cr ordination and a lack of mutual support between the major areas of man agement. The operations section was dissatisfied with the money made avai 1 able to it by the financial section ; the latter was concerned about providing mon financial support for operations when there seemed to be no adequate return and indeed the railroad was not performing as well as other railroads which were spending a good deal less. Its pricing and marketing functions were no* necessarily tied to the operation capability nor the financial needs. Merger— and the Road to Ruin Financial stringency and regulatory practices combined with man- agement's unswerving conviction that important benefits would develop early to produce the ill-fated merger. Because of merger associated losses in cash and productivity, however, the merger actually advanced the day of reckoning. (31) Merger planning Pennsylvania and New York Central managements established a team for the purpose of planning the merger. While a great deal of effort was expended, pre-merger planning turned out to be largely a paper effort. Plans were pro- duced but little was accomplished toward resolving major interfaces, determin- 19 ing what was to be done and how, and accommodating differences between the two companies. The ICC was a passive onlooker through it all — no more aware of planning pitfalls than the management or others. Effecting complete consoli- dation required a number of steps including construction of new facilities to handle rerouting, uniform car control, uniform billing and accounting, and es- tablishing a new organization structure. (32) Actual consolidation after merger At the time of the merger, the Pennsylvania Railroad desperately needed cash. The New York Central was in trouble also. Not surprisingly the two com- panies found themselves no stronger in union than as independents. Most of the merger startup costs were expended in 1968 and 1969 rather than over a longer period as planned. Service deterioration apparently was accepted as a necessary byproduct of the consolidation process. The faster the consoli- dation could be accomplished, the faster service could be restored to acceptable levels. Service deteriorated badly with problems such as no billings, multiple billings, misrouting of cars, and even lost trains. Jammed yards, communica- tion failures, angry shippers, and lost business were other manifestations of the effort to consolidate quickly. Management control over the operation dwindled during the organization crisis. To those on the inside it appeared that the merged company's problems were unmanageable. Disputes about marketing philosophy and other problems created a massive turnover of individuals es- sential to proper running of the railroad. It is important to note that the cen- tral region of the Penn Central did not have the same bad service experience or the employee turnover of other parts, suggesting that such problems were not inevitable. (33) Merger evaluation — The public process The Interstate Commerce Commission had before it at one time three merger cases of great significance to the Northeastern part of the country. Even so the Commission refused repeatedly to consolidate the cases and despite all contrary evidence disavowed that it was restructuring the Eastern railroad net- work. It was committed to a case by case method, thus simplifying its own ad- ministrative handling at the expense of providing for the overall public consid- eration that was so badly needed. The ICC was content to call balls and strikes. In 1966 the ICC recognized that public review of the merger might be necessary and it required periodic reports by the Penn Central partners. Despite all of the information available to the agency about the condition of the railroad, it was not until after the bankruptcy and after congressional outrage developed that the Interstate Commerce Commission instituted any formal review of the Penn Central merger. Another factor of importance was the long delay in the de- cisionmaking process which was itself a strong influence on management atti- tudes, e.g. maintaining the 1.3 to 1 stock ratio for a long period directly affected management fiscal policy. (34-) Merger evaluation — The private process The chronology of the merger is extensive. Final and serious negotiations date from September 1959. The companies reached agreement in 1962 and filed application with the ICC the following August. In April 1966 merger was ap- proved by the Commission, and finally on January 15. 1968, the Supreme Court had completed consideration of litigation. With unseemly haste the new com- pany died on June 21, 1970. The long delay put a great stress on both companies. While operating separately they had to continually assess the probability and effects of union. They had to keep their stock ratio equivalent at 1.3 contribut- ing to the Pennsylvania decision to maximize earnings. There were very definite fiscal policy implications of the merger such as disposal of Norfolk & Western stock and the urgent need for high payoff which contributed to the decision to diversify. In addition, there were the merger conditions which brought in the New Haven and resulted in expensive labor protection. There is no completely reliable answer here to the question of scale economies. But this merger very definitely makes clear that mergers are no panacea for deeply rooted ills. 20 (35) Merger evaluation — Monetary impact The monetary impact of the merger on a short run cost basis was very un- favorable. Anticipated annual savings were $81.2 million. A capital budget of $75 million was allocated for four years. It was exceeded in the first two years when $92.2 million was spent. Total cash outlays were $250.1 million, net cash outlays were $176.2 million. Thus the merger cost considerably more than it was worth in these first years. THE EVIDENCE AND ANALYSIS Environmental Conditions The Penn Central (PC) is not an island unto itself. Like other business enterprises it is caught in the shifting currents of economic and technological change. Being basically a railroad, however, with an enormous fixed investment in immobile assets, the PC, as is true of all railroads, is less free, at least in the short-run, to adapt to changes in the environment in which it carries out its activities. In reviewing the experience of the PC in recent years it is important, therefore, to identify what sorts of external change affected the PC, to measure their impact on the company, and to determine what steps were taken by management — or might have been taken — to adjust to altered circumstances. An examination of recent trends in the national economy, in transportation generally, and in rail transportation in particular, shows that the PC, in signifi- cant degree because of the region in which it operates, has been hampered by a number of forces that are substantially beyond its control. Some of these relate to changes in the production and use of coal (which historically has been the PC's principal source of traffic and revenue), the location of industry, new concepts of distribution management that place emphasis on speed and flexi- bility of shipment as dimensions of total cost, and in the growing attractiveness of other modes of transportation (notably trucks, using the vastly improved highway system that was put in place beginning in the late 1950's). While all these forces took their toll on the PC in terms of traffic and revenue, they do not appear to be of such magnitude as to explain completely the PC's bank- ruptcy. Clearly changes in the external environment were a factor, but it is in adapting to them — or failing to do so — that one also finds the sources of the company's ultimate financial collapse. To put all this in suitable perspective calls for a look back at developments in the 1960's — in the economy, in trans- portation, and particularly at rail transportation in the Eastern region. TRANSPORTATION AND THE NATIONAL ECONOMY — CHANGING PERSPECTIVES During the 1960's the role of transportation in the American economy de- teriorated somewhat, reflecting less emphasis on goods production. Transporta- tion obviously is concerned with the movement of physical things — minerals, agricultural products, and manufactured goods — which for many years were at the core of domestic economic activity. Recently, however, this has begun to change. It is the services, finance, trade, and government sectors that now are growing most rapidly. In terms of the share of the GNP they represent, agri- culture, mining, and non-durable goods have begun to diminish. Even durable goods today account for no more of the GNP than they did a decade ago. By contrast, the services, finance, and trade categories have expanded considerably. The important thing from the transport standpoint is that these sectors generate relatively little demand for freight transportation. (21) 7.4 4.1 3.1 2.1 1.3 .9 5.1 5.4 5.3 31.0 29.1 27.4 5.5 4.3 3.7 3.0 4.0 3.9 18.1 16.5 15.3 8.5 10.1 10.9 9.2 12.0 13.0 9.8 12.6 15.9 .2 .5 .6 22 SHARE OF NATIONAL INCOME ACCOUNTED FOR BY MAJOR SECTORS, 1950, I960, 1970 lln percent] Sector 1950 1960 1970 Agriculture, forestry, fisheries _ Mining Contract construct ion Manufacturing. _ Transportation '. Communication and electric, gas, sanitary services Wholesale and retail trade Finance, insurance, real estate. Services Government, Government enterprise Rest of world Source: Deoartment of Commerce, Survey of Current Business. Environmental and related social considerations have also had an effect on transportation. Coal has lost favor as a source of energy for producing elec- tricity. This has hurt the railroads as a group, but the impact has been the most severe in the restrictions on use of higher sulphur content coal. Signifi- cantly most of the coalfields served by the Penn Central are high in sulphur content. The net effect of the changes has been to reduce the relative volume of rail transportation and, as a result, to diminish the significance of rail trans- portation in the economy. In view of these trends it is not surprising to find that freight transport indices have been shrinking relative to aggregate economic expansion. Between 1960 and 1969 total intercity freight ton-miles rose 43 per cent, but the GNP (in real terms) expanded by 49 per cent. Similarly, intercity freight revenue (in current dollars) increased by only about three-fourths as much as the GNP, resulting in more than a 12 per cent decline in both its share of GNP and National Income. These shifts in the composition of the economy have been accompanied by changes in technology and other areas that have also had a constraining effect on transportation. The increased use of light weight materials, for example, has reduced the physical demand for transportation. There has been a trend to diver- sification in the location of factories and other production facilities, bringing them closer to consuming markets and thus also reducing the demand for transportation. Coal, once burned almost entirely at electric generating stations located in the using market after being hauled by rail from the mine, is now consumed in large quantities for electric generation at the mine-head (see dis- cussion of Coal below) . INTERCITY FREIGHT TRANSPORTATION AND THE NATIONAL ECONOMY, SELECTED MEASURES, 1960 AND 1969 Percent 1960 1969 change Intercity freight ton-miles (bill ions) 1, 326 Gross national product (bill ions of 195J I dollars) $487.7 Intercity freight revenue (millions of current dollars).. $28. 760 Gross national product (billions of current dollars). _ $503.7 National income (billions of current dollars) $414.5 Intercity freight revenue as a percent of $100 of GNP 5.710 Intercity freight revenue as a percent of $100 of national income _ 6.938 Source: Transportation Association of America and Economic Report of the President. The cyclical pattern of the economy also has a pronounced impact on trans- portation and especially on the railroads. Rail freight traffic closely parallels the ups and downs of the economy, something that during the 1960's had acute significance for all the railroads and particularly for the Penn Central in the decade's last years. During the period 1960 through 1969 the economy gyrated dramatically, from rapid expansion to actual contraction. For the decade as a whole the GNP (in real terms) increased at an annual average rate of 4 per cent, but reces- sions took place at the beginning of the decade (1960-61) and from 1968 (when the Penn Central merger was consummated), until 1970 (when the PC peti- tioned for bankruptcy), the economy was in almost a continuous state of de 1,901 43.4 $724.7 48.6 $46, 294 61.0 $929. 1 84.5 $763.7 84.2 4.983 -12.7 6.062 -12.6 23 cline, as is shown in the table. Between the first and second quarters of 1968 economic expansion slowed considerably, with only modest gains recorded through the remainder of the year. In 1969 growth slowed even more, with out- right recession setting in during the fourth quarter and persisting through 1970. Quarterly change in GNP, 1968-70 (percent change of 1958 dollars) 1968 : 1970 : I-II 1.7 IV-I -1.3 II-III 1.0 I-II .3 III-IV .7 III-III .3 1969: III-IV -1.0 IV-I .6 I-II .6 II-III .7 III-IV —.2 Powerful though their impact has been on transportation, the diverse forces of change have not uniformly affected the various forms of transporta- tion. Some (pipelines are an example) have increased their significance in the last ten years, some have about held fast (for-hire and private motor carriers), but others, notably the railroads, have lost ground — lost ground, it deserves to be reemphasized, in a sector of the economy that is itself of slightly diminish- ing importance. The key is that the rail share of intercity freight traffic has been substantially reduced, to the benefit of the other modes — truck (with its great- est penetration coming in general commodities), barge, and pipeline (with the latter two delivering substantial amounts of bulk traffic.) Although rail traffic losses slowed in the last ten years, the industry's share of traffic and of freight revenue continued to shrink in the 1960's. In 1960 the railroads accounted for 44 per cent of the nation's intercity freight transporta- tion, but by 1969 this had fallen to 41 per cent. Meanwhile their share of freight revenue declined even more, from 28 per cent to 22 per cent. It should be noted, however, that there was a 36 per cent increase in intercity ton-miles from 1960- 1969, slightly less than an average annual increase of 4 percent for railroads. This compares with a 44.7 percent increase for all modes of transportation, almost a 5 percent average annual increase. The significant factor is the relative rates of growth of the railroads when compared to the total for all modes of transportation. By contrast, the trucks (specifically the Class I motor carriers) sharply increased their revenues. Their tonnages doubled from 1960 through 1969, their x'evenues were up even more, and their profits rose by a still greater amount. This is mirrored in the East as well. In a decade when the railroads of the district were experiencing modest growth in traffic tonnage, the Class I motor carriers were doubling their traffic, with revenue up 2.4 times from the 1957-59 base. A major reason for the relatively far superior performance of the trucking industry is its virtual takeover of the small shipment market (a service that was abdicated by the railroads), coupled with the failure of the railroads, until fairly recently, to aggressively market their wholesale service for TOFC — trailer on flat car — and consolidated shipments. 24 y- 3 ■)U3r^000(T>000>0'-i'HM-CiirO^ , i/>c^<^csj'«a-r^o^oc3^Hcsi^-r-«.tocoroM'Oir»-o»cT> cd co cd csj cm" csi csi cd en *3- ^ ^- uS uS to r-! r-.' od od cri cy> o" o' o> ct> cd cy> cd ai ct> oi o> tNCTlOWOVI — ir)C\JCMCO'-~«COCMOOtOCM'mtOlOtf - >0»r-.tO~H^OO S •— t o •— « o •— * •— « o o o o> o od cd eo od (X3 to r*» (0 to 10° to us co to u">^CT>oo^cnor-.«Tr-." 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EASTERN REGIONAL PERSPECTIVE With its 20,117 miles of line, the Penn Central is the largest railroad in the East and thus is powerfully affected by any change in the relative stature or composition of the region vis-a-vis the nation as a whole. For comparison purposes the primary PC territory can be defined as consisting of the follow- ing states : Connecticut Pennsylvania Indiana Rhode Island New Jersey Illinois Massachusetts Ohio Michigan New York West Virginia Relating trends in this 11-state area to those for the country uncovers several significant deviations, almost all of which have worked to the PC's disadvan- tage. In very broad outline, the PC territory has lost ground relative to the rest of the nation. Consider population as one index. In 1950, 44 per cent of the U.S. population resided in the 11-state PC area; by 1969 this was down to 42 percent, not a dramatic decline, but nonetheless a measurable and indica- tive sign. From an economic standpoint the PC area was also losing ground. In 1950 the 11 states accounted for slightly over half of the nation's personal income ; by 1969 this share fell below 46 percent, reflecting the fact that in the intervening 20 years personal income for the country had increased 230 percent compared with only 200 percent for the PC area. There occurred an even more pronounced relative decline in manufacturing. In 1950, 65 percent of the nation's total value added by manufacturing took place in the 11 states, but by 1969 this had declined to 54 percent. In absolute terms, of course, states making up the PC area continued to bulk large in the national economy, but their relative rate of expansion lagged behind most other areas. The explanation lies partly in a shift of industrial facilities to other regions, but part of the answer also is to be found in changes in the technological make-up of the economy. Steel (of which about 80 percent is produced in the 11-state PC area), for instance, was encountering growing competition from other metals and from other materials whose production is more widely distributed. Output of aluminum, plastics, and other products has risen much more rapidly than steel. For the period 1957-1965, revenues from the production of primary iron and steel increased only 1.9 percent, while pri- mary non-ferrous metal manufacturing revenues were up 4.3 percent, plastics and synthetic materials rose 9.0 percent and glass and glass products gained 4.4 percent. To see how all these forces have come together and affected the PC, it is necessary to look at the key traffic sectors— coal, manufactured goods, and smaller shipment movements. Each embodies a different set of underlying 26 forces and shows the extent to which railroads are affected by external forces, some largely beyond the control of railroad management and some to which an appropriate response could enable a carrier to hold onto or recapture a market. Coal Changing patterns of regional output and of commodity use took their heaviest toll on the Penn Central (and on the Eastern roads as a group) in coal. For years coal was the principal source of traffic and of freight revenue for the eastern roads. In 1947, for example, coal constituted about 46 percent of Eastern district tonnage and generated 29 percent of the rail revenue. In the 1950's, however, coal consumption in the United States fell markedly, with the most severe decline in coal production coming in the East. Between 1957 and 1960, coal production in the country declined 16 percent and by 19 percent in the PC region. In the 1960's coal output began to increase, but the gains in the East were less than elsewhere. From 1965 to 1970 coal production rose 16 percent in the United States, but by only 5 percent in the 11 PC states. As a result the PC region's share of the nation's coal production fell from 71 percent in 1957 to 62 percent in 1970, with southern Appalachian states — where the coal is lower in sulphur content and supposedly cheaper to extract — gaining at the expense of states farther north. In 1959 Pennsylvania accounted for about 20 percent of the nation's coal output; by 1970 its share was down to about 15 percent, with Kentucky meanwhile having increased its share from 14 to 20 percent. In addition to the changing locale of coal production, transformations occurred in the place where coal is burned for the generation of electricity. Since 1965 there has been a three-fold increase in minehead use of coal. This "transportation-by-wire" has deeply cut into rail traffic : RAIL TRANSPORTATION AND MINEHEAD GENERATION OF COAL 11957-59=100) 1960 1965 1966 1967 1968 1969 1970 Transported by rail Consumed at minehead... 92.4 107.7 112.9 105.8 117.6 157.6 123.0 169.3 120.5 178.5 120.9 226.4 124.4 304.3 While changes in the amount, location, and "transportation" of output adversely affected most of the Class I railroads, the effects were most pro- nounced in the East, with the Penn Central the most severely disadvantaged in recent years. PERCENT CHANGE IN RAIL TONNAGE OF COALi 1957-60 1960-63 1965-70 Class 1 railroads. -19.6 4.2 2.5 .4 2.0 Eastern di strict -22.6 -7.8 Penn Central -18.9 -18.7 ' In this and similar tables infra, data for the 1960's are reported in 2 yearly groupings because of the ICC's redefinition of com- modity groups in 1964. Furthermore, information for individual railroads was not made public by the ICC for 1964. The 1965 to 1970 picture dramatizes the situation. In those five years, coal tonnage on all Class I carriers registered a modest 2 percent gain but fell by K percent on Eastern roads and by 19 percent on the PC (or, prior to merger, on its constituent lines). The PC's share of the Eastern district's coal traffic thus fell from 26 percent in 1965 to 23 percent in 1970. At the same time the Eastern railroads were carrying only 65 percent of all coal hauled by the nation's Class I lines compared to 72 percent in 1965. From a revenue stand- point the picture was less bleak but nonetheless damaging to the PC. The Eastern roads reported a 5 percent increase in revenue from coal traffic between 1965 and 1970, but for the PC coal revenue was off more than 11 percent. 27 PERCENT CHANGE IN RAIL REVENUE FROM COAL 1957-60 1960-63 1965-70 Class 1 railroads _ 9.8 14.9 11.1 16.0 20.4 Eastern district -6.2 4.8 Penn Central -6.4 -11.4 In 1960, the roads which later were to make up the Penn Central were getting approximately 17 per cent of their revenue from coal, but by 1970 that share was down to 15 per cent. Manufactured Commodity Traffic Generally The best and most comprehensive insight into the intermodal dimensions of intercity transportation for manufactured goods is provided by the Censuses of Transportation for 1963 and 1967. They present data for the movement of goods in 2-4 broad shipper categories. Comparing the 1967 statistics with those for 1963 shows that the railroads fared poorly, losing ground across a broad front to the other modes (especially the trucks) . In 19 of the 24 product classes, the volume of goods transported (measured in ton-miles) increased. Of these 19 categories, the railroads suffered an absolute ton-mileage decline in 13, while in the other six groups they increased their volume yet still lost position relative to one or more of the other modes. Of the remaining five classes where there were declines in total transport volume, the railroads increased their share in two. The available published data do not permit a highly refined assessment of trends in the East, but available information shows that the railroad share of the market declined at almost every Eastern city, with the trucks reporting uni- versal gains. At New York City, for example, the railroads accounted for 25.7 per cent of shipment ton-miles in 1963 but only 22.2 per cent in 1967. The trucks meanwhile increased their share from 50 to 73 per cent. Essentially the same is true of the other cities in the PC region. SHARE OF TRANSPORT MARKET FOR MANUFACTURED GOODS IN SELECTED PRODUCTION AREAS, RAILROADS AND FOR-HIRE MOTOR CARRIERS, 1963 AND 1967 [Percentage of ton-miles] 1963 1967 Production area Rail Motor carrier' Rail Motor carrier ' Boston New York City 28.7 25.7 50.0 49.2 42.3 23.8 30.7 34.3 35.3 20.4 44.9 17.4 22.2 40.2 45.2 48.3 37.7 52.2 71.5 34.6 73.4 59.0 Philadelphia 2 Pittsburgh Harrisburg Allentown/Bethlehem Cleveland.. Detroit 2 _ Newark/Jersey City. 41.0 55.6 53.8 58.8 56.9 73.6 29.3 45.4 24.0 41.3 47.7 39.1 23.6 46.3 ' Private truck excluded. 2 Excludes petroleum and coal product movements. Source: Census of Transportation, 1967. Two submarkets of manufactured goods — steel and autos — shed useful additional light on what has been happening in rail transportation, particularly in the East. Iron and Steel Products — Although the iron and steel industry has been losing position relative to the GNP and, indeed, to overall industrial produc- tion, it has been a major source of rail revenue. This industry is especially im- portant for Eastern railroads because so much of the nation's steel is produced in this region. Trends of the 1960's reveal that the railroads generally sustained losses in their steel traffic tonnage but were able to offset the revenue conse- quences with rate increases. Significantly, in retaining its steel traffic and in improving its revenue from it, the PC was considerably more successful than other roads. 74-924 O - 73 - 4 28 PERCENT CHANGE IN RAIL TONNAGE OF STEEL WORKS AND ROLLING MILL PRODUCTS 1957-60 1960-63 1965-70 Class 1 railroads -25.8 0.5 -1.5 -2.6 -15.3 Eastern district -28.4 -12.9 PennCentral -27.2 -1.9 As the table shows, steel tonnage moved by the PC was nearly as great in 1970 as in 1965, something which is manifestly not true of all the Class I roads. Paralleling this are the pertinent revenue data, showing a sizable increase for the PC in contrast with far more modest gains for the industry as a whole. In the market for steel transportation, therefore, the evidence indicates that the PC was quite successful in maintaining (and in some respects, improving) its relative position. PERCENT CHANGE IN RAIL REVENUE FROM STEEL WORKS AND ROLLING MILL PRODUCTS 1957-60 1960-63 1965-70 Class 1 railroads -25.9 -4.0 -8.4 -8.4 1.5 Eastern district _ -26.8 3.9 Penn Central -15.3 28.8 AvtomobHes — Despite the building of assembly plants and other facilities in other parts of the United States in recent years, the 11 states making up the PC region continue to dominate the nation's auto output, accounting for 56 per cent of assembly units in 1969 or almost exactly the same proportion as in 1957 (and up from the comparable figure earlier in the decade). In terms of inter- modal transportation, autos exemplify a major product in which the railroads have succeeded in regaining substantial traffic which had been lost to another mode, namely trucks. In the late 1940's and throughout most of the 1950's, the railroad tonnage of automobiles carried dropped sharply. In 1947, for example, the railroads moved 11.2 million tons of autos; by 1959 this was down to only 4.4 million tons. In the early 1960's, however, the railroads began to fight back with equipment (rack car), service (unit train), and other innovations. The success of this effort is shown in the sharp increases recorded by the railroads between 1960 and 1963. For the Class I roads, tonnage rose by 164 per cent and revenue, reflecting lower rates, increased by 93 per cent. PERCENT CHANGE IN RAIL TONNAGE OF MOTOR VEHICLES 1957-60 1960-63 1965-69 Class 1 railroads -0.6 163.6 184.0 158.8 -6.5 Eastern district -12.2 -6.4 Penn Central... . . 1.6 -12.8 As can also be seen, the Eastern roads did even better than the industry. For the PC, however, the situation, though not unfavorable, was less buoyant. Its auto traffic revenue (or the consolidated revenue of the lines later to make up the PC) was up 27 per cent (1965-69) compared with increases of 41 per cent for all Eastern district roads and 44 per cent for the Class I industry. PERCENT CHANGE IN RAIL REVENUE FROM MOTOR VEHICLES 1957-60 1960-63 1965-69 Class 1 railroads 15.3 92.9 107.5 66.2 44.0 Eastern district 17.1 40.6 Penn Central 31.8 26.7 One implication in this resurgence in auto traffic is that the rail mode is potentially capable of highly effective competition in higher-valued manufac- tured goods traffic and has demonstrated its capacity to constructively respond. 29 Small Shipment Traffic — Beginning in the late 1940's and early 1950's the railroads vitrually abandoned their LCL (less than carload lot) traffic and to- day only an inconsequential volume of LCL shipments is handled by railroads. Regardless of the reasons and their persuasiveness, the effect has been to divert to over-the-highway carriers a large and rapidly growing volume of shipments in approximately the 50-pound to 10,000-pound category. Shipments in this size range account for more than 95 per cent of all shipments by general commodity for-hire truckers and in 1970 they represented about 79 million tons of freight. That reflects about a doubling over the last ten years. This traffic, sizable and growing in amount, consists primarily of more highly valued manufactured goods, where service factors (speed, reliability of delivery, etc.) are important. Furthermore, because rates are high, yields (revenue per ton-mile) are signif- icant. The loss of this traffic by the railroad explains their loss of market share at key cities, as shown in the Census of Transportation for 1963 and 1967, and is such an important factor in the deteriorating financial situation of such roads as the PC. With coal traffic down sharply and with the loss of substantial manu- factured goods traffic to trucks, the PC (and it is not alone in this respect) has been caught in pincers. Slowly the railroads are getting back into the smaller shipment sector, albeit indirectly, in the form of TOFC, freight forwarder, and shipper associa- tion traffic. In each case the railroad is serving in effect as a wholesaler, moving truck-size or car-size lots that have been assembled by someone else. Based on recent experience the prospects for making gains are encouraging. TOFC car- loadings as a share of total rail carloadings increased from 1.8 per cent in 1960 to 4.7 per cent in 1970 for the Class I lines and from 2.2 per cent to 5.0 per cent in 1970 in the Eastern District. Separately identifiable forwarder and shipper association traffic has also been growing, up over 20 per cent from 1965 through 1969 for the industry (some of this traffic moves TOFC and is reflected in those figures). The return of small shipment traffic to the railroads — indirectly in the form of TOFC or consolidated movements — is moderately encouraging, but the amount of ground that has been lost to the trucks is enormous and the recent rate of growth in TOFC and consolidated traffic is such that without an inten- sive effort the railroads will fall far short of their potential for participation in such traffic. Divisions When goods are transported by rail over the facilities of two or more car- riers pursuant to a joint rate, there must be a division of the resulting revenue. The divisions issue assumes its greatest importance in the case of interterritorial shipments — between the roads of the Northeast (Official Territory), the South, the Southwest, and the Far West. In 1969 there were over $4 billion (46% of total line haul freight revenue) in interterritorial revenue to be divided among the various regional groupings of railroads. The sheer scale of the revenue subject to divisions suggests the importance of very small percentage shifts in the allocations. 1 Divisions cases are essentially private arguments among railroads, but when the arguments cannot be settled privately Section 15(6) of the Interstate Com- merce Act provides for Commission resolution. Thereafter the Federal courts have jurisdiction. The Commission has authority to initiate the procedure on its own motion, but has rarely done so. In all, since passage of Section 15(6) in 1920, the Commission has dis- posed of nine railroad interterritorial division cases — four before World War II. Relations between the Official Territory (Northeastern area) and railroads operating in other parts of the country have been the most significant. Division with the south are a notable point of controversy, 2 with the Eastern roads contending that the present formula, established in 1953, for 1 See Appendix C tables €-1 and C-2 which present data on the relative significance of North-South and East-West traffic to the carriers operating in these regions. See also tables C-3 and C-4 which present data on the volume and directional flow of Official-Southern and Official-Transcontinental traffic. 2 See Appendix C, table C-5 for legal history of Official-Southern and Official-Transcontinental cases. 30 north-south traffic, is seriously out of date, given changes in their respective operating expenses and revenue and earnings requirements. Currently the East- ern roads are allocated 44.478% of the revenue, and Penn Central trustees argue that the division for the Eastern railroads should be adjusted upward to 49.604%. The Penn Central estimates that if all major divisions cases were settled properly it would be entitled to an additional $46.3 million per year. From the Penn Central's perspective, therefore, an increased share of divisions is of considerable short-term economic consequence. The existing divisions between the Penn Central and Western Railroads were established by agreement in 1966. The divisions between the Official Territory and the South were prescribed by the Commission in 1953 on what is called an equal-factor basis — that is each railroad participating in such freight movements receives a portion of the joint rate commensurate with the distance moved. Where freight is moved the same distance in the North and in the South, the Northern railroads and the Southern railroads share the joint rate equally. The Southern Railroads and the Southern Governors' Conference have resisted efforts by Penn Central and other Northern railroads to obtain a greater share of North-South freight revenues on the ground that such a division would place the south at a competitive disadvantage with the North and hamper economic development in that region. The Southern Governors' Con- ference particularly has been vigorous in this opposition, contending that it would reestablish what it describes as the same territorial discrimination which existed prior to the Interstate Commerce Commission Docket No. 28300 Class Rate Proceeding, in which rates were placed on a uniform basis throughout the eastern part of the United States. The Conference has insisted in these proceedings that the problems of the Northern railroads, and particularly Penn Central, relate to their own waste and inefficiency and that the south should not be compelled to subsidize waste and inefficiency. No more complex issues exist than those presented by interterritorial divi- sions cases. A division's dispute can easily span a dozen years and the outcome may significantly shape the future of an entire region. No definitive treatment is presented here and no comment is herein offered on the merits of any dispute. It is sufficient to note that divisions cases affect the entire railroad industry and every' section of the country making equitable resolution of disagreements both vitally important and difficult to obtain. Financial Performance The recent financial history of the Pennsylvania and the New York Central Railroads is characterized by a series of ups and downs, but with gen- erally favorable trends in the early 1960's as a preface to the later dismal decline and ultimate collapse. This glimpse of hope capped by doom is sum- marized here, featuring the course of operating revenues, expenses, and net income; income from other sources; and fixed charges and their coverage. It is important in this summary to distinguish carefully between revenues and income from the railroad and from non-rail subsidiaries. The data series employed generally cover the period 1958-70 in order to fix the threshold that launched the companies into the 1960's. For the most part, primary interest centers in the absolute numbers and in the relationships between the two, although comparisons are also made with other railroads and groups of railroads. OPERATING REVENUES, EXPENSES, AND INCOME Operating revenues for both companies were generally unfavorable in the late 1950's, dropping to a period low in 1961 (Chart A-l). After further hesita- tion in 1961-63, the combined series advanced rather firmly through 1966, fell into a new trough in 1967-68, and climbed out in 1968-69. They were thus generally characterized by modestly increasing revenues during the 1960's. Compared with the upswing in economic activity and in the revenues of other railroads, their improvement was quite modest. Combined revenues increased by 10 percent (9 for Central and 11 for PRR) from 1961 to 1966 and an additional 7 percent by 1970, or 18 percent overall. This record even fell behind the performance for the Eastern District, with period advances of 14 and 8 percent, or 23 percent total, indicating the significantly better record of other area companies (Chart A-2). In the same time periods, Class I railroad revenues advanced by 16 percent and then 12 percent, or 30 percent overall. Industrial production increased by 53 per cent during this period. Freight revenues increased more favorably than passenger revenues, with a growth in the combined series of 20 percent from the 1958-60 base. The PRR ad- vance was stronger, however, amounting to 10 percent against 5 percent for the Central (Table A-l). The combined growth lagged behind that achieved by the comparison roads (Chart A-3). Rising freight revenues over the decade were supported by varying combinations of favorable changes in traffic volumes, haul patterns, and freight rates (Table A-l). A turning point for these charac- teristics also appears in 1966. Volume expressed in both tons and ton miles increased steadily during the earlier period (Chart A-4). Up to the 1966 turning point, growth compared favorably with the other Eastern roads. Average haul was virtually static to 1964 (Chart A-5) then started an upward movement in which ton miles advanced faster than tonnage increases, further feeding the favorable revenue trend of this period. The revenue advance was slowed, however, by a general decline in average revenue per ton mile that gradually dropped 11 percent from its late 1960 high, to a low in 1966 (Chart A-6). The first period was thus characterized by favorable revenue trends supported entirely by volume increases in the face of relatively stable haul patterns and declining charges. The same movements characterized the com- parison roads (Charts A-4, 5 & 6). The complexion changed markedly after 1966. A rather anemic freight reve- nue growth was nourished first by a further rise in average haul in 1967 leading to another plateau and then by sharply rising revenue per ton mile from 1967 (31) 32 on. The modest revenue growth was achieved despite a consistent drop in traffic volume as measured in both tons and ton miles, a force which cannot long be countered by compensating trends. The revenue patterns of the two companies performed about the same and were explained by about the same behavior of the controlling variables. These variables require further examination in connection with manage- ment performance considerations, particularly the pricing policy manifested in the rising ton mile revenues. It suffices here to note briefly the comparative movement of these critical variables. Post- 1966 revenue growth lagged far be- hind the performance of other railroads in the East (Chart A-3) because their traffic revived after the 1967 downturn while the Penn Central's continued to fall. By 1970, Penn Central's average revenue per ton mile was about 1.65 cents (Table A-l), compared to the Class I figure of 1.42 cents. The comparative figures for the merger partners suggest several important propositions which will be further explored. The similarity in the revenue patterns of the two companies is striking, with coinciding advances and down- turns. This coincidence provides the ingredients for the hypothesis that any differences in the two companies — in philosophy or policy — were not great enough to basically influence operating revenue trends; both were apparently influenced far more by other common forces. It is also desirable to place revenue trends in perspective with respect to the mounting financial problems. The generally upward movement during the 1960's suggests that the company was not done in by a revenue collapse in absolute terms, although higher revenues would, of course, have provided additional strength for withstanding the many onslaughts which finally brought the company down. The 1967-68 revenue trough was indeed rather costly and may be crudely estimated at about $150 million. This is based on straight-line revenue interpolations to replace the depressed 1966 and 1967 figures and an operating ratio of 0.79 achieved before the damaging breaks in the relevant series experienced in 1967. While imposing, this figure is hardly critical. Comparisons of operating expenses (Table A-2, Chart A-7) must be care- fully made to avoid false impressions arising from the fact that higher traffic levels are generally associated with higher costs. There are, however, several points to be noted regarding these series. Both companies were able to keep oper- ating expenses under close control before the merger. However, the patterns are sufficiently different to warrant noting, particularly in connection with a subse- quent discussion of maintenance expenditures. PRR operating expenses dropped about 15 per cent in 1957-58 and then stayed around $700 million. Central's expenditures declined more gradually, dropping from $577 million in 1959 to $518 million in 1963, and settling down at about $520-$530 million. In combina- tion, the expenditures declined during 1959-61 and then leveled off through 1967 (Table A-2). Declining operating expenses with increasing output and rising prices is an interesting anomaly that is readily explained at least in part by restrictions on maintenance expenditures. During the 1958-67 period, PRR maintenance outlays fell from a high of $262.6 million in 1959 to a low of $236.0 million in 1965, a decrease of about 10 percent. By 1967, however, these expenditures were back up to $243.5 million — still 6 percent lower than the high for the period. Meanwhile, the Central's figure fell by approximately 12 percent, declin- ing from a high of $202.9 million in 1959 to a low of $177.5 million in 1967 (Table A-3). These differentials are clearly a mixture of cutting down on main- tenance, cost reduction programs, and questionable accounting practices. The management performance and fiscal policy analyses wii 1 undertake to unravel this mixture. In 1968, operating expenditures increased by aoout $35 million, but this was followed by increases of over $145 million j i each of the next two years. The extra $400 million of operating expenses laid out in 1969 and 1!)7() at an operating ratio of 0.79 (the approximate 1966-1967 operating ratio*) was •The actual revenues multiplied by the operating ratio of 0.79 yields the operating expenses based on pre-merger operating performance. The difference between actual operating expenses and the operating expenses derived in this fashion approximates .$400 million, the "extra" operating expenses for 1968 through 1970. 33 enough in itself to wipe out any hope of net income. Even the one-year incre- ments of about $145 million were much larger than net railway operating in- come in any year after 1956. In these terms, rising costs were more damaging than softening revenues (Table A-2). Although uncertainty about the relative weights of cost saving and main- tenance scrimping remains, operating expenses are most meaningfully stated with reference to operating revenues. One such expression is the operating ratio (of expenses to revenues) (Table A-2). It is by now fully predictable that the operating ratio for the two companies separately, and as a composite, declined steadily through 1966 and then rose sharply. It is somewhat surprising, particularly in the light of relationships to be considered later, that the PEE enjoyed through the years a somewhat lower ratio than its merger partner, with the differential ranging as high as 3.6 points and averaging 2.14 points over the 1958-67 period. This margin represents $19 million annually expressed in terms of the PEE's average revenue over these years, or a total of nearly $200 million. The ratios maintained by these companies are expectedly higher than those for the system as a whole and for most other individual companies (Chart A-8). The falling ratios to 1966 followed the national (all Class I) trend, but at a higher rate to reduce the gap. But the national upturn after 1966 was less drastic and less insistent, so the Penn Central soon lost touch completely with other companies' measures. While systemwide forces were pushing operating ratios up during the last half of the 1960's, special influences shot the Penn Central's out of sight later on. With minor exceptions, the Penn Central's oper- ating ratio exceeded the comparison roads' ratios for the entire decade. NET RAILROAD OPERATING INCOME (NROI) An important figure in railroad income statements is "net revenue from railway operations", which also reflects the relationship between operating revenues and operating expenses (Table A-2). As the revenue and cost information has signalled, both companies enjoyed encouraging increases in net revenues through 1966, up 41 percent over 1961 in the composite series. The figure dropped off from $335 million in 1966 to $267 million in 1967, eased down to $238 million by 1969, and then crashed to a scant $134 million in 1970. The performance of the two companies was remarkably consistent in terms of this measure, with the PEE generally contributing about 60 percent of the composite revenues. As previously indicated, the catastrophic emasculation of this figure is primarily due to the increase in costs. Equipment and joint facility rents and taxes are deducted from net reve- nues to produce "net railway operating income." Since taxes were quite stable during the study period the main interest is in rents — moneys paid for the use of equipment, primarily freight cars, belonging to another railroad or some other lessor. For the combined companies, this figure advanced rather modestly until 1966, and then shot up in large annual increments to a total of $222 million — almost double the 1960 figure (Table A-4). Rentals jumped from 45 percent of net railway operating revenue in 1964 to 61 percent in 1967, 77 percent in 1968 and to over 160 percent in 1970. While a rising trend for all railroads collectively, this percentage is generally under 30. The roots of this cost behavior are also somewhat ambiguous. Changes can reflect the levels of use and detention of "foreign" cars and the associated rental payments or a change in equipment acquisition policy. Facilities pur- chased appear in capital accounts, with associated costs reflected in such financing charges as debt interest. If the same facilities are leased, the cor- responding cost items reside in the rental account. These companies (and particularly the PEE) turned increasingly to leasing during the 1960's, indicat- ing that a significant portion of the rental increment represents a substitute for financing costs entered under "fixed charges". This is a matter for explora- tion in a subsequent consideration of fiscal policy. Eegardless of the cause, the immediate effect of this swelling account is to further overwhelm the already 34 flabby revenues and contribute significantly to the deficits in "net railway operating income." "Net railway operating income" (NROI) is the first "terminal" figure in the income statement, measuring the portion of annual revenues remaining after payment of operating expenses, rents, and taxes. It is a sum available for payments to capital suppliers in the form of interest or dividends. Added to the sum are dividends from other companies and other miscellaneous income. This critical figure dropped off drastically for both companies during the late 1950's, the PRE settling in 1960 and the Central in 1961 (Table A-2). It then rose promisingly for both companies until the 1966 break, dropping steadily and drastically from then on. Because of the rental influence, it dropped more and faster than net revenues, producing deficits which soared from $27 million in 1968 to $68 million in 1969 and an unbelievable $237 million in 1970. All of the unfavorable movements which have been recounted come home to roost in this telling measure which spiraled downward after 1966. Operating revenues first fell off and then recovered only to be overwhelmed by higher operating expenses which were in turn compounded by the increased rentals. In these summary terms, the 1966-67 break divides the 1960's into two periods composed of increasingly favorable operating results followed by sharp declines leading to certain doom. The changing tide is depicted in the percentage of gross revenue carried through to NROI, starting with 1.2 percent (pro forma) in 1961 and working up to 7.2 percent before falling off to negative values. AFTER NROI With debt such an important part of railroad capital structures, contractual interest payments called "fixed charges" constitute an important reduction of net railway operating income before it can be pocketed as "net income." Mean- while, the NROI is supplemented by "other (non-operating) income" as an additional source of fixed charge coverage and net income. Both companies took on a relatively heavy burden of fixed charges as a result of rather large postwar investment programs. Both also embarked sub- sequently on substantial programs of debt reduction so that fixed charges were declining during the early part of the period of perspective (Table A-6). The composite figure declined from over $90 million in 1958 to a low of $75 million in 1964, then rose continuously to $85 million in 1967 and on to a new high of $144 million in 1970. The pattern was essentially the same for each company although the specific contours were quite different, with the Central's figures dropping more and rising less. The Central dropped from $45 million to $35 million and then advanced to only $36 million by 1967, while the PRR slid from $45 million only to $40 million and then recovered to $49 million. This coincidence of the ballooning of fixed charges, despite the big switch to leasing, with the collapse of NROI presented a particularly lethal combina- tion. But this unfavorable balance was not peculiar to the immediate pre- bankruptcy period. As a result of the rising NROI and falling fixed charges in the early 1960's, a positive balance was achieved for both companies in 1965 and 1966 (Table A-6). These were the only years, however, in the entire period 1958-70 when the charges were covered by NROI. During the 10 years 1958-67, 35 the PRR generated about $266 million of NROI and $437 million of fixed charges, while the Central had $230 million and $381 million. The PRR was short about $171 million and the Central approximately $149 million, or a total of $320 million. For the industry as a whole, fixed charges run about 40-50 per- cent of NROI. A chronic ratio of over 100 percent is certainly a crisis signal. The $320 million provides the dimension of support required from sources other than operating income to keep the companies going. Over the years, the PRR had higher absolute but lower relative fixed charges than the Central. One indication is the ratio of NROI to fixed charges. In the period 1956-65, the PRR ratio was generally higher but the position changed in the immediate premerger years to a slight Central advantage. The comparative ratios for the PRR and the Central, respectively, were 1.08 and 1.39 for 1965, 1.26 and 1.60 for 1966, and 0.30 and 0.09 for 1967. The differences were certainly not significant and neither company was supported by rail in- come in the recent past. The long-time salvation of the companies is found in the income statement item labelled "other income", contributions from sources other than the opera- tion of the primary railroads (Table A-6). Both companies were rather well loaded in this respect. The outside income tends to be more stable than the railroad-generated income and its proportion fluctuates rather widely. Between 1964 and 1970, for example, it ranged for Southern district railroads from 20.2 to 42.4 percent and for Eastern district from 33.5 to 65.9 percent. After 1958, NROI exceeded other income for the two companies and as a composite only in the three years 1964-66. During the 1958-67 period, composite NROI totalled $495.8 million and other income $684.7 million, a discrepancy of $188.9 million. The two items together — NROI and other income — constitute a pot of funds available to cover fixed charges, with any residual providing "net income" (Table A-6). Because of the strength of the other income, this was a positive sum for all years for the two companies and for all except 1970 for the Penn Central. It exceeded fixed and miscellaneous charges, however, only in 1963-67. For the 13 years 1958-70 the accounts about broke even, with fixed charges aggregating $1.2 billion and income available $1.0 billion. Dropping the 1970 deficit produces a positive balance of about $170 million. Premerger (through 1967), the composite balance was plus $258.6 million, or an average of only about $26 million annually. These figures show that the strength of the other in- come enabled the companies to realize a net income in 1963-66 and 1958-59. For the 13 years 1958-70, positive net income totalled $281.5 million which was offset by $434.1 million in losses, creating a negative balance of $152.6 million. Other regional carriers fared far better in this respect (Chart A- 9). Over the entire 1958-70 period under review, the railroads generated aggre- gate positive NROI of only $164.5 million, and incurred fixed charges of $1,180.5 million, running short by over a billion dollars. If the post merger experience is eliminated, the NROI is $495.8 million against fixed charges of $817.4 million, cutting the shortage to $321.6 million. While not quite so frightful, the elimi- nation of postmerger experience still leaves a very bleak picture. 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CM* CM - CM CM CM ^' CM CO CM CM CO w Q o .m^-t>-«coc T *oooo>toco i od cr> r»" co to r-.' to" r-.' r-." od •-•OO •-* >- * o oo o> ••* cj) f~* o ^^ ir-.iDCOoou-)*3-onoOp^ro i01"3"00i-«00CM(D00Ol0 uioonDOtftnoio^iDr .— h.-«COCM— «teLT)CMO00 i co r-»" o u o tr> ooi — co m i ro cm ^ o oi oo I — to tD tO (O tO to to tO tO tO U") tf°) CT1 C7i CT10">CT>CT*CT>OlO">C7}CTiCT>0"> Fiscal Policy The spotlight is now thrown on fiscal activities to catch a glimmer of their relationship to the financial fortunes of the companies. Fiscal policy assessment is difficult because it is so closely intertwined with other internal activities and with outside market forces. The ultimate purpose is to weigh the impact of decisions in this policy area on the financial decline. While specific measurement is beyond reach, achieving perspective is attainable. This discussion provides a particularly important link in the overall analysis since constrained fiscal policies serve in turn as constraints on management decisions in other substan- tive areas. This assessment considers first the constraints that condition the formation and implementation of fiscal policy. In the light of these constraints, policy in several key areas is examined, including investment programs, how they were financed, the reporting of earnings, cash management, and dividend payout. This selective treatment is based on potential contribution to bankruptcy, dealing generally with aspects of fiscal policy that have received public attention". Diversification is singled out for separate attention in a subsequent discussion. This does not, in other words, purport to represent the definitive history of recent fiscal policies of the Penns^dvania and New York Central Railroads. Frequent comparisons between the PRR and the Central are made since their somewhat different approaches to fiscal policy, as well as other aspects of busi- ness and of railroading, permit an evaluation of the results of diverse policies. CONSTRAINTS The constraints which are important for this discussion can be meaningfully sorted into three classes: (1) inherited, (2) merger induced, and (3) those dictated by outside factors. Inherited constraints are created by previous policies and events which themselves are the results of constrained managerial choices — and so on back to the beginning. In a sense, this inherited class raises the age old question of free will — the hand that is dealt and how it is played. Since this is a fairly open- ended category, it must be closely limited to the more explicitly relevant influ- ences — the fixed charges and debt laden capital structure resulting from the postwar investment program. The merger induced constraints are also a mixture of free will and neces- sity but with less rigid restrictions on options. Limitations were not generally absolute, decision makers could accept penalties as an option. One important fiscal policy constraint in this category is the agreement by the two companies in the merger terms to limit the amount of debt increase incurred to $100 million. The limit was later raised to $195 million, but it was still restrictive. Another is the agreed ratio for exchanging the stock of the two companies for that of the merged company. Under this arrangement, PRR stockholders were to receive one share and NYC owners 1.3 shares of the new company for each of their shares. It was incumbent upon each management to maintain earnings which would not disturb the ratio. The merger related constraints deserve special attention because of the long and totally unexpected delay between the time the merger was proposed and its approval. The constraints dictated by outside factors that are of particular relevance here are, from a fiscal policy viewpoint, virtually absolute. Of great importance is the severely limited earnings performance of the two companies which re- stricted both the range of investments that could be undertaken and the means of financing them. Financial market conditions also exerted a strong influence, with money rates and inflation particularly potent in the late 1960s just when borrowing was badly needed. (49) 50 Less rigorous but also important are financial market assessments of credit worthiness and security values. These factors are at least partly affected by fiscal stewardship, but they are significantly controlled by outside market forces. A related force is the effect of stockholder pressure or financial options. INVESTMENT PROGRAMS The capital investment programs separate into two categories representing commitments to the rail plants and operations and outlays for outside investment purposes. The latter category involves the well publicized diversification pro- gram of the Penn Central and is associated with the critical non-operating income examined earlier. This aspect of fiscal policy is covered in detail in a later section. This review focuses on investment in the railroad plants, comparing the magnitude and character of the plant investments of the two companies and providing a picture of their capital budgeting policies. Maintenance outlays are included in the investment discussion for some purposes because of special functional relationships. Each is discretionary within broad limits and they serve as both complements and substitutes. Together they largely determine the capital raising tasks of fiscal management and thus sharply condition the main outlines of fiscal policy. Investment patterns During World War II these railroads, along with the others, were used very intensively with inadequate repair and replacements and so roadway and equipment deteriorated badly. It has been argued that the plants were never restored to their prewar condition. Comparative evidence indicates rather clearly that these two companies fell behind the system as a whole and most individual companies throughout the country in rehabilitating and improving the physical plant. Railroad investment patterns fluctuate broadly with income and other variables as a reflection of their discretionary character. The result is a saw- tooth pattern for the two companies and for the system as a whole (Charts B-l, 2, 3). Investment in roadway and structures, however, shows far more stability than in equipment (or rolling stock). The two companies' investment troughs are noticeably wider and deeper than the total system has experienced. Although the specific movements are a little different, the investment patterns are generally similar for the two companies. The similarity includes a postwar peak followed by a sharp drop, a feeble revival in the mid to late 1950's, an early 1960's trough, and a last gasp effort prior to the fall. Through it all, the PRR program operated at a higher absolute level and held up a little better in the fluctuations (Table B-l ) . The general sweep of the investment programs emerges from summary fig- ures for two 10-year periods, 1948-57 and 1958-67 (Table B-2). The PRR total jumped from $986 million in the first period to $1,209 million in the second, an increase of $223 million or of about 23 percent. The Central's total, on the other hand, dropped from $895 million to $552.5 million, nearly 38 percent. Viewed in combination, the sharp NYC drop meant an overall decline of 6.4 percent. During the two periods, the PRR invested $2.19 billion and the Central $1.45 billion, a grand total of $3.6 billion and a difference of $747 mil- lion between the two railroads. Most of the difference was accounted for by the heavier PRR outlays for equipment in the second period, totalling $948 million. These figures portray a pattern of relative deficiency. Measured as a per- centage of operating revenues, the combined commitment paralleled the Class I railroad's performance, but was far below the achievement of many other major roads (Table B-3). Essentially the same pattern persists when relative per- formance is measured by the ratio of capital expenditures to gross investment. Maintenance figures for the same time periods and plant elements over- power the investment levels so that interdependences are badly obscured. The little light that is available here is drawn from the percentage relationship between the two outlay types. The pattern shows a high degree of stability, suggesting that maintenance behavior does not explain the different investment 51 patterns of the companies in the two time periods. The Central's maintenance expenditure for way and structure was 46 percent of the combined total in 1948-57 and 45 percent in 1958-67. Central represented 41 percent of the aggre- gate equipment outlay in the first period but 43 percent in the second. This two point difference represents $54.9 million, or an annual average of about $5.5 million, not a significant offset to the Central's lower rate of investment in the second period. 1 The merged companies' capital investment program, including leasing, continued in 1968 and 1969 at a level slightly above the expenditures of the com- bined roads in 1967 but well below their 1966 figure. The comparative figures are as follows: Year: Investment 1966 $216, 385, 400 1967 137, 166, 100 1968 147, 187, 700 1969 151, 548, 900 The post-merger outlays were particularly modest in view of the special- ized merger requirements that were imposed. They were supplemented, how- ever, by extraordinary maintenance expenditures which increased from $421.0 million in 1967 to $427.6 million in 1968 and then on to $473.3 million and $551.3 million in 1970. Capital expenditures related to the merger were a serious problem for the Perm Central. Merger plans estimated merger-related capital expenditures in the four years following the merger at $74.7 million but $90.2 million was re- quired just in the first two years. Miscalculations are exemplified by the $20 million cost over-run for the new Alfred E. Perlman Yard at Selkirk. New York, and the $22.4 million required for a new classification yard at Columbus, Ohio, that was totally unanticipated. Investment policy The investment patterns outlined reflected policies adapted to the financial conditions facing management. In the PRR case, they emerged in the face of conflicting pressures and criteria imposed by concern for fiscal measures and performance to support high credit standing and for operating requirements for plant improvement. Management clearlv tried for many years to compromise these two pulls. The PRR's governing approach to plant investment was articulated in an internal document as early as 1954 which expressed concern over unfavorable stockholder reaction to additional investment commitments following the rather large postwar surge: From an overall standpoint it also seems to us that we must, where possible, adopt a middle-of-the-road policy on capital expenditures, doing this gradually, because it is apparent from the letters we have already re- ceived that the stockholders are highly critical of the fact that we have spent such vast sums of money on the railroad. If we spread out the pro- gram it is going to be much less criticized. 2 Nearly 10 years later top management was reaffirming this middle-of-the- road policy regarding capital expenditures. Road expenditures occasioned particular concern since the required funds had to be generated out of earnings. It was believed that uncertainty about the railroad's future in light of such developments as piggyback, unit trains, the St. Lawrence Seaway, passenger deficits, and particularly the proposed merger and resulting changes in traffic patterns, dictated a conservative policy toward capital expenditures and main- tenance. It was stated that : Lack of earnings and limited cash flow during the past 4 years, plus the necessity for continuing our debt reduction program in order to bring 1965 maturities within manageable proportions, has precluded any con- sideration of major capital expenditures for roadway projects. 3 1 Moody's Transportation Manual. 2 Memorandum, DCB [Bevan] to JMS [Symes], January 21, 1954; see appendix D, Exhibit 47, p. 610. 3 Memorandum, Greenough to Symes, May 1963. 52 Although operating officers recognized the financial constraints, they frequently complained about the inadequate maintenance and the deteriorating quality of road and equipment and urged a reversal of this pattern. Finally in 1964 demands for a larger capital budget were granted on the basis of a mini- mum 30 percent return, or a $50 million operating profit. In the three years 1964-66 the PRR invested approximately $132 million in road and $372 million in equipment (excluding leases) or a total of $504 million, compared to $171 million in the previous three years. 4 However, operations fell short of the promised $50 million profit by $21 million in 1964 and $22 million in 1965. This experience confirmed Bevan's conviction that the railroad could not generate an acceptable return on new capital investment. In his view, the result of the last program was simply to "increase system debt by $240 million and interest charges by $17.5 million," further straining the deficit cash po- sition and damaging the company's credit with the investment community. The 1964-66 capital budget program and Bevan's reaction to it intensified the discord between the operations and financial departments. Operations complained that the primary concern was "the risk of a decrease in our Moody's rating" and blamed cash deficits on non-rail investments. "If the question is what has happened to our cash, there is no reason to single these fplant investments] , out from our non-railroad investments of all types over the past few years.' Bevan was accused of "the absence of a sense of common purpose" and of using operating properties as a cash source for large- scale diversification, although this policy was favored so long as the cash it required did not "make it impossible to profitably operate the $2.6 billion of assets sunk in the railroad." Operations spokesmen accused the financial com- munity of being "more concerned about an increase in our debt than an ade- quate capital program." The contentions regarding cash drains are examined later. In the financial view, Bevan asserted that despite the desirability of the investment objectives, excessive outlays in 1964 and 1965 impaired the com- pany's ability to carry on new financing. The company was experiencing "an acute shortage of cash and high maturities in relation to depreciation" and had to be allowed "a breathing spell . . . until the operating people can show a satisfactory return on capital expenditures already made." In 1967 capital programs were deferred and cash spending was limited until consummation of the merger between New York Central and Pennsylvania Railroads. On the eve of the merger, the Pennsylvania had no road capital expenditure budget for the ensuing year and the status of the equipment budget was still up in the air. Bevan put a stop to all future projects that did not show a 50 percent return on investment unless required for safety or for industrial development purposes. The financial officer's anguish shows clearly in this statement of ultimate disillusionment : The equipment financial situation is very serious. Over a long period of years it can be easily demonstrated that the P.R.R. spent (whether wisely or not) more money on its equipment than any other railroad in the United States. As a result, we are approaching a very serious situation where our annual equipment maturities very quickly are going to equal or exceed not only our equipment depreciation, but our total depreciation. This is almost unheard of in the railroad industry and unless corrected promptly will do more to hurt our credit than almost any other factor. If our credit is damaged this, in turn, will have a very serious and substantial effect on the value of our stock. 5 Investment policy evaluation Evaluation of some aspects of investment policy requires a consideration of other factors. In some respects, definitive evaluation cannot be provided and only limited observations are advanced at this stage. The central question is whether additional investment funds could and should have been provided for * ICC Form A, Railroad Annual Report. r 5 Memo from Bevan to Saunders, October 22, 1965 ; see Appendix D, Exhibit 48, p. 612. 53 the rail operations. Along with the foregoing policy statements, this summary is confined to the PRR, although the underlying financial stringency and the low returns were prevalent in the Central as well. Unquestionably, financial stringency severely limited the availability of funds for plant upkeep and improvement. In reviewing investment activity, it requires emphasis that the avowed policy was "middle-of-the-road" and not geared to financial starvation. During the years 1959-1967, over $1.5 billion was put back into two companies that were able to generate only $472.5 million of Net Railway Operating Income (NROI). This investment was nearly 10 times the amount put into diversification during the period 1963-70. Aside from recognizing that replacement funds, restricted by low earnings, were negligible by most standards, the fundamental question of the economic rationale for additional investment requires consideration even though it can- not be answered satisfactorily. Investigation does not reveal a comforting capi- tal budgeting process, but rather an ad hoc system of compromising conflict. There is no apparent firm and rational basis for either project justification or evaluation. Bevan declared himself displeased with proposals, indicating on one occasion that "there are so many discrepancies in the proposed program that it appears that figures have almost literally been picked out of the air." 6 Nor can his position be contested that, in later years particularly, projects did not earn justifiable returns. But while there is no evidence that projects with promising returns were passed up, the record still leaves some puzzling questions centering around the capital budgeting rules. It has been said that PRR's equip- ment investment decisions were controlled by narrow cost cutting criteria with inadequate regard for other benefit sources. Particularly fascinating were projects permitting personnel reductions, a laudable aim perhaps but hardly acceptable as an exclusive investment project criterion. The 1964-66 program was considered a failure by Bevan since it did not immediately produce such delights as a $50 million profit contribution or a 30 percent return. One can only wonder about the rationale for the criteria and the stringent payoff period expected. On the other hand, meeting fiscal goals was critical. Excessive debt and other unfavorable indications meant a credit weakening and higher capital costs. Given the financial stringency, the insatiable appetite of the plant, and the legacy of past obligations, steering a safe course between the fiscal and opera- tional shoals by these large Eastern railroads during the 1960's was a fierce and perhaps impossible challenge. CAPITAL STRUCTXJBE AND FINANCING METHODS Financing policies are mirrored in capital structures which reflect the relationship between debt and shareholders' equity. The long-term debt of both companies advanced rather substantially during the early postwar years. The Central jumped from $632 million in 1948 to $835 million in 1953, an advance of $203 million or 32 percent. The PRR increased to its 1952 maximum of $831 million by a more modest $154 million or 23 percent. After remaining rather steady at the new level for several years, the Central's debt dropped 23 percent after 1957 to a new low of $633 million in 1964. The PRR, on the other hand, turned downward immediately after the 1952 high, dropping every year to reach a new postwar low of $563 million in 1964. off $248 million or 31 percent from the 1952 high. During these postwar years, the PRR debt rose less and dropped more and faster than was true for the NYC (Table B-l). After the 1964 lows experienced by each company, however, the behavior patterns were completely reversed. The NYC debt advanced rather mildly from $633 million to $666 million, while the PRR jumped from $563 million to $721 million; up $158 million or 28 percent. These upward movements established patterns that were continued and enhanced after the merger. The result was a whopping 59 percent increase to 1970, staged as follows: 6 Memo from Bevan to Saunders, October 22, 1965 ; see Appendix D, Exhibit 48, p. 612. 54 In millions of dollars] 1,196.0 1.301.1 105.1 1,3*6.7 45.6 1, 387. 2 40.5 1, 606. 9 219.7 1, 8S9. 4 252.5 1,901.8 42.4 Year Long-term debt Annual increase 1964.. 1965.. _ 1966.. 1967 1968 1969 1970 The equity portion of the capitalization is somewhat more stable than the debt element. This is demonstrated in the following 5-year summaries: CAPITAL STRUCTURES 5-YEAR AVERAGES PENNSYLVANIA, NEW YORK CENTRAL; 1948-67 Period Pennsylvania New York Central Current Current Current liabilities Current liabilities liabilities plus long liabilities plus long Long term plus long Long term term debt/ Long term plus long Long term term debt/ debt/ term debt debt Equity equity debt term debt debt Equity equity equity (millions) (millions) (millions) (ratio) (ratio) (millions) (millions) (millions) (ratio) (ratio) 1963-67 $810. 7 $635. 5 $1, 374. 8 0.59 0.46 $782. 2 $652.0 $926. 8 0.84 0.70 1958-62.... 788.5 656.8 1, 387. 9 .57 .47 834.1 719.2 947.0 .88 .76 1953-57.... 888.0 749.9 1,387.6 .64 .59 953.5 825.3 945.0 .95 .87 1948-53 896.5 738.9 1,306.0 .69 .56 835.6 703.3 873.9 .95 .80 Source: Moody's Transportation Manual. Equity increased modestly for each company between the 1948-52 and 1953-57 periods (6 percent for PR R and 8 percent for NYC), with a high degree of stability thereafter. As a result the significant debt/equity ratio is largely sensitive to debt fluctuations and thus follows the contours laid out above. Including current liabilities in the debt component raises the ratios by roughly 10-15 points, but does not appreciably effect the contours (Table B-4). The ratios generally increased to 1952 and then fell back in response to the debt reduction programs. Equity growth, however, continued to bring the Central's long-term debt/ equity ratio down even after the debt upturn in 1964, reaching a low of .67 in 1966 before bounding up to .80 in 1967 in response to a small increase in debt coupled with a sharp drop in equity (off $145 million). The PRR ratio turned upward after the 1964 debt trough, jumping from .40 in that year to .57 in 1967. Building on the predecessor trends, the Penn Central started life with a lusty .79 in 1968 and then jumped to .97 and 1.27. Long-term debt figures and their relation to equity are underestimated in recent years because of the increased use of equipment leasing. As elaborated later, since the value of leased equipment is not capitalized, the real debt and debt-equity ratios are larger than shown. The historical differences in the capital structures of the two companies feature the Central's heavier reliance on debt financing (Table B-4) . The differ- ential reached 24 points in the 1948-53 period, advanced to 33 points in the next 5 years, and fell off to 29 points in 1958-63 in response to the debt reduc- tion programs. Movements of controlling variables in the 1963-67 period brought the differential back to 24 points. Throughout the entire 1948-67 period, the NYC ratio ranged from 67 to 91, while the PRR stayed within the 40 to 62 bounds. Despite a smaller asset and revenue base, the Central's debt actually exceeded thePRR's throughout the 1953-65 period. The debt/equity ratios of the two companies may be put in perspective by reference to ratios for all Class I railroads (Table B-5). In eeneral terms, the PRR generally stayed below the system average and the NYC well above. The PRR was only slightly under in the 1953-57 period, with a 5-year aver- 55 age ratio of 54 compared with 59 for the system. The spread was increased to 10 points, however, in the two subsequent 5-year periods. The all system aver- age remained very stable in the upper 50's while the PRR figure was dropping. The NYC, on the other hand, maintained an 87 average in the 1953-57 period against the all system average of 59. Even with its subsequent drops to 76 and 70, it remained on the high side by 15-20 points. DEBT BURDEN Since railroad earnings are rather volatile, a safety margin is needed for successful debt management to insure annual income sufficient to cover fixed charges and to provide a flow of funds to meet debt maturities. Not having these essentials, debt management for the PRR and NYC was precarious. The major debt movements included (a) the postwar buildup, (b) the debt reduction program to 1964, and (c) the PRR buildup in conjunction with the NYC plateau. The early buildup was required for the postwar renovation of the two plants. The fiscal legacy was a formidable schedule of maturities and a burdensome level of fixed charges that practically drove the Central into bankruptcy and created serious concern regarding the credit standing of the PRR. The burden imposed on earnings by the debt load is most directly measured by the ratio of the income available for fixed charges to fixed charges. In spite of debt retirement and declining fixed charges after 1952-1953, the average ratio of income available declined, demonstrating the crucial role of the income factor (Table B-6). Furthermore, the ratio patterns of the two companies were remarkably similar despite quite different debt policies during the 1960's. Avail- able income was less than fixed charges in 1960 for the Central and 1961 for the PRR. The Central maintained higher ratios in the earlier years but the gap was subsequently closed and it fell behind in the last period shown in this summary. Period New York Central Pennsylvania Railroad 1948-52 1.56 1.24 1953-57 1.65 1.40 1958-62 1.01 .98 However, the figures for recent years must be carefully interpreted because of the increased use of leasing. Viewed as a form of long-term debt, equipment leasing approximates a serial bond. The cash outflow in any given period would represent a payment of interest plus a payment for the current maturity of the debt. With leasing, the periodic lease payment represents the equivalent of a repayment of the principal (which should approximate the depreciation charge that would have been incurred if the equipment were owned by the railroad) plus a payment for imputed interest. Interest is included in lease payments as a fixed obligation like any other type of debt. Under leasing however, deprecia- tion and fixed charges are reduced and rent payments are increased. Both income available for fixed charges and fixed charges are thereby reduced, pro- ducing better ratios of income available to fixed charges than with equipment financing by conditional sales agreements or equipment trust certificates. 7 Since PRR increased its leasing relatively more than Central, its ratios are actually overstated in comparative terms. These ratios also are distorted by the accounting practices which inflated (maximized) reported earnings. This policy, which will be dealt with more extensively later in this section, created a divergence between reported income and true cash flows. The ratio of income available for fixed charges to fixed charges is designed to measure the ability of the rail- road to pay its fixed obligations from earnings. In the case of the PRR, and later the Penn Central, the coverage of fixed charges ratio was inflated by the earnings maximization policy. The related problems of meeting debt maturities also plagued the PRR in its last years. Along with the increased fixed charge burden associated with 7 Except when the ratio is less than one and the true ratio Is over estimated. 56 the 1964-66 capital improvement program, heavy maturities were comine due K 1 7^ t »*«■• ^ion issue of 1965 and another of $84.7 Son of Uoe. Ihe Central escaped these debt problems at this time by keeping capital expenditures at a minimum and deferring any substantial maturities until the 1970s. Bevan estimated that in 1967 maturities would approximate $57 million compared with estimated equipment depreciation of $35 million and road depreciation of $19 million, all devoured by the maturities. This violated the rule ot thumb limiting maturities to equipment depreciation and had begun to cause adverse comment in the investment community. Bv contrast, the Cen- tral s 1967 depreciation was estimated at about $30 million to cover only $20 million of maturities. 8 The debt reduction programs of the companies reflected expectations that future revenues would provide inadequate funds to meet obligations. The pro- grams were accomplished by paring down debt obligations of rail operations and greatly curtailing maintenance. Credit standing was reestablished in the early 1960 ? s but the effect was short term and by 1968 the Penn Central's debt/ equity ratio was the highest it had been since the late 1940's for the composite companies. EQUIPMENT FINANCING Rolling stock or "equipment" constitutes the major component of railroad plant investment. Aside from any production function dictating relative re- quirements for equipment and for roadway capital, investment in equipment is encouraged by the greater availability of funds because of more favorable financing methods. Investments in roadway plant can be secured only by gen- eral mortgages, while liens on resalable equipment provide greater protection for lenders. However, even this advantage can be seriously diluted for com- panies with doubtful credit, as the PER and NYC discovered. Thus, while equipment financing is rather straightforward under ordinary circumstances, credit availability, capital costs, and repayment potential can create complications. Three general methods of financing new railroad equipment, other than outright purchase, are available: (1) sale of equipment trust certificates, (2) conditional sales financing, and (3) leasing. The traditional method for the railroads had been equipment trust certificates, but in the mid 1950's the rail- roads (especially PRR) began to rely more heavily on conditional sales agree- ments and on leasing. In equipment trust financing, railroads make a 20 to 25 percent down payment on the equipment and then finance the balance of the expense by the sale to the public of equipment trust certificates. The certificates are usually repaid serially over 15 years and the owners have a lien on the equipment through the equipment trust. The interest rates on the certificates are generally below the interest rates on high grade utility bonds. In railroad accounting, equipment trusts are listed as long-term debt on the balance sheet (except for the amount due within the year, which shows up just below current liabilities) and interest on them appears as fixed charges on the income statement. Conditional sales agreements are installment loans backed by promissory notes usually payable within 10 to 15 years and possibly requiring a down payment. The lender retains title to the equipment until the note is repaid which makes repossession easier than with equipment trust certificates. Orig- inally financed by banks, in recent tight money years railroad conditional sales contracts have depended on pension funds, insurance companies, and savings institutions. Railroad accounting treats conditional sales contracts exactly as it does equipment trust certificates. A cited advantage of conditional sales agreements for a cash short railroad is the elimination or spreading out of the down payment. However, this is a questionable advantage since a higher debt in one area may weaken the rail- road's ability to borrow elsewhere. It should also be noted that deferring the down payments caused larger payments of principal and interest in later years, an optioii consistently selected by the PRR and later by the Perm Central. A disadvantage of conditional sales contracts is a somewhat higher interest rate. 8 Memo, from Bevan to Saunders, October 25, 1966 ; see Appendix D, Exhibit 36, p. 554. 57 Because of easier repossession, conditional sales contracts are usually easier to obtain than equipment trust financing in tight money periods and for firms with unimpressive credit ratings, but at the expectable cost of higher interest rates. In leasing-, the lessor retains title to the equipment and the railroad contracts to make regular payments for its use spread over the economic life of the equipment. Like 100 percent conditional sales contracts, leasing gives the questionable advantage of avoiding a down payment, Since the leases were not financial leases, accounting practice provides that their capitalized values are not long-term debt nor are interest payments listed as fixed charges. Lease payments are reported along with per diem rental to other railroads as "hire of equipment — debit," A switch from equipment trust or conditional sales financing to leasing gives the illusion of a reduction in the railroad's long-term debt and fixed charges while not improving its ability to meet contractual obli- gations. However, if investors and creditors accept the illusion, the railroad credit position may be improved. Like a conditional sales agreement, leasing carries a higher implicit interest rate than equipment trust financing, but is easier for a firm with weak credit to obtain because the lessor retains title to the equipment. The New York Central relied primarily on equipment trust financing until 1954 when its credit rating dropped from A to Baa. It subsequently resorted infrequently to equipment trust financing until the 1960's, turning mainly to private financing through conditional sales agreements. The conditional sales agreements carried a higher rate of interest (at first under five and sometimes under four percent) but apparently equipment trust financing was more diffi- cult to obtain because of the lowered credit rating. In 1956, the Central shortened some conditional sales contracts to 10 years from the traditional 15, making the contracts more attractive to lenders but also causing larger cash drains in the tight money period of the late 1960's. The Central did not use leasing until 1962. The Pennsylvania relied primarily on equipment trust financing until 1957 when it turned to conditional sales contracts and leasing, with leasing particularly favored. Approximately $248 million worth of equipment leases were added during 1958-60. 9 An apparent reason for the shift was the large drop in income in 1957 and the years following. This meant, first, that the rail- road needed to conserve cash (and these two methods meant smaller or no down payments) and second, that its weakened credit position made equipment trust financing more difficult. Leasing was also favored because it did not increase the reported debt structure, an advantage only if creditors failed to evaluate the effect of leasing on the railroad's ability to meet contractual obligations. After 1962, leasing provided a means to circumvent the merger agreement on debt limitation. The Central did not follow the leasing path so extensively. The ratio of lease payments to other car rentals during the 1960's stayed around 0.10 for the Central, while it was commonly 0.30-0.40 on the PRR, but began dropping off by 1967 (Table B-7). Leasing and conditional sales agreements were also the major means of financing equipment acquisition after the merger. It appears in retrospect that the companies were shut off from major reliance on equipment trust financing by low earnings and reduced credit ratings. The resulting higher interest rates were beyond their control given their earnings records and the tight money market conditions. Even the Cen- tral's retroactively questionable decision to switch from 15-year to 10-year conditional sales contracts may have been forced by lenders demanding shorter terms because of the low credit rating. In order to evaluate the effect of different types of financing on cash flow one would have to make a careful study of the amount and timing of the initial down and annual payments, and of relative contract periods. But there is no reason to argue a priori that leasing was a poor method of financing equipment. It was clearly a reasonable alternative considering all of the circumstances. Another aspect of fiscal policy associated with equipment financing involved the choice of rebuilding old freight cars instead of purchasing new ones. By 9 See Table, "Equipment Lease Agreements," Appendix D, Exhibit 49, p. 614. 58 1962, the PRR was following the refurbishing route extensively. Because of the twilight zone between purchase and rebuilding and between rebuilding and maintenance, significant accounting and financing questions are involved. Freight cars normally require major overhaul every 12 years. This may involve rebuilding, increasing capacity, or adding specialized equipment. In the years just prior to the merger the PRR began capitalizing some of these expenses and the practice was continued by the Penn Central. The ICC Bureau of Accounts argues 10 that even when rebuilding is involved, capitalization is usually improper and the costs involved should be written off as maintenance expenses in the year of the rebuilding. Capitalizing these expenses can be justified in accounting theory if rebuild- ing a car substantially changes the quality of service it will provide. While it is not clear that the maintenance expenses were of this type, the switch to a capitalization basis, in the short-run at least, reduces reported maintenance expenses and thus increases reported net income. In this equipment rehabilitation process, PRR sold the cars to straw parties (usually railroad employee groups or financial institutions) designated as "owners"' who would contract with the railroad to make the repairs. The costs were reported in an "Owners Equipment Fund" separate from the reg- ular railroad accounts. After completing repairs, the "owners" would sell the equipment to an affiliate of the railroad which made a 10-15 year leasing con- tract with the railroad that then would be assigned to a bank or other financial institution. There were three apparent reasons for capitalizing the equipment repairs. First, this procedure increased reported income as described above. Second, by leasing tiie equipment back, the cash drain in the year of the repair was reduced from the amount of the repair to the amount of the first lease payment. How- ever, the saving in cash in the first year meant larger cash drains in following years. Finally, capitalizing the rebuilding expenses permitted use of the invest- ment tax credit. Since the Penn Central was not earning enough to pay taxes, the investment tax credit was not a direct benefit, but selling rebuilt freight cars to financial institutions permitted the tax credit advantage and thus en- couraged more favorable credit arrangements for the railroad. But whatever the balance of benefits and disadvantages, capitalization's direct effect was lower reported maintenance costs than if this item were treated as an expense. The associated result is discontinuities which cloud trends and comparisons in such critical series as fixed charges, maintenance, and investment. While reducing short-run cash outflow, the practice deceptively increased reported net income. POST-MERGER FISCAL POLICY In the nearly two and a half years between the merger and bankruptcy, interest rates skyrocketed while the Penn Central suffered gigantic operating losses. The railroad relied progressively more on short-term borrowing and by the time a long-term debt offering was initiated it was too late. The railroad's financial difficulties had become too obvious for the debenture offering to be a success and the railroad was forced into bankruptcy. Aside from equipment financing through conditional sales agreements and leasing, two principal financing sources were revolving bank credit and com- mercial paper, supplemented by the Eurodollar market and debt offerings of the Pennsylvania Company. The revolving bank credit borrowing was brought up to the $100 million limit by the summer of 1968. It was then extended to $300 million under the aegis of the First National City Bank of New York, but under more stringent arrangements, including the strict maintenance of off- setting bank balances. This additional source of capital was immediately tapped. The ICC approved Commercial paper issues up to $100 million. This amount was sold in the second half of 1968, followed by a further authorization and sale of $50 million in March 1969 and $50 million in November 1969, for a total of $200 million. Commercial paper, favored because of its ostensibly lower interest 10 Interstate Commerce Commission, Docket No. 35291, Penn Central Investigations Verified State- ment 36, pp. 46-50. 59 rate, actually bore rates exceeding the prime rate in 1969 and 1970 because of its heavy use. It is also dangerous because of its extremely short-term status, with the real threat of inability to roll over the loans, which was the precise fate of the Penn Central. Between April 21, 1970 (the day preceding the announcement of operating results for the first quarter of 1970) and May 22, 1970, maturities of commercial paper exceeded sales by $78 million. The post merger financing; program also included a new long-term blanket mortgage of $200 million to $300 million which was to become the major long-term debt vehicle for the Penn Central. The proposal was to issue an overall blanket mortgage to refinance maturing bonds and to provide funds for further capital expenditures. The bonds would also enable the company to reduce or eliminate its commercial paper and to pay back the revolving loans, and this credit line would then continue as security for emergency cash needs. To avoid tying nonrail properties to the blanket mortgage, the plan was to pledge all of the system's strong first mortgage bonds that were available. 11 Unencumbered properties Avere to be mortgaged and already mortgaged holdings would be further encumbered to the extent possible, all placed under the new blanket mortgage. Legal and mechanical complications delayed the offering. By the spring of 1969. there was little market interest in straight debt of such magni- tude, and the Penn Central was apparently unwilling to issue convertible bonds. 12 But it is doubtful that even with a better bond market the Penn Cen- tral could have made a successful bond offering given its tremendous operating losses. Forced to give up the Penn Central mortgage bonds, two issues of bonds were made in 1969. Still in desperate need of funds, on April 2-4, 1970, the Penn Central through the Pennsylvania Company announced a proposed offering of $100 million in sinking fund debentures to be due in 1995, with warrants half exercisable for Great Southwest stock and half for the new Penn Central hold- ing company. The banks apparently indicated some concern before the April announce- ment over the railroad's continuing poor operations and questioned its ability to pay off the bank loans. 13 Nevertheless, they lent the Pennsylvania Company $50 million in revolving credit on January 27, 1970 "to proceed with its orderly financing program.'' These funds were to be moved "upstairs" to the railroad in return for some "income producing assets." On May 29, 1970, when the bankers for the offering could not attract sufficient support for half that amount at in- terest rates of as much as 11.5 percent, the offering was withdrawn. Cessation of the offering caused havoc in financial circles and the Penn Central manage- ment turned unsuccessfully to government officials for financial assistance. A review of the post-merger financing policy of the Penn Central shows that short-term financing was being used for long-term problems. The resulting interest costs to the railroad and the problems of rollover were enormous, given the very tight money market and the railroad's operating losses. By the time long-term financing was attempted the railroad was in such bad financial shape that the offering failed. With the gift of hindsight one can argue that the railroad should have real- ized it would have serious operating losses in the first few years and should have arranged long-term financing at the time of the merger. The most appropriate type of financing would have been a stock offering. Although equity financing is the most expensive form of capital, the price-earnings ratio was very high at the time of the merger because of expectations about merger savings making this financing method somewhat less expensive than usual. Equity financing also would have given the railroad a much needed margin of safety by providing 11 For example, the properties of the Pittsburgh and Lake Erie which were 93 percent owned by the Penn Central were not then mortgaged, nor were the 100-percent-owned Fort Wayne properties. 12 James O'Brien of Salomon Brothers wrote about, the lone-term bond market to Jonathan O'Herron in September 1969: "With reference to your recent inquiry it is our considered opinion that in the light of the present condition of the bond market and the scarcity of long-term bond money among institutional investors, it would not be feasible or practical to contemplate an offering of $50 to $200 million PC long-term mortgage bonds at this time on either a negotiated or com- petitive basis." 13 "Management has indicated they are willing to pay whatever price it will take to sell the $100 million issue in the Pennsylvania Co. and should be able to meet our interim loan. What bothers us is that they are slowly using up their debt free assets to pump funds into the railroad. This can only go on so long and should the railroad continue its poor operation for several more years, our direct loans would be seriously jeopardized." (January 11, 1970, memo from Chase Manhattan Bank.) 74-924 O - 73 - 6 60 capital without increasing fixed charges. Six months after the merger equity financing probably would have been difficult if not impossible. The detailed in- formation required on a prospectus would have shown that costs had skyrocketed and service had deteriorated. ACCOUNTING PRACTICE AND POLICY It is appropriate at this point, prior to discussing "earnings maximization," to briefly mention ICC accounting policies and practices. 14 The accounting policies and disclosure requirements of regulated common carriers are prescribed by the Interstate Commerce Commission. Such carriers are exempt from many of the provisions governing regulations of the Securities and Exchange Commission. In addition, such carriers are exempt from some of the provisions of the pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants, a committee respon- sible for promulgating "Generally Accepted Accounting Principles." The ICC's acknowledged hegemony in establishing the regulations and procedures best suited for the needs of common carriers is the reason for such exemption. There can be definite advantages to such regulation. The consistency in reported financial performance from one accounting period to another and the uniformity of accounting practices among all regulated common carriers can provide excellent financial information to the carriers of financial reports. Furthermore, the ICC can prescribe policies and procedures with greater speci- ficity than the Accounting Principles Board, which makes policy pronounce- ments for a much broader segment of the American industry. However, some extant policies and procedures prescribed by the ICC are in need of critical review so that the theoretical advantages of regulated accounting policies may be realized. The existing ICC position on "betterment accounting", deferred income taxes, accounting of investments in subsidiaries, and financial disclosure require- ments should be amended to reflect the increased complexity of the major common carriers' operations and the need for more relevant financial informa- tion by analysts and investors. The ICC's regulations presently lack precise requirements for certification of financial statements by independent accountants and standardized disclosure requirements for prospectuses. These regulations fail to obviate the sort of loose accounting practices evinced by the Penn Central Company's treatment of transactions designed primarily to inflate reported income on both a consolidated and non-consolidated basis. The ICC must respond to the changing nature of the transportation indus- try by adopting and adequately enforcing accounting policies and procedures that reflect the needs of the carriers as well as of the users of such information, and would serve as a palliative for existing policy and enforcement inadequacies. EAKNINGS MAXIMIZATION Earnings maximization is usually conceived as a behavioral phenomenon or as the goal doggedly pursued by entrepreneurs in the textbook economic models. It has a highly specialized and somewhat pernicious connotation here, being less concerned with substance than with appearance. It might best be de- scribed here as a policy of "earnings inflation." This concept of earnings maxi- mization — or earnings inflation — is much less concerned with the realities of income building, founded on the solid rock of quality output, effective cost con- trol, and superior marketing, than with chimeras. Earnings are thus "maxi- mized" — or "inflated" — by pretending they are larger than they really are. There is, however, a range in this pretense — running from reasonable options of taking income all at once, or spreading it out, to pure fakery; accounting principles are both compromised and corrupted in the process. There are, to be sure, behavioral explanations for the phenomenon. Whatever the real distribu- tion of these actions along the pretense scale, earnings maximization as it 14 For a more thorough discussion of accounting matters see "Accounting Practices and Policy" in "Fiscal Policy Analysis" in Part III of this report. 61 emerged in this context of desperation is a sleazy concept that deserves the scorn it has received. But righteously recognizing the shortcomings inherent in this charade doesn't help with the basic problem of assessing fiscal policy. The ultimate ques- tion is simply how the accounting games affected the longevity of the enter- prise. Taking all you can get today on the idea that there may not be a tomorrow may, actually be a sound long-run strategy. Hiding a weakness may be prudent business if its exposure enhances vulnerability. On the other hand, departures from reality in these critical matters may be dangerous. It takes cash to run a company; the engine can't be fueled with paper and accounting entries. But this doesn't say that pretending there's cash when there isn't causes the lack. The questions to be asked are how dismal the picture would really have been without this exercise in optimism and the real effects of the flight from reality. As with many of the aberrations requiring examination, earnings maximization appears to have been a special pursuit of the PRE, and the PC not pursued by the Central. Earnings maximization has been partially explained as resulting from the desire of management to protect the 1.3 to 1 stock exchange ratio agreed upon in 1962. Two explanations may be offered for the premerger concern over the ratio. If the NYC ratio were increased the percent of ownership of the Penn Central going to former PRR shareholders would be less and renegotiation caused by an altered earnings picture might further delay the merger. In order to avoid pressure to change this ratio, PRR management made adjustments to insure that Central's earnings and dividends per share were not more than 30 percent above the Pennsylvania's. Some associate the earnings inflation policy with the arrival of Stuart T. Saunders on October 1, 1963. 14a In any case, it was sufficiently formulated to warrant Bevan's description in 1966: The policy may be instituted of maximizing earnings to the greatest extent possible within the limits of good accounting practices. In the last several years, this has been done on the Pennsylvania in accordance with your expressed desires. It does mean, however, that we tend to create a wider and wider difference as between reported income and cash flow . Today the cash flow of the Pennsylvania Railroad is substantially less than its reported income. We changed the basis of consolidation and, there- fore, a substantial amount of earnings of subsidiaries are now included in our reported income but are not actually available to us from the stand- point of dividends. 15 Concern for the position relative to NYC was expressed in frequent compar- isons of Pennsylvania Railroad earnings with New York Central earnings and adjustments to reflect the exchange ratio. Concern about the relationship is also expressed in observations linking a subsidiary's dividend declaration to the PRR's quarterly earnings. Earnings inflation continued after the merger, even though the ratio was no longer relevant, apparently to maintain the credit position of the railroad. More conservative reporting of income might have made it more diffi- cult for the railroad to raise capital. (As with leasing to reduce the apparent debt structure, this assumes creditors take the reports at face value.) The need for increased earnings was given as one of the motives for the diversification program. 1 " 1 A number of devices were employed to inflate earnings statements. In 1965 the ownership share required for including a subsidiary in the consolidated income statement was reduced from 100 to 50 percent. (It should be noted that this action did not violate generally accepted accounting principles.) The included firms increased from 41 in 1964 to 100 in 1965 which brought in the 14a Interstate Commerce Commission, Docket No. 35291, Penn Central Investigation, Verified State- ment 36, p. 31. w Memo from Bevan to Saunders, November 21, 1966 ; see Appendix D, Exhibit 50, p. 616. 15,1 At the end of 1965 Bevan stressed to Saunders that sound nonrail acquisition would be neces- sary after the merger in order to maintain an upward earnings trend : "The only way that we have been able to offset our failure to realize adequate operating income has been through the companies that we have recently acquired . . . there are also one or two other companies that should be acquired after merger if we are going to keep the trend of our earnings growing upward on an adequate basis." 62 earnings of the real estate subsidiaries (Great Southwest Corporation and Macco Corporation). These earnings accounted for a large portion of consoli- dated income but largely consisted of paper profits and little cash flow. As another general approach, subsidiaries were required to inflate earnings and to pay large dividends to the Penn Central Transportation Co. to help swell its non-consolidated income statement. Forcing an earnings maxi- mization policy allowed the 1*01111 Central to report higher consolidated income from subsidiaries treated on a cost basis. After 1964 (the first full year of Saunders' tenure) there was a notable increase in dividends paid to the parent, with the 1968 and 1969 payments especially large although mostly not repre- senting equivalent cash flows. This earnings maximization and dividends policy was damaging to the suhsidiaries as well as misleading regarding the parent. 18 Another device was to report as much income as possible as ordinary rather than extraordinary, which involved some questionable accounting practices. The most obvious example was the 1968 swap of Penn Central's interest in Madison Square Garden for 25 percent of the outstanding common shares of Madison Square Garden Corporation. In addition, book or market values were alternatively selected on the basis of which would state the largest income. 17 The company also used a number of devices to reduce its reported expenses, both by altering real flows and by accounting manipulation. 18 As previously mentioned, a major element of control was the restriction of maintenance and capital expenditure budgets. These cutbacks to explicitly abet earnings goals started as early as August 1963 and were a paramount consideration thereafter. 19 Expenses were also understated by capitalizing equipment refurbishing as previously described. On some occasions the company avoided retiring non- depreciable property because retirement would involve recording service losses as operating expenses. Many expenses were questionably classed as "extraor- dinary"' expenses and thus placed below net income on the income statement. In an illiquid company, cash management would seemingly be the major area of management concern, but the generation of cash itself was secondary to attempts to maximize reported net income. Normal liquidity analysis from published financial statements is of little utility because of the distortions in those statements occasioned by the singleminded pursuit of a "respectable" bot- tom line figure. Accounting theory stresses conservatism and consistency, but the former was ignored and the latter was followed only where reported income would be maximized. The earnings inflation policy severely hampers analysis of the transporta- tion company's cash flows because of its great and growing divergence from reported net income. Since earnings maximization must be viewed in conjunction with a number of other considerations, it will be discussed again. It is clear that this practice posed some substantial issues affecting an array of matters ranging from operat- ing effectiveness to cost of capital. DIVIDEND POLICY The Pennsylvania Railroad enjoyed a proud history of uninterrupted dividends payments. The New York Central's record was spotty, with recent skips in 1954, 1958, and 1961. 16 See for instance memo from William C. Baker to David Bevan, September 12, 1969 ; Appendix 1), Exhibit 51, p. 618. 17 The difference between the book value of the property and the market value of the stock was $21 million, which the Penn Central reported as ordinary income. If the $21 million had been treated as non-recurring and hence as an extraordinary item, the Penn Central would have had a deficit in ordinary income of $22.9 million rather than a deficit of $2.8 million. In 1969 the Interstate Com- merce Commission required the Penn Central to treat the $21 million as an extraordinary item but the change was noted only in a footnote to the 1969 stockholders' report (Interstate Commerce Com- mission. Docket No. 35291, Penn Central Investigation, Verified Statement 9, p. 5). 18 For example, in July 1969 it sold Madison Square Garden stock to the Pennsylvania Co. at a book value of $11 a share although the market value was below $9. In March 1970 Penn Central sold the Pennsylvania Co. its stock in Clearfield Bituminous Coal Co. at its equity value of $16.9 million rather than book value of $82,200. The stock dividend of the Washington Terminal Co. to the Penn Central had a hook value of $3 million but the Penn Central recorded the dividend at its appraised (but questionable) value of $13.5 million (Id. pp. 6-9). 19 Another example is a mid-1967 memo stating that the PRR had "pushed credits and revenues to the limit . . . We have included everything that we can think of in the parent company and con- solidated, and we know of no other steps to take from an accounting standpoint." The only way to Improve quarterly earnings was "for very drastic cuts in maintenance, if this is feasible." See, memo from Bevan to Saunders, June 1, 1967. Appendix D ; Exhibit 52, p. 623. 63 In the period 1952 to 1959 PRR dividends averaged 51 percent of railroad net income and 38 percent of its consolidated net income (Tables B-8, and 9) and by 1960-1967 these figures were 103 percent and 35 percent. 20 Although on a consolidated basis the Pennsylvania's payout ratio did not increase (it actually declined by 3 percentage points), these figures are deceptive. The con- solidated income reported from 1960 to 1967 includes income of subsidiaries at least 50 percent owned by the PRR and, as indicated in the earnings maximiza- tion discussion, much of this income was merely "paper profits." In terms of cash available, therefore, the payout ratio probably increased significantly The Central also registered an increase in dividend payout between the 1952- 59 period and the 1960-67 period, jumping from 33 percent of railroad net in- come and 27 percent of consolidated net income to 73 percent and 47 percent. It is important to note here that while this appears somewhat more liberal than the PRR's dividend policy, comparison is nearly impossible because of the PRR's earnings maximization policy. The payout ratio of dividends to net income for Class I line-haul railroads as a whole was 51 percent between 1952 and 1959 and 65 percent between 1960 and 1966. These figures indicate that the Pennsylvania and the Central paid out somewhat less than the industry average in the first period and more in the later period. However, the estimated average payout ratio for all Class I rail- roads is probably too high. 21 First, net income is ordinarily measured after extraordinary expenses while net income for the PRR and the NYC is before extraordinary expenses. Second, large losses by a few railroads would reduce total net income. (For example, the payout ratio of almost six times net income in 1970 is largely explained by the Penn Central bankruptcy.) With the payout rate for all railroads overestimated, the dividends paid by the PRR and the NYC in the 1960-67 period seem extraordinarily high. The high premerger dividends may have resulted from a provision of the 1962 merger agreement which limited these payments to 25 cents a share for the PRR and 32.5 cents (1.3 times 25 cents) for the NYC or if higher, an amount derived by a complicated formula. In 1962, PRR paid 25 cents and NYC 32.5 cents a share and both increased every year thereafter (Table B-10). On the average the Central paid 1.10 times the dividend payments of the Penn- sylvania on a per-share basis (Table B-10). Although no evidence was discov- ered in the railroads' records, it is possible that each company was defensively and reciprocally raising its dividends to maintain the 1.3 ratio." Another reason for increasing dividends may have been to raise the market value of the stock. A high stock price might make the railroads look like good investments and impress their creditors. The high PRR dividend of $2.40 in 1967 set the stage for the large divi- dends issued after the merger. In 1968 the Penn Central paid $2.40 or 60 cents per quarter. The 60 cents quarterly dividend was continued for the first three quarters of 1969. Total dividends' paid in 1968 were $55.4 million while the Penn Central railroad lost $2.8 million ($41.9 million after the prior period's adjustments) and consolidated income of $87.8 million was reported. Total 1969 dividends were $43.4 million despite a deficit of $82.8 million ($91.6 million after extraordinary items) and a consolidated income of $4.4 million ($121.6 million loss after extraordinary items). The Penn Central's management evidenced a rather cavalier attitude toward the declaration of dividends considering the company's financial straits. Declarations of quarterly dividends were based on overly optimistic earnings forecasts and the 1969 third quarter dividend was decided upon before the end of the second quarter. In the fourth quarter of 1969 losses were so great that the Penn Central was finally forced to stop paying dividends. Since dividends were 1 Adjusted to reflect the 1965 change In reporting. Poli Cor on eea _ ; — , x . „ io ^.^e 1^1. ^vsvjj aMiviig umer unugs compares uie ouuiow or capital Hinds (including dividend payouts) of railroads with air lines and motor carriers. The total funds generated less Payouts (except dividends i by Class I trucking companies during the sample period (l.<.)h-l.i,<>.7 million between 1963 and 1969 and $36.9 million in L968 and 1969 alone. A higher interest cost could be imputed. Penn Central management has argued that the dividends kept up the price of the stock and gave the railroad a better credit rating. 22 As long as the railroad paid dividends perhaps creditors would believe that the troubles of the railroad were only temporary. The stock price of the Penn Central reached a high of $86 in 1968 and was over $70 in 1969; however, the price started falling before the announcement that no dividend would be paid in the fourth quarter. The announcement caused considerable upset in financial circles but the Penn Central still borrowed $50 million in additional bank loans in early 1970. Penn Central's management most certainly overestimated the importance of dividends to its standing in the financial community. An}- favorable consider- ation it might have received as a result of its steady dividend payments could hardly have offset the cash drain of more than $130 million in dividends and TABLE B-l CAPITAL EXPENDITURES PENNSYLVANIA AND NEW YORK CENTRAL; 1946-67 1 [In millions of dollars] Year 19672. 1966.. 1965.. 1964.. 1963.. 1962.. 1961.. I960.. 1959.. 1958.. 1957.. New York New York Pennsylvania Central Year Pennsylvania Central 114.7 69.1 1956 92.4 79.3 197.4 95.9 1955 69.0 39.6 244.2 107.9 81.3 39.5 1954 41.0 39.1 100.8 1953 80.5 88.0 82.4 1952 123.3 148.4 63.0 40.2 1951 215.6 125.7 60.9 32.0 1950 87.8 70.6 155.9 39.6 1949 105.8 100.5 125.2 28.7 1948 106.3 90.2 53.8 18.2 1947 52.7 48.4 97.7 114.2 1946 33.7 41.2 ' Includes leased lines. 1 Excludes expenditures on leased equipment. Source: ICC Form A, Railroad Annual Reports. TABLE B-2 SUMMARY OF CAPITAL EXPENDITURES PENNSYLVANIA, NEW YORK CENTRAL; 1948-67 1 [Millions of dollars! Period Road Equipment Total New New New Pennsyl- York Pennsyl- York Pennsyl- York vania Central Total vania 2 Central Total , vania Central i Includes leased lines. 2 Excludes expenditures on leased equipment; 1967. Source: ICC Form A, Railroad Annual Reports. Total 1948 to 1957 294.1 234.0 175.8 528.1 436.1 691.9 948.4 661.3 376.7 1,353.2 1,325.1 986.0 1, 208. 7 895.3 552.5 1,881.3 1958 to 1967 .. 260.3 1,761.2 Total 554.4 409.8 964.2 1,640.3 1,038.0 2, 678. 3 2, 194. 7 1,447.8 3, 642. 5 -- For example, David Bevan responded in part to a question on dividend policy raised by ICC investigators as follows : ". . . all members of the Board recognized the intangible value of the long unbroken dividend record of the P.R.R. and that over a period of years it did add something to the way investment analysts regarded it from a quality standpoint. Therefore, there was a desire to main tain this unbroken record if feasible and in a number of years so-called token dividends of 25 cents per share were paid." Interstate Commerce Commission, Docket No. 35291, Verified Statement 40, Ex. IN'T-G ; sec letter from Edward C. German to George Deller, February 15, 1972 ; answer to question 1 ; Appendix D, Exhibit 53, p. 623. 65 related interest payments after the merger. In fact, well informed creditors might have given more favorable consideration to a railroad following conserva- tive financial policy in times of operating difficulties. Penn Central's concern about maintaining the stock price is a curious anomaly since the stock offering was apparently never considered. TABLE B-3.— TOTAL CAPITAL EXPENDITURES AS A PERCENTAGE OF OPERATING REVENUES, SELECTED RAILROADS; 1960-69 Year Penn Central' Pennsylvania New York Central Baltimore and Ohio Chesapeake and Ohio Southern 1969 . 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 9.17 .... 5.96 16.92 7.85 7.65 6.26 25.46 26.15 9.66 .. 25.94 9.42 8.22 10.07 19.68 12.70 17.24 8.79 4.40 21.55 19.31 15.28 20.17 10.79 7.74 8.97 12.12 9.31 9.13 10.48 3.09 21.50 9.05 2.99 2.56 3.85 3.93 17.61 12.93 4.26 4.59 3.89 5.68 15.35 17.89 4.57 4.94 4.69 2.11 3.81 5.58 6.13 7.23 4.41 2.85 3.57 13.82 i Pro forma 1960-67. Source: ICC form A, railroad annual reports. TABLE B-4 CAPITAL STRUCTURE PENNSYLVANIA AND NEW YORK CENTRAL; 1948-1967 Year Pennsylvania Current liabilities plus long term debt (millions) Long term debt (millions) Equity (millions) Current liabilities plus long term debt/ Long term equity debt/equity (ratio) (ratio) New York Central Current liabilities plus long term debt (millions) Long term debt (millions) Equity (millions) Current liabilities plus long term debt/ equity (ratio) Long term debt/equity (ratio) 1967 $930.9 1966 858.6 1965 811.9 1964 736.3 1963 715.9 1962 752.1 1961 784.7 1960 777.8 1959 805.6 1958 822.3 1957 839.9 1956 874.8 1955.. 885.3 1954 889.4 1953 950.4 1952 977.8 1951 840.9 1950 863.5 1949 830.6 1948 869.8 $721.3 688.4 646.3 562.7 568.7 609.9 626.1 630.7 674.9 692.5 706.5 724.1 740.2 768.4 810. 830. 786. 707. 694. 676.3 $1,255.6 1, 422. 2 1,407.6 1,402.6 1, 386. 1 1,385.4 1, 388. 1, 392. 9 1,387.4 1, 385. 6 1,387.1 1,392.7 1,403.0 1,392.5 1, 362. 8 1, 343. 9 1,321.9 1, 305. 1,281.6 1,277.8 0.74 .60 .58 .52 .52 .54 .57 .56 .58 .59 .61 .63 .63 .64 .70 .73 .71 .66 .65 .68 0.57 .48 .46 .40 .41 .44 .45 .45 .49 .50 .51 .52 .53 .55 .59 .62 .59 .54 .54 .53 $803. 6 792.6 775.7 765.4 773.6 794.4 829.0 821.9 847.4 877.6 942.2 938.8 970. 947. 968. 953. 864. 826. 776. 757.7 $665. 9 658.3 654.8 633.3 647.4 674.0 703.6 714.6 736.5 767.5 827.7 813.7 827.4 822.7 834.8 819.8 721.4 675.0 668.1 632.1 $835. 2 980.4 956.9 938.2 923.6 926.0 933.6 956.5 956.1 962.9 960.3 972.6 949.1 909.9 933.1 904.3 884.7 872.5 859.0 848.9 0.96 .81 .81 .82 .84 .86 .89 .86 .89 .91 .98 .86 1.02 1.04 1.04 1.05 .98 .95 .90 .89 0.80 .67 .68 .68 .70 .73 .75 .75 .77 .80 .86 .84 87 .90 .89 91 .82 .77 .78 .74 Source: Moody's Transportation Manual. TABLE B-5.— LONG TERM DEBT/EQUITY RATIO: PENNSYLVANIA, NEW YORK CENTRAL, AND CLASS I RAILROADS, 1948-67 Year Pennsylvania New York Central Class I railroads Year Pennsylvania New York Central Class I railroads 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 0.57 .48 .46 .40 .41 .44 .45 .45 0.80 .67 .68 .68 .70 .73 .75 .75 0.59 .57 .56 .55 .54 .55 .56 .57 1959. 1958. 1957. 1956. 1955. 1954. 1953. 1952. 0.49 .50 .51 .52 .53 .55 .59 .62 0.77 .80 .86 .84 .87 .90 .89 .91 0.58 .59 .58 .59 .59 .69 .50 .63 Source: Moody's Transportation Manual. 66 TABLE B-6.-RATI0 OF INCOME AVAILABLE FOR FIXED CHARGES TO FIXED CHARGES: PENNSYLVANIA AND NEW YORK CENTRAL, 1948-67 [Dollar amounts in millions) Year Pennsylvania New York Central Income avail- Income avail- able for fixed able for fixed charges Fixed charges Ratio charges Fixed charges Ratio $37.2 $36.0 1.04 $62.9 $48.8 1.29 85.6 35.5 2.41 89.8 44.7 2.01 77.8 36.2 2.15 76.1 42.2 1.80 61.7 34.6 1.78 69.5 40.4 1.72 42.0 35.0 1.20 50.5 41.4 1.22 33.0 36.9 .90 39.0 42.2 .92 25.7 38.3 .67 46.4 42.9 1.08 41.7 40.7 1.03 36.1 43.9 .82 50.4 42.0 1.20 52.3 45.0 1.16 49.3 45.2 1.09 49.0 45.4 1.08 54.2 45.8 1.18 65.2 46.1 1.41 84.1 45.0 1.87 88.8 47.2 1.88 100.7 48.4 2.08 88.4 47.2 1.87 56.5 47.3 1.19 68.0 49.4 1.38 83.2 49.2 1.69 107.3 63.0 1.70 73.0 48.2 1.51 106.6 62.5 1.71 61.0 46.2 1.32 94.3 60.6 1.56 61.9 43.6 1.42 108.0 62.8 1.72 52.4 42.7 1.23 90.9 71.9 1.26 57.3 42.6 1.35 113.0 72.2 1.57 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 1959. 1958. 1957. 1956. 1955. 1954. 1953. 1952. 1951. 1950. 1949. 1948. Source: Moody's Transportation Manual. TABLE B-7 EQUIPMENT FINANCING PENN CENTRAL, PENNSYLVANIA, AND NEW YORK CENTRAL; 1958-69 (Dollar amounts in millions] Penn Central Pennsylvania New York Central Ratio of Ratio of Ratio of leased leased leased equip- equip- equip- ment ment ment Equip- expense Equip- expense Equip- expense ment Net to net ment Net to net ment Net to net trust leased rent trust leased rent trust leased rent certifi- equip- Net deficit certifi- equip- Net deficit certifi- equip- Net deficit cates ment rent (per- cates ment rent (per- cates ment rent (per- Year issued expense deficit cent) issued expense deficit cent) issued expense deficit cent) 1969 21.7 32.9 27.1 24.6 183.8 169.3 144.0 17.9 16.0 17.1 1968 1967 18.9 88.1 21.3 21.7 5.8 56.0 10.3 1966 33.6 24.0 131.3 18.3 12.0 19.7 81.1 22.4 21.6 4.3 43.2 9.9 1965. 25.6 30.6 126.9 24.1 10.4 25.1 84.9 29.6 15.2 5.5 42.0 13.1 1964 15.7 31.0 115.0 27.0 26.3 77.7 33.9 15.7 4.7 37.4 12.6 1963 7.9 28.4 111.8 25.4 23.9 74.2 32.2 7.9 4.5 37.5 11.9 1962.. 29.7 108.1 27.5 25.1 73.9 34.0 4.6 34.2 13.5 1961 8.0 29.6 95.5 31.0 25.7 64.8 39.6 8.0 3.9 30.7 12.8 1960 4.6 27.8 96.0 28.9 25.2 70.1 35.9 4.6 2.6 25.8 9.9 1959 15.3 82.3 18.6 12.6 61.6 20.5 2.7 20.7 13.2 1958 10.6 76.0 14.0 7.8 54.5 14.3 2.8 21.6 13.1 1 Pro forma combination of Pennsylvania and New York Central ; 1958-67. Source: ICC Form A, Railroad Annual Reports. 67 TABLE B-8 — RAILROAD NET INCOME AND DIVIDEND PAYMENTS PENN CENTRAL, PENNSYLVANIA, NEW YORK CENTRAL, AND CLASS I RAILROADS; 1952-70 IDollar amounts in millions) Penn Central l Pei insylvania New York Cenl ral Clas 1 1 railroads Payout Payout Payout Payout ratio of ratio of ratio of ratio of divi- divi- divi- divi- dends dends dends dends to net to net to net to net Rail- Divi- in- Rail- Divi- in- Rail- Divi- in- Rail- Divi- in- road dends come road dends come road dends come road dends come net in- de- (per- net in- de- (per- net in- de- (per- net in- de- (per- come 2 clared cent) come 3 clared cent) come 3 clared cent) come 3 clared < cent) * 1970 .... ($325.7) . $76 $439 578 1969 (82. 8) .... (2.S) 15.3 $43.4 55.4 55.1 464 565 322 487 516 537 105 1968 91 1967 360.1 $14.1 $33.5 237.6 $1.2 $21.6 1. 800. 167 1966 95.2 53.7 56.4 45.1 32.0 71.0 50.1 21.7 43.3 904 499 55 1965 75.4 M5.4 60.2 33.9 '27.7 81.7 Ml. 5 17.7 42.7 815 471 58 1964 56.1 >29. 51.7 29.1 '17. 2 59.1 3 27.0 11.8 43.7 698 457 65 1963 16.2 MO. 1 62.3 9.2 '6.8 73.9 3 7.0 3.3 47.1 652 379 58 1962 (7.0) 5.5 . (3.2) 3.4 . (3.8) 2.1 571 368 64 1961 .... (9.0) .... (6.8) 15.7 3.3 6.6 4.9 3.5 (7.8) 7.3 3.3 3.3 3.3 94.3 (12.5) 1.0 8.4 3.3 1.6 382 445 578 358 385 403 94 1960 330.0 19.1 87 1959 31.2 45.2 78 1958 7.6 3.3 43.4 3.5 3.3 94.3 4.1 602 372 62 1957 27.5 34.2 124.4 19.8 16.5 86.4 8.4 17.7 210.7 737 427 50 1956 80.6 38.0 47.1 41.5 20.4 48.1 39.1 17.6 45.0 879 432 49 1955 93.5 32.8 35.1 41.2 19.8 47.6 52.3 13.0 24.9 928 447 48 1954 27.8 9.9 35.6 18.6 9.9 53.2 9.2 683 374 55 1953 .... 71.0 26.2 36.9 38.9 19.8 53.5 34.0 6.4 18.8 924 382 41 1952 61.7 16.4 26.6 39.3 13.2 35.7 24.7 3.2 13.0 845 338 40 1 Pro forma combination of Pennsylvania and New York Central; 1952-67. 3 Excludes extraordinary items. • Extra dividends. « Figures rounded off to nearest million. Includes extraordinary items. i Figures rounded off to nearest whole percent. Source: ICC Transport Statistics and Moody's Transportation Manual. TABLE B-9 CONSOLIDATED NET INCOME AND DIVIDEND PAYMENTS PENNSYLVANIA AND NEW YORK CENTRAL, 1952-67 Pennsylvania New York Central Payout ratio Payout ratio of dividends of dividends of net of net Dividends income Dividend income Year Net income' declared (percent) Net income declared (percent) 1967 60.3 33.5 55.56 11.0 21.6 196.36 1966. 90.3 32.0 35.44 65.5 21.7 33.13 1965 70.1 3 27.7 39.51 52.4 217.7 33.77 1964.... _. 60.1 2 17.2 28.62 35.5 2 11.8 33.24 1963 31.8 26.8 21.38 13.8 3 3.3 23.91 1962 20.5 3.4 16.59 .2 2.1 1,050.00 1961 17.2 3.3 19.19 (10.3) 0. 1960 8.6 3.3 38.37 4.6 3.3 71.74 1959.... 16.7 3.3 19.76 13.2 1.6 12.12 1958 11.8 3.3 27.97 7.0 1957 29.4 16.5 56.12 12.2 17.7 145.08 1956 52.5 20.4 38.86 42.8 17.6 41.12 1955.... 50.2 19.8 39.44 57.1 13.0 22.77 1954 28.3 9.9 34.98 13.7 1953 47.3 19.8 41.86 44.8 6.4 14.29 1952... 46.4 13.2 28.45 31.9 3.2 10.03 1 Reported consolidated net income for the Pennsylvania RR. (1960-67) includes income of subsidiaries at least 50-percent owned by the PRR. 3 Extra dividends. Source: Moody's Transportation Manual. 68 TABLE B-10 DIVIDEND PAYMENTS PER SHARE' PENNSYLVANIA, NEW YORK CENTRAL, 1957 67 (1958-1967 average Pennsylvania $0.97; NYC $1.07) Year Pennsylvania New York Central Year Pennsylvania New York Central 1967 1966. 1965 $2.40 2.00 2.30 1.25 .50 $3.12 2.60 2.60 .75 .50 1962 1961 1960 $0.25 .25 .25 $0.33 .50 1964.... 1959 .25 .25 1963 1958 .25 i Includes extra dividends. Source: ICC form A, railroad annual reports. 69 o o CD CD o CD O O LO O LO CD o Ol r-. 10 O CD O O O . O <- ro i — 70 71 rmttSKcx i 91 o o O M O o O Ifl O LT) O i-l oo C\J CM O a Diversification Diversification is an aspect of fiscal policy requiring special attention be- cause it presumably set a basic management tone that permeated the Pennsyl- vania Railroad and the Penn Central (but not the New York Central) and virtually dominates public discussions of the bankruptcy. As with all elements of the case, this discussion endeavors as a minimum to put this policy manifesta- tion in clear perspective. THE DIVERSIFICATION FACTS Diversification facts are largely undisputed and need be reviewed only briefly. The PRR traditionally enjoyed a broad economic base of outside in- vestments, largely in the securities of other railroads and in land which con- stituted a major and stable source of earnings. The Central also enjoyed sub- stantia] external income, largely from development of its own property. It had only minor outside investments, and is unimportant for diversification considerations except for joint participation in the affairs of the Penn Central. This discussion focuses on the PRR's diversified investments after 1963 and their effects on the merged company, but with some intercompany comparisons. Although all dimensions of the program are of interest, the cash involve- ment is particularly significant. Acquisitions totalled $320,313,000, including $203,203,000 in cash outlays. An additional $20.5 million was paid to the ac- quired companies in cash dividends and interest on securities granted in the purchase. The PRR made $172.1 million of the cash payments, the Central $21.4 million, and the Penn Central $16.1 million. Investment transfers con- tributed $69.5 million of the PRR commitment (from the sale of the N&W stock and of its interest in the Long Island railroad) and $33.2 million of the Penn Central's (from liquidation of N&W holdings). The balance was from working capital, including all of the Central's $24.4 million, $21.4 million com- ing in 1967 when its net income was only $1.2 million (compared with PRR's $15.6 million outflow and $14.1 million net income) . The net income sources of working capital have been detailed. (See also Table D-l ) . In summary, PRR suffered a loss from railroad operations totalling $20.4 million during 1964-67, but earned $148.5 million from other income, of which $64.1 million or about 44 percent came from the new investments. Central suffered operating losses of $7.6 million and earned outside income of $107.7 million, of which $3.3 million, or 3 percent, came from diversification. ACQUISITIONS POST 1963 ' Total investment (plus dividends) $320,313,000 Cash (excluding dividends) _■_ __ 203,203,000 Dividend (cash) _ 20,479,659 Of which cash from— PRR (plus dividends) $10,924,302 172,069,000 NYC... 24,437,000 PRR 9,555,348 16,134,000 Transfer investment (millions): N. & W. and LI... (PRR) 69. 5 N. & W._ (PC) 33. 2 ' Partial summary of findings. Detailed text appear at pp. 9-20 infra- ;'% $24,4 (73) Note: Balance from "working capital" including all of NYC's $24,437,000 (versus $15,558,759 for PRR) and PRR net income in 1967 was $14,092,000 versus Central's $1,243,000. 74 SOURCES OF NET INCOME |ln thousands] Year PRR NYC Rail Other old Other new Other total Total Rail Other old New Total 1963 Total (12,252) (1,190) 3,349 11,799 (34,316) 21,710 22, 766 19,012 13,534 23, 094 7,557 11,536 19, 722 25,314 . 9,158 29, 133 33, 897 45, 055 14,092 (13,834) (437) 14,112 21,672 (32,936) 20,873 ... 7,039 1%4 27, 484 27,047 1965 1966 1967 27,407 27, 552 31,793 887 2,377 41,519 50,111 1,234 (32,610) 106,116 64, 129 170,245 137, 635 (47, 207) 107, 702 3,264 84, 406 Diversification earnings totalled $65.6 million for PRR, $3.3 million for NYC, and $94.3 million for Penn Central. Overall, the average annual cash return was $7.5 million against an invest- ment of $138.4 million, or 5.5 per cent. Balancing cash investment, payments. and receipts, the deficit was $145.4 million. Crediting this flow Avith the pro- ceeds of the N&W and Long Island liquidations as a substitute investment re- duces this balance by $103.6 million to a net of $41.8 million. In these terms, the PRR suffered cash drains of $47.4 million and the Central $19.1 million, totalling $66.5 million. Penn Central showed a cash gain of $24.7 million, pro- ducing a final net outflow of $41.8 million. RATIONALE Virtually all PRR's substantial real estate holdings in major cities of its service area prior to 1964 were associated with the rail operation of the com- pany and had been developed to enhance the revenues of the physical plant. 22 They contributed substantially through rental and capital gain income to the consolidated earnings of the railroad. The specific "diversification program" dates from late 1962 and early 1963. 23 The Pennsylvania then owned approxi- mately 2.4 million shares of Norfolk and Western common stock, acquired over many years, with a total market value of approximately $300 million. These shares, a pawn in the approval of the N&W merger and hence of the PRR-N YC union, would have to be liquidated, shutting off a substantial source of dividend income. It was necessary to establish an income producing investment program from the proceeds of these shares. Since these large holdings were lodged in the Pennsylvania Company, the liquidation had to be carefully handled to protect the subsidiary's credit standing because of its potentially vital role in upcoming refundings of transportation company debt in 1965 and 1968. The investment of the liquidation proceeds in the railroad was explicitly considered, but was rejected because of its inability to produce savings from capital improvements. According to Bevan, * * * If the savings can be brought down to net in the future, then there is no need of acquiring these funds from the Pennsylvania Company and if not, there is no justification from a stockholder's point of view for doing it. 24 On May 14, 1968, Chairman Saunders announced a new $500 million di- versification program to run over six years, still aimed at finding a good substi- tute investment for the N&W holdings. The objective investment criteria were a minimum acceptable profit return, adequate growth, and the beneficial use of tax shelter. Investment Pattern The PRR's non-rail investments embraced three basic industries: (1) pe- troleum pipeline distribution; (2) real estate development: and (3) air trans- portation. Buckeye Pipeline was acquired in July 1964, primarily for efficient 22 Because of the fact that ownership of such holdings was held in many subsidiaries, most of which were rail or rail-related operations, it would be nearly impossible at this date to segregate amounts expended on rail and non-rail activities in order to determine what the magnitude of total funds expended on the combined real estate holdings was, on either an annual or cumulattve basis. 23 The calculated acquisition of companies engaged in operations in product markets unrelated to that of the acquiring company, ostensibly for reasons of attaining economic stability. Increasing earnings, etc. 24 Memorandum by David C. Bevan, April 30, 1963, set out in full in text, infra, at p. 389. 75 railroad right-of-way utilization in a throwback to tradition. 25 However, at acquisition time, Buckeye was described by Saunders in a press release as "an important step in a long-range program of diversification." The emergence of this broader view of the acquisitions still tempered by the past is reflected in a May 1963, memorandum with the dictum that, "Logically, diversification should be into an industry which supplements or complements the basic operations and one which in concept and philosophy is readily understood by the management of the parent company." 26 Land use and transportation were the apparent com- mon denominators. 27 Another major criterion in investment selection was rate of return. The necessity of obtaining a high rate of return from any acquisition in order to replace the substantial 85 percent tax free cash dividend income from the N&W shares was stated as a dominant goal of fiscal management. However, this con- sideration played a relatively minor role in the Buckeye and (especially) in the real estate acquisitions. Initial entry into real estate development was accomplished by the acquisi- tion of controlling interest in Great Southwest Corporation (GSC) in June 1964. Called "an important step in a long-range program of diversification," by Saunders, 28 GSC was viewed as the nucleus of further diversification in real estate operations. It was subsequently employed in the acquisitions of Macco Realty Corp. and of I. C. Deal Corp. Although a cogent rationale was not enunciated by the railroad, some reasons for acquiring GSC and entering real estate development were contained in an informal memorandum from the investment adviser to the railroad for its acquisitions, Glore Forgan, William R. Staats and Company. Among the rea- sons cited were : "* * * the experience of the railroad in industrial property management" combined with "* * * the stability and growth of GSC opera- tions which could help overcome the cyclical character of the railroad business: and the opportunity to participate in the growth of an area which is expanding at a much faster rate than the operating territory of PRR." 29 The PRR press release on the acquisition also refers to the railroad's prior real estate "experi- ence" but these reasons are not particularly compelling. The railroad owned and managed commercial property yielding rental income and had sold or leased parcels to shippers adjacent to the rail line. This experience is only distantly related to the industrial district projects of GSC which was the basis of the real estate activities of Arvida, Macco Realty, and later GSC. GSC's "stability and growth" is also shallow in view of its short history marked by frequent losses. Even more basically, the real estate industry is highly volatile, dominated by fluctuating interest rates and the fortunes of local economies. Furthermore, the PRR's experience should have warned of the ex- traordinary financing demands normally made by such operations, with an endless need for external financing imposed by funds tied up in unsold proper- ties for future development and a high rate of receivables, principally in the form of second trust notes. These absorb all funds generated internally and permit little in dividends. The principal reward is in capital gains realized from stock appreciation. The investment in Executive Jet Aviation, Inc. (EJA), ostensibly an air taxi operator, was the vehicle through which the PRR hoped to enter a third area of business operations, air cargo transportation. 3U The railroad wanted to 25 No use of the railroads rights-of-way has been made for this purpose since acquisition of Buckeye. 28 See Memorandum dated May 10. 1963 from Pennsylvania Railroad Finance Department. Ap- pendix D, ExMhit 4 n. 494. for full text of this memorandum. Of course, the argument normally advanced In nearly all diversification programs, that of seeking to introduce earnings stability result- ing from a wider earnings base (by acquiring companies whose operations are either subject to liit'e or no cyclical pressures or whose business cycle is different from that of the parent company), was also present. 27 There was a possibility of increased earnings of Buckeye through the pipeline movement of dlesel fuel to railroad fueling points contiguous to the pipeline system (as well as reducing the railroad's own expenses In this regard). However, little of these possibilities appear to have been developed after acquisition. 2fi PRR press release dated July 24. 1904 : see Appendix D, Exhibit 11, p. 516. 29 Memorandum dated February 18, 1964, from WDS (Walter D. Scott) to CJH (Charles J. Hodge> : see Anpendix D Exhibit 13. p. 518. 30 EJA was also brought to the attention of the railroad by C. J. Hodge who later stated "I screened and proposed EJA. I thought any railroad management not aware of what's coming in air freight was not doing its job." ("End of a Bizarre Venture." Bussitiesa Week, August 16, 1969. PP. 122, 123). Moreover, both the Glore Forgan firm itself and several individual partners, including Hodge and S. A. Hartwell, who were both members of the EJA Board of Directors, possessed substan- tial equity holdings in EJA from the inception of the company. 74-924 O - 73 - 7 76 become an integrated transportation company ("a transportation department store"). 31 basically to counter competitive impacts in all areas and including certain bulk commodities that air freight threatened. 32 The, EJA investment was made despite Federal aviation laws effectively prohibiting control of transportation operations by a surface transportation company. The railroad attempted to avoid these "ownership'" prohibitions, at least in form, by investing principally in debt securities. Legitimatizing this investment required a CAB determination that the ownership of non-voting securities did not constitute "ownership" or "control" of an air carrier or re- quired a conclusion that ownership of EJA by the railroad was in the "public interest and to the public advantage" and not in restraint of competition. When EJA attempted to expand from its original air taxi activities, what might con- ceivably have permitted railroad ownership, to supplemental carrier status with nationwide passenger and cargo charter operations, the Civil Aeronautics Board ordered the railroad to dispose of its entire EJA investment. 33 This investment (totalling $21,365 million) was sold by the railroad in January, 1972, for $900,000 — a net loss of approximately $20.5 million. Be- sides the questionable legality of the investment, EJA was just commencing operations and needed large amounts of external financing in order to acquire the jet aircraft needed, most of which was provided by the railroad. There was little hope of an immediate or even near-term return on investment in either reportable earnings or, more certainly, in cash dividends. Like the real estate companies acquired, EJA was an extremely poor investment in light of the railroad needs. 34 The Central's sole acquisition of Strick Corporation was not as much of an abrupt departure from rail activities into a totally unrelated product market. Strick, a manufacturer of lightweight aluminum trailers and vans and contain- erized equipment for the railroad industry, was a company whose operations had been known to the NYC since the advent of the latter's Flexi-Van service in 1956. The combination trailer-rail shipping container used by the NYC was manufactured by Strick and, for that matter, developed for this purpose. More- over, the NYC was also a trailer customer of Strick for other parts of its rail- truck operations. Acquisition of Strick was therefore a partial integration of these operations, as well as an attempt to gain a greater return on investment. However, because of its own expansionary plans, Strick too became an unex- pected drain (in terms of advances) on the cash resources of the railroad. Kath- 31 See list of "Reasons Why Transportation Diversification Should Benefit the Public," prepared by PCTC legal department, appearing as attachment to memorandum dated 3/10/69 by Basil Cole, Vice Pres., Administration. PCTC (and executive assistant to S. T. Saunders) to all PCTC depart- ment heads, with accompanying comments by certain railroad officials ; Appendix D, Exhi'iit 27, p. 535. See also letter dated 1/23/67 from S. T. Saunders to Hon. Alan S. Boyd, Secretary U.S. Department of Transportation. Appendix D, Exhibit 29. p. 539. 32 Remarks by S. T. Saunders to the New York Traffic Club on February 20, 1969 restates these reasons : "Unless railroads are permitted to diversify into other forms of transportation, within a relatively short period of time air cargo will have the same effect on railroad freight traffic as passenger air- lines h ve h id on long-haul and intermediate range railroad passenger service since World War II. "The impact of airborne freight could be the last straw for railroad freight services except certain bulk commodities, and railroads cannot survive on this sort of traffic alone. This imminent new threat underscores the need for the revision of laws and regulatory practices which prohibit railroads from ownership of other modes of transportation." Memo from Bill C to WAL, attached to March 10, 1969 memorandum of Basil Cole. Appendix D. Exhibit 2S. p. K3J>. 33 Executive Jet Aviation, Inc. Docket No. 17657 et al. Order No. 69-10-67 entered October 14, 1969. In addition, for Its role in a series of illegal actions, including the pursuit of extensive for- eign supplemental carrier acquisition activities resulting in actual control over several carriers (before obtaining requisite CAB approval), and the leasing of certain owned jet aircraft to these companies without disclosing such ownership interests to the CAB nrior to receiving authority to lease the aircraft, the CAB levied a fine of $65,000 on the railroad (and $5,000 on EJA). 34 The bizarre story of EJA and PRR (and later Penn Central) relationship has been chronicled in detail in numerous instances including Hearings before the Senate Commerce Committee, Failing Rail- road, Part 2, serial No. 91-90. 91st Congress, 2d Session ; a lengthy staff report of the U.S. House of Representatives Committee on Banking and Currency (The Penn Central Failure and the Role of Financial Institutions. Part II. "Case Study of Penn Central Subsidiary ; Executive Jet Aviation." Staff Report of the Committee on Banking and Currency, dated December 21, 1970, U.S. House of Representatives. 91st Cong.. 2d Sess.) and in numerous magazine and newspaper articles (e.g. see "Is the Pfrv thp T >mit for the Pennsv." Busivesn Week. Deeem'-er 10. 1966: "Pnfl of h B'"»*re Ven- ture," Businesn Week. August 16. 1969, beginning at p. 122: "IAB : Aviations Big Whodunit." American Aviation, December 23, 1968 pp. 11-13: "CAB Studies Charge That Penn Central Sought Illegal Foothold In Air Transportation." Wall Street Journal, August 15, 1969 : "Penn Central Told to Shed Control of Flying Service. ' Wall 8 feet Journal, October 16. 1969K It is not the purpose of th's re"o-t to go into these details cgnin other thnn to note in pnssintr th»t the. shoriVlv manner in- which EJA was run bv its top management gives testimony to the lack of PRR managerial guid- ance given to the operations of companies Invested in (the special circumstances perhaps in existence here, that of trying to avoid the appearance of "control," not withstanding) . 77 er than permit continued advances, at the expense of rail projects, many of which were being turned down, the Central cut off to further loans the first year after acquisition. 35 When Strick profits fell off the following year, and the merged railroad made financing arrangements to acquire trailers needed in its trucking operations at more economically advantageous terms than it could obtain by leasing them from Strick, the Strick company was sold. 36 The merged company concentrated its initial diversification efforts on the acquisition of Kayser-Roth, the nation's leading apparel manufacturer. As an entry to the consumer goods field, this seemed to represent a vast improvement over the earlier acquisitions. The fundamental investment objectives restated by Saunders to the PCTC Board in connection with the consideration of the Kay- ser-Roth proposal reflected awareness of past difficulties; "* * * a company must be sufficiently large and established as a going concern * * *" (the three real estate development companies and EJA were all young companies with attendant financing demands and unstable earnings performances) ; "trans- portation companies * * * are not prime candidates because of potential con- flict with certain anti-trust theories and regulatory policies * * * ; "moreover, there are obvious advantages in using securities, rather than cash * * *"). 37 Had the other expressed objectives (profitability, growth potential, bene- ficial use of tax shelter) been employed with those set forth above, a more beneficial result from the diversification program of the PRR may well have emerged. Kayser-Roth appeared to represent a more reasonable approach to diversification in the sense of cash generation, than did prior diversification efforts. However, after approval by both companies' board of directors, but before submission to shareholders of the firms, Kayser-Roth officials terminated discussions in October. 1968. The PCTC's investment (23 percent interest) in Madison Square Garden Corporation neither added to any established investment pattern (i.e. real es- tate operations) nor reflected any new departure. It represented primarily an opportunity for the railroad to exchange its stock interest in its Penn Terminal Co. (through which it owned Pennsylvania Station in New York City) for that in a more promising enterprise whose physical plant had been erected over the site of the railroad subsidiary's property. It is also noted, however, that the transaction represented an opportunity for the Transportation Company to record a $21 million gain on the exchange of stock. Th Q Central was appropriately wary of its proposed merger partner's real estate diversification activities as revealed in the minutes of the Board of Di- rectors meeting in May, 1966, which considered a PRR request to raise its debt ceiling to cover these acquisitions. The Board expressed reservations about the wisdom of the PRR's entrance into the real estate development business but grudgingly consented to a raise to $195 million, nearly double the original $100 million ceiling. 38 Considering its needs and objectives, real estate development was a pecu- liarly inappropriate choice for the railroad's diversification. While not offering the spectacular stock appreciation possibilities of real estate, many other chan- nels could have provided the growth and return on investment objectives with- out the extraordinary financing demands or the accompanying sacrifice of cash dividends. 35 Beginning November 23, 1966 with a request for $1.1 million, seven more requests totalling $11 million were submitted to the railroad, $9.4 million of which was granted before it became apparent Strick was becoming much mi re of a cash drain than had been anticipated. On Mav 26, 1967, \V. K. Grant, V. Tres. Finance, NYC wrote to Sol Katz, President of Strick, that such requests would no longer be granted by the railroad, because (a) worthy projects of the railroad were being turned down in the interest of conserving cash ; (b) 2,000 people had been released from the Central's pay- roll : (c) Strick had g'ven no indication that it was going to request more funds than in the original proposition to the railroad and (d) the railroad's cash had dropped $15 million in the past few months $9 million of which ha'l >>een advance! to Strick. Spc /VTiPeiT'ix T> Exhibit SO. p. 541. 36 See letter dated May 6, 1969 (from A. E. Perlman to P. M. Shoemaker (Appendix D, Exhibit 31 (p. 544.) 37 Acquisition of Kayser-Roth would have been accomplished by the issuance of approximatelv $231 million of two classes of Pennsvlvania Co. cumulative preferred stocks, the onlv cash outflow to have been cash dividends paid on these shares ($1.05 million annually) to be, of course, offset bv cash dividends received from the acquired company. (Memo used bv S. T. Saunders, June 196S. Appendix D. Exhibit 7. o. 507.) 38 Minutes — XYC Board of Directors meeting, May 4, 1966 : Appendix D, Exhibit 14, p. 523. Railroad Operations Assessing the performance of the managements of the Pennsylvania Rail- road and the New York Central Railroad in order to understand how it affected and was affected by the financial position of the companies is somewhat like the "chicken and egg" riddle. While it cannot be definitely answered, it can be profitably considered. In keeping with this study's pursuit of perspective, establishing even a rough balance will be useful. A basic cornerstone of perspective is a clear assessment of the constraints conditioning management decisions; this is, indeed, the heart of putting re- sponsibility in perspective. Constraints may be viewed here as they were in the fiscal policy treatment and classified roughly on the basis of how elastic or rigid they were and whether they were external or internal influences. Important elements of constraint include regulation, shipper relation , technological fac- tors, competitive and market conditions, fiscal posture, merger gestation limita- tions, and connecting railroad relationships. With fiscal policy separately treated, this assessment concentrates on man- agement activities connected particularly with the operations of the railroads. The areas examined include plant and labor management, production man- agement as reflected in equipment and plant utilization and the pricing and marketing of services. The central purpose is evaluation rather than description. In some situ- ations, evaluation is possible with absolute indicators; in others, a comparative approach is more meaningful. Comparisons of the merger partners are revealing because their approaches were sufficiently different to permit an evaluation of alternatives. Further comparisons with other railroads and of the Penn Central before and after bankruptcy offer insights regarding the company's condition. The general setting of the evaluation is well known : The plant is run down, service levels are qualitatively impaired, physical indicators of performance efficiency are out of line, and costs are inflated. The purpose is to note specifics and search for reasons. DECISION CONSTRAINTS The major set of constraints may be considered as essentially environmen- tal. The unfavorable market environment spells both financial stringency and a traffic volume which is usually either inching up painfully slowly or actually de- clining. The former restricts the tools available and the latter is a drag on effi- cient plant utilization and operating arrangements. The constraints in this class are somewhat internal and slightly elastic ; that is, managements can assert some measure of control over market environment by "making a better mousetrap." But the opportunities are still limited if there is little interest in catching mice or if the mice still refuse to be caught. Another regulatory constraint prominently mentioned as imposing a heavy drain on many railroads and as particularly significant for the Penn Central and its components is the restriction on the abandonment of unprofitable lines. Given the high fixed costs characteristics of railroads, traffic density is an impor- tant variable in profitability. Light density lines which are readily separable from profitable segments are thus prime candidates for elimination. A prominent result of the weakened market position of many railroads is a decline in density to unprofitable levels. It is asserted that about 80 percent of the Penn Central's freight revenues are attributable to just 11.000 of its 20,000 mile total. 39 Alternatively stated, nearly 50 percent of the mileage accounts for only 20 per- cent of the receipts. The inference is drawn that some of the remaining 9,000 miles are prime candidates for abandonment. The profit impact, of these relationships is, however, far from clear since it is much more difficult to determine the cost reduction that would be associated 39 Report oj the Penn Central Trustees on Reorganization Planning, February 15, 1972. Appendix D, Exhibit 54, p. 623. (79) 80 with the 20 percent revenue decline from dropping the light density lines. The Penn ( lentra] is actively studying the matter, however, and tentative indications are that potential savings are not impressive in either absolute or relative terms. According to an estimate in the Trustees' Report of February 15, 1972 the operation of the 11,000 mile core system envisioned would transform an actual 1970 operating deficit of $101 million to a $91 million gain, given an 80 percent operating ratio. But since the ratio achieved in 1970 for the 20,000 mile system exceeded 90, it is apparent that much of the gain cited is attributable to the much lower operating ratio which was postulated. Applying the 80 ratio to actual 1970 freight revenues of $1,392.4 million and reducing it by 20 percent produces a positive net of $222.8 million. This leaves only about $24 million as a saving attributable to cutting the plant virtually in half. This figure is reason- ably consistent with an estimate of the Federal Railroad Administration of $0>0 million potential savings for all railroads in the country from justifiable plant reductions. 40 It is likely that even $24 million is too high when a system-wide view is taken. Traffic which is unprofitable on a light density route may contribute to system net when account is taken of the lower unit costs on high density seg- ments. The latest "Interim Report" by the trustees exposes for public scrutiny a study indicating that because of labor protection costs, a system reduced to 15,000 would produce a higher Net Railroad Operating Income than would an 11,000 mile system. 41 Necessarily, numerous assumptions are made in the report making a thorough critical analysis of it impractical. It may be assumed that the Penn Central has under its control certain track and roadbed Avhich is not only uneconomic but provides no redeeming social, environmental, or other virtue and should therefore be abandoned. But deciding what should be abandoned requires close coordination within a railroad's man- agement and demands careful attention to numerous factors including property taxation, changes in traffic routing, effects on pricing and marketing, and ca- pacity of alternative facilities. In some instances tax savings may play a dominant role in the decision to abandon. Because of peculiarities in Maryland's property tax laws, for example, a 1961 intercompany "personal" memorandum to the Pennsylvania Railroad noting that Maryland track "produces a savings of 2 to 4 times that obtained in any other state," concluded that "this statement vigorously demonstrates the need to eliminate as much track as is possible within the State of Maryland." 42 Tax savings for the Pennsylvania and the Penn Central were of great concern in every abandonment proposal. 43 Various documents from the Penn Central files question the wisdom of certain management abandonment proposals. In October, 1970 the Marketing Department officials expressed dismay over several lines which had been added to the abandonment list, about which Marketing had not been consulted and which Marketing felt should be more carefully evaluated. 44 Another document dated June 3, 1970 suggested additional criteria which could have been employed in making up the abandonment plan. 45 The writer was concerned about increas- ing "circuity of mileage" because "invariably" circuitous movements undertaken as the result of abandonment "supposedly to reduce costs" actually "increase our costs and show up in the guise of lessened profitability, lessened incentive for investment, inability to quote competitive rates, etc." He was concerned that abandonments also affect leases, other contracts, and mortgages. In addition the relationship between total investment in a branch, its actual net salvage value, 10 Executive Briefing, Transportation Regulatory Modernization and Assistance Legislation, Janu- ary, 1972. O.S. Department of Transportation : and Testimony by the Honorable John Volpe In hearines before Committee on Interstate and Foreign Commerce, House of Representatives, the Transportation Act of 1972, 92d Congress, 2d Session, Part I at page 148 Serial No. 92-76 . « Trustees Interim Report of October 1, 1972, In re Penn Central Transportation Co., E.D. Pa., No. 70-347 ; Appendix D, Exhibit 55, p. 655. 4a January 4, 1961 memorandum from J.P.N, to J.D.M. (J. D. Morris, in 1967 P.R.R. Vice- Pros, special services). Appendix D. Exhibit 56, p. 683. 13 See for example file "073" from the Office of Vice President — Operation entitled "Tax savings to he derived from abandonment of all unnecessary tracks and/or facilities" reproduced in part in Appendix D, Exhibit 57, p. 683. "October 13. 1970 memorandum from T. P>. Graves to J. R. Sullivan (Asst. Vice-Pres. Marketing). Appendix l>. Exhibit 58. p. 684. <5 .Tnne 3. 1970 memorandum from George R. Wallace (Vice-Pres. Coal and Ore) to J. R. Sullivan. Appendix D, Exhibit 59, p. 684. 81 and its present or potential return should be weighed. Also of concern to the author was that actual expenses of the branch line should be subtracted from revenues it generated and the estimated contribution to the rest of the rail sys- tem should be carefully evaluated. The difference in approach is evident. Some in management focus attention on cost reductions, others would emphasize an examination of future prospects tor business. It may be questioned whether a massive abandonment prooram will necessarily provide the financial lift that is commonly thought to be so important. The Trustees' October 1 report gave currency to this question when it identified the unexpected impact on labor protection costs On a massive aban- donment. It cannot be determined from the Trustees' October report the extent to which some of the other factors may have an unanticipated impact on costs. The Trustees' study assumes there would be sufficient traffic retained to ensure greater density, but apparently did not examine the very crucial question of impact on the main lines as compared to actual expense of the reduced traffic revenue generated by the branch lines. Nor does it seem to pay heed to possible extra costs of any circuitous routing which might be required where connecting links are severed. The Trustees have indicated that many factors must be given weight, including "practicalities of operation, future traffic potential and special characteristics of the various lines ;" 4G they further indicate in the October 1 report their intention to plan for a 15,000 mile system. Abandonment questions seem to be many and the projected benefits are not as clear as often stated. It is probably not justifiable therefore to place undue emphasis on the regulatory process as a restriction on line abandonment. Many other considerations are involved, not the least of which are sound business practices. Changing the ICC abandonment criteria may not yield the benefits claimed. There are a host of other influences restrictino; management freedom, many of them peculiar to railroads. Rate regulation, a classic case, appears prominently in connection with the rail industry and individual railroad efforts to adjust prices. Relations with other companies in the industry are peculiarly limiting because of the physical interconnections and the joint production of services, leading to added complexities in the processes of revenue gen- eration. Customers also exert a unique influence in rail transport markets; shippers are characteristically conservative, avowedly preferring rate stability to transport cost reductions. It is frequently difficult and risky for a carrier to contravene the desires and interests of large customers in matters in which he may have only an indirect interest. While this list could be expanded, it adequately demonstrates the broad range of forces impinging on railroad managements in the form of decision constraints. Management performance must be viewed in the light of these conditions. PLANT INVESTMENT AND MAINTENANCE As the earlier discussion indicated, the composite PRR-NYC put rela- tively small amounts of money into their plants in capital and maintenance as measured by other railroads, with a greater deficiency in the 1958-67 period than in the previous 10 years. The PRR consistently outspent its counterpart, both in maintenance and in capital investment and in roadway and equipment commitments. Its margin was even greater in the second than in the first 10-year period. In terms of available resources, the capital expenditures of the two com- panies were mediocre but not disgraceful. Investment as a percent of operating revenues approximates the national average in recent years. During 1960-67, the PRR invested 9.26 percent and the NYC 7.12 percent (Table C-l). They exceeded the B & O (4.68 percent) but fell well behind the C & O (14.73 per- cent). PRR's relative commitment is even greater when combined maintenance and capital expenditures are related to net railway operating income (NROI). Over the years 1958-62, the Pennsylvania returned 11.62 percent of this net to its plant compared to the Central's 8.66 percent (Table C-3). "Penri Cpntrnl Trustpps' P'an for Rporcnn'zit'on. April 1. 1972. In re: Penn Central Transpor- tation Co., (E.D. Pa.) No. 70-347; Appendix D, Exhibit 60, p. 686. 82 While the fiscal aspects of investment and maintenance programs are sig- nificant, it is necessary for present purposes to relate the outlays to physical and operating bases and to express the results in plant improvement terms. A basic element of operating effectiveness closely geared to investment- maintenance expenditures is the supply of freight cars. The investment by both railroads as measured by freight car units in operation declined in the 20 years prior to the merger (Tables C-3, CM). Between 1948-50 and 1964-66 L°p S T ) °T, , ' llVeilU l' freight fel1 15 P ercent on the Central and 16 percent on the 1 KK. 1 he number of freight cars dropped 38 percent and total tonnage capacity declined 33 percent for the NYC and 42 and 33 percent for the PER. In the absence of a great improvement in freight car utilization, the ratio of cars and capacity to traffic volume was declining as reflected in net rents. Both companies were net renters of equipment after World War II, but the Central's position deteriorated significantly after 1960 and the Pennsyl- vania's even more rapidly after 1957. Between 1948-50 and 1964-66 the NYC rent deficit increased 109 percent while the PRR figure leaped 367 percent. Although renting equipment saves capital expenditures in the short run and may offer flexibility in expenses during, a recession, it is probably much more expensive in the long run and endangers service quality. Meaningful interpretations and comparisons associated with investment and maintenance expenditures require that they be related to physical units. Generalizations regarding comparative performance are complicated by the wide annual fluctuations which characterize investment patterns, but some general relationships may be noted. The Penn Central companies collectively invested in roadway an average of $684 per mile of track in 1960-69, marginally less than both the C&O and the B&O ($800; $826) and sharply below the Southern ($1,332) (Table C-5, Charts C-l, C-2). Starting out in the early 1960's at a very low level, they moved up to a reasonably representative position during the latter half of the decade. The performances of the separate companies were, however, mixed. Over the years 1960-67, PRR averaged $393 of road investment per mile of track but the Central reached an average of $690, both falling well behind the C&O ($761) and the Southern ($1,011). The relative deficiency also holds for equipment investment (per mile of track), with a 1960-69 average of $2,346 for Penn Central, superior as usual to B&O but far below C&O ($4,079) and Southern ($3,742). Here again, the Penn Central performance was much better in the later years, largely because of PRR's programs. This company's 1960-67 average of $3,244 substantially ex- ceeded the Centrals $1,713 and compared favorably with Southern's $2,950. Roadway maintenance requirements are functionally related to use as measured by gross ton miles. The Penn Central companies performed surpris- ingly well according to this test over the years 1958-70. They averaged $914, superior to C&O and B&O and only slightly below Southern's $945 (Table C-6). The Central ran ahead of its partner on this measure, with 1958-67 outlays per million gross ton miles averaging $908 to Pennsylvania's $855. The higher PRR absolute outlay was deflated by the introduction of the physical denominator to spell inadequacy relative to the Central. Physical replacements expectedly reflect the monetary patterns. The com- posite level of tons of rail laid in replacement per mile of track operated and the cross tie replacement rate are low compared to the other roads (Charts C-5, C-6). The Central's volume predictably leads the Pennsylvania's, although the margin is small (Table C-9). PRR's rate of cross tie replacement fluctuated considerably over 1960-67 while Central's increased (Table C-9). The low rate of physical replacement had unfavorable operating conse- quences including an increase in the rate of accidents. The PRR was plagued bv slow order track Avhich peaked in 1961 at about 360 miles but soared off the board at over twice that level in 1967 (Chart C-7). The accident rate increased throughout the East during the 1960's, advancing from 4.18 per million units in 1960 to 9.02 by 1967. The Central's rate also increased but was consistently below the regional level, risincr from 3.3 to 7.0. The PRR rate rose from 5.5 to 14.4 (Table C-10 and Chart C-8). As a result of this behavior, the superior performance of the Central combined with the outlandish rate of the PRR pro- 83 duced a composite that was reasonably respectable in terms of the comparison roads. Comparisons involving expenditures for freight car maintenance are com- plicated by the PRR's switch to rebuilding cars through subsidiaries and capi- talizing the outlays and by the Central incorporation of the Pittsburgh & Lake Erie car fleet in 1964. The switch to capitalization understated maintenance expenditures, thus failing to reflect all of the resources devoted to the main- tenance function. The P&LE incorporation increased the maintenance respon- sibility of the Central in absolute terms. While significant for some purposes, these discontinuities should not seriously influence comparisons of maintenance expenditures stated in unit terms. While PRR's total 1958-67 expenditures for freight car maintenance ex- ceeded Central's on the order of $340 million to $288 million, its per car average of $252 was far below its partner's $305, a figure comparing favorably with the other roads (Table C-7a). Pennsylvania's poor showing is further reflected in equipment condition. Even though its freight cars were utilized less intensively (car miles per car) , its bad order ratio was consistently much higher than Central's which was also excessive (Table C-7b). A ratio of 5 percent is regarded as the maximum tolerable limit according to accepted industry stand- ards. Central achieved a progressive reduction from 10.7 in 1960 to 6.0 in 1963 and on to 3.5 by 1967. PRR, by contrast, actually lived at around 15-16 until 1963 after which it managed to get down to 7.7 in 1965, only to climb back to 9.0 by 1967. The PRR's total locomotive maintenance expenditure was also larger than Central's during the 1960's, reaching $458 million compared with $352 million, but the respective averages per unit were virtually identical at about $18,000 (Table C-8). Again, Pennsylvania's locomotives were utilized slightly less in- tensively than Central's in terms of annual mileage per unit with averages of 43,300 and 48,400 (1964-67). PRR's parity in average expenditure and lower utilization were linked with a higher unserviceable rate. The percentage of its fleet in unserviceable condition ranged from 15.4 to 18.5 in 1961-66 before settling back to 10.8 percent in 1967. Over the same period, Central's moved between 9.7 percent and 13.5 percent. In combination they exceeded the East, which dropped from 10.1 in 1961 to 7.2 by 1969. Penn Central started with 11.1 in 1968 and was able to get down to 7.9 in 1969 (Table C-8). According to the data available for this summary, the Penn Central com- panies were fairly representative in terms of their plant maintenance and invest- ment outlays relative to net railway operating income. They lagged further behind, however, in terms of commitments relative to physical plant units. As a result, their composite and merged plants were not adequately supported as manifested by unfavorable operating consequences. In absolute amounts and in terms of available net income, the Pennsylvania outdid its partner in plant support, particularly with respect to equipment, its figures compared favorably with other roads. But it was not successful in producing results visible for' these comparisons. In slighting roadway and favoring equipment, the Pennsylvania seems to have gotten the worst of both ends of the bargain. It gained iio real payoff from the equipment commitment but suffered directly and severely from the roadway neglect. The operating consequences in unserviceable equipment and unsafe track hit with particular severity. LABOR UTILIZATION Available indicators point to relatively inefficient labor utilization by the two companies that got even further out of control after the merger, bince wage rates are largely standardized, high labor costs are a symptom of an unfavorable labor mix or inefficient utilization. These factors can be illumi- nated even though definitive causal judgments are elusive. An initial hint of ineffective labor control is provided by the share of operating revenues accounted for bv wages (Table C-ll, Chart C T 9). Although generally declining throughout the 1960's, the wage ratio remained high tor both companies, ending up in 1967 at about 48 percent. Their performance was quite similar. They were able to match the C&O's record, but ran significantly 84 behind the B&O (and all Class I) and far behind the Southern. This unfavor- able percentage suggests a relatively low productivity level that is confirmed by other indicators. A significant measure of physical productivity is gross ton miles per em- ployee (Table C-12, Chart C-10). While increasing along with the general industry trend, this indicator was very unfavorable, with both companies fall- ing well behind the others. Here too they switched positions and observed no consistent differences. Over the three years 1965-67, the records were virtu- ally identical, with an average of 2.170 million gross ton miles for the Central and 2.102 million for the PRR. On the other hand, the B&O-C&O combination averaged 2.693 million— roughly 26 percent higher (Table C-12). Essentially the same picture appears when productivity is measured in gross ton miles per service hour (Table C-13, Chart C-ll). The story alters slightly when wages are introduced, making the Penn Central picture even more dismal. While the monetary factor served as a brake on physical productivity advances, gross ton miles per dollar of compensation increased for all the companies except the C&O (Table C-14, Chart C-12). As would be expected, the Penn Central companies fell far below the others, with the PRR, showing a slight superiority over the Central. But that margin, a 1965-67 average of 270 to 266 gross ton miles, was slight compared to the 28 per cent bulge of the C&O-B&O represented by a composite average of 343. The hypothesis of wage costs increasing more rapidly for the PC com- panies than for the others is confirmed by the data depicting compensation per employee. Because of the identity in compensation patterns the companies are closely bunched and follow similar trends (Chart C-13). Penn Central pro forma) started the decade in a median position but wound up much the highest, parting company with the others with a sharp surge after 1967. Since wage rates are standardized, this behavior indicates an employee mix that is relatively expensive and becoming increasingly so. Further insights regarding this phenomenon are supplied by the data for compensation per service hour (Table C-15, Chart C-14). Starting out again in a median position, this indicator for the PC companies generally moved upward along with the pack and managed to hold its position. The PC's supe- rior performance for compensation per service hour over compensation per employee suggests that the unfavorable elements are associated with employees who were not operating trains. Part of the explanation for the unfavorable showing of both the Penn Central companies is found in the relatively large number of employees per mile of track operated (Chart C-15). While following the general downward trend, the employment figure was well above the other companies' except in 1968 and 1969 when the C&O slid to the least favorable position. Notably, the PC improvement continued throughout even after the merger. These dr>ta clearly confirm low labor productivity persisting over the recent past for both Penn Central companies. There is little to choose between them in this respect and they are far more like each other than like any of the other companies. Financial results are significantly influenced by any leakage in wage ac- counts because of the overwhelming importance of this item, running around half of the revenue dollar. Furthermore, within the limits imposed by union contracts, wage costs are subject to rather close managerial control and can get out of hand without effective management vigilance. A verified statement submitted for the ICC investigation attempts to measure the fiscal impact of the unfavorable wage and productivity factors. 47 The verified statement estimates the excess labor cost in 1969 at $377 million and even more in 1970. 48 The methodology employed is questionable, developing a fro forma Penn Central wage bill by substituting the Class I percentage of wages to revenues (45.1) for the actual Penn Central percentage (57) and ap- plying the former to actual PC 1969 revenues. It is clear, in any case, that the wage bill is a real millstone, particularly considering the addition of fringe 47 Interstate Commerce Commission, Docket No. 35291, Penn Central Investigation Verified Statement 33. 48 Id. p. 20. ; In thousands Overtime as Number of a percent of employees Gross payrolls Overtime payments gross payroll (midmonth count) $869, 132 $56, 484 6.5 131,850 868. 697 58, 985 6.8 128. 290 847, 300 65,935 7.8 121,593 859, 257 77, 189 9.0 118,781 885, 338 83, 594 9.4 115.845 876, 046 84, 686 9.7 110,947 876, 763 85. 996 9.8 106, 150 919,145 104, 130 11.3 102,053 941,674 109, 346 11.6 97, 679 975, 646 111,671 11.4 93,869 85 benefits, estimated at about 15 percent of waffe co^ts for railroads Can additional $57 million). Overtime penalties are also historically severe for the PC, as indi- cated in the following table. Year 1961 1962 1963 1964 1965.. 1966 1967 1968 1969. 1970 Source: ICC Docket No. 35291, V.S. 33, p. 22; 1961-1967 pro forma NYC, PRR, NH ; 1969 & 1970 Penn Central Transportation Co. While employment dropped from 132,000 to 93,869, advancing wage rates upped the payroll from $870 million to $976 million. Overtime payments rose even more rapidly, however, constituting 6.5 percent of the total in 1961 but 11.4 percent in 1970. Regardless of their cause, these heavy wage payments represent a severe disability. They were undoubtedly inflated at merger time by the labor recall provided for in the premerger labor protection agreement, but the seriously unfavorable patterns were solidified well before then. But a real question is whether this huge disability is attributable to exogenous forces beyond manage- ment's control. Since wage rates are standardized, the cause is largely to be found in the high employment ratio (per gross ton mile) or in relatively high salaries of supervisory personnel. Excessive labor is an apparent concomitant of restricted capital investment. Another contributing factor is a relatively and absolutely high level of passenger traffic. But evidence of employment excesses is suggested by the sharp post bankruptcy declines and by prebankruptcy man- agement statements about anticipated work force reductions it expected to accomplish. It appears that there was really inefficient labor utilization pri- marily attributable to inadequate management control. PHYSICAL PERFORMANCE Conventional railroad economic analysis evokes a set of "performance" or "efficiency" measures useful for inter-temporal and intercompany comparisons. While providing readings which reflect factors both within and beyond the control of management, these indicators are valuable tools if cautiously em- ployed. It will be useful to see how the Penn Central companies stacked up in these terms. These readings are interpreted in the context of firms with generally debilitated plants and ineffectively controlled labor inputs. The first set of measures concerns the extent to which plant and equipment are employed. A basic influencing factor focuses on the utilization of roadway to measure traffic density. This is expressed by the ratio of net ton miles per mile of road. This relationship is subject to managerial control only within the broad limits of traffic development and is more a function of market condi- tions than salesmanship (mousetrap requirements rather than mousetrap de- sign). But since many costs are independent of volume, high traffic density has a very favorable income influence. The PRR enjoyed higher densities than its companion and ranked in the middle of the comparison roads — above the B&O and E-L but below the N&W and C&O. The Central had lower traffic density than any of the comparison lines (Table C-16, Chart C-16). Density generally increased within the region until the 1966 reversal, continuing downward for the Penn Central but subse- quently reviving for the others. Efficiency is also furthered by favorabTe utilization of the rolling stock. Be- cause of some stability in production functions relating rolling stock require- ments to roadway, higher traffic density favors equipment utilization. But fac- 86 tors more subject to managerial control are also at work. Annual mileage per unit is favored by sound adjustment of equipment supply, expeditious move- ment, and minimum downtime. Despite its lower traffic density, tbe Central managed more locomotive miles per unit than its counterpart, although both fell behind the comparison roads (Table C-17, Chart C-17) . A useful measure of freight car utilization is car miles per freight car day. It is sensitive to car utilization, train speeds, shipper detention and yarding time and is thus substantially subject to management control. Because of the superior physical factors previously reviewed, the Central fared slightly better than the PRR in this dimension. Here again the Penn Central companies were sub par throughout and continued to lose ground. This combination gained 20 percent 1960-67 against approximately 40 percent for the C&O-B&O (Table C-18, Chart C-18). The ratio of gross ton miles per freight train hour is a composite of various factors such as carloadings, train speeds, and train lengths. Because of the diversity of the underlying influence, it is a significant indicator. The PC partners were uncharacteristically respectable according to this test, being exceeded only by the C&O and N&W (Table C-19, Chart C-19). Both improved faster than the others during the upsurge of the 1960's. The most inclusive set of measures embraces a wide range of the indicators cited to produce what approximates an "efficiency" guage expressed in net ton miles per freight car day. The anatomy of this inclusive indicator features a structure composed of the following elements: (1) car miles per serviceable freight car day (a function of turnaround), (2) the ratio of loaded car miles to total car miles, and (3) net ton-miles per loaded car mile. Stated otherwise, the amount of daily work performed by a freight car (representing a high fixed cost) is determined by the amount of its movement, the portion of its movement under load, and the extent to which it is loaded. The car mile (uti- lization) ratio for the merger pair is relatively low, but the Central's advan- tages over the Pennsylvania were eliminated by 1966 (Table C-18) . The ratio of loaded to total car miles is highly erratic, but the PC (pro forma) occupies a median position (Table C-20, Chart C-20). PRR's perform- ance substantially exceeded the Central's, with respective 1961-67 averages of 61.5 percent and 57.3 percent. The average lading on loaded cars (net ton miles per loaded car mile) generally advanced for all the comparison roads and the PCC partners (Table C-21, Chart C-21). Again, however, the PRR showed consistent superiority as reflected in comparative 1961-67 averages of 40.0 and 37.8 tons. The data reviewed now lead to the critical efficiency measure designated "net ton miles per freight car day." The performance of the PC team is ex- pectedlv poor, consistently falling behind both individually and as a composite (Table'C-22, Chart C-22). They were well below the figures for the East and all Class I roads. Individually, the Central starts out slightly ahead of its part- ner but falls badly behind in later years despite a shot in the arm from the 1964 reporting consolidation of the P&LE. This performance leads to a critical juncture in the analysis. The poor performance of the PC partners in this vital indicator is not surprising. But the comparative PRR-XYC performance contains a lesson. The Central racked up a number of factors of advantage, including the manifestations of plant condition (train speed) and car control (car miles per freight car day), but these forces were not strong enough to carry this inclusive indicator. It is in- structive to review the comparative performances in the elements measured by the 1965-67 averages : Pennsylvania New York Indicator Railroad Central Car miles per serviceable freight car day 40.9 39.6 Percent loaded of total car miles. ._ 61. 4 57. 5 Average load per car _ 42. 4 39.6 Net ton miles per freight car day 1,066 952 It is apparent that deficiencies in the average car loading and loaded car percentage outweighed any other advantage the Central had for purposes of 87 this indicator, a significant factor in the final assessment of management performance. The true significance of these performance factors is their ultimate trans- lation into monetary terms. They are most intimately reflected in the set of expenses linked to the "transportation ratio"' which measures transportation expenses as a percentage of rail operating revenue. These expenses include the costs of operating, as distinguished from maintaining, the property. The largest single element is wages for operating trains as well as stations, signals, interlocks, and other property. The other major accounts cover locomotive fuel consumption and train supplies. The Penn Central companies expectably produced higher ratios than their neighbors in terms of both the total and freight only expenses (Chart C-23). Consistent with the performance on "net ton miles per freight car day" but contrary to most previous indications in this analysis, the Pennsylvania main- tained a consistently lower ratio than the Central. According to an intercom- pany comparison of accounts at intervals over the 12 years 1956-1967 sum- marized below, the ratios of wage elements to total transportation expenses are roughly equal, indicating that the differences arise primarily in the other expenses for train fuel, supplies and other expenses. While the transportation ratios are clearly a function of revenues as well as expenses, they are unques- tionably significant for present comparative purposes. [1 n percent] 1956 1960 1964 1967 Total 8 largest accounts ': New York Central.... 71.6 70.8 69.4 68.4 Pennsylvania Railroad _ 68.1 67.3 65.9 64.4 Total of wage accounts only: New York Central 57.0 57.3 55.1 55.4 Pennsylvania Railroad 55.1 55.6 55.9 54.8 ■Station employees, trainmen, yard conductors, and brakemen, train engine-men, train supplies and expenses, train fuel, yard engine- men, yard masters and yard clerks. PRICING AND MARKETING A review of transport pricing must carefully and explicitly consider uie legacy of the past and the constraints of highly conservative contemporary institutions, all built on an extremely complex base. The system was designed to meet the commercial requirements and economic development goals of the country and of its several regions, along with the proprietary interests of the railroads. It was strongly demand oriented, with cost serving primarily as a rough test of competitive price relationships and of equitable treatment to lo- calities, commodities, and shippers. This orientation, appropriate for the mo- nopoly characteristics of rail transportation at the time, served the development goals and helped to encourage use of a generally under-utilized rail plant. It was also comfortable because it did not press into the problems of cost measure- ment in an industry characterized by the inability to assign costs to individual segments of business. It is widely recognized that this structure has become less workable as eco- nomic conditions, transport requirements, and competitive relations have altered drastically in recent years. At the same time, a number of forces work against change that are far broader than the essentially conservative character of railroad management. Shippers themselves tend to favor the status quo um- bilical cord, declaring their preference for stability (and even rigidity) over re- ductions in transport costs. Like the ad valorem tax assessor, the favored guide is last year's routines. But aside from the institutional influences and behavioral proclivities, the problem of change is posed in particularly burdensome terms in the railroad case. Rates are literally formed into close knit and overlapping structures. No carrier or set of carriers controls a critical collection of the elements and a change in one collection inevitably has serious ramifications in others. How is massive reform engineered under these circumstances ? Even the tip of this iceberg clearly signals that the significant reform necessary to modernize railroad rate structures is a joint industry-government 88 problem that requires for meaningful consideration a considerable advance in concepts of public policy. Effectively addressing the problem is probably beyond the competence of an individual company. Evaluating management policy is essentially a question of how effectively available tools were employed. One of the central issues addressed is the railroads' response to inflation, along with the treatment of associated competitive adjustments which will introduce matters of basic pricing philosophy including the role and use of costs. Response to inflation is particularly critical in a segment of the railroad industry, such as the Penn Central pair, suffering relative traffic stagnation since economies of increasing utilization are not available as a dampener. This review will keep an eye on management responsiveness and performance and philosophical sources of incompatibility between the two. Sharp differences in approach are characteristic. The different policy approaches are epitomized by the positions of the two companies in the general rate level increase case of 1967. These general rate level or revenue cases pose unusually difficult and intractible issues, growing partly out of forces mentioned previously. Railroads, along with other industries, must at times and in some degree attempt to recoup the additional monetary costs im- posed by inflation. To be effective revenue generators, rate increases must be broadly based which necessarily alters vital structural relationships. Proceeding on a commodity-by-commodity basis is time consuming and may be self-defeat- ing from the carrier's short range viewpoint; over-generalizing intensifies the adverse structural effects and impairs the profitability of the increases by run- ning afoul of adverse demand circumstances. Solutions must be worked out which are acceptable from a revenue standpoint while satisfying the require- ments imposed by the ICC. There is no clearcut answer to the questions posed. The railroads, the ICC and shippers have struggled with them throughout the years since World War II. The issues regarding structural relationships and revenue requirements posed in general rate cases are now the subject of a comprehensive investigation by the Commission. The quite different approaches the PRR and the NYC took toward rates were rooted in contrasting philosophies and pricing approaches. It is note- worthy but not surprising that these general increases have extensively involved railroad top management not usually or heavily involved in the day to day re- rate adjustments. Primarily for this reason approaches to rate-making have typically been even more divorced from technical competence than the other as- pects of railroad pricing. By the fall of 1966 there was strong support in the industry for applying to the ICC for a rate level increase. The Central's position was stated in a Decem- ber 2nd meeting of the Eastern President's Traffic Conference. Its representa- tion, headed by President Alfred Perlman, vigorously opposed an across-the- board increase, stressing the necessity for a restructuring of rates and selective decreases as well as increases where they would be profitable. The PRR led the fight for the general approach and feared that the Cen- tral's opposition would cost the support of other companies both in the East and elsewhere and jeopardize an estimated $15 million revenue increase in 1967. Pennsylvania did not object to the merits of Central's view in principle, recog- nizing the economic superiority of that approach. But it feared that reaching industry agreement on the specific changes to be sought would delay presenta- tion of the proposal to the ICC and its complexities would enhance the chances that the proposal would be suspended by the Commission on structural grounds. The general approach was considered tried and true, while Perlman was con- sidered to have an unrealistic view of the type of revenue case that would have any jn'ospect of prompt approval by the Commission. Perlman was adamant but was unable to generate a decisive following. Although neither side held totally to its extreme position, effective com- promise was elusive. The Central was willing to classify commodities into broad groups established to receive no change, modest increases, or larger advances, but PRR feared regulatory consequences even of this. On the other hand, PRR was willing to seek special treatment on selected commodities, but Central considered this inadequate. It was finally agreed that the Central 89 would go along with a modified general increase request with the understand- ing that the PRR and other railroads would support the rate restructuring pro- gram as a later separate proceeding. The PRR's chief traffic officer justified its strategy with the explanation that it was not intended to actually impose the flat increase on all traffic. The uniform request was designed to facilitate prompt ICC approval after which actual increases could be selectively applied according to market dictates facing individual carriers. The PRR did in fact, however, agree to some selectivity in the Ex Parte 25G application in deference to PRR Chairman Stuart T. Saunders' concern for relationships with the merger partner. While both sides compromised, the Central gained the least; the restructuring it desired was never effectively undertaken. The division between the two companies reflected in the revenue case was a clear reflection of fundamental differences in general approaches to pricing prob- lems and related matters of marketing. The Central under Perlman was a devotee of change, and pricing and marketing practices were in the forefront of this commitment. It had been led by tradition and by its newer precepts to emphasize profit concerns on a commodity-by-commodity basis, with a strong foundation of cost measurement and application underlying its pricing and marketing decisions. The cost measurement and underlying concepts were predicated on ICC formulas that have been subject to fierce criticism on a num- ber of grounds. Despite this shaky foundation, the costs so derived were stand- ardized, computerized, and ground out on a grand scale. The PRR, on the other hand, had been sustained historically by its orienta- tion to the steel industry and thus by highly profitable bulk commodities (rep- resented primarily by coal) and steel products. It had traditionally given little emphasis to individual commodity profitability, but operated on the tradi- tional economic thesis that having high fixed costs, railroads should be pri- marily concerned with increasing traffic volumes to reduce unit costs and thus assure profitability. In this context of all traffic making some contribution to fixed costs, it was logical to accept carloads as the Golden Grail. This traditional view was being modified by the last half of the 1960's. In 1966, H. W. Large, Vice President in charge of traffic, instructed his newly formed Market Research Department to begin investigating costs on a disag- gregated basis. His interests and concerns were expressed along these lines : The two most serious problems confronting the Traffic Depart- ment and its marketing division today are accurate cost formulae to help in formulating pricing policies and to guide determinations for the acquisition of new equipment. I think you will agree Avith me that we are a long way today from achieving those two goals, as we are still largely dependent on system averages applied to specific com- modities and movements. 49 A related concern arose from indications of ICC requirements for more sophisticated cost support for rate applications. The interest in sophisticated cost support for pricing and related deci- sions was actively pursued and resulted in the development by the Market Research Department of a comprehensive computerized management informa- tion system which included timely cost outputs. 50 It is described on its frontis- piece as "a railroad management information system based on direct price/cost analysis of activity." Its accompanying inscription is lofty: "Business is Money. Business Management achieves in terms of money. The basic informa- tion for management must be in terms of Revenue/Expense/Net." Its launching was, of course, handicapped and, aside from its merits and the climate of acceptance, there was little opportunity for the system to be influential before the bankruptcy. Unsatisfactory progress in developing an effective information system to supply cost data was recognized as a severe handicap after the merger. According to the top traffic official of the merged company : «> Memo from H W.L. to B.J.R. [Relyea] January 30, 1967; see Appendix D, Exhibit 61, p. 701. °°Penn Central Price/Cost Management Information System, April, 1968 (mimeo). 90 There is no question about the shortcomings of our existing cost data. This is a severe handicap in making sound pricing and equip- ment investment decisions in the highly competitive transportation market. The M.I.S. has valuable added advantages in that the data produced through this system will provide operating personnel with accurate cost reactions to decisions in the field. 01 Along with other information failures, this probably contributed sub- stantially to the extreme postmerger managerial ineffectiveness. Both the PER and NYC approaches had merit. While from a private com- pany viewpoint, rates which do not contribute more to cash inflow than they do to cash outflow are undesirable, change must be approached with caution for a number of reasons. Railroad costs are difficult to allocate to specific output categories in terms relevant for pricing decisions. Routine cost measurements such as those produced by NYC can easily cast a misleading aura of precision not conducive to sound decisions. While manifestly a powerful tool capable of facilitating greater cost measurement precision, computers also may only appear to circumvent the harsh realities of railroad cost behavior. Building on the aver- age approach of the ICC cost formulations is particularly questionable. As a further consideration, the true role of cost in pricing is still question- able. Given the largely indeterminate nature of railroad costs, market realities, and problems of plant utilization, a sensitivity to demand is required in the pricing process. In the view of many disinterested students, costs are best con- ceived as a pricing constraint establishing minimum and maximum levels. Given the present state of regulatory processes, a highly selective approach to authorizations for rate adjustments responding to inflationary forces is not an unqualified best strategy. A substantial portion of the industry and many shippers concur in the PRR view that expedition and rough structural neu- trality dictate a more generalized approach. The main procedural concern is regulatory authorization ; there is some strategic advantage in achieving this as expeditiously as possible as a preface to effecting specific changes. These considerations support the view that the PRR policies and ap- proaches should not be judged in terms of the NYC as the normative standard. Differences in clientele and other circumstances and substantive complexities preclude this singular view. A related matter was the marketing of services. As with pricing, the ap- proaches were quite different. In keeping with its orientation to change, the Central had adopted approaches which were also commodity (product) ori- ented and reflected industrial marketing practices. They were explicitly de- signed to replace practices epitomized by the PRR and characteristic of virtually all other railroads. These practices were generally more customer and less analytically oriented. Differences in organizational arrangements may also be noted, the PRR marketing being a staff function but carrying line authoritv on NYC. It is particulaxly important for present purposes to note that the differ- ences were deep seated and considered critical by the participants, thus posing a primary source of incompatibility with severe postmerger implications. It is not clear that there is a neat black and white choice between right and wrong. Marketing must be related to the approaches that are appealing to the custom- ers. Although change is under way, industrial traffic departments are still largely led by managers susceptible to traditional approaches, certainly having short run significance for traffic development. The propriety of commodity marketing approaches for a service industry is also a matter of question. While the Central's innovative practices are commendable and its marketing pro- gram embraced many features worthy of emulation, it does not necessarily fol- low that the adoption of a similar approach by the PRR and PC would have 61 Memo from H. W. Large to Mr. Saunders, November 14, 1969 ; see Appendix D, Exhibit 62, p. 701. 91 had a significant impact on events. Indications are rather that the merits of the two approaches are sufficiently mixed and other forces so strong that marketing innovation (at least to the extent it was employed by the Central) was not a critical determinent of the financial fate. It seems, rather, that a critical need for the Penn Central was a unified policy approach of either type to avoid the organizational paralysis that set in. The complex range of variables controlling traffic volume, revenues, and profits preclude empirical investigation to effectively assess the respective fruit- fulness of the alternative approaches to pricing and marketing. Gross revenue results can be examined, but they miss the critical element of profitability which was the touchstone of the Central's approach. But revenue performance was a virtual standoff during the early 1960's, with differences frequently explained by objective developments in the industries involved (automobile, steel, chemi- cals, etc.) rather than in the pricing and marketing policies of the two rail- roads. Over the years 1960-65 the Pennsylvania's gross freight revenues per car increased by 9.98 percent and the Central's by 8.55 percent. The Central's show- ing was helped particularly by a recovery of automobile traffic which is partly attributable to pricing/marketing activity; but the PRR's traffic increased by a higher percentage, an advantage which was minimized by the lesser impor- tance of automobile traffic in its overall freight mixture. PRR did better on vehicle parts and the Central better on iron and steel products. It is interesting that the PRR did relatively better in the 1960's com- parisons after the launching of the Central's new look in pricing and marketing than in the longer sweep from the mid-1950's. Another question involves the effectiveness of their combined strategies in maintaining their composite position with respect to their neighbors and com- petitors. Rough indications are provided by comparative trends in traffic vol- ume, rates per ton, and revenues associated with 12 major commodities for the composite Penn Central and other Eastern carriers. (Charts C-23 to C-29.) 52 Contrasting the patterns for 1965-67 and 1968-69 is interesting to differen- tiate the experiences of the companies before and after the merger. The revenue changes were relatively modest in each segment, particularly in terms of the changes in average revenue per ton, but some inter-period contrasts are notable. In the 1965-67 period, revenues moved downward in six cases, were rather stable in one, and increased in five. In the 1968-69 period, however, increases occurred in only two instances. The patterns for average revenue per ton diverged far more in the two periods. All cases showed a sharp increase in 1968- 69 whereas 1965-67 was characterized by virtual stability (three cases) or rather slight increases. The postmerger is bleaker. Intercompany comparisons reveal some major contrasts. The Penn Cen- tral's 1968-69 increases in average revenue per ton mile far outstripped those of the other carriers for eight of the commodities and were in the same range for the others. The associated tonnages expectedly were less favorable, falling dis- tinctly behind the other performances in eight of the cases. These losses were partly recouped by the higher rates, however, since the revenue picture was relatively more favorable but still somewhat deficient. This discussion of pricing and marketing identifies serious policy prob- lems but hardly critical performance factors. Pricing and marketing strategy is a far longer range phenomena than would be decisive in the culmination of a financial crisis. Despite their differences of approach, the Pennsylvania-Cen- tral composite functioned reasonably well within the context of industry stand- ards. What is really needed is a complete restructuring of rates with the intro- duction of new forms to meet current requirements. But this is an industry function that will require positive government participation (not negative reg- ulation) to be achieved through new public policy concepts. 52 Including bituminous coal ; primary metals ; metallic ores ; food and kindred products ; chemi- cals ; stone, glass and clay products ; pulp, paper & applied products ; field crops ; lumber & wood products ; motor vehicle parts & accessories ; petroleum ; motor vehicles. 74-924 O - 73 92 SERVICE QUALITY The complete post-merger collapse in the quality of service provided rail- road users was essentially the culmination of a steadily deteriorating ability of the individual companies to provide acceptable service compounded by consoli- dation problems. 53 This deterioration is partially reflected in traditional rail- road "performance" measures but it can also be more directly viewed in terms of customer dissatisfaction. 54 Clues of the first type are abundantly provided by the picture that has been drawn of management performance in connection with the railroad operations. In the most general terms, the productivity limitations noted may be expected to affect output quality as well as cost. According to one survey of shippers, the deterioration was apparent primarily in the unavailability of freight cars as needed and unreliable delivery schedules. The first is a function of car owner- ship, condition, and utilization and the latter of terminal operations. The high bad order ratio which particularly plagued the PRR was com- pounded by a decline in utilization. Average daily car movement on the Penn Central actually declined from 42 miles in 1968 to 38 in 1969, while other Eastern roads were maintaining levels ranging between 48 and 57 miles. And this low and falling utilization was com- bined with a 6 percent decline in the size of the freight car fleet. The upshot was freight car availability so low as to frequently jeopardize shippers' production schedules, sometimes even to the point of plant shutdowns necessitated by clogged inventory pipelines. The problems arising from car supply were made more acute by unreliable delivery performance which made it impossible for shippers to effectively plan for the receipt of raw materials. The operating personnel of the railroad viewed the service problems as stem- ming from plant inadequacies. As previously explained, capital budgeting problems and the associated level of capital investment did result in inadequate car and locomotive fleets, obsolete yards, and poorly maintained roadbeds. But personnel problems, which peaked calamitously after the merger, also played a part. Performance was poor even in the modern yards. As an additional indi- cation, car turnaround time was high even on available cars. TABLE C-l.— CAPITAL EXPENDITURES AS A PERCENT OF OPERATING REVENUE, PENN CENTRAL, PENNSYLVANIA RR., AND NEW YORK CENTRAL RR., 1960-69 Penn New York Baltimore Chesapeake Year Central ' Pennsylvania Central & Ohio & Ohio Southern 1969 9.17 ... 5.96 16.92 7.85 7.65 6.26 25.46 26.15 1968 9.66 25.94 1967. 9.42 8.22 10.07 19.68 1966. 12.70 17.24 8.79 4.40 21.55 19.31 1965. 15.28 20.17 10.79 7.74 8.97 12.12 1964. 9.31 9.13 10.48 3.09 21.50 9.05 1963. 2.S9 2.56 3.85 3.93 17.61 12.93 1962. 4.26 4.59 3.89 5.68 15.35 17.89 1961. 4.57 4.94 4.69 2.11 3.81 5.58 1960. 6.13 7.23 4.41 2.85 3.57 13.82 l Pro forma 1960-67. Source: ICC Transport Statistics. 53 The broader context of declining railroad service quality generally should also be noted. "For more detail see ICC Proceedings Ex Parte 265 and Ex Parte 267, 339 ICC 136 through 156; study entitled "The Economy and the Railroads" in Part III of this report ; and Interstate Commerce Commission, Docket No. 35291, Penn Central Investigation, Verified Statement 15. 93 TABLE C-2. -RATIOS OF CUMULATIVE CAPITAL AND MAINTENANCE EXPENDITURES TO OPERATING REVENUES AND INCOME, PENNSYLVANIA RR. AND NEW YORK CENTRAL, 1958-67 Maintenance Capital Total expenditures investment expenditures Maintenance to operating to operating to operating expenditures revenues revenues revenuss to NROI Total Capital capital investment expenditures to NROI to NROI Pennsylvania RR.. New York Central. 0.28 .29 0.08 .06 0.36 .35 9.17 7.23 2.45 1.43 11.62 8.66 Source: ICC Transport Statistics and ICC railroad annual report, form A. TABLE C-3.-CHANGE IN FREIGHT CAR FLEET, PENNSYLVANIA RR., 1948-67 Year Aggregate capacity Revenue Net rent Freight cars Freight cars Total at (thousands of freight tons deficit added retired yearend tons) (thousands) (thousands) 4,419 9,649 112,431 7,646 175,758 88, 082 7,436 10,426 117,661 7,944 183, 104 81,129 10,974 9,821 120,651 7,780 177,251 84,924 8,261 22,695 119,498 7,530 173,452 77,678 9,308 15,911 133,932 8,262 164,267 74, 245 3,160 9,142 140, 835 8,649 161,173 73, 891 4,333 13,939 146,817 8,935 152,876 64,783 12,181 5,891 156,423 9,429 161,315 70,149 13,755 37,156 150,133 8,990 163,870 61, 566 4,439 5,812 173,534 10,187 154,255 54, 466 5,037 2,474 174,907 10,251 199,960 39,135 5,579 3,706 172, 344 10,069 211,493 35,078 5,165 20, 244 170,471 9,940 201,431 36, 222 541 7,001 185, 550 10, 381 169,436 29, 069 3,526 5,242 192,010 11,221 206, 196 24,763 4,951 10,732 193, 726 11,260 202, 281 18,205 15,012 10,516 199, 507 11,524 225,086 22,706 5,625 10,325 195,011 11,160 207, 103 18, 248 1,979 23,121 199,738 11,320 184,537 19,811 1,832 9,176 220, 880 12,343 245, 535 14,172 1967. 1966. 1965. 1964. 1963. 1962.. 1961. 1960. 1959. 1958. 1957. 1956. 1955. 1954. 1953. 1952. 1951. 1950. 1949. 1948. Source: ICC Transport Statistics. TABLE C-4.— CHANGES IN FREIGHT CAR FLEET, NEW YORK CENTRAL, 1948-67 Year Aggregate capacity Revenue Net rent Freight cars Freight cars Total at (thousands of freight tons deficit added retired yearend tons) (thousands) (thousands) 4,632 9,513 78, 172 4,753 135,079 55, 954 5,732 7,252 83,053 4,964 139,454 43,191 6,380 7,378 84, 573 4,901 142,649 41,988 4,582 7,502 85,571 5,012 140,054 37, 354 2,502 8,126 88, 491 5,083 132, 900 37,529 4,106 10, 940 94,115 5,382 128,968 34, 242 2,752 9,467 100,949 5,746 122,977 30, 666 2,124 5,075 107,664 6,088 133,361 25,811 2,012 5,872 110,615 6,225 131,950 20,723 468 5,306 114,475 6,419 126, 385 21.575 7,293 5,509 119,313 6,692 150,698 17,167 5,250 7,101 117,529 6,558 166, 102 21, 562 1,771 10,059 119,380 6,678 161,071 24, 382 1,535 16,170 127,668 7,139 141,245 23, 593 4,730 4,751 142,303 7,900 166, 865 17,777 7,017 3,334 142,324 7,856 164,041 13,155 5,237 3,034 138, 641 7,608 176,763 18,122 3,274 4,426 136, 444 7,445 165, 835 20, 748 6,300 2,667 137,596 7,548 147,787 17,114 6,262 3,003 133,963 7,234 184, 730 21,135 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 1959. 1958. 1957. 1956. 1955. 1954. 1953. 1952. 1951. 1950. 1949. 1948. 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JiDfOCiOf — O O it\JOC)T' 1| -' inin ip-coo»ir»--;cncor^ ioorocr)CT>oo«3'Ocr) . in lt> 00 iii *^ <-« •"-■ 95 TABLE C-6— MAINTENANCE EXPENDITURES FOR WAY AND STRUCTURE PER MILLION GROSS TON MILES, SELECTED RAILROADS, 1958-67 Penn New York Baltimore Chesapeake Central' Pennsylvania Central & Ohio & Ohio Southern 1970 1969 1968 1967 1966 1965 1964... 1963... 1962.. 1961 1960 1959.... 1958.... i Pro forma combination of Pennsylvania, and New York Central; 1958-67. Source: ICC Transport Statistics. TABLE C-7A.-FREIGHT CAR-MAINTENANCE SELECTED RAILROADS; 1959-70 Maintenance expenditures for freight-train cars Freight-train car maintenance expenditures per car owned (millions of dollars) (dollars) 1198 956 807 1091 989 910 873 990 920 .. 916 692 901 830 846 801 814 652 760 817 776 872 821 629 783 811 801 823 764 616 922 842 826 864 849 684 963 871 803 965 890 728 899 896 840 971 843 724 907 882 865 904 951 750 942 932 924 942 779 761 950 925 910 945 840 733 976 974 960 991 780 661 1198 New Balti- Chesa- New Balti- Chesa- Penn Pennsyl- York more& peake & South- Penn Pennsyl- York more* peake & South- Central vania Central Ohio Ohio em Central' vania Central Ohio Ohio ern 1970 1969 1968 1967 1966 1965 1964 1963 1962 1961 1960 1959. 1958 86.4 . 27.8 25.1 23.2 511 .. 466 329 469 70.7 . 23.8 22.2 19.4 22.2 20.1 18.5 20.4 19.4 16.5 404 314 290 279 306 381 348 305 287 256 227 425 58.9 . 432 55.3 31.3 23.9 423 57.2 32.8 24.5 21.9 19.6 15.7 285 279 295 334 240 363 56.7 31.1 25.7 20.9 18.0 15.1 276 257 303 302 214 352 62.7 34.3 28.4 19.3 17.0 13.8 306 287 332 257 199 335 62.7 35.1 27.7 23.3 16.1 14.1 282 262 313 322 184 357 58.8 29.2 29.6 23.7 16.1 13.5 250 207 315 319 184 338 59.4 27.8 31.6 24.5 15.9 13.5 240 189 313 277 179 337 68.6 35.7 32.8 26.8 16.5 11.9 260 228 305 300 169 291 80.7 43.8 36.9 27.8 15.9 13.6 309 292 333 292 163 323 65.1 38.7 26.4 22.6 14.9 12.2 226 223 231 235 153 284 ' Pro forma combination of Pennsylvania and New York Central; 1958-67. Source: ICC Transport statistics. TABLE C-7B.- FREIGHT-TRAIN CAR UTILIZATION AND BAD-ORDER RATIO Freight-train car-miles per car (thousands of miles) Bad-order ratio 2 (percent) New Balti- Chesa- Penn Pennsyl- York more & peake & Central' vania Central Ohio Ohio Southern 1970 20.1 19.2 15.4 19.8 1969 20.2 18.9 19.5 19.7 18.4 17.7 14.8 15.3 15.1 19.9 1968 19.0 1967 17.7 22.2 21.8 1966 18.7 17.5 20.6 17.5 15.6 19.6 1965 18.3 17.2 20.0 16.8 15.2 18.8 1964 17.8 17.3 18.6 15.0 14.2 19.4 1963 16.0 14.9 17.6 15.6 13.9 19.4 1962 15.3 14.3 17.0 13.9 12.9 18.9 1961 14.2 13.2 15.7 11.3 11.9 18.4 1960 14.2 12.9 16.1 12.4 11.5 17.0 1959 14.5 13.6 15.4 11.6 11.6 17.9 1958 12.9 11.8 14.5 11.3 12.1 16.8 Penn Pennsyl- ntral ' vania New Balti- Chesa- York more & peake & Central Ohio Ohio Southern 3.8 5.5 5.9 6.8 2.3 3.1 3.9 3.6 6.5 7.9 6.8 3.5 3.4 3.8 5.0 4.1 3.0 4.4 6.6 6.1 2.5 6.0 7.5 4.9 3.0 7.1 10.1 5.6 3.1 7.7 14.9 5.4 3.1 9.3 22.4 7.2 3.1 10.7 18.9 6.6 3.7 8.6 18.0 6.4 4.4 6.2 5.6 6.3 6. 5 9. 6. 4 8. 6 6. 3 7. 7 7.4 8.4 11.9 15.2 12. 8 16. 2 13.1 15.8 12. 7 14. 1 13.9 17.5 12.2 15.9 7.2 16.0 3.6 4.8 ' Pro forma combination of Pennsylvania and New York Central; 1958-1967. 3 Percent unserviceable of total freight cars on line (average of 4 quarterly counts). Source: ICC Transport Statistics, and AAR Operating and Traffic Statistics. 96 TABLE C-8.- SELECTED LOCOMOTIVE MAINTENANCE AND PERFORMANCE MEASURES- AND NEW YORK CENTRAL, 1958-70 PENN CENTRAL, PENNSYLVANIA RR. Year Maintenance expendi- tures for locomotives (millions) Maintenance expendi- tures per locomotive unit (thousands) Mileage per locomotive unit (thousands) 2 Percent unserviceable of locomo- tives assigned to freight service Penn Penn- New Cen- syl- York tral > vania Central Penn Cen- tral ' Penn- syl- vania New York Central Penn Cen- tral ' Penn- New syl- York vania Central Penn Cen- tral' Penn- New syl- York Eastern vania Central district 1970 100.5 1969. 81.9 1968 71.4 1967 74.9 1966. 76.7 1965.. 79.9 1964. 79.6 1963 76.8 1962.. 85.1 1961 81.8 I960.. 87.0 1959 89.2 1958. 79.1 24.1 19.5 13 3 46."i 34.8 18! 1 42.6 34.1 17.8 46.0 33.9 17.7 44.3 35.3 17.7 42.4 34.4 16.7 51.3 33.8 18.2 47.2 34.6 17.0 46. 8 40. 2 18. 1 51.3 37.9 18.5 46.0 33.1 16.4 42.7 41.3 33 5 18.T "18.5 45^5 18.0 17.6 46.0 18.1 17.3 45.5 17.6 17.8 45.2 16.4 17.1 20.7 19.3 16.7 20.6 17.2 16.8 19.8 17.1 19.5 21.3 18.8 18.1 21.5 17.0 15.6 21.2 8.9 7.9 11.1 43.7 47.5 11.3 44.3 48.1 13.2 42.5 49.4 14.5 42.7 48.4 13.7 20.8 20.7 14.9 20. 4 20. 8 16. 1 19.1 20.7 15.4 20.3 22.5 10.7 21.1 22.1 11.0 20.9 21.5 12.8 11.9 9.7 10.0 10.6 13.5 11.8 12.5 10.1 10.7 7.5 7.1 !:? 10.? 10.1 10.9 8.1 8.7 8.9 > Pro forma, combination of Pennsylvania, and New York Central; 1958-67. 1 Figures prior to 1964 indicate mileage per locomotives in train (number of locomotive units varies with the number of units attached to a train). Source: ICC Transport Statistics; ICC form A, annual railway reports; AAR, OS series. TABLE C-9.— MAINTENANCE OF PHYSICAL EMPLACEMENTS-PENN CENTRAL, PENNSYLVANIA RR., AND NEW YORK CENTRAL, 1960-69 Rail replacement Crosstie replacement Tons laid (thousands) Tons laid per mile of track Crossties 1 aid (thousands) Crossties laid per mi leof operated track operated Penn Penn- New Penn Penn- New Penn Penn- New Penn Penn- New Cen- syl- York Cen- syl- York Cen- syl- York Cen- syl- York Year tral' vania Central tral i vania Central tral' vania Central tral > vania Central 1969 30.1 . .. 122.6 . .. 115.7 71 238 287 297 275 1,478.3 1,246.6 1.519.9 34.6 1968 28.9 1967 65.0 50.7 787.4 732. 6 37. 7 36. 39.7 1966 75.5 29.1 46.4 186 132 249 1,362.8 658.3 704. 5 33. 5 39. 9 37.8 1965 99.3 54.3 44.9 243 246 237 1,477.6 791.6 686. 1 36. 1 35. 8 35.2 1964. 89.3 49.6 39.7 215 221 207 1,399.2 737.6 661.6 33.7 32.9 34.6 1963 93.1 40.2 52.9 220 176 270 1,207.9 599.4 608. 5 28. 5 26. 3 31.1 1962.. 111.1 50.6 60.6 262 220 304 1,354.2 741.1 613.1 31.6 32.3 30.8 1961. .. 71.5 32.4 39.1 164 140 192 917.6 525.1 392.5 21.1 22.6 19.3 1960 98.1 47.3 50.8 211 203 242 1,297.7 760.2 537. 5 29. 3 32. 6 25.6 ' Pro forma combination of Pennsylvania, and New York Central; 1960-67. Source: ICC Transport Statistics. TABLE C-10— RAILROAD ACCIDENTS PER MILLION UNITS, SELECTED RAILROADS; 1960-69 Year Penn Central ' Pennsylvania New York Central Baltimore & Ohio Chesapeake & Ohio Southern 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 12.6 .... 8.0 6.5 9.2 9.7 7.2 12.1 .... 8.5 10.8 14.4 7.0 5.6 9.4 11.5 9.2 12.5 5.5 6.0 7.0 12.0 7.9 10.5 5.0 6.0 7.4 9.6 5.5 7.8 3.7 7.6 6.3 8.6 5.1 6.9 3.8 5.6 6.1 6.8 5.0 6.9 3.7 5.0 4.1 6.8 5.0 7.0 3.2 4.2 3.9 5.2 4.4 5.9 3.3 3.8 3.0 4.6 ' Pro forma combination of Pennsylvania, and New York Central; 1960-67. Source: ICC docket No. 35291, U.S. 34. 97 TABLE C-ll.— WAGES AS A PERCENTAGE OF GROSS OPERATING REVENUE, SELECTED RAILROADS; 1960-69 Year Penn Central < Pennsylvania New York Central Baltimore & Ohio Chesapeake & Ohio Southern 1970. 1969. 1968. 1967. 1966. 196 b. 1964. 1963. 1962. . 1961.. 1960. 55.8 ... 40.3 38.9 47.1 48.0 ( 2 ) 51.3 .... 31.9 49.1 .... 40.3 41.0 47.5 45.3 32.1 47.8 47.7 48.0 32.9 46.5 46.9 46.0 41.2 44.1 38.2 48.0 49.0 46.8 42.5 42.7 39.3 48.9 50.3 46.9 42.8 44.4 38.9 49.5 49.6 49.5 43.3 44.1 35.8 51.9 50.3 54.0 46.0 46.1 37.9 53.9 51.4 55.6 51.2 47.1 39.0 53.7 52.6 55.0 50.1 45.1 38.5 ' Pro forma combination of Pennsylvania, and New York Central; 1960-67. 2 Not Stated. Source: Moody's Transportation Manual. TABLE C-12.— GROSS TON-MILES PER EMPLOYEE i SELECTED RAILROADS; 1960-70 [Thousands] Year Penn Central ■ Pennsylvania New York Central Baltimore & Ohio Chesapeake & Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 2,118.2 2,109.5 2,079.3 2,100.8 2,163.4 2,265.4 2.064.0 2,136.4 2,187.2 1,945.5 2,008.1 2,058.7 1,825.8 1,952.0 1,834.4 1.723.7 1,885.3 1,738.1 1,628.2 1,726.3 1,645.8 1.520.1 1,596.7 1,563.9 1.442.8 1,462.7 1,532.1 2, 990. 7 2, 727. 6 3,453.4 2, 967. 7 2,549.6 3,467.9 2,776.8 2, 579. 4 3,198.7 2, 629. 3 2,722.4 3,140.0 2,549.6 2, 849. 4 3,019.1 2,506.0 2,902.5 2,625.0 2, 288. 5 2,731.9 2,481.9 2,115.7 2, 642. 9 2, 063. 8 1,913.7 2, 409. 1 2,005.3 1,782.6 2,287.6 1,882.1 1,733.5 2, 326. 5 1,793.1 i Gross ton-miles of cars, contents and cabooses (freight and passenger.) 2 Pro forma combination of Pennsylvania; New York Central; and New York, New Haven & Hartford; 1960-67. Source: AAR, OS series; and ICC forms A & B, railroad annual reports. TABLE C-13.-GROSS TON-MILES PER SERVICE-HOUR, SELECTED RAILROADS; 1960-70 Year Penn Central 1 Pennsylvania New York Central Baltimore & Ohio Chesapeake & Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 852 .... 1.286 1,232 1,509 853 .... 1,277 1,139 1,487 840 .... 1,182 1,110 1,370 874 905 941 1,133 1,147 1,361 843 893 871 1,082 1,155 1,284 795 839 818 1,072 1,147 1,105 746 809 741 966 1,043 1,058 712 779 706 919 1,019 885 683 739 678 843 943 879 642 684 652 784 910 843 616 646 633 763 926 800 i Pro forma combination of Pennsylvania; New York Central; and New York, New Haven & Hartford; 1960-70. Source: ICC transport statistics. TABLE C-14.-GROSS TON-MILES PER DOLLAR OF COMPENSATION, SELECTED RAILROADS; 1960-70 Year Penn Central > Pennsylvania New York Central Baltimore & Chesapeake & Ohio Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 204 .... 319 291 355 219 .... 333 286 368 231 .... 332 310 361 254 267 267 345 332 377 261 275 269 332 351 384 254 267 261 337 353 344 252 269 254 332 350 353 247 270 245 319 354 298 240 259 239 297 333 302 231 245 234 285 328 297 227 236 233 282 342 289 ' Pro forma combination of Pennsylvania; New York Central; and New York, New Haven & Hartford; 1960-70. Source: ICC transport statistics, and ICC wage statistics. 98 TABLE C-15— COMPENSATION PER SERVICE-HOUR, SELECTED RAILROADS; 1960-70 [Dollars] Year Penn Central • Pennsylvania New York Central Baltimore & Chesapeake & Ohio Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 4.18 .... 4.03 4.23 4.25 3.90 . 3.83 3.56 3.28 3.99 3.58 3.45 4.04 3.66 .... 3.79 3.43 3.40 3.52 3.61 3.23 3.24 3.24 3.26 3.29 3.34 3.12 3.14 3.14 3.17 3.16 3.21 2.96 3.01 2.91 2.91 2.98 3.00 2.88 2.88 2.89 2.88 2.88 2.97 2.85 2.86 2.84 2.84 2.84 2.91 2.78 2.80 2.78 2.75 2.77 2.84 2.72 2.73 2.71 2.70 2.71 2.77 ' Pro forma combination of Pennsylvania, New York Central and New York, New Haven & Hartford, 1960-67. Source: ICC transport statistics, ICC wage statistics. TABLE C-16.— NET TON-MILES OF REVENUE FREIGHT TRAFFIC PER MILE OF ROAD OPERATED, SELECTED RAILROADS, 1960-69 [Millions of ton-miles) Year Penn Central 1 Pennsylvania New York Baltimore & Chesapeake & Central Ohio Ohio Norfolk* Western Erie Lackawanna 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 4.33 ... 5.22 5.10 4.88 6.70 6.75 6.90 7.02 6.80 6.55 5.36 4.38 .... 5.15 4.48 5.40 4.04 4.86 4.50 5.63 4.00 4.94 7.00 6.64 4.94 4.40 5.40 3.84 4.64 7.00 6.41 4.64 4.10 5.05 3.48 4.28 6.62 6.00 4.28 3.90 4.86 3.30 3.86 6.49 ( 2 ) 3.86 3.74 4.66 3.18 3.94 5.86 3.94 3.52 4.35 3.06 3.63 5.38 O) 3.62 3.55 4.34 3.12 3.62 5.72 ( 2 ) 3.60 1 Proforma combination of Pennsylvania; New York Central; New York, New Haven * Hartford; 1960-67. ■ Not available prior to W64. Source: Estimated from ICC, Docket No. 35291, V.S. 34, chart E-8 TABLE C-17— MILEAGE PER LOCOMOTIVE UNIT, SELECTED RAILROADS, 1964-70 [Thousands of miles Year Penn Central' Pennsylvania New York Baltimore & Chesapeake & Central Ohio Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 42.7 .. 54.2 55.2 50.5 53.0 76.9 41.3 .... 69.6 41.1 .... 57.7 53.3 74.8 45.5 43.7 47.5 54.8 51.5 68.0 46.0 44.3 48.1 57.7 54.7 70.1 45.5 42.5 49.4 53.6 54.5 65.9 45.2 47.2 48.4 50.1 52.5 68.4 1 Total locomotive unit-miles for freight trains per locomotive units at close of year. Figures not available prior to 1964. 1 Pro forma combination of Pennsylvania and New York Central; 1964-67. Source: ICC transport statistics. TABLE C-18.-CAR-MILES PER SERVICEABLE FREIGHT CAR-DAY, SELECTED RAILROADS, 1958-70 Year Penn Central 1 Pennsylvania New York Central Baltimore & Ohio Chesapeake & Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 1959. 1958.. 40.9 50.2 57.9 57.3 52.2 44.2 44.6 44.7 46.0 56.5 39.4 61.6 39.3 52.5 40.3 40.8 40.1 42.8 40.0 42.0 37.3 49.7 50.4 41.9 40.4 40.0 41.3 50.5 46.5 39.2 40.2 40.0 41.7 42.5 42.6 44.0 36.7 36.3 38.6 41.8 43.4 43.0 36.7 35.8 39.0 38.0 39.7 42.4 36.1 33.9 37.8 37.4 36.5 40.8 36.7 33.7 39.2 38.5 35.6 39.9 35.5 34.4 37.7 37.3 36.7 43.8 33.8 33.5 34.0 34.7 35.4 43.1 1 Pro forma combination of Pennsylvania and New York Central; 1958-67. Source: A.A.R..O.S. series. 99 TABLE C-19. -GROSS TON-MILES' PER FREIGHT TRAIN-HOUR, SELECTED RAILROADS, 1958-70 Year Perm New York Baltimore & Chesapeake Central 2 Pennsylvania Central Ohio & Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. '963. 1962. 1961. 1960. 1959. 1958. 72,376 ... 76, 307 82, 886 69, 002 68,883 ... 76, 194 77, 522 67, 169 72,281 ... 66, 024 83, 489 65, 230 73, 644 71,550 76, 557 63,913 76, 452 66, 859 71,222 69, 441 73,795 63,457 74, 348 63, 794 67, 657 66, 176 69, 761 66, 131 75, 383 57,453 64,912 64, 196 65,959 65, 424 79, 954 60, 325 63,336 63, 790 62,716 64,656 76, 320 59, 604 62,112 62,413 61,647 63,956 73, 576 61,220 59, 380 58, 858 60, 056 57, 865 72, 024 59, 490 57,960 56,134 59, 458 56, 849 71,546 56, 225 56, 190 55, 770 57,159 55, 243 75, 882 58,410 54, 903 55,967 53, 554 54, 751 78,052 53, 844 ' Gross ton-miles of cars, contents, and cabooses (freight only). 2 Pro forma combination of Pennsylvania and New York Central; 1958-67. Source: A.A.R., O.S. series. TABLE C-20.-PERCENT LOADED OF TOTAL FREIGHT CAR-MILES, SELECTED RAILROADS: 1958-70 Year Penn Central i Pennsylvania New York Central Baltimore & Ohio Chesapeake & Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963 1962. 1961. 1960. 1959. 1958. 58.2 .... 57.9 58.3 58.6 58.6 53.8 54.1 54.7 53.3 58.5 58.8 .... 60.1 58.7 .... 59.8 58.9 60.6 57.0 58.3 60.1 61.9 58.0 59.7 54.2 59.5 59.8 61.6 57.6 58.9 54.9 60.7 59.6 61.3 57.4 57.5 54.3 60.3 59.9 61.8 57.6 58.0 54.2 59.0 59.6 61.8 56.9 58.7 54.1 60.6 59.1 61.3 56.6 58.1 54.4 61.8 59.1 61.2 56.7 58.4 55.2 62.3 60.4 62.6 57.8 59.4 55.3 64.2 58.9 61.0 56.2 59.7 54.7 62.5 ' Figures for Penn Central are pro forma prior to 1968. Source: AAR, O.S. series. TABLE C-21— NET TON-MILES PER LOADED CAR-MILE, SELECTED RAILROADS; 1958-70 Year Penn Central ' Pennsylvania New York Central Baltimore & Ohio Chesapeake & Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 1959. 1958. 43.5 .... 44.8 43.9 45.6 44.4 60.2 57.7 56.0 53.7 46.7 43.3 .... 45.2 42.6 . 44.3 41.1 43.0 40 43.0 41.0 42.8 39.9 44.7 51.2 43.1 39.9 41.5 39.0 44.5 50.3 42.2 38.7 40.3 37.9 43.9 50.4 39.4 37.4 38.6 37.1 41.8 50.6 37.9 36.4 37.5 35.6 40.8 49.2 36.1 35.5 36.4 35.1 41.2 48.0 34.8 34.1 35.8 33.9 39.6 48.8 33.1 33.5 34.4 33.2 38.2 49.0 32.5 33.3 34.2 32.9 37.2 49.6 31.9 i Figures for Penn Central are pro forma prior to 1968. Source: A.A.R., O.S. series. TABLE C-22.-NET TON-MILES PER FREIGHT CAR-DAY', SELECTED RAILROADS; 1958-70 Year Penn Central 2 Pennsylvania New York Central Baltimore & Ohio Chesapeake & Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961.. 1960. 1959. 1958. 1,033 .. 1,302 1,462 1,432 1,391 1,543 1,005 .... 1,673 980 .... 1,529 1,360 1,367 1,317 1,390 992 1,063 3 916 1,073 1,049 1,113 3 974 1,324 1,400 1,077 997 1,021 3 966 1,325 1 285 997 955 989 908 1,074 1,168 1,040 747 734 766 910 1,125 939 708 694 729 767 999 990 655 638 680 696 886 843 652 635 676 722 896 800 631 610 662 692 930 875 566 589 582 647 926 817 ' Serviceable Freight Car-Days, only 1964-70. 2 Pro forma combination of Pennsylvania R.R. and New York Central; 1958-67. 3 Includes Pittsburgh & Lake Erie. Source: AAR, O.S. Series. 100 Dollars 1969 101 Dollars Penn Central Pennsylvania *tW YorX Central Hew York, New Haven & Hartford 9000 i Iter folic 6 Western ^Baltimore & Ohio Chesapeake & Ohio J- Southern Erie Lackawanna Miscellaneous JUL Fern WC£ arTZACK OpsfZATBD 7500 6000 ■ ■* 4500 3000 1500 fSSiipfi/| IC C OQZKtrr^S&l R=F - r f, ^ffiSSSffi .^ gSM - irrr gaM-i r-Ffflte ■ ' I ' i i »-rrt-:v — rrn — rvrr I ix: ■ ry I 102 Dollars '500 12 .0 1000 750 500 J 250 LEGEND | Pann Central Pennsylvania ■ew York Central Mew York, New Haven & Hartford -£BE NYE -J-LL JUtl tffl . ' X- .L^JW gT" :;:rrvi:: ' I P ill '— " 1960 1961 1962 1963 1964 1965. 1966 1967 1953 1969 103 Dollars 7500 6000 4500 3000 1500 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 104 Tons 1960 1961 1962 1963 1964 1965 1966 1967 1968 19f,9 105 u i 0> 51 &3 ill 4 II i! Li 4 r * % * % 9, * $ * Hit i fc< < K ^ o - ■v -- 106 So SO \ ^ & o 3^ V) _4 ,_ KJ 1. v\ z \J Hi. U u -- -r- 110 Ill 112 •p u « 3 a c n id m flj jc a> fc -p -W ? K H (6 C flJ C> fin o > o o «-♦ • > >■ o C C " V • •.90 O £ a, at a is O Ol 00 113 Bi-H ' *C ! FH : H FT5 \ v i — — i •■■-■-• sip . 1 -L. I - *8 -.v-.i tli-!l .-. •. - ■ > ' ■■ V "" • - Jul W \ ^^ V: !K U-«J ^ 7 'TM , ry -H-ff tttiriitt *■ ! Pzn^h n _. V.; : I > ;• ! i- L r 444- 4J- fctft V J-4:l itttj mi : | • i i Nli 1 c o ■H fc -H il mo; x-«h ! - -P cn o C 1 •H (0 C gi c > x r-t m ^ ^ C V ^* - 2 \ j -lit ± - \r - k- ^ J -V 1 V 1 1 1 \ N 1 / 1 __£tfc 4I P ,., ..... I , , I4 Jul x V 44\ ' i4 U4 it \\ 4t 34£ I ^0 1 ' \ i # 3 V ^ h * -£ C 7 - i 5 f x [ H _Jl.___ n4^t\ K ■ ~~z' * ^ 4r- ' 1 « ^ Jf L "1" ♦ ^ ~+~ Tpi " Ml ^ • !ii 1 n , 11 \ A ! X ^4^ 4lt r 4^ C ill X- v ]J^ \ ll • r| \ Vli \ Nv T' li 4 ~uj\ 1 1 m. lv. I 1 V 1 I 11 1 1 O 1 li i , . .... . -a i V - ^ £ 4^ ^ -" • Jl ' " 4^ 41 -.L. 41 r- 4^ ^ 4riflL4t r (V it: 1 Ml ! ' V> -- -4 1—4 m ' t ■ Ll i I ' 1 44 4 T 4: « •> . 1 1 1 i r ' m 1 1 , II II , 1 Hi , | 1 ' ' i» n 1 u 1 1 i — 'in 1 1 1 1 > « o 9- O s c T * '» 3 5 r >Q 2 I - - _ cj _ !_ __ __ _. >i J I £ S 4-S S _ o- 4j * T^ If ) - it ^ - '-it*- it V i ^ , ^ - tit I ^ i s * * 4 ! « ; \\ <*. I 'it *•' 5 ft. -I- ,_J_ £ » -I it > ■* *r ■ "" 1 1 13 * -1- - '!' 15 ZM,_ JI *l ■ J '4 i» n' ^ 1 I 3 — ? 1 cr t T *■ || ^t 2 zE - , 2 ft d S r . ,. . >• T ? a it c ^i¥- Ir 9 i 5 ~ 3^7 J *«j - - X - .* S . ± ? ' I / i IT i/t tt TI t ~ r M 1 s 2 : it h ztz ± H Q J 3 t S t // I ; I O M 4 . ■ ■ r -t *s it t iii it ± •. / /r - .Si It ilM f y U ll in« ft j fulfill ^^11,111111111^ II Mil Ml Ml HHWU 3 « VI w ] I ' i ! 120 i 121 15 4 I ! - <* vi V V kj (^ *. * 2* V) i* vl -j 't uq Vj o 122 123 Penh' Dollars 300 200 100 90 80 70 60 50 40 30 20 Eii- Millions r £■< £• ,s ■.;••■ :< .'v. , TJ; of - 'Baltimore & Ohio ~"*~T i ! /NorfolK & Western ••»••• --«f»**^H Chesapeake & Ohio Southern^ ■ ,-.'.. ■*'■•,. 'Erie i Lackawanna :rri!T_4iH:LT2 i^iavi^iV^iii: 1 , . . -4- ; — . ^r^xrz 1 — ■ ~*r~ — • — ^-^ f^' . L " - ^ — ~ ' . 1,--- ^-- ^^-^ » ■ an *■ ■ • • ■ ■*■■ 1 » — : — j — ; — : p ....,,... 1.. U.-—V*'*" i_I_ ^-i-u-i-i-l I i ;-|- Jlfni|-^-!Xp|J--j^4- 44 ; i~: ■t-r iGttm n 3S 10 9 8 ~r -f-H-H -M-4- 1 Ua-rtJE:' -f-h-!- + r-t-r -t-t- L.J'.;. i±hh — i— r- -f-f-H _l. i-n- ?tTt -1 — +-H- m- +++■ littt Si i ; £a<,t£J^n £>'s-rpuc"r /ffi/ue&ws : - - - r .: 19&S- S5&? V : 1965 1966 1967 1968 1 %9 - k/3 - 74-924 O - 73 - 10 124 Millions of Tons \ Penn Central * : Baltimore & Ohio — '- — -— • — — Norfolk & Western ••••••••— Chesapeake & Ohio ■— ■ Southern t Erie Lackawanna ' n . — — ■ — 200 100 80 60 40 * , ^- awry ^" > ^ ■ t> >-^- '- ' " * I " ' * ' "' " - V .-+-.- .-«...,...,--. 4 ... -. " -f '- — ' ■ - - ■ f ""- — --' ^trr -(-tij-i-xi" 1 -H- 20 itt 444: 3=r -U4- 10 -;--; - ~^frtT""^" •fff :xp -r-r J- r- u4: -i-^4- -14- ffl+ -ft — ; 1 ; 1 -ri— H-H ■44 j i_ m* +4- :n±i 44- -t-r — I — • — ► — r- tffi 4 - 4-1-4-1. 44- -14 jfitJ -r 1i:".. 44-44 XT 1965 1966 967 968 969 64- 125 Dollars 2.6 1.8 1.6 1.4 -G5- 126 Millions of Dollars 400 300 200 100 - U^J ; ; i r j H.: ; j : : ; \ \\ iK-n-HIjJH ttlliii'jti^H'Hillfei ^ 128 Dollars 5.4 5.0 4.6 129 o o 2 •' Ba ;% :irnore ^ & ' Ohio.;',— ^^-^-i.if;j*^ folkV&^Western"**---*-^'-'' sapeake & Ohio ''''m'' ,— - :hern ' ..". ! 7 ^''.'^ ^ Jfcrle Lackawanna ■»«•'■■ - ^51- 130 Millions of Tons ,„' H ' V 'I ' t n i j i j i Penn Central Baltimore & Ohio — - Norfolk & Western •••*T»-i--«-ff»« I -:i4-l Chesapeake & Ohio ' ' ■■ "' ■ ' ■ ' i > —~*-> : : '■ r-i Southern —-—,-— .■.•?• H '■• : ! ■■■ "™Vj--t-Tf'i i"M- ; r4-i ; : I :• s : __Erie_ Lackawanna 1 1 1 1 I H ! i Mil i 7- H ! ! ! j i iT' ! ! I =-?■!-■ 14 iH !"Hi|"Uh -1 '4-H- : I -1- T5fefe" T9*7 w -7fc- 131 Dollars 2.8 2.6 2.4 2.2 2.0 1.8 1.6 1966 1967 132 Millions of Dollars 200 100 — mz jjqii : u thtIT h —-ffl i-ll" 11 £ ffS i 4 TOT "T9S6 79S7 TW T9^- 133 H^S T355 T%T 1^58" "T95T i •*> 134 Dollars 4.6 4.2 135 Millions of Dollars 100 80 70 60 50 40 30 20 444- r -i4 n-±:rt 10 4-U ra ~ 44- 5S -U. *^ -i-i- ; ; ; ; j ; ; _■ j j ; ■ - ; j ; ; ; j 1 ; ; J ; | -1 ; ; mw- ;l =•; nM}m^^m^^x^m^\^: — — 1-> 4--r-r^4--t.-^ >> -r < ''* r - i —- -?- • • ^ -^ — ■■«'■• --t— . — — *-\- \:-y^^vr. - i~ . -+-H- it— i*t* -t-r i i ; -r— r-r I • i : rrrrr ,'j.U" rrffv t t ; ' rrtrrr: ::L I , ! T^ST ■ I i i -.4-i-i T^6T ffi ' iiT ±±tt T3ST iSj^ffittnfrtif^ t-TTT I- iw T9ST 136 Millions . of Tons J?enrv Central' Baltimore & Norfolk^ Western Chesapeake & Ohio -—■■■■ Southern Er ie Lacka wanna r , <-' ! I I Ohio 1 j I ] r mm' -»-H- i -j ' NT' 4 ■>-! 1 1-4- i j- |i| i i |i lj-j -^-T-r:- ; ; i i i : ■ ! . i HJl 1-1 ! : j i i i j 137 Dollars 6.0 5.6 5.2 4.8 4.4 1965 1966 L967 138 -i 6~ 139 Millions of Tons Ct-/ARTT C'40 TONS OF STONE, GLASS AND CLAY PRODUCTS, EASTERN DISTRICT RAILROADS, 1965 - 1969. -3-}~trt -| -t-r -f-t-f-j-t-l-i-j rt . | \..\-\-i. -> t- t-l-t-i^-1 | ter\n Centra^ ; : fj '"fch^gapg'ake; & Ohio ■ < ' " *" i-iXi 'Eri£; Lackawanna ."■— ■■■!■■*■ — »fe' H — -j ^^~\~--<^---*-. : "•**>■ «...»..,» i • f .-swr. ■> - - - - --j~,^s ; ■ \ — — T55S T52? TC57 7968" ::: :: : in iTn^twf 753T 74-924 O - 73 - 11 -•n 140 Dollars STONE, GLASS* & CLAY PRODUCTS AVERAGE REVENUE PER TON 1965 - 1969 4.4 4.2 4.0 3.-8 " 2.8 i- ! m ill .... 1965 T-rPeJTfiT Central*" " , „ "Baltimore & Ohio Norfolk's. 1 Western • — Chesapeake & Ohio i "■ ■ ■' — ~ — Southern; . ; •■" — - — -':—.-- Erie Lackawanna .■ — — .-■-* '%***. ■rir ..wf: |!;H. : : | I i . I Iti I T; IB H- 1966 1967 1969 on 1969 P noMC 141 Millions of Dollars 100 CHA*r'C-4Z "PULP, PAPER & ALLIED PRODUCTS - REVENUES EASTERN DISTRICT RAILROADS 1965 - 1969 t-t-t-t+Tt-J- -J— t— 1— J--S- t-t-i -t-t-i-i - **&ii\£fae &^ife\3g#ii d 1: I I f ■ /3bva/ Cehtra i. PC l i— -i— 1-_ A/oat "f"t~i~1" ^"^SApeAKe: £ Of-tio «—■■—■ »— DecAMiRZ f Hudson «_ 2£ H ^m. _ H fj | ?-;■♦ -:-|-i-t--! -i t :-t-r- -; 1-1-: !:;::;;" 10 yv?sr»j»^ ■ ■ • • ^i? "is* j*j^ ■'"* s uosoU — — *— — : I ; i £5E 143 Dollars PULP, PAPER & ALLIED PRODUCTS AVERAGE REVENUE PER TON 1965 - 1969 5.8 5.6 5.4 5.2 .Penn, Central ' -i-1— Baltimore & Ohio Norfolk & Western ••••• Chesapeake & Ohio— — Southern — ... Er Le Lackawanna; ' ■— ■ f34 if ■ ■ • 't | L 5.0 4.8 4.6 4.4 4.2 1965 1966 1967 1969 1969 a 3 144 Millions . of Dollars Cm a fir C~4S FIELD CROPS - REVENUES EASTERN DISTRICT RAILROADS 1965 - 1969 ~F~ Perm Central' i Baltimore & Ohio — -— -— — ■*—- ■ Norfolk & Western ......1... Chesapeake & Oh io — — — — '■ *— "^" r "j-Hr^ Erie Lackawanna TjTvr n ttt~ rrn -. i i i i : r j -i -:— bj v i ; ■ I : 1 -f : i : ■ : -i- : : | : : : : i : : : : 1 1 : ; : ; : T"*-r - i ::;:;::;: i : :t: -$q- 145 Millions " .of Tons Chart C-46 TONS OF FIELD CROPS EASTERN DISTRICT RAILROADS 1965 - 1969 H 5 * Penn Central' ' 1 Baltimore & Ohio *— - — r^r^H LLLL Nor folk & Western ^•-••••t^ i- 4 — i— | — Chesapeake & Ohio— — — — •"■'_•— -■"-» j- 4- 4 U- Southern —- — - — ■■.I 4- Erie Lackawanna. ' — ■— ■<■», ;; . ,.- ;• _4_ # ,.«2££2"s.,._! J_ \ , , _- " J— ..'> — 1_ - -i - — ' . " ■ " 1 — I — - " -• " * " ■ i — -*»**^ — • — • — * — • — ■ — * — - — *— • — '— * — '• — ** •* — * — — - — ■— - -»-- — • - • - : — * - - ■ ^ — « — ■ — ' — - ■ ' » * " * — • ' : - ' : ■ * Li r.: \ ~ :.i i ir:.:: : : : ■ . -' :::: i .: : ;t - ~ : ■ j .: :~ ,~|.: ■ _ V f^v-re ■ it r "; -rrr : : ~r — ,\> 146 Dollars Cmjplt C-47 FIELD CROPS AVERAGE REVENUE PER TON 1965 - 1969 4.4 4.2 4.0 ;Penn Central jBaltimore & Ohio iNorfolk & Western Hchosapeake & Ohio ^Southern Erie Lackawanna i K- ft -J. — -— - — j 3.8 1965 1966 1967 7 968 1969 . > 147 Millions of Dollars 148 Millions of Tons _, — >— r . &*-? — * — * — * -■*- ■*'•' ■«■ * — --*-~T i ' x~ " \. * " * — 1~~*~ ■ | Baltimore £' Ohio ■- ^a^r)A~tinim /yfiBp, TqAT^RR/, : — M-Tt-flr-rt- ;»i; — iriXiX 7 " 1- X t_r X vm 149 Dollars - LUMBER & WOOD PRODUCTS AVERAGE REVENUE PER TON 1965 - 1969 4.6 3.8 3.4 ii .HBfizJi: m i m Tenn Central'' -Baltimore & Ohio Norfolk & Western Chesapeake & Ohio ■■ — » ~~ : i— Southern -Erie Lackawanna ,'j,.. f" m ^-H^mj iTrf mm ff^ 3.0 ; ; t m ill ■ rn -Ht- 111: 1965 1966 1967 1968 1969 i! 1 ; •jJ 150 o Q --...' o - 151 152 Dollars Cas^&t- C-53 MOTOR VEHICLE PARTS & ACCESSORIES AVERAGE REVENUE PER TON 1965 - 1969 Perm ifientraSr" Baltimore & Ohio Norfolk & Western •• — Chesapeake & Ohio — - ' Southern *e Lackawanna i 1965 1966 1967 1968 1969 -S3l- 153 ^Millions. of Dollars -PETROLEUM - REVENUES EASTERN DISTRICT RAILROADS 1965 - 1969 i ; ! -r-T-t-1 t ±±J* ! I Pehn : Central 1 Baltimore & Ohio — - — -'— -—- - \- Norfolk & Western ••••■ Chesapeake & Ohio ». < '■ *— ' liSouthern . : . . ; , '_ ' - -i. — • '-- f[ "j_T"JBrie Lackawanna T " ' ' ' -■- ,l S*?^ 154 Millions of ' Tons Cha*t C-SS .TONS OF PETROLEUM MOVED BY SELECTED RAILROADS, EASTERN DISTRICT, 1965 - 1969 lltfl -^:fi-\-t-t~i rtr|- | -t-i-tr-i-t-t-i-t t tit? Penh Central - Baltimore & Ohio — -~— « -*» m i» Norfolk & Western •*•;•■••••'•• Chesapeake & Ohio — — — - — ,— • ' " r • Southern ; -j H-4. Er ie Lack awanna •-» -•< 33±]i:fi4i--^ffi •-■ H i-H -m w +-- r 4H~^-^^ ^^FH^^- irl- - Liii ■4-. . t -94- 155 Dollars 1965 1966 1967 1968 1969 74-924 O - 73 - 12 156 Millions of Dollars |-_: : ; ;- j ; ;•; ; ;) jig j 1^ : i r, ; ;-i i ; ; : ;;)-; '■ i S^f: \ \ j ;; ; ; [ : : : : i.:^: i : :44 5 3= 157 .i.:.:~i ;-U^- i_i_ -i :.) i 4_;-»_i-4-^ ffi^ = FRr = FR = Ft±tt -H+t- i - 1 i TE: 4-i W4 ~H4-M I 1 ; 4- .j_L i±±^ :£U=ttx; I ! I ~i. I t •■ S - i ^H- hb J-ii-U-i ffiffH -U-l- C^^itrC-55 TONS OF MOTOS VEHICLES EASTERN DISTRICT RAILROADS 1965 - 1969 mzuzm-m .80 ~3~£:= : 1.: -3»32r,: :n:r ,40 — f-rf--f-r-H :ri4= -M- :ffi ■-P- xtt SE =tt= -hr H- -M-i- ■f-H-n-H 4+4- rf r ! I II I T~ r -(-■ Tt -1-4-47* ,20 j* +-I-H- 4_M- 4-i, T4=cr: ^++3 — r~r~r\i~!~:-'- 3S iit fct±"-H-H- tt -i_i- tT 4-4-4- ,10 ,<;_j._._i_i._L.^X .06 ^? i-r -14- : +>f i I : I a Penn Central' rjBaltimore & Ohio — — Norfolk & Western"- — — • ■■ Chesapeake & Ohio— ■'■■"—"' Southern — -»• — -■ L tE^ie; i.ackawanha £h^6 r&M*ia^/rtsMAr/o& \>Ff%&i W^l\ ;&M^tyJ5&s~£7. 1965 1967 1968 1969 158 Dollars 9.5 1965 1966 ufl Mil I'M M If -| I I I Hi i ff I 1 1 1 LLL 1 1 i hi i M 1-M 1 H t-l-i l-l-l-t I rhtJ 1967 1968 1969 llt .i Merger and the Road to Ruin THE INCEPTION The marriage of the Pennsylvania and the New York Central Railroads, like others, got much of its style from its psychological foundations. It was certainly not born in Heaven and blessed with Love, but was strictly a mar- riage of convenience with a strong dose of parental fiat. "Polite cordiality" may be too generous a term to characterize the resulting relationship. The chronology of the merger is extensive. Final and serious negotiations date from September, 1959, agreement was reached between the companies in January, 1962, and the application for appi-oval was filed with the ICC the following August. After near recordbreaking hearings, the merger was ap- proved by the Commission in April, 1966, and after further litigation was finally approved by the Supreme Court on January 15, 1968. With unseemly haste, the new company died on June 21, 1970. The Penn Central combination was the last of a string of mergers that had essentially restructured the railroad system in the East in about five years. Starting with Erie-Lackawanna, the East saw the formation of new combines embracing the Chesapeake and Ohio-Baltimore and Ohio, the Norfolk and Western- Wabash et al.. and finally the grand culmination — Penn Central itself. The entire pattern bore to a remarkable degree the seal of the PRR as em- blazoned by its chief executive of many years, James W. Symes. The Pennsyl- vania's influence was exercised in a general way by the vast weight of its support of other mergers, and by its courting of the Central, but more specifically through its veto power over the critically pivotal Norfolk and Western deal derived from its heavy stock ownership in the N&W and its control of the Wabash. Successful disposition of all of the other principal railroads in the East was believed to be a condition for Penn Central's approval. The long period between the 1959 negotiations and the 1968 merger attempt brought severe change in the external operating environment and in internal company conditions. The economy was sagging, railroads generally were losing market position, and the Eastern competitors had been uniformly strengthened by their mergers. Internally, financial vitality had been further sapped. It is customary for the ICC to attach conditions to its approval of a merger. Those arising in this case were casually prescribed, having been previously agreed upon by management and one or more of its adversaries in the proceed- ings. But they are of much more than casual interest or consequence. In addition to some standard requirements involving relationships with other railroads, two stand out as vital landmarks. The Commission's approval of the merger required the Penn Central to take over the bankrupt New Haven Railroad at a fancy price and with protection for labor substantially exceeding standard provisions. The intention of the governing statute is to preserve employment from merger consequences for a stipulated period. The Penn Central agreement, negotiated by the applicants and approved by the Commission, bought labor's support by a generous commitment to also recall previously furloughed workers. The inclu- sion of the New Haven eliminated the Executive Branch of the Federal Gov- ernment and New England from the list of opponents. MERGER PLANNING Extensive planning was carried on over a number of years in two main stages. At the time of the first negotiations in the late 1950's, the companies jointly and separately reviewed their operations and were in the course of com- pleting a basic plan of merger. Upon resumption of negotiations in late 1961, this work was refined into the operational plan presented to the ICC and de- scribed at length in its initial report. (159) 160 After the presentation to the Commission, additional studies were made which resulted first in the Interim Plan and finally in the detailed Master Oper- ating Plan. The Master Plan is said to have been completed after many months of effort on the part of the best informed people of both roads. The companies used a somewhat formalized organization for planning, guided by a system coor- dinator for each railroad and staffed by 36 representatives of 18 departments. The planning committees were to identify important decision areas, describe the approaches of the two companies, and adopt approaches for the new system. In addition to developing the Master Operating Plan, the planning or- ganization facilitated communication between the departments of the two companies. No formal record is readily available of the extent to which the departments had reached agreements or resolved differences relating to their postmerger organization, policies, and procedures. But there are many indica- tions, including the abortive merger consummation attempt, that the planning was ultimately deficient. Despite all of the apparent effort, the planning focus was primarily on a rather narrow consideration of plant design. The basic determination of the merger plan was the design of traffic routing which established the track and terminal capacity necessary to handle the expected volumes and maintenance facility requirements. But the steps or processes necessary to move from two separate roads and to achieve the design specifications were not spelled out. There is little indication that the top officers took the steps necessary to make the merger work. Stuart Saunders, PRR's executive officer, apparently devoted his efforts to the legal, political, and financial matters required to secure ap- proval of the merger, leaving matters of operational organization to subordi- nates. On the other hand, Alfred Perlman, his New York Central counterpart, was more concerned with building up his company's strength as an independent railroad. Under the circumstances, it is not surprising that planning decisions were made only in the relatively rare cases where there was consensus, leaving divisive issues largely unresolved. From the standpoint of top officials, too much public attention to the differences between the railroads might disturb public opinion and jeopardize merger approval. The problem of evasion was compounded by the absence of real decision- making authority until the merger was formalized. Since planning was being conducted by two rather equal partners without a dominant authority able to commit both railroads, neither could be forced to make concessions. Areas of disagreement had to await resolution by the Board of the new company. The frustrations induced by these fatal planning problems appear to be pointedly summarized in an eloquent memorandum which plaintively confided : "I am searching desperately for some concrete evidence of progress — completed projects, networks, etc.— but am finding little." 55 Subsequent performance sug- gests that this underlying problem persisted. Paper planning can be effectively aided by the accommodation of organiza- tions, facilities, and services in preparation for ultimate consolidation. This process was stifled by the long period of gestation from inception of the merger to its final approval, during which the outcome remained quite uncertain. With separate operations continuing, investments must be geared to the requirements of the individual roads, with little regard for merger-associated benefits. Neither company could spare funds for projects with a payoff conditioned by merger approval or for the entire cost of a project that might be jointly financed after the merger. Plant investment appropriate for the Penn Central required added capacity of the New York Central far beyond its needs as a separate road. For example, the Selkirk yard required only 70 classification tracks as an individual facility but 90 tracks for the merged company. On the one hand, the only protection was an investment moratorium, but this was not practical. On the other hand, it was no more feasible to ignore the merger possibility and proceed full-speed ahead on independent courses. There was simply no satisfactory solution to the problem. 55 Letter from B. Cole to F. L. Kattau, August 1965 ; see Appendix D, Exhibit 63, p. 702. 161 Uncertainty about merger approval and timing also militated against accommodation in other areas such as operating and accounting procedures. Neither company could afford the cost of changing procedures that were in- dividually satisfactory in order to adapt to an uncertain consolidation. Conflict- ing procedures — a reflection of incompatibility — are a common characteristic of these two large and long-time rivals. And even when new projects were adopted, such as the introduction of computers, differences of opinion about the merits of alternative approaches frequently prevented the adoption of consistent solutions. The ICC viewed the planning requirements passively. In its initial decision of April 6, 1966, the ICC denied a petition to reopen the proceeding based on a public reference by PRR Chairman Saunders to different operating plans than those testified about at the hearings. The Commission, like the examiners, did not expect the merger plan described in the hearings to be followed in any detail. It did not pursue the matter further, apparently assuming that managerial discretion governed by survival instincts and the profit motive would insure appropriate execution. At one point, the examiners noted that it had been proposed to reduce the number of operating regions from 14 to 10, but concluded without discussion that the board of the new corporation would make the final decision on the matter. Reflecting a host of unfavorable forces, premerger planning was largely a paper effort. Plans were produced, but little was accomplished toward resolving major interfaces — determining what was to be done and how, and accommo- dating differences between the two companies. The ICC was a passive onlooker through it all, no more aware of planning pitfalls than the managements or others. The similarities of the companies dictated the types of fusion that would be required to effect the merger — essentially head-on consolidation of the physi- cal plants rather than a linear linkage. The identity of geographic territory, parallel route structure, and similarity of size and traffic patterns meant that the benefits of merger had to come from consolidation of duplicated operations. The Central and Pennsylvania brought roughly the same tilings to the merger. Neither could offer any particular advantages in terms of complementary sea- sonal peaks in traffic, new territory, gateways, or complementary route struc- ture. The singular benefit was the opportunity to consolidate much of thoir east- west traffic over the Central's water-level route. Although slightly longer in some cases than the Pennsylvania's route, it permitted bypassing the Alle- ghenies' mountainous grades and curves. Principally, the merger would permit the elimination of duplicating operation and facilities and the integration of the organizations. But while the similarities dictated the merger requirements, patent differ- ences barricaded the paths to achievement. Such differences constitute glaring incompatibilities when two partners must cooperate to perform the same tasks rather than supplementary or complementary ones. The Penn Central was expected to be a complete consolidation of the two predecessor companies. Main line traffic was to be rerouted in order to achieve a pattern of maximum concentration of freight for the greatest distances over the New York Central's routes. The lines of the former Pennsylvania Railroad were to see a substantial decrease in traffic. The degree of consolidation is in- dicated by the magnitude of traffic rerouting, with estimates during the merger hearings that train-miles over the Pennsylvania's routes would decrease by one- third. 56 A switch of this volume required substantial additions to the capacity of certain terminal facilities; in fact, the hearing examiners believed construc- tion of a classification yard at Selkirk to be "the single most significant change in terminal operations" and "the key to the merger program." 57 Inevitably, a substantial relocation of employees would be required to handle the new traffic patterns. Saunders was proud of the labor agreement he negotiated, particu- larly because it permitted the railroad to relocate employees. 69 Interstate Commerce Commission, Finance Docket No. 21989, Penn Central Merger, Hearing Ex- aminers Report, p. US. Their report is reprinted almost in full in Pennsylvania R. Co. -Merger-New York Central R. Co., 327 I.C.C. 475, 566-1072 (1966). 57 Id. p. 122. 162 Effecting the complete consolidation envisioned by the Penn Central re- quired a number of steps. Basic requirements included the construction of physical facilities to handle the rerouted traffic, and the full digestion of a single set of operating procedures by employees. Uniform car control, billing, and accounting procedures needed to be devised and implemented. Another funda- mental requirement was a new organizational structure specifying superior- subordinate relationships, a stable chain of command, and the allocation of decision making authority among the appropriate officers. 58 It is evident, at least upon hindsight, that consolidation is a complicated process requiring much time and effort to achieve. It is anomalous that during the years required to establish the legality of the merger, the parties pointed toward a "Merger-day" on which the merger could be finally consummated so that the Penn Central could at once begin to operate according to its ultimate design. Little thought was apparently given to the difficult process of forging one company from the pieces of its predecessors. Although it was acknowledged beforehand that the full amount of merger savings would not be available for eight years, the basis for this delay was usually attributed to the costs of plant construction and labor protection. Costs resulting from the process of consoli- dation were unexpected. When final approval came and consolidation began in earnest, the funda- mental decision about traffic routing had been made; the key terminals, yard and connection work had been identified. It now remained to implement those plans. This was no small task as the record of activity for the following two years indicate. 59 Ten classification yards were built or enlarged, 35 key ter- minals were consolidated; four yards were eliminated in 1968 and two in 1969 ; and numerous rail connections were made. The Pennsylvania Railroad's desperately declining cash position gave no time to pursue a leisurely pace with the consolidation effort. 60 Accordingly, just as soon as the Supreme Court decision of January 15, 1968 permitted the merger, the Pennsylvania Railroad rushed ahead with enthusiasm, aware that it would run out of cash if left on its own. Although the attitude at the NeAv York Central is not set out as explicitly as the Pennsyl- vania's in the records, it was probably about as anxious because of its critical cash needs. Not surprisingly, the two companies found themselves no stronger in union than as independents. Immediate action had to be taken to keep the Penn Central afloat. Since top management believed the decade of rhetoric that vast savings would occur upon the consolidation of the two railroads, they undertook a crash program to achieve those savings as soon as possible. There is no evidence that any serious consideration was given to a more gradual program. Several months after the bankruptcy, Alfred Perlman testified to the Senate Commerce Committee with obvious pride that physical work originally scheduled for completion in five years had been done in two. 61 Apparently, most of the merger startup costs were expended in 1968 and 1969 rather than prorated over the longer period. Perlman regarded this as a tremendous achievement. Upon merger, Penn Central expedited some plans and postponed others in the search for instant economies. By November 1968, PC had implemented the basic protective contract through agreements with unions representing 86 percent of its organized employees. Accordingly, it proceeded with the reloca- tion of personnel, consolidated facilities, reduced the work force, and termi- nated employment under the interim pensions and separation allowances pro- 68 It Is terminologlcally useful to use "merger" to indicate legal and financial aspects of the com- bination of the railroads and "consolidation" to Indicate the organizational aspects. Merger occurred when corporate officials signed the necessary papers on February 1. 1968. Consolidation, on the other hand, involved the reorganization of employees into new work patterns and a change in the physical flow of traffic over the rails. It required people to perform new functions or old ones differently. For example, the C&O and B&O merged, but they did not consolidate to any great extent; by and large, they were operated as before the merger. ... 59 See eg testimony by S. T. Saunders, Hearings before Senate Committee on Commerce, Failing Railroads', 91st Congress," 2dSesslon, Serial No. 91-90, Part 1, at pp. 310-11 (1970). 80 The PRR's cash position (expected to go to zero within 2 months) also dictated a plan to sell about *72 million in debt securities. To do this, the Pennsylvania would be forced to obtain agreement from the New York Central to raise the debt limits set in the merger agreement for the third time. Memorandum from Bevan to Saunders, November 8, 1967 ; see Appendix D, Exhibit 36, p. 558. 61 Hearings before Senate Committee on Commerce, Failing Railroads, 91st Congress, 2d Session, Serial No. 91-90, Part 2, at p. 393 (1970). 163 vided by the labor contract. The actual cost of the labor protective agreement greatly exceeded estimates. Management either must have decided to follow a greatly accelerated program to achieve economies or misused the contract arrangements by improvident transfers and separations. Staffing decisions were very important in view of the abruptly changing operating patterns. Shortly before merger day, the two chief executive officers, Saunders and Perlman, selected personnel from the companies for the upper levels of PC management. As provided in the merger agreement, Saunders would be chairman and chief executive officer and Perlman president and chief administrative officer. Of the departments selected to report to the presi- dent, three of major importance (operations, sales/marketing, and personnel) were headed by former PRR men, and three NYC executives were in charge of accounting, industrial development/real estate, and purchases/materials. Four central executives also reported to the president for departments handling various research, systems development and management planning functions and miscellaneous services. Directly under Chairman Saunders were the finance department, the secretary's office, the legal department, and public relations, all headed by former PER personnel. In the second and third level staff positions were persons from both companies, about equal in number overall, but not evenly distributed among departments. For example, in the operating department, under the executive vice president reporting to the president, were seven former NYC and three former PER officers. In general, however the Penn Central attempted where possible to intermingle former New York Central and Pennsylvania Railroad employees. They were placed side-by-side and frequently superior-subordinate relationships were arranged so that an employee of one railroad reported to someone from the other. Post bankruptcy statements tended to rationalize the drastic service deteri- oration as a calculated cost of the forced draft approach. When asked by Senator Hartke whether expected merger benefits of efficiency and better service had been realized. Mr. Perlman replied : No, sir, not the first 2 years and I didn't expect them to occur then, When we rebuilt the yard, say at Albany before merger, put in the new electronic yard, we had to throw everything over to the Syracuse yard. Just that one thing disrupted the New York Central service for 6 months. Now you take changing service at 35 yards within one year and you have got a heck of a mess. 62 There was no indication that strategies designed to minimize service deteri- oration during consolidation had been considered. This testimony clearly re- vealed a belief that service deterioration was a necessary by-product of the con- solidation process and that the faster the consolidation could be accomplished, the faster service could be restored to acceptable levels. Speed was the only cri- terion, whether due to the financial straits of the railroad or to a preference for a briefer sharp pain over a prolonged dull ache is not important since the direction given to the consolidation is the same. THE MERGER AFTERMATH Well documented and publicized, the service deterioration resulting from consolidation exceeded even the worst expectations. It involved no billing, or multiple billings for countless shipments, misrouted cars, and even lost trains. Yards were so jammed that many cars were kept floating around aimlessly for want of a place to rest. Angry and frustrated shippers took their traffic to other more reliable carriers when they had a choice. In its post-bankruptcy investigation, the ICC's Bureau of Enforcement considered as critical the congestion at key terminals and yards, and the in- ability of unprepared clerical forces to execute the classification and routing of combined traffic. Massive communication problems were also identified. The incompatibility of the PRR and NYC computerized car location and movement information systems was not corrected until June 1968 although the problem was recognized well in advance of the merger. Shortages of loco- id at pp. 391-2. 164 motive power seriously delayed train movements and aggravated the problem of an insufficient supply of freight cars. The handling of traffic interchanged with connecting lines, the Bureau asserted, was thoroughly confused at both the eastern and western connections. The total breakdown portrayed in this dismal recital does not reflect exces- sive size as much as ineffective consolidation. Chairman Symes pointed out in his merger case testimony that the merged company would not be as large in many respects as the separate companies in the past. 63 Nor is Chairman Saunders' post-bankruptcy contention that the company was unmanageable pursuasive if the reference is to size disabilities. The only valid meaning clearly is that the merger was unmanageable as 'it was undertaken, or that the company was unmanageable when operated with the shackles of a half-digested merger. The ability of the succeeding management to manage the property with the integration process reasonably complete is rather com- pelling witness to this view. The problem was not size per se or the merger per se. but precisely the inability to truly consummate the merger. While the disruption caused by the construction projects and physical changes in the traffic routing were influential, they may be easily overempha- sized because of their close identification with the physical manifestations of chaos. More fundamentally, however, the collapse was triggered by an organi- zational crisis. The rush to consolidate effectively destroyed the organizations of the predecessor companies and the Penn Central was unable to generate in time its own new cohesive and coordinated organization. The disruption caused by physical changes in the plant was compounded by the inability to put the pieces of the companies back together again. A key element in every organiza- tion is a structure of management personnel that is able to provide effective leadership. This must be doubly important when the disruptions of massive changes are present. Yet, a stable management structure was not created at the Penn Central. A revealing account of the organizational deficiencies of the Penn Central is set out in the Interim Report of the President's Task Force, just two and a half months before bankruptcy. 64 A measure of management instability is the very large turnover in management personnel at all levels in- dicated by the following proportions of incumbents in their present assign- ments less than one year : 61% of Trainmasters ; 81% of Transportation Superintendents; and 44% of Division Superintendents. In addition, all but one General Manager and 80% of Division Super- intendents were in their present assignments less than 15 months. The report concludes "that the tremendous turnover in supervision has had an adverse effect on operations and control," and says, "Nearly every other problem we saw could be related to supervisory personnel that were not yet qualified to handle the duties and responsibilities delegated to them." Changes in management personnel extended even into the executive suites. By the end of 1969 Mr. Perlman was no longer President ; the Executive Vice President for Accounting, Mr. Grant, the Executive Vice President for Opera- tions, Mr. Smucker, the Senior Vice President for Labor and Personnel Rela- tions, Mr. Knight, the Vice President for Transportation, Mr. Kennefic, and the Vice President — Corporate, Mr. Gerstnecker, to name a few principal officers, had left the Penn Central. It was significantly observed that the Central Region was less affected by merger problems than other sectors. Officers there had recognized the value and need for an adequate degree of stability in regional and divisional supervision. As a result, most supervisors had been in their present assignment for at least two years at the time of the inquiry. The rampant disorganization up to the time of the Task Force report was not a necessary result of the merger ; the better performance of the Central Region shows that the situation was amenable in a meaningful degree to managerial control. 63 The measurements of size to which he referred included number of employees, cars and locomo- tive units owned, revenue passengers handled, revenue ton miles, and total train miles. 61 Mr. Gorman, who became president in December 1969, created the special task force to evaluate the activities and functions of the operating regions. See Appendix D, Exhibit 64, p. 702, for full text of "Interim Report — President's Task Force" dated April 6, 1970. 165 Other indications of disorganization the Interim Report spotlighted in- cluded the lack of uniform procedures for payroll processing, car reporting, and management reports; poorly defined duties and responsibilities in some super- visory positions and territorial differences in the scope of the activities, and un- evenness in promotion and training programs. The Interim Report also noted a failure to adhere to the operating plan. This point was earlier made by the former Executive Vice President for Opera- tions who said that savings on merger projects had fallen short of estimates by 50 percent. Asserting that neither the Master Operating Plan nor the previous plan (placed in the record of the ICC merger hearings) had been followed, he stressed the need for effectuating future guidance. 65 Other external factors indicate the accuracy of the thrust of the allegations. The emphasis on speed and the associated disruptions of consolidation would make following any plan difficult. In addition, Perlman was noted for his pro- pensity to run a railroad from information in his head and intuition rather than from formal plans. His method of operation on the New York Central appar- ently was to travel over the railroad to spot problems to be corrected. It is, therefore, not unlikelv that he would have continued to devise ad hoc solutions to the manifold problems of the Penn Central rather than follow a plan. The lack of defined responsibility for important supervisory positions and lack of uniformity between regions further indicate that changes or reorgani- zations were not made systematically. According to the Interim Report, divi- sional and regional supervisors of data control and operating rules, of yard procedures, of train movement, and chief dispatchers, among others, were forced to rely on their past experience or differing individual ideas for job definitions. This is astounding in view of the vital importance of information and efficient train operations toward making a success of the Penn Central. The Report rec- ommended definition of duties and responsibilities for each supervisory position in the Transportation Department as "a necessary first step toward establishing transportation guidelines that will be uniform throughout the company." Two years after the consolidation began is woefully late for such important first steps to be formulated. Disorganization was by no means confined to the transportation depart- ment. Peat, Marwick, Mitchell & Company, certified public accountants, were hired to perform an outside investigation of the freight billing system. Their December 22, 1969, report found excessive delays in billing, inadequate man- agement control over the quality and promptness of billing, poorly trained and confused personnel and a management structure that threatened the integrity of financial control by its very organization. 66 Lacking a positive control system, errors generated in the system continued throughout the entire cycle until brought to the railroad's attention by cus- tomers. Peat, Marwick suggested initiation of comprehensive training programs for freight billing personnel, especially those who dealt with disputed rates. They recommended a change in organization to remove agents from the control of trainmasters. Trainmasters are responsible for moving cars and trains while agents are responsible for the documentation of movements. Priority was naturally given to car movement by trainmasters and agents were often used by them for operating duties when pressing agency problems de- served their undivided attention. Because of poor management, the freight billing process of the Penn Central was slow and money due it remained in the hands of customers. Thus, poor man- agement thwarted the prime purpose of speeding the consolidation process — to obtain funds to stave off collapse. 66 Memo from Smucker to Saunders, Nov. 13, 1969. Since Smucker had been ousted from his position as Executive Vice President for Operations nine months before, the credibility of his memo might be questioned. However, the coincidence of his view and that of the Interim Report support the proposition that a uniform plan was not adhered to on the Penn Central. The press has recorded a bitter dispute between Smucker and Perlman and concluded that Perlman succeeded in dumping Smucker. R. Loving, Fortune, "The Penn Central Bankruptcy Express" (August 1970). Saunders later claimed that he and Perlman agreed that Smucker had not done the job and that together they replaced him. J. Daughen and P. 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The finance, services, and government sectors together originated about 26 per cent. By 1965 the share accounted for by the latter had increased to more than 30 per cent while the agriculture/forest ry/mining sectors together were down to only about six per cent, or less than half of what it had been in 1929. The sig- nificance of this is that historically the railroads have been heavily dependent on agriculture and mining as sources of traffic. By contrast, the software area creates little direct demand for transportation and practically none for the railroads. To put it differently, those areas of the economy upon which the rail- roads have been more heavily dependent are now among the more slowly grow- ing while the more actively growing sectors create little demand for rail trans- portation. This has clearly been one of the more critical external problems for the railroad industry, and projections to 1980 show that it is likely to remain so in the future (see Table 4). TABLE 4.- -PROJECTED RATE OF GROWTH TO 1980 AND DISTRIBUTION OF GROSS PRODUCT ORIGINATING l, 1965, 1968, PROJECTED TO 1980, BY MAJOR ECONOMIC SECTOR Proiected rate of growth 1968-80 period Distribution of gross product originating 1965 1968 1980 Services economy Durables economy Services economy— 3-percent unemploy- ment 2 Durables economy— 3-percent unemploy- ment Major sector 3-percent unemploy- ment 4-percent unemploy- ment 3-percent unemploy- ment 4-percent unemploy- ment Total.. 4.3 4.2 4.3 4.2 100.0 100.0 100.0 100.0 Agriculture, forestry, fisheries Mining ... . ... _ 3.4 3.0 4.7 4.1 5.3 4.5 5.1 4.6 2.6 3.3 2.9 4.6 4.0 5.2 4.5 5.0 4.5 2.5 3.2 2.9 4.9 4.4 5.2 4.6 4.9 4.3 2.4 3.1 2.8 4.8 4.3 5.2 4.5 4.8 4.3 2.3 3.7 1.7 5.1 28.2 8.2 16.5 13.4 11.0 12.1 3.1 1.6 4.6 28.5 8.5 16.5 13.5 11.0 12.4 2.9 1.4 4.8 27.8 9.5 17.0 14.8 11.4 10.2 2.8 1.4 Construction Manufacturing Transportation, communications and public utilities 4.9 28.8 9.5 Wholesale and retail trade .. 17.0 Finance, insurance, and real estate.. Services, including household services _. 14.5 11.1 Government, including government enterprises. 9.9 1 Gross product originating is the value added by each sector to the total product. ■ Distribution at 4-percent unemployment is identical. Note: Detail may not add to total. Source: The U.S. Economy in 1980, Department of Labor, BLS Bull. 1673. pp. 10 and 11. The significance of different rates of growth among various parts of the economy can best be appreciated by looking at some key commodities. Table 5 lists those product groups which account for about 90 per cent of rail freight tonnage and for 75 per cent of railroad freight revenue. As one can see most of of these groups have grown only slowly, lagging beyond the overall rate of economic growth. TABLE 5 .- -PAST AND FORECAST RATES OF GROWTH IN OUTPUT OF MAJOR COMMODITY SOURCES OF RAIL FREIGHT TONNAGE 1957-80 STCC Commodity Share of Approximate annual average tonnage, rate of growth percentage, 1957-65 1965-80 1964-68 actual forecast ' 26.3 0.0 1.7 12.5 4.2 4.4 9.2 1. 7-2. 7 2. 6-2. 9 8.3 0. 1-2. 3 2. 9-4. 9 7.1 4.4 2.9 6.5 2.3 3.6 6.2 1.9 2.3 5.4 4.0 4.2 5.4 6. 0-9. 5. 3-6. 8 2.7 4.3 4.8 3.9 4.7 11 Coal 14 Stone 01 Farm commodities 10 Metallic ores 20 Food products 24 Lumber. _ _. 33 Primary metal products. 32 Cement. 28 Chemicals.... 26 Pulp and paper GNP 1 Forecasts are based on Labor Department projections for a durable goods economy with 4-percent unemployment. See "The U.S. Economy in 1980," Bureau of Labor Statistics Bull. 1673, table All (1970). Source: ICC, AAR, Department of Labor. 230 Take coal as a key example. It accounts for more than one-fourth of rail tonnage and generates about 12 per cent of railroad revenue. Its importance is thus obvious, yet coal production has dwindled. With 1957-1959 equal to 100, U.S. coal production is now only about equal to what it was in 1956 and is far below the production levels achieved in the early post war years 1947-1948 (the index then was approximately 150). One reason for this has been the changing use of energy sources for electricity generation and for other purposes. As a percentage of total energy in North America, Japan, and Western Europe (an appropriately large market since about ten per cent of U.S. production is now exported) coal supplied 55 per cent in 1950, only 37 per cent in 1960 and an estimated 25 per cent in 1970. Future forecasts of coal usage indicate that while aggregate coal consumption will rise in absolute amounts, its con- tribution to total energy requirements may well continue to fall, though at a slower rate than in the recent past. The diminishing relative economic significance of the raw materials sectors and the increasing importance of the software areas have left manufacturing with a slightly larger share of total economic activity. In some cases rapid industry growth has been helpful to the railroads because they carry a signifi- cant share of the traffic. This would be true of chemicals or paper. On the whole, however, developments have been disadvantageous to rail movement. The key facts relate to the relatively faster rates of growth in industries where the goods produced are usually higher valued. Tables 6 and 7 contain the basic data. These statistics show that the most rapid rates of growth have been in products, such as computers, which are of high value relative to size and bulk and which generate little transport demand relative to their final value. TABLE 6.-C0MPARATIVE GROWTH RATES FOR MAJOR INDUSTRIES, 1947-65 AND PROJECTED 1965-80 (Average annual rates of change of domestic output at producers value in 1968 dollars! Industry name and number 1947-65 1947-57 1965-80 Services economy 3-percent unemploy- 1957-65 ment 4-percent unemploy- ment Durables economy 3-percent 4-percent unemploy- unemploy- ment ment Agriculture, Forestry, and Fisheries 1. Livestock and livestock products 2. Other agricultural products 3. Forestry and fishery products 4. Agricultural, forestry, and fishery services Mining 5. Iron and ferroalloy ores mining 2.7 6. Nonferrous metal ore mining 1.8 7. Coalmining —1.8 8. Crude petroleum and natural gas 3. 3 9. Stone and clay mining and quarrying 5. 3 10. Chemical and fertilizer mineral mining 6.1 Construction 11. New construction 12. Maintenance and repair construction Manufacturing 13. Ordnance and accessories 7.4 14. Food and kindred products 2. 4 15. Tobacco manufacturers 1.3 16. Broad and narrow fabrics, yarn, and thread mills 2.4 17. Miscellaneous textile goods and floor cover- ings 4. 4 18. Apparel 3.4 19. Miscellaneous fabricated textile products... 3.8 20. Lumber and wood products, except con- tainers 2. 3 21. Wooden containers —2.1 22. Household furniture 3.5 23. Other furniture and fixtures 3.4 24. Paper and allied products, except container. 3.9 25. Paperboard containers, and boxes 4.7 26. Printing and publishing 3.3 27. Chemicals and selected chemical products... 6.8 28. Plastics and synthetic materials 9.3 1.7 1.4 2.1 2.9 2.9 2.8 2.7 1.7 1.7 .9 2.2 2.2 1.7 2.7 1.4 1.4 2.8 3.0 2.0 1.5 2.8 3.0 2.0 1.5 2.7 2.9 2.5 1.5 2.6 1.7 2.9 1.8 2.4 1.8 1.4 2.2 2.5 1.7 3.4 3.4 3.5 3.4 3.1 2.3 2.5 2.5 3.0 2.9 3.1 .1 4.8 4.8 5.0 4.9 3.1 1.8 1.8 1.8 1.7 4.6 1.8 3.4 3.4 3.4 3.3 6 ? 4.2 4.2 4.2 4.5 4.4 6.2 6.1 5.9 5.9 6.0 5.9 4.7 4.9 4.4 4.2 4.2 4.4 4.4 4.9 5.5 2.9 4.1 5.9 4.4 3.2 4.4 3.2 4.8 3.2 4.7 4.2 3.1 3.8 3.5 4.1 4.2 4.2 4.5 4.4 14.1 -.4 3.2 3.2 5.7 5.6 2.4 2.6 3.3 3.3 3.2 3.1 .3 2.4 2.3 2.3 2.2 2.1 1.3 3.7 3.7 3.7 3.7 3.6 2.5 6.9 4.2 4.1 4.3 4.2 3.4 3.4 3.8 3.7 3.5 3.5 3.6 3.9 3.7 3.6 3.6 3.5 1.4 3.3 3.5 3.4 3.7 3.6 -3.6 -.2 .3 .2 .4 .3 3.7 3.4 5.0 4.9 5.3 5.2 2.4 4.6 5.4 5.3 5.4 5.4 3.6 4.3 4.8 4.7 4.8 4.7 4.5 4.9 4.4 4.3 4.4 4.3 3.0 3.6 4.4 4.3 4.3 4.3 7.5 6.0 5.4 5.3 5.4 5.3 9.6 9.0 6.8 6.7 6.8 6.8 231 TABLE 6— Continued Industry name and number 1947-65 1947-57 1957-65 1965-80 Services economy 3-percent unemploy- ment 4-percent unemploy- ment Durable economy 3-percent 4-percent unemploy- unemploy- ment ment 29. Drugs, cleaning and toilet preparations 7.1 7.1 7.0 30. Paints and allied products 2.6 1.2 4.3 31. Petroleum refining and related industries... 3.9 4.8 2.8 32. Rubber and miscellaneous plastics products. 4.8 2.9 7.3 33. Leather tanning and industrial leather products. —1.5 —2.2 —.8 34. Footwear and other leather products .5 .4 .6 35. Glass and glass products 3.0 1.9 4.4 36. Stone and clay products 5.0 5.9 3.8 37. Primary iron and steel manufacturing 1.6 1.3 1.9 38. Primary nonferrous metals manufacturing... 3.7 3.1 4.3 39. Metal containers 3.1 3.3 2.9 40. Heating, plumbing, and structural metal products... 3.8 4.7 2.7 41. Stampings, screw machine products, and bolts 1.7 1.0 2.7 42. Other fabricated metal products 3.2 2.8 3.8 43. Engines and turbines. 3.0 2.4 3.9 44. Farm machinery and equipment 1.7 .2 3.6 45. Construction, mining and oil field machinery. 2.1 1.8 2.4 46. Materials handling machinery and equip- ment 3.4 3.0 4.1 47. Metalworking machinery and equipment 2.7 3.1 2.3 48. Special industry machinery and equipment. 1.1 —1.3 4.2 49. General industrial machinery and equipment. 3.4 1.8 5.5 50. Machine shop products 7.2 8.5 5.6 51. Office, computing and accounting machines. 8.9 7.7 10.5 52. Service industry machines 4.6 2.6 7.2 53. Electric industrial equipment and appartus. 3.9 4.1 3.6 54. Household appliances 4.5 2.7 6.8 55. Electric lighting and wiring equipment 3.3 2.1 5.0 56. Radio, television, and communication equipment 9.1 9.0 9.1 57. Electronic components and accessories 13.4 12.0 15.2 58. Miscellaneous electrical machinery, equip- ment, and supplies 2.2 .9 3.7 59. Motor vehicles and equipment 5.3 4.5 6.2 60. Aircraft and parts.. 11.1 20.2 .7 61. Other transportation equipment 2.5 .9 4.5 62. Scientific and controlling instruments. 4.1 4.0 4.2 63. Optical, ophthalmic, and photographic equipment 6.7 6.4 7.1 64. Miscellaneous manufacturing 3.4 2.2 5.0 65. Transportation and warehousing 1.6 .7 2.8 Communications and public utilities 7.5 8.6 6.0 66. Communications, excluding radio and TV broadcasting 7.4 7.7 7.1 67. Radio and TV broadcasting 7.5 10.3 4.1 68. Electric, gas, water, and sanitary services. . 7.5 9.0 5.7 69. Wholesale and retail trade 3.9 3.6 4.4 Finance, insurance, and real estate 5.1 5.0 5.2 70. Finance and insurance. 4.4 4.2 4.7 71. Real estate and rental... 5.4 5.4 5.4 Services and miscellaneous 4.0 3.5 4.6 72. Hotels, personal and repair services, exclud- ing auto 2.8 2.1 3.7 73. Business services 5.2 5.2 5.3 74. Research and development 6.4 5.2 7.8 75. Automobile repair and service 3.0 2.3 3.9 76. Amusements .2 -1.5 2.3 77. Medical, educational services, and nonprofit organizations Government enterprises 78. Federal Government enterprises 5.4 4.9 6.1 79. State and local government enterprises 3. 4 2. 3 4. 8 6.0 4.3 3.5 6.3 -.3 1.4 3.9 4.6 1.9 5.3 3.3 4.2 3.7 3.9 4.2 3.4 3.5 4.2 3.0 4.0 3.4 4.9 10.3 6.5 4.9 5.1 4.7 6.2 8.4 5.5 2.9 2.6 2.9 5.4 5.6 4.0 5.9 4.2 3.4 6.2 -.3 1.4 3.8 4.5 1.8 5.2 3.2 4.1 3.7 3.8 4.1 3.4 3.4 4.1 2.9 3.9 3.3 4.8 10.2 6.4 4.8 5.0 4.6 6.1 8.4 5.4 2.8 2.6 2.9 5.4 8.8 5.5 3.9 6.6 6.6 7.0 2.0 6.7 4.7 4.8 4.4 5.0 6.9 1.9 6.6 4.6 4.8 4.3 4.9 5.5 5.5 4.6 6.3 6.0 4.8 4.4 4.5 6.2 5.9 4.7 4.3 5.7 4.4 3.4 6.4 -.4 1.2 4.0 4.8 2.2 5.7 3.1 4.5 4.1 4.1 4.6 3.7 3.8 4.5 3.6 4.4 3.9 5.5 10.9 6.9 5.5 5.4 5.0 7.0 9.3 5.7 3.1 4.6 3.7 6.1 9.0 5.6 4.0 6.6 6.9 2.1 6.6 4.7 4.7 4.3 4.8 5.4 4.3 6.4 6.7 4.6 4.1 5.6 4.3 3.3 6.4 -.4 1.2 3.9 4.8 2.2 5.6 3.0 4.4 4.0 4.0 4.5 3.7 3.8 4.5 3.5 4.3 3.9 5.4 10.8 6.8 5.4 5.3 4.9 7.0 9.2 5.6 3.1 4.6 3.7 6.1 8.9 5.5 3.9 6.5 6.9 2.0 6.5 4.6 4.6 4.2 4.8 5.3 4.3 6.3 6.7 4.6 4.0 5.0 5.0 5.1 5.5 5.4 5.2 5.1 4.2 3.3 5.3 5.3 5.3 5.2 5.1 5.1 5.5 5.0 5.4 5.0 5.3 4.9 5.3 Source: The U.S. Economy in 1980, Department of Labor, BLS Bull. 1673, table A-ll. Input-output analyses of the Department of Commerce show, as an ex- ample, that for a given dollar increase in final demand of computers and related products (Row 51, Table 7), there is only a .02833 per cent increase in transport requirements (direct and indirect). By contrast a similar increase in steel output calls for four times as much transportation. As previously noted, how- ever, it is at the high valued, relatively low transport input end of the industrial 232 spectrum where the most rapid rates of growth generally are likely to come, just as they have in the last several years. Moreover, as goods increase in value and as the significance of transportation in the final price declines, the fastest growing sources of traffic will be exposed to growing intermodal competition. Given these trends it is interesting to recall that truck transportation has doubled its share of intercity freight movement in the last 25 years. For rela- tively expensive products like TV sets, cigarettes, office machines, electronic components and optical and photographic equipment, where transportation costs are a proportionately smaller share of the delivered price, non-rail modes, like truck and even air, can represent superior alternatives. TABLE 7.-0UTPUT OF TRANSPORTATION AND WAREHOUSINGSECTOR REQUIRED, DIRECTLY AND INDIRECTLY, FOR EACH DOLLAR OF DELIVERY TO FINAL DEMAND BY VARIOUS INDUSTRIES [In producers' prices! 1 Livestock and livestock products 05962 2 Other agricultural products 03203 3 Forestry and fishery products 05176 4 Agricultural, forestry, and fishery services 04894 5 Iron and ferroalloy ores mining .11195 6 Nonferrous metal ores mining 04261 7 Coalmining. 03795 8 Crude petroleum and natural gas.._ .03689 9 Stone and clay mining and quarrying 04034 10 Chemical and fertilizer mineral mining... 07874 11 New construction 07079 12 Maintenance and repair construction 05183 13 Ordnance and accessories... 03132 14 Food and kindred products 07633 15 Tobacco manufacturers .02202 16 Broad and narrow fabrics, yarn and thread mills 05366 17 Miscellaneous textile goods and floor coverings. .05850 18 Apparel. 03679 19 Miscellaneous fabricated textile products 04788 20 Lumber and wood products, except containers. .06941 21 Wooden containers... 09664 22 Household furniture 05893 23 Other furniture and fixtures 05506 24 Paper and allied products, except containers . .07337 25 Paperboard containers and boxes. 07393 26 Printing and publishing 04601 27 Chemical and selected chemical products .06474 28 Plastics and synthetic materials 05760 29 Drugs, cleaning and toilet preparations. .05065 30 Paints and allied products .06659 31 Petroleum refining and related industries .07914 32 Rubber and miscellaneous plastics products... .04924 33 Leather tanning and industrial leather prod- ucts .03166 34 Footwear and other leather products .03684 35 Glass and glass products ._ 04901 36 Stone and clay products 08984 37 Primary iron and steel manufacturing 08653 38 Primary nonferrous metal manufacturing .05795 39 Metal containers 07415 40 Heating, plumbing, and structural metal prod- ucts .05978 41 Stampings, screw machine products, and bolts. .05269 42 Other fabricated metal products .05069 43 Engines and turbines 04519 44 Farm machinery and equipment 05551 45 Construction, mining and oil field machinery. .. .04966 46 Materials handling machinery and equipment.. .04963 47 Metalworking machinery and equipment .03794 48 Special industry machinery and equipment .04196 49 General industrial machinery and equipment... .04281 50 Machine shop products 04125 51 Office, computing and accounting machines... .02833 52 Service industry machines 04946 53 Electric industrial equipment and apparatus... .04288 54 Household appliances 05205 55 Electric lighting and wiring equipment 04943 56 Radio, television, and communication equip- .03081 ment. 57 Electronic components and accessories 03844 58 Miscellaneous electrical machinery, equip- .04295 ment and supplies. 59 Motor vehicles and equipment 05742 60 Aircraft and parts 03439 61 Other transportation equipment 05641 62 Scientific and controlling instruments. 03877 63 Optical, ophthalmic and photographic equip- .03424 ment. 64 Miscellaneous manufacturing 04685 65 Transportation and warehousing 1.10440 66 Communications, except radio and TV broad- .01025 casting. 67 Radio and TV broadcasting .02336 68 Electric, gas, water and sanitary services .04457 69 Wholesale and retail trade 02263 70 Finance and insurance.. 02131 71 Real estate and rental. 01482 72 Hotels; personal and repair services except .02639 Auto. 73 Business services 03324 75 Automobile repair and services 02612 76 Amusements 02752 77 Medical, educational services and nonprofit .02183 organizations. 78 Federal Government enterprises 1 .13067 79 State and local government enterprises 03182 80 Gross imports of goods and services 03182 81 Business travel, entertainment and gifts .48005 82 Office supplies .05094 1 To remove a source of instability in the measurement of total requirements per dollar of delivery to final demand, the Commodity Credit Corporation has been excluded from this industry. The excluded inputs to the CCC from the specified industries are: Industry 2, $636 million; Industry 14, $214 million; Industry 16, $15 million; Industry 65, $642 million; Industry 69, $24 million; and value added, —$1,531 million. Source: Department of Commerce, Input-Output Study, in Survey of Current Business, November 1969, table 3, pp. 42-47. In addition to the changing pattern of industrial output, other more subtle economic and technological forces have also been at work that affect transporta- tion. Some of these relate to the way products are made, as with the substitution of lighter-weight components for heavier components. Others involve the loca- tion of manufacturing and distribution centers that bring goods closer to final markets. In some instances the "product" itself is altered. Electricity was once generated close to the consuming market, with coal or other energy sources trans- ported to the generating station ; now it is becoming common for electricity to be generated close to the source of fuel, with the electricity being "transported" through long-distance transmission lines. In still other cases the change involves the substitution of one transport mode for another, with the user taking advan- tage of speed/rate/service differentials in a way that alters the mix of transportation services consumed. 233 Recent studies have attempted to measure the impact of the factors in terms of the transportation implications. One assessment, conducted by Alexander L. Morton, estimated for some 20 industries the "losses in freight traffic" due to the changing composition of final demand and "structural changes" (the substitution of lower-cost inputs). Table 8 sums up the results. Those columns in the table identified as "loss due to changing composition of final demands" show the loss in freight traffic as estimated by the. difference between growth in the industry as compared with what would have occurred if the industry shown had grown as rapidly as gross domestic output. The columns headed "loss due to structural change" are based on changes in input- output coefficients between the years in question (i.e., did transport input fall or rise as a factor in output). For the period 1958-1963 freight loss is estimated at about $4 billion, with the dollar amounts varying widely by sector. In some there is an actual increase, in transportation requirements (signified by the negative numbers), but in most there, is a freight loss. The transportation and warehousing sector itself plays a major role, with more efficient means of dis- tribution reducing this sector's own requirements for transportation services. TABLE 8.— FREIGHT LOSS DUE TO CHANGING COMPOSITION OF FINAL DEMAND AND STRUCTURAL CHANGE AMONG THE 20 IN- DUSTRIES WITH THE LARGEST TOTAL TRANSPORTATION REQUIREMENTS' Industry 1947-58 (millions of 1958 dollars) 1958-63 (millions of current dollars) Loss due to Loss due to changing changing composition Loss due to composition Loss due to of final structural Total of final structural Total demands change loss demands change loss 3,492 -115 3,377 1,681 -282 1,399 -764 634 -130 285 421 706 620 151 771 811 403 1,214 280 1,055 1,335 7 71 78 174 -11 163 -361 166 -195 -135 682 547 -2 175 173 -246 121 -125 135 92 227 -89 289 200 -87 106 19 -212 127 -85 -37 -1 -38 76 173 249 49 125 174 -15 39 24 -22 143 121 46 4 50 10 38 48 -95 133 38 -28 31 3 -210 61 -149 8 14 22 -86 58 -28 -152 110 -42 -11 82 71 35 -40 -5 102 -12 90 -6 21 15 48 146 194 42 17 59 20 25 45 -67 13 -54 25 53 78 14 18 32 Transportation and warehousing New construction Food and kindred products.. Wholesale and retail trade Motor vehicles and equipment Real estate and rental Petroleum refining.. Medical, educational services and charities Electiic, gas, water and sanitary Appa rel Finance and insurance.. Hotels, lodging and personal services. . Drugs, cleaning and toilet preparations Aircraft and parts Radio, TV, and communication equip- ment Maintenance and repair construction. . Other transportation equipment Agricultu ral products i Business services... Household furniture Total 3,020 3,695 6,715 2,315 1,641 3,956 1 Minus signs indicate a gain. 2 Exclusive of livestock. Source: Ph.D. dissertation of Alexander L. Morton, Harvard University. LOCATIONAL ADJUSTMENTS The changes in the industrial mix of the economy have been accompanied by important changes in the location of economic activity. This development has also had major transportation ramifications, especially for the railroads. Unlike, most of the other modes, they have large, inflexible capital investments. A railroad plant, with its track, terminals, and other investments in fixed loca- tions cannot be shifted about in the short run as demand fluctuates. If there are material alterations in the geographic pattern of economic activity, a railroad can find its investment ill-suited to changed circumstances. Precisely this sort of process has been taking place. There have been substantial geographic adjustments in all areas of the economy. Consider manufacturing. In 1929 New England and the Mid-Atlantic States together accounted for about 42 per cent of the total value added by manufacturing in the United States. As shown in Table 9, their share had declined below .30 per cent by 1968 as industrial activity sharply increased in other areas of the country, notably in the South and the West. Auto production, once heavily concentrated in Michigan and in surrounding states, has been dis- persed, with new assembly plants opened up in the South, the Southwest, and on the West Coast. This, of course, has had major transportation consequences, 234 but they are most serious in the case of the railroads because so much of their investment is fixed in location. For the railroads serving the Northeast quadrant, diffusion of industrial activity has resulted in slowly growing traffic and, in some cases an actual decline. Unmistakably, this was one of the principal problems faced by the Penn Central. Finally, just as the changing pattern of the economy has hampered some railroads, it has helped others, with increasing traffic for roads in the South and the West. TABLE 9.-VALUE ADDED BY MANUFACTURING REGION AS A PERCENT OF TOTAL FOR NATION, 192M8 East West East West New Middle North North South South South United England Atlantic Central Central Atlantic Central Central Mountain Pacific Year States division division division division division division division division division 1929 100.0 10.2 31.9 31.3 5.9 7.7 2.9 3.0 1.2 6 1939 100.0 10.0 30.2 30.8 5.6 9.2 3.4 3.4 1.1 6.4 1947 100.0 9.2 27.9 31.6 5.5 9.3 3.9 4.1 1.1 7.5 1949... 100.0 8.4 27.4 32.5 5.8 9.4 3.8 4.1 1.0 7.6 1950... 100.0 8.3 26.2 33.2 5.7 9.4 3.8 4.3 1.2 7.9 1951 100.0 8.3 26.1 32.9 5.6 9.1 3.8 4.7 1.2 8.2 1952 100.0 8.3 26.2 32.5 5.9 8.8 3.7 4.7 1.2 8.7 1953 100.0 8.1 26.0 32.8 5.8 8.8 3.8 4.6 1.2 8.7 1954 100.0 7.8 26.0 31.2 6.1 9.1 4.0 4.9 1.2 9.7 1955 100.0 7.4 24.9 32.1 6.0 9.4 4.2 5.2 1.4 9.5 1956 100.0 7.5 25.1 31.2 5.9 9.3 4.2 5.3 1.5 9.9 1957 100.0 7.3 25.1 30.8 6.0 9.4 4.3 5.4 1.4 10.3 1958 100.0 7.4 24.6 28.9 6.3 10.1 4.5 5.5 1.6 11.1 1959.... 100.0 7.5 23.9 29.9 6.2 10.3 4.4 5.4 1.5 10.9 1960 100.0 7.5 24.1 29.4 6.1 10.4 4.4 5.4 1.6 11.0 1961 100.0 7.7 23.8 28.7 6.2 10.5 4.5 5.6 1.7 11.2 1962 100.0 7.5 23.3 29.2 6.2 10.7 4.5 5.4 1.8 11.4 1963 100.0 7.1 22.8 29.4 5.7 11.1 4.8 5.7 1.8 11.5 1964... 100.0 7.0 22.3 29.5 6.2 11.1 4.9 5.9 1.7 11.3 1965 100.0 7.1 22.5 30.2 6.2 11.1 5.1 5.8 1.6 10.7 1967.. 100.0 7.2 21.9 28.6 6.4 11.2 5.2 6.3 1.7 11.3 1968.. 100.0 7.0 21.3 28.6 6.5 11.4 5.4 6.4 1.8 11.6 Source: Bureau of the Census. Coal traffic illustrates the shifting location of output. In the 1950's, for example, Pennsylvania accounted for nearly 20 per cent of total U.S. bituminous coal production. By 1969, however, Pennsylvania's share had fallen by almost a third. Meanwhile Kentucky had increased its share from about 14 per cent to 20 per cent (Table 10). Not only did this southward shift in the balance of coal production open up coal traffic to other modes, namely inland waterway operators, but it hurt some railroads, like the Penn Central, and helped others, notably those with lines into the lower Appalachian territory. TABLE 10-PERCENT OF U.S. BITUMINOUS COAL PRODUCTION. BY SELECTED MAJOR PRODUCING STATES, 1951-69 1951-55 average 1960 1969 U.S. total. West Vi rginia Kentucky Pennsylvania Illinois..... Other Source: U.S. Bureau of Mines. The economic environment in which transportation must subsist has thus undergone radical change in recent decades. For a whole host of reasons the mix and geographic pattern of the American economy have been materially altered. For some modes and for many transportation enterprises this has meant new opportunities for growth and expansion. For others — and specifically for the railroads, notably those in the Northeast — the evolving circumstances are con- siderably less favorable. Areas of activity best served by rail transportation are generally experiencing slow rates of growth. In the more rapidly growing sectors the transportation market is becoming increasingly competitive, posing difficult new challenges for the railroads. In subsequent sections of this report the performance of the railroad industry is probed in considerable detail, im- plicitly testing the effectiveness of the way in which the railroads have been able to respond to changing economic circumstances. 100.0 100.0 100.0 30.0 28.6 25.2 14.4 16.1 19.5 19.4 15.7 14.0 10.1 11.1 11.5 7.7 8.2 9.1 235 RAILROAD. FINANCE AND EARNINGS This section examines the financial condition, earnings, and investments of the Class I railroads, with emphasis on the changes that took place during the 1960's. In carrying out this assessment, information has been developed not only for the railroads as a group but, selectively, for the major regions (East, South, West) and for individual railroads. This has revealed such sharp differences, in both situation and trend, among regions and roads that a cautionary note must be introduced whenever generalizations are made about the nation's railroads. Indeed, any presentation that lumps together the railroads and attempts to draw conclusions or create impressions about the railroad situation as a whole can be highly deceiving. This is especially so when the objective is to suggest that all railroads are in extreme financial distress. The fact is that while some railroads are in poor financial condition, many others are relatively well off and are likely to experience substantial rates of growth. To reveal how misleading can be general or aggregated statistics about the railroad industry, one has only to look at the impact of the Penn Central. It bulks so large in the railroad picture, accounting for about ten per cent of total rail traffic, and its performance was so disastrous from the date the merger became effective that it radically distorts industry results. For example, in 1969 railroad net ordinary income fell by $55.2 million; actually, all of this — and then some — was accounted for by the Penn Central, whose income alone fell that year by $80 million. What thus appeared to be a serious decline in rail earnings could more accurately be attributed entirely to the PC. Similarly, between 1969 and 1970 Class I railroad ordinary income fell by $288 million, but $243 million of this (84 per cent of the total) was reported just by the Penn Central. The lesson is that extreme care must be taken in drawing conclusions from consoli- dated industry statistics. Because of this the material in this section, as well as in other parts of the report, provides disaggregated statistics for key variables. For the railroads, like any industry or enterprise, financial condition is determined by flows of earnings and capital. The balance sheet sums up the situation at a particular point in time, with the flow data largely explaining the differences that have taken place. It is the actual flows of funds in which we are interested, of course, not the bookkeeping entries that are made to characterize particular items. This is why earnings or reported net income are inadequate bases for evaluation, since they reflect as expenses such things as depreciation which do not in fact involve cash disbursements. The succeeding sections deal, in turn, with flows of earnings, cash flow, and changes in balance sheet indicators. 3 EARNINGS During the 1960's Class I railroad net operating revenue, determined by revenues and expenses, rose from $1.9 billion in 1960, peaked at $2.5 billion in 1966, fell sharply in 1967, and then climbed slowly to $2.3 billion by the end of the decade. Total operating revenues, mostly from freight, increased almost every year from the preceding year, with a gain of almost $2.5 billion taking place between 1960 and 1970. Meanwhile operating expenses also increased, but by only a slightly larger amount. The operating ratio, which was 79.52 in 1960 was up to only 80.56 by 1970. On the whole, therefore, if the railroads were to be gauged solely by their net operating revenue, no significant change would appear to have taken place during the 1960-1970 period. 3 See Appendix, Tables A-3 through A-5 for comprehensive Income Statement, Financial Summary, and Selected Financial Ratios. 74-924 O - 73 - 17 236 Table 11, however, reveals considerable change during the decade, among individual roads and regions as well as for the railroads as a group. The over- all rail operating ratio fell almost steadily through 1966, then rose in 1967, remained relatively constant in the following two years, and then climbed again in 1970. The pattern for the regions and the identified railroads followed roughly this same pattern, but there are both differences in the timing of pai-ticular movements as well as in the level achieved. The operating ratio in the East has remained above that for the Nation while that for the South has held consistently below the national average since 1964. In the West the ratio has been generally slightly below the national ratio although beginning in 1968 the West has done considerably better. As among individual roads, all of those identified except the Penn Central have performed better than the national average. For the Penn Central the operating ratio had increased steeply since 1966, up from approximately 79 in 1966 (based on premerger pro forma results) to 92 in 1970. TABLE 11.— OPERATING RATIO,' CLASS I RAILROADS AND SELECTED RAILROADS, 1960-70 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Class I railroads.. 79. 52 Penn Central 2 83.40 Pennsylvania 82.81 New York Central 84. 15 Norfolk & Western 3 67.97 New York Chicago & St. Louis 71.65 Southern Railway 69.96 Illinois Central 81.14 Southern Pacific 79.11 Union Pacific 72.79 79.16 78.59 77.95 83.46 82.47 81.61 81.92 81.41 80.57 85.52 83.92 83.03 67.47 66.80 65.52 75.06 76.57 74.33 70.82 69.14 69.53 79.12 78.16 78.09 77.38 78.18 78.53 72.30 72.28 71.69 78.50 76.90 76.19 79.15 79.05 79.18 80.56 80.66 79.00 78.78 81.69 88.62 85.60 92.08 79.89 78.39 78.06 80.45 81.70 79.83 79.75 83.39 66.47 65.95 66.90 70.04 69.74 69.95 72.02 75.28 --.. 69.19 70.89 68.03 68.41 69.95 69.95 72.84 81.17 78.69 78.19 77.67 79.84 79.21 78.99 79.92 77.80 78.03 87.34 78.13 77.85 78.17 74.69 73.51 72.14 74.73 75.63 75.68 75.08 1 Operating expenses per operating revenues. = 1960-67 pro forma. 3 1960-64 pro forma. Source: Moody's Transportation Manual. 237 CHART 2 OPERATING RATIO, CLASS I RAILROADS AND SELECTED LINES, 1960-1970 YEARS 60 61 62 63 64 65 66 67 68 69 70 238 In explaining the differences in operating results among the various regions and roads, the answers naturally are to be found in the balance of revenue and expenses. In terms of revenue the East lags behind the nation, a point that further confirms the evidence advanced earlier concerning the chang- ing nature of the economy. With 1960 as an index, the operating revenue of the Eastern roads stood at only about 115 per cent of the base, while the railroads nationally had increased their revenue by more than 25 per cent. 4 This dis- crepancy is primarily explained by the more rapid rates of growth in the West and particularly in the South. On the expense side operational outlays can generally be expected to parallel changes in revenue and traffic, but the net revenue impact of even small differences can be substantial. By 1970 the operat- ing expenses of the Eastern roads were 120 per cent above the 1960 average; much of this was due to the Penn Central, whose expenses had increased by 23 per cent over the base period. 5 Generally speaking, those roads that did well during the 1960's, like the Southern Pacific and Union Pacific, were keeping their revenue and expense flows more nearly in balance. By 1970, for example, the SP's operating ratio was below what it had been in 1960. Although there was some deterioration in the railroad operating ratio during the 1960's, it was not because of operational reasons that the railroads sustained such a steep drop in their net income. Indeed it is in the sources of the differences between net operating revenue and net ordinary income that are to be found the principal adverse developments of the decade. The dollar differ- ences and changes in these basic earnings measures are indeed striking and can be quickly summarized as follows : CHANGE IN SELECTED INCOME ACCOUNTS, 1960-70, CLASS RAILROADS Amount Percent Net operating revenue .... +$382,000,000 +19.7 Net railroad operating income .. -100,000,000 -16.9 Ordinary income . -218,000,000 -49.0 The substantial differences noted in this table between net operating revenue, which was up significantly, and the subsequent items, down substantially, are determined by a combination of factors, notably rents paid for the hire of equipment, fixed charges, and "other income." Of these the former two increased steeply and while the latter also rose, it fell far short of offsetting the two other sources of cash outflow. The changes in these items can be summed up : CHANGE IN MAJOR ITEMS AFFECTING ORDINARY INCOME, 1960-70, CLASS 1 RAILROADS Amount Percent Rents for equipment hire.. +$415,000,000 +129.0 Fixed charges +216,000,000 +58.1 Other income +136,000,000 +39.3 Other items also changed during the period. Railway tax accruals, for example, increased by about $70 million, but their impact on earnings was small relative to the items noted in the preceding table. To gain a better impression of the impact of increased equipment rentals on railroad earnings, Table 12 shows that as a percentage of net operating revenue these rental payments held almost constant from 1960 through 1966, remaining on an approximate 20 per cent plateau. In 1967, however, rentals rose steeply and by 1970 they were absorbing a third of rail net operating revenue. Not all the regions and roads, though, followed this pattern. 6 In the * See Appendix, Table A-6. B See Appendix, Table A-7. 9 See Appendix, Table A-8. 239 East rentals were far more significant, largely because of the Perm Central. By 1970 equipment rents in fact exceeded the PC net operating revenue. In other geographic areas the pattern fairly closely followed that for the nation, with equipment rentals taking a larger share of operating revenue after 1966 but with the percentage remaining considerably below that for the nation. For some individual roads, such as the Southern and Union Pacific, rents for equip- ment continue to consume only a small percentage of operating revenue. TABLE 12. -EQUIPMENT AND JOINT FACILITIES RENTS AS A PERCENT OF NET OPERATING REVENUE, CLASS I RAILROADS 1960-70 Year Percent Year Percent I960 18.8 20.2 19.3 19.7 20.3 20.4 1966. 20.6 1961 1962 1963 1964 1965 1967. „ 1968 1969... 1970 26.6 28.6 29.4 33.3 Source: ICC and AAR. '240 CHART 3 EQUIPMENT AND FACILITIES RENTS AS A PER CENT OF NET OPERATING REVENUE, CLASS I RAILROADS AND SELECTED LINES, 1960-1969 (PER CENT) 80^ / [ f PENN CENTRAL » 68 / 46 • \ 44- 42~^ 36- 28-h > * % ^ v ^ CLASS 1 RAILROADS i Kf/r N SOUTHERN PACIFIC ILLINOIS CENTRAL 24 \ • lX i V 3 J ORDINARY INCOME 3 YEAR 60 61 62 63 64 65 66 67 68 69 70 246 Despite the decline in earnings and cash flow, with the former much larger than the latter, the railroads continued to pay substantial cash dividends in the late 1960's. By 1970 cash dividends exceeded net income and consumed more than 40 per cent of cash flow. " In some instances this practice might arguably be understandable. For example, if the railroads were raising significant amounts of capital through new equity issues, it might be that dividends were essential to attract and maintain investment interest. The fact, however, is that new public equity issues are highly insignificant in the railroad industry, pro- viding only a miniscule amount of funds. The explanation for the perpetua- tion of large cash dividend payments in the face of falling earnings thus must be found elsewhere. Conceivably, it reflects intercorporate relationships, with dividends being a means by which a holding company or affiliated firm with- draws cash from the railroad. Aside from this explanation, which is of grow- ing consequence because of the spread of holding companies in rail transporta- tion, there is no apparent explanation for the large cash dividends which have been paid under recent railroad circumstances. u Appendix, Tables A-16 and A-17. 247 CHART 6 CASH DIVIDENDS AS A PER CENT OF PRE-FEDERAL INCOME TAX ORDINARY INCOME, CLASS I RAILROADS AND SELECTED LINES, 1960-1970 (PER CENT) YEARS 60 61 62 63 64 65 66 67 68 J CLASS 1 RAILROADS V V fSOUTHERN PACIFIC v / NORFOLK & WESTERN fift-. >' -^.^ If 64- 1 I / F* / 62- /.' v / / // > Rft- // v f \ / //' \ «—— f // R9- ■.••' * V 5? /♦ k_ *"'*' \ 46" i ' / \ V / \ SOUTHERN RAILWAY 44- * / > ''', ? \ / k / i Tin \ / \ / ^ftto* 1- 5 .? i ILLINOIS CENTRAL \[ / ^ »^Lf UNION PACIFIC !\ * / J ^ } w 34- /\ ' VVW ** , ^Uv P / \ K I ' 69 70 248 WORKING CAPITAL The consolidated financial impact of all the preceding forces has been to reduce net working capital of the Class I railroads by more than $500 million since 1965. Current assets as a percentage of current liabilities have fallen from an average of more than 150 per cent in the first half of the 1960's to less than 125 per cent in 1970. 12 Since there is no acceptable measure for the desirable current ratio, this shrinkage in the margin of current assets over current liabili- ties cannot necessarily be judged as bad. Indeed, some of the stronger roads have maintained for some time only a small working capital margin. In addi- tion, corporations generally have reduced their working capital margins in the last ten years. Between 1961 and 1969 U.S. corporations cut back the margin by almost 20 per cent reflecting, in part, greater efficiency in the management of short-term balances. la Appendix, Tables A-18 and A-19. 249 (PER CENT) 270 CHART 7 CURRENT ASSETS AS A PER CENT OF CURRENT LIABILITIES, CLASS I RAILROADS AND SELECTED LINES, 1960-1970 YEARS 60 250 Where the financial situation is somewhat more troublesome is in the proportion of debt due within one year, which increased to more than $600 million at the end of 1970 (Table 14). 13 This amounted to about six times net working capital. On the face of it this would appear to be a highly dangerous condition, but the severity of the problem cannot be so easily gauged. For one thing, there were improvements between 1969 and 1970, with the debt due within one year/net working capital ratio being reduced from about 13 times to 4 times. Moreover, virtually all short-term debt is rolled over, so that except for rail- roads in grave condition, like the Penn Central was in just prior to its bank- ruptcy, the presence of a large amount of overhanging near-term debt is not nearly so awesome as is sometimes thought. What may be more significant is that short-term debt is usually more costly. TABLE 14.- -DEBT DUE WITHIN 1 YEAR AS A PERCENT OF PRE-FEDERAL INCOME TAX ORDINARY RAILROADS, 1960-70 INCOME, CLASS 1 Year Percent Year Percent 1960 69.8 1966. 48.6 1961 63.1 1967 84.6 1962 58.5 1968 93.7 1963 55.4 1969 ( 2 ) 1964 54.3 1970 ( ! ) 1965 47.4 1 Before 1967 reported as net income. 2 Over 100 percent. Source: ICC and AAR. As one looks back through the facts reviewed in this section, it is clear that investment — its amount, character, and inferentially its utilization — plays a dominant role in explaining the financial fate of the rail industry. As noted earlier it is fixed charges (representing primarily payments on loans made to purchase rolling stock) and equipment rentals (a disguised form of investment) that have contributed so greatly to the decline in railroad ordinary income during the latter part of the 1960's. Because investment is thus so important the next section is devoted to its assessment. 13 Similar data for selected railroads are reported in Appendix, Table A-20. 251 INVESTMENT AND PRODUCTIVITY As an industry rail transportation is one of the most capital-intensive in the economy. At the end of 1970 total investment in railroad property used in transportation amounted to $37.5 billion. After deducting accrued deprecia- tion and amortization of over $10 billion, average net investment came to more than $28 billion. The latter figure is only $600 million more than in 1960, but this masks the fact that between 1960 and 1970 the railroads reported more than $14 billion in gross capital expenditures. The industry has an enormous appetite for capital, one that is fed by its low rate of capital turnover. With net investment of more, than $28 billion and total operating revenues of about $12 billion, the ratio of revenue to assets remains low by comparison with other industries despite some improvement over the last decade. Because of its large capital requirements railroad economic health depends heavily on the way in which assets are used and how they are financed. The ability of the industry to increase its utilization of capital by even a very small amount can mean a large difference in earnings because of the impact on debt and fixed charges. For example, if freight car use were to improve at an annual rate of 3.5 per cent over the next ten years instead of 1.5 per cent, railroad capital needs could be reduced by as much as $18 billion. Equally important, more intensive use of capital investment would mean better service to shippers and attract addi- tional traffic. To a very great extent, therefore, the question of capital manage- ment is the key to the problems of the railroad industry. Investment statistics in recent years clearly demonstrate one fact: the railroads are able to raise large amounts of capital. It is often pointed out that the earnings of the railroad industry, as a percentage of net worth, are low by couq:>arison with other sectors. Class I railroad earnings amounted to only about three per cent on net worth in 1970, only a fourth of the rate of return in manufacturing and a third of the rate of return in all industries. If this were the appropriate investment yardstick, the railroads would obviously be unable to attract any external funds since a three per cent rate of return is below even the prime interest rate. What is also true is that both the railroads and their investors realize that for some, new, incremental investment returns are actually considerably higher. On an intensively used freight car, for ex- ample, the anticipated discounted return may be as high as 20 per cent. THE CHARACTER OF RAIL INVESTMENT Railroad capital requirements are highly diverse and the investment cir- cumstances are equally varied, meaning that it is much easier to raise funds for some purposes than for others and that the pattern of investment can be skewed. This is attributable in part to the fact that while investments are typically made by individual railroads, the benefits are shared by the entire railroad system. This is exemplified by freight cars, which account for the bulk of new railroad investment. Since at any given time a substantial per- centage of a railroad's freight cars will be in use on other lines and since a typical shipment moves on more than two lines, the benefits of such rolling stock investment are shared within the system. So long as some returns can be derived from the capital outlay which is made, as is true with per diem pay- ments for freight cars, the system characteristics may not inhibit carrier invest- ments. However, where this is not feasible, a railroad may hesitate or refrain from investing in certain types of capital. For example, any one carrier may not be willing to invest in a costly electronic system for freight car manage- ment if the benefits can be realized only if other railroads also make similar investments. 74-924 O - 73 - 18 252 In considering the nature of railroad investment, there are other factors to be taken into account. From the standpoint of legal security for lenders, it is often much easier to obtain funds for some types of investment than others. A locomotive or freight car is portable and in the event of default on required payments, rolling stock can be transferred to another railroad. This is not the case with investment in track, terminals and yards, or even in computer or telecommunication facilities. (Conceivably they may even be covered by after- acquired clauses in existing mortgages or covenants.) While such fixed invest- ments might add greatly to railroad operating efficiency, they tend to be under-financed except for railroads which can generate the necessary capital internally. Since 1964 the railroads have recorded gross capital expenditures of well over $1 billion a year. Between 1965 and 1970 their gross capital expenditures amounted to $9.'J billion (Table 1;")). Of this about three-fourths was for equipment. As noted elsewhere, additional capital investment was made in railroad property by non-railroad interests and either leased to the railroads or to special users. Precise numbers are unavailable, but some indication can be gained from the fact that private car companies and shippers (including firms such as the Trailer Train Company which are owned by the railroads) added more than 55,000 cars to their fleets between 1900 and 1970 (meanwhile, cars owned or leased by the Class I railroads declined by about 240,000). Although the number of freight cars in railroad service was nearly 200,000 fewer in 1970 than 1960, total freight car capacity increased somewhat, because of the substitution of bigger for smaller cars. TABLE 15.-GR0SS CAPITAL EXPENDITURES AND CASH FLOW, CLASS I RAILROADS, 1960-70 [ I n thousands of dollars| Gross capital expenditures Gross capital Year: expenditures Roadway and as a percent Total Equipment structure Cashflow of cash flow 1960... 919,154 633,490 285,664 1,191,693 77.1 1961 646.425 427,130 219,295 1,073,155 60.2 1962 832,938 593,369 239,569 1,023.229 81.4 1963 1,043,788 784,874 258,914 1,226,326 85.1 1964... 1,417,263 1.139,683 277,580 1,383,824 102.4 1965... 1,630,686 1,303,602 327,084 1,521,210 107.2 1966 1,952,804 1,554,223 398,581 1,634,349 119.5 1967 1,522,478 1,148.381 374,097 1.310,092 116.2 1968 1,186,979 818,720 368.259 1.363,132 87.1 1909. 1,509,393 1,088,712 420,681 1.280.043 117.9 1970 1,350,120 993,095 357,025 1,016,177 132.9 Source: ICC, AAR and Moody's Transportation Manual. 253 CHART 8 GROSS CAPITAL EXPENDITURES AS A PER CENT OF CASH FLOW, CLASS I RAILROADS AND SELECTED LINES, 1960-1970 (PER CENT) YEARS 60 1 K | \ \j f \/ CLASS 1 ; c • i » • • L f ¥ 1 • • • • • I • A J M SOUTHERN RAILWAY 3 • f m • u ? ILLINOIS CENTRAL A f \ l\ i i 1. ^r \ 1 I V ii 1 / i ..•rl ■ 1 •• It i; * \ ' UNION PACIFIC ", it i; ■• i i - • • c > < NORFOLK & WESTERN i\ ? i: • • * / i: r - ♦ V. *• i* H i: i 1 1 1 1 i 61 62 63 64 65 66 67 68 69 70 254 The character of freight car investment during the last decade has resulted in a fleet that in 1970 was quite different from what it was at the beginning of the period. First, a growing proportion of freight cars in railroad service are owned, not by the railroads, but by car companies and shippers. Of the cars in the railroad fleet in I960, 14 per cent were owned by car companies and shippers; by 1970 this share had increased to 19 per cent. One of every five freight cars is thus now owned by a non-railroad organization. Closely related to this development is the growing insistence by major shippers that railroads commit or dedicate a certain number of cars to their requirements. Second, the freight car fleet is becoming increasingly specialized by func- tion (Table 16). The number of unequipped box cars has fallen sharply, but the number of equipped box cars, special service flat cars, and covered hopper cars has increased. The general impression, therefore, is that the rail freight car fleet has been more closely tailored to special purposes, reflecting the par- ticular requirements of the approximately 100 or so big shippers who account for an estimated 75 per cent or more of rail traffic. Among other implications this trend means that the railroads are increasingly less flexible in their ability to meet seasonal requirements and the demands of the many small and medium- size shippers. It also helps explain why empty freight car miles have increased, as cars are routed empty rather than being used for a different return load. 255 co^cnr-oouJu-JCsii — cm en u"> CT> ^- o co oo**esioicsir-.o— 'Oiffiwoocewo 00U1(M( N J00OOl0U3O(000'*tD- o u"> ir> «"> cm to ~h i — tt — • en _ — ■ tj ' co ■* to co co" c\T cm co **" oo" cd ** to" ^r tOiTXIioOOOnLnOOcoO^-O^^-^- cococr>c?>oo^^ooCDr^.CT> w- ■ _ ^ l/>COCTlU">rf«frf «3-«OOCO«3-tO*5-COOOCslcOotO^T*'-^ ^J"00'3 - CNJCOtOcOU^COCT>OOa»0>^* i - -: - cnT ~- cm eg" co" ^ ■ O r-» •— r-. -^ -». • 00 CO OO ** *=■ <=• ' v-Ti-4 CM dooootic O^-^-«lO00^hC7iCT>CN)^3-C0co0>CI ~- cm cm cm cm u-> ix> co"r-Tc\i~H S ro CO ™ cMi£>-«3-oot£>Lnt£>ooo«Tco — <- r —. 7 . coOTxsicsjinesjooLnoooi — to *=- ^- *- m^Dr^oodO^cjro *s- u-> to r— oo cr> o inij">ii">ir>a")iOiOioto<£>a3to<^ ct» cr> cr> cr> cr> en cr» ct> ct> en en ct> oi o en 256 ADEQUACY OF INVESTMENT Little can be said about the adequacy of the investment in roadway, struc- tures, and other non-rolling stock items. It is often said, for example, that railroad replacement of cross ties and rail has not been sufficient to replace existing installations; but this would be true only if all rail and all cross ties had to be replaced at the same rate and on the same schedule. On some little-used track no replacement at all may be called for; secondary tracks similarly require less frequent upgrading than main lines. Currently the railroads are replacing about 17 million cross tics a year and installing over 2,000 miles of new rail (Table 17). What is not known is how these replacements and installations are being allocated among track types and uses. New rail and cross tie installations are presently running at a rate below that experienced in the early 1950's. However, the average weight per yard of rail has been increased; by the end of 1969 more than 63,000 miles of track had rails averaging more than 130 pounds per yard. This is up 10,000 miles since 1960 and almost 9,000 miles since 196'5. In addition, more than 40,000 miles of road are now under centralized traffic control ; this is up by a third since 1960. These facts represent major improvements in the physical plant, but whether they are adequate would require far more disaggregated information about patterns of use than is now available. TABLE 17.- -MILES OF NEW RAIL LAID, NUMBER OF TIES REPLACED AND MILES OF CENTRALIZED TRAFFIC CONTROL, CLASS I RAILROADS, 1960-70 Miles of Miles of Miles of Number of centralized Miles of Number of centralized new rail ties replaced traffic new rail ties replaced traffic Year laid (thousands) control Year laid (thousands) control 1960 1,285 14,237 35, 997 1966 2,363 15,250 44,258 1961 1,364 11,970 (') 1967 1,912 15,022 45,400 1962 1,802 13,375 0) 1968 2,292 17,044 46, 598 1963 1,669 13,601 (') 1969 (') 17,323 47,097 1964 1,882 13,524 (') 1970 (') (') 47,900 1965 1,885 14,714 44,025 1 Not available. Source: ICC, AAR, Department of Transportation and Moody's Transportation Manual. If there are inadequacies in railroad non-rolling stock investment, they are likely to be related to those elements that have a so-called systems effect. This relates to the point made earlier, namely that certain individual railroad investments may be worthwhile only if other railroads make similar commit- ments. The best example concerns national freight car utilization. Recognizing the need for a nation-wide approach to this problem, the Association of Ameri- can Railroads set up a computer system called TRAIN. It calls for member Class I railroads to transmit information about their car movements, notably at interchange points. Its potential is considerable, but its use to date has been limited largely because some carriers do not have sufficiently reliable inter- change teleprocessing systems to provide the necessary timely information. While adoption of such a national system would be highly advantageous and permit the railroads to make more efficient use of their rail car fleet, the neces- sary capital commitment is large and the uncertainty that others would also do so has caused carriers to hesitate, thereby frustrating implementation of a po- tentially high payoff system. PRODUCTIVITY The relative scale and composition of railroad investment, though an im- portant dimension of industry activity, necessarily offers an incomplete pic- ture for it concentrates on only the input side of the equation. Ultimately, of course, investment must be tested by its payoff and this calls for an examina- ion of the pertinent productivity data. 14 At issue here is whether and at what rate of change capital invested by the railroads is generating increasing returns per unit of investment. There is nothing peculiar to the railroads in this inquiry, 11 The basic data for capital productivity are in Table 18. 257 for the question of productivity is fundamental to the growth of the economy and is a well-accepted test of relative industry health. Normally we would expect that over time both labor and capital will become more productive. The hour of work or the dollar of capital that yields 100 units of output one year might generate 105 units the next year, 110 the following year, and so forth. Increased productivity, of capital and labor, is indeed the chief determinant of the growth of the American economy. Conversely, in sectors where pro- ductivity is not rising, or where its rate of increase is below that for the economy as a whole, decline is inevitable. TABLE 18— CAPITAL PRODUCTIVITY, SELECTED MEASURES, CLASS I RAILROADS, 1960-70 Index. 1960 = 100 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Operating revenue per dollar of net investment 0.346 0.338 0.365 0.371 0.379 0.388 0.390 0.374 0.392 0.411 0.425 Index 100.0 97.7 105.5 107.2 109.5 112.1 112.7 108.1 113.3 118.8 122.8 Originated tonnage per dollar of net investment. ...... .045 .044 .048 .050 .052 .053 .053 .051 .052 .053 .053 Index ... . 100.0 97.8 106.8 111.1 115.5 117.8 117.8 113.3 115.5 117.8 117.8 Dollar of opetating expenses per originated tonnage ($).. . 6.097 6.094 6.014 5.780 5.712 5.658 5.603 5.828 5.995 6.153 6.630 Index 100.0 99.6 98.6 94.8 93.7 92.8 91.9 95.6 98.3 100.9 108.7 Ton-miles per dollar of net investment.. 20.83 20.73 22.93 24.12 25.34 26.52 27.03 25.94 26.89 27.53 27.05 Index . 100.0 100.0 110.1 115.8 121.7 127.3 129.8 124.5 129.1 132.2 129.9 Railway operating income per dollar of net investment . .035 .034 .043 .047 .048 .055 .057 .045 .048 .049 .045 Index . ... 100.0 97.1 122.9 134.3 137.1 157.1 162.9 128.6 137.1 140.0 128.6 Net railway operating Income per dollar of net investment .021 .020 .028 .031 .031 .037 .038 .024 .025 .023 .017 Index .... .... 100.0 95.2 133.3 147.6 147.6 176.2 180.9 114.3 119.0 109.5 81.0 Income available for ,xed charges per dollar of net investment 032 .029 .038 .041 .043 .048 .050 .038 .039 .038 .030 Index . 100.0 90.6 118.8 128.1 134.4 150.0 156.3 118.8 121.9 118.8 93.7 Source: ICC and AAR. How to measure productivity? This has been a topic for extended debate among economists, with considerable argument (and little agreement) as to the appropriate indicia of both input and output. For immediate purposes several different standards can be employed, recognizing that each has some infirmity. As an example, the available output indicators — tons, ton-miles, operating revenue — are influenced by short-run fluctuations in the economic cycle, but inputs (number of workers, invested capital) do not change as readily. In short periods of time this imbalance can produce statistical aberrations and regardless of the statistical technique used this problem cannot be fully com- pensated for. Acknowledging the difficulties that are necessarily involved, we can define a few practical tests and apply them to the railroad situation. The objective is to determine whether the productivity of labor, on the one hand, and capital, on the. other, has been increasing over the last ten years, at what rate, and in what pattern within the period. Two sets of output criteria will be used : one will focus on physical measures (e.g.. tons of freight transported), the other on financial measures (e.g., has there been an increasing earnings return on investment). A good starting point is the relationship between railroad traffic and railroad investment. As Table 18 shows, between 19fi0 and 1970 there was a modest gain — very small in fact — of 18 per cent in tonnage moved per dollar of investment. In terms of ton-miles there was a somewhat larger increase, of about 30 per cent. By either standard the improvement was quite small. Why? For one thing productivity gains in the use of freight cars, the biggest continuing source of industry invest- ment, were modest. Net ton-miles per freight car day. for example, increased by less than three per cent a year during the 1960's. (And this gain, as noted elsewhere, is explained almost entirely by lengthening of the average haul and the substitution of bigger for smaller capacity cars.) Average freight car turn- around time has not significantly improved, the proportion of empty to loaded car miles has gone up. annual average car mileage in 1970 was no greater in 1970 than in 1960, and average train speed has remained constant. By other tests, such as gross ton-miles per freight train hour (up by about 22 per cent 258 between I960 and li)70) and car miles per day (up from 45.7 to 54.6, but with a higher percentage empty), productivity gains were also small. During the L960's, therefore, the railroads succeeded in getting only somewhat more physical output from their investment. When one looks at labor productivity the gains have been far more sub- stantial. This reflects a sharp reduction in the number, of railroad employees (Table 1!)). Between 1960 and 1!)7<) the work force was cut by more than 200,000, witli only 5<>C>,000 people employed in 1970. Since railroad revenue ton-miles had increased over that same period by about ',)'.) per cent, productivity rose rapidly. The Labor Department calculates that output per man-hour climbed at an average annual rate of approximately six per cent during the 1960's. 15 TABLE 19— NET INVESTMENT PER EMPLOYEE, CLASS I RAILROADS, 1960 70 Year Net investment Employees Net investment per employee (Millions of dollars) 1960 = 100 (Thousands) 1960 = 100 (Dollars) 1060 = 100 27,474 100.0 780 100.0 35,223 100.0 27,181 98.9 718 92.1 37,857 107.5 25, 858 94.1 700 89.7 36,940 104.9 25, 773 93.8 680 87.2 37,901 107.6 25,989 94.6 665 85.3 39, 081 111.0 26,319 95.8 640 82.1 41,123 116.8 27,322 99.4 631 80.9 43,300 122.9 27, 733 100.9 610 78.2 45,464 129.1 27, 668 100.7 591 75.8 46,816 132.9 27, 892 101.5 578 74.1 48,256 137.0 28, 186 102.6 566 72.6 49, 799 141.4 1960 1961 1962 1963 1964. 1965 1966. 1967. 1968. 1969. 1970. Source: ICC and AAR. One suggestive measure is found simply in the ratio of originated tonnage to employment. This shows that in 1960 tons per employee was 1,589; by 1970 this was up to 2,623, an increase of 65 per cent (Table 20). Thus on the labor side the productivity gains have been considerable, at least when measured by physical output indicators. TABLE 20.-LABOR PRODUCTIVITY, SELECTED MEASURES CLASS I RAILROADS, 1960-70 (Except where noted, 1960-100) 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Output per man-hour: 1 Production workers in- dex (1967=100) 63.2 68.1 72.4 76.9 81.9 91.0 97.6 100.0 104.4 109.3 ' 109. 9 Output per man-hour: i All employees index (1967 = 100) 63.6 68.2 72.6 77.1 82.1 90.8 97.5 100.0 104.4 109.2 ' 109. 7 Originated tonnage per employee (tons) 1,589 1,667 1,762 1,889 2,037 2,168 2,296 2.308 2,422 2,549 2,623 Index,... 100.0 104.9 110.9 118.9 128.2 136.4 144.5 145.2 152.4 160.4 165.1 Total labor costs per dollar of net investment.... .195 .188 .200 .199 .202 .204 .202 .202 .211 .219 .227 Index 100.0 96.4 102.6 102.1 103.6 104.6 103.6 103.6 108.2 112.3 116.4 Operating revenue per dollar of labor costs 1.775 1.779 1.882 1.860 1.876 1.901 1.933 1.849 1.858 1.872 1.874 Index 100.0 101.4 102.6 104.8 105.7 107.1 108.9 104.2 104.7 105.5 105.6 Labor costs per labor costs plus income available for fixed charges (cents) .860 .865 .841 .829 .824 .810 .801 .842 .843 .852 .883 Index 100.0 100.6 97.8 96.4 95.8 94.2 93.1 97.9 98.0 99.1 102.7 Labor costs per labor costs plus net railway op- erating income (cents) . 902 . 905 . 877 . 864 . 865 . 848 . 841 . 892 . 896 . 903 . 929 Index 100.0 100.3 97.2 95.8 95.9 94.0 93.2 98.9 99.3 100.1 103.0 Labor costs per labor costs plus railway operating income (cents) . . .849 .847 .823 .808 .808 .788 .788 .818 .815 .819 .835 Index 100.0 99.8 96.9 95.2 95.2 92.8 91.6 96.3 96.0 96.5 98.4 1 Class I railroads and Class I switching and terminal companies. Source: ICC, Department of Labor and AAR. 2 Preliminary. Physical measures of a change in productivity — how much more output is being derived per man-hour or dollar of investment — represent but one approach to the issue. The other relates to financial returns: have the railroads been able to increase their earnings relative to the share going to labor and their additional capital investment ? In summary, the record shows that from 1960 to 1970 there was about a 23 per cent improvement in the capital/output ratio, with a dollar of net investment "producing" 4:5 cents of operating revenue in 1970 as 15 See Appendix, Table A-25. 259 compared with only 35 cents in 1969 (Table 18). Operating revenue per dollar of labor costs rose about 6 per cent. The result is that despite a sharp decline in the number of workers, the labor share of railway operating income as well as net railway operating income and income available for fixed charges remained about the same or was up somewhat in 1970 compared with 1960. This signifies that the full measure of rising physical labor productivity has been paid out in increased employee compensation. The pattern of productivity change during the 1960's was highly uneven, however, which further helps explain the problems experienced by the industry in the later years of the decade. Especially noticeable is a sharp break point in capital productivity that took place about 1966. First, though, consider labor productivity, where there was a noticeable yet less pronounced slowdown in the rate of increase. As can be seen in Table 20, aggregative measures of gains in output per man-hour rose steeply from about 1962 through 1966, with annual percentage gains averaging well over six per cent. The freight tons per em- ployee index, as indicated in Table 20, climbed from 105 per cent of the 1960 base in 1961 to 145 per cent in 1966. In the face of these gains total labor costs per unit of net investment held steady from 1962 through 1967, as seen in Table 20. Even more importantly labor costs as a percentage of income available for fixed charges plus labor costs — what has sometimes been called the labor distributive share — fell in the early 1960's. From a value of 86.5 per cent in 1961, the highest it had been since 1950, the labor share declined to 81 per cent in 1965. Seen in another way, labor costs were consuming a smaller proportion of operating revenues. The index of operating revenue per dollar of labor costs rose 9 per cent. From the standpoint of investment efficiency measured in financial terms, the early 1960's were a similarly optimistic period for the railroads. Relative to investment, railway operating income, net railway operating income, and income available for fixed charges all rose steeply through 1966. As seen in Table 18, the net railway operating income/investment index escalated 81 per cent from 1960 to 1966. There were similar sizable though less dramatic gains in the two other financial measures of capital productivity. In short, the railroads were squeezing far more revenue out of their investment and this efficiency was being carried forward into earnings. In about 1966 railroad fortunes went into sharp reverse, with a particularly marked deterioration in the financial measurements of productivity. The rate of increase in labor output per man-hour slowed considerably, averaging only about three per cent a year from 1966 to 1970 — in contrast with gains of more than twice that in the earlier years. This slowdown in labor productivity was not offset by any change in compensation. Total labor costs began to consume a growing share of operating revenue, with the index of operating revenue per dollar of labor costs falling from 108.9 in 1966 to 104.2 in 1967 and rising modestly to 105.6 in 1970. Even more striking, the labor distributive share climbed from 81 per cent in 1965 to more than 88 per cent in 1970 when measured against income available for fixed charges (it also increased in comparison with net railway operating income and railway operating income). The financial measurements of capital productivity also displayed sharp declines after 1966, with the most pronounced setbacks showing up in earnings. While the index of operating revenue/net investment was higher in 1970 than in 1966 (and 23 per cent more than 1960), the ratio of railway operating income (revenue less expenses) to net investment began to fall in 1967. By 1970 this latter ratio was only 29 per cent above 1960, down from 63 per cent in 1966. Significant though this is, it understates the problem for railway operating income does not take into account the growing costs associated with equipment rentals. If net investment is related to net railway operating income, the fall in productivity is dramatically portrayed. In 1966 the investment/NROI index was 181 per cent of the 1960 base, but as shown in Table 18 by 1969 it had fallen to 110 and by 1970 it was down to 81. There was a nearly comparable pre- cipitous decline in the ratio of investment to income available for fixed charges. 260 From 1966 on, therefore, increasingly more investment was required each year to produce a dollar of net earnings and by 1970 the situation was worse than it had been in 1960. By these tests the improvements in capital productivity that had been made in the first half of the 1960's were dissipated in the decade's later years. Some of this decline, of course, can he explained by falling output, attributable to the general slowdown in the economy, but by no means all of it. The rate of average annual gains in net ton-miles per freight car day from 1967 to 1970 slowed to about half the rate recorded from 1962 to 1966. By 1970 turnaround time was slower than in 1960. The index of ton-miles per dollars of net rail investment showed practically no gain from 1966 through 1970 in contrast with an increase of nearly SO per cent from I960 through 1966. To sum up: for the railroads the 196()'s were a decade marked initially by improvement and then by decline in the productivity of their investment. In the earlier years stepped-up capital investment and declining employment resulted in productivity gains and better earnings for the industry. After 1966, however, although labor productivity continued to increase, capital output fell at a substantial rate when measured in financial terms. With the labor share of operating income tending to rise, offsetting gains in physical labor productivity, the effect was to depress earnings. In this later period railroad capital outlays were not contributing to increased efficiency or higher capital productivity. Quite the contrary : capital output was falling, gains in labor productivity were being counterbalanced by rising labor compensation, and there was poorer investment utilization as reflected in financial results. While there were more tons of freight carried per worker and per dollar of investment in 1970 than in 1960, the financial returns on capital — as reflected in the ratio of investment to earnings and in the share of net revenue — were off significantly. Unmis- takably investment management has clearly now become the railroad s number one problem. 261 EFFICIENCY AND SERVICE The appeal of rail transportation to shippers is a composite of many variables, with the qualitative dimensions of service becoming increasingly important. Rates, always significant of course, are but one aspect of the product the railroads have to offer. As shippers become more sophisticated and come to view the distribution process as a totality, the "cost 1 ' of transportation ranges far beyond its quoted price. This is especially the case with higher-valued manufactured goods, whose rate of growth and yield make their movement such a crucial factor in the future development of the railroad industry. The quality of service, important as it is in attracting rail traffic, is largely dependent on the efficiency of rail operations and the utilization of equipment. What this signifies is the interdependence of railroad problems, for without better use of equipment there can neither be improved service nor a more profitable exploitation of the substantial rail capital investment in plant and rolling stock. From the standpoint of shippers, rail transportation services comes down to a function of: * rates * availability * dependability * shipment loss and damage Obviously these can be consolidated into a single cost function, but for present purposes they are best viewed separately. In doing so one finds the keys to some of the railroads' most serious problems — namely, the relatively low overall rate of capital utilization and the generally deteriorating quality of service. Several highlights can be noted: * There is evidence that shippers have experienced increasing difficulty in recent years in obtaining cars on a predictable schedule. This reflects less an inadequate supply of cars than the absence of a system to manage the distribution of cars. * In-transit and car delivery schedules have slowed but, more importantly, they have become less reliable. * Less trains are hauling heavier carloads greater distances. From a service standpoint, these facts suggest that the railroads are concentrating more of their efforts in servicing the relatively small number of big shippers whose rail transportation needs are both great and highly routinized. One result of this concentration of effort, of course, is increasingly poor service to shippers whose demands for rail service are not as great and not as regular. * Loss and damage claims for rail freight movements have escalated sharply, rising from $167 million in 1967 to more than $224 million in 1970. ,: Utilization of the railroads' single biggest category of investment, freight cars, has shown some improvement during the last decade, but almost all of this can be attributed to shipper insistence on larger cars and to lengthier hauls rather than to better management of the car fleet. With this overview in mind, we can turn to a more detailed examination of the efficiency and service record of the industry in the last decade. FREIGHT TRAIN INDICATORS Statistics for all Class I railroads show that both the number of miles and hours logged by freight trains has remained virtually constant during the 1960s (Table 21). Regional figures, however, indicate that there has been a 23 per cent increase in freight train miles for lines in the Southern district, but 262 a six per cent drop for Eastern district roads. Given the fact that the average length of haul 16 has increased about ten per cent ( from 452 to almost 500 miles), it might be expected that a similar increase in freight train miles and hours would be evident. That this is not the case points to the falling number of trains being made up for line haul operation. This is confirmed in Table 21 which shows that more than one million fewer trains were made up in 1970 than in I960. In short, the combination of fewer trains traveling greater distances has resulted in about the same number of train hours and miles of service in the 1960's. TABLE 21.— FREIGHT TRAIN MILES AND HOURS AND TRAINS MADE UP FOR LINE HAUL, I CLASS I RAILROADS, 1960-70 [Index, 1960 = 100) Freight Freight train train miles hours Number of Year- (thousands) Index (thousands) Index trains Index 1960 404,464 100.0 20, 708 100.0 1, 569, 779 100.0 1961 386,410 95,5 19, 460 94.0 1,466,350 93.4 1962 393,346 97.3 19,653 94.9 1,471,477 93.7 1963 399,897 98.9 19, 899 96.1 1,483,504 94.5 1964.. 414,470 102.5 20, 548 99.2 1,546,396 98.5 1965. 420,962 104.1 20,977 101.3 1, 508, 889 96.1 1966 437,491 108.2 21,597 104.3 1,542,208 98.2 1967 420,365 103.9 20, 669 99.8 1,477,056 94.1 1968..... 429,276 106.1 21,031 101.6 1,465,268 93.3 1969 433,371 107.1 21,561 104.1 1,471,684 93.8 1970... 427,116 105.6 21,247 102.6 1, 437, 392 91.6 1 Total tonnage per average freight train load. Source: ICC and AAR. Similarly, there has been virtually no change over the decade in the number of cars in the average freight train. 17 (In addition, there has been no change in the tendency for Eastern district railroads to make up slightly longer trains than lines in both the Southern and Western districts). Nevertheless, there has been a steady increase in the amount of freight hauled by the average train. 18 Since there has been no dramatic shift in the type of commodities carried by the railroads, and since the number of cars in the average train has held constant, this steady gain in tons hauled must be attributable to the increase in the size of the newer cars being placed in service. Finally, the 24 per cent increase in gross ton-miles per freight train hour 19 is consistent with other data already pre- sented : heavier trains are traveling greater distances, while their hours of running time have remained unchanged. FREIGHT CAR INDICATORS Table 22 presents data regarding loaded car-miles. 20 It indicates that while there has been no change in the absolute number of loaded car-miles, there has been a drop (almost seven per cent) in the ratio of loaded to total car-miles. Taken together, these probably reflect the increase in empty backhauls resulting from the introduction of unit-trains and specialized equipment. What this suggests is that in accommodating the wishes of a shipper and gaining traffic by supplying specialized equipment, a railroad may or may not benefit depending on the net earnings derived from the relevant movements. If equipment use is sufficiently increased, as it can be with a unit train operation, the investment can be rewarding even though the empty haul ratio is high (i.e., more hauls and reduced turnaround time onsets the empty backhauls) . On some special equipment, however, there may be little increase in usage except for short seasonal periods so that the investment, though pleasing to a shipper, may be harmful to the railroad. 18 See Appendix, Table A-26. " See Appendix, Table A-27. 18 See Appendix, Table A-28. 19 See Appendix, Table A-29. 20 Similar data for selected railroads can be found in Appendix, Table A-30. 263 TABLE 22.— LOADED FREIGHT CAR MILES, CLASS I RAILROADS, 1960-70 Loaded Loaded car-miles car-miles Car-miles as percentage Car-miles as percentage loaded Index of total loaded Index of total Year (millions) 1957-59 = 100 car-miles Year (millions) 1957-59 = 100 car-miles 1960 17,287 95.9 61.4 1966 18,304 101.6 60.3 1961 16,648 92.4 61.2 1967. 17,449 96.8 58.9 1962 16,990 94.3 61.2 1968 17,825 98.8 59.3 1963 17,133 95.1 60.9 1969 17,965 98.9 59.2 1964 17,487 97.1 60.6 1970 17,300 96.0 57.8 1965 17, 885 99.3 61.0 Source: ICC and AAR. The trend toward building larger freight cars is reflected in a gain of over 11 tons in the capacity of the average car over a ten-year period. 21 Reflecting this gain in capacity is a similar increase in the average freight car load (Table 23). It is interesting to note, in this respect, that the industry employs two methods for calculating the average freight car load. One procedure simply measures the weight of originated freight, while the other, based on operating statistics, introduces distance factors. It is clear from Table 23 that when the first method is used, only a 23 per cent increase is seen, whereas operating data suggest an increase of 32 per cent. TABLE 23.— AVERAGE FREIGHT CARLOAD, CLASS I RAILROADS, 1960-70 Tons par originated Net ton miles per Year carload Index 1960 = 100 loaded :ar mile Index, 1960 = 100 1960. 44.4 100.0 34.0 100.0 1961. 44.9 101.1 34.7 102.1 1962. 45.4 102.2 35.7 105.0 1963. 46.7 105.2 37.1 109.1 1964. 47.8 107.7 38.3 112.6 1965. 48.9 110.1 39.6 116.5 1966. 50.1 112.8 40.3 118.5 1967. 51.1 115.1 41.2 120.9 1968. 51.8 US. 7 43.0 126.5 1969. 53.1 119.6 43.5 127.9 1970. 154.6 123.0 44.9 132.1 1 Estimated. Source: ICC and AAR. Along with these increases in freight car capacity and load, there has also been a rise in daily car mileage (Table 24). While the 20 per cent increase in car mileage is consistent with earlier data indicating an increasing length of haul, nevertheless this statistic should be regarded with some caution. The daily car mileage figure is calculated for serviceable freight cars both loaded and empty. 22 Since there has been a drop in the percentage of loaded to total freight car miles, it must follow that the rise in daily car mileage includes an increase of "light" car-miles. TABLE 24— DAILY CAR MILEAGE AND TIME AVERAGE CAR SPENDS IN FREIGHT TRAINS', CLASS I RAILROADS, 1960-70 Year Miles Index, 1960 = 100 Hours per day in freight train Index, 1960 = 100 1960 45.7 100.0 2.34 100.0 1961 45.5 99.6 2.29 97.9 1962 _ 47.6 104.2 2.27 97.0 1963 49.2 107.7 2.38 101.7 1964.... 50.0 109.4 2.48 106.0 1965 _ 51.7 113.1 2.57 109.8 1966 53.0 116.0 2.61 111.5 1967 51.5 112.7 2.54 108.5 1968 53.5 117.1 2.62 112.0 1969 54.9 120.1 2.73 116.7 1970 54.6 119.5 2.72 116.2 1 Daily car mileage times average freight train speed. Source: ICC and AAR. 21 See Appendix, Table A-31. 21 For data on car serviceability, see Appendix, Table A-32. 264 An oft-cited composite index of freight car efficiency is "net ton-miles per freight car day." Table 25 reports that this measure is up almost 50 per cent since 1960. The gain in this item is due primarily to the increase already noted in the average freight car load. To a lesser extent, the gain in daily car mileage is also responsible. Clearly, however, the increase is not due to the percentage of freight car miles loaded for this statistic, as we have just seen, has declined. Since the performance of this key index of efficiency is so dependent on the weight of the average carload of freight, it is important to recall how this latter item can be computed. When based on statistics that take length of haul into account the average freight car load shows a far greater increase than when calculated on a mere tonnage basis. The nearly . r >() per cent increase in "net ton-miles per freight car day," therefore, results from inclusion of distance ; if the tonnage figure were to be substituted, only a 38 per cent increase in freight car efficiency would be indicated. Before leaving this efficiency indi- cator, it is useful to note the great variance in performance by different roads. Whereas the Southern and Union Pacific have registered increases well above the national average, the Illinois Central and Norfolk & Western are below the national norm while the Penn Central and Southern Pacific closely follow the performance of all Class I roads. TABLE 25.-NET TON-MILES PER FREIGHT CAR DAY, CLASS I RAILROADS, REGIONAL DISTRICTS, AND SELECTED RAILROADS, 1960-70 Year 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Class I Railroads Eastern District Penn Central ... Pennsylvania. . New York Central Norfolk & Western .... New York, Chicago & St. Louis Southern District . . . Southern Railway Illinois Central Western District Southern Pacific Union Pacific. ... . . 954 805 966 813 1,041 1,113 942 635 674 1,038 1,096 934 (0 (') 1,131 0) (') 638 680 1,046 1,056 942 843 961 1,140 1,394 1,425 694 729 1,119 1.092 1,005 990 1,019 1,232 1,581 1.465 734 766 1,209 1.266 1,084 939 1,078 1,313 1,696 1.493 1,160 1,006 989 908 1,328 1,102 1,040 1,047 1,347 1.790 1.528 1,251 1,079 1,310 1,108 1,271 1,094 1,021 966 1,281 1,113 974 1,259 1,063 916 1,352 1,350 1,416 1,418 1,103 1,124 1,128 1,050 1,005 1,033 1,206 997 1,143 1,453 1,929 1,768 1,286 1,077 1,187 1,529 2,075 1,850 1,264 1,073 1,114 1,455 2,020 1,741 1,392 1,390 1,429 1,593 2,188 1,992 1,487 1,673 1,249 1,694 2,141 2,209 1,411 1,393 1.422 1,403 1,543 1,243 1,735 2,024 2,354 1 Not available. Sources: Class I Railroads and Regional Districts— ICC and AAR: Selected Railroads-Moody's Transportation Manual. 265 CHART 9 NET TON MILES PER FREIGHT CAR DAY NET TON MILES PER FREIGHT CAR DAY, CLASS I RAILROADS AND SELECTED RAILROADS, 1960-1970 J- < • UNION PACIFIC 1 • > * 7^ i i SOUTHERN PACIFIC 4 ► 1 t / \ \ t i i i w \ i r / / t t i * / \ .,-* .-'" w r SOUTHERN RAILWAY 7 -•"• j CLASS 1 f A NORFOLK & WESTERN j Sk \ \ >*i ■N— ILLINOIS CENTRAL ) * y y ,<'"' ** •^_ i »,-• — y' , 334 169, 169 164, 052 41.5 144.8 140.4 ,411 107,678 108,275 50.3 158.0 158.9 1,977 81,078 85,488 24.2 124.4 131.1 ,407 129,715 126,198 23.3 130.6 127.1 1,426 71,551 74,038 22.2 127.8 132.2 co OO in cm CM*" CD OO CM (jD r-» cm r-".r*»CftCDi/}c\joooii"i*t o en*"*- cm r-* .co .mr*.r-» .oo -co -co .© Or-.OOCMr-©*J-OOCOOr-«.CM^CMCMOO r— ^- r-coto co n*. •— to r»r-coo">*J'*3 - Tr».CMeooocsjcocncM CO . lo ,Oi^n- , _« . m . ^r ,oo -CM .— t - - .*T -CO -CM -CM -CM *t —■ i(VH- iCOCT>O»~HCM^00.—i~H^r-.~H ^f CM OOCO^O Ol P* CM tD ooooo-'OJM^iflio^'tror^ono r— .CD - H* "* CO .CO -CO .CO .CM . viomu3C\HDu3CMmOif>Jtno30or^^ ^j- ~- r«. ^ cc OO l — f* cO j^ro^mo ■ *s> .en . to .3 if -o— • u->LocnOOc . cm'^h m f* oo"<— i cm •■ -»«. r^. co co — < to in r— co r-» . mr—. o . OO w .^ ,r>.(0(c , r-^ .to .co . co cncOfHinf-cno*>cMr--tDCMr«.oocj>cn~- coocootor-- momor- o-^oo^o co -in ,r-»r-.fH ,*r .co .oo -5? F-OOOOOOOlOOO-Oi-'ONoOO -O -O . - -O -<=> -o -o -o CM fh in ^^ CM CM (^rHOOF-lrtFH CO fh"'^ J— O) iC (Ji I'EoS: o o o. 5. U3 tp c SI 271 As Table 28 also indicates, however, the traffic generation picture of vari- ous individual railroads deviates sharply from the national pattern. The Penn Central, for example, closely follows the national trend through 1965, but falls off thereafter. On the other hand, two Western District roads, the Union Pacific and the Southern Pacific, follow the trend for all Class I railroads through 1968, but then register gains that far exceed the aggregated figures. Of special interest are the data reported for the two Southern District lines examined, the Southern and the Illinois Central. No doubt reflecting the economic growth prevalent in this territory, these lines record traffic gains even in those years when the national totals are in decline. At this point, it is worth considering the impact of the selected lines on the national figures. Despite the large gains registered by the Union Pacific and Southern Pacific, their respective shares of total rail tonnage in 1970 were still below five per cent. On the other hand, the relatively stag- nant performance of the Penn Central more directly affects national totals when it is realized that it hauls over ten per cent of all rail tonnage. 25 When the concept of distance is considered along with tonnage, the picture for the industry is not altered markedly. In Table 29, it can be seen that all Class I roads experienced a 35 per cent increase in ton-miles hauled. For the most part, the better performance indicated for ton-miles in contrast to tonnage reflects gains in the length of haul (increases in mileage were recorded for all years except 1964). Again, 1967 serves as a distinct break-point for the decade : up to that year annual gains of over five per cent can be noted, while thereafter increases of only three per cent (1968 and 1969) are interspersed with declines in 1967 and 1970. Table 29 also reports 'data for the major geographical regions and various railroads within them. In comparison with ten year improvements of 60 and -38 per cent in the Southern and Western Districts, the Eastern region is up only 22 per cent and therefore acts adversely on the national statistics. TABLE 29.-REVENUE TON-MILES, CLASS I RAILROADS, REGIONAL DISTRICTS AND SELECTED RAILROADS, 1961-70 IMillions; 1961 = 100] 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Class I railroads 563,361 Index 100.0 Eastern district 208, 550 Index 100. Penn Central' 72,725 Index 100. Pennsylvania 42, 071 New York Central 30,654 Norfolk & Western 2... 31,249 Index 100.0 Southern district 87,873 Index 100. Southern Railway 14, 931 Index 100. Illinois Central 16,954 Index. 100. Western district.-. 266,938 Index 100. Southern Pacific 50,740 Index 100.0 Union Pacific 32, 409 Index 100.0 592, 862 621, 737 658, 639 697, 878 738, 395 719,498 744. 023 767, 841 762, 431 105.2 110.4 116.9 123.9 131.1 127.7 132.1 136.3 135.3 220, 216 230, 382 244,691 259, 477 265, 504 258, 361 259, 391 259, 827 254,694 105.6 110.5 117.3 124.4 127.3 123.9 124.4 124.6 122.1 76, 698 78, 806 83,601 89, 128 92, 061 89, 630 86,561 88,156 83, 955 105.5 108.4 115.0 122.6 126.6 123.2 119.0 121.2 115.4 45, 239 31 459 46 396 49, 765 33 835 51 755 53 316 50, 730 32, 410 34, 581 37 373 38 744 38, 901 32, 086 45, 405 48, 301 50, 194 49, 039 51, 396 52, 928 52,815 102.7 110.7 145.3 154.6 160.6 156.9 164.5 169.4 169.0 95, 829 102, 532 108, 316 116,836 125, 462 127, 988 130,686 139, 256 140, 034 109.1 116.7 123.3 133.0 142.8 145.7 148.7 158.5 159.4 15, 941 17, 164 18, 533 20, 100 21,356 21,933 23, 820 25,601 26, 111 106.8 115.0 124.1 134.6 143.0 146.9 159.5 171.5 174.9 19,681 19, 582 20,556 21,926 22, 831 22, 410 23. 700 24,673 23, 701 116.1 115.5 121.2 129.3 134.7 132.2 139.8 145.5 139.8 276, 818 288, 823 305,631 321, 564 347, 429 333, 149 353, 946 368, 757 367, 703 103.7 108.2 114.5 120.5 130.2 124.8 132.6 138.1 137.7 54, 697 56,617 60, 479 64,813 69, 330 66, 845 73, 520 75, 480 74, 115 107.8 111.6 119.2 127.7 136.6 131.7 144.9 148.8 146.1 33, 188 35, 076 37, 949 38, 883 41,766 41,071 44, 133 46, 483 47, 575 102.4 108.2 117.1 119.8 128.9 126.7 136.2 143.4 146.8 ' 1961-67 pro forma. 2 1961-64 pro forma estimate. Sources: Class I railroads and regional districts— ICC and AAR; selected railroads— Moody's Transportation Manual. Important to these considerations is the question of how traffic is generated. Of the six lines selected for close study, four (the Illinois Central, Norfolk & Western, Southern Pacific, and Union Pacific) can be classified as originating lines in the sense that over 60 percent of their tonnage begins its trip on line (Table 30). In contrast, the Penn Central and the Southern tend to haul about as much originated freight as that received from other carriers. Thus any gen- eralization suggesting, for example, that Eastern District roads are receiving carriers is belied by the case of the N&W. Similarly, there is no consistency with respect to the Southern District roads. 25 See Appendix, Table A-35. 50 51 51 51 51 49 51 51 51 /I 72 ( 3 ) 70 70 72 72 71 72 47 48 49 49 49 51 51 51 50 69 70 69 69 67 71 72 73 75 69 68 70 70 70 67 69 68 69 61 62 61 60 6C 60 60 61 63 272 TABLE 30.-ORIGINATED TONNAGE AS A PERCENT OF TOTAL FREIGHT TONNAGE, SELECTED RAILROADS, 1961-70 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Penn Central > 49 Norfolk & Western «... 71 Southern Railway 48 Illinois Central 70 Southern Pacific 69 Union Pacific. 61 ' 1961-67 pro forma. Source: Moody's Transportation Manual. 1 1961-64 pro forma. 3 Not available. General railroad theory holds that lines which have significant amounts of terminal traffic are likely to be burdened with costly turnaround expenses. For most of the lines examined, the extent to which they are terminating traffic which they originate has changed very little over the decade. 20 There are, how- ever, two notable exceptions. First, both Eastern District roads are terminating ten per cent more of their originating traffic now than they did in 1965. In the case of both the Penn Central and the N&W, there were significant gains in this item after their respective mergers. Second, the Union Pacific terminated six per cent less of its originated traffic in 1970 compared with 1960 — a down- ward trend that began in 1964. What is the picture with respect to received freight? Consider those lines handling significant amounts of this kind of traffic. 27 The data shows that for the Southern there has been a drop of seven per cent in the amount of received traffic terminated, but the Penn Central has experienced an increase of 11 per cent. While this gain for the Penn Central is not extraordinary (the other lines — except for the Southern — also registered 11-12 per cent increases), it is significant when it is recalled that half of Penn Central's total traffic is in received freight. If the statistics for terminated traffic of both originated and received freight are combined, it is clear that the Eastern roads are increasingly burdened. 28 Overall, the Penn Central and the Norfolk & Western have reg- istered gains of ten and eleven per cent respectively in the amount of total traffic terminated, whereas the other lines are terminating about the same per- centage now as at the beginning of the decade. REVENUE i,' In the earlier discussion of tonnage, it was noted that 1967 was a critical ear for the industry as a whole. Up to that point traffic had increased steadily, ut thereafter the railroads experienced either relatively modest increases in tonnage or absolute declines. For the revenue side of the picture, 1967 serves as a crucial benchmark as well. Through that year the annual changes in revenue did not exceed five per cent and (with the exception of 1961 and 1967) these changes were steadily upward (Table 31). These gains in revenue closely track similar gains in traffic. However for the last three years, the revenue gains were far more dramatic — averaging 6.2 per cent — at times when traffic gains were negligible or non-existent. The net result is that whereas traffic increased 20 per cent over the decade, freight revenues jumped 41 per cent. 28 See Appendix, Table A-36. » See Appendix, Table A-37. 25 See Appendix, Table A-38. 273 -j 2 CO~- r-t cor-, oo ~- .CO .CO . 00 -^ r*~> csj co ct» csj co in to in m .CO -CM _CSI to _« esj ~- *r <^- COOCSI O^ps r» co ~- csl oo to .csj -CM .—< r- . tO -^ -H ~- en m .— i CO CO *)• in CO CSJ C CO .ID . PO .C csj oo co in r- co * JcsjinoocMtr>ifioop*--cT)-«tcsj«3---iooooo-— cnr-si— •— o«nr-*o"> -co .in .in .co MpHNfrVF-MtHlfJ^F- ^ips.1- CNJ *— *t OO P-. .— .O r*-0">tn^-«co^«a , cooor , »^ i o T >co-^ ^ .csj .csj . ^ .(-. .to .to ^" cr> C7> rsrs^r-o^iDOOTO^'^ .CSJ -CO .*!• .CO .CSJ .CO .CSJ CO ^h PO — ^ PO ^™ ^■^-iCT>^-*^ •■— CO CSJ to — « ~- f i-OCO«JP r-oo .N CS) COCT>OOP po esi in oo oor-.^j-^Htocr)COtjr— W9- b» fa* focwmcnt'to^^tonooinopoovOoo'-iiDts ~- .in . *r .csjcsjco . co .to . to .in -to . co co tn -rn — mtocncococsjm*i-csjr-.cn**ino~-cooo u~> — CO trA. fe^ ^ ooc^i--csi m .«— ' -m .—* co . . cr>'5 , csju-)incococsjtnooo**rs.o*>o CnoOCnCNJCSJCnCsi^Hrx.^-U")^-CO^-CSJto— « csj co to in *r to — OO — OO — ' oo — CO — CO CSI CSJ ^jCSJpsjcDOOOO*»OOCSJC7»in«3-^3T*«.O^H <-* .co .in . cr> ■ r*? _• " * c-ocnr ~ r-» co *3- — > po c m . f> • in .c irsio ^3-CJSOOC3Cs(CT»COOOr*-TtOPOCO -O .~< LO . . >h .~- -— \^-";o m^cn-— ^-^-nj3^r(sj^Hinr-"Co^-^H»—cr)— ■ in oo r«» i — cr> *r o to co in ^ csj ■— « to ^t m co csj esi oo _» - fa'K/J-fa'* fa* fa* OO PO "— " ~* ro co .m .r». — . m r- in co < rcotnmOcocoooco "> -CO .CSJ -CD -CO • - co co cT) oo ^ ~^ in ^ ^ *0 .-» ^|S.rH ~- ■— ■ toi in - - fa^fe^-fa** U3COCSIO.— •[—. — Op-.CO^'CsjCsir *j . en . r- .mcsjin .oo . — • ^— coc7>^Tps.^3-^j-rocOPOininco^ en "— • ^h >r-*^-CT>p^ rOfSlOoOoOfsJiOOfjOlsOtsO^OooOioO r ■ *** —j CD _• — r*. r-» . r-» .co . p- .co -O -in . )COf^COLncOc7 s tOPOCOCOO^J-0-^COcs|0"-'OtOCO «><*■ fa9- fr**- 1 w 00 a>ccyccut_3 a)Q, c:cun)tt> ^J C"OA"°vO rT3 i""0 "-"O _"0 p"C3 *- "O Q_ "O to— -- NORFOLK & WESTERN 1.33" ^% I f I r <$> yfl * - r m » # • # • ._ i— ^? ^. m • # • m ♦ 1 1 1 i i f • • • 1 • • 1 1 i f • 1 4 • • • • a * • • 1 •. 1 i • • • • ^ 115" • _ • » ■ • \^ ^° 112* 1 09" 1.00- YEAR 60 61 62 63 64 65 66 67 68 69 276 In Table 32, the significance of the Penn Central and the Southern in the national figures is apparent: in every year for which data are available, the yields of these lines are greater than for all Class I roads together. Previously the impact of the Penn Centra] on national statistics has been noted. It is pro- vocative, therefore, to indicate the extent to which that road boosts the aggre- gate yield figure for the entire Class I rail system. The following table compares revenue per ton-mile for all Class I roads in the post-1966 period with the Penn Central included and then excluded : |ln centsj Year All class 1 roads All class 1 roads except PC 1967 1.27 1.26 1%8 1.31 1.29 1969 1.35 1.32 1970 1.43 1.40 MODAL COMPETITION What has been the effect of these traffic trends insofar as the standing of the railroads with its competitors is concerned? Table 1 presented earlier offers an answer to this question. It shows that since 1967 the industry's share of the transport market has dropped over two percentage points. In short, despite a ten year increase of 35 per cent in ton-miles, the railroads have seen their share of the total transportation market slip from 44 to just over 40 per cent. It is this anomaly which lies at the core of the industry's traffic problems, pointing up the interplay between pricing, service and utilization variables. To 1967 rail rates (as reflected in yield per ton-mile) fell, traffic increased rapidly, the rail share of intercity freight traffic remained nearly constant, and railroad efficiency (as reflected in revenue per unit of investment) improved. After 1967 there was deterioration in each of these measures. Much of the explanation for this "squeeze" on the railroads rests with the carriers' inability to penetrate more substantially the manufactured goods market. Available commodity statistics convincingly demonstrate that the rail- roads continue preponderantly to haul low-rated, bulk traffic and that there has been little change in this in recent }'ears. The matter can be simply seen by examining two separate groups of commodities both of which account for about one-fifth of total rail freight revenue. The following table, which averages statistics for the years 1964-1968, tells the story : the low-rated bulk commodities make up nearly half of originated rail tonnage, whereas the higher yield finished goods total to less than a tenth of such tonnage. COMMODITY GROUPS CONTRIBUTING 20 PERCENT OF REVENUE [Share of originated tonnage] Percent Commodity : Coal 26. 3 Stone, minerals 12. 5 Metallic ores 8. 3 Total 47. i Transportation equipment ' l. 8 Pulp, paper 2. 7 Electrical equipment . 3 Machinery . 5 Metal products . 8 Petroleum and coal products 2.0 Total 8. 1 277 Comparison of the Census of Transportation for 1963 and 1967 reveals that the railroads have failed to improve their position with respect to the move- ment of higher valued commodities; indeed the rail share of intercity ton-miles for 24 manufactured commodities fell about one percentage point. It is reason- able to assume that were it not for the intensified use of "piggyback" move- ments, 29 the rail share would have dropped more. (To the. extent that TOFC has merely diverted shippers from rail carload movements to rail piggyback, the railroads may have suffered from the substitution of some net lower-tariff shipments.) What is clear, though, is that even with greater TOFC carloadings, the railroads have failed to make any substantial inroads on the movement of higher yielding commodities. One key reason is the railroads' near total abdica- tion of LCL and other small shipment traffic to the trucks. Growing rapidly in volume, such traffic now makes up over 95 per cent of all shipments that move by for-hire motor carrier and has contributed materially to the doubling of Class I and II truck revenue that took place between 1960 and 1969. Looking to the future, there is a good reason to believe that the fate of the railroads will in large measure be determined by the extent to which the industry can gain a greater share of the manufactured goods market. If the railroads are to improve their financial posture and keep up with the rapidly changing character of the economy, more aggressive initiatives aimed at these kinds of markets are called for. Should the industry continue to depend so heavily on the. lower valued bulk commodities, it runs the risk of confining itself to traffic that not only yields comparatively little in terms of revenue, but, as noted earlier, possesses less potential for traffic growth. In contrast, manufactured goods offer the railroads the twin prospects of greater returns and growing markets. Can the industry move more of this kind of traffic ? The answer ultimately reduces to the matter of rail-motor carrier competition since almost all truck traffic is concentrated in the high yield sectors. As Table 34 shows, the railroads now move less than 30 per cent by weight of manufactured goods traffic, while the trucks enjoy about two-thirds of this market. What is particularly striking, however, is that contrary to popular impression, about a third of all truck shipments move 500 miles or more, a distance on which for most shipments (with weight and cube considered), comparative costs should make rail move- ment superior. The example of how the. railroads regained from trucks a significant share of the. automobile, market stands as evidence that high-rated traffic can be held by or attracted to the railroads. The fact, however, is that for most, manufactured goods the rail share of longer-haul shipments is decidedly below the apparent potential. 28 See Appendix, Table A-39. 278 TABLE 34.-SHIPMENTS SUBJECT TO TRUCK AND RAIL COMPETITION Shipper class Commodity Total tons (thousands) Percentage distribution Rail For-hire truck Private truck Oil Meat, fresh or frozen.. 16,641 28.7 012 Meat products.... 10,579 26.7 013 Dairy products 11,455 35.5 021 Canned fruits and vegetables 17,229 51.3 022 Canned specialties and frozen food 14,826 43.3 023 Grain mill products and sugar 85,724 59.6 024 Miscellaneous food preparations 37,592 55.1 031 Candy and confectionery 4,931 22.4 032 Alcoholic beverages '. 23,995 40.4 033 Soft drinks and flavorings 9,587 4.3 034 Tobacco products 1,814 52.1 041 Broadwoven fabrics 5,517 6.9 042 Other basic textiles 7,695 11.0 043 Footwear, except rubber 409 3.9 044 Leather and leather products 874 9.2 051 Men's, youth's, and boy's clothing 862 2.8 052 Women's and girl's clothing 757 9.0 053 Knitted clothing 1,046 9.7 054 Millinery, fur goods, and miscellaneous clothing 1,849 17.3 061 Pulpand paper 25,370 71.9 062 Building paper and boards 18,951 68.5 063 Paperboard products, excluding boxes and cartons 13,085 45.7 064 Containers, boxes and similar products 14,271 17.8 071 Basic inorganic chemicals 29,247 54.2 072 Miscellaneous industrial chemicals. 56,115 55.2 073 Plastic materials and synthetic resins and fibers 12,257 35.8 081 Drugs ,.... 1.917 30.2 082 Soap, detergents, toilet preparations 10,372 23.8 083 Paint and applied products 5,061 10.2 084 Gum and wood chemicals, agricultural chemicals 43,819 43.0 091 Products of petroleum refining 404,721 5.3 092 Paving and roofing materials 12,939 23.1 101 Tires and inner tubes 4,143 45.3 102 Rubber footwear 295 5.6 103 Miscellaneous rubber products 2,605 9.6 104 Miscellaneous plastic products 3,014 13.9 112 Lumber and dimension stock .- 38 714 51.7 113 Millwork, veneer, plywood, and prefabricated wood products.. 12,227 71.1 114 Wooden containers and miscellaneous wood products 10,918 39.4 121 Household and office furniture 4,482 26.4 122 Other furniture and fixtures 1,830 14.7 123 Jewelry, toys, amusement and sporting goods 760 29.6 124 Musical instruments, pens, pencils, and miscellaneous manufactured goods . . 1.640 6.8 131 Flat glass 1,388 50.0 132 Glass containers 12,751 16.3 133 Structural clay products 23,680 33.5 134 Concrete, gypsum and plaster _. 31,273 41.5 135 Hydraulic cement, cut stone, abrasives, asbestos 75,221 37.2 141 Steel works and rolling mill products 113,521 52.9 142 Iron and steel castings.. 12,556 31.5 143 Miscellaneous primary metal products 2,898 29.5 151 Nonferrous metals primary smelter products 11,156 70.4 152 Nonferrous metal basic shapes 10,167 29.0 153 Nonferrous metal castings 1,453 18.1 161 Cutlery, tools and hardware 1.925 20.6 162 Plumbing fixtures and heating apparatus 1.686 18.3 163 Fabricated structural metal products 13,057 23.9 171 Metalcans 5,067 29.0 172 Bolts, nuts, screws, rivets 1,842 5.8 173 Metal stampings and plating 6,320 19.8 174 Miscellaneous fabricated wire and metal products 5,179 21.2 181 Metalworking machinery 1.908 10.0 182 Special industry machinery 1.447 12.5 183 General industrial machinery and equipment 3,348 23.3 191 Engines and turbines i: 1.237 28.1 192 Farm machinery and equipment 4,199 32.3 193 Construction mining, and materials handling equipment 6,386 40.1 194 Office and service industry machinery -. 3,520 23.1 195 Miscellaneous machinery and parts, exc. electrical 478 1.3 201 Radio, TV and phonographs and records 1.288 21.6 202 Communication equipment... 653 26.2 203 Electronic components and accessories... 573 14.6 211 Electrical transmission and distribution equipment 1,636 23.5 212 Electrical industrial apparatus 2,159 22.7 213 Household appliances - - 4,077 65.3 214 Electrical lighting and wiring equipment 'To o'e 215 Miscellaneous electrical machinery 2, 018 9.6 221 Truck and bus bodies 896 57.9 222 Motor vehicles and parts. 35,629 5/. 5 231 Aircraft and parts 1.232 Zb.9 232 Shipsand boats 605 21.7 233 Other transportation equipment '%{, i'a 242 Measuring and controlling instruments 354 3.9 243 Medical instruments and supplies - 524 b. 3 244 Watches, clocks and photographic equipment and supplies 564 a.i 32.7 34.3 30.3 23.6 40.5 12.5 23.8 73.4 23.3 19.6 46.4 67.9 53.9 61.2 59.6 70.9 61.0 67.8 60.2 22.7 17.4 39.0 39.7 23.4 22.4 51.6 60.0 61.5 74.1 23.0 9.8 44.2 47.9 77.7 77.3 71.8 11.5 12.4 21.6 40.5 65.9 60.0 70.3 41.4 70.2 33.4 36.3 47.6 35.9 49.8 55.6 15.7 56.1 66.4 65.7 64.8 38.9 44.3 82.1 58.5 55.9 59.1 73.0 66.5 62.3 42.0 49.3 65.3 58.1 64.7 65.4 59.8 64.5 57.0 30.3 64.1 60.6 26.4 37.2 62.3 44.7 29.1 81.3 71.4 66.7 37.6 37.6 34.0 22.4 15.3 26.8 12.4 3.2 35.5 74.3 .9 24.2 34.2 27.0 27.8 16.0 14.1 16.9 19.5 3.0 12.1 14.6 41.1 10.0 8.8 11.0 6.2 13.4 15.2 21.2 4.0 32.1 6.1 6.1 10.3 12.6 28.8 16.2 38.4 30.8 18.4 2.0 18.6 8.6 13.4 32.1 21.3 11.8 3.6 17.6 14.8 10.8 13.8 15.2 11.4 15.8 34.4 24.8 7.5 19.5 22.0 14.4 13.2 8.3 8.1 24.6 9.4 8.2 37.8 10.6 1.2 15.9 10.5 16.2 3.2 11.6 26.8 14.3 4.7 6.5 25.5 18.0 4.6 17.1 3.2 Source: U.S. Bureau of the Census, Census of Transportation, 1967 Commodity Transportation Survey: Shipper Series. 279 To further participate in high yield traffic will require policies that are highly sensitive not just to pricing, but to speedier delivery, and sharply re- duced loss and damage claims as well. Although a finer tuning of rates is important, it would probably be a mistake to regard lower tariffs as the only barrier to be surmounted. Delays in and the increasing uncertainty of delivery also contribute to shipper avoidance of rail service, with terminal and classifica- tion yards representing notable bottlenecks. With freight transportation con- sumers increasingly viewing the intercity movement of merchandise as only one part of a complete distribution system, these delays and attendant costs assume growing significance. Especially for, higher-valued commodities these factors can assume more importance than the tariff itself. They help explain why some shippers will pay a premium to ship via truck rather than rail. Along with the problem of delivery schedules, the railroads must also develop solutions to the rising rate of loss and damage. Shippers now using rail are becoming increasingly concerned about these claims, but perhaps equally as critical, other shippers may well be avoiding rail service because of the poor reputation the carriers are gaining. Calculations reveal that over $224 million was spent by the railroads for loss and damage in 1970 — an amount equaling 46 per cent of net railway operating income. CONCLUSION As has been true for many years and as is likely to be the case for many years to come, the railroads are heavily oriented to the transportation of bulk commodities. On this traffic yields are relatively low (though not necessarily unprofitable, at least in the sense of coverage of marginal costs) and the rate of growth is likely to continue to be generally slow. If the railroads are to expand and increase their share of intercity transportation they must exploit the poten- tial that lies in the movement of manufactured goods, notably including ship- ments by TOFC — trailer on flat car — and container. The economies of the situation make this feasible for many types of movements, taking into account the character of the product, costs, weight, and shipment distance. If, though, the potential is to be converted into reality it will require better service (mean- ing improved utilization of equipment, notably freight cars), faster turn- arounds, reduced terminal and handling times, and a highly flexible marketing apjiroach that more closely relates rates and service to competitive modes of transportation. Among other things this demands a complementary public policy, one that is conducive to innovation. 280 RAIL TRANSPORTATION AND PUBLIC POLICY Public policy for the nation's surface transportation system is a composite of many elements, assembled piecemeal fashion over the years into a patehquilt of highly diverse ingredients. Among the modes there are great differences in the way they are treated in terms of regulation, financial aid, and other key economic and institutional variables. For the railroads these differences have presented major problems, from an intermodal as "well as intramodal respect. Many of the crucial issues deal with regulation (its character, administration, scope of coverage), but government policies generally, especially in the form of subsidized infrastructure investment, have also been significant in their impact on the railroads. The details are important, but even more so is the economic and attitudinal environment which these divergent government policies have produced over the years. In speaking of public policy as it pertains to the railroads we are dealing with forces that have been at work for a long time and that have conditioned management thinking as well as every aspect of their operations. There is an enormous investment in the transport status quo and changes thus take place very slowly, a fact that is well to keep in mind in examining the topic and in thinking about modifications in approach. One lesson for the railroads is that as much emphasis must be placed on working more effectively within what is essentially the existing legal framework as on changing it in some fundamental way. RATE REGULATION Of the many ways in which public policy affects the railroads, rate regula- tion has been the most influential. A review of existing regulatory policies pertinent to railroad rates reveals these highlights — * Despite Congressional efforts in 1958 to expand the zone of rate-making freedom for the railroads, the applicable cost and tariff standards remain unclear as they pertain to intermodal competition. * Value-of-service rate-making principles still seriously distort the rail rate structure. On the basis of available cost evidence, many commodi- ties move at rates substantially below or above cost, raising the distinct possibility that by selectively adjusting rates, up in some cases and down in others, the railroads could increase their traffic and earnings. * Although value-of-service principles continue to dominate railroad pricing, cost elements influence ICC decisions and railroad rate initia- tives. Unfortunately, however, the cost criteria used by the Commission are highly misleading and of severely limited economic utility. Without better, more precise cost data, no one — the Commission, railroads, or shippers — can determine the economic validity or consequences of changes in individual rates. * On the whole, the existing rate-making regulatory process is unduly slow, cumbersome, inflexible, and hostile to marketing innovation by the railroads. One by-product is that the railroads have placed greater emphasis on general rather than selective rate adjustments as a way of attempting to increase revenues. As shown by the experience of the late 1960's, such increases can be disadvantageous, suppressing traffic growth, diverting traffic to other modes, and hurting rather than helping earnings. Railroad rate regulation is a subject of inexhaustible interest to academic, professional, and transport specialists. A review of the recent literature, how- ever, reveals little that has not been said many times before. The billions— perhaps a trillion — railroad freight tariffs on file manifest the same basic 281 features as they have for years. Rates continue principally to reflect value-of- service elements, as modified by shipper bargaining power, rather than relevant costs. The most recent ICC study of rail traffic, for example, reveals that 86 per cent moves at less than 98 or "more than 103 per cent of fully allocated cost, with about 18 per cent falling in the former category and 68 per cent in the latter. This distribution reflects the regulatory supposition that higher-valued traffic is inelastic to rates and that if it were to bear lower rates the railroads would lose revenue and hence be unable to move lower-valued commodities (primarily agricultural and mine products) at rates less than their full costs. The nature of the industry rate structure has produced many important consequences, whose ramifications range far beyond their impact on the rail- roads. Economic analyses indicate that rail shipment costs for many manu- factured commodities, especially on medium-to-long-haul movements, are lower than by truck. However, many existing rates are sufficiently higher than the costs of truck transport so that taking into account the service (and implicit cost) advantages of truck movement (speed, dependability, shipment size etc.), much traffic goes by highway that could more efficiently move by rail. The railroads thus lose traffic and overall transportation costs for the nation are artificially raised. In the case of low-valued bulk commodities and agricultural products, existing regulatory policies make it difficult to achieve a closer conformance of rates and costs. Even acknowledging the arbitrariness of present procedures to determine costs it is no doubt indicative of the situation that some 18 per cent of rail traffic, moves at rates that yield less than 98 per cent of fully allocated cost. Products like, sand, gravel, crushed stone and pulpwood as well as agricultural commodities like fresh fruits', fresh vegetables, and sugar beets are moved at rates that generally fail even to cover ICC-estimated variable costs. The prob- lem is aggravated at the state level, with intrastate rates often being lower than interstate rates. Although some of this low or no-yield traffic may cover true marginal costs, much no doubt is below-cost and represents a drain on railroad earnings. The obvious prospect of adjusting rail rates to correspond more closely to costs raises the complex and highly controversial question of intermodal rate competition. In 1958, after years of dispute, Congress revised the rule of rate making, declaring that "rates of a carrier shall not be held up to a particular level to protect the traffic of any other mode of transportation, giving due consideration to the objectives of the national transportation policy." While the latter clause introduces considerable ambiguity into the "rule" because of the Uncertainty inherent in the 1940 statement of policy, the Supreme Court was later to say that the ICC was wrong in concluding that the 1958 amendment brought about, "no fundamental change in the law." 30 It is still not clear, however, exactly what "change" was made and, in par- ticular, how it should be reflected in specific cases. The courts have said that one modes rate is not to be held up "simply" to protect the traffic of a competing regulated mode. Beyond that there is great uncertainty as to the rules governing intermodal rate competition. In the 19(58 Ingot Molds case 31 the Supreme Court set aside a District Court decision that negated a Commission ruling cancelling a proposed rail rate that, though compensatory (above long term out-of-pocket costs), was both less than rail fully-distributed costs and competing barge-truck fully-distributed costs. The railroads had argued that the appropriate standard was out-of-pocket costs, but this was rejected by the Commission. In upholding the ICC on this point the Supreme Court seemed not to be saying that any particular cost standard must be used but only that the 1958 amendment did not. require, the use of out-of-pocket costs. 32 In the wake of Ingot Molds the Com- mission initiated a rule-making proceeding to consider what cost standards should be used in cases of intermodal regulated competition. For all practical purposes, then, the 1958 Act appears to have had far less impact on intermodal rate competition than many thought it would have. It did not succeed in providing the railroads with a new, clearly-defined zone of rate-making freedom. 30 ICC v. New York, New Haven & Hartford R.R., 372 U.S. 744 (1963). 31 American Commercial Lines v. L&N Railroad Co., 392 U.S. 571 (196S) 32 Id. at 591-92. 282 Pervading the entire subject of rail rates is the question of costs, which remain a significant point of reference for rail initiatives and regulatory action. For many years the Commission has estimated rail "variable"' and "fully allo- cated" costs. Its techniques for doing so have been the subject of a great deal of attention. The nearly-unanimous opinion of independent analysts is that the Commission's cost estimation procedures are so seriously deficient that the results they produce are virtually useless." The principal objection is to the way in which variable costs are determined. To make this calculation the ICC uses a so-called pei cent variable, treating 80 per cent of operating expenses as variable. As an approximation of marginal costs this has grave weaknesses. Among other things it assumes that the percentage variable remains the same for all railroads. In economic fact this will rarely be true. Operating circum- stances, traffic volume, and expense components will range widely and in any given case, as a result, marginal costs can be significantly higher or lower than 80 per cent. The Commission's cost determinations are now simply so aggrega- tive that they are of dubious value, yet they remain the yardstick by which rates are supposed to be tested. This introduces such an extreme degree of arbitrari- ness into rate regulation that it renders the entire process highly artificial. Subject to even less empirical examination is the matter of elasticity of demand to rates. The implicit regulatory assumption is that traffic is highly inelastic to rates, so that a tariff reduction is likely to produce no increase in demand and thus result in a decline in revenue. The evidence, however, sug- gests that much traffic is in fact highly sensitive to rates and that a rate reduc- tion can lead to increased revenue because of the additional traffic it generates. Nonetheless the belief that traffic is insensitive to rates is firmly held by the Commission and even by some railroads. As a consequence, with rail rates often equal to or only slightly below truck rates (even though rail costs may be lower), significant amounts of manufactured goods traffic moves by truck be- cause of superior truck service and resulting lower total distribution costs. Another pertinent characteristic in this area is a regulatory attitude re- flecting a philosophical disinclination to experiment, a hesitancy to act without a sure and comprehensive awareness of all the facts and likely consequences, and a reluctance to proceed on an interim basis with subsequent reassessment in the light of actual experience. These are hardly objectionable qualities per se, but pursued relentlessly — as they have been for many years — they can imprison the regulators and those they supervise in a climate that is hostile to innovation and unresponsive to rapidly changing technological and economic events. While regulation thus plays a role in explaining the considerable rigidity that characterizes the rail rate structure, railroad marketing perspectives also are a key ingredient. On the whole, industry attitudes, shored up by the consen- sus-seeking compulsion of the rate bureaus, have not been sympathetic to the aggressive tailoring of rates and service to potential market opportunities. Al- though the auto rack car experience shows that substantial traffic can be re- gained from other modes, the railroads in recent years have placed more em- phasis on across-the-broad rate increases rather than on selective rate adjust- ments calculated to improve net earnings. Cases such as the Big John proceed- ing and Rent-a-Trahi are by now well celebrated, but they remain exceptions to a more general pattern of passive ratemaking. While across-the-board in- creases advocated by the industry are handled relatively speedily by the Com- mission, it displays a general lack of enthusiasm — often reflected in lengthy delays — for innovative rate initiatives proposed by individual carriers. AVhat must be stressed is that despite the deficiencies of ICC rate regulation, the railroads do now have considerable room within which to adjust their prices. Most rail rates, it must be remembered, are above fully-distributed costs and it is fairly well established that as long as rates cover fully-distributed costs there is usually little basis for objection from competing regulated modes (and practically none from competing unregulated carriers). In most respects, therefore, the railroads now have considerable 1 discretion to reduce rates, par- 33 A pertinent court assessment of the Commission's cost definitions is in New York, New Haven & Hartford R.K., 199 F. Supp. 6:C>, 647-4S (I). Conn. 1961). For an economic valuation see John R. Meyer et al., The Economics of Competition in the Transportation Industries (1959), Appendix A. The comments of the Supreme Court in the Ingot Molds case, supra, are also in point. See 392 U.S. 571, n. 16 at 586-89. 283 ticularly on higher-valued commodities. Admittedly the process of rate adjust- ment can be long and tedious, especially where there are applications for suspension. Nonetheless the number of suspension cases must be kept in perspec- tive. In fiscal year 1971 only 392 rail rate proposals were considered for suspen- sion and only half of these were actually suspended. Industry sources informally concede that they have had good success in putting into effect the great bulk of rates they have proposed. Part of the problem, therefore, turns into a question of the relatively low level of specific rate initiatives made by the railroads for pur- poses of traffic generation. Overall too much emphasis has been placed on general upward rate increases, of the sort sought by the railroads in the late 1960s and early 1970's (Ex Parte proceedings 256, 259, 262, and 265), and too little on tailored upward and downward adjustments as a way of improving earnings. MERGERS In recent years, particularly beginning about 1957, a great wave of mergers has swept through the railroad industry, involving virtually every carrier and leading to substantial structural realignments. Since mergers have been viewed as a way of increasing railroad efficiency, primarily through consolidation of plant, and since they have been so pervasive in railroading, they warrant careful examination. The beginning point is the law itself. Under Section 5'(2) of the Interstate Commerce Act, as amended in 1940, mergers or consolidations between railroads (or the acquisition of control of a railroad by one or more other railroads) must be approved by the Commission. (By contrast, as will be noted later, the Commission's power to deal with railroad holding companies is considerably more limited.) Only if the ICC finds that the merger (or other related trans- action) will be "consistent with the public interest" may it be carried out and then only upon such "terms and conditions" and with such modifications as the Commission finds "just and reasonable." In making the requisite statutory determinations the Commission is di- rected by Section 5(2) (c) to "give weight to the following considerations, among others: (1) the effect of the proposed transaction upon adequate trans- portation service to the public; (2) the effect upon the public interest of the inclusion, or failure to include, other railroads in the territory involved in the proposed transaction; (3) the total fixed charges resulting from the proposed transaction; and (4) the interest of the carrier employees affected." As to what weight is to be assigned to each of these factors, how they are to be applied, and what other factors are to be considered, the law leaves vast discretion to the Commission. The courts, however, have effectively added a fifth element that must be taken into account, namely the antitrust laws. Under section 5(a) mergers and other transactions that are approved by the Commission have immunity from the antitrust laws. In a string of cases, running back to the McLean decision in 1944 34 and continuing through major recent rail merger cases (such as Sea- hoard Coast Line, 35 and Northern Lines™), the Supreme Court has acknowl- edged that while the Commission has the authority to approve mergers that might lessen competition and otherwise violate the antitrust laws (specifically Section 7 of the Clayton Act, as amended, and the Sherman Act), it must spe- cifically consider the competitive consequences of a proposed merger and deter- mine that any likely adverse competitive results are outweighed by probable transportation and public interest benefits. While the courts have acceded to the Commission's expertise in making such a judgment, it is also clear that the evaluation of the antitrust issues cannot be merely pro forma and that a mere declaration that the benefits outweigh the competitive effects will not suffice. As amended in 1940, Part I of the Interstate Commerce Act significantly changed those provisions of the. 1920 Act that applied to railroad consolidations. Under the 1920 Act the Commission was instructed to prepare a plan for consolidation of the railroads, the weak as well as the strong, into a limited number of systems of approximately equal strength. Only such combinations that conformed to the plan were to be approved. This approach proved unwork- 34 McLean Truck Co. v. United States, 321 U.S. 67 (1944). 35 382 U.S. 154 (1965). M 396 U.S. 491 (1970). 284 able and with the passage of the 1940 Act, the plan requirement was repealed. Congress, however, was not inattentive to the effects of a proposed merger on other railroads and, in fact, even left the ICC with the authority to require the inclusion of other railroads if requested and if such inclusion was consistent with the public interest. From the passage of the 1940 Act until well into the 1950's railroad mergers were few in number and limited in economic significance. Beginning, however, with the filing of the Virginia-N&W merger in 1959 the flood gates opened and thereafter, until the collapse of the merged Penn Central, dozens of major merger applications were filed with the Commission. Between 1957 and 1970 all of the 25 largest railroads were involved in at least one merger, usually in several (Table 35). Every region has been affected, but it is in the East where the impact so far has been the greatest. Through a process of merger the entire Eastern railroad picture has been radically transformed. TABLE 35.-INVOLVEMENT OF THE LARGEST RAILROADS IN THE CURRENT MERGER WAVE Railroad Consummated or approved mergers Pending mergers Pennsylvania Pa.-L.V.; Penn Central... Southern Pacific SP-Tex. & New Orleans UP-RI. Santa Fe AT&SF-Toledo, Peoria, & Western UP-RI; MP-SF. New York Central Penn Central... _ N &W N&W-VGN;N&W-NKP-Wab Union Pacific UP-Spokane International UP-RI. Seaboard Coast Lines SAL-ACL B&0 C&0-B&0. C&0 C&0-B&0 Southern Sou-C of Ga; Sou-C of Ga. & Fla Missouri Pacific MP-C&EI (with partial divestiture) MP-AT&SF. Illinois Central... IC-GM&O L&N L&N-NC&SL; (Monon.) L&N-IC. Burlington Northern Lines Northwestern CNW-CSPM&O; CNW-M&SL; CNW-L&M; CNW-CGW.... CNW-RI; CNW-Milw. Milwaukee CNW-Milw. Great Northern Northern Lines Rock Island UP-RI; CNW-RI. Erie-Lackawanna Erie-Delaware, Lackawanna & Western (Dereco) Northern Pacific Northern Lines New Haven Penn Central Cotton Belt SP'SLSW-Alton & Sou Gulf, Mobiles Ohio IC-GM&O Looked at as a whole the railroad merger proceedings of the last 15 years display these rn-incipal features — * In handling merger applications the ICC has proceeded on a strict case- by-case approach, generally failing explicitly to consider the impact of a pending merger on other railroads. This has led to a domino effect, particularly in the East, with one merger inspiring and often forming the justification for other follow-on mergers. * The Commission role in merger proceedings has been almost entirely passive, with nearly complete dependence on the parties to come forward with the evidence and analysis. There has been no meaningful effort to develop the facts, to test the claims advanced by proponents, or to assess rigorously the merger's contribution to improved service. * Justification of proposed mergers has rested almost exclusively on claimed cost savings that would result from consolidation. Little empha- sis has been placed on a factual showing of the benefits in better service likely to result. Where mergers have been approved the evidence shows that the alleged cost savings have generally failed to materialize or have been much smaller than were anticipated. * Mergers have substantially reduced railroad competition in point-to- point markets. Of 57 point-to-point markets with three or more rail car- riers in 1955, after the Penn Central and Northern Lines mergers there were only 36 — a decline of 37 per cent. * Merger proceedings have been excruciatingly slow. Three years is "quick response" and as much as a decade can pass before final Commission action. * There has been grossly inadequate regulatory follow-up to assess the actual performance of largo-scale mergers in terms of conformance with representations made during the proceedings, gains in efficiency, and qualitative performance. 285 The interlocking pattern of rail mergers, with one spawning another in a snowballing process, is best illustrated by developments in the East. The Eastern railroad story began in 1958 when the ICC approved the merger between the Norfolk & Western and the Virginian, two financially strong rail- roads heavily engaged in the movement of coal. Their merger promised cost savings; and, looked at as an isolated event, appeared to be of no great signifi- cance for the structure of rail transportation. Innocent though it seemed at the time to be. that merger unleashed a wave of mergers that did not expire until the entire Eastern rail system was completely restructured and the Penn Cen- tral, the great house of cards, had been created. The Virginian-N&W merger ended the New York Central's access to the Pocahontas coal territory. With its valuable coal traffic threatened, the New York Central sought protection in a merger with the B&O. Pressed to consider merger, the B&O decided to merge instead in a two-way arrangement with the C&O. When the C&O and B&O merjred, the N&W was threatened because it gave the C&O access to St. Louis and to transcontinental traffic. To counter this move the N&W merged with the Nickel Plate and the Wabash railroads (the latter through a lease arrangement), an affiliation that, in a sense, "one-upped" the C&O-B&O since it gave the N&W access not only to St. Louis but to Chicago, Kansas City and Omaha as well. These moves placed the NYC in even greater jeopardy. With what it regarded as its more desirable partners having already merged, the NYC finally agreed to join with the Pennsylvania in their ill-fated union. When the Penn Central merger was authorized in 1968, only ten years had passed since the Virginian-N&W merger but the entire Eastern railroad industry had been restructured. The Commission is now faced with a number of mergers in the West and the as yet unresolved question is whether it will consider them in the same piece- meal fashion as it did in the East or whether it will examine comprehensively their interrelationships and overall svstem and competitive consequences. Now that the Northern Lines merger has been approved, pending cases principally affect service along the central western arteries, notably those linking Chicago and points along the Missouri River. In the area between the Rockies and the Mississippi there is undisputed excess capacity, which carries with it the tempt- ation to consolidate independent carriers into larger systems as a means of eliminating redundancy and gaining greater line-haul density. The more basic question concerns the makeup of the surviving systems, the impact on competi- tion, and the realism of claimed cost savings and alleged gains in operating efficiency. The Eastern rail merger experience dramatically underscores the importance of looking at the various proposed mergers as a whole, viewing their interrelationships and assessing their downstream impact on other carriers (including those not immediately involved in pending applications). If the lessons of the Eastern merger are drawn upon, they would urge considerable caution in the West as to the acceptance of claimed cost savings and service improvements, point up the sizable managerial problems encountered in con- solidating different carriers, and underscore the value of maintaining competi- tion between surviving systems in and as related to the affected region. Claimed cost savings have formed the backbone of the case for proposed rail mergers. Adding up the individual items yields total annual cost savings approximating half a billion dollars — or about five per cent of aggregate cur- rent operating expenses for the Class I railroads. The amounts have varied from case to case but often have been large. In the Seaboard Coast Line merger savings of almost $40 million were forecast, of over $40 million in the Northern Lines case, and of $27 million in the N&W-Nickel Plate-Wabash case. The largest claims came in Penn Central, with projected cost savings of more than $80 million. Suffice it to say that they did not materialize, but the size of the gap between promise and reality in Penn Central, though dramatic, is not unique. In the preponderance of the mergers that have been approved since 1959 the record reveals that cost savings forecasts have typically been overblown, that where some savings have resulted they have been exceedingly modest, that savings are far more difficult to realize, and require far longer than is antici- pated, and that merger can lead to rising rather than falling costs. Finally, from the standpoints of service and performance there is no respectable empirical evi- 286 dence to show that mergers have resulted in any general improvement. To the contrary : by bringing together two or more disparate operations, merger often leads to confusion and a deterioration in service which, when and if corrected (which it was not in Penn Central), bring the system back to about the same ef- ficiency level the separate roads had achieved prior to consolidation. The available evidence, as borne out by the experience of the last 15 years, simply does not establish that mergers are a generally useful way of increas- ing efficiency, eliminating excess capacity, or improving rail service. By and large they are more likely to be harmful than beneficial. In particular cases they may hold out the promise of achieving net benefits that could not be realized in any other way, but experience strongly suggests that mergers should be viewed with considerable suspicion and that proponents should bear a far heavier burden to establish affirmatively the benefits of consolidation and to demonstrate that the anticipated gains cannot otherwise be achieved (such as through abandonments or the sharing of common facilities that do not involve outright merger). HOLDING COMPANIES AND RAILROAD DIVERSIFICATION During the 1960's several of the country's railroads transmuted themselves into conglomerate corporate enterprises with the aim of diversifying into non- rail areas of investment activity. By the end of 1970 some 14 companies had taken this step, with others planning to do so (Table 36). Included were rail- roads in relatively strong financial condition (e.g., the Union Pacific) as well as less prosperous lines. Railroad holding companies now account for over half the assets of the railroad industry. From a legal standpoint these reorganiza- tions took several basic forms, each leading to the creation of a non-rail invest- ment vehicle. In one variation the railroad formed a parent holding company, with its stockholders swapping their railroad shares for equivalent interests in the new holding company. This was the device used by Northwest Industries and the Union Pacific, for example. In another variation the railroad formed a downstream non-rail subsidiary, whose stock was held by the rail parent. This approach was followed by Penn Central with its organization of the Penn- sylvania Company. In some cases railroad assets have been transferred, some- times as dividends, either at book or at estimated market value. TABLE 36.-CONGLOMERATE HOLDING COMPANIES AND MAJOR RAILROAD COMPANIES CONTROLLED AS OF DEC. 31, 1970, WITH SELECTED BALANCE SHEET DATA Working capital > Working capital 2 Debt Equity Northwest Industries, Inc. (consolidated) s $229.5 $185.9 $147.3 $389.0 Chicago & North Western Ry.« >2.2 ' 20.9 282.8 422.5 Penn Central Co. (consolidated) *.._ .-. Pennsylvania Co. * M0.8 M0.8 103.5 345.2 Penn Central Transportation Co.* 109.9- 25.2 1,901.8 1,500.4 Illinois Central Ind., Inc. (consolidated) s _ 120.0 109.4 317.4 705.0 Illinois Central RR.* _ 37.4 26.7 237.1 611.1 Rio Grande Ind., Inc. (consolidated) » 22.2 18.1 84.3 159.2 Denver & Rio Grande Western RR. Co.* 27.1 23.0 80.6 182.8 Union Pacific Corp., (consolidated) 3 70.0 23.5 634.1 1,416.7 Union Paicfic RR. Co.* 105.7 75.3 470.7 1,805.6 Sante Fe Industries, Inc. (consolidated) s 48.7 6.6 542.6 1,298.3 Atchison, Topeka & Santa FeRy. Co.* 55.7 16.2 335.1 1,419.1 Kansas City Southern Ind., Inc. (consolidated) 3 5.9 .7 107.1 138.1 Kansas City Southern Ry. Co.*. 9.6 5.9 916 147.8 Southern Pacific Co. (consolidated) 3 _ _ 19.5 » 2.0 800.9 1,596.6 Southern Pacific Transportation Co.* 48.5 29.5 789.0 1,483.8 Katy Industries, Inc. (consolidated)' 21.1 1.7 21.3 33.6 Missouri-Kansas-Texas R.R. Co.* ! 3.6 ' 6.7 108.2 1.9 Mississippi River Corp. (consolidated) 3 _ _. 2.1 M.O 92.2 106.6 Missouri Pacific System 3 21.1 7.4 719.2 510.0 Missouri Pacific R.R. Co.*. 1.3 s 8.9 561.3 383.7 Seaboard Coast Line Ind. Inc. (consolidated) 3 S3. 7 » 31.3 390.0 668.8 Seaboard Coast Line R.R. Co.* 30.1 3.3 377.8 780.0 Boston & Maine Ind., Inc Boston & Maine Corp.* 2.2 »1.5 71.8 84.9 Amoskeag Co _ --- Bangor & Aroostook R.R. Co.* ! .4 .9 25.8 35.2 Western Pacific Ind. Inc ! •» Western Pacific R.R. Co* '2.5 '6.5 60.8 120.9 1 Including materials and supplies. 2 Excluding materials and supplies. 3 From annual stockholder report. * From Form A report to ICC. » Deficit. Source: ICC. 287 Form aside, the principal objective underlying these moves has been a desire to simplify diversification into non-rail areas and to permit fuller exploitation of railroad assets (such as real estate, whose current market value may exceed its book value). Common is a belief that such investment moves will improve earnings, either because the railroad qua railroad is yielding less than could be obtained elsewhere or because the cash being generated by the railroad is in excess of its requirements. The former objective is more typical, but some of the wealthier roads may very well be in the latter category. Once a railroad is linked with a controlled or controlling holding company its intrafamily financial transactions are effectively shielded from public or regulatory view. Under existing law, the Commission has concluded that it lacks the authority either to approve or even to require regular comprehensive reports on transactions that involve the holding company and its various affiliates. Because of this situation a great deal can take place in the financial shadows, so to speak, that is actually or prospectively detrimental to the rail- road and those it serves. It is the risk of abuse, not its certainty or inevitability, that calls for far closer continuing supervision of railroad-holding; company relationships than presently exists. Where a railroad-holding company or linked firm relationship exists, the opportunities for abuse are limited only by the ingenuity of their financial managers, lawyers, and accountants. The devices are many and flexible, and they can be manipulated in a way that reduces the railroad's earnings, saps its assets, impairs its liquidity, and reduces its working capital. Through compelled cash dividend payments, loans, or the provision of equipment or services under lease, the railroad can be disadvantaged, with its financial strength and managerial independence undermined. Whether this has taken place is a matter requiring case-by-case assessment, but experience shows that the prospect is one of more than theoretical specula- tion. Special Commission investigations have revealed seemingly abusive behavior or practices of a highly questionable character, including — * Intercompany dividends paid by the railroad to its financial detriment. * Sales of carrier real estate for the exclusive benefit of the holding company. * Intercompany sales and transfers of railroad assets without adequate or equitable compensation. * No reimbursement by the holding company or its affiliates for the use of railroad losses in consolidated tax returns. * Intercompany leasing arrangements that are detrimental to the railroad, * Advances or loans by the railroad without interest or at submarket rates of interest. * Provision of services by a holding company or affiliate to a railroad at excessive costs. The cumulative effect of these practices can be to siphon cash from the railroad and weaken its capacity to function as a common carrier. This need not necessarily be the case, but the evidence developed by the Commission with respect to Bangor Punta and Kansas City Southern, to cite two specific cases, shows that cash outflow from a railroad to a holding company or affiliate can exceed any benefits that may be present. The holding company-conglomerate phenomenon can ultimately only be understood through a detailed examination of each situation. Estimates of aggregative dollar flows into and out of the industry, as expressed in Sources & Uses statements, are too gross to be of any practical value, failing to shed light on the practices that can take place within a holding company family. So rapid has been the spread of holding companies in the railroad industry and so ripe the potential for abuse, that close, continuing regulatory supervision is essential. At the minimum this calls for detailed information on intrafamily corporate transactions to be regularly submitted to the Commission for timely assessment and appropriate action. 288 GOVERNMENT FINANCIAL AID TO TRANSPORTATION Since the founding of the country, government has played a role in the development of transportation, providing infrastructure, subsidies, and sup- portive technological research. In the last century the railroads, primarily in the "West, were substantial beneficiaries, but during this century, with but limited exceptions, virtually all government assistance has gone to the other modes. This uneven treatment of transportation, coupled with regulatory modal inequities (virtually all rail freight service is regulated, only some truck, and only a small fraction of barge traffic), has placed the railroads at a disadvan- tage. In a larger perspective of public policy this situation is but another symp- tom, albeit an important one, of the nation's lack of a consistent, coordinated approach to transportation. One of the key differences in government policy to the modes is the wide disparity in the provision of infrastructure. As noted elsewhere in this report, railroad investment reflects an overwhelming emphasis on rolling stock. Capital outlays for items which relate to the functioning of rail transportation as a system (like telecommunications and computer facilities essential to the better management of the rail freight car fleet ) have been seriously deficient, in signifi- cant measure because their payoff is limited if other railroads do not make similar investments. By contrast, government aid for highways, airways, and waterways has led to the creation of infrastructure systems that can be and are used by many independent private transporters, contributing markedly to the efficiency of their operations. As one illustration, the airways system, repre- senting an investment of approximated $25 billion, embodies highly-sophisti- cated electronic components that no individual air carrier could have afforded since its benefits accrue to many users synergistically. The systems characteristic of non-rail public modal investment are as important a relative advantage to the other modes as the more obvious subsidy benefits they represent. Government provision of capital, tailored to the needs of modal systems rather than the internal investment generating capacities of single carriers, has been of enormous benefit to the non-rail modes. Total government investment (Federal, State, local) in the highways, airways, and waterways now can be estimated at more than $350 billion. Only a portion of this has been recovered through user charges. State and local property taxes of rail rights-of-way, which currently amount to about $300 million annually (with the underlying valuations and applicable rates varying from jurisdiction to jurisdiction), now approach or exceed in amount total Class I rail net income. To redress these oft-recited instances of intermodal inequity, what is needed is not piecemeal reform, but rather a comprehensive reexamination of govern- ment promotional policy. This calls for the broad leadership that can best be supplied by the Department of Transportation and the active participation of the appropriate Congressional Committees. Patching up the present system by, for instance, providing offsetting promotional aid to the railroads is at best short-lived and symptomatic in character. Small improvements can be made on a case-by-case basis but the greatest gains will come only by a fundamental reconstitution of national transportation policy. Public policy as it affects transportation is such a heterogeneous mass that it does not readily yield to meaningful general conclusions. As one contemplates the material dealt with in this report, however, it is evident that if the railroads are to strengthen themselves financially and again become an active and grow- ing participant in the nation's transportation, many basic changes are called for — in operations, approaches to marketing, and investment and related finan- cial practices. Only by increasing their own efficiency and improving their pro- ductivity and reflecting the gains in well-targeted rate and service strategies, can the railroads effectively adapt these new approaches. Government policy can help, but it would be a serious mistake to think that adjustments in regula- tion or provision of special financial aid alone will be sufficient. The principal burden still rests with management. 289 The best that can be expected of government is that it act with reasonable impartiality between the modes and not impede change through regulation that fails really to promote more efficient transportation service. Even these limited goals are not now being satisfied. At present the regulatory process is unsym- pathetic to innovation, especially in rates and marketing concepts — the areas to which the railroads must devote far greater attention in the future than they have in the past. Steps must be taken to create a climate that is more cordial to innovation and that both creates and rewards vigorous competition in rail trans- portation. It deserves to be repeated, however, that the initiative still rests with management and that government policy, however changed, alone cannot re- store vibrancy to the rail industry. Part III Analysis of Selected Issues THE ECONOMY AND THE RAILROADS CONTENTS Page Economic Trends .__ 295 Analysis of Traffic Patterns 296 Coal Shipments 299 Projections for Coal-Generated Electricity 300 Less-than-Carload Service 302 Analysis of Census Data 303 Intermodal Competition 304 Motor Carrier Comparison 306 Qualitative Aspects of Rail Freight Service 307 Non-Rail Surface Transportation Subsidies 308 Passenger Traffic 309 Innovations To Stimulate Freight Traffic 310 (293) Economic Trends There are a number of different methods of measuring business activity. The most common methods are institutional series that reflect in one way or another economic conditions. There are many such indicators and ideally a measure of general economic change should satisfy certain functions : (1) reflect the turning points in economic activity; (2) measure the amplitude of change; (3) measure the rate of economic growth or decline; and (4) have a leading tendency in relation to other series. No single series consistently contains all of these characteristics. The most comprehensive measure of aggregate economic activity is gross national product. It constitutes the total amount of final goods and services produced during the year valued at current market prices ; and it also represents the expenditure side of the national accounts and includes local, state, and Federal government, businesses, and individuals. The advantage of the use of GNP for indicating business conditions is its compre- hensiveness. It does have disadvantages in that it is ( 1 ) so broad in its coverage that it tends to be somewhat sluggish; (2) all of the component figures cannot readily be estimated on a monthly basis and even as prepared on a quarterly basis some detail must be sacrificed; and (3) it appears several months late and is not as current as one might desire. The Federal Reserve Board's monthly index of industrial production is de- signed to measure monthly changes in the physical volume of output of manu- facturing, mining, and gas and electric utilities. One should note that even though the index directly measures the output of those industries accounting for an important part of total economic activity, it excludes certain sectors of the economy, such as construction, transportation, trade service, and agriculture. Inasmuch as it is not a measure of total economic activity, it tends to exhibit wider and more frequent fluctuations than a broader based series, such as GNP. Our national economic growth and expansion has generally been a continu- ing one since 1950 except for recessions in 1958 and in 1970-71. Our rate of growth, as reflected by GNP, has been approximately 5 percent a year during the last decade but dipped below that in 1970. 1 As shown in Exhibit l, 2 GNP has risen from $355 billion in 1950 to $739 billion in 1971, based on 1958 dollars. During this 22-year period, it has more than doubled. (Numerous long range projections use 4 percent as the expected increase in the GNP.) Exhibit 2 shows the trend of intercity ton-miles, industrial production, and GNP. less services, for the period 1960-70. 3 Placed on an index basis, this Ex- hibit indicates a correlation between industrial production, GNP, less services, and intercity ton-miles. During this time, the relative share of railroads in the intercity ton-mile market declined from 44.1 percent to 40.1 percent. Exhibit 3 compares the trends in national income (based on a base year of 1967) with the revenues of five groups of carriers. As indicated in the index, railroad revenues beginning in 1959 have grown from 94.1 to 115.2 in 1970. This is a modest increase compared with the growth in revenues of motor carriers of freight which showed an increase from 63.2 to 127.3. During a period of eco- nomic expansion of our national income, 1959-70, the rail revenue ratio to national income decreased by almost 40 percent, while motor carriers of freight maintained their revenue ratio to national income. Because of the broad nature of the gross national product as a measure of economic activity and because of the regional nature of the subject roads' opera- tions, Exhibit 4 includes several measures which reflect economic activity, both nationally and in the New England region. The measures of economic activity 1 Council of Economic Advisers. Economic Report of the President, 1972, p. 196. ' Exhibits referred to in this discussion of economic trends may be found in Appendix B, p. 435. 3 Interstate Commerce Commission. Annual Report, 1971, p. 139. (295) 296 include gross national product, national industrial production as reported by the Federal Reserve Board, and New England regional production as compiled by the Federal Reserve Bank of Boston. The table shows some rather striking trends. When measured either against gross national product or industrial pro- duction for the nation as a whole, the regional production has exhibited less growth than either measure of national production. Also included in Exhibit 4 are the trends in freight revenue growth experienced by the Pennsylvania, New York Central, and the New York, New Haven and Hartford (hereinafter sub- ject roads). These trends show a lesser rate of growth than that of the New England region. Further the rate of growth of the subject roads bears no com- parison to the growth of economic activity as depicted by either the gross na- tional product or national industrial production. The variance between the growth rate of the New England region and that of the Penn Central roads is important in that the entire New Haven operation and significant portions of the New York Central and Pennsylvania operations are generated within the New England region. The lesser growth exhibited by the subject roads would tend to indicate a failure to participate within the New England market at a rate equal to the growth in that market. Analysis of Traffic Patterns Besides facing competition from the other modes of transportation, the Penn Central faces competition from other railroads in the Eastern District and from railroads in other districts. To determine the subject roads' position in the railroad system, it was necessary to examine major commodity revenue and tonnage trends. Limited insight in the matter of intra-modal competition can be developed by examining the tonnage and revenue trends of major com- modities generated by the industry, the Eastern District, and subject roads. The major commodity groupings involved are "Manufactures and Miscellaneous," "Products of Agriculture," "Products of Mines,*' "Products of Forests," and "LCD" traffic. These data are set forth in individual exhibits. While the exhibits do not demonstrate direct intramodal competition, the trends of each group (industry, Eastern District, and subject roads) provide some measure against which to judge generally whether the subject roads have been successful in competing for the movement of the products involved. The first commodity grouping to be examined is "Manufactures and Mis- cellaneous" products, Exhibits 5 through 10. Exhibit 5 compares the amount of tonnage originated for this category grouping for Class I railroads in the United States, in the Eastern District, and for the subject roads. Exhibit 6 is an index compiled from Exhibit 5 which shows the tonnage originated for the period 1951 through 1963, and, separately, the period 1965 through 1970. It was necessary to divide the periods since the freight classification was changed extensively in 1964. Prior to that year, the classification of the statistics assem- bled by the ICC were grouped on a consumption basis. From 1965 to the pres- ent, these figures are based on production rather than consumption. As a result it is necessary to review each separately since the combination of the two would yield inaccurate data. During the period 1951 through 1963, the Cla^s I railroads remained rather stable as regards the origination of "Manufactures and Miscellaneous" tonnage. This group, in 1963, originated approximately 5 percent more tonnage than was accomplished during the base period (1957-1959). During the same time frame, the Eastern District carriers as a group experienced a slight decline in "Manu- factures and Miscellaneous" tonnage originated. In 1963, the Eastern District railroads originated comparable tonnage to that generated during the base period. The performances of the Pennsylvania and the New York Central were somewhat better than the District as a whole. The New York Central originated approximately 5 percent more tonnage than in 1957-1959 and the Pennsylvania originated approximately 2.5 percent more than the base period. The New Haven experience was that of a general decline. In 1963, the New Haven was originating 21 percent less tonnage than had been originated during the base period. 297 The data fail to show any dramatic shifts in tonnage originated which might have been occasioned by intra-modal competition. Although the freight classification changed significantly in 1964 and a new base period (1967) was utilized, the trends for the period 1965-1970 show a decline from the levels attained during the prior period. The performance by all groups in tonnage originated for all of the railroads is significant in that this product group is a very important contributor of revenue to the railroads. Exhibit 7 provides data comparing the tonnage terminated for "Manufac- tures and Miscellaneous'' products during the period 1951 through 1970. From these data, an index for the base period 1957-1959 was developed and is found in Exhibit 8. With the exception of the New Haven, the indexes reflect similar trends to those indexes for traffic originated. The New Haven has experienced a lesser decline in the tonnage terminated over the base period (approximately 6 percent). The trends since 1965 show that the railroads have reached a plateau and do not indicate any shift in industry terminations. As in the case of tonnage originated, the relative change in traffic termi- nated was slight for tonnage whose contribution is so important to the railroad industry generally and particularly to the subject roads. Exhibits 9 and 10 provide a comparison of the revenues generated by the transportation of "Manufactures and Miscellaneous" products during the pe- riods 1951-1963 and 1965-1970. Indexes of the revenues received for this prod- uct group are contained in Exhibit 10. Here again the most revealing fact is the small relative change in the revenues generated by the product group. While the Eastern District had a slight decline in revenues received in 1963 versus the base period, the two major roads involved in the merger maintained their revenue levels at rates somewhat comparable to those of the nation. The New Haven experienced an approximate 19 percent decline in revenues received for the transportation of "Manufactures and Miscellaneous" products (1963 versus 1957-1959) . The data would indicate that, while the relative share of this market has not been eroded by railroad competition from other carriers since there was no significant increase with a corresponding decline for the subject roads, there appears to be a failure of railroads as a whole to be maintaining growth in this product group at a rate comparable to the market growth for this product group. The second major product group examined was "Products of Mines," with comparative data covering tonnage originated presented in Exhibit 11. The comparison covers the period 1951 through 1963 and 1965 through 1970. From the data, indexes covering the two periods were compiled (Exhibit 12). The Exhibit shows that during the early and mid-1950 , s, United States rail- roads as a whole were experiencing a plateau as regards mine products origi- nated. In the. late 1950's, the plateau gave way to a general decline in tonnage originated. In 1963, the tonnage originated was approximately 2 percent lower than the base period 1957-1959. The experience of the Eastern District followed the experience of the nation as a whole with tonnage orginated in the Eastern District in 1963 being approximately 4 percent below the base period. The New York Central had a somewhat better experience, originating approxi- mately 6 percent more tonnage in 1963 than in the base period. The amount of tonnage originated in this category by the Pennsylvania Railroad was some- what less favorable than either the Eastern District or the total United States. In 1963, the railroad originated 7 percent less than the base period. The New Haven had shown, prior to 1963, a gradual decline from the late 1950's of ton- nage orginated but still managed to originate tonnage at a level of 9 percent over the base period 1957-1959. The trends within the industry as shown by the indexes covering the period 1965-1970 show slight declines for the Eastern District and the subject roads. These declines are significant in that this cate- gory provides large amounts of tonnage and revenues. A comparison of the absolute and relative changes in tonnage terminated for the subject category ("Products of Mines") is found in Exhibits 13 and 14. With the exception of the New Haven, which in 1963 terminated about 14 percent less tonnage, the subject roads, the Eastern District, and the total United States were fairly comparable, which would appear to discount any 298 shifts due to intramodal competition. The recent experience has seen a slight decline in tonnage terminated by the subject roads. Exhibits 15 and 16 provide a comparison and index of revenues received for the movement of "Products of Mines." Without exception the various groups showed relative declines in revenues received for the transportation of this product category. The most notable decline in revenues received was experi- enced by the New Haven which received in 1963 almost 20 percent less in reve- nues than during the base period. Since 1965 all the groups have shown a slight improvement in revenues received. These data show a general decline in revenues received for this traffic cate- gory which is significant since it provides substantial tonnage for the Penn Central. Also it is much less subject to intra- or intennodal competition be- cause of the fact that it is geographically fixed and to a significant degree can be considered "captive" traffic. The next category of traffic examined is "Products of Forests." Exhibits 17 and 18 give the absolute and relative changes in tonnage originated for the periods 1951-1963 and 1965-1970. The indexes are found in Exhibit 18. They show that during the period, tonnage originated by all Class I railroads has varied somewhat but steadied at a level fairly comparable to that expe- rienced during the two base periods. In 1963, the tonnage originated by all Class I railroads amounted to about 1.5 percent more than during the base peri- od. The experience of the Eastern District railroads followed fairly closely that of the Class I railroads as a whole. The New York Central originated less traffic and showed a somewhat more pronounced decline than the Eastern District and the United States as a whole. In 1963, it originated about 2.5 percent less tonnage than during the base period. The converse was the experience of the Pennsylvania railroad. The early 1960's saw a stronger relative change in ton- nage originated by the Pennsylvania than either the Eastern District or the United States as a whole. The New Haven, while showing a significant increase in tonnage originated in 1963, had still come back from a decline which was more pronounced than that of either the Eastern District or the United States. The index for the period 1965-1970 shows declines in the Eastern District and for the subject roads while all railroads showed an increase in tonnage handled. Exhibits 19 and 20 compare the tonnage of the "Products of Forests" termi- nated. The indexes developed in Exhibit 20 show that for the United States as a whole the relative change in tonnage terminated has been slightly upward. In the case of the Eastern District railroads, after a relative decline in the late 1950's, they have shown relative improvement in the amount of tonnage which they terminated. Neither of the major subject roads in 1963 was terminating tonnage at the level appreciably greater than that achieved during the base period. The New Haven, since the early 1960's, showed an improvement over the base period of approximately 16 percent in 1963. Recent years have seen a slight increase in tonnage terminated by the subject roads which is somewhat less than the experience of the nation as a whole. Exhibits 21 and 22 for "Products of Forests" show, as in the case of "Prod- ucts of Mines," a slight decline in revenues received during the latter part of the period covered (1951-1963) with the exception of the New Haven which, in 1963, received over 5 percent more in revenue than during the base period. This position has improved during the last few years. Here again, the category is one that is in most cases geographically fixed and to a substantial degree could be considered captive in nature which would preclude any shifts intramodally. The next commodity group to be examined is "LCL" — less than carload — traffic. Exhibits 23 and 24 compare the tonnage orginated by the United States railroads as a whole, the Eastern District roads, and the subject roads. The comparison covers two periods, 1951 through 1963 and 1965 through 1970. All the groups i.e., the United States as a whole, the Eastern District, and the sub- ject roads, show a dramatic decline in the amount of "LCL" tonnage originated. With the exception of the New Haven, the subject roads demonstrated a more pronounced decline in the amount of tonnage originated than the Eastern Dis- trict which, in turn, declined at a faster rate than the United States as a whole. 299 In 1963, the United States railroads were handling 63 percent less "LOT," traffic 951 wherenUh e e fC Pl^f ^ ""^ ^^ «K Sneoccu^ed rfm KSsSl^* 18 originated over 126 percent more than during me oase period. Since 1965 tonnage originated by the subject roads has leveled for ?LCL$ tS Jffi ^ 26 sh ™ ^absolute and relative changes respectively 1% a 7 ° terminated b y the various groups mentioned The index of railroad tonnage terminated in "LCL" traffic is cL V ^b\X\ht^ZZ{ of tonnage originated for the same category of traffic experience of "lcf»1lm a ^ 28 -° m ? are the re 7 enues received for the transportation V , LCL TA tra ? ic and again show a steady decline in the rate of United States lu 6rn P 1 ? ^ and Sub > Ct r ° ad Participation. Here agai^the simnarity of con^eTitlrn " partlC1 P atl ° n tends to *<**» a lack of a n ; real intra moVa! Data on the tonnage and revenues originated and terminated for "Prod- ucts of Agriculture" are included in Exhibits 29 through 34. The relative and absolute changes in tonnage originated are found in Exhibits 29 and 30 Ex- amination of the index shown in Exhibit 30, which is derived from the' data in Exhibit 29, indicates that for the United States as a whole there has been a steady increase in the tonnage originated. This increase is somewhat less steady but fairly comparable in the Eastern District to the experience of the United States as a whole. In 1963, tonnage originated in the Eastern District was approximately 12 percent greater than the base period. The Pennsylvania Railroad showed a rather steady level of tonnage originated during the period with the exceptions of 1958 and 1959 which were recession years. In 1963, the tonnage originated on the Pennsylvania Railroad was 17 percent more than that originated during the base year period. As in the case of the Pennsylvania, the New York Central also experienced a plateau during the period studied. In 1963, the New York Central originated tonnage comparable to that originated during the base period. The experience of the New Haven was one of rela- tive stability until the recession years of the late 1950s and, with one exception, has shown a marked decline so that in 1963 tonnage originated was almost 20 percent below that originated during the base period. Since 1968 both the Eastern District and the subject roads have experienced declines in tonnage originated. Exhibits 31 and 32 cover the tonnage terminated in "Products of Agricul- ture." The index, as contained in Exhibit 32 for the United States as a whole, shows a decline in tonnage terminated in the Eastern District and for the sub- ject roads. A comparison of the absolute and relative changes in revenues received by the railroads for the transportation of "Products of Agriculture" is found in Exhibits 33 and 34. The index of revenues received, as developed from Exhibit 34, shows little or no change for total United States railroads over the period covered. In 1963, the railroads as a whole received almost 4 percent less than during the base period. The Eastern District experienced a similar decline in revenues received for the movement of "Products of Agriculture." The subject roads experienced somewhat comparable declines, with the New Haven's record being the worst. Its revenues in 1963 were approximately 13 percent less than during the base period. The relative change in both tonnage carried and reve- nues received as among the carrier groups would tend to indicate little or no intra-modal competition. This trend has continued since 1965. The data, as a whole, seem to indicate that the subject roads and the in- dustry are not participating in the growth of the markets for these commodities. Where growth has occurred, it has been very slight. Coal Shipments Since coal tonnage has historically been so important to the Pennsylvania and New York Central Railroads and continues to be so for the Penn Central, it is pertinent to examine the potential market for coal in future years and determine the extent to which the industry and the subject roads will participate in that market. Trends in tonnage and revenue are found in Exhibits 35 through 40. The examination of the future market for coal is covered elsewhere. 300 Exhibit 41 shows the method of transporting bituminous coal and lignite from mines during the period 1950-1970. These data were used to develop an index of relative change which is contained in Exhibit 42. The index indicates that in the past ten years the railroad industry has shown a steady increase in tonnage handled. However, the change has been less than the relative change in total production. In 1969, total production increased about 38 percent over the base period while rail movement increased only 24 percent. Significant increases occurred in the movement by water, truck, and utilization at mine site. These exhibits show that while the railroad relative share has been in- creasing, it has not kept pace with the increase in total production. This is also illustrated by the diminution of the rail share of total production. In 1950, the railroads transported 81 percent of total production. By 1960, its share was 73 percent and decreased to 68 percent in 1970. In 1970, of the 94,624,142 tons of coal which were transported by the Penn Central, 45.9 million tons or 48.6 percent, were delivered to electric utilities, the major portion of which was in the New England and East Central areas. 4 Based on the projections of the National Power Survey, the Penn Central, like other railroads, will find an intensified competitive situation. Evidence of this competition is the extensive use of unit train movements. The unit train is considered as a system whereby more or less conventional cars are moved in supervised service with the capability and intention that part or all of the equipment be interchangeable with other general purpose equipment with or without control of the empty cars once a mission is completed. The unit trains have sometimes been termed "run-through" trains since they operate as an integral unit and bypass terminals. (In some instances the equipment is supplied by shipper or consignee.) The Penn Central and its predecessor lines participated in numerous unit train tariffs for the movement of coal. In lote 1970, according to a private study, the railroad was listed as a party in 66 tariffs covering unit train movements of coal. It could provide direct routing over its own lines in 36 of the tariffs. Further, in conjunction with other carriers, the Penn Central could provide a portion of the service covered by 32 tariffs. Since some tariffs list several routes, there are duplications which overstate the number of instances in which the Penn Central could participate. In the majority of instances, the equipment in- volved is railroad-owned equipment. The tariffs specify railroad supplied equip- ment in 55 cases and shipper or consignee equipment in 13 cases. This degree of involvement on the part of the Penn Central raises certain questions. Has the shift to unit trains generated enough extra tonnage to offset the loss of some or all of the margin over cost which the traffic contributes? Is the market for coal going to continue to expand at a rate which would justify the extensive invest- ment in cars for that service? There is no evidence, that thp increasing use of unit trains has increased the rail share of the coal market. The aforementioned exhibits show increasing rail tonnage but at a lesser rate than the expansion of the total market. Projection of Coal Usage in Generating Electricity The 1970 National Power Survey, 5 issued by the Federal Power Com- mission, has provided, through its regional advisory committees, some insights into the demand for electric power in the various U.S. regions in 1970, 1980, and 1990. An important part of the analysis involves the type of electrical generation, whether nuclear, fossil fuels, or hydro. The comprehensive study deals with many facets of the demand for electrical power but the amount of transportation needed in connection with an expanding power demand is of considerable importance in analyzing the future for railroads serving the North- east and East Central regions, inasmuch as coal is an important commodity both on a tonnage and revenue basis for Eastern railroads. The Northeast region consists of essentially the 11 Northeastern states of Connecticut. Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, * Hearings before Senate Committee on Commerce, Review of the Penn Central's Condition — 1971, 92d Cong.. 1st Sess. Serial No. 92-33, at p. 33 (1971). 6 Federal Power Commission, The 1970 National Power Burvev, Parts I, II, and III. 301 Pennsylvania, Rhode Island, Vermont, and the District of Columbia (see Ex- hibit 43). The East Central region extends from the southern and eastern shores of Lake Michigan and the Illinois-Indiana state line on the west to western Pennsylvania and western Maryland on the east, and from the lower peninsula of Michigan and Canada on the north to southern Kentucky and the borders of Tennessee and North Carolina. Exhibit 43 shows the boundaries of these districts. The 1964 National Power Survey indicated that by 1980, 10 percent of the nation's KWH generation would be nuclear. However, the 1970 survey indi- cated that in the Northeast region, the nuclear generation had reached 10 per- cent in 1969, and that this power source would account for 60 percent of total generation in the Northeast by 1980 and 82 percent by 1990. In 1966, 57.9 million tons of coal were used for electric generation in the Northeast area. By 1980, the amount is estimated to be 56.8 million and by 1990, 40.6 million tons. In an expanding power market which necessitates substantially increased KWH generation, coal tonnage is expected to decline dramatically from 1980 on in the Northeast region, as shown in Exhibit 44. In the Northeast, the concern regarding air pollution and the distance from coal sources have combined to cause a decrease in the importance of coal for boiler fuel. In spite of the use of unit trains or high speed shuttle trains which have improved transportation efficiency so as to reduce freight rates as much as 30 to 50 percent, the trend is away from coal usage. The competitive aspects of other fossil fuels, such as oil and gas, are con- tinuing to be intense but they too are expected to decline in relative and abso- lute terms as nuclear generation develops. Technological improvements, which have reduced the cost of extra high voltage transmission, have made the trans- portation of "coal by wire" more competitive. Thus a coal generating plant at the mine head which can be used for the transmission of electrical energy 600 to 700 miles away obviously has a deleterious effect on the transportation of coal. This reduces air pollution problems, particularly in metropolitan areas, as well as the cost of transporting and handling coal. In 1966, the utilities industry considered that unit train rates from 4 to 6 mills per ton-mile were necessary to compete with other fossil fuels and the atom. 7 Even though reductions were effectuated through the institution of unit trains, it is reported that coal shipments in 1966 from Pennsylvania and West Virginia mines to Eastern destinations had a weighted average rate of 7.85 mills per ton-mile for an average haul of 414 miles; and unit trainload rates to New England destinations averaged 7.07 mills per ton-mile for an average distance of 605 miles. 8 The increased use of nuclear generation and its expected acceleration in the Northeast area is shown in Exhibit 44. As this Exhibit indicates, approxi- mately 10 percent of the Northeast region is currently served by nuclear genera- tion. By 1980, this is expected to be 60 percent of the total and by 1990 to be approximately 82 percent. In the expanding power market in these two decades, the relative position of coal as fuel for Northeast electric generation plants is expected to decline significantly. The East Central region of the National Power Survey embraces an area in which is located a major portion of the Appalachian coal resources. His- torically, coal has provided most of the energy for utility purposes and in 1970, according to the survey, would supply about 97 percent of all electric energy requirements in the region. 9 In 1966, 82.3 million tons of coal were used in this area. The study projects an increase to 135.5 million tons in 1980 and 166.3 million in 1990. 10 This projected increase would indicate that the trans- portation potential for coal in this region is substantially better than that for the Northeast region. Competitive fossil fuels of oil and gas are of negligible significance but there is competition in the transportation of coal between « Id., II-1-20. 'Id., II-4-11. 8 Id., II-4-12. •Id., II-2-lx. 10 Id., II-2-24. 302 water and rail, and the possibilities of mine mouth generation with "coal by wire" is another competitive factor. Another aspect of the coal traffic potential in the East Central region is that the average length of haul because of the proximity to the mines is less than in the Northeast region. It is expected that an increase in total KWH generation will occur but increased use is expected to be made of nuclear generation so that by 1980 about 32 percent of electric generation will be nuclear and by 1990 about half of the power generation will be nuclear. Coal as a source of electrical energy in this region then is expected to decline from 97 percent in 1970 to about 50 percent in 1990, as shown in Exhibit 45. The projection for the East Central region indicates that the market for power will expand during the next two decades and coal as a source of energy will show an absolute increase in usage but its relative share of the total energy market will decline significantly. The elements of competition from intermodal carriers and from extra high volt- age transmission will have some impact on this segment of traffic. So in spite of reductions in freight rates averaging from 30 to 50 percent on some deliveries which are made possible by volume train movements, the advantages of competitive fuel, particularly nuclear energy, appears to be so substantial that the railroads cannot anticipate, even in the most favorable area of coal production (East Central), an expansion of electric generation. Less-Than-Carload Service The development of competitive and alternative modes of transportation in the 1920's resulted in significant inroads in the railroad share of traffic in less-than-carload freight. In 1920, the Class I railroads originated 52 million tons of less-than-carload tonnage, but this had dropped by 1939 to 36 million tons. This tonnage in 1947 amounted to 22.5 million tons which generated $522.4 million in revenue. As shown in Exhibit 46, it had declined by 1955 to 14,045,- 000 tons; by 1960 to 6,447,000 tons; and, in 1969, it was down to 1,279,000 tons. Revenue generated by this traffic had dropped to $35,589,000. In contrast, the revenues of motor carriers from this traffic had increased four-fold. The small shipments market has been expanding but the railroad share, both rev- enues and tonnage, has declined drastically. The original rail less-carload lot service was on a station-to-station basis, and the cost of pickup and delivery at origin and destination was generally an additional expense. With the development of motor carriers with store-door to store-door service, the railroads in the 1930's instituted free pickup and de- livery for less than carload traffic to meet motor carrier competition. Because of gasoline and rubber rationing during World War II, the rail LCL volume increased during the period from 1940 to 1946 by 66 percent. Within two years after the end of the war, motor carriers regained the momentum. The rail- roads, through pricing and service deficiencies, abetted the down trend of this traffic. Between 1946 and 1958, they received 14 general rate increases on a per- centage basis. This meant that the highest rates applied on LCL traffic, and so this traffic segment of the railroads was very adversely affected. Motor carriers were granted rate increases, but typically they lagged behind rail increases, and their service was superior so traffic shifted increasingly to motor carriers. Rail service on LCL traffic was also greatly influenced by the elimination of free pickup and delivery and/or the imposition of additional charges for collection and delivery of such freight within the Eastern Territory in the late 1940's and early 1950's. This was followed in 1957 by the Chicago North- western discontinuing pickup and delivery service completely and by a similar action by the Chicago Great Western in 1958. Other railroads adopted this practice and, in 1962, the Pennsylvania Railroad discontinued almost all its less-carload service. These actions affected other railroads, especially connecting lines, for it was no longer possible for the shipper to move freight in less-carload lots between many points on connecting lines. Essentially, a nationwide rail less- carload lot system no longer existed. Another aspect of the small shipments involves freight forwarders. At one time, several of the largest forwarders were controlled by railroads but, by 1970, no railroads owned or controlled any Class A (annual gross of 303 $100,000) freight forwarder. On the other hand, 170 Class A freight forwarders are controlled by regulated motor carriers. In the small shipments field, freight forwarders who historically had utilized railroads increasingly used motor carrier service with the result that their transportation purchase of $188 mil- lion from the railroads in 1960 had declined to $174 million in 1970. During the same years, the purchase of motor transportation by freight forwarders had increased from $58 million to $89 million. Shippers associations are handling some small shipments tonnage. An- other small shipment category can be found in what is termed the miscella- neous mixed freight-all freight in which certain mixes of freight can be shipped in a single unit. A portion of this would fall in the small shipment category although the amount of this is not known — only the total tonnage of the con- tents is known. The trailer-on-flatcar provides another area in which there are some small shipments but it is not possible to identify precisely the amount of less-car- load lot traffic handled in such service. Some of it is obviously in substitution of less-carload or less-truckload. The volume of these three categories — shippers associations, miscellaneous mixed freight-all freight, and trailer-on-flatcar — is not felt to be of sufficient magnitude for a detailed breakdown although they are competitive means of moving small shipments. The volume of small shipments (defined for statistical purposes by the Interstate Commerce Commission as less than 10,000 pounds) tonnage has been growing, in part because of the efforts of businessmen to control inventories more closely and in part because of improved service of some of the modes. While there are numerous problems associated with this small shipment traffic, including its pricing, it should be pointed out that this traffic is now the primary source of revenue for the regulated motor common carriers. Analysis of Census Data One of the methods by which to ascertain rail participation in the total freight transportation market is to examine the data contained in the 1963 and 1967 Censuses of Transportation. The material covered in these Censuses pro- vides some insights which have not heretofore been available, and permits a limited check of two points in time of total market, as well as the proportionate shares of this market held by the different modes of transportation. The Census data cover movements of manufactured and processed com- modities that originate at manufacturing establishments (as defined in the Census of Manufacturing based on the standard industrial classification). This obviously excludes the flow of agricultural commodities as well as unmanufac- tured minerals. Manufactured products which are reshipped from a warehouse or distribution center are also not included. The data in the Census consist of the traffic which historically has been the most profitable and should be of special revenue value to the railroads. Exhibit 47 compares the relative changes during the period 1963-1967 of both total tonnage generated by the shipper groups used by Census and the rail share of the same. During the aforementioned period, the total tonnage increased with the exception of but three shipper groups. At the same time, the rail share of tonnage originated decreased in 16 of the 2-1 shipper groups. This meant that with the exception of shipper group 12 (furniture, fixtures, and miscellaneous manufactured products) which showed a very slight decline, the rail share of tonnage generated was decreasing while the total market was increasing for the 16 categories. Perhaps more importantly, in the eight shipper groups where the railroad share increased, that increase, with but three exceptions, failed to keep pace with the growth in the market. As noted before, the data are limited in the fact that but two points in time are being compared. However, it would certainly appear that the railroads have failed to generate growth in this important traffic and in a period of general economic growth and expansion in our country. Exhibit 48 provides a comparison of relative changes in total ton-miles generated by the shipper groups and the rail share of that ton mileage. With 304 few exceptions, the data indicate a similar pattern of decline in rail participa- tion. Only five of the 24 shipper group categories showed a decrease in total market ton mileage between 1963 and 1967. The percentage decreases from high- est to lowest are group 8 (13.5 percent), group 24 (10.1 percent), group 22 (5.8 percent) , group 13 (2.1 percent) , and group 4 (1.8 percent) . The increases in the other 19 categories ranged from 86.5 percent to 1.0 percent. In 13 categories, the increase exceeded 15 percent or more. The rail share of the total ton-mile market shows a decrease in 16 categories despite the expanding ton-mile market. The range of the decrease is from a high of 11.1 percent to 0.7 percent. In 13 of the 16 categories, the decline exceeds 3 percent. The increase in the rail share of the ton-mile market between 1963 and 1967 applies in eight of the 24 shipper groups. However, except in two of these cate- gories, their increase is less than the increase in the total ton-mile market. During a period of expanding tons and ton-mile markets for the 24 shipper groups, the overall railroad share either failed to match the growth in the market or de- clined significantly. By significantly, we mean the railroad share of the market declined at a time when the total market was expanding. This erosion of their market share assumes special importance because the economy was expansionary and because of the nature of the traffic involved (manufacturing and/or proc- essed) whose revenue contribution is relatively greater than other categories of traffic. INTERMODAL COMPETITION As our population has become urbanized, it has moved toward a dispersed urban pattern. Many of the new industrial parks and shopping centers are completely dependent upon truck transportation. Even in intercity transporta- tion, there are so many competitors for both the general commodity traffic and the specialized commodities, such as those in bulk, that the railroads generally are not participating to a sufficient degree in general traffic growth. Intermodal competition provided by regulated for-hire motor carriers pos- sesses certain advantages for shippers. It offers a complete service that is store- door to store-door. This mode of transportation also allows a considerable degree of latitude in ordering shipments which is very important in physical distribu- tion management. The movement of small shipments expeditiously enables ship- pers to reduce their inventory carrying costs because they do not have to have as much inventory on hand. In addition, shippers have had a greater latitude in packaging their shipments as these requirements generally have not been as restrictive as those of the railroads. The development of specialized equipment in motor transportation has made it possible, through the use of specialized carriers such as tank trucks, to tailor the movement of bulk commodities— flour, sugar, chemicals, and other dry or liquid commodities — to meet the needs of shippers. Other specialized motor carriers transport commodities of unusual value, house- hold goods, and heavy equipment. _ .... The average speed in motor transportation is double, that of rail which is a factor of importance in delivery of shipments. Currently. 76 percent of the 42,500 miles of the interstate highway system is open which allows truck ship- ments to be moved even more expeditiously. The interstate system, upon its completion, will link all major metropolitan areas in the United States and thus provides a basic network of high speed, limited-access highways for motor The size of the motor carrier unit, too, provides a substantial degree of flexibilitv. The use of twin trailer combinations, which consist of a tractor and two semi-trailers, each of which is 24 to 28 feet in length, is permitted on the highways of 33 states. As more of our freight gets lighter m weight (with the use'of plastics and aluminum) and bulkier in size, the increase in cubic ca- pacity and heavier loading which twin trailers permits makes motor carriers more competitive. , Motor carriers that transport agricultural commodities are exempt from economic regulation, and these carriers have been a keen competitive segment in the transportation of livestock and agricultural commodities. Perhaps the most incisive competitive factor, however, is that of private trucks which a companv can operate in transporting its own products. Since 305 equipment of general or special type can be leased, a company does not even have to invest in transport equipment in providing its own service. The speed and larger capacity of many of our new jet planes have ena- bled airlines to develop cargo services for small and medium-size shipments of a wide range of manufactured or processed goods. Although the volume is small as compared to surface transport, the planes are becoming more of a competitive factor on certain traffic segments. In large bulk commodity flows, a substantial measure of competition is gen- erated by the inland water carriers and pipelines for transportation of such commodities as coal, ore, grain, and petroleum. An additional aspect of competition is the increased use of the physical dis- tribution concept by business firms. This management of transportation, stor- age, protective packaging, inventory, and material handling to and from the production line has widespread and intensive application in industry. The em- braced areas are managed as a system, and there are numerous opportunities for managerial trade-offs to meet a company's objectives. Thus, a firm may seek improved customer service which can result in changed transportation re- quirements which, in turn, can affect warehousing, inventory, and packaging requirements. The emphasis upon physical distribution management is resulting in more effective control of each of its components which means that for-hire carriers will have to be more responsive to reliability and performance requirements with at- tractive pricing of their service in order to pai'ticipate in future traffic. In order to gain insight into the degree to which the subject railroads have competed successfully in the transportation market, a compilation was made of the freight revenues generated by various modal groups. These groups included : Class I railroads, Class I motor common carriers, freight forwarders; Eastern District railroads, Eastern District motor common carriers; and the three railroads — Pennsylvania, New York Central, and New Haven. The data are found in Exhibit 49, and an index using 1957-1959 as base years was calcu- lated and is found in Exhibit 50. As illustrated in Exhibit 50, the growth experienced by Class I motor com- mon carriers was substantially greater than either the growth of the Class I railroads or the freight forwarders. The Class I railroads, in 1969, generated freight revenues approximately 22 percent in excess of those generated during the base period; and the freight forwarders generated freight revenues about 39 percent greater than in 1957-1959. On the other hand, the revenues of the Class I motor common carriers in 1969 were 179 joercent above their revenues during the base period. To some extent, this substantial increase has been affected by the smaller revenue base of Class I motor common carriers. Even dis- counting this factor, their rate of growth has been considerably greater than for the other two modes. The index illustrates the failure of the Eastern District railroads to grow at a rate comparable to that of the Class I railroads as a whole. In 1969, the Eastern District railroads had revenues which were about 9 percent above the. level which they had during the base period. The Eastern District motor car- riers, on the other hand, have increased their freight revenues comparably with the Class I motor common carriers as a whole. It is difficult to state that the growth of the Eastern District motor carriers has been at the expense of the Eastern District Class I railroads since the designation ''Eastern District motor carrier" merely includes those carriers domiciled in a certain part of the nation. There is little doubt, however, that many of the motor carriers geographically located in the Eastern District of the railroads are indeed quite competitive with the railroads as regards their service areas. With regard to the individual railroads depicted, i.e., Pennsylvania, New York Central, and New Haven, their rate of growth has, with the exception of the New Haven, compared favorably with the growth in the Eastern District, primarily because the Pennsylvania and the New York Central are the two dominant lines in that district. As in the case of the Eastern District, the rate of growth as reflected by revenues of the Pennsylvania Railroad and the New York Central Railroad has been less than for all Class I railroads. 306 The performance of the New Haven during the period 1954 until 1968 when it was merged into the present Perm Central shows a steady decline in freight revenues received. Exhibit 50 shows that, in 1968, the road received freight revenues that were about 23 percent below the revenue level experienced during the base period. Exhibit 51 provides data comparing tonnage generated by the various modes covered in Exhibit 49 and for the same period of time. As in the case of freight revenues shown in Exhibit 50, the index of tonnage generated, found in Exhibit 52, shows that both Eastern District carriers as a whole and the two principal roads in the Eastern District, the Pennsylvania and the New York Central, have not participated to a comparable degree in the growth of tonnage generated by Class I railroads as a group. Perhaps the most salient point is found in a comparison of tonnage and revenues included in the abovementioned exhibits. The rate of growth in ton- nage for the railroads as a group is fairly comparable to their rate of growth in revenues whereas the motor carriers, as a whole, and those domiciled in the Eastern District, have actually experienced a decline in tonnage while achieving the rather significant increase in freight revenues for the same period. It would appear that the motor carrier industry has been very successful in capturing very profitable traffic. Selected Class I Motor Common Carriers In an effort to determine the extent of motor carrier competition for the Eastern District rail carriers and the principal roads being studied, a group of Class I motor common carriers was selected for examination. These carriers have extensive operating rights within the Eastern District and thus provide the potential competition not only within the Eastern District but also provide single-line service to many areas of the country. Exhibit 53 illustrates the growth of these selected carriers during the last 16 years, with yearly data cov- ering the last 11 years. Exhibits 54 through 58 show the operating rights of cer- tain of these carriers; and Exhibit 59 provides a historical overview of the growth through merger and acquisition of certain of the carriers. As shown in Exhibit 53, since 1955 the revenues of these 12 motor carriers have increased about 300 percent. This compares with the growth of the Eastern District rail- roads during the period 1955-1969 of 4 percent and 4.5 percent for a combined Pennsylvania-New York Central Railroad. The period 1960-1970 shows that the carriers, with the exception of individual years for certain carriers, ex- hibited a steady growth in revenues. During the same period, the principal rail- roads in the Eastern District and the Eastern District as a whole experienced a much lower rate of growth. The significance of these extensions of operating rights which these car- riers have experienced is primarily two-fold : not only can they provide direct competition within and between districts but they also can provide single-line service in both instances. Illustrative of these general commodity carriers are three with transcontinental operating authority — Consolidated Freightways (Exhibit 54), P-I-E (Exhibit 55). and Yellow Freight System (Exhibit 56) — and two with regional authority — Associated Transport (Exhibit 57), and Roadway Express, Inc. (Exhibit 58). An indicator of the amount of competition provided by regulated intercity motor carriers of general commodities can be found through analyzing the number of carriers in 1964 holding operating authority to serve the designated city both as to origin and termination of shipments (many more carriers have operating authority which is limited either to provide origin service or to pro- vide termination service to a particular city than to provide both origin and termination service) . This tabulation is by size of carrier at a number of metro- politan areas in the Eastern District and New England. 11 11 Tabulation by Assistant Professor Jay Smith, Southern Illinois State University, Carbondale. Illinois. 307 Class III New York 149 64 45 Chicago.... 180 52 20 Philadelphia.. Ill 39 56 Cleveland 81 12 4 Pittsburgh 60 29 15 Baltimore 81 21 15 Boston 88 58 99 Indianapolis 76 11 3 Akron 74 9 2 Detroit 70 10 9 As recently as 1960, there were two regular route general commodity car- riers operating from coast-to-coast but through acquisition, there are now nine. Several motor carriers have authorized regular route mileage greater than that of any railroad. The development of these transcontinental carriers provides the shipper with single-line service that is a strong competitive advantage for motor carriers. (Yellow Freight System shipments in 1970, for example, moved an average distance of 1,175 miles according to Yellow Freight's 1970 annual report. ) Qualitative Aspects of Rail Freight Service Typical shipper dissatisfaction with carrier service is reflected in complaints filed with the carrier ; and over a period of time, if there are not improvements to correct service deficiencies, the shipper may turn to competitive for-hire modes of transportation or supply his own transportation service in the form of truck or barge service. In a recent Interstate Commerce Commission proceeding, Ex Parte 265 Increased Freight Rates, 1970, and Ex Parte 267 Increased Freight Rates, 1971, decided March 4, 1971, the Commission invited all parties to Ex Parte 265 to submit examples of deficiencies or inadequacies in railroad service as well as recommendations they wished to make on how such conditions might be corrected. Details regarding this are found at 339 ICC 136-156. Twenty pages of detailed rail service deficiencies, some of it in summary form, were submitted. The service deficiencies mentioned by coal shippers include car shortages, uncooperative and inefficient labor, excessive transit times, bad order cars, poor switching service, inadequate road bed maintenance, and lack of motive power. Toledo Edison indicated "* * * extremely poor service of the Penn Central at its Acme and Water Street generating stations." 12 With a standing order to the Penn Central for daily delivery of 50 carloads of coal at its Acme sta- tion, this company's weekly summary from April 14, 1970 to June 6, 1970, recorded 696 cars not received during the 8-week period. 13 Consolidated Edison Company of New York stated that it failed to re- ceive tens of thousands of tons of coal during 1969 as a result of the inability of the railroads to deliver an adequate number of coal cars to the coal mines. 14 The General Mills Corporation in Ex Parte 265 (1970) and Ex Parte 267 (1971) presented evidence that on-time reliability of the railroads, which the railroads agreed should be 90 to 95 percent, was 65-72 percent in 1966 and had not improved since. General Mills said that railroads exercise little control over the quality of their service in the movement of either a loaded freight car from a loading facility to an unloading facility or an empty freight car in "car distribu- tion." This company stated that there are few performance standards" and little "measure of performance." 15 These examples are illustrative of the many pages of service inadequacies. Exhibit 59A contains a summary of such service deficiencies. "339 ICC 138. 13 Id. » Id. d ► 1B £. r ,? sent o atlon by William K. Smith, Vice President, General Mills, February 16, 1971, In Ex rVirte 2<0, p. 8. 308 Non-Rail Surface Transportation Subsidiaries The examination of the non-rail subsidiaries is confined to the major sur- face transportation subsidiaries. Their operation is important since their per- formance could adversely affect the financial and managerial posture of the railroad. While there has been little publicity concerning their operations since the declaration of bankruptcy, other of the railroad's subsidiaries have created both financial and managerial drains on the railroad. The Penn Central either owns completely or controls two pipeline companies and five motor carriers. These subsidiaries are Buckeye Pipe Lines, Everglades Pipe Lines, Merchants Trucking Co., New England Transportation Company, New York Central Transport, Pennsylvania Truck Lines, Inc., and Penntruck Co. 10 The individual operations are different in nature. Merchants Trucking and New England Transportation Co. are principally involved in the movement of general freight between cities. The other three to be examined, New York Central Transport, Pennsyl- vania Truck Lines, and Penntruck, derived substantial parts of their revenues from local operations. In each instance, the carrier's operations are compared with the aggregate group involved in comparable operations. Exhibit 60 provides a comparison of operating ratios achieved by Mer- chants Trucking and New England Transportation Co. and those achieved by all Class I intercity common carriers. The comparison covers the period 1965- 1970. It shows two different operations. During the period, Merchants con- sistently achieved a better operating ratio than that achieved by all Class I common carriers. On the other hand, New England never managed to achieve a ratio which equaled that of the Class I common carriers. This experience of the two carriers carried over in the comparison of relative revenue growth shown in Exhibit 61. This Exhibit compares the revenue growth achieved by the two carriers with the revenues generated by all Class I intercity common carriers. The index is based on the 1967 experience. While the revenue growth experi- enced by Merchants was more than all Class I common carriers, New England Transportation Co. grew but not at a rate equal to the aggregate. Exhibits 62 and 63 provide comparisons for the three rail subsidiaries pro- viding local service. The operating ratios of the three carriers are compared with the operating ratio achieved by all local carriers of general freight in Exhibit 62. With the exception of Pennsylvania Truck Lines, the Penn Central subsidiaries achieved lower operating ratios than all general freight local car- riers. In fact, the ratios achieved by New York Central Transport would indi- cate a very profitable posture. Exhibit 63 gives the revenue growth of the three subsidiaries and compares it to the growth of all general freight carriers providing local service. All the carriers experienced a growth in revenue during the 1965-1970 period while the revenues generated by all local carriers was declining. As expected, the rate of growth varied greatly as between the carriers, with New York Central Trans- port registering the highest relative growth. The lowest growth of the three was registered by Pennsylvania Truck Lines, Inc., which was manifested in the high operating ratios shown in Exhibit 62. As a whole, it would appear that the motor carrier subsidiaries owned by the railroad have not provided either a financial or managerial drain on the carrier. Moreover, the merger of four of these subsidiaries into a single carrier, as aforementioned, has potential benefits for the future. The carrier must still contend with the continuing unprofitable posture of the New England Trans- portation Co. As early as 1951, this carrier's poor performance was a burden on the New Haven prior to its inclusion in the Penn Central and has now become a problem for the carrier. The performance of the major pipeline owned by the Penn Central is examined in Exhibits 61 through 66. Exhibit 61 provides a comparison of revenues and production generated by Buckeye and United States pipelines as "As of January 1, 1972, New York Central Transport, Pennsylvania Truck Lines. Inc., Penn- truck Co., and Merchants Trucking Co. were merged and retained the name Pennsylvania Truck Lines, Inc. 309 a whole. These data are utilized to develop indices of both revenues and produc- tion which are included in Exhibits 65 and 66, respectively. Exhibit 65 shows that during the period 1955-1969, Buckeye Pipeline grew at a faster rate than United States pipelines, as measured by revenues. Buckeye registered revenues approximately 71 percent greater than the base period (1957-1959) while all pipelines generated revenues approximately 49 percent above the base period. A comparison of production, as represented by total barrels delivered out of the system, shows an opposite trend. Over the period 1955-1969, as illustrated in Exhibit 66, all pipelines exhibited a stronger trend in barrels delivered than Buckeye. In 1969, all pipelines generated 73 percent more barrels than during the base period while Buckeye produced 55 percent more. Taken together, the trends indicate that Buckeye has a more profitable traffic consist than all United States pipelines since it generated more revenues from the product transported. Thus, with the exception of the apparent unprofitable posture of the New England Transportation Co., the major nonrail transportation subsidiaries would appear to provide no strain upon the parent company. Passenger Traffic In the early and middle 1950's, the railroads attempted to lure intercity passengers to train service with large expenditures for new equipment and the institution of service and pricing inducements. Generally they were not suc- cessful in their efforts to hold and attract customers, and passenger service continued to be an increasingly heavy drain on rail revenues. As measured by intercity passenger-miles of travel in 1970, motor vehicles account for 88.73 percent; air transportation 10.01 percent; and railroads 0.92 percent. Twenty years ago, the division was motor 91.3 percent, air 1.7 percent, and railroads 6.8 percent. There has been a decline of railroad intercity passenger-miles in spite of an expanding travel market. Air transport has become the dominant for-hire passenger carrier on a passenger-mile basis. Exhibit 67 shows a comparison of passenger revenues received by all Class I railroads, Eastern District railroads, and the subject railroads. The period covered is 1954-1969. Exhibit 68 is an index developed from the data found in Exhibit 67 and is based on the 1957-1959 experience. All of the indices show a significant rate of decline from 1954 on. The Class I railroads received revenues for the move- ment of passengers in 1969 which were about 35 percent less than those for the base period. At the same time, the railroads located in the Eastern District experienced an approximate decline of 30 percent in revenues received. Prior to the merger, the Pennsylvania Railroad had experienced a decline similar to that of the Eastern District roads as a whole while the New York Central's revenues declined to a greater extent (48 percent). The New Haven at the time of its inclusion showed the least decline with approximately 27 percent. Even though it would appear that the New Haven has suffered a lesser decline than the other two roads, much of its revenue is generated from commuter op- erations which cannot easily be abandoned. Most railroads, including the Penn Central, turned their money-losing intercity passenger service over to a new quasi-public agency, Amtrak, begin- ning in May 1971. This has resulted in some improvement of the passenger deficit. The Trustees of the Penn Central have stated, however, (Report of Trustees to U.S. District Court for Eastern District of Pennsylvania, Febru- ary 15, 1972) that inadequacies of the present contract with Amtrak, as well as the heavy losses it sustains in commuter service, must be remedied. Amtrak does not share the Penn Central's view, but some readjustments have been made. When one considers that more than two-thirds of the train miles operated in the Boston-Washington corridor are in passenger service, it should be apparent that the Amtrak contract should be equitable for all involved. Efforts of the past several years to upgrade rail passenger service in the corridor between Washington, D.C. and New York by use of new equipment with high speeds and other passenger service improvements, are making money. 310 The service between New York and Washington is the most consistent money maker in the Amtrak system. Innovative Efforts to Stimulate Freight Traffic Although earlier efforts had been made, it was during the early 1950's that trailer-on-flatcar service (TOFC) was instituted and subsequently container- on-flatcar (COFC). As the service was offered, several variations developed which became identified by number. These are : Plan I. Kailroad movement of trailers or containers of motor common carriers, with the shipment moving on one bill of lading and billing being done by the trucker. Traffic moves under rates in regular motor carrier tariffs. Plan II. Railroad performs its own door-to-door service, moving its own trailers or containers on flatcars under tariffs usually similar to those of truckers. Plan II 1 /^- A combination of Plans II and III whereby the railroad fur- nishes the trailer or container but the shipper performs the service to and from rail terminals. Plan III. Ramp-to-ramp rates based on a flat charge, regardless of the contents of trailers or containers, owned or leased by freight forwarders or shippers. No pickup or delivery is performed by the railroad. Plan IV. Ramp-to-ramp rail movement of trailers or containers owned or leased by shippers or freight forwarders. Plan V. Traffic moves generally under joint railroad-truck or other com- bination of coordinated service rates. Either mode may solicit traffic for through movement, and either mode will bill for the traffic. After considerable growth over a number of years, TOFC traffic leveled off and, in 1970, decreased. The economic downturn was probably responsible in part for this but the rate of growth had not been as rapid during the past four years as had been true in earlier years. The market for this type of traffic has been rather thoroughly sold and special additional efforts will have to be made to develop greater TOFC traffic. Exhibit 69 shows the growth of this traffic by plan during the period 1964-1970. As TOFC traffic has increased, the per- centage under Plan I of this traffic, which involves transportation for motor common carriers, has declined from 25 percent in 1964 to 10 percent in 1970. Under Plan II, which is the basic railroad service performed door-to-door and designed to be competitive with motor carriers, the relative share has declined from 39 percent in 1964 to 35 percent in 1970 despite an expansion of the total TOFC and COFC market. The great growth that has occurred dur- ing this period has been in Plan IH/ 2 in which the railroad furnishes the trailer or container but the shipper performs the service to and from rail terminals. TOFC carloadings as a percentage of all carloadmgs have grown from 2.6 percent in 1963 to 4.8 percent in 1969. Evidence of the Penn Central's awareness of the importance of this tramc is found in the Report of the Trustees to the U.S. District Court for Eastern District of Pennsylvania, dated February 15, 1972, wherein on page 4 the Trustees stated : Penn Central is becoming a more effective competitor. Divergence of views regarding piggyback service on the part of the former New York Central Pennsyl- vania, and New Haven, and unfulfilled commitments after the merger— a ong with increases in piggyback rates almost twice as great as increases in truck rates- resulted in a post-merger drop in Penn Central piggyback business from 520,000 trailers in 1968 to 420,000 trailers in 1971. In the last half of 1971 when Penn Central's new services and reduced rates began to take effect, that trend was reversed." The development of unit trains during the past decade has enabled the railroads to become more competitive in the bulk commodity categories, both in service and price, than had earlier been the case. The unit trains are made up of a designated number of cars, typically 50 or more, each loaded with a mini- w See Appendix D, Exhibit 54, p. 632 for text of Trustees' February 15. 1972, Report on Reorga- nization Planning. 311 muni tonnage per car, and the entire train carries but a single commodity, pri- marily bulk. The unit trains operate between two established points in a shuttle service. This enables the operation to be rather precisely scheduled by bypass- ing classification yards, and by eliminating the coupling and uncoupling of cars, the turn-around time can be minimized. In some instances, the bulk products can be loaded and unloaded automatically while the train is in mo- tion. The most common unit train has been that hauling coal between mines and public utility plants. In unit train service, the equipment which is used is typically dedicated to that particular service. In some instances, the rail cars have been purchased and are owned by the shipper, such as a utility company. Unit trains have been placed in operation for a number of commodities including ore, grain, fertilizer, chemicals, and steel slabs. In addition to those of coal and grain, the Penn Central has one which is designed to transport logs for processing into pulp for paper making. This par- ticular operation is one in which the paper company provides 136 cars that are extra long and have high sides. This type of car triples the capacity of the gondolas previously used. One of the most successful traffic recoveries by railroads has occurred with their development of specialized (rack) cars to haul new automobiles. This equipment, coupled with a rate adjustment and improved service, enabled rail- roads to secure 51.6 percent of this traffic as measured by gross revenues as compared with but 14.9 percent in 1959. The motor carrier share during this same period dropped from 83.6 percent to 48.2 percent. Multiple car rates have also been established that apply a lower rate for a designated number of cars, such as five. These cars move as a single shipment at a lower rate than would apply on individual cars. Such pricing incentives have been applied on a number of different commodities. THE PENN CENTRAL MERGER: A STUDY OF ITS PLANNING, APPROVAL, AND RESULT CONTENTS Paw Chronology of the Merger 316 Managing the Merger: Pivotal Figures 325 The Conditions of Approval imposed by the ICC 330 Merger Meant Consolidation 333 What Consolidation Involved 334 Preparation and Execution of the Merger 335 What was left undone on Merger Day 337 Decision to Rush Consolidation 337 Failure to Reorganize 340 Corporate Character 342 Conclusions 345 (313) The Penn Central Merger-. Planning, Approval, and Result On February 1, 1968, The New York Central Railroad Company (NYC) was legally merged into The Penns}dvania Railroad Company (PRR) to form what is now known as Penn Central Transportation Company (Penn Central or PC), the largest railroad system in the United States at that time. 1 Fewer than 30 months later, on June 21, 1970, Penn Central filed a petition for re- organization under § 77 of the Bankruptcy Act in the Federal District Court at Philadelphia where reorganization proceedings are now pending. This report reviews the Penn Central merger proceedings before the Interstate Commerce Commission and the courts, summarizes presently available information about the PRR/NYC plans for merger, and analyzes the part the merger played in the ultimate collapse of Penn Central. A short summary of pertinent statutory provisions in the Interstate Com- merce Act (ICA) may be helpful in understanding the complex world of railroad mergers. 2 Under ICA §5 (2) (a), 3 two or more railroads may consolidate or merge their properties or franchises into one corporation with the prior approval and authorization of the ICC. The Commission's approval is also required when one railroad, or two or more jointly, acquire control of another railroad through purchase of its stock or otherwise. Any party proposing a subject transaction must first present an application to the ICC. After appropriate procedures, if the Commission finds that the proposed transaction will be con- sistent with the public interest, "it shall enter an order approving and author- izing such transaction" upon such terms, conditions and modifications as it finds just and reasonable. Under ICA § 5(2)(c), 4 in passing upon any proposed merger or other uni- fication transaction, the Commission is directed to give weight to (1) the effect of the proposed transaction upon adequate transportation service to the public; (2) the effect upon the public interest of the inclusion of, or failure to include, other railroads in the territory involved in the proposed transaction; (3) the total fixed charges resulting from the proposed transaction; and (4) the interest of the carrier employees affected. Under §5(2)(d), 5 when the proposed transaction involves railroads, the ICC is authorized, as a prerequisite to its approval, to require the inclusion of another railroad in the territory involved upon petition by the railroad request- ing inclusion. The terms of inclusion must be equitable, and the Commission must find that the inclusion is consistent with the public interest. Section 5(2) (f) 6 provides that as a condition of approval of any unification involving a railroad, the Commission shall require protection of the interests of the railroad employees affected. The Commission must include conditions pro- viding that for four years after the effective date of its order of approval, the transaction approved will not put employees of the railroad affected by the 1 Railroads are often designated in this chapter by their widely used common names or initials. 2 Rail unifications are subject to S§ 5 (2) to (13), inclusive, of the Interstate Commerce Act (here- inafter cited as ICA). 49 U.S.C. §§ 5 (2)-(13). » ICA 5 5(2)(a), 49 U.S.C. § 500(a). «ICA&5(2)(c),49 U.S.C. }5(2)(c). » ICA 5 500(d), 49 U.S.C. § 5(2) (d). • ICA } 5(2) (f), 49 U.S.C. 6 5(2) (f). (315) 74-924 O - 73 - 22 316 order in a worse position with respect to their employment. However, the em- ployee shall not be protected for a period longer than the period of his employ- ment by the railroad prior to the effective date of the approval order. The last sentence of the section is a "notwithstanding" proviso: notwithstanding any other provisions of the Act, an agreement pertaining to the protection of the affected railroad employees "may hereafter be entered into" by any railroad and the authorized representative of its employees. Chronology of the Merger For many years prior to 1950, rail transportation in the Eastern District was dominated on a territorial basis by PRR, NYC, the Baltimore and Ohio (B&O) and the Erie. Other rail carriers provided important service in parts of the district as, for example, the Chesapeake and Ohio Railway (C&O), the Norfolk and Western Railway (N&W) and the Virginian in the Southern Appalachian (Pocahontas) coal fields in southern West Virginia and Virginia. The New York, Chicago and St. Louis Railroad Company (Nickel Plate or NKP) and the Wabash operated lines reaching important parts of the region west of Pittsburgh and Buffalo. In addition to the longhaul trunklines, numer- ous linehaul railroads of lesser length served various parts of the East as, for example, the Reading and the Central Railroad of New Jersey along the eastern seaboard north of Hampton Roads and the Lehigh Valley connecting Lake Erie and New York City through the declining Pernod vania anthracite coal fields. In the central area were the Pittsburgh and West Virginia (P&WV) and the Akron, Canton and Youngstown Railroad (AC&Y), among others. The New England lines with substantial coverage in the upper northeast sector were the New Haven (NH), the Boston and Maine Railroad (B&M) and the Boston and Albany arm of NYC. Prior to 1950, the Eastern railroads, with several notable exceptions, had been generally profitable, except in the depression years of the 1930's. PRR, then one of the two or three strongest railroads in the nation, had an exceptional earnings record as did the Pocahontas lines. However, NYC and B&O en- countered difficulties at times. The Erie had an unfavorable debt structure and low earnings and so had more serious problems. The New England lines, parti- cularly the New Haven, were in perennial trouble. The passenger train deficit had been a burden since the 1930's, except for the war years; competition from trucks and other transport modes intensified in the years following the end of World War II; and signs of railroad decline in the East were appearing with increasing frequency. In the decade beginning with 1950, the railroads generally suffered a de- cline in traffic and revenue. Technological improvements did not stem the ad- verse trend. A series of general increases in rates improved revenues, but the increases were offset by higher costs. In the East, overall earnings declined as did the net income of important lines. In the case of both PRR and NYC, for example, net railway operating income in 1957 through 1959 failed to meet fixed charges by substantial amounts. In this atmosphere of decline, the rail- roads searched for means of improving their position in a highly competitive transport economy. From the early days of the railroads, merger and consolidation have been frequently used to expand operations and to achieve the economies of scale. As far back as 1907, the ICC formally reviewed the consolidation and combination of railroads, 7 and the subject has been repeatedly studied since 1920. An active phase in the long history of railroad regroupings opened in the latter part of the 1950-59 decade and is not yet concluded. This phase has been nationwide and has substantially revised the railroad system of the country. T Consolidations and Combinations of Carriers, 12 I.C.C. 277 (1907). 317 t! 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In the N <&W /Virginian case decided October 8, 1959, 8 the ICC authorized the merger of the Virginian into the N&W. The merger was effected on December 1, 1959 and thus reduced Eastern rail competition in the Poco- hontas coal fields to the N&W and the C&O. The Virginian had been a friendly connection of the NYC. Its prospective unification with N&W likely influenced the first merger negotiations between the PRR and the NYC which began in November 1957. They were terminated by the NYC in January 1959. The second 1959 application was approved by the ICC on September 13, 1960 in the Erie-Lackawanna Merger case. 9 The corporate unification of the Erie and the DL&W into Erie-Lackawanna Railroad Company was consum- mated on October 17, 1960, but the consolidation of forces and facilities was not effected until May 16, 1961. Following the termination of merger negotiations with PRR in January 1959, the NYC first proposed an NYC-C&O-B&O alignment. Failing to nego- tiate C&O-NYC control of B&O, the NYC interests then entered into a contest with C&O for purchase of B&O stock. On June 14, 1960, the C&O filed its applications with the ICC for control of the B&O through acquisition of its capital stock. Shortly thereafter, the NYC also filed applications to acquire control of B&O, or, in the alternative, to participate jointly with C&O in the control of B&O. The contest continued, and by early 1961, the C&O was in a position to control at least 61 percent of the B&O stock. The NYC interests acquired a little more than 20 percent of B&O's voting stock or sufficient to prevent the C&O's filing of consolidated tax returns if eventually C&O acquired control of B&O. Meanwhile, other plans to restructure the Eastern railroads were in process. Five applications, the first filed with the ICC on March 17, 1961, and the last on August 21, 1962, proposed to create an N&W system consisting of (a) the N&W as it then existed, (b) the Nickel Plate by merger with N&W, (c) the Wabash by lease and by control through stock ownership, (d) the Sandusky line by purchase from The Connecting Railway Company, a wholly owned subsidiary of the PRR system, (e) the AC&Y by control through stock owner- ship, and (f) the P&WV by lease. The assent and participation of the PRR were necessar} r for presentation, approval and consummation of the proposal to create an expanded N&W" system. PRR owned not only 87 percent of the outstanding Wabash voting stock but also 34 percent of the N&W stock then outstanding. N&W, a major coal carrying railroad, did not then have a port on lower Lake Erie for the transshipment of lake cargo traffic. Under the N&W merger plan, it would purchase from the PRR subsidiary the Sandusky line between Columbus and Sandusky, Ohio, and also port facilities at Sandusky and thus gain access to the lake. The Sandusky line also provided the necessary link between the west end of the N&W at Columbus and the Nickel Plate's main line at Bellevue, Ohio. The distances from Columbus over the Sandusky line are 108 miles to Sandusky and about 90 miles to Bellevue. In the N&W Merger case, the hearing examiner considered the Sandusky line to be "the key to the Norfolk & Western's pro- posed system." 10 On September 21, 1961, the PRR's chief executive officer, while testifying in the Ct&O-Bd'O case, indicated that the PRR was willing to resume merger talks with NYC. He said that a merger of PRR and NYC would still make pos- sible the formation of balanced competitive systems within the Northeast sector of the country and that in time, there would probably be three systems, Perm Central, C&O-B&O, and the N&W group. He referred merger to savings which NYC and PRR in their 1957-58 study agreed were in the neighborhood of $100 million annually. " Facing the possibilities of a C&O-B&O coupling and a new N&W group and confronted with substantial net losses in the then current year 1961, NYC resumed merger negotiations with the PRR in late 1961. The result was the merger agreement approved by the Boards of Directors of the two companies • Norfolk and Western Ry. Co. Merger, 307 I.C.C. 401 (1959). • Erie R. Co. Merger, 312 I.C.C. 185 (1960). >° Norfolk & Western Ry. Co. and New York. C. & St. L. R. Co. Merger, 324 ICC 1, 83 (1964). » The C&O-B&O case, 317 ICC. 320 on January 12, 1962, and signed on the same day. The application for ICC approval was filed March 9, 1962. Then there followed the tortuous adminis- trative and court proceedings which finally resulted in the merger of Penn Central nearly six years later on February 1, 1968. In a little less than nine years — from the filing of the N&W-Virginian ap- plication on April 6, 1959 to the merger of PRR and NYC on February 1, 1968 — the Eastern rail system was almost completely realigned. The critical period of gestation appears to be the year 1962. A convenient date for reviewing the state of things at that time is April 1, 1962. The C&O-B&O control case was then awaiting the report of an ICC examiner. All the applications necessary for the new N&W system had been filed except the N&W-P&WV lease application* and it reached the Commission on August 21, 1962. The Penn Central proceed- ing was about to enter the hearing stage. The Government position was amor- phous as the merger movement progressed rapidly. On April 4, 1962, the ICC approved the acquisition of control by PRR of the Lehigh Valley through stock ownership. 12 The ferment of merger activity was generating wide interest in the numer- ous proposals for rail unifications not onl}- in the East but also in the South and the West. In the South, Seaboard Airline and Atlantic Coast Line railroads were processing their application for merger. 13 In the West, an examiner was con- ducting hearings on the proposed unification of the so-called Northern Lines serving the northern tier states between the Great Lakes and the Pacific Northwest. 14 On April 5, 1962, in his transportation message to the Congress, President Kenned}' referred to the major mergers proposed in recent months in the rail- road and airline industries. The President shortly appointed the Interagency Committee on Transport Mergers to develop general criteria applicable to rail and airline mergers for use by the Department of Justice in developing the Government's position on each merger application for presentation before the regulatory agencies. The Committee was composed of the Under Secretary of Commerce for Transportation as Chairman, the Chairman of the Council of Economic Advisers, the Assistant Attorney General in charge of the Antitrust Division of the Department of Justice, and the Assistant Secretary of Labor. The Committee issued its report stating general criteria in January 1963 while the Penn Central hearings were in progress. In June and July 1962, the Subcommittee on Antitrust and Monopoly of the Senate Committee on the Judiciary held hearings on a bill, the effect of which would have been to postpone until December 31, 1963 any railroad merger or control transaction involving more than $200 million in assets. 15 The bill would have applied to the proposed three systems in the East. No legis- lation resulted. The merger process in the East continued to move rapidly in the latter half of 1962 and in 1963. The extensive Penn Central hearings before two ICC examiners began on August 20, 1962, and there was great opposition, although much of it was expressed as conditional support. The N&W merger proceeding was progressing through its later stages almost without opposition. The C&O's proposed control of B&O had an examiner's approval on May 1, 1962 and was awaiting the Commission's decision. Throughout the Eastern unification cases, the ICC had before it petitions seeking consolidation of the several applications. The issue was first presented in C&O-B&O, the first of the major Eastern merger proceedings. 16 Several parties, including the Department of Justice, urged that the C&O-B&O pro- ceeding be consolidated with the Penn Central and N&W merger cases. In its » Pennsylvania R. Co.— Control— Lehigh Valley R. Co., 317 I.CC 139 (1962). u Seaboard Air Line R. Co.— Merger— Atlantic Coast Line, 320 I.CC. 122 (1963), finally aff'd per curiam sub nom., Florida East Coast Ry. Co. v. United States, 386 U.S. 544 (1967). » Great Northern Pacific & Burlington Lines, Inc.- -Mercer, etc.— Great Northern Ry. Co., 328 I.CC. 460 (1966), (approval denied), 331 I.CC 228 (1967) (approval granted), 331 I.CC 893 (1958) (conditions modified), afT'd sub nom., Northern Lines Merger Cases, 396 U.S. 491 (1970). » Hearings on S. 3097 before Subcom. on Rail Merger Legislation of Senate Committee on the. Judiciary, 87th Cong. , 2d. Sess. (1962). "Chesapeake* O. Ry. Co.— Control — Baltimore & O. R. Co.. 317 f.C.C. ZB1 (196?), aff'd per curiam sub nom. Brotherhood of Maintenance of Way Employees v. United States, 375 U.S. 216 (1963). 321 decision rendered December 17, 1962, the Commission refused to consolidate the proceedings or to withhold its determination of the C&O-B&O application. 17 It approved control by C&O of B&O through stock ownership subject to protec- tive conditions for labor and competing carriers. Among the points discussed by the Commission were "the poor financial condition of B&O", "that B&O's properties are in dire need of rehabilitation", "that B&O's financial condition will ultimately be strengthened as the result of the proposed modernization plan", and "the complete inability of B&O by itself to improve its financial position." 18 Three of the 11 ICC commissioners voted against the C&O-B&O approval. At the root of Commissioner Tucker's long dissenting opinion was the conten- tion that the Commission with unnecessary haste and without adequate inquiry was taking an irretrievable first step toward approval of a far-reaching realign- ment of the Eastern railroad S3~stem. 19 Reviewing the extensive evidence, Commissioner Tucker found a distinct probability of significant diversion of traffic from NYC to C&O-B&O as a result of approval of the new system. 20 The ICC's refusal to consolidate the C&O-B&O, Penn Central and N&W cases came to the courts on the appeal by the labor unions of the ICC's approval of the C&O-B&O control in 1963. Before the three judge district court, the Department of Justice strongly urged that the Commission failed to make adequate findings concerning the impact of the proposed C&O-B&O control upon other railroads in the East, upon the two pending Eastern merger pro- posals (N&W and Penn Central) and hence upon the future structure of the Eastern railroad industry. It argued that the Commission's finding that the N&W and PRR-NYC merger proposals were irrelevant to the C&O-B&O case, amounted to a failure to come to grips with the most significant issue of the proposed acquisition — the future structure of the Eastern railroad industry. 21 The labor unions made a similar contention. The court affirmed the Com- mission's approval. The unions then appealed to the Supreme Court. In their jurisdictional statements, they referred to the ICC's "closed mind" and attacked its refusal to consolidate the interrelated applications. They emphasized that the outcome of the case was of vital importance in the reshaping of the entire railroad system in the Eastern part of the country. On motion of the Commission and C&O-B&O, the Supreme Court on December 9, 1963 affirmed the decision of the district court dismissing the appeal from the Commission's order of ap- proval. 22 The consolidation issue remained throughout the Eastern merger pro- ceedings. 23 To be sure, the consolidation of the cases for hearing appeared neither feasible nor necessary. The Penn Central applications had 128 days of hearing over the period August 20, 1962 through October 2, 1963 in 18 cities in nine states extending from Boston to St. Louis. A huge record of oral and written testimony and exhibits was made. More than 200 parties intervened initially, and these included states and their subdivisions, rail and other for- hire carriers, shippers and trade associations, labor organizations, and the Department of Justice. At the conclusion of the hearings, the protests against the merger were extensive. Among the most aggressive protestants were the labor interests supported by the Department of Justice although it offered no evidence in the proceeding. On the day before the hearings ended, October 1, 1963, an assistant attor- ney general of the United States presented a prepared statement of opposition to the proposed merger. He also stated that the United States would not oppose the N&W-NKP-Wabash unification applications then in their final " Id. at 263-66. » Id. at 266, 275, 279. » Id. at 296, 318-26. » Id. at 326. 21 See brief for United States to Federal district court for Kastern District of Michigan in Brotherhood of Maintenance of Way Employees v. United States, Civil Action No. 23467 (April 1963), 221 F. Supp. 19 (E.D. Mich. 1964). » Brotherhood of Maintenance of Way Employees v. United States, 375 U.S. 216 (1963). 23 Petitions for consolidation of then pending Eastern unification cases were filed as late as April 1967 by the Reading Railroad and May 1967 by the Trustees of Central Railroad of New Jersey. Both railroads are now in § 77 reorganizations. 322 stages before the Commission, or the C&O-B&O control which the labor in- terests were in the course of appealing to the Supreme Court. 24 Throughout 1963, the managements of PRR and NYC were facing serious opposition to the merger and probably long and costly delays. PRR's chief executive officer, James M. Symes, was then beyond the retirement age of 65, and his replacement was under consideration. For the first time in over a century, the Board of Directors of PRR elected as its head an executive who had not come up through the PRR ranks. The new chairman and chief execu- tive officer, Stuart T. Saunders, took office October 1, 1963. As president of N&W in the previous five years, Saunders had seen the merger of N&W and the Virginian in 1959, and had worked out the then pending N&W-NKP-Wabash unification. It was virtually unopposed and headed for ICC approval. In less than one year after Saunders took over as PRR's chief executive officer, the extensive opposition to the Penn Central merger was greatly reduced. States and their subdivisions withdrew or modified their opposition. With the joinder of NYC's President Perlman, Saunders worked with the protesting labor unions. On May 20, 1964, PRR and NYC entered into the so-called attrition agreement with 17 labor organizations. This agree- ment was later extended to cover a total of 23 unions. With major labor opposi- tion thus satisfied, the merger partners next neutralized the Department of Justice objections, apparently at the price of agreeing to include the New Haven in the proposed merger. 25 However, the opposition of Milton J. Shapp, now Governor of Pennsylvania, and a labor group designated the Pennsylvania Labor Interests, continued throughout the Penn Central proceedings. Shortly after the May 20, 1964 agreement between PRR/NYC and the labor unions, the ICC on June 24, 1964 approved the N&W unification in the N&W Merger case. 25 Two conditions of approval require comment here: First, the Commission provided that for a period of five years, it would retain jurisdiction to permit the filing of petitions by EL, D&H and B&M for inclusion in the N&W system. 27 EL originally opposed the applications but then changed to support when it obtained an agreement from N&W that upon approval of the N&W-NKP merger, N&W would enter into negotiations with LL in an attempt to agree upon some form of affiliation with EL. In its decision, the Commission, in effect, extended the benefits of this agreement to D&H and B&M. Second, as stated above, the PRR held substantial stock ownership in N&W and Wabash. In the N &W Merger decision, the Commission required that the Pennsylvania system divest itself of its then or thereafter acquired holdings of stock of N&W and Wabash within ten years after the N&W-NKP- Wabash unification and that all management relationships between PRR and N&W be severed within 60 days after the N&W unification. 28 If the PRR failed to agree to the divesture condition, then the proposed N&W-NKP- Wabash merger could not be consummated. Pending divestiture, PRR was required to put the voting rights of the N&W stock in three independent trustees. The Wabash stock was not required to be trusteed. 29 Thus PRR for the second time was in a position to determine the structure of railroads in the East. As stated above, its assent was essential to the original proposal for the new N&W system as evidenced, for example, by its willingness to sell to the N&W the Sandusky line, a necessary link for efficient operation of the new system. PRR faced the critical uncertainty: would its proposed merger with NYC be approved? The record in the Penn Central merger case was closed, and with labor and other opposition diminishing in force or disappearing, the prospects of approval were improving. Moreover, the financial and tax features of its divestment appeared to present no insur- mountable barrier. PRR assented to the divestiture condition. The new N&W system began operation on October 15, 1964. M Penn Central transcript of testimony, Oct. 1, 1963. pages 19,416ff . 25 See the later discussion at page 328 concerning the PRR/NYC meetings with officials of the Department of Justice in 1964 and 1965. » Norfolk & Western Ry. Co. and New York, C. W Q4 i I fin r,pt ° f Perlmans testimony in Penn Central case, pp. 980-1014 and especially pp. 981-83. 326 successful over the years, but at that time in a period of uncertain transition. With PRR facing declining profits and frequent losses from its railroad opera- tions, he undertook numerous courses of action to improve the situation. Illustrative of the efforts to improve or retain revenues, on the one hand, and, on the other, to reduce expenses are the following : In 1952, with the cooperation of General Motors, Symes led PRR into an extensive program for the development of trailer-on-flatcar (piggyback) serv- ice. To stem the decline of coal traffic, an essential segment of PRR's business, fields in Pennsylvania among its extensive holdings were marked for develop- ment. PRR also undertook a plan of plant improvement which included, for example, the construction of a new $30 million facility at Conway, Pa., near Pittsburgh. Centrally located on the PRR system, Conway at completion was the largest classification yard in the East. To bring expenses in line, Symes ordered strict austerity in the operations, a measure familiar to the railroad since the Depression of the 1930 s during which PRR operated without a single loss year. Work began on a system of responsibility accounting which permitted increased autonomy to the regions but held them strictly accountable for results. By the time of the merger in 1968, the system was a settled part of the PRR's procedure. Symes recognized the signs of weakness, and they continued into the late 1950's. PRR had long invested in areas generally related in some way to trans- portation and was considered one of the richest railroads of the Nation. It held as much as 44 percent of the outstanding voting stock of N&W and was the owner of almost all the stock of the Wabash. In close touch with PRR's pres- tigious Board of Directors and particularly its Executive Committee, Symes reviewed the Eastern railroad situation and determined a course of action without a formal study of the long and short range prospects of the Eastern railroads as a group, PRR's operations as a railroad, or its unification with various merger partners. In the 1930's, as a member of the staff of the Federal Coordinator of Transportation, he had participated in the studies leading up to the so-called Prince Plan of unifying the railroads in the United States into a limited number of systems. Later he also directed a study looking to coordina- tion of rail terminal operations in the complex Port of New York area. Numerous options were available to PRR. Its unification with B&O had frequently been mentioned. N&W and Wabash were regarded as members of the PRR family. In the 1950-59 period, the prices of their common stock were in the range of UK to 30% for PRR and 39% to 108 for N&W. Concentrated in the Pocahontas coal fields, N&W, the crown jewel of PRR's numerous invest- ments, was highly profitable and efficiently operated. The Wabash appeared disposable; it added little to the PRR system except for the lines extending west of the Mississippi to Kansas Cit} r , Omaha and Des Moines. The one merger rarely if ever considered was joining the arch rivals, PRR and NYC. Symes believed that this union had huge potential for savings. West of New York City to the Pittsburgh and Buffalo areas, though their lines were roughlj' parallel but miles apart, they served different areas, PRR being dominant in the Pennsylvania-New Jersey-Maryland sector and NYC in the populous New York state area. Both were highlr competitive in the Pittsburgh- Youngstown-Cleveland manufacturing corridor. West of Pittsburgh and west of Buffalo, the two railroads reached substantially the same major markets such as Chicago, Detroit, Cincinnati and St. Louis. With the approval of the PRR Board of Directors, in the fall of 1957, Symes first approached Robert R. Young, then chairman of NYC's Board, and shortly thereafter discussed the subject with Young and Perlman. Merger studies were initiated in November 1957 and are said to have then indicated annual savings of about $100 million. However, the parties were unable to agree on an exchange ratio for the PRR and NYC stock and were considering whether outside appraisers should be brought in. Negotiations were terminated in January 1959. In the ensuing months, NYC turned its effort in other directions. These culminated in its intervention in the C&O-B&O case in June 1960 and in the later filing of its applications to acquire control of the B&O jointly with C&O. N YC had engaged in a contest with C&O for purchase of B&O stock. N YC 327 interests ultimately held more than 20 percent of the B&O's voting stock. The C&O had assents from holders of over 60 percent of the total B&O shares. 50 The ICC consolidated the NYC applications with the C&O applications filed a few months before, and the combined cases were being heard in 1961. Symes, still hopeful of a PRR-NYC merger, testified in September 1961 in the C&O-B&O-N YC hearings in rebuttal to Perlman's testimony concerning a balanced competitive system in the East. Asked whether NYC would be left out in the cold in the Eastern merger picture and would eventually be unable to survive, Symes commented that the merger door was not closed if NYC wanted to reopen it. In fact, Symes helped to open the door again by arranging meetings between the chief executives of NYC and C&O. Late in 1961, NYC agreed to sell its B&O holdings to C&O, withdrew from the C&O-B&O case, 60a and resumed negotiations with the PRR. These further negotiations resulted in the PRR-NYC joint agreement of merger which was dated January 12, 1962 and was signed by all directors of PRR and NYC including Symes, Perlman and those directors constituting the two three-man merger committees of each board. The merger application, filed March 9, 1962, encountered many difficulties. Throughout the merger hearings extending from August 20, 1962 to October 2, 1963, PRR and NYC as applicants steadfastly adhered to two points of par- ticular significance later in the proceedings. They were agreeable to the impo- sition of the usual provisions prescribed by the ICC for the protection of labor. Thev opposed any condition requiring the inclusion of New Haven. Symes testified that if the ICC attached such a condition to its approval, he would submit the condition to PRR's Board of Directors for decision, but would recommend against acceptance of merger approval subject to this condition. While the C&O-B&O-N YC matter was being resolved, a second new s}*stem was being formed around N&W. Symes and three other PRR repre- sentatives were on the N&W board. As first announced, the N&W plan included onh T merger with the NKP. Symes has stated that the PRR then insisted on the inclusion of the Wabash as a condition for PRR's voting of its stock in favor of the N&W-NKP unification. The so-called Sandusky line between Columbus and Sandusky, Ohio, was then owned by a PRR subsidiary. That line was necessary to join the lines of N&W and NKP; the connection between N&W and Wabash would be via the Sandusky line and the NKP. As finally presented to the ICC in the applications initially filed March 17, 1961, the N&W proposal included both NKP by merger and Wabash by pur- chase of stock for PRR or b}* lease and, perhaps of equal importance, the pur- chase of the Sandusky line from the PRR subsidiary. The purchase price approved for the Sandusky line was $27 million or about $2 million less than $29.2 million representing reproduction costs less depreciation. The N&W-NKP- Wabash applications, as originally filed, proceeded to hearing in 1963, but there were complications. Two relatively short railroads, the P&WV operating in the Pittsburgh district and the AC&Y running west from Akron, Ohio, were primarily overhead carriers hauling freight between their interchanges with connecting railroads. They depended on their con- nections with NKP for substantial traffic. Negotiations finally resulted in agree- ments for their inclusion in the proposed N&W system, applications were filed, and the procedure rapidly completed. In fact, the new N&W System as sub- mitted was approved by the ICC on June 24, 1964, several months before the last da} T of hearing on the PC applications in September 1964. By that time, important changes in management had occurred. Saunders became president of N&W in 1958. The N&W-Virginian merger in 1959 was 50 C&O-B&O case, 317 I.C.C. at 267. 284 (1962). 50a B.v order dated January 29, 1962, the ICC authorized NYC to withdraw from the case and dismissed its application to control B&O. 317 I.C.C. at 262. During- the weekend of February 17-18. 1962, Messrs. Tuohy (President of C&O), Perlman. Saunders (then President of X&W) and Symes met in Palm Beach, Fla. to discuss various matters pertaining to the Eastern merger situation. In a memorandum dated February 20, 1962. Symes recorded that the big question considered at the weekend meeting was the XYC and Alleghany Corporation holdings of Baltimore and Ohio common stock (about 560,000 shares or slightly in excess of 20 percent of the total outstanding) on their books at approximately $24 million. These holdings. If transferred to C&O, would enable C&O to hold just a little over 80 percent and receive the benefit of tax savings through a consolidated tax state- ment. After many arguments on the subject over several days, Symes stated it was finally agreed (subject to approval by the boards of C&O, NYC and Alleghany) that XYC and Alleghany would dispose of their B&O holdings to C&O at the cost of the B&O stock to them (approximately ?24 million). 328 finalized in his administration as was the building of the N&W system in the expanded form approved in 1964. The details of the building included critical matters such as the several attrition agreements made with the labor unions which assured no substantial labor opposition, the inclusion arrangements with EL under which EL withdrew its opposition and supported the applications, and the inclusion of P&WV and AC&Y described above. Saunders was party to the 1962 meetings leading to the agreement terminating the C&O-NYC fight over B&O. He was, in short, experienced in the merger game. Highly recommended by Symes, Saunders was elected chairman of the board and chief executive officer of PRE, and took office on October 1, 1963. On the same day, at the ICC hearings, the Department of Justice presented a statement in opposition to the Penn Central merger. Hearings on the case were completed the following day, October 2, and there was serious opposition from many sectors. The prospect of success was bleak. Nearly 18 months later, on March 29, 1965, the hearing examiners rec- ommended approval of the Penn Central merger. By that time, a superbly planned and executed campaign led by Saunders and Perlman had reached most of the parties protesting the merger. Important opposition became inactive, was withdrawn or was modified so as to seek approval conditions. The states of Connecticut, Massachusetts, Rhode Island and New York, and certain labor groups advocated inclusion of the New Haven's passenger as well as its freight service; the Commonwealth of Pennsylvania did not oppose, but sought treatment of secondary adverse results of the merger; and communities in Pennsylvania such as Pittsburgh, Philadelphia, New Castle and Ambridge, no longer objected to the merger. The missionary work sometimes had trouble- some repercussions; Saunders' address on December 16, 1965, at New Castle, Pa., for example, upon which protester Shapp relied in his futile attempt to reopen the merger case. In effect, the campaign substantially eliminated state and community protests. Of equal and greater importance were the measures taken to placate the labor opposition and to change the Department of Justice's position from opposition to support. Saunders as N&W's president had reached an accord with labor in the N&W Merger case. Now he as PRR's chairman and Perlman as NYC president undertook negotiations with the major labor groups. On May 20, 1964 and thereafter, PRR and NYC entered into the so-called Luna- Saunders attrition agreement with 23 unions representing 77,000 employees or about 75 percent of applicants' labor force. The agreement ended national labor's opposition to the merger. Though closely allied for several years, Saunders and Symes were not close after Saunders became the PRR's chief executive officer on October 1, 1963. Symes continued as a member of the board of directors for two periods of time prior to the merger. He did not approve of the labor attrition agreement nor of the inclusion of the New Haven. He is said to have opposed both at meetings of the board. Perlman, the other architect of the merger, had also been adamantly opposed to the New Haven inclusion. Yet on June 1, 1964, NYC joined in applicants' opening brief stating their willingness to enter into a contract to operate the New Haven's freight service. The Department of Justice in its June 1, 1964 brief continued to oppose the merger on its merits. As it turned out, its opposition and the New Haven problem were handled together: 61 A conference to discuss the Government's opposition to the merger was arranged for August 24, 1964, in the office of Attorney General Robert F. Kennedy in Washington. Saunders, Perlman and George Leighty, Chairman of the Railway Labor Executives' Association, met with Mr. Kennedy, Nicholas deB. Katzenbach, Deputy Attorney General, and William H. Orrick, Jr., Assistant Attorney General in charge of the antitrust division. Saunders and Perlman explained in detail why the Penn Central merger was necessary to the survival of their railroads. They reasserted their previously asserted » The following discussion of conferences between PRR, NYC and the Department of Justice Is based on Mr. Katz- enbach's letter of Sept. 4, 1964, to Saunders to which Is attached Mr. Robert Kennedy's memorandum of Sept. 3, 1964; Saunders' reply of Sept. 9, 1964 to Katzenbach, Saunders letters of Jan. 14, 1965 to Katzenbach, of Jan. 14, 1965 to Mr. Or- rick, and of Apr. 22, 1965 to Katzenbach, see Appendix D, Exhibit 67, p. 714. 329 willingness to cooperate with the Department or the ICC in assuring that transportation services would continue to be rendered by the New Haven and that its services would not be impaired by the Penn Central merger. Saunders referred to the ICC's decision of June 24, 1964, approving the pro- posed N&W merger subject to divestiture by PRR of its N&W stock. He indicated that the Government's attitude on the pending Penn Central merger would have an influence on the PRR's important decision as to divestiture. After considerable discussion, the Attorney General pointed out that his further tenure in office would be quite brief and that he could make no commit- ment binding his successor. Circumstances, he said, made it inappropriate to take any action at that time contrary to the position of opposition stated in the Department's June 1964 brief to the ICC. On the other hand, Mr. Kennedy said that he would, by memorandum, inform his successor of his recommendation along the following line: If the hearing examiners' decision should be favorable to the merger and the merger applicants had by that time formulated terms for the New Haven's inclusion satisfactory to the New Haven's trustees and the District Court, he would recommend that the Department discontinue its opposition to the Penn Central merger unless circumstances had materially changed. Saunders indicated that this information would be helpful to him and the PRR board of directors in reaching a decision on the divestiture question. On September 4, 1964, Mr. Katzenbach, as Acting Attorney General, transmitted the promised Kennedy memorandum to Saunders and expressed agreement with Mr. Kennedy's conclusions. A few days later, in a clarifying letter to Mr. Katzenbach, Saunders referred to an agreement that the merger applicants would diligently seek to find a fair and reasonable basis to include the New Haven in the proposed Penn Central system. As he understood the situation, inclusion was not to be an absolute condition to withdrawal of the Department's opposition to the merger, and the inclusion action did not neces- sarily have to be taken prior to the examiners' report. On January 8, 1965, Saunders and Perlman again met in the Attorney General's office with Attorney General Katzenbach and Mr. Orrick and in- formed them about the then pending negotiations with the New Haven. Mr. Katzenbach reconfirmed the Government's position stated in the September 1964 correspondence. On April 19, 1965, after issuance of the examiners' proposed report approving the merger, the}' again met and reviewed the current status. Several days later, on April 22, 1965, Saunders wrote the Attorney General about a memorandum of understanding between the merger applicants and the NH trustees for the inclusion of the New Haven in Penn Central and outlined how, in their NH agreements and negotiations, the applicants were complying with the Kennedy memorandum with which Mr. Katzenbach was in agreement. Based on the understanding reached with the Department, Saunders said, the PRR had agreed to divest itself of its N&W and Wabash stock as required by the approval conditions in the NdcW Merger case. Pivotal figures in the merger picture were thus turning the view from defeat to success. ICC Commissioner Tucker, a New Englander with a natural interest in the New Haven, reflected the change. He dissented at length from the Commission's authorization of the C&O-B&O control in 1962 and voted against the N&W merger approval in 1964. In the Penn Central decision in 1966, he concurred without qualification in the approval of the merger. He spoke of the risk of leaving PRR and NYC separately to face the powerful competition of the two new systems, C&O-B&O and N&W. In his judgment, the New Haven Railroad problem had to be given very substantial weight, and the proposed merger presented an opportunit}- to assist in the revitalization of the New Haven's rail operations. 52 Pivotal figures in the two merger partners had persevered. The work of accommodation was largely done by the time of the ICC's initial decision on April 6, 1966. The work of physical planning for merger, discussed later in this report, had the benefit of time provided by the delays of litigation. The con- " Initial Penn Central decision, 327 I.C.C. at M8-51. 330 troversies subsequent to the initial decision related principally to the conditions of approval reviewed in the next subsection. The first appeal to the Supreme Court in 1967 reflected little opposition to the merger on the merits. In tho second appeal approving the merger, the Court in January 1908 noted tho general accord among tho parties before it that the merger was in tho public interest. Among those listed by the Court as urging immediate consummation of the merger were tho ICC, the Department of Justice, tho Railway Labor Executives Association, six Eastern states and tho New Haven trustees. 53 The Conditions of Approval Imposed by the ICC The Interstate Commerce Commission attached numerous conditions to its approval of the Penn Central merger. Viewing the surge of railroad unifica- tions in the 1960-69 decade, many observers evaluate the ICC's role as passive. It approved all the major unifications presented for its approval. Its main con- cern appeared to be the protection or inclusion of other railroads in tho terri- tories involved, and such was its approach in tho Penn Central case. INCLUSION OF OTHER RAILROADS In the initial proceedings, New Haven, Erie-Lackawanna, Delaware and Hudson, Boston and Maine, New York, Susquehanna and Western (NYS&W), and Brooklyn Eastern District Terminal (BEDT) sought inclusion in Penn Central. EL, D&H and B&M were ultimate!}- designated for the N&W system. EL becamo a separate part of that system on April 1, 1908. D&H came into the N&W family in July 1908. The B&M rejected inclusion in N&W in May 1969 and one year later went into reorganization under § 77 of the Bankruptcy Act where it is still continuing. BEDT, a terminal carrier connecting with all railroads serving the port of New York, operates rail and car float facilities in the port area. It asserted prospective diversion of traffic growing out of the PRR's ownership of the Long Island Railroad. BEDT suffered annual deficits averaging about $90,000 on revenues of $2.1 million in the years 1901-03. The Examiners recommended denial of immediate inclusion of BEDT. The Long Island was sold by PRR to the state of New York prior to the Commission's initial report. Nonetheless the Commission made provisions for the inclusion of BEDT in Penn Central, BEDT has thus far made no proposal, and the matter is dormant. 5 * NYS&W, a railroad operating 70 miles of track all within New Jersey, sought inclusion in PC by petition filed October 12, 1962. It was incurring annual operating deficits in excess of $300,000, most of which resulted from commuter service. In the initial decision, the Commission required inclusion of NYS&W under terms and conditions to be agreed upon by the parties and, failing agreement, to be fixed by the Commission. The parties failed to reach an agreement, but nothing further has transpired. 55 Inclusion of the insolvent New Haven was crucial to the approval of the Penn Central merger by the ICC. The inclusion appears also to be a major factor in the insolvency of the merged company. The NH trustees presented their petition for inclusion on June 26, 1962, and thereafter stood firm until NH was included in PC on December 31, 1968. 66 New Haven had been in reorganization since early 1961. At the PC hearings, it did not ask for inclusion of its passenger service and presented no evidence of adverse effect on that service. In the five year period 1959-63, its passenger deficit ranged from a low of $8.6 million in 1963 to a high of $13.3 million in 1960. On the freight side, the high and low in that period were net income of $3.5 million in 1959 and deficit of $7.2 million in 1961, respectively. In their Penn Central report, the examiners recommended inclusion of New Haven freight service only, 57 but in its several decisions, the Commission " Penn Central Merger case, 389 U.S. at 19S. " Initial Penn Central decision, 327 I.C.C. at 488, 534, 552, 889, 1062. " W. at 552, 903. » The New Haven situation is fully reviewed in New r Haven Inclusion Cases, 399 U.S. 392 (1970). " Id. at 842-70, 922-23. 331 not only required unlimited inclusion but also made provisions to keep NH alive pending inclusion. 58 The initial decision relied on the Commission's contemporary decision authorizing NH to discontinue about 50 percent of its long haul passenger schedules. This action, the Commission said, was only the beginning toward sound restructuring of NH. In fact, New Haven did not discontinue the trains in question as authorized by the Commission. Tottering on the edge of total cessation of operations, New Haven managed to survive until inclusion. The dispute finally was reduced to the price to be paid by PC for the NH properties. The inclusion became a two-step affair when on November 25, 1968, under prodding of the reorganization court, the ICC ordered Penn Central to take over the New Haven properties by January 1, 1969. 59 PC took over December 31, 1968, or 11 months after merger of PRR and NYC. The net railway operating deficit of the New Haven in 1968 was $24.2 million. The final word on the NH price came from the Supreme Court on June 29, 1970, eight days after PC had filed its § 77 petition for reorganization. 60 The ICC had set a price of $140.6 million which the reorganization court increased by $28. 9 million. The Supreme Court affirmed, expressly leaving open the question whether the financial obligations discussed in its opinion were subject to modification in or because of the PC § 77 proceedings. 61 PROTECTION OF OTHER RAILROADS In the Penn Central proceedings, the ICC imposed numerous conditions to protect competitive railroads. These included the standard DT&I routing and traffic conditions which limit the merged company's ability to discriminate against connecting lines with respect to routes, gateways, schedules and the movement of traffic. 62 It approved and prescribed, as a condition, the terms of an agreement between PRR, P&LE and WM relating to routes, rates and service between the Eastern seaboard and the Midwest through the Pittsburgh gateway. 63 The Commission also required PC to accept an agreement between NYC, NYS&W, and Seatrain Lines, a water common carrier, relating to certain rail-water routes. 64 Unique protective conditions, never before used, were prescribed for the protection of EL, D&H and B&M pending decision on their petitions for inclusion in Penn Central or the N&W system. These provisions, commonly called the Appendix G conditions, were designed to maintain the status quo of traffic patterns of PRR, NYC and the three protected roads and to set up bases on which PC would indemnify the protected carriers against certain rev- enue losses after the PC merger and pending their inclusion in PC or in the N&W system where they preferred to be. The Appendix G conditions were extensively litigated. They evinced the Commission's concern for protection of the smaller lines and were reviewed in the Supreme Court's two opinions in the Penn Central Merger case. LABOR PROTECTIVE PROVISIONS The Interstate Commerce Act makes specific provision for the protection of employees involved in railroad unifications. The opening part of this report summarizes §§ 5(2)(c) and (f) of the Act relating to labor protection. The ICC recently argued that the "notwithstanding" last sentence of § 5(2)(f) 65 relieved it of any duty to review the adequacy of protective provisions contained in a collective bargaining agreement and that they were not accorded protection by an ICC order approving a unification, even though it gave its authorization "subject to such agreements." In the recent Nemitz case, 66 the Supreme Court "Id. at 524-26; Pennsylvania R. Co.— Merger— New York Central R. Co., 331 I.C.C. 643, 699-721 (1967) (second supplemental report). " Pennsylvania R. Co.— Merger— New York Central R. Co., 334 I.C.C. 25 (1968) (fourth supplemental report). •° New Haven Inclusion Cases, 339 U.S. 392 (1970). 41 Id. at 398, footnote. « Initial Penn Central decision, 327 I.C.C. at 541, 564-65, 835-42, 1041; Detroit, T. & I. R. Co., 275 I.C.C. 455 (1950). « Initial Penn Central decision, 327 I.C.C. at 537, 563-64, 828-31, 938-39, 1041-42. •« Id. at 552, 831-32. • 5 The last sentence of § 5(2) (f) provides: "Notwithstanding any othei provisions of this Act, an agreement pertaining to the protection of the interests of said employees may hereafter be eiltered into by any carrier or carriers by railroad and the duly authorized representative or representatives of its or their employees." " Norfolk & Western Ry. Co. v. Nemitz, 82 S. Ct. 185 (1971). 74-924 O - 73 - 23 332 rejected the argument, It found that the "notwithstanding" proviso provides the machinery for a premerger collective agreement and thus supplies the minimum measure of fairness required under §5(2)(f). Under ICA labor provisions, the Commission has prescribed several types of protective conditions. At the hearings, applicants proposed the imposition of modified New Orleans conditions. 67 In their initial brief filed June 1, 1964, they adhered to the modified New Orleans conditions, but referred to the agreement reached by PER. NYC and various unions affiliated with the Kail Labor Executives Association on May -•', 1!M>4. Applicants believed that the agreement did not require the Commission's approval. The Commission re- opened the case for further hearing and on September 1(5, 1964, heard testi- mony concerning the labor protective contract. By the time of the Commission's first decision of April 7, 1966, the merger partners were willing to make the terms of the 1964 labor contract available to all employees required to be protected including those not represented by unions signing the protective agreement. 68 By reason of the last sentence of §5(2)(f), the Commission found that it could make no requirement for the protection of employees covered by that agreement. However, stating that the benefits of the protective conditions agreed to were greater than any theretofore required of any § 5 applicant, the Commission adopted the agreement as a condition of approval and required Perm Central to obtain assents to the conditions from employees not represented by the signatory unions. 69 The Commission later characterized the agreement as "providing for employee benefits far in excess of what had ever been required by this Commission and superior to benefits available in industry generally." 70 Opinions differ about the wisdom of the May 20, 1964 agreement and its attrition provisions. 71 Uniform application of its provisions to all employees, improved employee morale and flexibility in work assignment are said to be valuable advantages of the agreement. Furthermore, applicants estimated the cost of protection under the agreement to be $78.2 million, all payable within eight years after merger, as against a total cost of $83.0 million under the modified New Orleans conditions. RELATIONSHIP TO OTHER RAILROADS In Subsections (1) and (3) above, the Commission's treatment of the in- clusion and protection of other railroads was reviewed. A related protective condition provided for application by D&H for trackage rights over Penn Central between Hagerstown, Md. and Wilkes Barre, Pa. These rights would give D&H a direct connection to the N&W system and make possible competi- tive service to and from the South. 72 Throughout the Eastern merger cases, the ICC followed the case-by-case method of decision. Occasionally, it came upon a troublesome matter growing out of this approach. The Lehigh Valley Railroad operates between the New York City area and the Buffalo gateway through Scranton, Pa. It was controlled by PRR through stock ownership and depended on PRR support for traffic. The examiners recognized and discussed LV's difficult position, 73 and the initial ICC decision provided for negotiations leading to LV's inclusion in either the C&O-B&O or the N&W system. 74 During the merger hearings, Penn Central expressed willingness to sell its interest in IV to C&O-B&O, but C&O showed no inclination to discuss the matter. The Commission in its initial decision directed Penn Central to retain its interest in IV and to render such support to LV as the Commission might determine; and if IV were not included in C&O-B&O or N&W, the Commission might direct its inclusion in PC if found to be in the public interest. LV's fortunes depended on Penn Central. Accord- ingly, it is presently in reorganization under S " of the Bankruptcy Act. •' New Or.eans Passenger Terminal Case, 282 I.C.C. 271 (1952). •« Initial Penn Central decision, 327 I.C.C. at 543. •• Id. at 544-45. 70 Penn Central Merger ease on reconsideration, 328 I.C.C. at 313. 71 Initial Penn Central decision, 327 I.C.C. at 544-45, 686-87. '» Id. at 527, 924-25, on reconsideration, 328 I.C.C. at 322-23. "Id. at 327I.CC at 940-42. » Id. at 544-55. 333 Finally, as to ICC approval conditions, the PRR's strategic position in the Eastern railroad structure was recognized. To fill out the divestiture pro- gram, the Commission required that, except as provided in the N&W Merger case, PC dispose of any interest it may have in any railroad corporation in the C&O-B&O and N&W systems and prohibited the acquisition of any such interest in the future. 75 OTHER CONDITIONS Several conditions of approval prescribed by the Commission related to the protection of rail service at specific cities. PC is required to enter into reciprocal switching arrangements at Pittsburgh with any rail carrier desiring such an arrangement. 76 The merged company is also prohibited from adjusting schedules or service or otherwise prejudicing the Port of Erie, Pa. 77 Finally, several corporate and reporting matters were treated. The Com- mission directed PC to simplify its complex intercorporate structure and to submit plans relating to the motor carrier operations of certain subsidiaries. 78 Merger Meant Consolidation On the whole the Pennsylvania Railroad was larger than the New York Central. In 1963 when evidence was supplied for the hearings of the Interstate Commerce Commission, the Pennsylvania Railroad had 62,905 employees while the New York Central had 48,527; its railway operating revenue was $840,111,654 and assets were $2.3 billion to the New "York Central's figures of $623,332,762 and $1.8 billion. But in other measures of size the two railroads were equal. The Pennsylvania Railroad had 9,706 miles of track while the New York Central had 9,927. From considerations of size the merger would be one between more or less equal partners. The two railroads were of sufficiently comparable size that one would not clearly dominate the other. The geographical territory now served by the Penn Central is roughly the Northeast quarter of the United States. The bulk of its operations are bounded on the south by a line running from St. Louis to Baltimore and on the west by a line running from St. Louis to Chicago. The Great Lakes form its northern boundary from Chicago to Buffalo; a line from Buffalo to Boston (broken by a principal route north to Montreal) completes its northern boundary. About half of the Nation's population lives in the territory and 55 percent of its man- ufacturing plan's are located there. The territory served today by the Penn Central was largely the same territory served by both the New York Central and the Pennsylvania Railroad prior to the merger. To be sure, the Pennsylvania Railroad had eastern Penn- sylvania, New Jersey, Delaware and Maryland free from the competition of New York Central lines. The New York Central was similarly free of the Pennsylvania Railroad in Massachusetts, eastern and upstate New York. Both railroads served the major cities of New York, Chicago, Detroit (although the Pennsylvania's representation there was small), Cleveland, St. Louis, Indian- apolis, Cincinnati, and Buffalo. West of the Alleghenies the routes of the two roads largely paralleled or duplicated each other. Both had a tangled network covering Indiana and Ohio. However, there was an important difference in their main lines for east- west traffic. The New York Central funnel ed its traffic along the water-level route from Albany to Cleveland. From Cleveland main lines ran southwest to St. Louis and northwest to Chicago. Another important line connected Detroit with Columbus. The water-level route offered the advantage of gentle grade and curves. The Pennsylvania was forced to go over the more severe grades and curves through the Alleghenies on its principal route from Pittsburgh to Philadelphia. The rest of its principal route ran from Philadelphia north to New York and South to Washington, D.C. At the other end, major lines ran from Pittsburgh west to Chicago and southwest to St. Louis. " Id. at 553-54. '« Id. at 547, 554, 939. " Id. at 547, 555, 945. '• Id. at 651. 334 The traffic carried by the two roads was similar. In L963, 89 percent of the total tonnage of each road was composed of the products of mines and manu- factures and miscellaneous commodities. Products of mines produced •!'.) per- cent of the Pennsylvania's revenues and 27 percent of the New York Central's; manufactures and miscellaneous commodities produced 58 percent for each. Ag- riculture ranked third for both roads. These patterns had remained constant during the preceding decade. Although there were differences in patterns with- in the general groupings, th< two railroads relied largely on the same type of traffic. Tims, their operations faced similar demands. The identity of geographic territory, parallel route structure and similarity of size and traffic patterns meant that the benefits of merger had to come from consolidation of duplicating operations. The New York Central and Pennsyl- vania Railroads brought roughly the same things to the merger. Neither could offer the other any particular advantages in terms of complementary seasonal peaks in traffic, new territory, or complementary route structure. The singular benefit of the merger was the opportunity to consolidate much of their east-west traffic over New York Central's water-level route. Although slightly longer in some cases then the Pennsylvania's route, it permitted bypassing the Alle- ghenies' mountainous grades and curves. Principally, the merger would permit elimination of duplicating operations and facilities and would allow consolida- dation of traffic into higher density patterns that could be handled more effi- ciently by the railroad. What Consolidation Involved Geography, size and traffic combined to require that the New York Central- Pennsylvania Railroad merger be a consolidation of facilities and operations and this was, in fact, the ground upon which the merger was justified and merger savings predicated. To understand the effect on the merged companies of their manifold differences in character — history, point of view, procedures and policy — one must examine what was involved in bringing about a consolidation. First, as a matter of terminology, let us use "merger" to indicate legal and financial aspects of the combination of the railroads and "consolidation" to indicate the organizational aspects. Thus, the merger was made when corporate officials signed the necessary papers on February 1, 1968. Consolidation, on the other hand, involved reorganization of employees into new work patterns; it also involved a change in the physical flow of traffic over the rails. Consolidation required people to perform their functions differently or to perform new func- tions differently or to perform new functions. Merger need not require such changes. For example, the C&O and B&O merged, but they did not consolidate to any great extent; by and large, they were operated as before the merger. Not so with the Penn Central. It was contemplated to be a complete con- solidation of the two predecessor companies. Main line traffic was to be rerouted in order to achieve a pattern of maximum concentration of freight for the great- est distances over the New York Central's routes. Traffic over the lines of the former Pennsylvania Railroad was to substantially decrease. The degree of con- solidation is indicated by the magnitude of traffic rerouting — it was estimated during the merger hearings that train-miles over the Pennsylvania's routes would decrease by one-third. 78a This amount of traffic rerouting required substantial addition to the capacity of certain terminal facilities; in fact, the hearing examiners believed that construction of a yard at Selkirk was "the single most significant change in terminal operations" and "the key to the merger program." 78b Inevitably, a substantial relocation of employees would be required to handle the new traffic patterns. Saunders was proud of the labor agreement he had negotiated, because, while it might have been expensive in terms of employee protection, it permitted the railroad to relocate employees. In the actual process of consolidation the Penn Central attempted where possible to mingle former New York Central and Pennsylvania Railroad 78a Interstate Commerce Commission, Finance Docket No. 21989, Penn Central Merger, Hearing Examiners' Report p. 118 (1965). nb Id. at p. 122. 335 employees. They were placed side-by-side and frequently superior-subordinate relationships were arranged so that an employee of one railroad reported to someone from the other railroad. Officers were similarly mixed in the executive suites, although there was some complaint that the Pennsylvania Railroad people got most of the higher positions. To bring about the complete consolidation envisioned by the Penn Central a number of tasks had to be accomplished. Physical facilities had to be con- structed to handle the rerouted traffic. A single set of operating procedures had to be devised and then taught to employees. Paperwork procedures for car control — routings and destinations — and for billing customers had to be adopted and put into consistent use throughout the system. Uniform computer and accounting systems had to be chosen and existing systems accordingly altered. Equally as important, a new organizational structure had to be developed so that superior-subordinate relationships could be developed and stable chain of command established. Decision-making authority had to be settled on appropriate officers. It appears evident, at least upon hindsight, that consolidation was a complicated process that would require much time and effort to achieve. The New York Central and Pennsylvania pointed toward a "Merger-day" on which the merger could be finally consummated as if the new Penn Central could at once begin to operate according to its ultimate design. Little thought was ap- parently given to the difficult process of forging one company from the pieces of its predecessors. Although it was acknowledged prior to merger that the full amount of merger savings would not be available for eight years, the basis for this delay was usually attributed to the costs of plant construction and labor protection. Costs resulting from the process of consolidation were not expected. Preparation and Execution of the Merger This section describes, in broad outline, how PRR and NYC prepared for the unification of their properties, managements and operations upon merger and how the merged company executed the plans. The premerger planning was prepared in two main stages. At the time of the first negotiations in the late 1950's, the companies jointly and separately reviewed their operations and were in the course of completing a basic plan of merger. Upon resumption of negotiations in late 1961, this work was refined into the proposed routing and operational plan presented to the ICC and described at length in its initial April 6, 1966 report. 7 '-' That plan covered the rerouting of traffic with detailed routes from and to major points and areas, changes in terminal operations, passenger terminal operations, and the coordi- nation and elimination of maintenance facilities. This planning, devoted primarily to definition of plant design, did not spell out the steps or processes necessary to move from two separate road9 to one unified railroad. After determining traffic routing, the capacity of track and terminals neces- sary to handle the expected traffic was determined. This was the only kind of information relating to implementation of the merger that was presented to the Interstate Commerce Commission in its hearings. The Commission did not question the railroads further about their plans, apparently assuming this to be an area for managerial discretion and that the company's interest in survival and profit would insure appropriate execution. For example, a question was raised by the State of Pennsylvania about the location of the corporate headquarters. The hearing examiners dismissed the State's request that the Penn Central headquarters be located in Philadelphia with the observation that the interests of New York and Philadelphia in ob- taining the headquarters balanced each other and that this was a matter for the company to decide. At another point the examiners noted a proposal to reduce the number of operating regions from 14 to 10 but concluded without discussion that the board of the new corporation would make the final decision on the matter. " Initial Penn Central decision, 327 I.C.C. at 654-73, 1018-24. 336 Committees composed of representatives of the two railroads continued to meet throughout the legal proceedings on the merger to plan for the eventual merger. It appears that the substantive contribution of such committees was to identify important areas of decision, describe the approaches of the two railroads to the issues, and propose approaches for the new railroad. Decisions were made only where there was a consensus on the recommendation. If a consensus could not be developed, decision was deferred. After the presentation of evidence to the Commission, additional studies were made and resulted first in the Interim Plan and finally in the detailed Master Operating Plan. The Master Plan is said to have been completed after many months of effort on the part of the best informed people of both roads. 80 The companies used a somewhat formalized planning organization guided by a system coordinator for each railroad and staffed by 36 representatives of 18 departments. Aided by the repeated postponements of Merger Day, the organization refined the Master Plan and had it in form for distribution to the regional managers of the merged company. Apparently at all stages, outside management consultants were extensively used to provide overall guidance and to prepare the organization and procedures of the merged company. One consultant was said to have had broad experience gained from work in mergers in a wide range of industries and situations. In its initial decision, the ICC ruled on a petition for reopening the pro- ceeding on the ground of newly discovered evidence, specifically, a December 1965 speech by PRR Chairman Saunders which referred to operating plans said to be different from those about which testimony was given at the hearings. Denying the petition, the Commission indicated that it, like the examiners, did not expect the merger plan to be carried out in all its details as proposed at the hearings. 81 In addition to developing the Master Operating Plan, the planning orga- nization facilitated communication between the departments of the two companies. No formal record is readily available of the extent to which the departments had reached agreements or resolved differences relating to their postmerger organization, policies and procedures. 82 Differences, however, were explicitly acute in at least two areas of major importance. The two companies did not follow similar systems of budgeting and cost control, and their approaches to marketing were known to spring from different philosophies. And while numerous steps were taken to unify operations or functions and to carry out capital projects related to the unified service, the divergent fiscal policies were not rationalized, and the sales and marketing departments continued their intense competitive rivalry and different methods to the day of merger. Perhaps most important to understanding the inefficiency of pre-merger planning is that no decision-making authority was created until the merger was consummated. There were two more-or-less equal companies involved in the planning until the merger papers were signed. Neither could be forced to accept something it did not want. There was no strong man or group dom- inating both companies who could make consistent decisions for both railroads prior to the merger. What could not be mutually agreed upon had to await resolution by the board of the new company. It is not clear that much attention was given by top officers to the steps necessary to make the merger work. Saunders apparently devoted his efforts to the legal, political and publications matters required to secure approval for the merger. He left matters of operations to his subordinate officers. Perlman, on the other hand, devoted his efforts to building up the strength of New York Central as an individual railroad. To the top officers, the most important issue was probably to keep strong differences between the railroads from reaching the public in order not to 80 See memorandum from David E. Smucker to Stuart T. Saunders, November 13, 1969, Appendix D, Exhibit 85, p. 704. •' Initial Penn Central decision, 327 I.C.C. at 484-86. 8 - Only two departments in the two roads, the financial croups, did not participate significantly in the major planning through the principal merger coordinators (Cole and Kattau). The financial departments ultimately arrived at an accommodation: in the final organization chart, the financial work appears under two separate lines of management, financing under David C. Bevan (PRR) reporting to Chairman Saunders and accounting under Walter R. Grant (NYC) reporting to President Perlman. 337 disturb public opinion and jeopardize final approval of the merger. Thus, they could be expected to avoid discussion (and resolution) of divisive issues. No evidence has been found that PRR and NYC considered in depth a corporate merger on merger day and a physical consolidation of facilities and personnel at a later time. PRR executives appeared to have a sense of urgency about the necessity for integrating operations as promptly as possible after authorization, but NYC counterparts often centered on long-range studies. In any case, the Master Operating Plan was developed, refined and appeared to be ready on Merger Day for immediate and comprehensive use. A short time before Merger Day, the two chief executive officers, Saunders and Perlman, met and selected personnel from the companies for the upper levels of Penn Central management. As agreed by the two partners, Saunders would be PC's chairman and chief executive officer, and Perlman its president and chief administrative officer, upon merger. Of the departments selected to report to the president, three of major importance (operations, sales/marketing and personnel) were headed by former PRR men, and three NYC executives were in charge of accounting, industrial development/real estate, and pur- chases/materials. Four NYC men also reported to the president for departments handling various research, systems development and management planning functions and miscellaneous services. Directly under Chairman Saunders were the finance department, the secretary's office, the legal department, and public relations, all headed by former PRR personnel. In the second and third level staff positions were persons from both companies, about equal in number overall, but not evenly distributed among departments. For example, in the operating department, under the executive vice president reporting to the president were seven former NYC and three former PRR officers. What Was Left Undone on Merger Day On January 15, 1968, a decision came down from the Supreme Court clear- ing the way for the New York Central to merge with the Pennsylvania Railroad. At that point consolidation could begin in earnest. The fundamental decision about traffic routing had been made; the key terminals, yard and connection work had been identified. It now remained to implement those plans. This was no small task as the record of activity for the following two years indicates: 10 classification yards were built or enlarged; 35 key terminals were consolidated (a total of 51 freight stations and terminals consolidated in 1968 and 54 in 1969); four yards were eliminated in 1968 and two in 1969; and numerous rail connec- tions made. The Penn Central's own records show that it made a cash outlay of $90.2 million for capital improvements, $64.6 million for labor protection, $18.6 million for the purchase of homes, training and excess overtime, $15.0 million in excess per diem and $16.7 million in lost income (due to diversion of $33.4 million in revenue traffic). 83a Totaling $205.1 million, this sum provides a monetary measurement of the magnitude of the consolidation process in the first 23 months of Penn Central's short life. 81b The Penn Central recorded merger savings of $73.9 million, $9.6 million of which were related to incorporation of the New Haven. Thus, consolidation of the New York Central and the Pennsylvania Railroad produced a net savings of $64.3 million so that the first 23 months of operation required a net eash outlay of $140.8 million. Decision To Rush Consolidation In a memo on November 8, 1967 to Saunders, Financial Officer David C. Bevan discussed the Pennsylvania Railroad's desperately declining cash position (expected to go to zero within 2 months) and stated the inescapable need to sell about $72 million in debt securities. To do this, the Pennsylvania would be 83i Interstate Commerce Commission, Docket Xo. 30291. Penn Central Investigation, Brief of Bureau of Enforcement, p. S4 (March 8, 1!)72). Mb Other expenses were incurred by reason of inclusion of the New Haven in the Penn Central system but do not reflect changes in plant and organization stemming from the planned consolidation. 338 forced to obtain agreement from the New York Central to raise the debt limits set in the merger agreement. 88 Thus, when the final decision came down from the Supreme Court on January 15, 1968 permitting the merger, the Pennsylvania Railroad rushed ahead, its enthusiasm spurred by knowledge that it would run out of cash if left on its own. Although the situation at the New York Central is not set out as explicitly in the records, it was doubtless only slightly less anxious. The New York Central was also very short of cash. The New York Central and the Pennsylvania Railroad found themselves no stronger in union than in independence. Immediate action had to be taken to keep the Penn Central afloat. Since top management believed the decade of rhetoric that vast savings would occur upon the consolidation of the two rail- roads, a crash program was undertaken to achieve those savings as soon as possible. The course was to consolidate the two railroads at once. Several months after bankruptcy, Perlman testified to the Senate Com- merce Committee with obvious pride that physical work originally scheduled for completion in five years has been done in two years. 80 Apparently, most of the merger start-up capital costs were expended in 1968 and 1989 rather than prorated over the longer period. Perlman regarded this as a tremendous achievement. The computer systems of the two roads had to be consolidated after consummation of the merger. The better system was not necessarily chosen because speed was very clearly the primary criterion for the process. 87 Not only in the computer area, but throughout the entire railroad it appears that speed was the primary criterion and the overriding goal in the consolidation process. Although savings were produced by the consolidation, speed had its costs. In the hearings Senator Hartke inquired of Perlman: After the merger occurred, did the expectations which you had anticipated in regard to increased efficiency and better service, did they occur? Mr. Perlman. No, sir, not the first 2 years and I didn't expect them to occur then. When we rebuilt the yard, say at Albany before merger, put in the new electronic yard, we had to throw everything over to the Syracuse yard. Just that one thing disrupted the New York Central service for 6 months. Now you take changing service at 35 yards within 1 year and you have got a heck of a mess. 88 Mr. Perlman's testimony revealed clearly his belief that service deteriora- tion was a necessary by-product of the consolidation process and that the faster the consolidation could be accomplished, the faster service could be restored to acceptable levels. He noted, in fact, that shippers were very happy with the service by the following spring (1969). 89 He did not indicate that any con- sideration had been given to strategics designed to minimize service deterioration during consolidation. He was concerned only that it was done quickly. Whether his concern arose from the financial weakness of the railroad or from a personal belief that sharp pain quickly over is preferable to a prolonged dull ache is not known. In either case, the direction given to consolidation of the Penn Central would be the same. PRR and NYC formally merged on February 1, 1968. Whatever the extent, merits or depths of the planning for merger, whatever the bright prospects of great economies envisioned by combining the two carriers operating many miles of parallel railroad and serving many common points, Penn Central's manage- ment found it impossible to merge the properties, provide reasonably good 85 Memo from Bevan to Saunders, November 8, 1967. Appendix 1>. Exhibit 36. p. 558. "Hearings before Senate Committee on Commerce, Failing Railroads, 91st Congress, 2d Session. Serial No. 91-90, Part 2 at 393. "U.'f . Interstate Commerce Commission, Docket No. 35291. Penn Central Investigation, Verified Statement 32, p. 4. *" Hearings before Senate Commerce Committee, cited supra, note 82 11 at :!91-2. »>Id. at 393. 339 service and maintain a solvent operation. In broad and brief outline, the sad course of events went as follows: Upon merger, Penn Central expedited its plans in some respects and post- poned them in others. The objective appeared to be the achievement of econ- omies as rapidly as possible. In labor relations, by November 1968, PC had implemented the 1964 basic protective contract by making agreements with unions representing 86 percent of its union employees. Accordingly it proceeded with the relocation of personnel, made consolidations of facilities with reduc- tion of the work force, and terminated employment under the interim pensions and separation allowances provided by the labor contract. The actual cost of the labor protective agreement greatly exceeded estimates. One must con- clude that management must have decided to follow a greatly accelerated program to achieve economies, badly estimated the cost, or misused the con- tract arrangements by improvident transfers and separations. Merger of the PRR-NYC physical operations utterly failed. The service became so unacceptable to shippers and connecting lines that much traffic was lost or was routed around PC over competitive railroads. The causes of the operational collapse were many, some of them controversial. One general hy- pothesis summarizing them reflects the seemingly insuperable difficulties attend- ing the abortive attempt to unify the operations. But first this comment: dis- cussing the claim that the combined properties would result in an unwieldy company difficult to manage efficiently, Chairman Symes in his merger testi- mony pointed out that the merged company would not be as large in many respects as PRR alone at various times in the past and, in some instances, not as large as NYC alone. The measures cited include number of employees, equip- ment owned, locomotive units owned, revenue passengers handled, revenue ton miles, and total train miles. One hypothesis explaining the operational collapse can be simply stated. Despite extensive planning, incompatible partners not truly receptive to the merger were not ready either to merge or to carry out the plans; and because of inadequate execution, instant merger created and compounded operating problems and ultimately led to chaos. After the bankruptcy and after the ensuing congressional and public uproar, the ICC instituted a formal investigation of the Penn Central collapse and directed its Bureau of Enforcement to participate in the proceeding. In its presentation, the Bureau reviewed and analyzed the postmerger operations of Penn Central. 00 It first pointed to the congestion at key terminals and yards m the immediate postmerger period. One cause of congestion was that ill-prepared clerical forces were unable to execute the classification and routing of the com- bined traffic in fulfillment of the basic operating plan or any other plan. Clerical error separated cars from their billing, and the no-bill cars intensified the con- gestion. Massive problems of communications appeared; the incompatibility of the PRR and NYC computerized svstems for car location and movement information was not solved until June 1968, although the problem was recognized well in advance of the merger. Shortages of locomotive power seri- ously delayed train movements. The disrupted and disorganized operations aggravated an insufficient supply of boxcars, hoppers, gondolas and other freight cars. The handling of traffic interchanged with connecting lines, the Bureau asserted, was fraught with confusion, and the confusion obtained at both the eastern and western connections of Penn Central. The Master Operating Plan prepared by the planning committee was ready for use on Merger Day. To what extent the partners were committed to its use is not now easily ascertained, but the plan must have had the ap- proval of both parties. Each was equally represented on the committee, and each had at least the right of dissent. No record of dissent had been found othei than the fact that immediately following merger the Master Operating Plan was marked "preliminary", was not used and was not resurrected until about October I960." 1 To what extent this Plan was followed or tried is not definitelv known. 9,1 Interstate Commerce Commissions Docket No. 35291, Penn Central Investigation. Brief of Bureau of Enforcement (March 8, 1972). 01 See letter dated October 14. 1969, from R. G. Flannery, Vice President — Operations, to the regional managers concerning "Master Operating Plan Progress and Appraisal", Appendix D, Exhibit 340 The confusion generated by the operating difficulties was intensified by the virtual breakdown of procedures for the billing and collecting of freight charges. Millions of dollars due Perm Central were not seasonably collected. Cash, inadequate as it was on Merger Day, was further and rapidly depleted. Quite clearly, the labor protective agreement (at least as implemented) and the inclusion of the New Haven proved improvident. They may indeed have been the price for securing approval of the merger, but the costs of labor protec- tion and the New Haven inclusion were major factors in the financial collapse of the company. In his testimony before the Senate Commerce Committee in July 1970, former Chairman Saunders of Penn Central enumerated some of the reasons why Penn Central was forced into reorganization under § 77 of the Bank- ruptcy Act ("the factors that really broke our back"). 92 He referred to the inflation-caused spiralling cost of operating the railroad (the increase in 1969 being $100 million for Penn Central), the inadequacy of revenues because of recession and the time lag in getting freight rate increases, the huge deficit from passenger operations, the heavy merger startup costs amounting to $193 million after taking into account $74 million in merger savings, inadequate divisions of revenues with Southern and Western railroads on interterritorial traffic, and the inclusion of the New Haven in the merged Penn Central. These problems, he said, presented conditions which were "unmanageable" and made it impossible to operate the railroad on a break even basis. He said that the net merger startup costs were substantially larger than were presented in the initial ICC merger decision. 93 How r ever viewed, the leakage of cash was of flood proportions, the op- erating losses were overwhelming, and the result was Penn Central's petition for reorganization filed June 21, 1970. 94 Failure to Reorganize The chaotic conditions that existed on the Penn Central during consolida- tion cannot be attributed solely to the disruption caused by construction projects or the physical changes in traffic routings. The continuing unorganized condition of the company is fundamental to understanding the company's descent into reorganization. The rush to consolidate, in effect, resulted in the destruction of the organizations, to greater or lesser degree, of the predecessor companies. The Penn Central was not able by the time of its bankruptcy to create a new, cohesive and coordinated organization to take their places. The disruption caused by physical changes in the plant was compounded by the continuing failure to put the pieces of the merger back together again. A key element in every organization is a structure of management personnel that is able to provide effective leadership. This must be doubly important when the disruptions of massive changes are present. Yet, a stable management structure was not created at the Penn Central. A revealing account of the organizational deficiencies of the Penn Central is set out in the April 6, 1970, Interim Report of the President's Task Force, just two and a half months before bankruptcy. 95 A measure of management instability is the very large turnover in manage- ment personnel at all levels cited by the Interim Report : 61% of Trainmasters in their present assignments less than one year. 81% of Transportation Superintendents in their present assignment less than one year. 02 Hearing before Senate Committee on Commerce, Failing Railroads, 91st Cong., 2d Sess., serial No. 91-90, Part 1, pp. 298-364 (1971). 83 See letter dated Mav IS. 1972 from S. T. Saunders to the Secretary of the Interstate Commerce Commission in connection' with Docket No. 35291, the ICC's Penn Central investigation. Appendix D, Exhibit 69. p. 717. M See brief dated March 8, 1972 of the ICC's Bureau of Enforcement in the ICC's Penn Central investigation, Docket No. 35291, pp. 84-106. 116. 85 Mr. Gorman, who became president in December 1969, appointed the Task Force to evaluate the activities of operating regions. See Appendix D, Exhibit 64, p. 702, for full text of "Interim Report- President's Task Force" dated April 6, 1970. 341 44% of Division Superintendents in their present assignment less than one year. 80% of Division Superintendents in their present assignment less than 15 months. Changes in management personnel extended even into the executive suites. By the end of 1969 Mr. Perlman was no longer president. And the Execu- tive Vice President for Accounting, Mr. Grant, the Executive Vice President for Operations, Mr. Smucker, the Senior Vice President for Labor and Per- sonnel Relations, Mr. Knight, the Vice President for Transportation, Mr. Kennefic, and the Vice President — Corporate, Mr. Gerstnecker, to name a few principal officers, had left the Penn Central. The preface to the Task Force's July 22, 1970, report on the Central region notes: The Task Force, in the reports of April 6, 1970 and May 20, 1970, concluded that one of the major problems in achieving better results was a lack of stability and proficiency in front-line supervision brought about by the many changes resulting from merger. The Central Region has been much less affected by merger problems. The geographical territory is much the same as it was prior to February 1, 1968. Of even greater importance is the fact that the Central Region recognized (under the prevailing conditions of merging) the value and need to establish an adequate degree of stability in regional and divisional supervision. A large segment of this supervision has been in their present assignment for at least two years. As a result, there is an atmosphere of stability on the Central Region which was not apparent on the Western Region. This apparent difference between the two regions substantiates our belief that transfers of key personnel and other changes should be minimized during the next one to two years and training of front-line supervision to improve their proficiency should be emphasized. The clear inference is that the degree of disorganization that existed up to the time of the Task Force interim report was not a necessary result of the merger. That there was less disorganization in some regions shows that manage- ment could have exercised control over the situation in other regions. Other indications of disorganization spotlighted by the Interim Report are: lack of uniform procedures for payroll claim processing, car reporting, and management reports; lack of defined duties and responsibilities in some super- visory positions and iack of uniformity in activities in those positions between regions and divisions; lack of adherence to the operating plan; and lack of uni- formity in promotion and training programs. The Interim Report notes a lack of adherence to the operating plan. Whether there was indeed a uniform operating plan, at least in the early days of the consolidation, is questionable. In a memo to Saunders on November 13, 1969, Smucker pointed out that savings on merger projects have fallen short of estimated savings by 50 percent, complained that neither the Master Operating Plan nor the previous plan (placed in the record of the ICC merger hearings) had been followed, and called for a sweeping plan to be adopted and actually followed in the future. 96 Since Smucker had been ousted from his position as Executive President for Operations nine months before, the credibility of his memo might be questioned. The press has recorded a bitter dispute between Smucker and Perlman and concluded that Perlman succeeded in dumping Smucker. 97 Saunders later claimed that he and Perlman agreed that Smucker had not done the job and that together they replaced him. 98 However, even allowing for an element of self-vindication that may have motivated Smucker's memo, there are external factors that indicate the ac- curacy of the thrust of its allegations. The emphasis on speed and the disrup- tions that erupted during consolidation would make following any plan quite 96 See Appendix D, Exhibit 65, p. 704. 87 Loving, Fortune, "The Penn Central Bankruptcy Express," August 1970. 98 J. Daughen and P. Binzen, The Wreck of the Penn Central, p. 121 (1971). 342 difficult. In addition, Perlman was noted for his propensity to run a railroad from information in his head and intuition rather than from formal plans. His method of operation on the New York Central apparently was to spot problems to be corrected by traveling around the railroad in his business car. It is, therefore, not unlikely that he would have continued to devise ad hoc solutions to the manifold problems of the Penn Central. The lack of defined responsibility for important supervisory positions and lack of uniformity between regions further indicate that changes or reorganiza- tion were not made systematically. The Interim Report states that peoplo in divisional and regional supervisory jobs of data control and operating rules, supervisors of yard procedures, supervisors of train movement, and chief dis- patchers, among others, were forced to rely on their past experience or differing individual ideas for definitions of their jobs. This is astounding in view of the vital importance of information and efficient train operation toward making a success of the Penn Central. The Interim Report recommends definition of duties and responsibilities for each supervisory position in the Transportation Department as "a necessary first step toward establishing transportation guidelines that will be uniform throughout the company." Two years after the consolidation began seems woefully late for such important first steps to be formulated. Disorganization was by no means confined to the transportation depart- ment. Peat, Marwick, Mitchell & Co. were hired to perform an outside investi- gation of the freight billing system. Their December 22, 1969, report found excessive delays in billing, inadequate management control over the quality and promptness of billing, poorly trained and confused personnel and a threat to the integrity of financial control by the very organization of the operation." Errors generated in the system continued throughout the entire cycle until brought to the railroad's attention by customers because there was no positive control system. Peat, Marwick suggested initiation of comprehensive training programs for freight billing personnel, expecially those who dealt with disputed rates. They recommended a change in organization to take agents out from under the control of trainmasters. Trainmasters were responsible for moving cars and trains while agents were responsible for the documentation of moves. Priority was naturally given to car movement by trainmasters and they used agents for operating duties when pressing agency problems deserved their undivided attention. Because of poor management, the freight billing process of the Penn Central was slowed and money owed to it remained in the hands of its customers. Thus, poor management thwarted the prime purpose in speeding the consolida- tion which was to obtain funds to stave off collapse. Corporate Character The corporate characters of the merger partners also have some bearing on the collapse. The Pennsylvania Railroad was part and parcel of the Philadelphia social establishment. Civic pride played a large part in the railroad's founding in 1846. It was established to insure a continued flow of commerce through Pennsylvania and Philadelphia and thereby to maintain their importance in the economy of the growing country. Philadelphia contributed $5 million of the first $12 million to the railroad's capital and received in return three seats on the board (which it held until 1879). The original identification of the Penn- sylvania Railroad with Philadelphia continued throughout the railroad's history. The western, Main Line, suburbs of the city came into being because the railroad developed land adjacent to its right of way into residential use. The cit3''s social structure was characterized by clubs and the extensive member- ship of the Pennsylvania's officers demonstrated the railroad management's substantial social standing. On a broader scale, the railroad that was created hx a state legislature came thereafter to work its influence on the legislature. Its earliest presidents num- •» Letter and report from Peat, Marwick, Mitchell & Co. to C. S. Hill, Dec. 22, 1969; see Appendix D, Exhibit 66, p. 705. 343 bered among their ranks skillful politicians and the railroad seemed to have little difficulty obtaining what it wanted from the State. Nor was its political orbit limited to the State. Its last president, Stuart T. Saunders, apparently had a close relationship with administrations of both parties in the national government. 100 The Pennsylvania Railroad was secure in its place in the Social Register, long in tradition and proud of a reputation earned in the 1920's as the "stand- ard railroad of the world." It was the largest railroad in the country, had sur- vived the Depression intact and without bankruptcy, and remained a substantial force in the business community of the Nation. The railroad's character, if a corporation can be said to have one, must be likened to that of the paradigm person of social standing: genteel, guided by tradition, sensitive to the values and opinions of his peers. The Pennsylvania's peer group was an exclusive one. Because it was the leader of the rail industry in a sense (by virtue of its size and strategic location), it felt itself superior to other railroads. However, its railroad character could not be denied, so that it could not precisely be a mem- ber of the fraternitj 7 of large corporations. It appears that the Pennsylvania Railroad responded substantially to the people its management met socially. Its direction was determined more by the social ethos of Philadelphia and its own traditions than by the demands of the market or the concepts of the business community at large. In the decade preceding the merger the railroad's direction seemed largely determined by tradition. Although there were a number of strong and able men in its upper echelon, it is difficult to identify one voice that uniquely shaped the railroad's course of action. There seemed to be no strong leadership of the railroad either by an individual or by a single body of its corporate structure. The board of directors largely rubber-stamped decisions that the management brought to it. It neither dictated nor criticized corporate policy. The management was not a single body unified by a chief executive officer. Rather it was divided into several, somewhat independent, spheres of influence each of which had a degree of access to the board, and which contended with one another to make general policy decisions. Within the separate domains, the dominant officer went his own way. The task of the chief executive officer was to mediate between other officers rather than to determine the railroad's course. Lack of unified leadership meant that yesterday's decisions modified by an accretion of compromises controlled the railroad. This made for very diffuse corporate policy and prevented the formulation of effective over-all goals for the railroad. It was difficult to hold one person responsible for the railroad's performance because no one officer controlled it. It also made it difficult to adapt to changing circumstances because no one took a global point of view. Each officer responded to the circumstances of his narrower field of responsibility. The decision to merge with the New York Central offers an example. The initial decision was apparently made in 1957 by Symes, who was then Chief Executive Officer. Once that decision had been made, it remained corporate policy, apparently never seriously questioned, during the years that the New York Central spurned the advance and it continued to be corporate policy throughout the remainder of the decade required to bring the merger about. 101 Passing over officers in the company, Symes brought Saunders in to succeed him in the railroad's top position. Saunders saw his principal duty to be ac- complishment of the merger. He left the railroad's finances and operations largely to other officers. It does not appear that Saunders ever re-analyzed the principal of merger with the New York Central ; that decision had been made and his job was to bring the merger into reality. [Neither does it appear that Saun- ders ever closely considered what would be necessary to make the merger work once it was legally possible. That, perhaps, was the duty of others. The dominant character of the Penn Central management seems to have been one of compromise and reconciliation, born of the need to strike compro- 100 See, J. Daughen & P. Binzen, The Wreck of the Penn Central, Chap. 2 (1970), for an account of the railroad's past. 101 See Hearings before the Senate Commerce Committee, Failing Railruuds. Hist Congress, 2d Session, Serial No. 91- 90, Part 1, p. 325 (1970): p. 325: "Senator Hartke. . . But that decision to merge was t hat not a managerial decision? "Mr. Saunders. I suppose it was. It was made before I came. I didn't initiate this merger." 344 mises between its independent top officers and of the need to reconcile new policies with the dogma of tradition, the feelings of fellow club members, and the views of the political leaders upon whom they depended. In contrast to the Pennsylvania Railroad, the New York Central did not possess a secure connection to a community and to the past. Although it was the (second or third) largest railroad and without doubt an important fixture in the commerce of the Nation in the decade preceding the merger, it was a kind of lone wolf, cut off from its peers. Its historic association with the New York banks was disturbed by Robert Young's take-over in 1954. Young campaigned against bankers and the rail industry establishment in his fiercely contested proxy fight and installed a hand-picked board upon his victory. Dominance over the railroad passed to his Alleghany Corporation, found by the ICC to be in control of the railroad. Along with his board, Young brought in Perlman to run the railroad. Perlman had been educated as an engineer at MIT and believed in the value of education above traditional railroad experience. He brought college graduates into responsible positions and encouraged innovation in railroad operating and marketing policies. He also believed in spending money on plant modernization in order to achieve operating savings. Volatile in temperament, he was a tough, blunt man who did not hesitate to state matters as they appeared to him. Accommodation and compromise were not his characteristic approach. His job at the New York Central was not to make friends but to make the railroad run profitably. He was also the only Jewish top executive in an industry not noted for its tolerance; this combined with his character kept him from an easy camaraderie with the industry. Young committed suicide in 1958, shortly after he had opened merger talks with Symes. His Alleghany Corporation was shortly thereafter plunged into a vigorous battle among stockholders for control, diverting its attention from the affairs of the railroad. Thus, Perlman became the controlling voice at the New York Central. The railroad was organized so that his officers reported information and problems to him and the railroad's decisions were in his hands. There was no division of powers, no independent domains, as there were at the Pennsylvania Railroad. Neither was there a lack of corporate goals or direction; Perlman had a vision of what the railroad should be. He molded the New York Central into his own image to the extent that he could — an aggressive, non- traditional railroad oriented toward new styles in management control and marketing policy, intensely focused on making railroad operations efficient and profitable. By the middle of the 1960's the New York Central was characterized in the press as the most progressive railroad in the East. Yet, similar to Saunders at the Pennsylvania Railroad, Perlman lacked complete control over the railroad's future. Although Perlman dealt with finan- ciers as president of the Railroad, he was not a financial man and could not bend them to his will. Perlman did not want to merge with the Pennsylvania Rail- road, yet was forced to do so because he could not put together an alternative merger with the P>&0 nor could he block the C&O's take-over of the B&O. Neither had he been able to cure the fundamental weakness of the New York Central. Believing that the New York Central could not stand by itself against the competition of other large Eastern railroads in the process of merger, Perl- man capitulated to the Pennsylvania's merger offer. Differences in organization reflected the different policies of the railroads. The Pennsylvania Railroad saw its basic role to be the movement of large volumes of traffic. Securing and keeping traffic were fundamental to this approach. Thus, the Pennsylvania Railroad had a vice president of traffic who reported to the president. Subordinate to him were assistant vice presidents of marketing and traffic. The sales function was located within the traffic area. Market research and pricing were located within the marketing area. Within the marketing area, market research played a supporting role for pricing, being used to justify prices rather than to determine them. Prices were determined on the basis of tradition and negotiation with major customers. The end result was that sales had a stronger voice in the organization than did market research. At the New York Central the situation was reversed. Vice presidents for sales and marketing each reported directly to the executive vice president, 345 thereby establishing a greater degree of visibility and responsibility for market- ing. The New York Central gave a dominant role to market research. On the basis of research findings and conclusions, the New York Central would develop new services and price them accordingly. Another significant difference in organization was in the crucial area of introduction of computers into the railroads' operations and paperwork. The Penns}dvania attempted to computerize its operations on a system-wide basis all at once. The New York Central, on the other hand, moved gradually, first introducing computers in one area of operations, then another. Computerization was treated as a service for existing functions so that its costs were billed to the other functions of the railroad and the computer people had to convince those who paid the bill of the worth of their service. Another important difference was in the accounting function. The Pennsylvania Railroad had adopted responsibility accounting where officers were responsible for meeting the budget and profit requirements for functions within their control. Officers formulated a budget for their functions and sub- mitted them for review at a higher level where they were incorporated into a broader budget. The budget became the chief means of expressing corporate goals and also of monitoring performance. At the New York Central, budgets were formulated in headquarters and imposed upon the organization. Budgets were not used as a control mechanism but rather as a way of allocating resources. Historical reports of financial and operating performance were utilized to control the railroad's operation. The chief function of accounting at the New York Central was to provide data on costs and revenues so that the profitability of its different services could be determined. The responsibility accounting approach had been suggested to the New York Central but had been rejected. The Pennsylvania Railroad might be viewed as having a more decentralized organization than the New York Central. Decisions were made at lower levels and reviewed by superiors as, for example, in the budget process. More impor- tantly, decisions were made in the independent domains of finance, operations, and traffic which had been carved out by the several officers on the railroad. The chief executive officer seemed basically to coordinate the decisions of others. The New York Central, on the other hand, seemed organized to pass informa- tion upward so that decisions could be made at higher levels. These differences between the New York Central and Pennsylvania Railroad, while evident and strong, do not by themselves indicate an incompatibility so fundamental as to foredoom the merger to failure. They do indicate that substantial adjustments would be needed in the merger whatever its guiding organizational principles. Overview and Conclusions In this section, the Penn Central merger is related to the rail system in the East; Government participation in the proceedings and overview is summarized; and the effect of the merger on the collapse of Penn Central in June, 1970 is examined. The basic law governing rail unifications has not changed since the Trans- portation Act, 1940, made ICA §§5(2) to (13), inclusive, applicable to all carriers regulated by the ICC. The law made it possible for PRR to have the power to veto, if not to control, the ultimate revision of the structure of railroads in the East. Since prior to 1920 when unification provisions were first added to the ICA, PRR had a substantial stock interest in N&W. N&W served the lucra- tive Pocahontas coal fields. Evidently the ICC considered the PRR-N&W affiliation not harmful, for no move was made to disturb it until approval of the N&W-NKP-Wabash system on June 24, 1964. The Commission made that approval subject to PRR's divestiture of its interests in both N&W and Wabash. PRR consented to the divestiture. By that time, the C&O's control of B&O authorized in December 1962 had been consummated, and the system was in operation. In the N&W Merger case, the ICC disavowed that it was restructuring the East. Nonetheless, one fact is clear: With the Commission's approval, by the end of 1964, two new systems, N&W and C&O-B&O, were formed 346 around the cores of two strong railroads and were well underway over three years in advance of the consummation of the Penn Central merger. They both had direct access to the important industrial areas of the East and ocean ports as well as to the Pocahontas coal fields. Penn Central had somewhat broader territorial coverage and in many respects equalled C&O-B&O and the new N&W combined. The 1965 proposal to form an N&W/C&O-B&O system was based in large part on the alleged necessity of meeting the coverage and competitive strength of PRR and NYC unified as Penn Central. The ICC was early committed to a case-by-case method of deciding the unification proposals, and repeated efforts to change that approach failed. The basic applications for approval of the three new systems were filed in a geriod of less than two years (June 1960-March 1962), and at the time of the enn Central hearings in 1963, all were still pending before the ICC. The ICC's decisional method may have simplified administrative handling, but prevented overall consideration in public of the merits of the several unifi- cation plans in the context of national and regional goals and needs. Would consolidation of the cases have yielded different results? Given the ICC's passive attitude it is difficult to say. The ICC is empowered to condition but not compel a unification of carriers. 102 Any railroad not satisfied with con- ditional approval can refuse to proceed with a proposed unification. C&O's refusal to join in a C&O-B&O-NYC system is said to have forced NYC out of the C&O-B&O case and into the proposal to merge with PRR. The dangers to NYC were recognized and were briefly treated in one paragraph of the ICC's 1962 decision approving the C&O-B&O affiliation. The Commission realized that the Central was "not well able to absorb any substantial loss of traffic", but concluded that the prospective loss of revenues to NYC was not such as to require disapproval. 103 The C&O-B&O affiliation consummated in February 1963 is often regarded as the keystone of the present alignment of Eastern railroads. At that time, apart from statutory standards set out in the Interstate Commerce Act and the antitrust laws, Government policy relating to mergers in the railroad and airline industries was being developed. President Kennedy, in his April 5, 1962, message to Congress, directed the Departments of Commerce, Justice, and Labor and the Council of Economic Advisers to form an interagency committee to develop criteria to determine whether proposed mergers are in the public interest. 104 The message stated three general guidelines. The first provided that effective competition should be maintained among alternative forms of transportation and, where traffic volume permits, between competing forms in the same mode of transportation. The second criteria aimed to secure economic, efficient and adequate service to the public "by the realization of genuine economies." Under the third criteria, affected workers should be given assistance, to make necessary adjustments caused by a merger. The Interagency Committee on Transport Mergers issued its report stating the general criteria in January 1963 after ICC approval of C&O-B&O control the preceding month and a few days before consummation of that control. On October 1, 1963, the Interagenc} T Committee made a public statement opposing the Penn Central merger. That merger, it claimed, would eliminate a vast amount of beneficial rail competition. The committee referred to the dominance of the merged company in the East and saw danger to several smaller railroads not included in the merger. The merger, it said, would pre- clude a more balanced restructuring of the East. The Department of Justice had intervened in both the C&O-B&O and N &W Merger cases. In the first, it did not oppose approval, but urged con- solidation of the two cases with the PRR-N YC proceedings. 105 In the second, it made a similar contention, but also pressed for inclusion of Erie-Lackawanna in the transaction, and stipulated into the record a memorandum developing the ties between N&W and PRR since about 1900. On brief before the examiner, it asserted that, by reaching agreements with various intervening railroads, N&W succeeded in silencing all carrier opposition to the proposed merger, that iw Cf. St. Joe Paper Co. v. Atlantic Coast Line Ry. Co., 347 U.S. 298, 316-21 (1954). >°3 Chesapeake & O. Ry. Co.— Control— Baltimore & O. Ry. Co., 317 ICC 261, 282 (1952). ,M Message from the President Relative to the Transportation System, H.R. Doc. 384, 87th Cong., 2dsess., 8 (1982.) '»' C&O-B&O case, 317 ICC 254. (1962). 347 as a result, the record was inadequate to enable the determination of the public interest issue, and that the applications therefore should be denied . At the oral argument, it maintained that the proposals should be approved only if PRE's financial interests in N&W were eliminated and Erie-Lackawanna included in the transactions. 106 The Commission found the record adequate, approved the N&W merger without requiring inclusion of EL at that time, and ordered PRR's divestiture of its interest in N&W and Wabash as a condition of ap- proval. Commissioner Tucker dissented in both the C &0-B &0 and N&W Merger cases. In C&O-B&O in December, 1962, in his lengthy dissent, he commented that the public bodies are not in a position to present public, as distinguished from private, evidence. He picturesquely described the failure of large Eastern railroads to present opposing evidence to be the "natural conse- quence of their own self interest which dictates a reciprocity of silence." l07 In the N&W Merger case in June, 1964, he considered that for such a unification proposal to be submitted on a relatively "noncontroversial" record dealing with the entire region, the proceeding was deficient in some respect. On the other hand, with some foreboding, he noted the rather formidable opposition to the PRR-NYC merger, not the least of which was the President's Interagency Committee on Transport Mergers. 108 The Interagency Committee opposition disturbed PRR and NYC and evidently intensified their efforts to neutralize the protests against the merger. After realization of C&O-B&O control in February 1963 and the new N&W system in October, 1964 and with the Penn Central record finally closed in September, 1964, the Commission within the next year was confronted with three possibilities for restructuring the railroad East — two systems (Penn Central and N&W-C&O proposed by the N&W-C&O application filed October 11, 1965), three sj's terns (C&O-B&O, N&W with possible additions and Penn Central), and four systems (C&O-B&O, N&W, PRR and NYC). The Department of Justice, representing the Government, was party to the more important merger cases before the ICC in the 1960's. It opposed the merger of the Northern Lines in the West through the Supreme Court. It participated in the Seaboard Coast Line Merger case settling how the antitrust laws were to be applied to rail mergers. 109 In Penn Central, its position changed from unqualified opposition to the proposed merger at the time of the examiners' report in March 1965 to agreement that the proposed merger was in the public interest before the Supreme Court in 1968. At the time of the initial ICC decision in 1966, the Department was urging a four-system East (PRR, N&W, C&O-B&O and NYC) and that if the time came when four systems could not be supported, then PRR should be consolidated with N&W, and NYC with C&O-B&O. 110 Whatever the changes in position, the Penn Central merger encountered substantial opposition, that opposition gradually disappeared, and its approval created the present three-system East. Delay is inevitable in any unification of carriers. In Penn Central, the six- year delay gave the two railroad applicants ample opportunity to allay the substantial opposition and provided time to refine their extensive plans for physical merger. However, the realization of economies was postponed, sub- stantial losses continued, plants deteriorated, working capital continued to decline, new rail competitors were solidifying their positions, and so the many pressures induced substantial concessions not only to obtain but also to expedite approval. Delay did not bring any change in one important respect. The January 1962 merger agreement between PRR and NYC provided for a stock exchange ratio of 1.3 shares of NYC capital stock for one share of PRR capital stock. The initial ICC decision in April, 1966 found that this ratio was fair and rea- sonable. Maintenance of the ratio influenced the managements of the two railroads in making short term decisions affecting profits. To what extent ■«« Norfolk & Western Ry. Co. and New York, C. & St. L. R. Co. Merger, 324 ICC 1, 20, 26, 32, 91 (1964). '«' C&O-B&O case, 317 ICC 326 (1962). 108 Nto finance short term needs and is not normally regarded as a proper source of long-term financing of capital expenditures or for the refinancing of^baturing long-term debts. It 349 expressed its concern "about the use of short-term financing for long-term purposes." The report then said, that on the whole, PRR was in a strong financial condition. The Commission concluded that in view of the tight money market and PRR's stated intent to negotiate long-term financing as soon as feasible, the application should be approved. 111 The ICC by late 1969 knew of Penn Central's service deficiencies and fi- nancial problems. Several informal meetings were held, but, except for the May 1968 order requiring performance and status reports, the Commission under- took no formal or informal action of overview until after the bankruptcy in June 1970. What, if anything, continuous and thorough overview could have achieved is an interesting subject of inquiry for imaginative minds. Where specific governmental approval is required by law to merge corporations and their properties engaged in providing service of critical public importance, such as transportation, the duty of overview must certainly fall on some authorita- tive body. The responsibility for approval of railroad unifications is vested in the ICC and carries with it the duty of overview. In the post merger period prior to bankruptcy, .the longtime atmosphere of conservative policies characteristic of the PRR for over a century seemed still to affect the public view of Penn Central. Except for an on-the-ground inquiry used to produce a financial analysis for brokerage houses, no outside group made any significant investigation of Penn Central and the merger results prior to the critical days in the spring of 1970. Penn Central stock prices had been declining for some time, and accelerated their downward plunge after the announcement of frightful first quarter results in 1970. Rumors of Penn Central difficulties persisted, but the complexities of the critical difficulties were not fully realized. The result was a major railroad bankruptcy which, without a substantial change in the rules of the game, will likely continue in bankruptcy for many years without any certainty that eventual reorganization will ever occur. With the bankruptcy have come numerous investigations, a multiplicity of law suits, conflicting views of the causes of the bankruptcy, doubts about achieving economies of scale in railroad mergers, and serious damage to the public interest in a sound and efficient system of rail transportation in the Nation and in the East. To conclude this segment of the report on the Penn Central merger, its approval and its effect, the following points should be noted : 1. C&O-B&O control approval as determinative. — The ICC's approval of C&O's control of B&O in December 1962, determined, as a practical matter, the realignment of the Eastern railroads, especially since the N&W merger applications were contemporaneously pending and little opposed. 2. Little opposition to C&O-B&O and the N&W merger. — The acquiescence of many affected parties such as competing railroads, the shipping public, states, cities and other community interests, facilitated approval of the C&O- B&O control effected in 1963 and the N&W merger consummated in 1964. 3. Control of the Eastern rail structure. — The law made it possible for the PRR system to have the power to veto, if not to control, the ultimate revision of rail facilities in the East. Policy makers ma} T well doubt whether control of the rail structure by one industrial power center comports with the national interest in a sound transportation system. 4- Effect of merger on Penn Central. — The Penn Central merger, badly managed and poorly executed, hastened the financial collapse of the new company. The merger, skillfully managed and effectively executed, might have at least postponed the crisis. 5. Effect oj Penn Central denial. — Denial of the Penn Central merger would have continued a four-system East (C&O-B&O, N&W, PRR and NYC) and delayed the crisis which it appears would have eventually confronted PRR and NYC. 6. The case-by-case method oj merger approval. — The firm adherence to the case-by-case method of rail merger approvals prevented thorough public consideration of the major merger proposals in the East as related, first, to 111 Penn Central Transportation Co.. Notes, ICC F.D. 25S54, decided Oct. 29, 1969, reprinted, Hear- ings before the Senate Committee on Commerce, Failing Railroads, 91st Congress 2d Session ; Serial No. 91-90 (1971), pp. 174-175. 350 national and regional needs for rail service and, second, to improvement of the economic condition of the Eastern railroads generally. 7 . Delay. — The extensive opposition to the merger, the inevitable time lag in ICC processes, and the provision of protection for smaller railroads seeking inclusion, resulted in damaging delay. Merger in 1963 or 1964 would have conserved cash and permitted shakedown operations in a more favorable period from a revenue/expense standpoint. 8. Effect of delay. — During the six year delay, PRR and NYC continued past policies to maintain public confidence in the two companies and their proposed merger as planned, but these policies resulted in severe cash losses and likely in serious deterioration of plants. 9. Uncertain national policies. — The uncertainties of national and Govern- ment policy on rail mergers contributed to the delay and likely influenced PRR/ NYC to make costly concessions. 10. Conditions of approval. — The conditions imposed by the ICC on its ap- proval of the merger proved not to be burdensome, except for the required in- clusion of the New Haven and except perhaps for the Appendix G indemnifica- tion provisions which discouraged solicitation of competitive traffic subject to Appendix G. 11. Plans for physical merger. — PRR/NYC made extensive plans for physical merger of their facilities. Delay of the merger permitted refinement of those plans. However, they were not properly implemented after the merger. Whether full use of those plans would have facilitated physical merger and prevented the chaos is not known. Even with their extensive planning, the merger partners were, in fact, not prepared to merge their operations and properties. 12. Post-merger overview. — The post-merger overview by the ICC was in- adequate. The ICC is not structured, staffed or funded to provide the kind of overview needed to protect the public interest in the effective and economic unification of critically important transport companies. FISCAL POLICY ANALYSIS CONTENTS Financial Situation: Pa R e Financial Outlook : Introduction 353 Financial Position 354 Sources of Funds 355 Financial Position: Analysis 357 Accounting Practices and Policy 358 Earnings Maximization : Introduction 367 Implications of Earnings Maximization 368 Effect of Earnings Maximization on Reported Income .''>7(t General Comments on Earnings Maximization 374 Conclusion 374 Dividend Policy 378 Internal Control after Merger 38] Internal Control - 381 (351) Financial Situation FINANCIAL OUTLOOK : INTRODUCTION The financial environment in which the PER operated in the years preced- ing the merger gives an excellent indication of the financial situation carried over to the merged Penn Central. The minutes of a Finance Committee meeting on May 21, 1963 provide an insight into the financial constraints : . . . However, the next seven years will be the most difficult from a financial standpoint of any period of the history of the Company. Earnings during the past five years amounted to only $695,000 and there is no assur- ance of a sudden upturn in net profits. For the years 1952-1962 inclusive, there was a cash loss of about $110,000,000 notwithstanding the receipt of approximately $10,000,000 a year from the sale of real estate. During 1963, based on current estimates, there will be a net cash loss of $20,000,000. At the end of 1962 there was an adjusted working capital deficit of $60,000,000 and at present this deficit is $68,000,000. Provisions will have to be made for maturities during the next seven years of $565,000,000 ... In addition, the merger with the NYC will require capital expenditures during the first five years of $75,000,000 less $45,000,000 to be provided through salvage. The NYC had an adjusted working capital deficit of $40,000,000 at the end of 1962. Both companies had a net income deficit last year and if there should be a deficit for them again this year, there will be a further cash loss. 1 This situation did not seem to improve in the next three years, as witnessed by a memo from Bevan to Saunders, dated October 25, 1966 : . . . Herein lies the truth why today the financial resources of the Company have been stretched further than at any time since I have been with the Railroad. Throughout this entire period, and the last twelve months money has been scarcer than at any other time in my business career . . . The foregoing are the reasons for our present difficulties, but we should also look at some other aspects of the situation : Capital expenditures:* . . . We have . . . outstripped the NYC in [capital] expenditures by a wide margin and this is also true for almost any of the other Eastern Roads proportionately, and basically the same may be said on a National basis . . . E armings: . . . The improvement in our earnings has not been ma- terial . . . Share of market: . . . Despite huge sums spent on our equipment during the first six months of 1966 our share of the Eastern markets was 20.1% as compared to a high in the 1960's of 20.9%, in 1962 ... if even in 1965 we had been able to maintain our position in the Eastern Markets, we would have had over $5 million more in revenue than we did . . . New financing ability : As has been pointed out many times in the past three years, we have reached a danger point with respect to our ability to carry on new financing. At any time, because of the serious maladjustment in the ratio of equipment depreciation to maturities, Moody's may drop our rating from A to Baa, and if this happens our ability to finance equip- ment, even at a substantially advanced cost, would become extremely diffi- cult if not impossible, in the present tight money market. . . . In addition, just recently, the Morgan Guaranty Bank which is now a very substantial holder of our stock has manifested a great interest in ob- 1 Minutes, Meeting of PRR Finance Committee, May 21, 1963, Appendix D, Exhibit 70, p. 730. - Italicized descriptions added for clarification. (353) 354 taming figures showing projected maturities of PRR in relation to its proiected cash flow. . . . Per diem situation: . . . There has been no noticeable improvement in our per diem situation during the year 1966. . . . Moody's ratings: The most basic and serious problem has to do with our ratings for Moody's. The greater the increase they see in our debt, the more likely they are to analyze our equipment situation and the more vul- nerable we are to having our ratings decreased. 3 The problems presented above are certainly more serious than anyone outside of top management realized at the time. It is these financial problems, coupled with the merger agreement limitations and the labor agreement signed by Saunders and Perlman, which made the financial plans of the PRR and later the Penn Central reactive, rather than proactive. The basic problems seemed to be whether the PRR would be able to fund its operations, debt matu- rities, equipment policies, etc., until the merger could be consummated, and then whether the anticipated merger savings would be realized soon enough to pro- vide sufficient funds from operations to sustain the Railroad's heavy fixed re- quirements and debt maturities. FINANCIAL POSITIEON The merger agreement between the NYC and the PRR provided that the debt of neither of the railroads could be increased by more than $100 million prior to the consummation of the merger. This agreement placed harsh con- straints upon both of the railroads, since it was six years between the time when the merger agreement was signed and the merger was consummated. Fur- ther, Saunders and Perlman signed a labor protection agreement with the major railroad labor unions in May 1964. The costs of this agreement were estimated at that time to be $2.8 million, $16.5 million, and $25.2 million, respectively, for the first through the third years of the merger. The delay involved between these agreements and the merger changed a number of the estimated costs and benefits presented to the ICC in the early 196()'s. The labor agreement escalated from a total cost of $78.2 million to $195.2 million. The anticipated capital expenditures necessitated by the merger due to obsolescence of certain facilities, and for the consolidation of others, re- sulted in large discrepancies between the actual costs and the initial estimates. Confronted with underestimated merger costs and overestimated merger savings, as well as poorly maintained track, roadbeds, and rolling stock, the Railroad had to spend massive sums of money after the merger to modernize facilities, maintain the tracks and roadbeds, and provide for very costly labor agreements. Even before the merger, the PRR undertook a massive capital expenditure program to improve its facilities. But it had to do all of these activities without increasing its debt by more than $100 million. (This agree- ment was later modified and the debt limitation was increased to $195 million.) Bevan had indicated that the environment in which he had to finance the Railroad's programs in 1963 was limiting, at best. He could not increase debt by more than $100 million because of the merger agreement; but even if he had not faced that constraint, Moody's would have investigated the PRR much more eai-efully if the debt structure of the Railroad increased much more than its 1963 levels. In addition, Morgan Guaranty and Trust was interested in the cash flows from operations and the debt maturities projections, a careful anal- ysis of which could have had a disastrous impact on the PRR's future financing ability. In light of this debt constraint, the PRR and later the PCTC made exten- sive use of equipment leases. The advantages of leasing are that it does not necessarily require a cash down payment, it is not shown on the balance sheet, and the total financing costs of such leases 4 are not significantly different from more conventional forms of equipment financing. Also, the investment tax credit applicable to such equipment could not be used by the Railroad directly, 1 Memo from Bevan to STS (Saunders), October 125, 1966: see Appendix D. Exhibit 36, p. 554. 1 Memo from DCB (Bevan) to STS (Saunders), August 31, 1966; Appendix D, Exhibit 71, p. 731. 355 since it had huge tax loss carryovers, but could be used by the lessor in return for more favorable leasing terms. The obvious advantage of leasing is that it does not change the debt-equity ratio of the Railroad, since it is not capitalized. Another important factor is the "analysts' rule of thumb" in analyzing the Railroad: "When equipment maturities equals equipment depreciation, you are in balance, anything above, you are in trouble". 5 The PRR was not in a good position in this regard, since its ratio of equipment maturities to depreciation for 1966 was greater than unity, while the NYC's was less than unity. 4 The important point is that the PRR was obliged to use leasing to maintain the existing ratios on its balance sheet, even though these existing ratios indicated a marginal operation. The NYC was confronted with similar problems, and correspondingly made in- creasingly greater use of lease agreements during the 1960 s. An indication of the degree of lease utilization appears in the following table. The effect of the leasing practices was to mislead the investing and financial community by showing a better balance sheet, but the effect of this policy on the income state- ment is negative. The lease expense is composed of principal and interest, both of which are shown on the income statement. If the equipment were financed by serial bonds, only the interest would appear on the income statement, the principal would not appear anywhere after it had been paid. Thus the income statement would show net income as being less than it would have been had the Railroad chosen to finance equipment purchases by the use of serial bonds. 6 PENN CENTRAL TRANSPORTATION CO.i-EQUIPMENT LEASING AND CAPITAL EXPENDITURES 1963-69 [Dollars in thousands] Year 1963 1964 __ 1965 1966 1967 1968 1969__ Total Average Percent of total 1 After 1967, P.RR. and NYC figures are combined. 2 Source: Moody's Transportation Manuals. 3 Source: Table: Equipment Lease Agreements; see Appendix D, Exhibit 49, p. 614. SOURCES OF FUNDS The PRR had been liquidating some of its real estate holdings for at least 15 years prior to the merger. Bevan indicated that such liquidations brought about $10 million per year in additional cash from 1952-1962. 7 Such holdings were liquidated when they not only brought a cash inflow into Capital expenditures : Leasing s Total Percent leasing PRR NYC $17, 354. 1 $14,159.2 55,829.2 53, 818. 1 39,101.7 41,038.7 $36, 303. 3 12,466.3 69,781.3 27,063.9 72,616.0 93, 428. 8 71,208.1 $67, 816. 6 134,677.4 283, 788. 7 210,859.5 172,676.9 189,646.4 157,249.1 53.5 66, 381. 9 9.3 160, 189. 3 24.6 144, 693. 9 12.8 59,022.2 42.1 96,217.6 . 49.3 86,041.0 . 45.3 629, 900. 203,946.9 382, 867. 7 1,216,714.6 .. 89, 985. 7 40, 789. 4 54,695.4 173,816.4 51.77 16.76 31.47 100.00 ... 8 The "eauillbrium" is that point at which the maturities can be met with Internally generated funds. Since depreciation is a noncash expense, if a railroad's revenues and expenses are exactly equal, it has funds equal to the amount of noncash expenses, depreciation, to pay the maturity. Also, equipment obligations are usually serial bonds, paid over a 10-15-year period (the useful life of the asset). Depreciation is the systematic allocation of the cost of an asset to expense over its estimated useful life. A balance of these two figures implies that financing has been arranged such that the rate of payment on the bonds is equal to the estimated loss of service potential of the assets. In essence, the cash payment for the asset equals the service potential of the asset consumed. While there are theoretical flaws in this argument, this rule of thumb is valid for approximation purposes. 6 It must be noted that theoretically, the net effect on the income statement over the entire life of the lease would be zero. The equipment depreciation would offset the total amount of the repay- ment of principal had the equipment been financed by serial bonds. The only Income statement effect would be a smaller equipment depreciation expense, and a larger fixed charge over the entire life of the lease. In the case of the Penn Central, however, such was not necessarily the case. In the sales- leasehack arrangements of rolling stock, the Penn Central would consistently overestimate the cost of rehabilitating the equipment, while receiving the total amount of estimated repair costs in cash at the time of repair. The difference between the actual expense and the amount received could be used for general corporate purposes. The lease navments would reflect this higher repair cost. But, depreciation is only allowed on the total cost of the equipment : thus depreciation expense, in total, would be less than the portion of principal repayment by the amount of the difference between the estimated and actual rehabilitation costs. 7 Minutes, meeting of PRR Finance Committee, May 21, 1963 ; Appendix D, Exhibit 70, p. 730. 356 the Company, but especially when they also brought a profit on their disposi- tion. By 1966, profits from the disposition of these holdings were becoming scarce. While cash was generated from their sale, there were fewer gains on the disposition, such that net income was not increased. Some of the sources of funds from 1967-1969 arc detailed in the table below. This is not intended to be a comprehensive analysis of all asset and security dispositions, since such information is not readily available. PENN CENTRAL TRANSPORTATION CO., ASSET AND SECURITY DISPOSITIONS-CASH EFFECT (Thousands omitted) Source 1967' 1968 2 1969 Property sales.... _ $19,650 $59,700 $54,600 Securities sales.. _ 2,444 U.S. Government bonds _ 1,066 ~~~~~~~ Total 23,160 59,700 54,600 i P.RR. only. 2 PCTC only. The Railroad relied to some degree on the sale of its assets to provide funds, and placed even more emphasis on transactions with the Pennsylvania Company to purchase securities from it in order to provide cash for the Rail- road's operations. This is discussed at length in another section. After the merger, a program was instituted to generate cash from the sale of inventory, scrap sales in excess of normal, and the deferral of road improvements and decreases in estimated capital expenditures. In addition, when the cash situa- tion became critical, purchases of operating supplies were deferred until the Railroad was in a better cash position. The Railroad could finance its equipment programs by leasing, equipment trust certificates, or conditional sales agreements. However, the capital expendi- tures for road and track could not be financed by these methods, because the asset would not be accepted as security for the loan, since it was not easily re- movable nor easily resold. This required that the funds spent on this type of capital improvement be generated from operations, or provided from debt financing with equipment used as collateral for the bonds. To provide the required funds, long term financing was augmented by the issuance of commercial paper, revolving credit agreements, and other short term financing. The external sources of funds provided by such financing for the years 1968-1969 are as follows : PENN CENTRAL TRANSPORTATION CO. SOURCE OF EXTERNAL FINANCING TRANSPORTATION COMPANY ONLY |ln thousands of dollars] 1968 1969 Equipment: Conditional sales agreements Leasi ng agreem ents Bank loans. _ Advances from subsidiaries Total 332,000 401,000 The extensive use of revolving credit agreements and commercial paper was a short term solution to a long term problem. In May, 1969, Bevan nego- tiated a new loan and revolving credit agreement w T ith a number of banks led by First National City Bank of New York. Prior to this agreement, PCTC had $50 million outstanding, and with the renegotiation it immediately drew upon another $50 million, the limit of the debt agreement. In April 1969 the agreement was renegotiated, with the amount of credit available increased to $300 million. The PCTC was also using commercial 76, 000 74, 800 104, 000 86, 900 130,000 155,300 22, 000 84, 000 367 paper as a means of financing; $100 million in 1968, $50 million in March 1969, and another $50 million in November, 1969. The ICC had to approve the issuance of commercial paper, and each time the amount PCTC issued in- creased, it required separate ICC consent. The biggest problem with the com- mercial paper is that while the interest rates are comparable with short term bank borrowings, 8 the paper must be rolled over frequently, since it is issued for a very short term. The inability to meet these obligations or roll over the commercial paper was a major factor in the reorganization decision. Bevan also used a "blanket" mortgage of up to $300 million to provide funds for the Company. When the PCTC wanted to issue further bond offer- ings in early 1969, it became apparent that PCTC would not be able to sell the securities due to the bond market conditions. At this juncture, he hoped to have the Pennsylvania Company issue $35 million of Collateral Trust Bonds, which was successful at an interest rate of 81/4 % using $100 million of Buckeye Pipe- line Common stock as collateral. Late in 1969, the Pennsylvania Company issued $50 million convertible bonds at 9%, convertible into stock held by that Company as an investment. In the Spring of 1970, Bevan hoped to issue a $100 million bond offering of the Pennsylvania Company, but the excessive losses of the Consolidated Penn Central and the non-consolidated Transportation Company made that offering impossible. This money was desperately needed to fund the maturing commercial paper and equipment trust maturities. When it could not be issued, the PCTC filed for reorganization. FINANCIAL POSITION : ANALYSIS The merged Railroads had a very high debt/equity ratio even before operations began in February 1968. The extensive use of leasing minimized some of the effects of the rapidly increasing debt, but also had a negative effect on net income in that the principal was included as a cost of operation. The huge cash losses of the Transportation Company, the massive capital expendi- ture program undertaken by the Railroad, and the excessive dividend and diversification policies made the need of external financing all the more imperative. It could be said that Bevan relied too heavily on debt instruments; but after the merger had been consummated and the results of operations became known, he had little alternative. The financing options were severely limited by the huge losses of the Transportation Company, which could not be offset by improved earnings of the subsidiaries. At the time of the merger, an equity issue could have had success in the financial markets. A wave of optimism (relative to past evaluations of the individual railroads before the merger) was present in the financial community in anticipation of the merger savings to be realized by the Transportation Company. This is evident from the evalu- ation (in terms of common stock earnings and dividends) of the pre-merger railroads, and the post-merger Penn Central by Standard and Poor's. Prior to the merger, both the New York Central and the Pennsylvania were ranked B minus (the next to lowest ranking given to common stocks by Standard and Poor's). After the merger, however, the Penn Central was given a ranking of B, even though there had been no change in any of the indicators used in deter- mining the ranking. The only apparent rationale for the upgrading was the optimism with which merger savings were anticipated. But those savings never materialized. After the operating losses of the merged railroad became known, an equity issue would not have been possible. Had the Penn Central actively pursued the possibility of an equity issue, then further defense could be made of the excessive post-merger dividend payments. 3 Initially the rate was lower than short-term bank loans, but after mid-1969, commercial paper was more costly. 9 Standard and Poor's Stock Guide, Standard and Poor's Corporation, 345 Hudson Street, New York. X.Y. It must be noted that Standard and Poor's does not attempt to evaluate stock quality, but rather their ratings attempt to indicate the stability of growth of earnings and dividends using a mathematical formula which weighs dividends and earnings separately, giving greatest emphasis on the most recent years, and then combines these separate evaluations to give an overall ranking. 358 While Bevan used every option that he could to provide funds through debt issues in hopes of keeping the Railroad alive until merger savings could offset additional merger costs, he had created a debt structure that had to spell doom. The equipment maturities that existed as of the end of 1961) would require $997.4 million by 197<>, a sum that would require a strong improve- ment in the operating performance of the Railroad. Additionally, approxi- mately $60 million per year was required for the lease agreements, there was $200 million in commercial paper outstanding and $300 million in revolving credit agreements. These obligations alone amount to the staggering sum of $1,917,404,000, and this does not include the other fixed obligations, such as interest on this debt. It is quite questionable that anything could have kept the Railroad from reorganization, its capital structure was simply too debt laden. ACCOUNTING PRACTICES AND POLICY As has been cited previously, the Penn Central employed many question- able accounting techniques to maximize its reported net income and improve its financial ratios. Observations concerning general accounting policy can be made about the failure of the ICC to thoroughly investigate the financial reports sub- mitted by the Penn Central. But the most significant general accounting policy implications relate to two other areas. The first concerns accounting policies prescribed by the ICC and followed by the Penn Central which affected their operating decisions. The second area is the lack of uniformity between regu- lated accounting and "Generally Accepted Accounting Principles." such as those promulgated by the Accounting Principles Board of the American In- stitute of Certified Public Accountants. Before discussing the differences between "Generally Accepted Accounting Principles" (GAAP) and ICC accounting policies, a review of the nature of uniform accounting rules and the economic environment of the transportation industry is in order. The Accounting Principles Board was established to pro- vide criteria by which accountants could audit corporate records and certify financial statements. The audit certificate declares that the financial reports present fairly the financial position of the company, in accordance with gen- erally accepted accounting principles and consistent with the prior period's method of presentation. The principles established were necessarily broad in scope, giving much latitude for handling certain transactions, because of the wide variety of situations which occur in American Industry. The principles constitute "substantial authoritative support" for a particular method of accounting for a transaction. However, these principles recognize existing reg- ulatory accounting procedures as constituting such "authoritative support," and permit those regulatory agencies to dictate accounting procedure in regulated industries. ICC accounting principles were originally established in the first part of this century, to provide a standardized method of accounting for transactions within regulated industry. Such procedures, however, have in many cases not kept pace with the dynamic nature of the transportation industry, and are in need of revision. The railroad as a single corporate entity is rapidly becoming the exception. The transportation holding company, with many subsidiaries in a diversity of industries, is becoming much more common, with attendant accounting complexities of fairly presenting the financial position of such a broadly based corporation. I(V accounting policies relied heavily on the single industry nature of transportation companies for providing the rationale for specific, stringent accounting procedures. Such procedures have the distinct advantage, in theory, of narrowing the acceptable methods of accounting for specific transactions, thus providing greater control for the regulatory agency as well as greater consistency in financial reporting. However, the multi-industry nature of many transportation companies has made the accounting process more complex, while regulatory accounting policy and procedure has not responded adequately to this increase in complexity. It is clearly incumbent upon the ICC to provide changes in its accounting policies to meet the new demands of the industry it is regulating. 359 Divergence in regulatory accounting techniques from GAAP is justified when the advantages of greater control and specificity afforded by regulatory accounting policies outweigh the loss of comparability between regulated and nonregulated industries. There are certain situations, however, where regula- tory accounting practices have not adequately met the demands of the changing nature of the transportation industry, and where the divergence from GAAP is not substantiated by increased control and specificity in the financial report- ing process. The ICC has taken the position that a transportation company may use GAAP in reporting to the stockholders, provided that any differences between the results filed with the ICC and the results presented to the stockholders be adequately disclosed in the financial statements. This seems to be a reasonable alternative, in that control is provided over the accounting practices used in reports to the ICC, while the investors can obtain all the information necessary to convert the statements to reflect the results using GAAP. For example, the Penn Central disclosed the amount of deferred income taxes that would have increased "earnings from ordinary operations by $1,500,000 ($.06 per share) and reducing the extraordinary charge by $22,500,000 (.93 per share) ; and in 1968 would have had the effect of decreasing earnings from ordinary operations by $8,000,000 ($.35 per share).'- This information has been presented, but the question is whether it can be understood by the average investor. Financial statements are confusing enough to the average investor, and differences cited in the footnotes between alternative accounting methods quite probably do not clarify the report, rather they tend to cloud the issue of the financial performance of the company by presenting too much conflicting and technical data. Major differences oetxoeen ICC and GAAP One area of divergence of GAAP and regulatory accounting procedure con- cerns the recognition of deferred income taxes. GAAP requires a company to show, as a current expense, deferred income taxes, while regulatory accounting does not allow such a recognition. Deferred income taxes result from differ- ences between net income reported to investors and the net income used for in- come tax purposes. The most prominent situation in which such differences oc- cur is the use of straight line depreciation for financial reporting purposes and accelerated depreciation for income tax purposes. For the first few years after the acquisition of assets eligible for accelerated depreciation, accelerated depre- ciation expense will be greater than straight line depreciation. Thus, net income for financial reporting purposes will be higher than the taxable net income for income tax purposes. The difference in net income is the amount of difference between the accelerated and straight line depreciation. Assume, for illustration purposes, that an asset is acquired by a railroad for $100,000, has a salvage value of $10,000, and an expected life of 5 years. The depreciation expense for the life of the asset is shown in the table below. COMPARISON OF STRAIGHT LINE AND ACCELERATED— DEPRECIATION METHODS Deferred Straight line Accelerated income taxes Year depreciation depreciation Difference for year ' 1 2 . 3 4 5.. Total 90,000 90,000 1 Assumes a 50-percent tax rate and no other tax minimize policies followed. Accelerated depreciation is larger than the straight line depreciation for the first two years, the total deferred income taxes for this period represent the decrease in income taxes payable for that period. GAAP requires that the in- come tax expense reflect the amount that would have been payable had the ac- $18,000 $40, 000 $22, 000 $11,000 18,000 24, 000 6,000 3,000 18, 000 14,400 (3, 600) (1.800) 18,000 8,640 (9,360) (4,680) 18,000 2,960 (15,040) (7,520) After tax net income before deferred ■ income taxes After tax reported net income in published financial statements GAAP ICC $50, 000 50, 000 50, 000 $39,000 47, 000 51,800 54,680 57, 520 $50, 000 50, 000 50, 000 50, 000 50,000 50, 000 50,000 360 eelerated method not been used for tax purposes. That is, the current federal income tax expense would be shown as the actual tax payments plus the de- ferred income taxes for the year. ICC accounting requires that the income tax expense reflect the actual amount paid to the government, without any provi- sion for recognizing the deferred portion. Thus, if after tax net income before deferred income taxes on the published financial statements was $50,000 for each year, the difference in after tax net income under regulated and GAAP accounting would be as follows : Year 1 2 3 4 5 Total 250,000 250,000 250,000 Several observations must be made about the above example. First, the total reported net income resulting from both methods of accounting for de- ferred income taxes will be the same, the increased deferred income taxes in the earlier periods are actually offset bj' decreased deferred income taxes in later years. The second observation is that the total income taxes paid are also the same. The difference results from the timing of reported expenses for income tax purposes. It would seem, on the surface, that the ICC method provides for less erratic reported after tax net income. It must be noted, however, that the de- creased deferred income taxes in the later years is offset by increased deferred income taxes due to more recent property additions. Thus deferred income taxes, in effect, do not decrease in later years where the railroad is maintaining or in- creasing its rate of capital expenditures. The problem presented above is one of interperiod tax allocation; (i.e. in- come and expenses are reported in different accounting periods for financial reporting and income tax purposes). The question is which method should be used to present the income tax expense on the income tax statement. The accounting profession has debated this problem for more than a decade, and finally, in December 1967, the Accounting Principles Board (APR) issued Opinion Number 11, which discussed this problem. The contents of this opinion will be examined subsequently. It will be necessary to first consider some of the accounting problems associated with the question of deferred income taxes. There are basic differences between the goals of financial accounting and the goals of the Tax Laws. The former is concerned with a fair presentation of the financial position of the company, while tax law is concerned with economic effects of fiscal policy and the intentions and goals of Congress, as well as the taxation of reported income. Financial accounting, in conformance with GAAP, is much more con- cerned with conservatism and the matching of revenues and expense. The match- ing principle implies that revenues be reported in the period in which they are earned and that the costs associated with the generation of that revenue be recorded in the same period as the revenue. Stated differently, the resources of a company (its assets) are consumed to generate sales or revenues. The consump- tion of these resources become expense when the revenue is generated. By record- ing the costs and expenses in the same accounting period, a measure of the per- formance of the company is derived, this measure conveniently called "income." While the complexities of business transactions cause certain departures from this basic tenet, this is a central concept in "Generally Accepted Accounting Principles." Recognizing deferred income taxes is an extension of the matching prin- ciple. In essence, the tax payments that result from the net income of the period (the revenues less the expenses that generated the revenues) regardless of when 361 the taxes are actually paid should be considered a legitimate expense of the period. Thus, the current and deferred income tax should be considered as part of the current costs of generating revenues. Deferred income taxes are simply timing differences; the taxes will have to be paid in the future instead of the current period. But this does not necessarily imply that the taxes will not have to be paid ultimately. George M. Stafford, Chairman of the Interstate Commerce Commission, responding to a letter from the Honorable Harley O. Staggers of the House Committee on Interstate and Foreign Commerce discussed the position of the ICC with respect to the question of recognition of deferred income taxes : 10 In 1960 the ICC instituted rulemaking procedure relating to the applicability of its accounting rules to financial statements of carriers contained in reports to stockholders or otherwise released to the public. By report and order dated January 25, 1962, in Docket No. 33581, Financial Statements Released by Carriers, it found that, 'Carriers desiring to do so may prepare and publish financial statements in reports to stockholders and others, except in reports to this Commission based on generally ac- cepted accounting principles for which there is authoritative support, that any variance from this Commission's accounting rules contained in such statements is clearly disclosed in footnotes to the statements.' From the foregoing, it can be seen that, although the ICC does not permit carriers to record provision for deferred income taxes in its ac- counts, the effect of the various accounting methods permitted for income tax purposes is clearly disclosed in annual reports filed with us and in reports to stockholders and others. Of course, the basis of the ICC ruling is 'the present day shipper should not be required to provide from current freight rates for possible increased tax rates of the indefinite future'. 11 The ICC study, referred to in the above paragraph, is presently over 10 years old, and was written before the Accounting Principles Board issued its Opinion Number 11, which considers all of the opinions considered in the ICC study. The opinion of the APB appears, in part, as follows : The Board has considered the various concepts of accounting for in- come taxes and has concluded that comprehensive interperiod tax alloca- tion is an integral part of the determination of income tax expense. There- fore, income tax expense should include the tax effects of revenue and expense transactions which enter into the determination of pretax ac- counting income. The tax effects of those transactions which enter into the determination of pretax accounting income either earlier or later then they become determinants of taxable income should be recognized in the periods in which the differences between pretax accounting income and taxable income arise and in the periods in which the differences reverse. . . . The Board has concluded that the deferred method of tax alloca- tion should be followed since it provides the most useful and practical approach to interperiod tax allocation and the presentation of income taxes in financial statements. 12 It must be noted that the opinion presented above makes exception to the applicability of this opinion to regulated industries, as provided for in the Addendum to APB Opinion Number 2, which states : However, differences may arise in the application of generally ac- cepted accounting principles as between regulated and non-regulated busi- nesses, because of the effect in regulated businesses of the rate making process, a phenomenon of the rate making process, a phenomenon not present in non-regulated businesses. Such differences usually concern mainly the time at which various items enter into the determination of 10 Penn Central Transportation Company: Adequacy of Investor Protection, Hearing before the Special Subcommittee on Investigations of the Committee on Interstate and Foreign Commerce of the House of Representatives, September 24, 1970, pp. 137-162. " Ibid., p. 140. 12 Opinion Number 11, Accounting For Income Taxes, issued by the Accounting Principles Board of the American Institute of Certified Public Accountants, December 1967. 362 net income in accordance with the principles of matching costs and reve- nues. For example, if a cost incurred by a regulated business during a given period is treated for rate making purposes by the regulatory author- ity having jurisdiction as applicable to future revenues, it may be deferred in the balance sheet at the end of the current period and written off in the future period or periods in which the related revenue accrues, even though the cost is of a kind that would be written off currently in a non-regulated business. 13 The ICC position, cited previously, that "the present day shipper should not be required to provide from current freight rates for possible increased taxes in the future" supports the "flow through" method of handling deferred income taxes, that is, taxes become expense only as they become due. It considers that the decreased income taxes, due to the use of accelerated depreciation, really is a reduction in the tax rate, rather than a reduction in taxable net income. It would seem that the alternative treatment, the recognition of deferred income taxes, provides a closer association of revenues with the costs associated with generating those revenues. The tax difference is due to a managerial decision to file their income tax return using a tax reducing option, it is not due to a change in the tax rate. Another important consideration in the differences between ICC and Gen- erally Accepted Accounting Principles is the different way of recording certain additions to property and plant. There are two areas in which accounting policy affected the operating decisions of the Penn Central, the installation of new non-depreciable property, and the improvement of non-depreciable property. It must be noted that, in certain circumstances, the regulated accounting policy is not in absolute contradiction to Generally Accepted Accounting Principles, rather it is an archaic version of GAAP. Consider the situation in which a railroad wishes to add new track to its system in the form of a branch line that will be used to connect a main line to a warehouse. Further, let us assume that the warehouse will be removed in 20 years. 14 ICC accounting prescribes that the track, ties, most grading costs, etc. should not be depreciated. Rather, upon retirement of the branch line, the entire capitalized, non-depreciable cost is to be written off against income. Let us fur- ther assume that the cost of this branch line is $200,000. Current accounting practice in non-regulated industries would require the cost of the branch line to be allocated, as expense, to the income statement (depreciation). This would reflect the true cost of generating revenue by the asset (the matching principle). In this illustration, annual straight line depreciation would be $10,000 ($200,- 000/20 years, assuming no salvage value). Thus, net income for the period would be decreased by the amount of depreciation, which is $10,000. At the end of the 20-year period, when the warehouse is removed, the abandonment of the track would result in no charge to the income statement, since the entire cost of the track would have been "expensed" in the form of depreciation. That is. there would have been no "service loss" on the retirement of the track. Let us now consider the revenue generated by the branch line. Assume that the total revenues per year were $100,000. and that operating costs, exclusive of depreciation, were $7r>.000. The net income under nonregulated accounting practice would be $15,000 (revenues-expenses-depreciation equals net income). Xow consider the same example using regulatory accounting policies. The revenues would still he $100,000 per year, and the expenses (exclusive of de- preciation) would still be $75,000, but there is no depreciation charge; thus re- ported net income would be $2f>.0()0. Xet income is increased by the amount of depreciation which is not allowed under ICC regulation! This seems tine, until the 20th year comes, in which case there is an abandonment charge (or service loss) of $200,000. the entire amount of the cost of the branch line. The state- ments for the 20 years would be as follows: 13 Opinion Number 2, for the Investment Credit, December, 1f>62. 14 A life of 20 years is used for descriptive purposes, the exact life of the branch line is of minimal consequence, under ICC accounting, until the line is retired. 363 COMPARISON OF ACCOUNTING METHODS Year GAAP ICC 1: 2: Revenues $100,000 $100,000 Operating expense 75,000 75,000 Depreciation ._ 10,000 Total , 15, 000 25, 000 100,000 100, 000 75, 000 75,000 10,000 15, 000 25, 000 100,000 100,000 75,000 10, 000 75, 000 15, 000 25, 000 100,000 75,000 10,000 100,000 75, 000 200, 000 Revenues Operating expenses Depreciation Net income ___ 19: Reven ues Operating expenses _ Depreciation Netmcome _ 20: Revenues Operating expenses Depreciation Retirement of Track Net income (loss) 15,000 (175,000) Cumulative net income 300,000 300,000 From the above table, it is seen that the net income over the entire life of the branch line is the same, regardless of what depreciation method is used. However, the $175,000 loss at the end of 20 years under ICC accounting methods produces a strong incentive for management not to abandon track to avoid the service loss. The implication in the Penn Central case was that there were a number of miles of track that were not abandoned (to avoid excessive charges against net income) at the expense of the salvage value of track, which would have represented a cash inflow to the cash starved Transportation Company. As is also seen, there is an artificial overstatement of net income for each of the first 19 years of operation of the branch line. This violates the matching prin- ciple, discussed in the preceding section, since it does not accurately allocate costs to expense in the period in which the revenues associated with those costs were generated. The effect on Penn Central was to encourage management to act in a man- ner that was not in the best economic interests of the railroad; the main inducement was avoidance of an accounting charge. Thus, cash was foresaken to maximize net income. It must be noted that this accounting policy does not directly contradict Generally Accepted Accounting Principles, rather it is an outmoded accounting principle that has decided disadvantages to managerial decisions. It must be noted that there would be problems in changing the present ICC system of accounting to the more Generally Accepted Accounting Principle of systematic, straight line depreciation. Principally, this problem is that the past charges for depreciation which were not taken by the railroads on track and road bed structures now in service would be enormous, seriously affecting the earnings of every railroad, and significantly distorting long run time series data on depre- ciation and net income. The GAAP depreciation method would increase annual depreciation charges and thus lower net income, making financial analysis over extended periods a difficult, if not impossible task. The history of this "non-depreciation" concept is founded upon the limited ability of railroads to process the massive amounts of information necessary to maintain adequate records for depreciation purposes. In the days of automated data processing, however, such an argument is hardly valid. Further, there is the very real problem of determining the real economic life of an asset such as a mainline, or a graded roadbed. This argument can be easily refuted by referring to the Accounting Principles Board Opinion Number 17, in which the economic 74-924 O - 73 - 25 364 life of intangibles (good will, for example) is deemed to be their estimated eco- nomic useful life, up to a maximum of 40 years. This opinion discusses the man- datory amortization of intangibles acquired after October 31, 1970, while in- tangibles acquired prior to that time do not have to be amortized. The analogy that can be drawn is that an attempt to estimate economic life is better than no estimation at all, especially if there is a reasonable maximum limit placed on the asset in question. The need for this estimate is central to allocate cost to ex- pense (depreciation), over a reasonable period of time. The depreciation problem is compounded by the ICC position toward bet- terments. Betterments are defined as the replacement of physical property with property possessing greater quality. For example, the replacement of 56# track with 112# track is a betterment, due to the improved "quality" of the replace- ment, If the railroad has, on a given segment of track, 56# track presently in service, and assuming this track cost $75 per unit when it was installed at the turn of the century this track would not be depreciated, but would remain on the books at its cost of $75 per unit. Xow assume that in 1970 that railroad replaced the 56# track with 112# track, which cost $280 per unit. The effect on the books would be that $140 would be capitalized, and $140 would be charged as expense. The reason for this is that the difference in quality is all that can be capitalized. Since the "quality" went from 56# to 112#. only the additional 56#, at current costs, can be capitalized. Thus, the capitalized value of track (originally capitalized at $75 per unit) would be increased to $215 per unit, the increase of $140 due to the current cost of the increased "quality" of the track. The other $140 would be charged against expense. The effect is that the asset value of the track is understated by $65 per unit, and expense is overstated by $65. The implications of this for management become very clear when it is seen that an addition to track of improved quality results in a charge to expense that is overstated because the old track is not retired (and charged to expense) and the cost of the new track is not completely capitalized. Referring to the original problem of depreciation, if the track structures were depreciated, the resultant extraordinary charge against income for the retirement would be even less, since the bulk of the cost of the original track would have been sys- tematically depreciated over the 70 years it had been in service. (The track- probably would have been fully depreciated in that amount of time, depending on the estimated service life of the track when it was placed in service.) A third area of distinction between ICC accounting and GAAP is the treatment given to investments in subsidiaries. ICC policy requires all invest- ments to be carried under the "cost" method, while GAAP requires that under certain general conditions, investments in companies be carried under the "equity" method. An explanation of the mechanics of these differing procedures reveals this difference. The cost method maintains the legal distinction between the parent and the subsidiary. (It should be noted that the cost method also applies to investments in corporations in which less than 50 percent of the outstanding voting stock of the company has been acquired.) In the case where 50 percent or more of the common voting stock has been acquired, the cost method provides that the recorded value of the investment in the subsidiary be maintained, on the parent company** book*, at the initial cost of the securities, not adjusted for dividends paid to the parent by the subsidiary. The investment is not reduced by the pay- ment of dividends. Instead, the income of the parent is increased by the amount of the dividend. It must be noted that the cost method does not provide for rec- ognition of the parent's share of the net income or loss of the subsidiary in the investment account of the parent's books. If less than 50 percent of the voting stock of a corporation is acquired, on a long term basis, the treatment is exactly as described above for greater than 50 percent ownership, except for the very minor difference of segregating under "Long Term Investments," on the parent's books, the investments in affiliates of 50 percent or more and investments of less than 50 percent. Common to both "controlling" and non-controlling ownership is the parenthetical inclusion of the market value of the securities if such information is available. The invest- 365 ment account is reduced for the decreased market value of the investment only when such a decrease is significant and believed to be "permanent". Permanent in this sense means that the market value is below cost by a significant amount, and is expected to have such a reduced value for at least the next several years. The "equity" method of handling securities reflects the parent company's pro rata share of the net income or loss of the company in which the investment was made. Dividends do not increase income as they do in the case of the cost method, but rather represent a return of the investment. In essence, the equity method provides that the parent should recognize the change in the net worth of the subsidiary subsequent to the date of acquisition. The table below sum- marizes the differences between the cost and equity method as it is carried on the books of the parent company. COST AND EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS IN SUBSIDIARIES COMPARED Parent company's books only Event Cost method Equity method 1. Purchase of 90 percent of a com- Investment Increases by $1,000,000 Investment increases by $1,000,000. pany for $1,000,000. 2. Company reports $100,000 income There is no recognition of this event on Investment in the company is increased by $90,000 for the period after the acquisi- the parent company's books. ($100,000 times 90 percent), and net income is tion. increased by corresponding amount. 3. Company pays a $50,000 dividend Dividend income is increased by $45,000 Investment in the company is decreased by $45,000 on its common stock. ($50,000 times 90 percent) and cash or and cash or dividends receivable is increased by dividends receivable is increased. that amount. 4. Company reports a $10,000 loss No recognition of the event Investment in the company is increased by $9,000 for the period. ($10,000 times 90 percent) and net income is decreased by that amount. It should be noted that there are differences in the balance sheet of the parent company depending on which method is used. The cost method does not recognize the income of the subsidiary as a decrease in the investment by the parent, but recognizes the distribution of earnings, in the form of dividends, as income to the parent company. Recent Accounting Principles Board Opinions have dictated that the equity method be used in accounting for investment in which only 20 percent of the ownership is controlled by the investing company. The controversy of cost versus equity is becoming even more important because of the even greater tendency of railroads to form holding companies, in which extensive investments in other companies are becoming commonplace. The cost method, by virtue of the fact that the earnings of the subsidiary are not recognized, provides a degree of conservatism in that only dividends are considered income. However, the disadvantage is that subsidiaries' losses are not recognized either, so that a parent whose subsidiaries had significant losses in a given period would not reflect the poor performance of these subsidiaries. The equity method considers that the economic performance of the sub- sidiaries is a reflection of the current performance of the parent company, and should therefore be reflected in the income statement of the parent. This method considers that the entire entity, parent and subsidiaries, is one economic unit, and that part of the parent company's assets are diverted into subsidiaries for the purpose of generating a return on that investment. Thus, the recognition of the income of the subsidiaries reflects the return on the assets of the parent invested in the subsidiaries. The difficulty with the equity method is that the earnings of the subsidiaries are not necessarily available to the parent, for its own use. in the form of cash. This was seen in the Penn Central case in its invest- ment in Great Southwest and Macco. Thus, it is possible that the equity method would have improved the financial performance of the Pennsylvania Company, even though the increased income would have reflected little'real improvement in the financial/economic reality of the Pennsylvania Company. The ICC is engaged in a study of the equity versus cost method of accounting for such investments, and recommendations concerning the merits of two are withheld pending the results of that study. 366 It may well be said that, in some cases, accountants play the "numbers game;" a game that is not well understood by the average investor. The Ac- counting Principles Board recently issued a number of Opinions on varied topics, prescribing "Generally Accepted Accounting Principles." But, these Opinions are considered to be only one of several possible treatments of a given economic situation. The Accounting Principles Board states that the Opinions they issue constitute substantial authoritative support for the method of ac- counting, but also recognize that the dynamic nature of accounting, and the characteristics of particular situations may obviate the accountant from using their published accounting method provided that there is substantial authorita- tive support for an alternative treatment. A classic case of "substantial authori- tative support" is in regulated industries, where the regulatory agency prescribes an accounting treatment different from that which is constituted as being "Gen- erally Accepted'' for non-regulated industries. This exception has both advantages and disadvantages. The advantage be- ing that specialized accounting practices may be used in special circumstances which are peculiar to the industry in question, and also provide for greater con- trol on the part of the regulatory agency in prescribing a more uniform method of accounting procedures. This could theoretically result in greater control over varied accounting techniques, and also provide for greater consistency among the various firms representing that industry. A disadvantage results from the lack of prompt revision of accounting standards by the regulatory agency in response to the changing economic en- vironment of the industry in question. The economic complexities of the trans- portation industry require a responsive regulatory agency to modify its stand- ards to adjust to the changing economic environment. Divergence from Gen- erally Accepted Accounting Practices is certainly justified when real differences exist in the economic environment of the regulated and non-regulated indus- tries. However, divergence from these standards because of lack of responsive- ness of the regulatory agency is clearly not rational, and rather than providing consistency, control, and understandability of the financial data, it provides greater confusion and potential management performance impairment. The exclusion of ICC regulated companies from some of the provisions of the Se- curities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940 has been examined in detail by the Staff study for the Committee on Interstate and Foreign Commerce, House of Representatives, entitled (Inadequacies of Protections for Investors in Penn Central and other ICC regulated companies) 92d Congress and the points are well made. The ICC must obtain better information about the transportation industry. Pres- ently, the exclusion of common carriers from the provisions of the above-men- tioned legislation and the lack of precise regulation by the ICC, places effective control of their financial operations and disclosure in jeopardy. Such control and responsiveness on the part of regulatory agencies is a needed and necessary prerequisite to effective regulation of these industries, and should be imple- mented with the recognition that deviation from the regulations of the ^VA' and "Generally Accepted Accounting Principles" must be for legitimate and significant differences between the nature of the regulated and non-regulated industries. Earnings Maximization INTRODUCTION The earnings maximization policy of the Penn Central, and its predecessor, the Pennsylvania Railroad, has been criticized because it represented only a cosmetic improvement in the reported net income of the Railroad. It can be argued that this policy also had a detrimental effect on the cash flow of the Railroad, as well as the financial well being of the subsidiaries. The Railroad is accused of "bleeding'' dividend payments from the sub- sidiaries at a time when the subsidiaries could least afford to pay dividends. Most of these dividend payments were not in the form of cash, rather they were nothing more than the forgiveness of debt owed the subsidiary by the Railroad, or the incurrence of debt by the subsidiary to the Railroad. Generally, the Railroad urged certain nonrailroad subsidiaries to use lib- eral accounting procedures to report as large a net income as possible. This re- sulted in three positive income effects for the Railroad. First, the greater the income of the subsidiaries, the greater the consolidated net income of the Rail- road. Second, the increased income of the subsidiary allowed it to justify a higher dividend payment urged by the Railroad, even though the subsidiary might not be in a position to make a cash dividend payment. The dividends of the non-railroad subsidiaries increased the non-consolidated dividend income of the Pennsylvania Company, since this company owned most of these subsidi- aries. Most of the railroad subsidiaries (excluding the Norfolk and "Western RR, Wabash RR, and Detroit, Toledo and Ironton RR ; the principal railroad sub- sidiaries owned by the Pennsylvania Company) were owned by the Penn Cen- tral Transportation Company, and their dividends increased the non-consoli- dated dividend income of the Transportation Company. Finally, the Railroad had Tax Allocation Agreements with certain subsidiaries. These agreements provided that each subsidiary would pay to the Transportation Company an amount equal to 95% of the income tax liability that would have been due had the subsidiary filed a separate tax return. The Railroad urged maximum profits from the subsidiaries, and then received on a consolidated income statement basis, as income, the tax payments that these subsidiaries would have had to make had they filed separate returns. The consolidated tax returns filed by the Railroad offset the profits of the subsidiaries with the huge tax losses of the Transportation Company. It is interesting to note that the nonrailroad subsidiaries would probably not have chosen to use the accounting techniques that they did to report maxi- mum earnings had they been independent of the Railroad's influence. The non- railroad subsidiaries, however, never made any material cash payments under these tax agreements. Whatever cash inflow that was received by the Transpor- tation Company came from the profitable railroad subsidiaries. The Tax Allocation Agreements had a unique advantage to the Transpor- tation Company. If the Penn Central desired to increase its consolidated net income by increased dividend payments from the subsidiaries, but the subsidiary was not wholly owned, the minority stockholders would similarly receive their share of the dividend distribution. The Tax Allocation Agreements however, served to increase consolidated net income without the disadvantage of a pay- ment to minority interests. The effect of this was to conserve the liquid re- sources of the consolidated Penn Central by using this method of increasing net income without a distribution of cash to minority interests. Since the Trans- portation Company had no Federal Income Tax Liability (due to huge tax loss carry-overs), credit for the Tax Allocation Agreements served to increase consolidated net income. (367) 368 IMPLICATIONS OF EARNINGS MAXIMIZATION The policy of earnings maximization began with the Pennsylvania Rail- road, probably with the beginning of Saunders' term as Chairman. This policy was carried over to the merged Penn Central, and was extensively used during the period 1968-1970. In essence, the railroad followed less conservative ac- counting practices than other railroads during the same period. The result of this policy was to create a wide divergence between the reported net income and the true cash flow of the company. The main vehicles by which this policy was implemented were through transactions between the Railroad and its subsidiaries, and transactions be- tween the subsidiaries and outside firms. The effect of these transactions was to increase the profits of the subsidiaries, thereby increasing the reported net in- come of the consolidated Transportation Company. This also increased the net income of the non-consolidated Pennsylvania Company by the increased divi- dends that the subsidiaries were able to "pay" because of their marked increase in net income. These dividends frequently did not represent an actual transfer of cash to the parent company, but frequently represented a forgiveness of a debt. Another way of reporting the dividend amounted to increasing the parent company's dividend income while increasing the debt owed by the dividend declaring company to the Railroad. The main issue here is that the profits of the subsidiaries, which showed rapid growth and implied increased dividend paying ability, were in reality "paper profit*", contrived by the imaginative Accounting Department officials and financial managers of the Railroad. An excellent illustration of the prevailing attitude within the Railroad concerning this policy is seen in a memo dated October 5, 1967 from W. S. Cook to Bevan concerning a pay increase for Charles Hill, Manager of General Accounting : . . . He has been instrumental in the progress that has been made in the accounting department within the last several years. He is extremely creative, is an excellent manager, and is very cost conscious. His imagina- tive accounting is adding millions of dollars annually to our reported in- come. 15 (Emphasis added.) One of the cash effects of the earnings maximization policy was that dividends were declared by the Penn Central on the basis of reported or esti- mated net income, while the true amount of cash available for such dividends was not indicated by the company's inflated earnings. This situation existed for years prior to the merger, as stated in a memo to Saunders from Bevan on November 21, 1966 : . . . Today the cash flow of the Pennsylvania Railroad is substantially less than its reported net income. We changed the basis of consolidation and. therefore, a substantial amount of earnings of subsidiaries are included in our reported net income but are not actually available to us from the standpoint of dividends. . . . Over the short term today, the Xew York Central earnings as reported are much more real and tangible from the standpoint of an ability to pay dividends than are those of the Pennsylvania. 16 Bevan indicated that the subsidiaries income as reported by the PRR was not available for dividend payments because these subsidiaries had need of the funds they generated from operations to sustain their future activity. What Bevan did not clearly indicate was that, in some cases, the income of these subsidiaries did not represent real cash flow. That is, the subsidiaries themselves were reporting inflated or "paper profits," but were not generating a compar- able cash flow from their operations. One explanation of this policy of earnings maximization is that before the merger, the Pennsylvania Railroad needed profits to maintain the stock exchange ratio of 1.3 to 1.0. In 1962, both the Pennsylvania and the New York Central agreed to exchange 1.3 shares of the Penn Central stock for each w Memo from \v. s. Cook to I). C. Hi-van, October .">, 1!)67 ; Appendix 1). Exhibit 72, p. 732. "Memo from D.C.B. (Bevan) to S.T.S. (Saunders), November 21, 1966, Appendix D, Exhibit 50, p. 016. PENN CENTRAL CORPORATION Organization Chart (1.) NanO" cr Corr.panes Owned % C'rv.v. ntl Technical Center, Inc. 100% Fru't G'Owers Express Co. 24% G'een Real Estate Co 33% Mcntvnis C'spatch Transportation Co. 100% NY Central Development Corp. 100% Pe.m Cf"t'di Pa'k. Inc. 100% Per.ndona Irr.pt. Co. 100% Terminal Realty Penn. Co. 100% Western .wrpnoui'ng Cn. 100% • Compares Owned % Baltimore & Eastern R.R. 100% Beach Creek RR 79% Boston T-rminai Corp. 100% C* Minci Western R.R. 75% Canada Southern Rwv Co. 12% Ci-ad an Pacific Car & Paw. Tfr. 50% Central Indiana Rwy. 50% Cherry Tree & Duonville R.R. 100% Chicago R,.-er e. ir.d.ana R R. 100% Chicago Union Station Co. 25% Cleveland ti Pil'sburgh R.R. 28% Cleveland Union Terminals Co. 71% Connecting Railway Co. 26% Dayton Uninn Rwy. 33% Delaware R.R. 85% Detroit Icm-mui Railway 25% Fanpo't. Pamesvilk & Eastern 50% Fnrt Wayne Union Rwy.' 50% la v." pom & Dock B.R Term. 50% Lake Erie & Pittsburgh Rwy. 100% Mahoning Coal R R. 83% New England Tiansnortation Co. 100% New York «, Harlem R.R. 94% New York & Long Branch R.R. 50% New Yo-k Connecting R.R. 100% Nicholas, Fayette & Greenbrier R.R. 50% Niagaia Junction Hwy. 50% Pennsylvania & Atlantic R.R. 100% Penn Ridge S S Lines b7% Pennsylvania Truck Lmes. Inc. 100% Penna Tunnel & Terminal R.R. 100% Peoria 4 Eastern Rvvy. Co. 30% Peoria Or Pekirr Union Rwy 8% Phi'adeir-ni* & Trenton R.R. 11% Pittsburgh. Ft Wayne & Chicago Rwy. 100% Pullman Company ly% Railway Express Agency Holding Corp. 26% St Lawrence & Adirondack Rwy. 100% Shamokm Va'ley 6. Pottsville R.R. 29% Toledo Terminal R.R. 32% Toronto. Hamilton & Buffalo Rwy. 37% Union Freight Co. 50% Weynescrg Southern R.R. 100% West Jersey & Seashore R.R. 57% Wilkes Barre Connecting RR. 50% PENN CENTRAL COMPANY (holding company) The Penn Central empire. A chart prepared by the House Comm,ve« on Banking and Currency staff. The immense scope of what was once a $6 5 billion corporation is shown. (House Committee on Banking and Currency) 100% Owned PENN CENTRAL TRANSPORTATION COMPANY (Railroad) Clearfield Bituminous Coal Corp. Company Owned % Cambria 8r Indiana R.R. Co. 40% Foil Wayne * Jackson R.R. Co. 27% Cambna Cty. Witer Supply Co. 100% 51st Street Really Co. 100% Henrietta Water Supply Co. 100% J 00% Owned Lehigh Volley R.R. Company Owned % Bay Shore Connect. R.R. Co. 50% Buffalo Creek R.R. Co. 50% Ironton R.R. Co. 50% Lehigh & Hudso'. River Rwy. Co. 22% Niagara Junction Rwy - . Co. '25% Owasco River Rwy. Co. 50% 97% "Owned" American Contract Company ICwns 100.* of below listed companies) Merchants Trucking Co. Penntruck Co., Inc. Delbay Corpoiation Excelsior Truck Ls. Co., Inc. Northern Central Railway Company Owned Shamokm Valley & Pottsville R. R. 71% Co. Union R.R. Co. of Bait. 08% United T-lcw Jersey R.R. and Canal Co. Company Owned Phila. & Trenton R.R. Co. Associates of mo Jersey Co. l>6% 100% 100% "Owned" 80% "Owned' .53% "Ownod" 100% Owned .65% "Owned 35% 99% . Owned Cleveland. Cincinnati. Chicago & St. Louis Railway Company Owned % Central Indiana Rwy Co. 50% Union Depot Co. 50% Cleveland Union Term. Co. 22% Dayton Union Rwy. Co. 33% Indianapolis Union Rwy. Co. 40% Peoria &j Eastern Rwy. Co. 50% Cincinnati Union Term. Co. 14% Chicago & Harnsburg Coal Co. 100% ,93% Ownod Pittsburgh & Lake Erie R.R. Company Owned % Pittsburgh. Chariinrs & 50% Youghiogheny Rw Co. Montour Realty Co. 50% Lake Erie & Eastern R.R. Co. 50% Monongahela Rwy. Co. 33% Own Philadelphia. Baltimore & Washington R.R. Co. Company Owned % Union Depot Co. 50% Union R.R. Co. 42% Washington Terminal Co. 50% Waynesburg & Washington R.R. 100% Co. Indianapolis Union Rwy. Co. 60% Tylerdale Con. R.R. Co. 50% Chicago Union Station Co. 25% Pittsburgh. Chartiers & 50% Youghtogheny Rwy. Co. PENNSYLVANIA COMPANY (Investment Company) .*_J .100% Owned 21% Owned" 100% "Owned" Michigan Central Rail>oad Company Owned % Canada Southern Rwy. Co. 59% Detroit Manufacturers R R. 81% Detroit Rivei Tunnel Co. 100% Detroit Terminal R.R. Co. 25% Indiana Harbor Belt R R. Co. 30% Mackinac Transportation Co. 33% Toronto, Hamil. & Buffalo Rwy. Co. 22% Buckeye Tank Terminals, Inc. Everglades Pipe Line Co. .100% "Owned Owned Buckeye Pipe Line Company (Crude oil & Refined Petroleum Products,Pipelines ) .100% Owned I * Montour R.R. Co. (Owns 100% of listed Cos.) Youngstown & Southern R.R. Co. Montour Land Co. .50% 'Owned" 17% Owned 103% Owned L 100% Owned Richmond W J sh i rvgto n Co. P'ovioence Produ I i Warehouse Co. 76% Ownad New York Central Transport Co. Richmond. Fredericksburg & Potomac R.R. Co. 100% Owned _1_ New England Car Co. Penndel Company Company Owned . Mackinac Transp. Co. Norfolk & Portsmouth Belt R.R. Co. 33% 13% _100% "Owned" Ann Arbor R.R. Co. Manistique & Lake Superior R.R. Co. .100% . "Owned 500% Owned Manor Real Estate Company Company Owned .40% 'Owned" DTI Enterprrses. Inc. (DTI owns 60% of the listed Cos.) Delaware Car Leasing Co. General Car Leasing Co. Greencar Corp. Perils Car Leasing Co. Detroit, Toledo & Ironton R.R. .100% "Owned zr .100% . "Owned C. I. West Ve. Corp. 50% Western Allegheny R.R. Co. 100% G.S.C. Leasing Corp. 50% .74% "Owned Connecting Railway Co. Name of Company % Owned Akron & Barberton Belt R.R. Co. 25% Akron Union Passenger Depot Co. 50% Little Miami RR. Co. 79% Pgh., Youngstown & Ashtebuie 80% Rwy Co. .90% Owned 100% Owned 68% Owned Companies Owned Wabash R.R. Co. 77% Illinois Northern Rwy. Co. 12% Pullman Co. 16% Norfolk & Western Rwy. Co. 23% Penn Towers. Inc. 40% Toledo, Peoria & Western 50% Rwy. Co. West Jersey & Seashore RJV 28% Great Southwest Corp (Real Estate Devtl opment Corporalonl (Owns 100\ol Listed Cos I GSC Apartments, Inc. GSC Oevelopmem Corp. GSC Industrial Props, Inc GSC Propertres. Inc. Leadership Mort. Iny. Co. Six Flags. Inc. Sin Flaos Inn, Inc. Macco Corpoiation (Real Fst.nel (Owns 100%of Listed Cos) Balmoral Homes, Inc. Bar M Bar Ranch. Inc Bonnie V illey Corp C.ipiMvanii Highlands Casfleli.iy Devi Ip Co Courtyard Homes Custom Planning, Inc GlcneaglrSl Fsi.iies, Inc Jamboree lend Co Leadership Homes. Inc Marco Busmen Props , Inc. Macro Drstr ibutors. Inc Macco Indus Props , Inc. Newport H.nbor Hemes. Inc. fVnll. mil Homes Ranctio Santa Barbara Rer reatuin Concept!, Inc. Richardson Homes Corp. Scnppi Mnamei Oereiop. Co Strathaven Estates Terlan Homes. Inc. Temerula Invest Co. Waverly Homes, Inc. Weslchffe Adverns.Co. Arvida Corporation (Real Esiate Devel- opment Corporation) (Owns 100% of listed Cor) Arvida Realty Sales. Inc. Frank B. Morgan A Co. University Park Water Co Arvida Mortgage Co. Source: The Wreck of the Penn Central, pp. 112-113. — ■■ Non-Curt cr Companies Owned % C'rveLnd Technical Center, Inc. 100% Fruit Growers Express Co. 24% G'een Re.il Estate Co 33% Merchants D'spatch Transportation Co. 100% NY Central Development Corp. 100% Penn Central Park, Inc. 100% Per-ricii.ina lrr.pt. Co. 100% Terminal Realty Penn. Co. 100% Western wVarehoui'ng Co. 100% Carrier Companies Owned % Baltimore & Eastern R.R. 100% Beach Creek R.R. 79% Boston Terminal Corp. 100% Can. met Western R.R. 75% Canada Southern Rwy. Co. 12% Conad an Pacific Car Si Past. Tfr. 50% Central Indiana Rwy. 50% Cherry Tree & Dixonville R.R. 100% Chicago River ri Indiana R.R. 100% Chn.-9'i Un.on Station Co. 25% Cleveland & Pit'sburgh R.R. 28% Cleveland Union Terminals Co. 71% Connecting Railway Co. 26% Dayton Union Rwy. 33% Delaware R.R. 85% Detroit Terminal Railway 25% Fa.iport. Pa.nesv.lle & Eastern 50% Fort Wayne Union Rwy.' 50% Lakepuri & Dock R R Term. 50% Lake Er.e & Pittsburgh Rwy. 100% Mahnmng Coal R R. 33% New England Transportation Co. 100% New York & Harlem R.R. 94% New York & Long Branch R.R. 50% New Yo-k Connecting R.R. 100% Nicholas. Fayette & Greenbrier R.R. 50% Niagara Junction Rwy. 50% Pennsylvania Si Atlantic R.R. 100% Penn Ridge S S. Lines b7% Pennsylvania Truck Lines. Inc. 100% Penna. Tunnel & Terminal R.R. 100% Peoria & Eastern Rwy. Co. 30% Peons & Pekirr Union Rwy 8% Philadelphia & Trenton R.R. 11% Pittsburgh, Ft. Wayne & Chicago Rwy. 100% Pullman Company 19% Railway Express Agency Holding Corp. 26% St Lawrence & Adirondack Rwy. 100% Shamokm Valley & Pottsville R.R. 29% Toledo Terminal R.R. 32% Toronto, Hamilton & Buffalo Rwy. 37% Union Freight Co. 50% WaynesCag Southern R.R. 100% West Jersey & Seashore RR. 57% WiUes Bane Connecting RR. 50% 17% Owned 1 103% Owned iy the House Comm.vco on pe of what was once a 56 5 i on Banking and Curtency) COMPANY -smpany) Clearfield Bl Company O Cambna & I Fort Wayne Cambna Ct^ 51st Street I Henrietta Vv Lehigh Voilf Company Bay Shore C Buffalo Crei Ironton R.R Lehigh & Hi Niagara Juni Owasco Rts'i Northern Ce Company O Shamokin V Co. Union R.R. United T^'ew and Canal C Company 0^" Phila. & Tre Associates o 100% Ov. nod Richmond Washington Co. P.-ovioence Produc Warehouse Co. New York Centra Transport Co. 76% Ownud Richmond. Fredericksburg & Potomac R.R. Co. 100% Owned vned New England Car Co. .90% ' Owned 100% Owned Great Southwest Corp (Real Estate Devel opinrnt Coiporot onl (Owns 100% of Listed Cos) 58% Owned to. irn Rwy. Co. Item Rwy. Co. inc. i & Western 77% 12% 16% 23% 40% 50% Seashore RA 78% GSC Apartments, Inc. GSC Development Corp GSC Industrial Props. Inc. GSC Properties. Inc. Leadership Mort. Inv. Co. Six Flags. Inc. Six Flaas Inn. Inc. Macco Corporation (Real Estate) (Owns \0>>X of Listed Cos) Balmoral Homes. Inc. Bar M-Bar Ranch. I"C Bonnie Valley Corp Capistvann Highland! Castlebay Devi Ip Co Courtyard Homes Custom Planning. Inc Glene.igles Estates, Inc Jamboree land Co Leaik'iship Homes, Inc Mai co Business Props . Inc. Macro Distributors. Inc Macco Indus Props, Inc. Newport H.etior Hemes. Inc. Pentland Homes Rancho Santa Barbarl Recreation Concepts, Inc. Richardson Homes Corp. Scnpps Muamer Develop. Co Strathaven Esiales Tertan Homes. Inc. Temerula Invest Co. Waverly Homes. Inc. Westclille Adverbs Co. Arvida Corporation (Real Estate Devel- opment Corporation) (Owns 100% of listed Cos) Arvida Realty Sales. Inc. Frank B. Morgan & Co University Park Water Co Arvida Mortgage Co Source: The Wreck of the Penn Central, pp. 112-113. 369 share of New Yoi'k Central stock, and 1.0 shares of Penn Central stock for each share of Pennsylvania Railroad stock. Thus, if the per share earnings of the Pennsylvania were much lower than 76.9% of the comparable earnings of the New York Central, there might be pressure to change the exchange ratio. Post merger, the earnings maximization policy could be justified on the basis of the Penn Central's need for external financing. If Penn Central's earnings were poor, the interest cost of debt financing might be much higher, assuming ex- ternal funds would be available at all. The increased divergence of net income and cash flow which resulted from the earnings maximization policy had serious implications for the Transporta- tion Company. It was paying large cash dividends, following a massive capi- tal expenditure program to modernize and improve the railroad, and diverting significant amounts of cash into non-raih*oad activities. Further, it was obliged to finance these programs with debt issues, since the railroad itself was not generating enough cash to fund these activities. The diversification of the Pennsylvania Railroad, and later the Penn Cen- tral, was consummated by the Pennsylvania Company, a wholly owned subsidi- ary of the Railroad. Thus, when a discussion of the diversification of the company indicates that the Railroad invested heavily in these non-railroad sub- sidiaries, it is technically in error. Granted, the Railroad did invest in non- railroad subsidiaries, but the investment was either minimal, or was. sold to the Pennsylvania Company shortly after the investment was made. Also, there are significant implications, resulting from the way the dividends and income from these subsidiaries were handled, which must be carefully considered before one indicates that the Railroad showed a significant improvement in its earnings because of the ''paper profits'' generated by these subsidiaries and the excess dividends forced by the parent company. The Pennsylvania Company provided most of the funds that were directly invested in non-railroad subsidiaries, even though some of these funds might initially have originated from the Railroad. The investments were recorded, therefore, on the books of the Pennsylvania Company. The dividends that re- sulted from this diversification were income to that company, thus increasing its ability to pay dividends to the Transportation Company. On a non- consolidated basis, the only effect of these transactions on the Railroad was the Pennsylvania Company dividend. On a consolidated basis, however, the Rail- road received the benefit of the higher income of the consolidated Pennsylvania Company, since these earnings are included in consolidated Railroad income. If one remembers that the dividends paid to the Transportation Company by the Pennsylvania Company remained constant at $24 million from 1966 to 1970, it is seen that the Transportation Company's non-consolidated dividend income was not improved by the diversification. The only source of dividend income to the Transportation Company from the non-railroad acquisitions was the dividends of the Pennsylvania Company. Consolidated Railroad income was significantly improved by the inclusion of all the subsidiaries. It is this im- provement that is generally referred to as the inflated earnings due to the diversification program. It is important to realize that the Railroad used these subsidiaries as a vehicle for certain earnings maximizing transactions which are discussed in another section. Since the diversification program was carried out by the Pennsylvania Company, the accounting distinctions made concerning the way in which the dividends and earnings of the acquired companies were reported are important. These distinctions are not as significant, however, when one is concerned with the economic effect on the entire Penn Central conglomerate. The economic reality is that the funds expended by the Pennsylvania Company could have been available for use by the PCTC. The Pennsylvania Co. was regarded as a major source of financing by the Railroad, and therefore its borrowing power was, to a degree, dependent upon its earnings. The Pennsylvania Company's importance to the PCTC's financing requirements is illustrated in the minutes of a PCTC Finance Committee meeting of May 1963 : . . . He (Bevan) stressed the importance under these conditions of maintaining liquidity and credit. Liquidity is presently provided by Nor- 370 folk and Western stock and this fact is recognized by financial institutions. Credit is available in the Pennsylvania ( onipany and it is essential to con- tinue this situation for purposes of further borrowing. 17 Probably most significant, is the point made at this meeting with respect to earnings maximization and the investment policy of the Pennsylvania Company, which is broughl out in the next section of the minutes : ... A third important ingredient in the financial picture is the necessity of replacing the income which is currently being received on the Norfolk C>!) annual report. This gain did not result in a cash inflow, but rather represented a "paper profit" on the exchange of securities. The consistency in financial reporting by Penn Central seemed to be that of valuing transactions on whatever basis that would show a profit to the Transportation Company. When PCTC sold this stock to the Pennsylvania Company in July. 1969, the selling price was PCTC's book value, even though the stock was selling on the open market at about $2.50 per share less. The Transportation Company could not afford to record a loss on the trans- action, while the Pennsylvania Company would not have to show a loss until the stock was sold. The key issue in this transaction is that a cash flow did not occur, thus income was increased by Siil million, and yet the Railroad was not in any better condition to pay the dividends that it was to declare at the end of the year. Further, the inclusion of this item in ordinary income was misleading to investors who were not informed about the nature of the transaction. "Minutes. Meeting of PRR Finance Committee, May 21, 1963; Appendix D, Exhibit 70, p. 730. WMinutea Meeting "t I'RK Finance Committee, May 21, 1963; Appendix D, Exhibit 70. p. 7.10. 371 In the same year, the PCTC reported a dividend declared by a subsidiary at its market value, as opposed to book value. The Penn Central and the B&O Rail- road each owned 50% of the Washington Terminal Company, which owned Washington Union Station. After preliminary negotiations with the Depart- ment of the Interior concerning the proposed leasing of the station by that agency, an independent appraiser valued the property at $27,050,000. In antici- pation of leasing this property to the Government, and to simplify a compli- cated tax situation, the Washington Terminal Company formed two subsidiaries, the Terminal Realty Penn Company, and the Terminal Realty Baltimore Company. Each of these newly formed subsidiaries received 50% ownership of the Washington Union Station, their sole assets. The Washington Terminal Company then declared a dividend of 100% of the stock of these two subsidiaries to the Penn Central and the B&O. Penn Central recorded the value of its dividend (100% of the stock of the Terminal Realty Penn Company) at the appraised market value of $13.7 million, while the B&O recorded the 100% stock dividend of the Terminal Realty Baltimore Company at its more con- servative book value of $3,107 million." The appraised value of the Penn Cen- tral's dividend was later adjusted from $13.7 million to $11.7 million. One of the major complications was that this did not represent a cash flow, but rather the valuation of an asset at an appraised value that might never be realized. Even if the lease were signed with the Department of the Interior, it would be many years before the PCTC would realize its full share, of the appraised value. The next item was the dividend declared by the Strick Holding Company to PCTC. The Holding Company was a non-operating unit whose principal assets consisted of its holdings in its two operating subsidiaries, the Strick Corp., and Transport Pool, Inc. The Holding Company's investment in these two subsidiaries consisted of advances of $8.2 million and the book value of its investment of $2.3 million, for a total of $10.5 million. The selling price of these subsidiaries was $27.!) million; and consisted of $15 million in cash, promissory notes for $9.4 million, and the balance in warrants to purchase the stock of the firms formed to acquire these subsidiaries which were independently valued at $1.7 million. PCTC had an investment in the holding company of $15 million in cash and advances of $9.4 million. The transaction to record the proceeds from the sale was recorded on the books of Penn Central Transportation Company, not on the books of the Strick Holding Company, i.e. PCTC received the notes and cash, and then recorded a long term liability to Strick Holding Company for this amount. The PCTC received the value of its initial investment back. The Holding Company, however, reported a profit on the sale of these subsidiaries in the amount of $17.4 million. It is at this point that the policy of earnings maximization worked to the detriment of cash flow. By handling the transaction such that the holding company sold these subsidiaries, a sig- nificant profit was reported, which increased the tax liability of the Holding Company. While it is true that the Federal Income tax would be offset against the PCTC s tax losses, there was a Pennsylvania State tax which amounted to $787,291 which was paid by PCTC. The profit the Holding Company reported served as the basis for the declaration of a $5.0 million dividend to the Transportation Company. It was ultimately recorded at $4.8 million, the decrease due to the tax paid by PCTC. Thus, to record a $4.8 million dividend, the Transportation Company paid more than $750,000 in taxes. Had the Transportation Company sold the Strick Holding Company instead of having the Holding Company sell its operating subsidiaries, there would have been a smaller profit on the transaction, and a much smaller tax bill from the State of Pennsylvania. The timing of these transactions is of some importance, also. Both the Madi- son Square Garden stock exchange and the sale of the Strick subsidiaries oc- curred during December of 1968, a time when the officers of PCTC were well aware of the impending losses to be reported by the PCTC unless profits and/or dividends could be obtained from an extraordinary transaction. During the same period, 1968, PCTC relied more heavily upon the earnings of its subsidiaries than in prior years. The effect of maximizing the earnings 372 of the subsidiaries was to increase the reported net income of the consolidated PCTC. Also, the tax allocation agreements provided income in the amount of 95% of the subsidiaries' tax liability. The Transportation Company was never to receive any cash from the non-railroad subsidiaries for the tax allocation agreements even though a receivable was set up on the books of PCTC against the subsidiaries. The maximization of earnings of Great Southwest Corp. for example, worked to the disadvantage of that subsidiary, and to the benefit of PCTC. A September 12, 1969 letter from W. C. Baker, president of GSC, to Bevan indi- cated some of the disadvantages that resulted from the tax allocation agree- ments : . . . By the very nature of GSC's real estate operations, it operates in a constant tenuous cash position. This is nothing peculiar to us, but is a fact inherent in our business. Thus, the necessary effect of the tax allo- cation agreement is to drain resources from one of the major earnings contributors to the consolidated group; thereby hindering and restricting its ability to continue being a major contributor of such earnings. As I noted earlier, if called upon immediately to pay its full accounts payable to Penn Central, arising from the tax allocation agreements. GSC would be unable to do so, because it just does not have the cash. By the same token, we are expected to independently finance our own operations insofar as possible, but, at the same time, our ability to do so is lessened by the fact that our balance sheet must show this resulting substantial account payable to Penn Central Parent. Again, therefore, I personally question whether, in the exercise of reasonable business judgment, this is proper utilization of group financial resources. Baker also discusses the relative disadvantages of the. earnings maximization policy used by GSC at the request of Penn Central. ... a disgruntled minority shareholder could nevertheless easily argue that GSC at the direct instance of the Penn Central, sold two of its substantial and profitable assets solely to produce substantial profits for the majority shareholder within given financial periods. . . . not only was GSC's income from such assets reduced, but there was no longer any depreciation whatever to offset such income; the result being that every dollar of the substantial tax savings that would otherwise be lost to the Internal Revenue Service by GSC (on a separate return basis), now amounts to a loss of $0.95 to Penn Central, at least in the form of an account payable (on a consolidated return basis), as a result of the Tax Allocation Agreement. 10 The point to be made is that the subsidiary had front ended its profits, resulting in a higher tax liability to the PCTC because of the tax allocation agreement, and yet had no cash to pay this debt. Further, carrying the payable to Penn Central on its books made external debt financing more difficult to obtain for Great Southwest. The degree of earnings maximization is illustrated by GSC and Macco, two real estate subsidiaries of the Pennsylvania Company. In 1968, GSC and Macco reported income of $9,654,000 and $21,021,000 respectively, for a total of $30,- 675,000. Because of the nature of the sales that generated these profits, two ac- counting methods have applicability. The first records the entire profit in the period in which the sale is made, regardless of the amount of payment received. The second, and more conservative approach records the profit on an installment basis, the amount of profit recorded is equal to the percentage of payment re- ceived in that period. If these subsidiaries had reported these sales on an install- ment basis, the profits would have decreased from $.30.7 million to $9.4 million, a $21.3 million decrease. Another method of improving earnings involved the write-up of reuseable material removed from scrapped equipment. These materials were recorded in inventory at nominal carrying value. When these materials were renovated in 19 Memo from William C. Baker to David C. Bevan, September 12, 1969; Appendix D, Exhibit 51, P. 618. 373 the PCTC repair shops, they were increased in value in inventory to a "stand- ard carrying value", the offset being a reduction of operating expense. If the parts were then used to repair equipment, they were expensed. However, if they were used in the rehabilitation of equipment — equipment that would either be sold, or the repair costs capitalized — the materials were written-up to 75% of replacement cost, the offset again being a credit to expense. The total write-up of inventoried material in 19(58 at the Altoona repair shop alone, was as follows : Writeup from nominal to standard $4,938,000 Writeup from standard to 75 percent of cost 3, 369, 000 Total writeup 8, 307, 000 All of the write-up from standard to 75% of cost, and the bulk of the write- up from nominal to standard went to decrease operating expenses. 20 During 1969, the earnings maximization policy had an even greater effect on reported income. The front-ending of profits by GSC and Macco resulted in an overstatement of their income by $30,521,032. Thus, their reported net income before tax of $51,569 million, could have been restated to $21,048 million, and the resulting tax liability would have also been reduced. The effect of certain non-cash transactions on the reported net income of the PCTC was to increase net income by $15,326,100. This was the result of two specific transactions, the details of which follow : The New York Central Transport Company (NYCTC) declared a $14,500,- 000 dividend to its parent company, the PCTC. NYCTC could only afford to pav 82.5 million in cash, and so the rest of the dividend, $12 million, was re- corded as a payable of NYCTC to PCTC. But, instead of NYCTC recording the payable as "dividends payable", which is a current liability, it was recorded as a long term payable to PCTC. In this transaction, the cash actually did change hands. The $12 million that remained outstanding as a payable, actually did get paid to PCTC, and was immediately repaid to NYCTC. In fact, the transactions were almost a simultaneous transfer from NYCTC to PCTC and then back again. The next transaction is a bit more complicated, but briefly it occurred as follows : PCTC advanced to Penntruck Co., Inc., and Merchants Trucking Co., $1.7 million and $0.3 million respectively. These subsidiaries are wholly owned by American Contract Co., a wholly owned subsidiary of PCTC. The advances were then paid to American Contract by Penntruck and Merchants Trucking. Meanwhile, Excelsior Truck Leasing paid a $1 million dividend to American Contract. Thus, the $3 million received by American Contract from its subsidiaries, $2 million of which originated with PCTC, was declared as a dividend from American Contract to PCTC. It would seem that $2 million of this had just made a circuit through two subsidiaries and was returning to the orginator, PCTC, as cash and dividend income. However, the $3 million was dividend income, but no cash was returned to PCTC. Instead American Con- tract used the dividend declaration to offset a debt owed to it by PCTC. The result of this was to decrease PCTC's cash by $2 million in advances to sub- sidiaries, while increasing its reported dividend income by $3 million. PCTC also reported decreased maintenance expense during 1969 because of the write-up of reuseable materials, offsetting this write-up as a credit to expense. Writeup from nominal to standard $7, 913. 000 Writeup from standard to 75 percent cost 4,224,000 Total writeup 12, 137, 000 While not all of this write-up was offset as a credit to expense, a substantial portion of it was used to decrease expense. For the first six months of 1970, information is not presently available concerning the maximization of the earnings of the subsidiaries. The Trans- portation Company accelerated the earnings it could report from extraor- dinary items in the first quarter of the year, in hopes that the improved earn- 20 Interstate Commerce Commission, Docket No. 35291, Penn Central Investigation, verified statement 36. pp. 48-9. 374 ings of the consolidated Penn Central would result in the successful issuance of $100 million of Pennsylvania Company debentures, the funds desperately needed by Penn Central to continue operations. In March, L970, PCTC sold its holdings of the Clearfield Bituminous Coal Company to the Pennsylvania Company at its equity value of $16,938 million. The book value of this investment on PCTC's hooks was $82,200. Thus. PCTC reported a profit of $16,856 million on the sale of these holdings. In a direct attempt to report increased earnings in the first quarter, PCTC negotiated an agreement with Norfolk and Western to accelerate an exchange agreement in which the Pennsylvania Company's holdings of Wabash Pail- road stock would he exchanged for Norfolk and Western stock. The gain on this transaction was about $50 million; it did not represent an inflow of cash to the company, and it was executed soldi/ for the purpose of improving the earnings of the first quarter. Associated with this exchange, N&W demanded certain concessions, one of which was the sale of land to N"&W which was owned by PCTC. The appraised value of this land was $858,600, and it was sold to N&W for $572,400, a potential cash loss of $286,200. A quarter of a million dollars was given up by PCTC in order to improve its earnings, and it did report a profit of $508,927 on the sale of the land. In 1970, the write-up of reuseable materials in inventory increased mark- edly, as indicated below : Writeup from nominal to standard $11,584,000 Writeup from standard to 75 percent cost 658, 000 Total writeup 12, 242, 000 The bulk of the $12,242 million was credited to expense during this period, and yet this decreased expense did not represent an inflow of cash. To summarize the transactions described in the preceding sections, spe- cifically their impact on earnings and cash flow, the chart below r is presented. PENN CENTRAL TRANSPORTATION CO. (COMPANY ONLY) EFFECT OF NONCASH TRANSACTIONS ON REPORTED NET INCOME [Millions] 1968 1969 1970 Reported net i ncome Deduct: Noncash items: Inventory write-up ■_ Dividends. _ Deduct: Extraordinary: Profits __ Sale of land (profit) _ Conservative net income (loss) estimate.... (42.73) (110.14) (131.37) GENERAL COMMENTS ON EARNINGS MAXIMIZATION There are some aspects of the earnings maximization policy that do not lend themselves to an analysis of income effect by time period. Even though the amounts of these transactions might be small in comparison with those previously discussed, the point to be made, is the management philosophy which prompted handling these transactions the way they were handled. The Railroad had a policy of using sale-leaseback arrangements wherever possible. This topic has been discussed in detail elsewhere. It is interesting to note that PCTC charged the freight costs of transporting equipment to be used in rehabilitating equipment to the sale-leaseback transactions. If the PCTC repair shops needed parts to rehabilitate the equipment for the owners, the cost of the equipment was its cost to PCTC 1 plus a charge for transporting along PCTC lines. This resulted in additional revenue for PCTC. and for additional costs of leased equipment to PCTC. However, the increased costs of this leased equipment were paid for over the life of the lease. In essence, the Railroad re- ceived cash in the present period, but paid higher rentals for the life of the lease. Not only is this in direct violation of generally accepted accounting principles, but it is also in violation of ICC accounting regulations. These ($2. 77) 8.00 16.50 ($82.81) 12.00 15.33 .. ($102.0) 12.00 21.00 ... 16.86 .51 375 regulations require that such charges must equal at least "50% of the reproduc- tion cost in kind, new, exclusive of repaired material and dismantled labor cost." 21 An ironic twist to the earnings maximization policy of the Eailroad ap- pears in employment contracts of the officers of Macco and Great Southwest. An incentive compensation agreement was signed by the Boards of Directors of these firms and the officers, which provided for a base salary and also additional compensation based on the reported net incomes of the firms. These agree- ments had no ceiling: the higher the profits, the higher the income for the officers. The irony is that after these contracts were signed these subsidiaries were urged to maximize their profits to improve the consolidated earnings of the Transportation Company. The additional compensation paid as a result was a significant sum of money. The employment contracts (as amended in 1968), provided that the follow- ing compensation shall be paid to the officers : Base Incentive Officer Position salary (percent) ' Wynne, A. G Chairman $25,000 3 Baker, W. C__._ President ._. 60,000 2 Ray, W. D Executive vice president 35,000 1 Caldwell, H.L ..._ do 55,000 1 ' Incentive compensation was based on net reported income in excess of $10,000,000 in any fiscal year. Thus, Wynne received 3 per- cent of the net income in excess of $10 million, Baker 2 percent, and Caldwell and Ray 1 percent each. Additional provisions in these five year contracts called for a severance pay of $3 million to Wynne, $2 million to Baker, and $1 million each to Ray and Caldwell, should any of them have their employment terminated by the Company. The result of these agreements in cash paid by Macco and GSC are as follows : Wynne Baker Ray Caldwell December 1968... June 1969 Settlements July 1969 August 1969 December 1969 January 1970. Total. $200, 000 99, 000 1,000,000 .. $130,000 69, 000 $70, 000 29, 000 $30, 000 69, 000 2,000,000 125, 000 100, 000 40, 000 35, 000 55, 000 3, 124, 000 299, 000 174, 000 154, 000 Thus, $3,751,000 was paid to these officers as a part of their employment contracts. The payments listed under "settlements" above, are due to the can- cellation of the old employment contracts, and the renegotiation of new con- tracts. There is some question that the settlements provided for in these con- tracts were not legally binding on the Company, since there was a clause in each of them providing that the contracts could be terminated at will by the Company. The point is that Saunders, Gerstnecker, and Bevan, all members of the Board of Directors of GSC, signed the minutes of the June, 1968 Board of Directors meeting indicating that they had read the individual contracts and gave their approval. Bevan sent a copy of the minutes to Saunders, who was not at the meeting, and received his signature on October 23, 1968. Bevan indicated that the contracts were similar to other contracts within the industry, and with the contracts that were approved several years before when PCTC first acquired control of Macco. The approval from Saunders in October validated the con- tracts, each of which was dated June, 1968. Less than 7 months later, Bevan had Saunders sign a memo to the effect that these contracts would be terminated, and the settlement penalties would 21 Id. at p. 50. The amount of these freight charges during the 1968-1970 period was $2,457 million. 376 be paid to the officers. Saunders indicated that he understood that the settle- ments were "the best that can be made under the circumstances". 22 There was no serious attempt made to verify the legality of the contracts or the settlements. The settlements imply that the earnings of Macco (in l!M - >!) Macco merged with GSC) would be $35 million, and do not take into considera- tion discounting the settlement payments. 23 It seems that Bevan was a supporter of these contracts, and indicated to Saunders that these contracts were reasonable and characteristic of those within the real estate industry. Although this is speculation, it seems incongruous that any financial officer as experienced as Bevan would be ignorant of the nature of these contracts. That is, that the salaries of the officers had no ceiling, and that the earnings of the Company were highly variable depending upon which accounting treatment was used. Thus, Bevan might have advocated the con- tracts as incentive to the officers to use liberal accounting practices to deliber- ately "front-end" profits; thereby furthering both their interests and the earnings maximization needs of the Penn Central Transportation Co. The Transportation Company engaged in other policies and practices which depressed current expenses in an effort to improve the .reported net in- come of the Railroad during the post-merger period. Unfortunately, data does not appear to be available to indicate the dollar magnitude of such practices, although there are indications which lead one to believe that the amounts of money are significant. One of the more interesting practices was that of capitalizing repairs to rolling stock. While ICC accounting regulations specifically proscribe the capi- talization of repairs of owned equipment, the Railroad would sell the equipment to "straw parties", repair or rehabilitate the equipment for the new owners in the Railroad's repair shops, and then lease back the repaired rolling stock from its new owners. The effect of this procedure was to decrease the amount of maintenance ex- pense, provide cash to the Railroad for general corporate use, remove the sold equipment from the provisions of the general mortgage bonds under which it was originally financed thus allowing it to be used as collateral for funds to finance the repairs, and provide increased lease payments in future periods to cover the cost of overstated repair estimates for this equipment. One procedure by which the sale-leaseback arrangements were consum- mated was an initial sale to a "straw party" of used rolling stock or equipment. The Railroad would then negotiate an agreement with the new owners to repair the equipment for an estimated amount of money. The new owners would then negotiate sale agreements between themselves and a subsidiary of the Railroad. The subsidiary would then lease the property to the Railroad, and assign the lease to a bank or other financial institution.-' The fee of the "straw party" was the equivalent of the amount of the investment credit. This was done for several obvious reasons. As mentioned above, the sale of the equipment removed it from the provisions of the general mortgage bonds of the Transportation Company. It then became available as collateral to finance the renovation. The expense of the renovation was not charged against in- come, but lather was capitalized on the books of the new owners. Finally, the financing obtained from the banks to pay for the renovation was based on the estimated costs of such renovation. The Railroad consistently overstated these cost estimates, thus the difference between the actual costs and the funds avail- able from financing was then made available for general corporate use. This meant that the increased repair costs were paid over the life of the lease, but the Railroads present need of cash for survival was a much more immediate concern than the increased lease payments in the future. Another way the Railroad decreased current expense was the liberal use of the merger impairment reserve to charge off the labor costs the Railroad felt was due to a labor protection agreement. This agreement was signed by 23 Memo from S. T. Saunders to D. C. Bevan, June J, 1969; Appendix I). Exhibit 7.".. p. 7."i.'i. 11 Wayne's $3 million settlement, for example, was equal to incentive compensation of $75,000 pet year, based on profits of $35 million. Had the payments been discounted at 8 percent for example. n\er tlie remaining 4 years of the contract, Wynne's payments would have been $2,205 million. The premise that the earnings would have been *33 million for the next 4 years is very questionable. 21 Interstate Commerce Commission, Docket No. 35291. Penn Central Investigation, Verified Statement 36. p. 47. 877 Saunders and Perlman on May 20, 1964, and required that in the event of merger, to take into the merged company all PRR-NYC employees : who are willing to accept employment and that none of the present employees of either applicants shall be deprived of employment or placed in a worse position with respect to compensation, working conditions, fringe benefits or rights and privileges pertaining thereto at any time during employment. 25 A major problem here was that the agreement was one of a kind, and accurate estimates of the costs of some of the provisions were not available. One of the worst aspects of this agreement was the delay in consummating the merger. The three year delay meant that any furloughed employee must be given a job by the merged Railroad. The costs of this were readily determinable by De- cember of 1967. The total labor cost estimate of the agreement, initially pro- posed at $78.2 million over eight years would now cost $195.2 million. The in- creased $117 million was the estimated cost of the recalled labor. Provisions for this cost were included in the Merger Impairment Reserve, set up by the Railroad in 1967 in the amount of $275.4 million. The total amount paid in connection with the labor protection provisions was $54.4 million not including $5 million in relocation expenses. In 1968, $22,460 million was charged against this reserve, and in 1969 $12,604 million was charged against the reserve. While conceptually the Railroad and the ICC agreed that these costs would not have been incurred had there been no agreement, the use of the impairment reserve to charge employee's wages when the employees were work- ing opened the door to disagreement concerning how the account should be handled. The Railroad was charging the wages of operating employees against this account, if the employee had been recalled as part of the labor protection provisions. Although the propriety of these charges has been strongly defended by the PCTC, there are questions about how an employee's time can be charged to a reserve account if that employee is engaged in productive labor. The Railroad's position was that these employees were operating at far less than a standard level of efficiency established by the Railroad. The exact amount of charges to this reserve, which applied to recalled labor in 1968 and 1969, amounted to $14,842 million and $8,126 million respectively. The total amount of $22,968 million eludes analysis of what should have been charged to operating- expense, and what was a reasonable allocation to the merger impairment reserve account. 26 CONCLUSION One of the most important questions concerning the Penn Central debacle centers on the effects of the earnings maximization policy and the degree to which this policy contributed to the ultimate financial collapse of the Trans- portation Company. While an obvious effect of the policy was to improve the earnings of the Transportation Company by profits on inter-company transactions and large non-cash dividend payments extracted from the subsidiaries, the result of this was to conceal the true crisis that the Railroad faced, e.g. constant operat- ing losses and a poor (and frequently negative) cash flow from ordinary operations. In the sense that this is considered from an investors viewpoint, they were certainly misled by the devious machinations which produced a significantly inflated net income figure. The financial community was also led to believe that the Railroad was performing better than it really was. On a consolidated basis, with most of the intercompany profits and divi- dends eliminated, the Penn Central still benefited from the ''front-ended" profits of some of the real estate subsidiaries. The point is that the profits were significantly improved on both a consolidated and non-consolidated basis, and this improvement was deceptive to the investing community. While this approach may be rationalized on a pre-merger basis as an at- tempt to preserve the long agreed to exchange ratios; and on a post-merger 25 Penn Central Merger, 327 ICC at 684. 20 See Interstate Commerce Commission, Docket No. 35291. Penn Central Investigation. Verified Statement 11. Exhibit XPE S ; Reproduced in Appendix D, Exhibit 74, p. 733. 378 basis- as a means of providing a profit picture which would facilitate financing arrangements, it is still a rationalization. There is another aspect of earnings maximization that is quite significant : What was the effect of this policy on.the subsidiaries? While not all subsidiaries were "bled" of dividends and "forced" to maximize earnings, those that were affected by the Railroad's policy were damaged because of it. Subsidiaries were forced to provide financing for their own operations to the greatest extent possible, and yet had to pay taxes to the Railroad instead of the Government. GSC and Macco are prime examples of companies that had a potential of future growth, and suffered serious liquidity problems, directly because of the policies and requirements urged upon them during the period when the Transportation Company exerted strong influence over their opera- tions. In a sense, the Railroad drained every dollar of profit from them that it could, without providing anything to them in return. Probably the most vexing question concerning the earnings maximization policy is the extent that the Railroad suffered from budget cuts and de- creases in maintenance expenditures in a desperate attempt to show a profit. The reason this is the most difficult question is that the Railroad had been un- profitable, so how could additional (and excessive) maintenance and capital expenditures be justified? It was a vicious circle. The Railroad could not make a profit because of poor service, partly due to poorly maintained facilities and equipment. But when vast sums were spent on capital improvements, the Rail- road could not generate any return on the investment. How could Bevan justify borrowing funds at 8-10% and not receive any return on the funds borrowed? Obviously Bevan felt that the way to maintain the Penn Central as a viable operation was to offset the unprofitable Railroad with the profits of the subsidiaries. The earnings maximization, to the extent that it deceived the investing public, drained the resources of its subsidiaries, deferred maintenance and capi- tal expenditures, and sought to improve profits at the expense of losing cash, certainly postponed the seemingly inevitable reorganization, but at a great cost to everything that came under its influence. Dividend Policy The dividend policy of the PRR and later the PCTC has been criticized because of the excessive payouts relative to both reported net income and cash provided by operations. It might be that the Board of Directors simply was not aware of the financial situation of the Railroad or acted solely upon information presented by the Finance Committee (discussed subsequently), or there was a conflict of interest between the members of the Board's personal interests and their responsibility to the Penn Central. Before the merger, it may be argued that the dividend payout of the PRR was influenced to a strong degree by the merger agreement signed in 1962. From 1964 to 1967, the dividend payout per share for the NYC and PRR approxi- mated the 1.3 to 1 stock exchange agreement. That is, the NYC dividend was close to 1.3 times the PRR dividend. The dividend payout ratios and the ratio of PRR dividends to NYC dividends appear below : PENN CENTRAL TRANSPORTATION CO. DIVIDEND PAYOUT RATIO' 1963-69 IPercent) Class I Year PRR NYC PCTC Class I (adjusted)' 1963 .._. 73.75 46.47 61.89 1964 58.96 43.62 51.58 1965. 81.60 43.69 60.18 1966 70.99 43.23 56.37 1967 237.70 1,747.58 359.21 1968. 0) 1969 - ( 3 ) > Computation: dividend paid/net income after tax. ' Restated to eliminate PRR and NYC dividend payouts. » Negative ratio: 1968, $55.400,000/— $2,800,000; 1969, $43,400,000/-$82,800,000. Source: Moody's. 58 158 65 67 58 58 55 55 167 157 91 81 105 81 379 While the 1963-1966 dividends payouts are not significantly different from those of all Class I railroads, the PRR paid a much higher dividend relative to net income than the NYC. When this is coupled with the acute cash shortages that plagued the railroad, it is difficult to justify the dividends paid by the PRR as being anything but excessive. Even so, the fact that dividends had been paid consecutively since 1848 was a strong factor in maintaining a dividend payment. Breaking a record of consecutive payments of over 115 years might not have been justified, but the magnitude of the dividends paid is inexcusable. The computations presented in the preceding table are for the Transporta- tion Company only, not for the Penn Central System. While it can be said that this is not a valid comparison, it is illustrative of the payout ratios from the most significant aspect of the Penn Central System in terms of income gener- ating power available for dividend payouts. That is, the income generated on a consolidated basis was not available for dividends since the subsidiaries had their own needs for the funds that they generated from their operations. A major question of responsibility for the dividend payouts leads to a pres- entation of how th * dividends were appi*oved. Usually the Finance Committee of Penn Central met to evaluate the earnings and proposed dividends : from this evaluation came a recommendation to the Board of Directors for their consideration. The Finance Committee's minutes for May 13, 1969 read as follows : The Chairman of the Board reviewed briefly estimated earnings on a consolidated basis for the second quarter of the year. He reported also on the steps taken to improve the earnings of the railroad. Whereupon the Committee, on motion, approved a recommendation to the Board that it declare a regular quarterly dividend of 60 cents a share. 27 Present at the meeting were Bevan (Chairman of the Committee), Saunders and Perlman, among others. The presentation of the results of the meeting to the Board of directors was made by Saunders : At this time we will take up the matter of the second quarter dividend. Our earnings projections for the second quarter are inconclusive at this time. We estimate, however, that our consolidated earnings will be around $20 million. Our preliminary figures show that while it is still an uphill fight, we are making real progress in bringing the Railroad into the black. While, as I have said, it is much too early to know exactly where we will come out, I think that the prospects are very good to equal or better the results in the Second Quarter of last year. Recommendation : In light of the results to date and the prospects for the remaining weeks of the quarter, the Finance Committee recommends the payment of the regular quarterly dividend of 60 cents per share . . . 28 In a Board meeting of June 25, 1969 a discussion of the proposed third quarter dividend was as follows: As we discussed at the meeting of the Finance Committee and Execu- tive Committee on June 13, preliminary estimates . . . are about the same as last year ... on a consolidated basis. After discussing some possibly negative aspects of the economy, i.e. high costs of money, governmental anti-inflationary policy, and a long coal miners holiday, Saunders proceeded: Despite these unsettled conditions, the Finance Committee, after con- sideration of all the factors, recommends the payment of the regular dividend of 60 cents per share . . , 29 The information presented to the Board of Directors is certainly not a true picture of the real performance of the Railroad, and makes no mention of the 27 Minutes. Meeting of PC Finance Committee, May 13, 1969 ; Appendix D, Exhibit 75, p. 735. 28 Board Memorandum, May 13, 1969 ; Appendix D, Exhibit 76, p. 735. 26 Board Memorandum, June 25, 1969 ; Appendix D, Exhibit 77, p. 737. 380 perilous cash position of the Railroad. While some directors resigned from the Board because of information not presented to them in the Board of Directors meetings, and later discovered through the news media, most of the Board com- placently authorized dividend payments without knowing the true difficulties of the Transportation Company itself. Possibly Saunders' credibility and politi- cal skills let the Board lapse into a state of accepting whatever was presented. PENN CENTRAL CO. STOCK OWNERSHIP AND STOCK REPRESENTED BY DIRECTORS AT DECEMBER 31. 1968 MEETING Number of Personal Gain by Name Position with Penn Central Nature of stock interest shares gain representa- tion Bevan, D _ Chairman of finance committee.. Personal Saunders, S Chairman of the board do Seabrook, J Director do International Utilities Corp Graham, R. Jr do Personal Wife Kirby, F do Coguardian for Allan Kirby.Sr. 34, 107 45, 987 $81,856 110,368 14, 040 5,850 500,000 .. $1,200,000 84, 000 201.600 6,264 936,312 2,610 390, 130 196,195 . 470, 868 1,020,000 . 2, 448, 000 Alleghany Corp. Investors International Diversified Services, Inc. Totals 2,278,879 1,350,440 4,118,868 Source: ICC Docket No. 35291. Penn Central Investigation, V.S. 8, pp. 19-20. One cannot help but wonder what motivated Bevan and Saunders to mini- mize the true performance of the railroad and its cash position at those meet- ings where dividends were declared. Saunders, as it turns out, held every share of stock until after the reorganization, but Bevan sold 25,000 of his shares be- tween January 1, 1969 and June 24, 1970. Bevan knew of the precarious posi- tion of the Railroad and benefited from the sale of his stock, while the reports issued by -Penn Central indicated that the Transportation Company had prob- lems, but the non-rail subsidiaries were more than adequate to compensate for the poor position of the Railroad. Is it not realistic to assume that Bevan, who had been with the Railroad since 1954, and was hoping for the chairman's posi- tion when Symes retired, was quite disturbed when Saunders was appointed in his place. It seems that the pattern for this assumption is evidenced by the encouragement of dividends, his "private" investment club, Penphil, and his selling of the bulk of the Penn Central stock, when published reports indicated that the Companv's performance was improving. In any event, the dividends placed a considerable cash drain on the Rail- road that could not be paid from the Railroad's profits. In fact the Railroad had to borrow money to finance such dividend payments. The imputed interest costs of the dividends declared by the Penn Central is as follows : PENN CENTRAL COMPUTATION OF INTEREST COST RELATIVE TO MONEY BORROWED TO REPLACE MONEY EXPENDED THROUGH DIVIDEND PAYMENTS, 1963 TO JUNE 1970 (Thousands omitted) Dividends Cumulative Interest rate Imputed Year paid value (percent) Year interest cost $10,026.9 $10,026.9 4.63 1964 $0,464 53,646.7 138,035.1 6.25 967 8.627 1964-1 28! 974. 6 SPOOKS 4.67 1965 1.821 }«22 AR 3RK 84.388.4 5.71 1966 4.819 1965" " ".".'.'.'.'. 45,386.9 84,388.4 5.71 [III 53,646.7 138,035.1 6.25 -•-■ 967 ::•::::::: 55051.9 193.037.0 7.76 968 u.mj Jggg "" 55 400.3 248,287.3 9.00 1969 22.384 J|ll — " 43 396.2 291883.5 10.00 U970 14J94 Total. 67.673 i Through the 1st 6 months of 1970. Source: ICC Docket No. 35291, Penn Central Investigation, V.S. 4, Exhibit DD7; Reproduced in Appendix D, Exhibit 78 p.743. 381 Internal Control After Merger INTRODUCTION The internal controls present in the merged Penn Central give an indication of the effectiveness with which pre-merger planning was implemented. The cash shortages which constantly plagued the Railroad originated long before the merger took place. One would think that timely and accurate reports of cash balances and outstanding receivables would have been the subject of consider- able attention during the initial phases of the merged Railroad's operations. In fact, after the merger, cash balances were not reconciled promptly, nor were receivables properly controlled. The write-off of estimated bad debt expense soared after the merger. The internal controls of the Railroad were either nonexistent or had seriously deteriorated. While operating and accounting offi- cials might have been aware of this situation, the correction of these deficiencies never became a reality. Bevan had operated for years with severe cash shortages, but the cash drains of the merged Railroad created a liquidity crisis that even he had not experienced before. Bevan had indicated that the minimum cash required for the Pennsylvania Railroad to operate and still maintain adequate cash com- pensating balances required by certain loan agreements was $45 million to $50 million. 30 The merged railroads set $100 million as an acceptable cash balance. At the date of the merger, February 1, 1968, the cash balances of the railroads were $5.5 million and $7.8 million for the PRR and NYC, respectively. The $86.3 million shortage from the ideal cash balance suggested by Bevan, was complicated by the cash losses incurred after the merger. Initially, Bevan had been in charge of the Accounting Department of the Pennsylvania Railroad ; but upon merging, this function was given to Perlman, the President of PCTC. Even when this department was restored to Bevan's control in 1969, there was no improvement in the amount of receivables out- standing, nor was there an improvement in the timeliness and accuracy of the reconciliation of the cash accounts. The following sections give an indication of the effect of the breakdown in internal control on the operations of the Rail- road, and the increased interest expense and borrowings necessitated by this breakdown. INTERNAL, CONTROL Both the PRR and NYC had been moving toward a centralized billing and collection system prior to the merger. The PRR had progressed further in this centralization than the NYC. After the merger, the PRR's basic system was modified into a system of seven Customer Accounting Centers. These cen- ters were responsible for checking and revising weights, preparing freight bills covering inbound carload freight, collecting charges from credit patrons, main- taining agency accounts to insure the collection of cash items by agency forces, and checking and revising rates and charges. The employees at these centers would perform the above functions, and then code the bills for key-punching. The data was then transferred to a master accounts receivable tape. Inexperienced personnel, understaffed and overworked departments, and the resultant backlog of waybills to be processed resulted in a breakdown of the accounts receivable system. The effective operation of this system depended upon the accuracy and timeliness of the processed information. Peat, Mar wick, and Mitchell (PMM), in a December 22, 1969 letter to C. S. Hill, pointed out that inaccurate ratings of waybills produced an excessive volume of disputed bills, each requiring the individual attention of an already overworked staff. 31 The PMM study found 30 Memo to Saunders from Bevan, November 8, 1967 ; Appendix D, Exhibit 36, p. 558. 31 Letter and report to C. S. Hill from Peat, Marwick, Mitchell & Co., December 22, 1969 ; see Appendix D, Exhibit 66, p. 705. 382 that there were no incentives offered by the Railroad to attract and keep the experienced and qualified personnel required to verify and revise the rates on waybills. Perhaps the greatest concern in this area of control should have been the management of accounts receivable. The processing of payments took so long, that frequently customers received several notices requesting payment for bills which had been paid long before. It was quite common for customers to refuse to pay bills promptly, if at all, because of poor service or lost shipments. Many customers returned bills amounting to thousands of dollars, when only a small amount of the bill was in dispute. The internal procedures in the Centers were not set up to handle the large volume of disputed customer's bills. When a partial payment was made, the system made the application to the customer's account a difficult procedure. This resulted in the item being charged to a fictitious account "Paul P.", which served as a clearing account for unidentified and partial payments. The head clerk was to reconcile this account, clearing it out and correctly applying the payment to the customer's account. Since the original entry to the "Paul P." account did not update the customer's master file, and the time taken to clear this account was so long, the customer would receive another bill for the entire amount. The Accounting Department lacked a mechanized way of processing the volume of disputed and partially paid bills, leading PMM to recommend that such a system be implemented. The breakdown in control was not due to the in- compatibility of the different computers used by the PRR and NYC, both be- fore and after the merger, since there was little need for the interchange of data between the two computers in the accounting function. 32 The problem centered upon the great amount of manual handling and analysis of transactions. The loss of control of receivables had a negative cash impact on the Rail- road. The PCTC had a self-imposed target on the collection of receivables. A negative cash effect was due to receivables over 30 days old. that were in excess of 12.8% of total receivables. The results of the cash impact of the failure of the Transportation Company to meet its target are found in Table AR-1. TABLE AR-l.-PF.NN CENTRAL TRANSPORTATION CO. ACCOUNTS RECEIVABLE OUTSTANDING OVER 30 DAYS-CASH IMPACT POSTMERGER [Dollar amounts in thousands] Date January 1968... June 1968 January 1969 » June 1969 January 1970 March 1970 Total _ 3,554.6 ' Source: ICC Docket No. 35291, Penn Central Investigation, V.S. 4, Exhibit DD-7 modified by schedule AR-1; reproduced in Appen- dix D, Exhibit 78, p. 743. 2 Interest expense computed on the average amount delinquent for each period. Taken as an average of: f Delinquent,, -r delinquent, .1 ) 2xi rate/2. NOTE: This assumes that funds were borrowed to provide the funds for operations which could have been generated had the 12.8, percent target been met. Source: ICC Docket No. 35291, V. S. 31, pp. 1-9. The interest expense and the amount of additional funds which would have had to have been borrowed to replace the funds tied up in excessive receivables is determined by the following table : 83 See Interstate Commerce Commission, Docket No. 35291, Penn Central Investigation, Verified Statement 32, pp. 7-11. Delinquent 1 nterest Amount (over 12.8 rate 1 Interest - unsettled percent) (percent) expense 2 $51,688.1 $9, 277. 5 7.25 $297. 7 57,645.3 7,148.0 7.25 384.0 72, 316. 4 14, 040. 6 8.25 721.3 86, 987. 4 20,933.1 9.75 1,088.1 86, 529. 4 23, 707. 9 9.75 554.2 100, 547. 9 21,763.7 10.00 509.3 383 TABLE AR-2.-PENN CENTRAL TRANSPORTATION CO. EFFECT OF ACCOUNTS RECEIVABLE ON INTEREST EXPENSE AND BORROWINGS [In thousands of dollars] Interest Additional Cumulative Year expense borrowings > borrowings 1968 _ 681.7 8,212.8 8,212.8 1969.. - -... 1,809.4 9,274.1 17,486.9 1970 (6 months) 1,063.5 5,248.9 22,735.8 Total _ 3,554.6 > 22, 735. 8 'Additional borrowings are required only to the extent of the average accounts receivable increase between periods. 2 This total represents the average accounts receivable (over 12.8 percent) for the first 6 months of 1970. Source: Chart AR-1, schedule AR-1. The purpose of this analysis was to illustrate the extent to which the Trans- portation Company had to borrow funds that would normally have been avail- able had the accounts receivable system been designed and managed properly. Thus, management's abdication of effective control of accounts receivable cost the Kailroad $3.5546 million in additional interest costs and required them to borrow additional funds, indicated by Tables AR-1 and AR-2, to fund its ex- cessive receivables. While it is true that in a period of rising interest rates, and a general short- age of funds available on the open market, the collection of accounts receivable will become increasingly more difficult, the rate of increase in these balances of PCTC was far greater than those of all Class I railroads. It is interesting to note that PCTC's management spoke of estimated bal- ances in accounts receivable, as opposed to specific amounts. In an undated memo (about December, 1969) , Basil Cole stated : The accounts receivable balance is now $75 million which is $15 million higher than it was assumed to be in October. (Emphasis added.) Considering the magnitude of the balances, it is hard to believe a 25% increase in accounts receivable in two months, especially when the amount is $15 million can be treated as casually as Cole did in the next sentence : . . . This does not represent a loss of position as much as it does identi- fying more accurately the scope of the problem. 33 (Emphasis added.) It would seem that an increase of this magnitude would represent a loss in posi- tion, and would require immediate attention. In the same memo, he disclosed the results of a special study undertaken to determine the best areas in which to concentrate to speed collection. The results are as follows : PENN CENTRAL TRANSPORTATION CO., ANALYSIS OF DELINQUENT ACCOUNTS AT DECEMBER 1969 (OVER 10 DAYS OLD) Amount outstanding Number of firms whose debts total this amount Average $2,000,000.. 2 $1, 000, 000 $3,000,000 5 600, 000 $4,000,000 8 500, 000 $5,000,000 15 333,333 $6,000,000.. 23 260, 870 $7.000,000 35 200, 000 $8,000,000 _ 50 160,000 $9,000,000. 88 102, 273 $10,000,000 161 62, 112 Cole indicated that the larger offenders were withholding payments until claims against the Railroad were resolved. He felt that when the offenders were identified, officers within PCTC should be requested to contact them for payment. It seems that Cole minimized the cause of the build-up by 33 Memo from Basil Cole (no date) ; see Appendix D. Exhibit 79, p. 745. 384 suggesting that the effect (excessive receivables) be resolved. Further, he chose accounts that were only 10 days old. In a study made in April 1970, an analysis of billing and collection lags yielded the following : PENN CENTRAL TRANSPORTATION CO. AN ANALYSIS OF BILLING AND COLLECTION LAGS, APRIL 1970 Lag Inbound freight (days) Outbound freight (days) Billing (processing) 7.61 6.33 Mail lag(PCTC to customer and customerto bank) 5.47 5.32 Customer payment 9.18 7.22 Total lag 22.26 18.87 In each case, the customer billing lag is less than the processing lag of the Transportation Company. Even though the payment lag is greater than that allowed by ICC regulation, it certainly doesn't seem excessive, especially considering the quality of PCTC's billing system. Cole expects his customers to perform significantly better at paying than the Railroad was at billing. While inaccuracy in billing, double billings after payment, and rapidly deteriorating quality of service affected the Railroad, as discussed above, it also alienated customers and caused a marked increase in estimated bad debts expense. This is dramatically illustrated when a comparison of the combined estimated bad debts expense is compared with sales volume : PENN CENTRAL TRANSPORTATION CO.' AN ANALYSIS OF BAD DEBTS EXPENSE AS A PERCENT OF SALES Year Estimated amount uncollectible (thousands) Percent change in writeoff 2 Percent o revenues 1965 $2,805.5 100.00 97.96 97.25 514.93 809. 86 0. 1805 1966 ._ _ 2,748.4 .1742 1967 _ 2,728.4 .1807 1968 _ 14,446.4 .9528 1969 22,720.6 1.3754 i Prior to 1968, data is for combined NYC and P.RR. 1 Percent change: 1965 equals 100 percent. Source: Schedule AR-2. The absolute and percent changes in the write-off is less significant if there had been a marked change in revenue levels (which had not happened), but the percent of bad debts expense to revenues is quite significant. Pre-merger, the average write-off as a percentage of sales was .1785% ; post-merger, the average write-off was almost 1% of total revenues. The increase in the write-off as a f>ercent of revenues was 762%. This certainly indicates that management had ost control of collection of its receivables. Equally important, it indicates that the quality of service had deteriorated drastically after the merger, assuming one can conclude that the degree of bad debt expense write-off is highly corre- lated with the quality of the service performed. While none of the conclusions drawn from this data is new, it certainly corroborates already stated hypoth- eses about the service and management control of the post-merger Railroad. A second general area of a breakdown in control was in the preparation of bank reconciliations. Not only was there no standard form on which these reconciliations were made (the format varied from month to month, making interperiod comparisons difficult), but Peat, Marwick, Mitchell & Co. reported to Saunders: Bank account reconciliations are not prepared promptly by the Treas- urer's office at the close of the accounting month. Delays as long as three to five months occurred in the preparation of such reconciliations. . . . Obviously, failure to reconcile promptly bank accounts and outstanding 385 checks and drafts causes a serious breakdown in the maintenance of an effective system of internal control. 34 A result of the lack of internal control with respect to these reconcilia- tions was that when the accounts were finally reconciled, a massive accumula- tion of unidentified adjustments had to be written off. While the trustees of PCTC could not indicate the magnitude of the prior period write-offs, they identified $797,075 of unreconciled bank charges and $430,309 of un- reconciled credits on December 31, 1970. In essence, the lack of control certainly worked against effective cash man- agement. Accurate and timely reports of cash balances were not available; and yet this was the most pervasive problem faced by the Transportation Company, a chronic shortage of cash. In this situation, having a control on the exact amount of cash available is essential, not only for the obvious reason of mini- mizing borrowing, but also to prevent the misappropriation of funds. An excellent example of the loss of cash was the appropriation of $4 million by Fidel Goetz in 1969. Goetz established the First Financial Trust of Liechten- stein, a shell corporation organized to be the depository of $10 million of PCTC funds to be used for the repair of rolling stock. The $10 million was a loan arranged through a consortium of German banks, and was deposited with First Financial on September 18, 1969. The same day, Goetz transferred $4 million to Vileda Anstalt, another shell corporation controlled by him. Goetz felt that he was entitled to the funds because of losses he suffered in connection with his participation in Executive Jet Aviation's financing, another subsidiary of the Transportation Company. PCTC believed that the funds were still on deposit with First Financial, and accordingly reported it under "Capital and Other Reserve Funds" on their 1969 report to the ICC. The loss of the funds was not discovered until after the bankruptcy. Although the $4 million loss was quite extraordinary, it should have been discovered had effective control existed within PCTC. While internal control problems, losses, and the additional expenses result- ing therefrom did not make enough of a difference to have prevented the col- lapse of the Railroad, it was symptomatic of the general operational and managerial environment. M Letter from Peat, Marwlck, Mitchell & Co. (Henry A. Qulnn) to Stuart T. Saunders, June 3, 1969 ; See Appendix D, Exhibit 80, p. 746. DIVERSIFICATION The diversification program of the Penn Central Railroad was principally that of the Pennsylvania Railroad to which the Penn Central Transportation Co. had fallen heir. More precisely the program was largely carried out by Pennsylvania Company, a subsidiary of the Pennsylvania Railroad and subse- quently a subsidiary of Penn Central Transportation Company. Pursuant to a decision made earlier, the Pennsylvania's diversification program essentially began in June of 1964 with the acquisition of controlling interest in Great Southwest Corp. and 100 percent of the outstanding stock of Buckeye Pipe Line Co. a month later. A little over a year later the Pennsylvania made two other acquisitions, the Arvida Corp. in July, 1965 and Macco Realty Corp. in August, 1965. 1 A major investment, principally in debt securities, was also made begin- ning in late 1964, in Executive Jet Aviation, Inc. The New York Central (NYC or Central), on the other hand, made only one major non-rail acquisition during the 1960-1967 period preceding the Penn Central merger. This was of Strick Holding Co. in November, 1966. Unlike the Pennsylvania Railroad (PRR or Pennsylvania), no formal diversification pro- gram was devised at the Central and little or no effort seems to have been made in seeking additional acquisition possibilities. Moreover, unlike the acqui- sitions of the PRR, which were of businesses engaged in operations entirely independent of those of the parent company, Strick's activities, that of manu- facturing light-weight trailers and containerized equipment used in the rail- road industry — both of which had been utilized in the Central's Fexi-Van operations since 1956 — bore a relationship to the operations of the railroad. The PCTC, while announcing plans for a major diversification effort it- self soon after the consummation of the merger, 2 and although attempting to acquire Kayser-Roth, a major apparel manufacturer, in 1968, 3 nonetheless com- pleted only one acquisition before bankruptcy, that of Southwestern Oil Re- fining Co. and its subsidiary, Royal Petroleum Corp., in February, 1970. Moreover, this transaction was later rescinded pursuant to an agreement and court order dated April 4, 1971. 4 In connection with the following discussion several tables have been pre- pared in order to present the several effects (financial and otherwise) of the diversification efforts. These include (1) total amount of purchase funds committed (including types of consideration utilized) ; and other funds com- mitted to the program in the form of (2) interest and dividends paid out on debt/equity securities used in the purchase price of the acquired companies and (3) loans and advances by the railroad and its subsidiaries to the non-rail sub- sidiaries after acquisition. The magnitude of these investments will also be 1 Initial efforts at diversification were actually begun as early as 1960, not so much at that time because of the desire on the part of the railroad to diversify (although admittedly this was a factor), as It was an attempt to find a means by which the railroad could more effectively utilize Its existing Sropertles, and, more specifically, its rights-of-way. A group called the "Committee on Potential Plpe- nes In the PRR System," which included Charles J. Hodge, Chairman of the Executive Committee of the Investment banking firm of Glore Forgan, Wm. R. Staats and Co., and a firm of engineering con- sultants, Pipe Line Technologists, Inc., submitted as early as July 28, 1960, a specific recommendation for the PRR to acquire Buckeye, Appendix D, Exhibit 1, p. 493. 2 Associated Press article May 14, 1968, In which Stuart T. Saunders announced plans for a $500 million diversification effort by the railroad into "companies with imaginative management with the promise of expanding profits." Appendix D, Exhibit 2, p. 494. 3 Preliminary agreement for the acquisition of Kayser-Roth, the nation's largest apparel manufac- turer, by the PCTC (to have been accomplished through the Pennsylvania Co.) was announced June 26, 1968. Terms called for the Issuance of two series of Pa. Co. preferred stock with a total value of approxi- mately $230.7 million. After approval by the board of directors of both companies (and a later revision which was also approved), but before submission to the shareholders of the companies for their affirma- tive vote, the transaction was terminated on November 6, 1968 — ostensibly because the two firms were "unable to agree upon final detailed terms." (Even here, however, the initial acquisition of Kayser- Roth stock had been begun by the PRR through its Pension Fund in mid-December of 1967.) * See judgment in Civil Action 70-C-135 (Former Shareholders of Southwest Oil Refining Co. and Royal Petroleum Co. versus Penn Central Co.), U.S. Federal District Court (S.D. Tex., Corpus Chrlsti Div.). (387) 388 compared to funds being reinvested in the railroad itself — in terms of total capital and maintenance expenditures, and an examination made of the source of funds for each. Other tables will among other things measure the return which the railroad received on its non-rail investments in the form of (1) re- ported earnings (including the effects on the parent railroad's consolidated statement) and (2) actual cash return (including dividends, interest and tax allocation payments) with respect to total cash investment (including loans and advances). The discussion of the diversification program and its effect on the PCTC and its predecessors will be divided into four parts: (1) an analysis of the program itself — including its raison d'etre (stated or implied), its magni- tude, how financed, and investment pattern (stated or implied) ; (2) the financial effects of the program (as determined by the operating performances of the acquired companies post-acquisition) measured in (a) absolute terms (reported income and total cash returns) and (b) relative terms (to railroad investment [total capital and maintenance expenditures] and to pro-forma railroad income — less income from non-rail acquisitions) ; (3) an evaluation of diversification itself as a policy, including an examination of its application in the PCTC (and/or its predecessors') case in terms of its effect on, e.g., the railroad's cash position and otherwise, and the role, or lack thereof, that the ICC has played in this area; and (4) conclusions and recommendations includ- ing an assessment of the weight (relative and absolute) that should be given to diversification as a factor leading to the bankruptcy of the railroad. Diversification Programs PENNSYLVANIA RAILROAD Although the Pennsylvania Railroad possessed substantial real estate hold- ings in major cities in the geographical area which it served (e.g., New York, Chicago, Newark, Detroit, Pittsburgh and Philadelphia), the vast majority of these holdings prior to 1964 had been acquired incident to the rail operations of the company and had been developed in an effort to seek additional revenues from the existing physical plant. 5 Unquestionably these combined non-rail ac- tivities did contribute substantially through, for example, rental and capital gain income to the consolidated earnings of the railroad and cannot be ignored. The effect of income from these sources on the total earnings of the company will be examined later in this discussion. However, a specific diversification program in the usual meaning of that term was not begun until late 1962-early 1963. 6 The Pennsylvania then owned about 2.4 million shares of Norfolk and Western Railway Co. common stock — which it had purchased beginning in the early 1900's — with a total market value of approximately $300 million. Realiz- ing that ownership of this large block of stock, which had given the Pennsyl- vania effective control of the Norfolk and Western, might well have posed a competitive barrier to the proposed NYC-PRR merger pending before the Interstate Commerce Commission, David C. Bevan, then Vice-President Fi- nance, of the Pennsylvania, in his August 1962 testimony before the ICC in connection with the merger, had discussed the possible disposition of these shares. Faced with the situation that the PRR in all probability would have to sell its N&W holdings, which had produced a substantial dividend income which the company had used to supplement its other earnings, the railroad was confronted with the decision as to what should be done with the proceeds of such sale. In consideration of this problem, a memorandum, dated April 30, 1963, was prepared by Bevan setting forth a full discussion of the issue including analysis of the alternative uses of such funds which could have been employed "Because of the fact that ownership of such holdings was held In many subsidiaries, most of which were rail or rail-related operations, it would be nearly Impossible at this date to segregate amounts expended on rail and non-rail activities in order to determine what the magnitude of total funds expended on the combined real estate holdings was, on either an annual or cumulative basis. 9 Diversification Is here defined as the calculated acquisition of companies engaged in operations In product markets, unrelated to that of the acquiring company, ostensibly, e.g., for reasons of attain- ing economic stability, increasing earnings, etc. 389 by the railroad. Because the document's conclusions express the management philosophy adopted by the Pennsylvania, 7 the text is inserted herein in its entirety : [Memorandum by David C. Bevan, April 30, 1963] The holdings of the Pennsylvania Railroad System of the Norfolk & Western Common are listed below showing the amounts held in each company, the cost land market values, as well as the number of shares pledged : Shares Free Pledged Total Cost Market Valua Owned by: Pa. Co 645,540 1,711,343 2,356,883 $60,847,706 $284,004,402 P.R.R _ 40,401 40,401 2,139,611 4,868,321 Total 685,941 1,711,343 2,397,284 62,987,317 288,872,723 Some time ago, on the recommendation of the Financial Department, the board ap- proved, in principle, of disposing of our Norfolk & Western Preferred stock and a portion of this has been liquidated and the balance will be as soon as we can get a proper price for our stock. Until now, however, no action has been taken with respect to the possibility of disposing of any or all of our common stock. Although personally I believe the market price of the common should tend to move upward over the next several years, no one can be sure that this will be the case, and purely from a standpoint of market value conservatism would indicate that it would be well to start a gradual liquidation of our holdings. However, at this time, of course, it is still not possible actually to predict whether or not our merger will be approved. Therefore, it would seem wise that we retain at least a portion of this stock to maintain a strong strategic position in the merger picture in the event our merger application is disapproved. Just how much this should be, of course, Is a matter of judg- ment, but in my opinion it should represent a minimum of 15% of the voting power of the Norfolk & Western in the event their merger is approved and ours is not, or in other words, 1,550,000 shares. (This is based on the proposed capitalization of the Norfolk & Western rather than that now outstanding.) In the event that a policy of liquidation up to the amount indicated is agreed upon, the question naturally arises as to how it would be ac- complished, the timing, and, of course, of great importance the utilization of the proceeds. In analyzing this situation, it should be pointed out that at the present time there are only 40,401 shares of common stock held by the Pennsylvania Railroad with the balance in the Pennsylvania Company. Over a period of time we have been transferring the Norfolk & Western common to Pennsylvania Company as it had cash with which to purchase the stock and as the cash was needed by the Pennsylvania Railroad. This procedure was followed rather than that of declaring excessive cash dividends to the Pennsylvania Railroad. As a result, the record shows that a sound and conservative dividend policy has been followed by Pennsylvania Company and its assets have gradually been increased through the pur- chase of Norfollk & Western stock with a corresponding Improvement, of course, in its earnings position as well. If the Financial world or the public were to think that the Pennsylvania Railroad manipulated the company to satisfy its own requirements and needs without regard to maintaining the financial stability of the Pennsylvania Company, the letter's credit could be irreparably damaged overnight. At first we had in mind the necessity of maintaining and improving Pennsylvania Company's credit to facilitate the refunding operation which took place in 1960. As the railroad industry's credit picture continues to deteriorate generally and as the earnings situation of the Pennsylvania Railroad does likewise, it has become increasingly doubtful that we will be able to carry out refunding operations in 1965 and 1968 on the basis orig- inally planned. This problem has been further accentuated by the necessity for going to the market for $50 million of financing this year. In other words, it is now entirely possible that we will have to use Pennsylvania Company as a vehicle for further financing in 1965 and 1968. In order to be able to accomplish this, we must continue to manage the affairs of this company on a conservative basis both as to dividends and the maintenance of its assets. Although this was not the case originally, in the past 4 or 5 years, in our opinion, the banks who are making our standby credit available to us have looked more and more to the assets of the Pennsylvania Company to Justify the credit rather than to the credit of the Pennsylvania Railroad itself. It was probably for this reason that in 1958 the banks changed the standby agreement to provide that specifically the Pennsylvania Company stock could not be pledged for any other purpose. Therefore, it seems apparent that main- tenance of the credit of the Pennsylvania Company is not only necessary from the stand- point of possible refunding operations in 1965 and 1968, but also for the maintenance of our standby credit with the banks. 7 On October 1, 1963, Stuart T. Saunders, the former President of the N&W Railway Co. became the new Chairman of the Board of the PRR. Saunders quickly dispelled any thoughts as to what course the railroad would pursue in regard to a diversification program. At a news conference held on No"ember 7, 1963, soon after assuming office at the Pennsylvania, he renorted that the railroad was actively considering a variety of diversification proposals. Although not being more explicit than Indi- cating that some acquisitions might lie outside transportation, he noted at the time that the railroad would have a "new look." (Philadelphia Bulletin, November 7, 1963) ; Appendix D, Exhibit 3, p. 494. 390 With the foregoing in mind, we can therefore analyze the various possibilities which are available for the utilization of the proceeds of the sale of any of the Norfolk & Western common stock. 1 — It has been suggested that we might buy in the debt of the Pennsylvania Railroad thus reducing our obligations and our interest charges. On the surface this would appear to represent a conservative course, but on analysis, it would be unattractive and undesirable for several reasons. If the available cash is either paid out in dividends to the Pennsylvania Railroad or advanced to the Pennsylvania Railroad by Pennsylvania Company, the credit of the latter will be injured, and in our judgment, it will be likewise impaired if Pennsyl- vania Railroad debt is purchased by Pennsylvania Company rather than Pennsylvania Railroad. This would follow because Pennsylvania Company credit would become increas- ingly dependent on the success of Pennsylvania Railroad. Furthermore, as a practical matter it is not possible to buy in very much railroad debt at current prices. We know this from experience. We have a very difficult time buying our 4%s of 1965, our 5s of 1968 and it is all we can do to get sufficient bonds to meet the sinking fund requirements on the 3%s of 1985. However, even if this were possible, as a practical matter this would mean permanently investing our money on about a 6% basis before taxes and 2.9% after taxes. It may be said that we are not in taxes at the present time but certainly no one contem- plates that we will not be sometime in the not too distant future, and as indicated, this represents a permanent investment on this basis and to the extent that it is done, the liquidity of the System has likewise been reduced. 2. — It has also been suggested that the money be invested in projects showing an overall saving of 25% or more in the Pennsylvania Railroad. Here again we have the same problem as in the case of buying in the bonds. As funds are transferred to the Pennsylvania Rail- road, the assets are reduced correspondingly in Pennsylvania Company and its earnings decreased. However, in addition this means reducing the liquidity of the system and putting more funds into fixed property. In the post-war period, we have invested approximately $100 million annually in capital expenditures in the Pennsylvania Railroad. Much of this has been in projects theoretically yielding savings. However, as the records indicate, we have not realized the savings or they have been taken away from us in one way or another. There is nothing to indicate that there is any change in this situation at the present time and if this is true, then the acquiring of additional funds from the Pennsylvania Company for this purpose cannot be justified. However, if for some reason these savings can be realized in the future, and there is nothing to indicate they can, the amount we are spending on capital projects based on capital expenditures savings should be such to rather quickly put us back on a profitable basis and then an increasing amount can be put into such projects. In brief, if the savings can be brought down to net in the future, then there is no need of acquiring these funds from Pennsylvania Company and If not, there is no justifica- tion from a stockholder's point of view for doing it. It seems fairly clear that proceeds realized from the sale of the Norfolk & Western stock can best be justified for the acquisition of other equities the income from which, when we get into taxes, will only be taxable on a 7.8% basis. Furthermore, this should be done with an eye to capital gains which will be involved upon the sale of Norfolk & Western stock. As- suming liquidation ultimately of all of Norfolk & Western common stock, based on present market values the capital gain involved will approximate $220 million exclusive of the Norfolk & Western stock which we may or may not get for our Wabash holdings. Assuming that we use all of our loss carry forward to offset these capital gains, there would still be a capital gains tax of approximately $32 million. This would also be a very extravagant use of our loss carry forward since if it were used instead as an offset to net income, the savings would be 52% instead of 25%. At the present time we also have flexibility in that in any year we see we are going to lose a portion of this tax carry forward loss at that point we, of course, could sell Norfolk & Western stock and utilize the loss carry forward. If the common stock is sold gradually, we should be able to find sufficient capital losses to offset capital gains. For example, we still have a substantial amount of Lehigh Valley stock involving a substantial potential capital loss if a way to sell it can be devised. Mr. Warner and I believe that if we do receive a divestiture order from the ICC that it may be possible to obtain specific legislation to minimize the capital gains problem. Legislation of this character was passed in 1942 at the time there was a forced liquidation of utility holding companies and more recent specific legislation was passed to minimize the tax problems in the duPont divestiture of General Motors stock. Finally, it should be pointed out that at the present time we have only in round figures (?8G,000 shares of Norfolk & Western stock that is not pledged so that this is the maximum amount that now could be included in any liquidation program. Further, if it is desired to go ahead with the one investment project that we have in mind at the present time, based on present market values, it would require the proceeds from the sale of almost 550,000 shares of Norfolk & Western stock to enable us to acquire 80% of the company in question. There are some legal and technical problems involved which, depending on the amounts and manner of disposition, will tend to complicate this situation to some extent. Summarizing, it would appear that a conservative course would indicate the liquidation of approximately 850,000 shares of Norfolk & Western stock as this amount becomes free. This should be done gradually so that we can avoid a capital gains tax and so that we will have sufficient time to plan an intelligent program for the reinvestment of the proceeds in other common stocks of a quality which will allow us to maintain the credit standing of the Pennsylvania Company so that it can be used as a vehicle for refunding operations in 1965 and 1968, if this is necessary, and so that it will continue to be a credit cornerstone for our standby agreement with the banks. Through the proper selection of companies in which we can invest the proceeds, this should assure an enhancement of the value of the Pennsyl- vania Railroad stock over a period of time. 391 Also It should be borne In mind that over a year ago we outlined a long range program for the utilization of Pennsylvania Company as a holding company, which we believe is completely compatible with everything said in the foregoing paragraphs. (The fact that the N&W holdings did not in fact provide the expected funds to finance the resulting acquisition activities of the Pennsylvania will be dis- cussed at a later point in this analysis.) 8 In addition to the stated rationale that diversification was being under- taken in order to most effectively utilize the proceeds from the expected sale of the company's N&W stock interests, there were also other implied reasons under- lying such action, paramount of which was a serious concern over rail opera- tions earnings and the prospect for their ever achieving an adequate return. The Bevan memorandum [above] itself makes quite clear that the chief financial officer of the railroad believed that any amount of investment in the railroad would not result in savings sufficient enough, even on a sustained cumulative basis, to put the railroad in the black — pointing to the $100 million in capital expenditures made annually by the railroad in the "post-war" (presumably WW II) period which had either not realized the savings anticipated, or if so, had been taken away from the company "in one way or another." 9 Such a philos- ophy, when taken in conjunction with the urgency and vital manner in which the merger with the NYC was viewed by the PRR, demonstrates the rather clearly held belief of the top management of the Pennsylvania that the company was on a liquidation course unless an acceptable means of subsidizing the failing rail operations could be found. Diversification into non-rail business operations with a better rate of return was viewed (along with the expected savings from the proposed merger) as a principal means of accomplishing this result. 10 Another implied rationale for adoption of a diversification program re- lated to the above improved rate of return argument was the attempt by the railroad to enhance the value of its stock by achieving a higher reported con- solidated income figure. This demonstration of the company's concern for the interest of the shareholder is also evident from the following excerpts from the Bevan memorandum, supra (as well as from the approval of such a course of action by the Chairman of the Board and its adoption by the company's Board of Directors) : * * * In brief, if the [rail operation projectsl savings can be brought down to net in the future, there is no need of acquiring these funds from Pennsylvania Company and if not, there is not justification from a stockholder's point of view for doing it. 8 A secondary reason for entering Into a program of diversification (In connection with Its more practical objective of buying earnings) was the desire on the part of the railroad to utilize its large unused tax carry-forwards. More specifically, assuming that 80% of a company could be acquired by the railroad, permitting the consolidation of its financial operating results with those of the parent company, earnings of the acquired company could be as much as doubled (assuming an approximate 50 percent corporate tax rate) by utilization of the railroad's unused tax loss carry-forwards. Con- tinued losses from rail operations could also be offset against earnings from the non-rail acquisitions. Tn addition, a railroad financial department memorandum dated Mav 10, 1963, nrenared in connec- tion with the Buckeye Pipe Line Co. acquisition noted that the railroad had not "claimed all permis- sible deductions and thus there were options available with respect to additional deductions which we [the railroad] can exercise when our earnings position so warrants." Appendix D, Exhibit 4, p. 494. "It has also been suggested that the money be Invested In projects showing an overall saving of 25% or more in the Pennsylvania Railroad. Here again we have the same problem as in the case of buying the bonds. As funds are transferred to the Pennsylvania Railroad the assets are reduced correspondingly in Pennsylvania Company and its earnings decreased. However, in addition this means reducing the liquidity of the system and putting more funds into fixed property. In the post-war period, we have invested approximately $100 million annually in capital expenditures in the Pennsyl- vania Railroad. Much of this has been in projects theoretically yielding savings. However, as the records indicate, we have not realized the savings or they have been taken away from us in one way or another. There is nothing to indicate that there is any change in this situation at the present time and if this is true, then the acquiring of additional funds from the Pennsylvania Company for this purpose cannot be justified. However, if for some reason these savings can be realized in the future, and there is nothing to indicate they can, the amount we are spending on capital projects based on capital expenditures savings should be such to rather quickly put us back on a profitable basis and then an increasing amount can be put into such projects. In brief, if the savings can be brought down to net in the future, then there is no need of acquiring these funds from Pennsyl- vania Company and if not. there is no justification from a stockholder's point of view for doing It." Memorandum dated April 30, 1963, by David C. Bevan In text, supra. 10 It was also necessary that any reinvested proceeds from the sale of N&W stock realize an ex- traordinary high rate of return merely to replace the income which the stock had provided to the railroad. This was true hecause of the highly favorable cornorate tax treatment afforded dividend Income received from other domestic corporations. In the Bevan memorandum, supra, It Is stated "At 1962 levels, our N&W holdings provide annual Income of almost $13.5 million and the stock which we would receive in connection with the Wabash transaction would increase this annual income to almost $17 million. Although this dividend income is not now subject to any Federal income tax because of our current lack of taxable earnings, it Is important to remember that a substantial difference exists tax-wise between dividend income and other types of income." Under existing federal corporate income tax regulations, only 15% of such corporate domestic dividends are taxable as ordinary income to a shareholder corporation. The remaining 85 percent of any such dividend Is excluded. (Internal Revenue Code of 1954, Section 243 [a].) 392 * * * Through the proper selection of companies in which we can invest the proceeds this should assure an enhancement of the value of the Pennsylvania Railroad stock over a period of time. [Emphasis suplied.] NEW YORK CENTRAL Although the New York Central also possessed extensive real estate hold- ings J1 which contributed heavily to consolidated earnings (and, more spe- cifically, which had for several years been depended upon to offset unfavorable results from rail operations), no independent effort to diversify was under- taken until the railroad acquired the Strick Corporation in November, 1966. 12 No stated rationale for the acquisition was to be found in connection with the transaction other than that contained in an ex-post facto reference in the company's 1966 Annual Report wherein it was remarked : "This investment was made to achieve further diversification [in addition to the real estate activities described in footnote 11 above] with the potential for a good rate of return on our investment." 13 Acquisition of Strict was thus not reflective of a major change in management policy but was more an ad hoc supplement to the com- pany's rail operations. No formal analysis procedures for appraising potential acquisition candidates were apparently ever established. PENN CENTRAL TRANSPORTATION CO. The merged company was thus the heir to the above-described diversifica- tion activities of its predecessors. However, despite the fact that only one non- rail acquisition was accomplished during the little more than two years of its existence (and that was eventually rescinded), the PCTC had nonetheless formulated its own diversification program. As has been mentioned above, on May 14, 1968, just three and a half months after merger, S. T. Saunders an- nounced that the new company would diversify by spending approximately $500 million in a variety of fields over the following six years. Moreover, as it had been five years earlier with the PRR, the stated rationale was that the com- pany was seeking to replace its 1,700,000 shares of N&W stock holdings with "investments that would become additional sources of growth and [have] stability of earnings." 14 (Quite obviously disposition of these holdings had been much slower than originally anticipated.) More specifically, the objectives of the program were set forth in a memo- randum used by Saunders in connection with the presentation of the proposed Kayser-Roth acquisition to the PCTC Board of Directors in June, 1968 : u Llke the PRR, the Central's real estate holdings had also been developed Incidentally to the company's rail operations. Held through various subsidiaries, the most valuable of these were situ- ated in New York City along and over what had formerly been the open cut which the railroad had used for its tracks leading to and from its Grand Central Terminal in mid-Manhattan. It was on the viaducts constructed over these tracks and alongside of them that the railroad, beginning In the early 1900's built office buildings and hotels stretching from 42nd Street to 50th Street and from Lexington Avenue to Madison Avenue. Some 22 major office buildings are situated on this 29 acres of land. In addition the Central owned Realty Hotels, Inc., which owns and operates four hotels — the Biltmore, Barclay, Commodore and Roosevelt. The Central also owned the Waldorf-Astoria Hotel, which Is leased to an outside operator. Moreover, the NYC also held large tracts of land on Man- hattan's West Side, and In the Bronx, in New York City, as well as In the Great Lakes and mid- West regions. Other non-rail operations owned (but not acquired during this period) by the Central Included the Clearfield Bituminous Coal Corporation, engaged primarily in the business of owning and develop- ing conl mines. For reasons expressed earlier in connection with the non-rail operations of the PRR, it would be Impractical (if not impossible in the NYC case because of a lack of records — as well as the mixture of corporate activities in the several subsidiaries) to determine what magnitude of funds was ex- pended by the railroad on its non-rail activities. However, the importance of total non-rail income contribution in comparison to that from the railroad has been extracted and will be set forth later In this chapter. u Acquisition was actually of the parent Strick Holding Co., of which Strick Corp. and World Investments, Inc. (which owned a trailer rental company and the sales and service subsidiaries) were the principal operating subsidiaries. Although no other non-rail acquisitions were actually consummated by the NYC during this period (1/1/60 through 1/31/68) records of t*ie company do reveal that diversification for the railroad was discussed as early as 1963 when the company considered the possibility of using railway rights-of-way as a water distribution network, and, more specifically, considered the acquisition of the Ohio Water Service Co. — a firm engaged in the distri- bution and sale of water In Ohio. (See letter dated 11/8/63 from J. J. Wright to J. O. Boisl, Vice President Real Estate, NYC and letter dated 10/8/65 from J. J. Wright to A. E. Perlman, Appendix D. Exhibits 5 and 6, pp. 503, 506.) Consideration of this acquisition appears never to have gone beyond the preliminary analysis Rtate. "NYC 1966 Annual Report at p. 19. 14 Associated Press article dated 5/14/68 ; Appendix D, Exhibit 2, p. 494. 393 Before going into the details of the plan, I would like to mention some of the funda- mental objectives of our diversification program which have served as guideposts in investi- gating the merits of this particular investment. First, of course, are the minimum require- ments of profit, growth potential and beneficial use of our tax shelter. Next, we feel that a company must be sufficiently large and established as a going con- cern to insure perpetuation and growth with existing management. In other words, we are seeking to become investors in profitable firms, not managers. Transportation companies and basic industries which are large users of railroad service are not prime candidates because of potential conflict with certain anti-trust theories and regulatory policies of the ICC. In addition, we have no desire, indeed cannot, compete with some of our best customers. Another objective is to coordinate our diversification program with the requirement that we divest ourselves of our N&W holdings within the next seven years. This accom- plishes two results in one transaction. It also improves acceptability of the diversification in the eyes of the Government, at whose insistence the divestiture is taking place. More- over, there are the obvious advantages in using securities, rather than cash, in a trans- action of this size. Another requirement is to make the acquisition in a clear-cut, business-like way, in order to eliminate the prospects of proxy fights and price competition. 15 The unstated reasons for a continued pursuit of acquisition activities re- mained, however, the same — the need for additional earnings to offset the continued losses from rail operations. 16 TIMING The timing of the PRR's acquisition program was ostensibly planned to coincide with the expected divestiture of its N&W stock holdings. 17 However, the adoption of a diversification program at that time seems to have been also prompted by a concern over dwindling non-rail income (from a high of $37,894,000 in 1958 to a low, excluding income from acquired subsidi- aries of $13,534,000 in 1966) — which had been providing the consolidated earn- ings for the railroad. The latter concern was, moreover, in addition to the larger problem confronting the railroad of how to combate its failing rail operations. The timing in regard to the specific acquisitions made by the PRR was, of course, dependent upon their availability for purchase. The NYC's sole acquisition of Strick Corp. appears to have had little, if any, planning in regard to its timing. Its availability, the Central's familiarity with its operations and the fact that it was an opportunity to further add to its non-rail earnings appear to have made this acquisition, as stated, an ad hoc situation. The PCTC's diversification program was essentially a continuation of that of the PRR and was undertaken for the same basic reason : the need to supple- ment the continued rail losses. The timing of actual investments undertaken was again on an availability basis. MAGNITUDE The combined purchase commitment by the PRR, NYC and PCTC (includ- ing the type of consideration utilized) to diversification is set forth in the fol- lowing table : u Appendix D. Exhibit 7 at p. 507 for full text. M The concern for such an effect is evident from a reading of a memorandum dated 8/14/68 from s. T. Saunders to D. C. Bevan wherein it is stated : ' What is your schedule for submitting the Kayser- Roth proxy material to the SEC and filing the ICC application? It would be helpful to be in a position to include the income in our third quarter earnings." (Appendix, Exhibit 8,.) See also a similar memorandum dated 5/28/68 from D. C. Bevan to S. T. Saunders, wherein it is stated that Kayser- Roth ". . . would add substantially to our earnings, and continue to do so in the future and should have a favorable effect on the market value of our stock." Appendix D, Exhibit 9, p. 508. 17 Such divestiture was later required by the Interstate Commerce Commission on June 24, 1964, as part of the conditions imposed in connection with its approval of the N&W s merger with the Nickel Plate and the Wabash. (See report and order of the same date in Finance Docket No. 21510, etc., Norfolk and Western Railway Co. and N^w York. Chicago and St. Louis Railroad Co. — Merger, etc., 324 I.C.C. 1 (1964). These conditions included the requirements that the PRR and Pennsylvania Co. (1) place all voting rights in N&W common and preferred stock owned by them under three sep- arate voting trust agreements, with the agreements and trustees of each to be approved by the Com- mission ; (2) divest themselves of all ownership in N&W common and preferred stock within a ten year period ending October 15, 1974 ; and (3) divest themselves of all ownership in Wabash preferred stock within the same ten year period. In addition the PRR and N&W common stock held by Pennsyl- vania Co. will be exchanged, over the period of ten years, for N&W's 4%%, 15 year subordinated convertible debentures in a total principal amount of $104,000,000. 394 INVESTMENTS BY RAILROAD AND RAILROAD SUBSIDIARIES (AND/OR PREDECESSOR COMPANIES) IN SELECTED NONRAIL BUSINESSES (JAN. 1, 1960 TO DEC. 31, 1970) [Dollar amounts In millions! Company making acquisition, date Company acquired Type of interest Consideration (in millions) Pennsylvania Co. , Jan. 1, 1963 to June 24 , 1964. Great Southwest Corp. Pennsylvania Co., June 24, 1964 to Dec. 31, 1969 do Total Pennsylvania Co., July 26, 1965 to Dec. 31, Arvida Corp. 1966 do 50 percent (voting stock)... 32 percent (voting stock)... 82 percent (voting stock)... . 51 percent (stock). 7 percent Total. Pennsylvania Co., July 24, 1964.. Buckeye Pipe Line Pennsylvania Co., 1963 Long Island Pipeline Co. (later merged into Buckeye Pipe Line Nov. 15, 1966. 58 percent 100 percent (stock). 50 percent (stock).. Debt Total. Pennsylvania Co., Aug. 13, 1965 to Dec 31, Macco Realty Co. (later merged into Great 1965 Southwest Corp., Feb. 26, 1969). 99.9 percent (common and 6 percent cum. pfd. stock). New York Central RR. Co., Nov. 1, 1966 to Strick Holding Co. (including Strick Corp. 100 percent (stock). Feb. 1, 1968. and World Investments, Inc.). Penn Central Transportation Co., Feb. 1 , 1968 to Dec. 31, 1969. .Do. Loans. .do. American Contract Co. (P.R.R.), Nov. 4, 1964 Executive Jet Aviation, to Dec. 31, 1967. American Contract Co.. and Pennsylvania Co., Executive Jet Aviation. Jan. 1,1968 to Dec. 31, 1969. Total Pennsylvania Co. & Penn Central Transporta- Madison Square Garden Corp tion Co. (joint ownership), December 1968 to Dec. 31, 1969. Penn Central Co., February 1970 Southwestern Oil & Refining Co. (including wholly-owned subsidiary, Royal Petro- leum Corp.).* Total purchase investments. M3.246 2 38. 58 2 51.826 » 18. 335 2 3.711 2 22.046 * 100. 293 2.203 2 6. 797 2 7.000 2 39.451 2 15.000 2 6. 337 21.337 '3.100 24. 437 Long term notes 2 13. 865 57 percent Class B non- 2.345 voting common. Advances (short term 2 7.155 notes). 2 21. 365 23 percent (common stock). '27.697 100 percent (stock).. 21.083 100 percent (stock). 5.115 > 26. 198 « 320. 313 i Market value on date of preliminary agreement, if securities. For further breakdown of purchases see tables supplied by railroad pursuant to request of Committee special staff (Appendix 10). 'Cash. • $5,214,750 cash; $13,097,712 in noninterest bearing notes. One-half ($6,548,856) principal amount of these notes paid in cash on July 26, 1966 with remaining balance issued in 6 percent Pennsylvania Co. notes on the same date. $3,548,856 principal amount of these notes was paid in cash by Pa. Co. on Feb. 1, 1968 with the remaining $3,00t,000 payment being made in cash on Dec. 31, 1969. • $30,381,000 cash; $69,912,000 i% Pa. Co. cum. pfd. $100 par. 5 $6,697,000 cash; $21,000,000 new cost basis from profit resulting from exchange of stock. For more detailed description of trans- action see railroad-prepared tables entitled "Purchase of Investments 1964-1969", Appendix D, Exhibit 10. • Transaction later rescinded to a settlement agreement entered into on Feb. 25, 1971 by both parties to Former Shareholders of Southwest Oil Refining Co. and Royal Petroleum Cj. versus Penn Central Co. and approved by the court and entered for judgment on Apr. 9, 1971 in C.A. 70-C-135, U.S. Federal District Court (S.D. Tex., Corpus Christi Division). 7 $26,198,000 in $3 cum. pfd. stock. ' Total cash expended in purchase investments $203,203,000; total equity securities (Pennsylvania Co. cum. pfd. $100 par, $69,912,000; Penn Central Co. $3 cum. preference, $26,198,000); other, $21,000,000 (reportable cost basis resulting from inter-company profit on exchange ef securities). As noted in the above table, the total amount expended in making non-rail acquisitions was $320,313,000, of which $203,203,000 was in cash (including $13,097,912 in notes paid in cash within four and a half years from date of is- sue), $96,110,000 in preferred equity securities and $21.0 million in subsidiary common stock (resulting from an intercompany sale of stock between PCTC and the Pennsylvania Co., in which the selling price exceeded the cost by that amount). More specifically, the PRR expended $172,069,000 in cash and issued $69,912,000 in cummulative preferred stock in making its non-rail investments. The NYC paid out $21,337,000 in cash. On the other hand, the merged company itself expended $9,797,000 in cash, $26,196,000 in cumulative preferred stock (which was returned 14 months later as the result of a recission of the transac- tion), and $21,000,000 in subsidiary common stock. (Note that this $21 million does not really represent a cash outflow from the consolidated Penn Central, but rather represents a transfer of cash from the Pennsylvania Co. to Penn Central 395 Transportation Co. The implications of this were discussed in the Earnings Maximization section of the Fiscal Policy Analysis.) Moreover, in determining the cash impact on the railroad of the diversifica- tion effort, one should also consider interest paid on debt and the value of equity securities used to finance the acquisitions as well as the dividends and interest received from the subsidiaries. Implicit in this analysis is a recognition of the acute cash shortages faced by the Transportation Co. (and its predecessor com- ponent railroads) during the period in which this diversification effort oc- curred which necessitated borrowing to provide the cash expended. The follow- ing table shows the cash cost to the railroad of the interest on the money used in diversification : INTEREST AND DIVIDENDS PAID ON SECURITIES USED BY RAILROAD IN MAKING SELECTED NONRAIL ACQUISITIONS [From date of acquisition to Dec. 31, 1970) Interest Cumulative rate net investment (percent) Compounded investment value Cumulative Interest interest expense expense 1963 _ $28,176,000 1964.. 43,362,000 1965.. 73,553,000 1966 82,241,000 1967 103,178,000 1968 113,362,000 1969. 160,573,000 1970 159,105,000 4.52 4.63 4.67 5.71 6.25 7.76 9.00 10.00 $28,176,000 44, 635, 560 76, 893, 190 89, 172, 100 115,200,820 132, 584. 880 190, 084, 460 205, 724, 070 $1, 273, 560 2, 066, 630 3, 590, 910 5,091,730 7, 200, 050 10, 288, 590 17,107,600 10, 286, 200 $1,273,560 3, 340, 190 6,931,100 12,022,830 19, 222, 880 29,511,470 46,619,070 56,905,270 The cumulative net investment represents the cumulative total net cash outflow for each period which was derived by adding the total cash outlay for diversification, increased by interest and dividends paid on debt and equity securities issued in conjunction with an acquisition and reduced by the interest and dividends paid by the subsidiaries acquired. The rationale for this com- putation is that the Transportation Co. was not generating enough cash to meet its own cash needs, thus any cash diverted into a diversification effort, regardless of its source, could have been used to reduce the borrowings of the Transportation Co. As noted in the table, the cumulative, compounded interest expended in making these non-rail acquisitions was almost $57 million, resulting in a com- bined outlay of $377,218,270, of which $260,105,270 was in cash. On an individual company basis $18,098,000 was paid out by the Pennsyl- vania Railroad (raising its commitment to $190,167,000), $1,125,000 was paid out by the New York Central (bringing its total commitment to $22,462,000), and the PCTC's commitment was increased bv $37,682,000 to a total of $56,- 905,000. In addition, in order to give a complete picture of the total funds com- mitted to the non-rail operations invested in, pursuant to the diversification program, information was requested by the special staff from the company in regard to the quarterly balances of loans and advances from the railroad (PCTC and/or predecessor companies) and railroad subsidiaries (including the Penn- sylvania Company) to the company's non-rail subsidiaries. This information is included below : QUARTERLY BALANCES OF LOANS AND ADVANCES BETWEEN RAILROAD (PCTC AND/OR PREDECESSOR COMPANIES) AND/OR RAILROAD SUBSIDIARIES AND SELECTED ACQUIRED NONRAIL SUBSIDIARIES (JAN. 1, 1960 TO JUNE 20, 1970) [In thousands] Company making advance Company receiving advance Mar. 31 June 30 Sept. 30 Dec. 31 1964 American Contract Co Executive Jet Aviation, Inc. Pennsylvania Co _ Buckeye Pipe Line Co Do __ Great Southwest Corp Do Macco Realty Co Do Arvida Corp Pennsylvania RR., total loans and advances: Receivable (Payable to)... New York Central RR Strick Holding Co $575 575 396 QUARTERLY BALANCES OF LOANS AND ADVANCES BETWEEN RAILROAD (PCTC AND/OR PREDECESSOR COMPANIES) AND/OR RAILROAD SUBSIDIARIES AND SELECTED ACQUIRED NONRAIL SUBSIDIARIES (JAN. 1, 1960 TO JUNE 20, 1970)-Continued [In thousands] Mar. June Sept. Dec. Company making advance Company receiving advance M 31 30 30 31 1965 American Contract Co Executive Jet Aviation, Inc 2,893 5,846 8,011 8,163 Pennsylvania Co Buckeye Pipe Line Co Do Great Southwest Corp Do Macco Realty Co Do Arvida Corp Pennsylvania RR., total loans and advances: Receivable 2,893 5,846 8,011 8,163 (Payable to) New York Central RR Strick Holding Co... 1966 American Contract Co Executive Jet Aviation, Inc.... 9,664 12,050 12,081 13,865 Pennsylvania Co _ Buckeye Pipe Line Co Do Great Southwest Corp Do Macco Realty Co 750 Do ArvidaCorp Pennsylvania RR., total loans and advances: Receivable 9,664 12,050 12,831 13,865 (Payableto) New York Central RR. Co Strick Holding Co 2, 199 1967 American Contract Co. Executive Jet Aviation, Inc... 14,781 15,591 15,976 16,306 Pennsylvania Co Buckeye Pipe Line Co Do Great Southwest Corp 3,000 Do Macco Realty Co... (1,300) 1,350 3,700 6,000 Do ArvidaCorp (500) (250) Pennsylvania RR., total loans and advances: Receivable 14,781 16,981 19,776 25,306 (payableto) _ (1,300) (500) (250) New York Central RR. Co Strick Holding Co 6,997 8,997 9,437 9,437 1968 American Contract Co Executive Jet Aviation, Inc. 3,000 3,000 3,000 3,000 Pennsylvania Co Buckeye Pipe Line Co 16,421 16,621 16,621 19,020 Do Great Southwest Corp 7,100 9,100 12,100 12,400 Do Macco Realty Co (250) (250) Do ArvidaCorp New York Central RR. Co./Penn Central Strick Holding Co... 9,437 9,437 9,437 2(19,700) Transportation Co. (Feb. 1, 1968 to June 20, 1970). Penn Central Transportation Co., total loans and advances: Receivable 35,958 38,158 41,158 35,420 (Payableto) (250) (250) (15,000) 1969 American Contract Co Executive Jet Aviation, Inc 21,020 21,020 21,020 321,020 Pennsylvania Co Buckeye Pipe Line Co... Do Great Southwest Corp 18,550 20,900 21,600 Do Macco Realty Co («) Do ArvidaCorp Penn Central Transportation Co Strick Holding Co (15,000) (14,984) (9,384) (*) Penn Central Transportation Co., total loans and advances: Receivable 39,570 41,920 42,620 21,020 (Payableto) (19,700) (19,684) (14,084) 1970 American Contract Co Executive Jet Aviation, Inc 21,020 21,020 Pennsylvania Co Buckeye Pipe Line Co (5,500) Do Great Southwest Corp Do Macco Realty Co Do ArvidaCorp Penn Central Transportation Co Strick Holding Co - Penn Central Transportation Co. total loans and advances: Receivable 21,020 21,020 (Payableto) (5,500) 1 Extracted from information submitted by railroad pursuant to request of Committee's special staff and set forth in tables III and IV (Quarterly Balances for the Period Jan. 1, 1960 to June 30, 1970 of Penn Central Transportation Co. (and Railroad SubsiJianes) Loans and Advances Receivable from (Payable To] non-rail subsidiaries); App. D, Exhibit 51. 2 Strick Holding Co. sold its investment in Strick Corp. (Manufacturing Co.) and Transport Pool for $27,900,000 ($15,000,000 in cash, $9,400,000 in promissory notes, and $4,700,000 in warrants) in 1968. Since the proceeds were paid directly to Penn Central Transportation Co., Strick Holding Co. recorded such payment as an advance to Penn Central Transportation Co. In 1969 alter payment of state in- come taxes for the gain on sale of its subsidiaries in 1968, Strick Holding Co. paid a dividend of approximately $4,800,000 to Penn Central Transportation Co. At date of dividend payment Strick Holding Co.'s balance sheet had receivables due from Penn Central Trans- portation Co. and a net worth of approximately $19,800,000. Subsequent to the dividend payment, Strick merged into Penn Central Transportation Co. in December, 1969. » Other railroad information contained in an internal report ("Cole Report") on EJA indicated a total debt investment of $21,365,000 at this date. * Macco Realty Co. merged into Great Southwest Corp. in March, 1969. 397 These tables reflect that by the end of 1967, immediately preceding the merger, the PER had extended an additional $9,000,000 in loans to Great Southwest Corp. and Macco Realty Co. (excluding the $16,036,000 debt investment in Executive Jet Aviation, Inc. which is accounted for in the pur- chase investments table (Exhibit 10) because of the nature of its commitment 18 ) As of the same date, the NYC had advanced $9,437,000 to Stride Holding Co. By the end of the third quarter of 1969, total advances (excluding Executive Jet Aviation) had risen to $21,600,000 for the PCTC. Source of Funds In order to understand exactly what total cash expenditures were made in the combined diversification programs the following table was constructed re- flecting the total cash expenditures of the PCTC and its predecessor companies, the NYC and PRR, on a yearly basis : TOTAL CASH FUNDS EMPLOYED BY PCTC (AND/OR PREDECESSOR COMPANIES) AND SUBSIDIARIES IN REGARD TO SELECTED NONRAIL SUBSIDIARIES (ON A YEARLY BASIS-JAN. 1, 1960 THROUGH JUNE 20, 1970) Year Acquisition purchase price 1 Dividends paid on preferred stock issued as acquisition consideration Interest paid on debt securities issued as part of acquisition consideration Increases (decreases) in loans and advances outstanding at end of calendar year Total cash PCTC: 1968 $8,245,856 $3,264,441 $215,084 $10,364,000 $22,089,381 1969 5,000,000 3,264,305 242,707 2 6,700,000 15,207,012 1970 1,632,152 336,668 1,968,820 Total NYC: 1966... 1967 Total. PRR: 1963 1964... 1965 1966 _ 1967 Total 102,385,396 11,326,546 157,318 25,631,000 139,500,260 13, 245, 856 8, 160, 898 457, 791 17,064,000 39, 265, 213 15,000,000 2, 997, 000 6, 440, 000 2,997,000 21,440,000 15,000,000 9,437,000 24, 437, 000 28, 303, 000 17,514,983 45, 227, 849 10, 393, 564 946, 000 1,529,785 3, 267, 542 3, 264, 778 3, 264, 441 157,318 575, 000 7, 588, 000 6,277,000 11,191,000 28, 303, 000 19,619,768 56, 083, 391 19,935,342 15,558,759 1 Includes commissions and fees paid in connection with acquisition. 2 Excludes repayment of advances totaling $23,058,000 (along with $2,153,000 in tax allocation payments due PCTC) in the 4th quarter 1969 by Great Southwest Corp. by the issuance of an equivalent amount of its common stock. Both the PRR and the PCTC publicly stated that the funds used to finance these activities would come from the proceeds of the sale of the N&W common stock holdings. Actual proceeds from the sale of its N&W stock for the period 1/1/60 through 12/31/70 were as follows : DISPOSITION OF NORFOLK & WESTERN RAILWAY CO. STOCK HELD BY PCTC (AND/OR PREDECESSOR COMPANIES) AND SUBSIDIARIES FROM JAN. 1, 1960 THROUGH DEC. 31, 1970' Date and company making disposition Type and amount of interest disposed of (common stock) Cost basis (book value) Sale proceeds « July 5, 1963, Pennsylvania Co.. Dec. 19, 1968, Pennsylvania Co March 1969 to December 1969, Pennsylvania Co Total 37, 312 shs. 135,000 do 215,799 do 388,101 $2, 092, 886 7, 572, 420 12, 104, 597 21, 769, 903 $4, 506, 792 13,831,779 2 19, 305, 247 37, 643, 818 1 Extracted from tables entitled "Investment Analysis— Norfolk and Western Railway Company Stock (Common)" submitted by rail- road pursuant to request of Committee special staff (Appendix D, Exhibit 45, p. 576.) 2 Net proceeds. 'Sales by month are as follows: March, 51,440 shares, $4,977,245 net proceeds; June, 45,999 shares, $4,109,555 net proceeds; July, 6,900 shares, $625,272 net proceeds; August, 44,360 shares, $3,894,733 net proceeds; September, 42,900 shares, $3,771,643 net proceeds; October, 21,400 shares, $212,291 net proceeds; November, 7,000 shares, $600,527 net proceeds; December, 14,800 shares, $1,113,981 net proceeds. 18 Because of provisions of the Federal Aviation Act making ownership of an "air carrier" by a surface transportation company highly improbable, if not impossible, the PRR had taken nearly all of its investment in Executive Jet Aviation, Inc., in debt form. 398 Quite obviously this expected source did not begin to provide the funds used by the Pennsylvania Railroad for its non-rail acquisitions. However, the 1968-1969 sale proceeds do appear to have been of sufficient magnitude to have financed the non-rail diversification-related cash expenditures incurred by the PCTC. In addition, in order to assist in determining what funds were employed in financing these activities, the following tables showing all extraordinary addi- tions to the working capital of the railroad (s) is included : EXTRAORDINARY ADDITIONS TO WORKING CAPITAL OF RAILROAD (JAN. 1, 196IKIUNE 20, 1970)' Date Company making disposition Interest disposed of Proceeds July 5, 1963 PRR: . Pennsylvania Co . PRR.._ ordinary additions .. 37,312 common shares— N & W... __ $4, 506, 792 Jan. 20,1966 Total extra .. Long Island RR Co. (100 percent of outstanding stock) » 65, 000, 000 69. 506, 792 PCTC: . PCTC . Pennsylvania Co _ do ordinary additions . . Strick Corp. and Transport Pool, Inc. (operating subsidiaries of Strick Holding Co.) (100 percent of outstanding stock). ._ 135,000 common shares— N & W December, 1968.. Dec. 19, 1968.... M5,000,000 13,831,779 Mar. 19, 1969- Dec. 19, 1969.. .. 215,799 common shares— N & W. 19, 305, 247 Total extra 48, 137, 026 extraordinary additions Combined 117,643,818 1 Includes major sales of equity investments, rail and nonrail. 2 $10,000,000 was deposited in December 1965 pursuant to the preliminary agreement of sale dated Dec. 20, 1965. The balance of $55,000,000 was paid on Feb. 7, 1966 after consummation of the transaction. 3 Cash. It admittedly cannot be stated with absolute preciseness that the exact funds from one source are those later utilized in a particular manner where such receipt and allocation is done by a large corporation and there is a com- mingling of all funds received. However, such a tracing process can be accom- plished on a net effects basis as was done in this case in conjunction with an examination of the various documents relating to each transaction. 10 In the case of the PRR, $69,506,792 of the total $139,500,260 cash expended during the period 1963 through 1967 was provided from the July 1963 sale of N&W common stock ($4,506,792) and from the proceeds of the sale of the Long Island Rail Road Co. in early 1966 (resulting in $65,000,000 in cash). The re- mainder was furnished from working capital of the corporation. On a yearly basis, $23,796,208 was furnished from working capital in 1963 ($28,303,000 less $4,506,792) ; $19,619,768 came from the same source in 1964 ; $56,083,391 was sup- plied by working capital in 1965 (including a $6,000,000 bank loan by the parent railroad to finance the Macco Realty Corp. acquisition) ; $19,935,342 expended in 1966 was financed entirely by the proceeds of the Long Island Rail Road Co. sale (which could also be said to have replaced the remaining $45,064,658 of working capital used for diversification-related expenses the previous year) ; and $15,558,759 was financed from working capital in 1967. In regard to the NYC, the entire amount, $24,437,000 ($2,997,000 in 1966 and $21,440,000 in 1967) was financed from working capital sources of that railroad. On the other hand, the total cash amount expended by the PCTC on di- versification-related costs ($33,228,545) appears to have been covered by pro- ceeds from the 1968-1969 N&W common stock sales ($33,137,026). More specifically, the $22,089,381 expended during 1968 would have been partially fi- nanced with proceeds from the December 19, 1968 N&W common stock sale ($13,831,779). The balance, however, was financed from working capital. The total 1969 cash outlay of $10,507,012 was also funded by total proceeds ($19,305,- 247) of N&W sales during the year. The remaining $8,798,235 effectively re- placed the working; capital used to finance the 1968 diversification costs not covered by the N&W stock sale proceeds for that year, as well as serving to pro- a See also the railroad-supplied table entitled "Selected Subsidiaries, Analyses of Purchase of Investments, 1964 through 1969," for comments In footnotes, see sources of funds. Appendix D, Ex- hibit 10, p. 508. 399 vide nearly all of the 1970 diversification-related (pre-bankruptcy) of $1,632,152. 20 Kather than dismissing the subject with the observation that the bulk of the diversification or diversification-related expenditures was financed from work- ing capital of the railroad (s) it is believed of significance in this connection to examine what "working capital" consisted of. In order to analyze working capital (technically current assets minus current liabilities), an analysis was made of the earnings from which the current assets of the corporation arose. Admittedly some of the assets have their genesis in funds earned years ago. However, by far the vast majority are generated by current or reasonably current operations. Nonetheless, the period examined covered the eighteen years prior to bankruptcy, or from 1952 through 1969. Net income was divided into rail (including rail-related, e.g., trucking and terminal operations) and non-rail contributions, 21 the purpose of which was to determine the validity of the proposition so often advanced that funds from the company's rail operations were financing its non-rail acquisition activities. The result of this comparison on a total net income and earnings per share basis are set forth in the following tables : NEW YORK CENTRAL RAILROAD [In thousands] Net income Earnings per share — Dividend Year Rail Nonrail Total Rail Nonrail Total per share 1952 $1,574 $23,142 $24,716 $0.24 $3.29 $3.83 $0.50 1953 14,027 19,975 34,002 2.18 3.10 5.28 1.50 1954 (14,290) 23,478 9,188 (2.22) 3.64 1.42 _. 1955 25,513 26,771 52,284 3.94 4.13 8.07 1956. _ 13,336 25,768 39,104 2.05 3.96 6.01 2.70 1957 (16,275) 24,698 8,423 (2.51; 3.81 1.30 2.73 1958 (33,419) 37,470 4,051 (5.15) 5.77 .62 1959 (18,012) 26,415 8,403 (2.77) 4.02 1.25 .25 1960. (24,485) 25,523 1,038 (3.76) 3.92 .16 .50 1961.. (38,763) 26,214 (12,549) (5.94) 4.02 (1.92).... 1962 (24,255) 20,419 (3,836) (3.71) 3.12 (.59) .325 1963 (13,834) 20,873 7,039 (2.11) 3.19 1.08 .50 1964 (437) 27,484 27,047 (.07) 4.13 4.06 1.77 1965 14,112 27,407 41,519 2.06 4.00 6.06 2.60 »« 2 .,672 fM3* %™} 3.14 {};» 7.27 } , 15 ™ (32,936) {£»> J;*} (4.75) {J;§ ;{? } 3.12 Note: Nonrail amounts for 1966-67 are shown including results from Strick Holding Co. (top figure) and excluding results from this acquired subsidiary. PENNSYLVANIA RR. CO. [In thousands] Net income Earnings per share Dividend Year Rail Nonrail Total Rail Nonrail Total per share 1952.. $12,463 $26,849 $39,312 1953 11,834 27,041 38,875 1954 (1,378) 19,930 18,552 1955 _ 21,779 19,405 41,184 1956.. 19,881 21,664 41,545 1957 (2,980) 22,037 19,057 1958.. __ (33,685) 37,229 3,544 1959.... (15,177) 22,444 7,267 1960... _ (39,713) 31,894 (7,819) 1961 (25,070) 28,586 3,516 1962 (24,312) 21,102 (3,210) 1963 (12,552) 21,710 9,158 1964 l\ 19rn Z 30 ' 323 29 ' 133 \ 1SM — — (1 ' 130) 122,766 21,576/ 1965 3 349 I 30 ' 548 33 ' 897 1 I36:> -- s ' s ™ 119,012 22,361 / 1966 11 799 J 33, 256 45,055 1 i3oo ii, /as \13,534 25,333 1 1967 fU 1\H\ /48i408 U, 092 \ n ... .3.45 1.011 , , n 1967 (34,316) | 23094 11,222/ < 244 > 1.1.65 -79/ 2 ' 4 ° Note: Nonrail amounts for 1964 through 1967 are shown including results from the acquired subsidiaries (top figure) and excluding results from these subsidiaries. $0.95 $2.04 .90 2.05 (.10) 1.51 1.65 1.47 1.51 1.65 (.22) 1.67 (2. 56) 2.83 (1.15) 1.70 (3.02) 2.43 (1.90) 2.17 (1.81) 1.57 (.93) 1.61 (.08) /2.20 1l.65 .24 /2.21 1l.37 .85 /2. 39 I .97 (2.44) .3.45 \1.65 $2.99 $1.00 2.95 1.50 1.41 .75 3.12 1.50 3.16 1.55 1.45 1.25 .27 .25 .55 .25 (.59) .25 .27 .25 (.24) .25 .68 .50 2.12 1 1.57 / 1.25 2.45 1 1.61 / 2.00 3.24 1 1.82 / 2.30 20 $1,968,820 through 12/31/70. 21 Included, principally, real estate rental income, capital gains from sale of real estate and dividend income. The real estate activities are briefly described at p. 387, supra. 400 PENN CENTRAL TRANSPORTATION CO. [In thousands] Income Earnings' Net Net Including including Extra- extra- Extra- extra- ordinary ordinary ordinary ordinary Dividend Year Rail Nonrail Net items items Rail Nonrail Net items items per share 1962.. (48,566) 41,520 (7,046) (2,21) 1.89 (0.32) .... 0.25 1963. (23,386) 42,583 16,197 (1.20) 1.93 .73 .45 "64 d.626) {g;« ftjg}. (.07) {f; » |» } 1.29 "65 1M61 {«;» g;«|} .77 £» ■;« 1.99 lQfie « 47n /61.695 95,165 1 /2. 70 4.16 1 , ,, 1966 " 33 ' 470 141,086 74,556/ " 11.80 3. 26 I Z 35 1967 (67.254) {g;|g gg? J~. (2.92) g| ;gj 2.40 1968 (122,422) {pJJ*?, |;™ } (18, 142) (41,915) (5.08) {^° 2 :84}< 075 > < 174 > 2 30 1969 (191,079) { l °Ul* ,1^15} (8,818) (91,632) (7.92) j*;*' 3. 43 j ( 37) (3 80) , 80 1 Includes for period 1962-1967 adjustments for exchange of 1.3 shares of PCTC common stock for each N.Y.C. common share pur- suant to merger agreement. Note: Nonrail amounts for 1964 through 1969 are shown including results from the acquired subsidiaries (the top figure) and ex- cluding results from these subsidiaries. These tables quite clearly show that the company's rail operations were not directly financing non-rail acquisitions. In the case of the PER for 1952 through 1967, only in one year (1955) did rail earnings exceed non-rail earn- ings (and then only slightly, $21,779,000 to $19,405,000). In only six of those years (1952-53, 1955-56 and 1965-66) did rail operations contribute anything to net income, losing as much as $39,713,000 in 1960, and $34,316,000 in 1967. Over the entire 16-year period while non-rail operations were contributing $442,426,000 in total reported net earnings, 22 rail operations contributed a total net loss of $129,268,000. If the losses from passenger operations are eliminated from reported rail earnings, the results (although not as contrasting in later years) are basically the same. While shippers may want to see earnings generated from the rail traffic operations reinvested in the rail plant, the working capital utilized by the PRR appears to have been generated by the company's non-rail activities. A similar analysis of NYC earnings reveals the same basic conclusions. In only six years of the 16-year period (the same six years in which the PRR also reported earnings: 1952-53, 1955-56, and 1965-66) did the rail operations contribute anything to consolidated income, reaching losses of $38,763,000 in 1961 and $32,936,000 in 1967. Over the entire period total non-rail earnings were $418,196,000, in contrast to rail operation losses totalling $126,492,000 (both figures bearing a striking similarity to comparable PRR figures). The $34,228,545 expended by the PCTC on diversification-related costs (all but $6,697,000 of which was applied on inherited PRR acquisitions), as dis- cussed above, could well have been said to have been financed by proceeds of N&W common stock sales in 1968-1969. However, assuming arguendo that such expenditures were financed from working capital, the table discloses that it was equally as dependent, if not more so, upon non-rail earnings as were its predecessors. Non-rail earnings for 1968-1969 totalled $206,913,000, as com- pared to total rail losses of $313,501,000. (Excluding the acquired subsidiaries, total non-rail income nonetheless reached $116,101,000). Once again, it appears that such expenditures were not financed by rail operations. It should be noted at this point that the "earnings inflation" policy of the PRR and the PC in particular distorted the income figures by an indeterminate amount thus making it necessary to exercise some caution in analyzing the flow of cash. As is pointed out in other segments of this report, reported earnings differed substantially from cash realities in many instances. 23 Figures Include earnings from acquired non-rail subsidiaries in 1964 through 1967. Excluding these earnings, total non-rail net income for the period V.)WJ. l!)tw amounted to $378,297,000. 401 Investment Pattern An examination of the non-rail investments made by the PRR reflect entry into three basic industries: (1) petroleum pipeline distribution; (2) real estate development; and (3) air transportation. Entry into the firs!" of these areas was accomplished by the acquisition of Buckeye Pipe Line Co. in July, 1964. As was discussed previously, consideration of the acquisition of a pipeline company was begun as early as 1960 not so much at that time with diversification itself as the primary objective (although it did serve as a factor) but in order to attempt to gain a more efficient use of its existing plant through use of its rights-of-way. 23 However, by the time of acqui- sition. Buckeye was described by S. T. Saunders in an accompanying press release as "an important step in a long-range program of diversification." 24 A memorandum dated May 10, 1963, prepared in connection with the Buckeye acquisition, gives some indication of the considerations which the railroad was, ostensibly, utilizing in its acquisition programs. At page 1 of this memorandum it was stated ''Logically, diversification should be into an industry which sup- plements or complements the basic operations and one which in concept and philosophy is readily understood by the management of the parent company." 25 The application of the latter considerations, other than the fact that the same geographical areas were served by both corporations, is not apparent. Another factor, discussed earlier, which was to be of major consideration in regard to type of operations acquired, was rate of return. The Bevan memo- randum dated April 30, 1963 (in regard to possible courses of action available upon disposition of the N&W holdings) 20 pointed out the necessity of ob- taining a high rate of return from any acquisition in order to replace the substantial 85 percent tax free cash dividend income from the N&W shares. It is again difficult to see how the latter consideration (at least from the stand- point of cash return), which would seemingly be of great importance to the cash poor railroad (regardless of the N&W income replacement considerations) , played the least significant role in the selection of Buckeye, or, more especially, that of the real estate development acquisitions. This question will, however, be discussed in more detail later on in this chapter in connection with the rate of return (in terms of both reportable income and cash) achieved by the PRR on its non-rail acquisitions. The second industry area entered by the railroad, and the one in which it concentrated its major effort, was that of real estate development. Initial entry into this product market was accomplished with the acquisition of controlling interest of Great Southwest Corporation (GSC) in June, 1964. Called "a major step in the Pennsylvania's long-range program of diversification" by S. T. Saunders, 27 GSC was viewed as being the nucleus for further diversifi- cation in real estate operations (and was in fact later utilized as such with the acquisition of Macco Realty Corp. and its eventual merger into GSC in early 1969, the additional acquisition of I. C. Deal Corp. in 1969, and GSC's own expansionary efforts). More specifically, GSC was (initially) primarily in the business of developing properties for lease for commercial use within an industrial park. To supplement lease income, the company also de- veloped and operated a Disneyland-type amusement park with a historical theme, with an accompanying motor hotel- restaurant operation, in order to generate sufficient cash flow. Such operations were carried on at two locations, between Dallas-Ft. Worth, Texas and near Atlanta, Georgia. The second real estate development firm acquired was that of Arvida Cor- poration, controlling interest in which was purchased on July 26, 1965, about one year following the GSC transaction. Arvida, a Florida firm, possessed sub- 23 No use of the railroad's rights-of-way has been made for this purpose since acquisition of Buckeye. » Appendix D, Exhibit 11, p. 516. 25 See Appendix D, Exhibit 4, p. 494, for full text of this memorandum. Of course, the argument normally advanced in nearly all diversification programs, that of seeking to introduce earnings stabil- ity resulting from a wider earnings base (by acquiring companies whose operations are either subject to little or no cyclical pressures or whose business cycle Is different from that of the parent company) was also present. 26 In Text, p. 389. Supra. 27 PRR press release dated June 24, 1964, Appendix D, Exhibit 12, p. 517. 402 stantial holdings on both the East Coast of Florida in the Miami-Ft. Lauder- dale-Boca Raton-Palm Beach area, and around Sarasota on the West Coast. Holdings at the time of acquisition included major resort, residential and com- mercial properties. Operations were, moreover, primarily concerned with devel- opment and sale, although certain leasing and investment activities were also included. The third in a succession of real estate operation acquisitions was that of Macco Realty Corporation, effected by the railroad less than a month later by purchase of controlling interest. 28 Macco, a California company, was one of the leading residential real estate development companies in the Los Angeles area, with extensive holdings in Los Angeles, Riverside and Orange Counties. The Macco acquisition, made at the urging of Great Southwest Corporation, was termed by railroad officials as a transaction which would conclude its real estate investment activities. Few stated reasons were to be found anywhere in regard to the rationale employed by the railroad for its decision to enter the real estate development field. Certain reasons, however, for acquisition of GSC and entry into real estate operations were contained in an internal memorandum 28 of the invest- ment adviser to the railroad — for this, and all its acquisitions — Glore Forgan, William R. Staats and Company, which was prepared in connection with the transaction. These reasons were : ". . . the experience of the railroad in indus- trial property management," [presumably through its industrial development department] ; ". . . the stability and growth of GSC operations which could help overcome the cyclical character of the railroad business; and the opportunity to participate in the growth of an area which is expanding at a much faster rate than the operating territory of PRR." In addition, the PRR press release in connection with the acquisition also gives reference to the rail- road's prior "experience" in real estate matters. The railroad had some real estate experience in that it did own some com- mercial properties including office buildings from which it derived rental in- come, had engaged in the sale and/or lease of some of its own real property ad- jacent to its real operations (to potential shippers) , and managed its own prop- perties. While some of the business development activities of the railroad may have given some substance to the claim that it had experience which could be related to the development of the industrial district projects of GSC (excluding the amusement park-motor hotel-restaurant operations), it hardly follows that PRR officials were also experienced in residential property development and sales, which formed the major part of the railroad's acquired real estate activi- ties (through Arvida and Macco Realty — and for that matter much of GSC's own later activities as the result of its acquisition of I.C. Deal Co.) . The "stability and growth" of GSC operations is an assertion whose validity was highly questionable not only because of its short history of opera- tions, several years of which resulted in losses, but more importantly in view of the volatile nature of the real estate industry itself because of the large role that fluctuating interest rates and local economies play (most notably in con- nection with residential development operations). Furthermore what real estate experience the PRR did possess should have provided ample warning of the extraordinary financing demands normally made by such operations. The almost endless need for external financing results from several factors including (1) having funds tied up in properties which are unsold or held for future development; (2) a high rate of receivables principally in the form of second trust notes; (3) expansionary purposes (including e.g. the continual need to purchase land for future development). Because of this demonstrated need for financing, all funds generated internally are invariably used to supplement working capital and it is a rarity that dividends are paid. The principal re- turn on investment must ordinarily come from capital gains to be realized from stock appreciation possibilities. Unfortunately, as will be discussed later in more detail, and as should certainly have been foreseen at the time of acquisition, the GSC and Macco Realty acquisitions were continual cash drains on the railroad's already depleted 28 Conditioned on a later tender offer of September 13, 1965, which successfully increased owner- ship to in excess of 80 percent (to approximately !)8 percent). » Memorandum dated February 18, 19G4, from "WDS" [Walter D. Scott] to Charles J. Hodge, Appendix D, Exhibit 13, p. 518. 403 cash reserves (by the end of the third quarter 1969, in excess of $23.8 million had been advanced to both companies — $9 million of which had been advanced by the PRR by the end of 1967 ). 30 Moreover, no cash dividends have ever been paid by Arvida or Macco Realty and only $4,266,441 in cash dividends was re- ceived from GSC in appropriately six and a half years of ownership from 1964- 1970 ($297,500 to the PRR from 1964 through 1967) on a total investment of $61,286 million. In addition, although there were satisfactory reportable earnings gener- ated which were consolidated in the income statement of the railroad, part of these paper profits were produced by questionable accounting practices. 31 Such reported earnings had the further undesirable effects of covering over the failing rail operations and serving as a distraction to the continuing cash drain which these subsidiaries were having on the railroad. Furthermore, the volatile nature of the industry was eventually reflected in the reported earnings of GSC (including Macco) in 1970 — a loss of nearly $132 million was reported for that year, giving the railroad a total net loss of over $80 million for that company's operations from 1964-70. Of significance in this connection was the attitude of the NYC toward its proposed merger partner's real estate diversification activities. Comments con- tained in the minutes of a meeting of the NYC Board of Directors on May 14, 1966, at which was considered a request by the PRR to raise its ceiling on debt (arrived at in a pre-merger agreement between the two railroads) in order to include debt incurred principally as the result of its four major acquisitions, the Central's Board expressed reservations about the wisdom of the PRR's en- tering the real estate development business. 32 However, the Board grudgingly consented to the request that the aggregate debt limit be raised to $195 million (nearly double the $100 million ceiling originally agreed to). Entry into other modes of transportation is of course either prohibited or effectively prohibited by law. 33 However, of all areas of business operations which the railroad could have entered, considering its cash needs, real estate development was perhaps the most ill-suited. Although not normally offer- ing the spectacular stock appreciation [and accompanying decline] possi- bilities that real estate does, many other forms of business activity could have 30 Repayment of the $23.8 million in advances was made by GSC on December 31, 1969, by the issuance of its common stock in an equivalent amount — which nearly immediately suffered a severe decline in value (from 15% [bid] on 12/31/69 to 2% [bid] on 12/31/70, or 85 percent — declining even further to 1% [bid] on 12/31/71). 31 Accounting and tax provisions permit the reporting of profit on a real estate sale in the year in which the sale occurred despite the fact that only a small down payment might be made and the remainder repayable in Installments over 20^30 years. For example, because GSC was not achiev- ing its income goals in 1968 and 1969, it attempted to bolster them by resorting to sale of its amuse- ment park operations ("Six Flags Over Texas," and "Six Flags Over Georgia ). Both sales, clearly undertaken in order to maximize consolidated income for the year in which sold, did result in sub- stantial short-term profits, but, of course, also relieved the corporation of two of its principal Income producers. Moreover, substantial controversy surrounded the reporting of their sales. One-half of the entire profit for GSC in 1969 resulted from gain on the sale of "Six Flags Over Texas." Gross pro- ceeds from the sale totalled $40 million, but only $1.7 million was actually received in cash with the balance due in installments until the end of the century. Under pe-missible Internal Revenue Service tax provisions the entire profit ($8.75 million) was reportable in the year of sale. Furthermore, the corporation changed its original accounting designation of the transaction from that of extraordinary gain (because of its size and nature) to that of ordinary income, thereby avoiding a financial state- ment notation as to the nature of the transaction and its effect on the corporation's income for the year. In addition, less than a year earlier, on December 31, 1968, the corporation "sold" Six Flags Over Georgia", generating a net gain of $4.8 million from a transaction whereby the purchaser contributed the amusement park to a limited partnership in which the selling corporation was the general partner and operator. Once again, cash produced bv this sale was negligible in that out of a total purchase price of $23 million. GSC took back a 7% note in the amount of $21 million. In the same year, GSC generated additional net gain of $1.5 million on a sale of securities by Macco which also bolstered income for the vear. 33 Appendix D, Exhibit 14, p. 523. 33 E.g., ownership of an air carrier, a non-rail related trucking company, a freight forwarder, as well as water carriers are all effectively prohibited. Ownership or control of an "air carrier" by a surface transportation company is prohibited by 'Section 408(b) of the Federal Aviation Act, unless such ownership "promotes the public interest . . . (is) to the public advantage, and will not restrain competition." Although the existence of ownership of convertible debentures of Slick Airways by the C&O Railroad Co. and of similar debentures of Flying Tiger Lines by the NYC Railroad Co. was per- mitted by the CAB to continue, there was substantial reason to believe that acquisition of an "air carrier" by a surface transportation company would not be permitted, not only from the restraint of competition standpoint but from previous decisions relying on Section 408 and reflecting the estab- lished policy of the CAB that ". . . our air transportation system shall be free of control by surface carriers" as the controlling consideration in the application of the "public convenience and necessity standard" of Section 401. (Railway Express Agency, Freight Forwarder Application, 27 CAB 500, 50^ [ 1958 ] ) . Ownership of trucking companies by railroads is similarly effectively prohibited by Section 5(2) (d) of the Interstate Commerce Act with Its requirements that such ownership "promote the pub- lic interest to public advantage." However, such ownership has, of course, been approved by the Commission in situations where the trucking activities Involved piggyback and other rail-related operations. Ownership of freight forwarders and water carriers by surface transportation companies are also basically prohibited. 404 provided the growth and return on investment objectives without the extraordi- nary financing demands and accompanying non-payment of cash dividends that real estate developmet operations present (e.g. consumer services or con- sumer goods, to name only two). Given the objectives of tbe program and the railroad's only slight acquaintance with real estate activities of the type ac- quired, it is apparent that factors other than cash generation were determinative. For example, real estate offered opportunities for inflating the company's pub- lic financial picture as discussed in the Earnings Maximization section of the Fiscal Policy Analysis portion of this report. Explanation of how such a step was taken is perhaps best made by an examination of what might be described as the complex interrelationship of the railroad and its investment banking adviser, Glore Forgan, Wm. R. Staats and Co. This relationship evolved from the friendship of David C. Bevan, Chairman of the Finance Committee of the PRR, and Charles J. Hodge, the Chairman of the Executive Committee of Glore Forgan. The two men had been friends on a social as well as on a business basis for a considerable length of time, 34 Hodge openly considering himself an "intimate friend of the family." Moreover, both belonged to a fishing and social club called the "Silverfish," consisting of twelve men, most of whom were high-ranking officials in finance- oriented business operations. 35 On a business basis, through Hodge's contact Avith Bevan, Glore Forgan had acted as the broker through which both Pennsylvania Co. and the Con- tingent Compensation Fund of the railroad had made their securities purchases in the early 1960's. In 1960 Hodge himself was appointed a member of the "Committee of Potential Pipelines in the Pennsylvania Railroad System" whose study produced the confidential memorandum, of which he was the author, recommending the acquisition of Buckeye Pipe Line Co. Moreover, in October, 1961 Hodge was apparently sent as an emissary on behalf of the railroad to Switzerland in an attempt to convince certain Swiss banking interests (who asserted at the time that they controlled some 1.3 million PRR common shares) that they should vote for the then reactivated PRR-N YC merger proposal, 36 giv- ing assurances to the banks that they could obtain representation on the PRR Board of Directors, if they so desired. 37 Also, during the early 1960's after reacti- vation of the merger plans, the Staats firm itself served as an investment adviser to both the PRR and NYC railroads in the working out of an agreeable stock ex- change ratio (which the railroads' principal underwriters had apparently been unable to accomplish). Hodge cultivated the relationship even further by giving a dinner in New York in honor of S. T. Saunders, D. C. Bevan and H. R. Pevler (President of the N&W at the time) , soon after Saunders' appointment as PRR Board Chair- man, and attended by a large group of top officials of the nation's largest finan- cial institutions, 38 — and later (in 1965) even arranging part of the itinerary of a European tour by Saunders. 39 34 ". . . (F)or twenty years" according to a letter dated 3/29/65 from Hodge to A. T. Brown, Sales Administrator, Arvlda Realty Sales, Inc., In support of Bevan's application for purchase of an apartment In an Arvlda-owned condominium in Boca Raton, Fla. Appendix D, Exhibit 15, p. 524. The casualness of the relationship is furtuer evidenced by the fact that in connection with a similar apart- ment which Hodge purchased, the title insurance policy for it was secured on his behalf by an attorney In the railroad's legal department. Appendix D, Exhibit 16, p. 525. 36 See Appendix D, Exhibit 17, p. 526. 36 Letter dated 10/16/61 from C. J. Hodge to D. C. Bevan, Appendix D, Exhibit 18, p. 526. 37 ". . . (P)roviding that the representative was not an Investment Banker" (see letter dated 11/15/61 from an official of one of the Swiss banks to Francis N. Rosenbaum Appendix D, Exhibit 19. That such a mission would be undertaken on behalf of the railroad by an independent third party (whose only previous connection with the railroad was his friendship with Bevan and his services in connection with the pipeline study) apparently without authorization by the PRR Board of Directors, or its Chairman, is highly unusual, if not extraordinary. 38 See document entitled "Dinner Given by J. Russell Forgan and C. J. Hodge. The Links Club, October 30, 1963," Appendix D, Exhibit 20, p. 527. 39 See letter dated 4/6/65 from C. J. Hodge to D. C. Bevan and other various pieces of corre- spondence, Appendix D, Exhibit 21, p. 528. Moreover, an April 5, 1965, letter refers to a meeting arranged by Hodge between Saunders and a group of "Spanish friends" which included representatives of a manufacturer of freight cars in Madrid, called "Euskalduna," and a "Carlos Mendoza, the head of RENFE, which is the government-controlled [sic] railroad monopoly In Spain [which] would be a proper platform for the building up of a slmpatico between Stuart, the Pennsylvania and the Spanish." According to Hodge's letter, the Spanish group was seeking advice in regard to expansion of rail freight car manufacturing facilities. However, Hodge states in the letter "There is no question here of requesting financing. Any money required will be available in Spain from the Spanish. This is merely an effort to bring the Spanish closer to the Pennsylvania Railroad." Just what the purpose of bring- ing the "Spanish closer to the Pennsylvania" was, was not clear from the letter. 405 The entire purpose of setting forth this otherwise irrelevant material re- garding the personal relationship existing between Hodge and Bevan, is to question the objectivity, if any, which was exercised in regard to analysis of the acquisition proposals submitted by Hodge to the railroad. Because of the friendship between the two men which had developed over the years and the trust arising therefrom, the objectivity and thoroughness of examination ac- companying normal arms-length transactions may well have been absent in the Hodge-Bevan situation. 40 From the outset of its program, Hodge (and the Win. R. Staats & Co. firm — later Glore Forgan, Wm. R. Staats & Co.) was the principal, or more accurately, sole investment adviser to the PRR. 41 Be- ginning in 1964 with the Buckeye Pipe Line and Great Southwest Corporation transactions, Glore Forgan received major investment advisory fees in con- nection with every acquisition made by the railroad (as well as acquisition- related stock purchase commissions). These, and other acquisition-related ad- visory and stock commission fees are set forth in the following table : COMMISSIONS AND OTHER FEES PAID BY RAILROAD AND/OR RAILROAD SUBSIDIARIES IN CONNECTION WITH ACQUISITION OF STOCK OF SELECTED NONRAIL SUBSIDIARIES! Acquisition and date Company, partnership or individual receiving fee Amount and form of consider- Company making ation J payment Buckeye Pipe Line Co., January 1963 to Glore Forgan, Wm. R. Staats & Co » $314, 893 Delbay Corp. ($47,184) August 1964. (initial stock acquisitions) Miscellaneous investment brokerage firms.. < 56, 786 Pennsylvania Co. ($331,294) Covington & Burling » 4,300 Berl, Potter & Anderson • 2, 500 Total 378.478 Great Southwest Corp., February 1962 to Glore Forgan, Wm. R. Staats & Co '263,650 Pennsylvania Co. December 1969. Miscellaneous investment brokerage firms.. « 11, 207 Do. Total _ 274,855 Arvida Corp., July 1965 to December 1966 Glore Forgan, Wm. R. Staats & Co ' 317.696 Do. Miscellaneous investment brokerage firms.. < 18, 600 Do. Total _ _ _ _ 326,296 Macco Realty Corp., October 1965 to July 1966. Glore Forgan, Wm. R. Staats & Co... • 642, 846 Macco Development Corp. To various brokers under tender offer * 455, 211 through Bank of America Trust and Savings Association. Kindel and Anderson... 8 100,765 Total _ 1,198,822 Executive let Aviation, October 1964.. (•) Strick Co., November 1966. (') Total _ _ 2,178,451 1 Information extracted from "Table VI— Commissions and other fees paid in connection with acquisition of stock during period Jan. 1, 1960, to June 20, 1970." submitted by railroad. Appendix D, Exhibit 51, p. 618. 2 Market value at date of payment, if securities. 3 $162,000 advisory fee; $152,893 stock commissions. * Stock commissions. 6 Legal fees. 6 $259,183 advisory fee; $4,464 stock commissions. 7 45,000 shares of Arvida common received as advisory fee, July 25, 1965 (market value of 6J 8 as of that date or $308,395) plus $9,321 stock commissions. 8 Advisory fee partially received on Aug. 13, 1965, in form of 10 percent (10,000 common shares) participation in Macco Development Corp., a P.R.R. subsidiary established solely to facilitate acquisition of Macco Realty Corp. (a nominal contribution of $10,000 was made for this interest by Glore Forgan— far below its actual value). After a series of related merger transactions, this interest was eventually ex- changed for shares of Great Southwest Corp. common (the merger between Macco Realty and GSC having taken place earlier) with a market value of $641,450, shares with an approximate value of $300,000 were then distributed to the firm and to partners, with stock valued in the amount of $385,705 going to officers. 9 Fees paid, if any, unknown. Railroad accounting records indicate no fees were paid. As can be seen from the above table, Glore Forgan received a total of $1,539,085 in advisory fees and stock commissions relating to the four non-rail acquisitions made by the PRR ($589,260 of which was in cash and $949,285 in *° In addition Hodge's personal files reveal numerous pieces of correspondence between Hodge and Saunders, as well as Bevan, Indicating a freindship -with Saunders. However, quite obviously the bonds were stronger between Hodge and Bevan. 41 By 1967 Hodge's dominant role in the railroad's diversification program had apparently become well known to the financial community. This comment appeared on a note dated May 15, 1967, from Gerald H. McGinley, a partner of the investment banking firm of Kidder, Peabody and Co., to Hodge, which was attached to a Kidder, Peabody research department report on the PRR : "General — ko much of this is you — I know you will find the attached most Interesting." 406 subsidiary stock). 42 C. J. Hodge was also appointed to the board of directors of Buckeye, Arvida and Macco at the recommendation of D. C. Bevan and con- currence of S. T. Saunders. 43 He was already a member of the board of Great Southwest at the time of its acquisition by the PRR and continued on thereafter. In regard to the acquisition of Great Southwest Corp. and the railroad's entry into real estate development, it was Charles J. Hodge who brought the acquisition to the railroad and provided the investment services in connection with the transaction. 44 Examination of the surface acquisition rationale appar- ently employed by Hodge was presented above. A further analysis reveals that other reasons may have consciously or subconsciously prompted his urging the railroad to take the action that it did. Not only was there the possibility of a large advisory fee in connection with the GSC transaction, but from his posi- tion as a member of the company's board of directors and investment banking adviser to GSC, he would have known of its expansionary (through acquisi- tion) plans and the greater fee possibilities obtainable here if it were a subsidi- ary of the PRR whose larger financial backing would permit greater acquisition potential. For example, Macco Realty had been under study by GSC for over a year before its acquisition was later made by a PRR subsidiary established spe- cifically to make the acquisition because GSC's debt-ridden financial structure would not permit its own acquisition of Macco. Hodge would have had knowl- edge of these plans. (In addition GSC itself also later acquired I. C. Deal Co., a residential developer, and Richardson Mobile Homes, Inc., the nation's second largest mobile homes producer.) Furthermore, Hodge and other members of his firm also possessed GSC stock interests themselves which could have been in- fluencing factors in the recommendation to the railroad to purchase GSC. 45 To assess the extent to which the above-mentioned factors influenced the Hodge and Glore Forgan recommendation to the PRR that it acquire GSC and enter the real estate development business would be a matter of speculation. Nonetheless (it is clear that from the railroad's cash starvation point of view), the recommendation was a poor one. Bevan himself had the opportunity and absolute responsibility to evaluate the suggestion. However, as stated above, his friendship with Hodge and apparent trust in his judgment may well have impaired the objectivity and analysis he would have employed in a normal arms-length transaction. The investment in Executive Jet Aviation, Inc., ostensibly an air taxi operation, actually was the vehicle through which the PRR hoped to enter a "The suggested size of the first advisory fee ($200,000) apparently prompted Bevan to request that Hodge submit a memorandum setting forth in detail what services Glnre Forgan had performed In connection with the acquisition, presumably In justification of the fee. This Hodge did in a letter dated August 3. 1964, which produced a further request from Bevan that Hodge also submit, presumably for purposes of comparison, a list of merger fees charged by Glore Forgan and other Investment banking firms in other transactions, as well as a breakdown of the Buckeye fee into its proper factors (i.e., advisory fee and brokerage commissions in connection with the acquisition of a large block of shares). This Hodge also did (breaking down the fee into $132,000 and $38,000. re- spectively) which he forwarded along with a letter dated August 21, 1964. Full text of letters appears in Appendix D, Exhibit 22, p. 531. See also Glore Forgan interoffice memoranda dated July 30. 1965 and August 4, 1965 from Donald Royce, Sr. to Charles Hodge and from "RWG" to Charles Hodge, respectively, congratulating Hodge on the Arvida deal — the former also remarking "It certainly comes at a time when we can use the fee" and the latter commenting on "ii'st "-lint this means in dollars and cents."] $317,096 in Arvida stock and stock commissions. Appendix D, Exhibit 24, p. 533. 43 See letters dated September 28, 1964 and July 19, 1965 from D. C. Bevan to S. T. Saunders, Appendix D, Exhibit 23, p. 532. " In this connection see letter dated August 19. 1964 from C. J. Hodge to S. T. Saunders wherein Hodge states, "I assure you that the group from Texas [Great Southwest Corp.] is of the highest standard. I repeat to you that I have dedicated myself to the service of yourself and to Dave, and to the Pennsylvania in attempting to help you build a real great empire." Appendix D, Exhibit 25, p. 533. 45 The Glore Forgan firm had been introduced to GSC back in August, 1958. when a Herbert HerfF came to J. Russell Forgan a senior partner of the firm, with a financing nronosition for the then Great Southwest Development Cornoration. Details of this meeting are provided in a memorandum dated August 22. 1958. from C. I. Hodge to other partners of the firm. Appendix D, Exhibit 26. p. 533. Briefly the proposition was that GSC wished to borrow $2.75 million over 36 months and Herff would he paid a SI million bonus over that period if he could raise the funds. Although Herff stated he would lend the funds himself if he could find no other sources, it was finally agreed that Ezra K. Zilkha, later a member of the GSC Board, would lend the money, receiving 45 percent of the bonus, with Herff receiving 45 percent and Glore Forgan 10 percent as placement fees. Shortly thereafter certain Glore Forran partners, including Hodge, began to accumulate GSC stock. Tin addition, in payment for their Macco Realty acquisition investment advisory services. Glore Forgan received a 10 percent stock Interest in Macco Development Corp. (the PRR subsidiary established solely to make the aconisltion) whose existence was understood from its inception to be eventually merged with GSC and later was, in March 1969. with Glore Forgan receiving for Its Interest. GSC common stock valued at $641,450. apnroximately $300,000 of which was distributed to the firm and its partners and $385,705 to Its officers.] 407 third area of business operations, that of air cargo transportation. 46 The rail- road had never disputed, and in fact candidly admitted that it wished to become an integrated transportation company ("a transportation department store") . 47 The basic reason for the adoption of such an approach was principally the fear by the railroads of the competitive impact in all areas but certain bulk commodities that air freight operations would have on rail freight traffic. 48 Investment in E JA was, however, made in the face of existing Federal aviation laws which in effect prohibited ownership of such air transportation operations by a surface transportation company 49 ( prompting the railroad to attempt to avoid these "ownership" prohibitions, at least in form, by making their invest- ment principally in debt securities) . To categorize the risk taken by the rail- road that (1) the ownership of non-voting securities (primarily debt) would not be construed as "ownership" or "control" of an air carrier; or (2) the CAB would make a policy change and find that ownership of EJA by the railroad, (even as its operations were contemplated) was in the "public interest and to the public advantage" and not in restraint of competition ; or that (3) Congress would pass legislation permitting such ownership, as injudicious would, how- ever, be charitable regardless of the business merits of the objective. As might well have been foreseen, when EJA attempted to expand its operations from its original air taxi activities (which might conceivably have permitted rail- road ownership) to supplemental carrier status (permitting nationwide passen- ger and cargo charter operations) the Civil Aeronautics Board denied its ap- proval and ordered the railroad to divest itself of its entire EJA investment. 50 This investment (totalling $21,365 million) was eventually disposed of by the railroad in January, 1972 for $900,000 — a net loss of approximately $20,465 million. Besides the almost certain illegality of the investment objective, and consequent enormous risks attendant thereto, EJA itself was just commencing operations, and in need of large amounts of external financing in order to ac- quire the jet aircraft needed in the business (most of which was provided by the railroad). Certainly there was little hope of an immediate or even near- term return on investment (in worthwhile amounts) in either reportable earn- ings, or more certainly, cash dividends. EJA, like the real estate companies acquired, was another example of extremely poor investment judgment in light of the needs of the railroad. 51 48 EJA was also brought to the attention of the railroad by C. J. Hodge who later stated "I screened and proposed EJA. I thought any railroad management not aware of what's coming In air freight was not doing its job." ('T5nd of a bizarre overseas venture," Business Week, August 16, 1969, pp. 122-123). Moreover, both the Glore Forgan Arm itself and several individual partners, including Hodge and S. A. Hartiwell, who were both members of the EJA Board of Directors, possessed substantial equity holdings in EJA from the inception of the company. 47 See list of "Reasons Why Transportation Diversification Should Benefit the Public," prepared by PCTC legal department, appearing as attachment to memorandum dated 3/10/69 by Basil Cole, Vice Pres., Administration, PCTC (and executive assistant to S. T. Saunders) to all PCTC depart- ment heads, with accompanying comments by certain railroad officials. Appendix D, Exhibit 27, p. 535. See also letter dated 1/23/67 from S. T. Saunders to Hon. Alan S. Boyd, Secretary, U.S. Department of Transportation, Appendix D, Exhibit 29, p. 539. 48 Remarks by S. T. Saunders to the New York Traffic Club on February 20, 1969, restate these reasons : "Unless railroads are permitted to diversify into other forms of transportation, within a relatively short period of time air cargo will have the same effect on railroad freight as passenger air- lines have had on long-haul and Intermediate range railroad passenger service since World War II. The Impact of airborne freight could be the last straw for railroad freight services except certain bulk commodities, and railroads cannot survive on this sort of traffic alone. This imminent new threat underscores the need for the revision of laws and regulatory practices which prohibit railroads from ownership of other modes of transportation," Appendix D, Exhibit 28, p. 539. 49 See discussion of applicable FAA provisions at footnote 33, supra. 8° Executive Jet Aviation, Inc. Docket No. 17657 et al. Order No. 69-10-67 entered October 14, 1969. In addition, for its role in a series of illegal actions, including the pursuit of extensive for- eign supplemental carrier acquisition activities resulting in actual control over several carriers (before obtaining requisite CAB approval), and the leasing of certain owned jet aircraft to these companies without disclosing such ownership interests to the CAB prior to receiving authority to lease the aircraft, the CAB levied a fine of $65,000 on the railroad (and $5,000 on EJA). 5l The bizarre story of the EJA and PRR fanrt later Penn Central) relationship has been chronicled in detail in numerous instances including Hearings before the Senate Committee on Com- merce Failing Railroads, Part 2, Serial No. 91-90. 91st Congress, 2d Session. A lengthy staff report of the U.S. House of Representatives. Committee on Banking and Currencv (The Penn Central Failure and the Role of Financial Institutions. Part II, "Case Study of Penn Central Subsidiary ; Executive Jet Aviation. Staff Report of the Committee on Banking and Currency, dated December 21, 1970, U.S. House of Representatives, 91st Cong., 2d Sess.) and in numerous magazine and newspaper articles (e.g. Illezal Foothold in Air Transportation." Wall Street Journal, August 15, 1969 ; "Penn Central Told to Shed Control of FKine Service." Wall Street Journal. October 16. 1969). It is not the purpose of this report to go into these details again other than to note in passing that the manner in which JiJA was run by its top management gives testimony to the lack of PRR managerial guidance given to the operations of companies invested in (the special circumstances perhaps in existence Mere, that of trying to avoid the appearance of "control." notwithstanding). 408 The sole acquisition which the NYC made, that of Strick Corporation, was not as an abrupt departure from rail activities, into a totally unrelated product market, as were those of the PRK. Strick, a manufacturer of lightweight alumi- num trailers and vans and containerized equipment for the railroad industry, was a company whose operations had been known to the NYC since the advent of the latter's Flexi-Van service instituted in 1956. The combination trailer-rail shipping container used by the NYC was manufactured by Strick and for that matter developed for that purpose. Moreover, the NYC was also a trailer cus- tomer of Strick for other parts of its rail-truck operations. Acquisition of Strick was therefore a partial integration of these operations, as well as an attempt to gain a greater return on investment. However, because of its own expansionary plans Strick too became an unexpected drain (in terms of advances) on the cash resources of the railroad. Rather than permit continued advances, at the expense of rail projects, many of which were being turned down, the Central put a stop to further loans the first year after acquisition. 52 When Strick profits fell off the following year, and the merged railroad made financing arrangements to ac- quire trailers needed in its trucking operations at more economically advanta- geous terms than it could obtain by leasing them from Strick, the Strick com- panies were sold. 63 The PCTC, moreover, its top management perhaps realizing the mistake that had been made by the PRR in concentrating its efforts in real estate, and beginning to forcefully understand the illegality of its EJA venture by that time, concentrated its initial diversification efforts on the acquisition of Kayser- Roth, the nation's leading apparel manufacturer, as an entry to the consumer good field. The refined, or perhaps more accurately, defined (apparently for the first time) fundamental investment obiectives that were set forth by S. T. Saunders in his remarks made to the PCTC Board in connection with the consideration of the Kayser-Roth proposal are also of note — reflecting attempts to eliminate mistakes of the past (". . . a company must be sufficiently large and established as a going concern . . ." [the three real estate development companies and EJA were all young companies with attendant financing de- mands and unstable earnings performances] ; "(t)ransportation companies . . . are not prime candidates because of potential conflict with certain anti-trust theories and regulatory policies . . ."; "(M)oreover, there are obvious advan- tages in using securities, rather than cash . . ."). 54 For the purposes of analysis it w y ould have been useful to compare the results of the Kayser-Roth transaction with the other diversification efforts. But Kayser-Roth officials terminated dis- cussions in October, 1968. The PCTC's investment (23 percent interest) in Madison Square Garden Corporation, rather than adding to any established investment pattern (i.e. real estate operations) or reflecting any new departure therefrom, represented primarily an opportunity for the railroad to exchange its stock interest in its Penn Terminal Co. (through which it owned Pennsylvania Station in New York City) for that in a more promising enterprise whose physical plant had been erected over the site of the railroad subsidiary's property. The sole other investment made by the merged company was the acquisition of Southwestern Oil Refining Co. (and its wholly-owned subsidiary Royal Pe- * a Beginning November 23, 1966 with a request for $1.1 million, seven more requests totaling $11 million were submitted to the railroad, $9.4 million of which was granted before It became ap- parent Strick was becoming much more of a cash drain than had been anticipated. On May 26, 1967. W. R. Grant, V. Pres. Finance, NYC, wrote to Sol Katz, President of Strick that such requests would no longer be granted by the railroad, explaining that (a) worthy projects of the railroad were being turned down In the Interest of conserving cash ; (b) 2,000 people had been released from the Central's payroll ; (c) Strick had given no Indications that it was goinsr to request more funds than In their original proposition to the railroad, and (d) the railroad's cash had dropped $15 million in the past few months. $ 9 million of which had been advanced to Strick. See also letter dated May 25, 1967 from W. R. Grant to M. Bnchman, V. Pres. Finance, Strick Corp. to the effect that with Strick sales volume down, an increase In which hart been the basis for the advances commit- ment bv the railroad, he could no longer justify additional advances. Appendix D, Exhibit 30, p. 541. 63 See letter dated May 6, 1969 from A. E. Perlman to P. M. Shoemaker, Appendix D, Exhibit 31, p. 544. 84 Acquisition of Kayser-Roth would have been accomplished by the Issuance of approximately $231 million of two classes of Pennsylvania Co. cumulative preferred stock, the only cash outflow to have been cash dividends paid on these shares ($1.05 million annually) to be of course offset by cash dividends received from the acquired company. 409 troleum Corp.), consummated in February, 1970 not by the railroad itself, but by the Penn Central Company, established in 1969 as the holding company ve- hicle through which the merged company would pursue its diversification efforts. 55 Acquisition of Southwestern appears to have been made in an effort to integrate the railroad's Buckeye Pipe Line Co. subsidiary 56 and make its operations more profitable, as well as to gain the additional consolidated income of Southwestern and its subsidiary. Financial Results of Diversification Program The actual financial results of the railroad (and its predecessor companies) diversification programs in terms of reportable income and rate of return on investment are shown in the following tables. Care must be exercised in making definitive conclusions based on the data presented therein, however, since the front-ending of profits by the real estate subsidiaries significantly overstated reported net income, especially during 1968-1970. SUMMARY OF EARNINGS OF SELECTED NONRAIL ACQUISITIONS Plus dividends/interest paid on equity/ Percentage return debt securities used in purchase price reported only Per- Average centage investment Total Average Percent Total Average return PENNSYLVANIA RR. (1964-67) Buckeye $100,671,478 (3.44) $32,561,039 $9,451,998 9.4 $43,887,916 $12,732,202 12.6 Great Southwest Corp 20,360,928(3.523) 8,062,432 2,288,511 11.2 ArvidaCorp 22,446,784(2.436) 936,327 384,371 1.7 1,093,645 448,951 2.0 MaccoRealty 40,516,391(2.386) 12,605,373 5,283,056 13.0 Total average annual investment 183,995,581 17,407,936 9.5 20,752,720 11.3 Total investment (end of 1967).... 197,977,432 54,165,171 65,649,356 N.Y.C. (1966-67) Strick 15,000,000(1.173) 3,263,391 2,782,014 18.6 P.C.T.C. (and Penn Central Co.) 1968-69 Buckeye 100,671,478 18,445,128 9,222,564 9.2 24,973,874 12,486,937 12.4 GSC. 59,188,677 43,742,637 21,871,319 37.0 Arvida 24,359,758 1,736,452 868,226 3.5 2,194,243 1,097,122 4.5 Macco Realty (1968 only) 40,563,039 20,994,190 51.8 Strick 2 (1968 only) 15,000,000 2,341,025 15.6 Total average invest- ment 212,001,427 44,129,717 20.8 47,622,986 22.5 Total Investment (end of 1969) 220,569,432 87,259,432 94,245,969 TOTALS (1964-69) Average annual investment... 184, 122,987 27,121,304 14.7 30,731,484 16.7 Total investment (end of 1969)3 220,569,432 144,687,877 _ 163,158,716 P.C.T.C. (and Penn Central Co.) 1970 Buckeye... 100,671,478 8,513,537 8.5 10,145,689 10.1 GSC 95,538,196 (131,984,808) (138.2) Arvida 24,359,758 63,649 (.003) Southwestern Oil Refining Co 26.198,000 336,688.... * 2, 563. 000 M0. 4 TOTALS (1964-70) Average Annual Investment.. 204, 170, 355 3,618,207 1.8 6,991,153 3.4 Total investment (end of 1970)3 274,464,432 20,943,577 41,383,256 ' Includes Macco Realty Co. 1969-70. 2 Sold in December, 1968. ' Excludes results of Madison Square Garden (investm nt of $27,697,000 or 23 percent of total outstanding equity) which were not consolidated with those o parent coTpany. (Earnings, however, for Madison Square Garden for the fiscal year ending May 31 were $1,081,000 for 1968 and $4JO,000 for 1970 with a loss of $1,2J4,000 for 1969.) * Not consolidated with earnings of parent company (Penn Central Co.) 65 See p. 426 herein for a more detailed discussion of the reasons for formation of the holding company. 68 One of the original reasons Buckeye Pipe Line was available for acquisition was that it was one of the few pipeline companies not owned by a major oil producer. 410 PERCENTAGE RETURN ON TOTAL INVESTMENT BY RAILROAD (AS DETERMINED BY REPORTED EARNINGS OF SELECTED NONRAIL ACQUISITIONS) Total Percentage Gross reported Less investment Acquired company and year investment earnings dividends' Net return 2 Buckeye Pipeline Co. (100 percent) [purchased July 24, 19641: 1964 $100,671,478 $7,055,850 $1,529,785 $5,526,065 10.6 1965 100,671,478 11,227,550 3,267,542 7,960,008 7.9 1966 100,671,478 12,425,130 3,264,778 9,160,352 9.1 1967 100,671,478 13,179,386 3,264,779 9,914,607 9.8 1968 100,671,478 13,322,756 3,264,441 10,058,315 10. 1969 100,671,478 11,651,118 3,264,305 8,386,813 8.3 1970 100,671,478 10,145,689 1,632,152 8,513,537 8.5 Total 79,007,479 19,487,882 59,519,697 Average gross investment 100,671,478 Average annual earnings (6.447 years) _ '9,232,154 9.2 Great Southwest Corp. [controlling interest purchased June 24, 1964): 1964 15,272,240 501,387 6.4 1965 21,405,157 1,520,005 7.1 1966 22,383,157 2,268,453 10.1 1967 22,383,157 3,772,587 16.9 1968 ._ 22,829,157 9,000,887 35 1969 95,538,196 < 34,741.750 36.4 1970 95,538,196 < (131, 984, 808)... -(138.2) Average gross investment 42,192,751 . Average annual loss (6.523 years) (12,381,066) -(29.3) Arvida Corp. (59 percent) [controlling interest purchased July 26, 1965|: 1965 18,620,837 (144,810) (144,810) -(1.8) 1966 24,359,758 613,486 613,486 2.5 1967 624,969 157,318 467,651 1.9 1968 1,426,806 215,084 1,211,722 5 1969 _ 767,437 242,707 524,730 2.2 1970 63,649 63,649 .003 Total 3,351.537 615,109 2,736,428 Average annual investment 23,404,771 Average annual earnings (5,436 years) 503, 390 2.2 Macco Realty Corp. (99 percent) controlling interest purchased August 13, 1965], and Macco Development Corp. (80 percent).': 1965 40,433,094 453,532 2.9 1966 40,563,039 4,414,829 10.9 1967 40,563,039 7,737,012 18.1 1968 40,563,039 20,994,190 51.8 Total _ 33,599,563 Average annual investment _ 40,530,553 Average annual earnings (3.386 years) 9.923,114 24.5 Strick Holding Corp. '(100 percent purchased, Nov. 1, 1966): 1966 15,000,000 886,880 34.2 1967 15,000,000 2,376,511 _ 15.8 1968 15,000,000 2,341,025 15.6 Total 5,604,416 Average annual investment 15,000,000 Average annual earnings (2.713 years) 2,579, 115 17.2 Madison Square Garden Corp. (23 percent acquired by PCTC December 1968): 1968 27,697,000 (•) 1969 27,697,000 («) 1970 27,697,000 («) Average annual investment 27,697,000 Southwestern Oil Refining Co. [and wholly-owned sub- sidiary Royal Petroleum Corp.] (100 percent acquired by Penn Central Co. in February 1970): ' 1970 26,198,000 '2,563,000 336,688 "2,236,312 9.2 i Less dividends paid on equity securities used in purchase price. 2 Percentage investment return (on average annual basis since date of acquisition). 3 Includes cash used in purchase price, market value (at date of preliminary agreement) of debt or equity securities issued as part of purchase price, commissions and fees paid on acquisition, plus additional equity investment, if any. < Includes Macco Realty Corp. which was merged into Great Southwest Corp. on February 26, 1969. 5 80 percent owned PRR subsidiary incorporated August 1965 specifically to make Macco Realty Corp. acquisition. Assets consisted solely of stock (99 percent) of Macco Realty. Macco Realty Corp. later merged into Macco Development Corp and the name of the company changed to Macco Realty Co. Operating results of Macco Development in 1965 and 1966 included with those of Macco Realty Corp. « Earnings not consolidated with those of parent company (less than controlling interest owned). However, earnings for Madison Square Garden for fiscal year ended May 31 were $1,081,000 for 1968 and $400,000 for 1970 with a loss of $1,249,000 for 1969. 7 Transaction later rescinded pursuant to settlement agreement entered into February 25, 1971 by both parties to Former Shareholders of Southwest Oil Refining Co. and Royal Petroleum Co. versus Penn Central Co. and approved by the court and entered for judgment on April 9, 1971 in Civil Action 70-C-135, U.S. Federal District Court (S.D. Tex., Corpus Christi Division). • Earnings not consolidated with those of parent company (Penn Central Co.) for year. As shown more particularly by the above tables, the results of the diversi- fication efforts by the PCTC and its predecessor companies were, briefly, as fol- lows. From 1964-1967, the PRR realized an average 11.3 percent return ($20.75 411 million in average total reportable earnings) on an average total annual invest- ment of $183.99 million. The NYC, on the other hand realized an 18.6 percent average return ($2.78 million average annual earnings) on its Strick investment ($15 million) in 1966-67. The Penn Central Transportation Company realized a 22.5 percent average return ($30,731,484 in average annual reportable earn- ings) on its inherited, and partially supplemented investment of $184.12 million in the same nonrail acquisitions in 1968-1969- Overall, the combined results in the period 1964-1969 reflected an average return of 16.7 percent ($30,731,494 in average total annual reportable earnings) on an average total annual invest- ment of $184.12 million. Total reported earnings from the nonrail acquisition earnings for the same period amounted to $163.16 million, $65.65 million of this amount was earned during 1965-67 by the nonrail acquisitions of the PRR, $3.26 million by Strick for the NYC in 1966-67 and the balance of $94.25 million while under merged company ownership in 1968-69. Quite obviously, the railroads were reasonably successful, in the 1964-1969 pre-bankruptcy period, from the standpoint of reported income, in obtaining a good return on their investment. 57 However, while the program objective of generating additional earnings to offset rail operations was successful it also had the undesirable effect of covering over the failing rail condition. 58 Total Diversification Investment Relative to Reinvestment in Rail Plant The following tables place into perspective the relative amounts expended by the railroad on (a) its diversification program and (b) its own rail plant: TOTAL CASH INVESTMENT IN DIVERSIFICATION PROGRAM RELATIVE TO TOTAL REINVESTMENT IN PLANT (1963-67), P.R.R. AND N.Y.C. Total cash investment in Total reinvestment in diversification program ' plant J Percent P.R.R. Year: 1963 1964 _ 1965 1966 1967 Total N.Y.C. Year: 1966 _ 1967 Total 24,437,000 430,704,178 5.7 1 Includes total cash used in purchase price; commissions and fees paid in connection with acquisition; dividends/interest paid on equity/debt securities issued as part of acquisition purchase price; net increases (decreases) in loans and advances outstanding at end of calendar year. 3 Includes all capital and maintenance (road and equipment) expenditures. $28, 303, 000 $205, 384, 912 13.8 19, 619, 768 268, 681, 436 7.3 56, 083, 391 366, 014, 140 15.3 19, 935, 342 342, 400, 175 5.8 15, 558, 759 260, 095, 335 6. 139, 500, 260 1, 442, 575, 998 9.7 2, 997, 000 230, 235, 645 200, 468, 533 1.3 21, 440, 000 10.7 67 The net effective earnings column shown in the tables (netting out dividends/interest paid on equity/debt securities issued as part of the purchase price) is also of interest and of course reflects a lower net return. Only in the case of Arvida however would there be any effect on reported earnings (Interest paid on debt securities of course being a business expense deducted in arriving at net income while preferred dividends are not) . 68 In late 1968, the decision was made by the company to place primary emphasis in earnings reports and financial press releases on consolidated results, stressing the fact that the company was diversified in scope of operations. (See S. T. Saunders' Board Memorandum dated April 23, 1969. Appendix D, Exhibit 32, p. 545.) All reports to the company Board of Directors also gave primarily em- phasis to consolidated results. Regardless of rationale employed, the move was quite obviously another reflecting management's own concern with the financial performance of its rail operations. Moreover, besides seeking to acquire earnings through diversification the PRR in its quest for additional reportable earnings earlier in 1965 had extended its consolidated financial statements to include all majority-owned subsidiaries which it controlled. The exchange resulted in the inclusion, for statement purposes, of the income of all companies in which the PRR interest exceeded 50 percent. (Inclusion for tax reporting purposes of course requires at least an 80 percent interest). The major change this brought about in the reporting of the PRR consolidated income statement was the including of the PRR stockholder share of undistributed earnings of majority owned and controlled companies which were formerly shown, in part, in the notes to the financial statements but not in the consolidated Income and balance sheet figures. See memoranda dated February 15, 1965, and February 26, 1965, between D. C. Bevan and S. T. Saunders, Appendix D. Exhibit 33, p. 550. 74-924 O - 73 - 28 412 TOTAL CASH INVESTMENT IN DIVERSIFICATION PROGRAM RELATIVE TO TOTAL REINVESTMENT IN PLANT (1963-69), P.C.T.C. AND PREDECESSOR COMPANIES Year Total cash investment in diversification Total reinvestment program ' in plant 2 1963 1964 1965 1966 1967 1968 1969 Total (1970) Percent $28 303 000 $374,412,811 476, 426, 014 572, 514, 308 572, 635, 820 460, 563, 868 449, 830, 258 530,049,112 7 6 19, 619, 768 4 1 56, 083, 391 9 8 22 932 342 4 36, 998, 759 8 22, 089, 381 4 9 15, 207, 012 2 201, 233, 663 1,968,820 3, 436, 432, 191 516, 809, 429 5.7 .4 ' Includes total cash used in purchase price; commissions and fees paid in connection with acquisition; dividends/interest paid on equity/ debt securities issued as part of acquisition purchase price; net increases (decreases) in loans and advances outstanding at end of calendar year. 3 Includes all capital and maintenance (road and equipment) expenditures. CAPITAL EXPENDITURES PENNSYLVANIA AND NEW YORK CENTRAL; 1946-67' [In millions of dollars] Year 1967 2. 1966.. 1965.. 1964.. 1963.. 1962.. 1961.. 1960.. 1959. _ 1958.. 1957.. New York New York Pennsylvania Central Year Pennsylvania Central 114.7 69.1 1956 92.4 79.3 197.4 95.9 1955 69.0 39.6 244.2 107.9 1954 41.0 39.1 100.8 81.3 1953 80.5 88.0 82.4 39.5 1952 123.3 148.4 63.0 40.2 1951.... _ 215.6 125.7 60.9 32.0 1950 87.8 70.6 155.9 39.6 1949 105.8 100.5 125.2 28.7 1948 106.3 90.2 53.8 18.2 1947 52.7 48.4 97.7 114.2 1946 33.7 41.2 1 Includes leased lines. 2 Excludes expenditures on leased equipment. Source: ICC Form A, Railroad Annual Reports. TOTAL MAINTENANCE EXPENDITURES; SELECTED RAILROADS; 1958-701 [In millions of dollars] Penn Central » Pennsylvania New York Central Baltimore & Ohio Chesapeake & Ohio Southern 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961- 1960. 1959. 1958. 651.2 .... 138.2 126.8 139.5 133.4 133.6 473.3 .... 117.6 427.6 .... 123.5 114.0 122.1 118.5 102.0 421.0 243.5 177.5 86.8 421.8 239.3 182.5 114.3 115.4 87.2 416.1 237.1 179.0 108.2 111.2 87.8 418.4 239.1 179.3 107.2 113.7 87.1 420.9 236.0 184.9 112.4 131.3 80.9 435.2 247.5 187.7 73.6 108.0 79.4 418.5 232.7 185.8 114.8 100.6 78.0 449.0 246.6 202.4 114.5 105.6 75.9 465.5 262.6 202.9 117.0 101.4 77.2 437.2 252.0 185.2 107.6 97.2 81.4 1 Pro forma combination of Pennsylvania and New York Central; 1958-67. Source: Moody's Transportation Manual. 413 TOTAL REINVESTMENT IN FLANT, 19E0-69— (CAPITAL • AND MAINTENANCE-ROAD AND EQUIPMENT— EXPENDITURES) N.Y.C. P.R.R. P.C.T.C. Year Amount Percent increase (decrease) Amount Percent increase (decrease) Amount Percent increase (decrease) 1960 190, 175, 444 253,469,515 443, 644, 959 393, 212, 490 405, 561, 363 374,412,811 476,426,014 572, 514, 308 572, 635, 820 460, 563, 868 1,616,831,623 2,082,140,010 449, 830. 258 530,049,112 516,809,429 1961.. 1962 1963 1964 1965 1966..... 1967 1960-63 173, 500, 982 171,923.673 169,027,899 207,744,578 206,500,168 230, 235, 645 200, 468, 533 704,627,998 . (8.8) (9) (10) 22.9 (6) 11.5 (12.9) 219,711,508 233, 637, 690 205,384,912 268,681,436 366,014.140 342,400,175 260, 095. 335 912,203,625 .... (13.7) 12.9 (12.1) 23.6 36.6 (6.4) (24.0) (11.4) 3.1 (7.7) 27.2 20.2 0.02 (19.6) 1964 67.._ 1968 .. 844, 948, 924 19.9 1,237,191,086 35.6 (28. 8) (2.5) 1969 20.1 1970 (2.5) 1 Includes new equipment purchases, reconstruction of old equipment expenditures and capital improvement and betterments. Source: Form A Annual Reports submitted by N.Y.C. and P.R.R. to ICC for calendar years 1960-1967 and P.C.T.C. for calendar years 1968-1970. As can be seen from the above tables the amounts expended on the diversi- fication program of the railroad (s) were small when compared to the cash funds which the companies continued to reinvest in the rail plant. On a combined basis (PRR and. NYC) the total amount invested in non-rail acquisitions aver- aged but 5.7 percent of the amount expended on capital and maintenance (road and equipment) expenses over the period 1963-1969. The maximum spent in one year, $56.08 million in 1965, amounted to only 9.8 percent of total capital and maintenance expenditures by the combined railroads for the year. Looking at the predecessor companies individually, the 1965 figure still amounted to but 15.3 percent of the total funds employed by the PRR for capital and main- tenance projects for the railroad itself. Moreover, that same year, the PRR increased its capital expenditures 126 percent from approximately $80 million to $180 million. Furthermore, while the PRR was in the midst of its diversi- fication program in 1964—1967, it was increasing its total rail capital expendi- tures 201 percent from $162.3 million to $488 million in comparison to the four year period 1960-1963. The merged company itself expended a much smaller part of its funds on diversification-related costs in comparison to total amounts spent on total capital and maintenance expenditures than did its predecessors (4.9 percent in 1968 and only 2 percent in 1969). Furthermore total amounts reinvested in the rail plant rose 20.1 percent. It would be impossible at this date to measure the return achieved on the total sums reinvested in the railroad itself other than to note that there seemed to be little noticeable effect on rail operating results — which continued to decline at nearly all times during the period. On the other hand, the amounts invested in the diversification program achieved far greater reported returns in the 1963-1969 pre-bankruptcy period, accounting for substantial parts of re- ported consolidated income during that time. 414 TOTAL INCOME FROM DIVERSIFICATION PROGRAM RELATIVE TO RAILROAD INCOME The substantial effect which earnings from non-rail acquisitions had upon consolidated income for the railroad (s) for period 1964—1969 is demonstrated in the following table : EARNINGS CONTRIBUTED BY SELECTED ACQUIRED NONRAIL SUBSIDIARIES TO CONSOLIDATED EARNINGS OF RAILROAD (1964-69) Contribution to consolidated Gross earnings (per Year and company revenues Net earnings share) 1964: Buckeye Pipe Line (100 percent).. $29,964,347 (12) $7,055, 850 $0.51 Great Southwest Corp. (63 percent) (12)7,725,591 (23) 501.387 .04 Total (Percent of consolidated figure) 37,689.938 (4%) 7,556,237 .55 (13%) (PRR). 1,002,717,519 60,097,048 4.37 1965: Buckeye Pipe Line (100 percent) 29,716,357 11,227,550 .81 Great Southwest Corp. (73 percent) 17.741.929 1,520,005 .11 Arvida Corp. (51 percent) (2 5, 037.612 CO (144,810) (.01) Macco Realty Corp. (98 percent) ( Includes liquidating dividend of $4,800,000 paid before merger of Strick Holding Co. into P.C.T.C. in December 1969. PERCENTAGE CASH RETURN ON SELECTED NONRAIL INVESTMENTS Company acquired, year payments Percentage received return on (dividends investment Total Total cash payments and interest (on annual Total cash interest received (paid out) plus tax basis since Gross cash dividends payments under tax allocation allocation date of investment 1 received received agreement payments) acquisition) Buckeye Pipe Line Co. (100 percent purchased July 24, 1964): 1964 $32,289,263 1965 35,556,805 1966 38,821,583 1967 42,086,362 1968 45,350,803 1969 48,615,108 1970 50,247,260 Average annual investment (cash). 41, 852, 455 $2,850,000 P). 5,965,000 5,800,000 6,300,000 6,300,000 6,300,000 3,100,000 $2, 850, 000 5, 965, 000 5,800,000 6, 300, 000 6, 300, 000 6, 300, 000 3, 100, 000 Total Average annual payments (cash)(6.447 years). 36,615,000 5, 679, 383 19.0 16.7 14.8 15.9 13.9 13.0 6.2 13.6 •o See memoranda dated 10/25/66 and 11/8/67 from D. C. Bevan to S. T. Saunders. Appendix D, Exhibit 36, p. 554. "See memorandum dated 8/30/68 from D. C. Bevan to S. T. Saunders, Appendix D, Exhibit 37. p. 560. 93 However, the effect of these dividends was considerably reduced (well over half) after payment of dividends on preferred stock used In making the acquisition. (See table at p. 410 above.) 417 PERCENTAGE CASH RETURN ON SELECTED NONRAIL INVESTMENTS-Conttnued Company acquired, year Total cash Gross cash dividends investment 1 received Total Total cash payments interest received (paid out) payments under tax allocation received agreement Total cash payments received (dividends and interest plus tax allocation payments) Percentage return on Investment (on annual basis since date of acquisition) Great Southwest Corp. (82 percent) (controlling interest purchased June 24, 1964; additional equity interest acquired through Dec. 31, 1969.) 1964 1965 1966. 1967 1968 19693 1970 Average annual investment (cash) Arvida Corp. (59 percent) (controlling interest purchased July 26, 1965:) 1965 1966 1967 1968 1969 1970 Average annual investment (cash) Macco Realty Co. (99 percent) (interest purchased August 13, 1965 in conjunction with tender offer of Sept. 13,1965:)' 1965.... 40,007,644 1966. 40,137,589 1967 46,137,589 1968 53, 537, 589 . 15, 272, 240 219,781 1, 056, 589 2,990,071 8,450 57, 383 199, 500 195,000 C <0 Total Average annual payments (cash) (6.523 years) 8,450 277, 164 1, 256, 089 3,185,071 21, 407, 122 25, 888, 122 29, 388, 122 39, 472, 122 93,009,711 93,009,711 .0003 .009 3.2 3.4 . 45, 375, 306 4, 726, 774 726, 165 1.6 5, 214, 750 15, 502, 527 (») 15, 659, 845 19,232,785 22, 566, 492 22, 566, 492 Average annual payment (cash) (5.436 years). 15, 138, 982 Average annual investment (cash). 44, 955, 103 495,361 (2) 495,361 1.2 309,678 309,678 .7 103,426 103,426 .3 570,892 _ 570,892 1.1 Total 1,479,357 Average annual payment 437,707 1.0 (cash) (3.386 years). Strick Holding Co. (100 percent (purchased Nov. 1, 1966 by New York Central Railroad Co.) 1966 17,997,000 1967. 24,437,000 1968 24,437,000 1969 (') Average annual investment (cash). Madison Square Garden Corp. (23 percent interest acquired in December 1968): 1968.. 1969 1970.. Average annual investment (cash) Southwest Oil Refining Co.: 1970. 4, 800, 000 533, 339 689, 902 (915,599) 533, 339 689, 902 3, 884, 401 Total Average annual payment (cash) (3.173 years). 4 1 107,642 . 22,290,333 .... 294, 580 6, 697, 000 («) 6, 697, 000 6, 697, 000 6, 697, 000 Average annual payment (cash). 336, 688 400, 000 400, 000 118. 9 > Includes cash used in purchase price, interest (dividends) paid on debtor equity securities used in purchase price, cash fees paid in connection with acquisition and loans and advances to each subsidiary on a cumulative basis at the end of each calendar year. 2 No tax allocation agreement between parent railroad and non rail subsidiary. 3 Includes Macco Realty Co. which was merged into Great Southwest Corp. on Feb. 26, 1969. * Balance payable to Great Southwest Corp. from PCTC as of Dec. 31, 1970 was $2,152,875. 1 Railroad ownership of subsidiary did not reach the 80 percent (of total voting stock outstanding) necessary in order to consolidate operating results for tax purposes. • Merged into Great Southwest Corp. on Feb. 26, 1969. 7 Principal operating companies of Strick Holding Co. (Strick Corp. and Transport Pool, Inc.) sold for $24,437,000 in December, 1968 and Strick Holding Co. merged into PCTC in December, 1969. 418 DIVIDENDS (INTEREST) PAID BY SELECTED ACQUIRED NONRAIL SUBSIDIARIES TO PENNSYLVANIA CO.i (1964-70) Company making payment 1964 1965 1966 1967 1968 1969 1970 Total Buckeye Pipe Line $2,850,000 $5,965,000 $5,800,000 $6,300,000 Great Southwest Corp (8,450) Arvida Realty Co Macco Realty Corp _. (495,361) (309,678) Strick Holding Co _._ Executive Jet Aviation, Inc. 4 (118,000) (370,000) Dividends 2,850,000 5,965,000 5,800,000 Interest .._ 613,361 688,128 Total 2,850,000 6,578,361 6,488,128 219,781 (57,383) (103,426) (533, 339) (136,000) $6, 300. 000 $6, 300, 000 $3, 100, 000 1,056,589 2,990.071 (199,500) (195,000) (570,892) (1,297,174) (689, 902) $36, 615, 000 4, 266, 441 2 (460, 333) 3(2,776,531) (1,223,241) (624, 000) 6,519,781 830, 148 7, 356, 589 1,460,294 9,290,071 40,881,441 1,492,174 5,084,105 7,349,929 8,817,883 10,782,245 3,100,000 45,965,546 i Figures in parentheses indicate interest payments. 1 $23,750 paid in cash, remainder of $436,583 in GSC common stock of equivalent market value. * Payments made in cash 1965-68. $721,522 of amount due in 1969 paid by issuance of Great Southwest Corp common stock of equivalent market value (after merger of Macco Realty Corp. into GSC on Feb. 26, 1969). Total cash payments on Macco originated obligations during 1965-70 amounted to $2,055,009. * Investment in Executive Jet Aviation, Inc., principally in form of debt interest— and also class B nonvoting common stock (although amounting to over 57 percent of total equity outstanding). Note: Unless otherwise indicated all dividend and interest payments were made in cash. Source: Tabular information submitted by railroad pursuant to request of Committee's special staff. DIVIDENDS (INTEREST) PAID BY SELECTED ACQUIRED NONRAIL SUBSIDIARIES TO PENN CENTRAL TRANSPORTATION CO. (AND/OR PREDECESSOR COMPANIES) YEARS 1964-70 Company making payment 1964 1965 1966 1967 1968 1969 1970 Total Pennsylvania Co .. 20,000,000 $23,000,000 $24,000,000 $25,500,000 $24,000,000 $24,000,000 $140,500,000 Strick Holding Co 4,800,000 4,800,000 Dividends 20,000,000 23,000,000 24,000,000 25,500,000 24,000,000 28,800,000 Interest 145,300,000 PENN CENTRAL TRANSPORTATION CO. (AND/OR PREDECESSOR COMPANIES) ACCOUNTING FOR TAX ALLOCATION' RECEIVABLE FROM (PAYABLE TO) SELECTED SUBSIDIARIES 2 Date Strick Corp. Great Southwest Corp. 1967: Tax allocation (payable to) $(915,599).. December 31, 1967: Balance (payable to) (915,599) 1968: Tax allocation receivable from (payable to) (13,401) $2,574,000 December 31, 1968: Balance receivable from (payable to) (929,000) 2,574,000 1969: Tax allocation receivable from 13,401 5,393,929 1969: Payments (received) made - 3 (915,599) * (2,152,875) December 31, 1969: Balance receivable from 5,815,054 1970: Tax allocation (payable to) (7,967,929) December 31, 1970: Balance (payable to) , (2,152,87 5) Netcash realized (paid out) (915,599) 1 Both Strick Holding Co. and Great Southwest Coro. entered into an agreement with the parent railroad immediately after acquisition whereby the subsidiary agreed to reimburse it for 95 percent of the takes that would have been paid by the subsidiary had there beta no consolidation of its income with that of the railroad. In the case of Strick there were also provisions whereby the parent railroad would pay it for use of certain Strick deductions and credits in the consolidated statement, and thus the amounts shown as payable to Strick. Great Southwest Corp. also claims that similar provisions applied to its agreement with P C.T C. and even though the latter's books reflect the above shown amount of $2,152,875 was payable to Great Southwest Corp. as of Dec. 31 ,1970, this amount is in dispute. 'Selected subsidiaries— Great Southwest Corp., Macco Corp..Arvida Corp., Buckeye Pipe Line Co., and Strick Holding Co. No agreement was entered into between the railroad and Buckeye Pipe Line Co. or Macco Realtv Co. In addition, only 58 percent ofArvida Corp. is owned by the railroad and its income is therefore not consolidated for tax purposes with that of the parent company. ' On the date of Strick Holding Co.'s merger into Penn Central Transportation Co. in 1969, the amount of $915,599 was offset against receivable's due Penn Central Transportation Co. from Strick Holding Co. • Amount was assigned to Pennsylvania Co. in 1969 for an advance receivable. Penn Central Transportation Co. received cash in the amount of $2,152,875 from Pennsylvania Co. in February 1970. As shown above, a total of $196.5 million in cash was expended on diversi- fication-related costs from 1963-1969 by the railroad (s)— with $139.5 million of that amount spent by the PRR. As has been commented upon earlier, how- ever, although such expenditures were financed from working capital, approxi- 419 mately $69 million would have been replaced from proceeds of a sale of N&W stock in 1963 ($4 million) and the sale of the Long Island Eail Road Co., in 1966 ($65 million in cash). 63 Furthermore, 1968-1969 N&W common stock sale proceeds amounted to $33.1 million, replacing nearly all funds expended by the PCTC on diversification costs. Making allowances for dividends and interest payments received from these subsidiaries (net loans and advances are included in the above cash loss figures) amounting to $47.32 million received over the same 1963-1969 period ($22.1 by the PRR, $24.6 by the PCTC and $0.5 by the NYC) the overall net cash loss is diminished to $46.26 G4 million. More specifically, net cash losses on an individual railroad basis were $47.4 million for the PRR, 65 and $19.1 mil- lion for the NYC— while a net cash gain of $24.7 million was realized for the merged company alone. Other than cash used in the purchase price, the next largest drain was in the form of loans and advances to the acquired non-rail companies. Although the dividend paying performance of a company might not be considered of major importance in a growth oriented investment program such as that ap- parently undertaken by the railroad, 66 whether a company will have a continual need for external financing (as mentioned, a demonstrated characteristic of real estate development companies) would certainly be of importance to a cash short acquirer. The latter assumes, of course, that financing may have to be pro- vided by the parent company — as happened with GSC and Macco Realty. A total of $23.8 million was advanced to the two companies by the end of the third quarter. 1969, and although the above table reflects repayment of the amount in the next quarter, such repayment was in the form of additional GSC common stock, not cash. 67 Moreover, total loans and advances to Executive Jet Aviation, Inc., a new company whose existence was dependent on external financing to fund heavy start-up costs (principally in the form of expensive jet aircraft equipment purchases), amounted to in excess of $21 million by the end of the first quarter, 1969 (on which $0.9 million was eventually realized by sale com- pleted in January, 1972). Thus although reported earnings from the diversifica- tion program were satisfactory they effectively worked a distraction from the continued cash drain which the real estate development and EJA subsidiaries were having on the parent company. Such an undesired result might have been effectively avoided by a more appropriate selection of investment opportunities. In this connection it might be noted that an expected source of cash funds from the non-rail acquisitions, tax allocation payments, never developed, and in fact worked as a further drain. (See table supra at p. 416) . These agreements between parent and subsidiary provided that 95 percent of all taxes that would have been paid by the subsidiary, if its return were filed independently and not consolidated with the railroad, would be paid by the subsidiary to the parent. Such payments would amount therefore to payment for the privilege of utiliz- ing the accumulated tax loss carry-forwards of the railroad. Actually only two such agreements, with GSC and Strick, were ever signed. The agreement with Strick, negotiated by the NYC, also contained certain unique provisions where the subsidiary would receive payment for certain tax deductions used by the parent company (which was still profitable at the time) resulting in a credit to the subsidiary of $915,599, which was eventually offset against receivables owed to the parent company, upon merger of Strick Holding Co. into the PCTC in 1969. The agreement with GSC did result in the receipt of $2.15 million in common stock of that company in 1969 in partial payment of amounts owing under the allocation agreement (leaving a balance receivable at the end of 1969 *> Excluding the effects of this sale from the consideration of the total cash drain (for which there is some basis in view of the nature of the assets disposed of) would of eoirse increase the net cash drain incurred by the railroad by a corresponding amount (to a total loss of $135.5 million for the PRR). u $111.26 million excluding sale proceeds of L.I.R.R. Co. 63 $112.4 million excluding sale proceeds of L.I.R.R. Co. 66 As the table above reflects, on an average total annual cash return basis, the railroad realized an approximate 6 percent return on investment. (Such return does not, however, take into considera- tion dividends and interest payments on equity/debt securities used in making the acquisitions, which would reduce the net return figure by approximately 43 percent to 3.3 percent.) 67 In addition. $4 million in preferred stock of GSC was also purchased by the railroad in 1965- 1966 in order to assist the subsidiary In Its financing needs. 420 of $5.82 million). However, no cash payment for such obligation was ever realised by the railroad. 68 As the previous figures reflect, although the diversification nropram of the railroad was not the overall cash drain that some have port rayed it. it nonethe- less did nothing to improve the railroad's cash flow problem either. Of some mystery, in this connection is why the railroad saw fit to resort in every acquisi- tion to the heavy, if not sole use of cash as part of the purchase price — further depleting existing cash levels. 69 In only one acquisition, that of Buckeye Pipe Line, were equity securities (Pennsylvania Co. 4% cum. preferred stock) em- ployed as consideration. 70 and even there the initial $30,213 million investment was in cash. Cash would have been unquestionably the only weapon to have been used if the railroad had been seeking to secretly establish an ownership base from which to launch either a tender offer (after obtaining the maximum permissible limit without public disclosure of its holdings and investment purpose) or to have simply negotiated from strength. But these tactics were not employed by the railroad (s) — with the sole exception of the Buckeye trans- action where the PRR did acquire an approximate ten percent interest in the company before disclosing such to the management of Buckeye. 71 It is believed that, at that time, the railroad's (principally the PRR) secu- rities were still possessed of sufficient value and attraction to have been used to a much greater extent than they were. In this regard the assertion that dividends payable on any such securities so issued would have worked an ever greater de- pletion of cash over the long period carries no weight. Excluding again the real estate development business sector, whose idiosyncrasies have been set forth above, there are other "growth'' areas in which specific companies also pay rea- sonable dividends on their own stock, the proceeds from which could have offset considerably any dividends paid by the acquiring company on stock used in making the acquisition. Moreover, not until the proposed acquisition of Kayser- Roth in June, 1968, after merger, does this objective appear to have been of major consideration. 72 Credit reserves The diversification program and its related cost also had the added disadvantage, because of the low cash reserves problem, of forcing the parent company to borrow to replace the net cash loss effected (whether the lat- ter was with respect to the railroad itself or its wholly-owned Pennsylvania Company subsidiary). It would be nearly impossible to trace what borrowings replaced what working capital source expenditures. However, using the infor- mation on total diversification-related cash funds expended on a yearly basis and total extraordinary additions to working capital, and considering the latter funds as replacements for the former, total interest costs 73 on the average work- ing capital funds outstanding would have approximated between $16 and $18 million from 1963 through 1969. The calculation of such a figure admittedly 08 Furthermore, at the end of calendar 1970, railroad books reflected a balance owing GSC of $2.15 million under such agreements (apparently resulting from an interpretation of the agreement in regard to additional tax loss carry-forwards generated by GSC's 1970 losses). This obligation is, how- ever, disputed by the railroad. * See, for example, the Board memorandum utilized by S. T. Saunders in his report to the railroad's Board of Directors at the August 1964 meeting wherein it is stated : "Net cash at the end of July totaled $5,000,000 which compares with $13,200,000 at the end of August 1963." In the same Board memorandum. Saunders also reported : "Pennsylvania Co. on July 15th purchased 518,367 shares of stock of Great Southwest Corporation bringing the system holdings to 532.867 shares, or 54.94% of the total outstanding stock at an aggregate cost of $12,196,000." Appendix D, Exhibit 38, p. 561. 70 Excluding the February 1970 acquisition of Southwest Oil Refining Co. (and Royal Petroleum Corp.) by Penn Central Co., accomplished solely bv the use of preferred stock of the latter company, but later rescinded by court settlement entered 4/9/71 C.A. No. 70-C-135, U.S. Federal Dist. Ct. (S.D. Tex., CorDus Christi. Piv ). 71 B"t even then the railroad continued to make a substantial cash investment (approximately $20 million more) after such disclosure, before acquiring the remaining approximate two-thirds interest with Pa. Co. preferred stock. 78 See memorandum utilized by S. T. Saunders in his report re proposed Kayser-Roth acquisition to the PCTC Board of Directors at the June, 1968 meeting wherein it is stated : ". . . there are obvious advantages in using securities, rather than cash, in a transaction of this size". Appendix P, Exhibit 7. Furthermore, "lthoueh the T 'avse--*>oth "eirnt'-t'oi" T-e-e inter terr-'iiate^ t^e it»ipr "in- rall acquisition made by the company, that of Southwest Oil Refining Corp. (acquired through the Penn Central Co.) was accomplished through the Issuance of preferred stock. (A 23 percent interest investment in Madison Souare Garden Corp. by PCTC was also accomplished primarily as the result of an exchange of stock held by the railroad in a subsidiary, for stock in Madison Square Garden Corp ) 73 Interest computed at the average rate in effect for equipment financing for the railroad(s) for each of the years in question. 421 involves many hypotheticals and is no more than speculation. It is sufficient for our purposes to simply point out that substantial interest costs were involved in the replacement of working capital funds used for diversification purposes and at rates in excess of those that would have been paid if equity securities had been used as consideration instead of cash. Also of significance to the railroad's total credit reserves, in addition to the borrowing it did to replace cash used for diversification-related costs, were the credit arrangements it made for its non-rail subsidaries (again almost ex- clusively for its real estate development operations and for Executive Jet Aviation, Inc.). Such bank loan arrangements were made nearly totally in reliance on the credit standing of the railroad (or more accurately, through its principal credit generating subsidiary, the Pennsylvania Company).* 4 Once again it is nearly impossible to calculate the effect such nomrail sub- sidiary borrowing had upon the credit resources of the railroad, since those resources were principally derived from Pennsylvania Co., whose credit stand- ing was in turn dependent in large measure upon the value of these same non- rail subsidiaries— the stocks of which were the principal assets of Pennsylvania Co. (along with the company's N&W holdings). The amounts borrowed by the real estate development companies and by EJA were of significant size, how- ever, and did work at least a partial erosion upon the credit sources of the rail- road (Pennsylvania Co.). Such effect is in further demonstration of the ill- advisedness of the investment selection by the railroad into areas with a patent need for large amounts of financing (to say nothing of the illegality of the pro- posed EJA objective) . Effect on management No basis in fact was found for the assertion that the railroad's manage- ment diverted excessive or unwarranted attention and efforts to the diversifica- tion program, and to the affairs of non-rail subsidiaries after acquisition. There was some time expended at the PRR in reaching a decision as to how to rein- vest the expected N&W proceeds, as well as in the earlier efforts of the "Com- mittee on Pipelines of the PRR." Both these efforts, headed principally by the chief financial officer of the railroad, amount to little more than consideration of problems he would be expected to confront as manager of the financial resources of the company. The same can be said for time spent by D. C. Bevan and other members of the finance department staff (including W. R. Gerst- necker and J. E. Dermond, the principal financial analyst and, later, Assistant Vice President Corporate) in evaluating potential acquisition candidates. Little time, relative to that expended on other corporate affairs, was de- voted to diversification by S. T. Saunders, who, although approving such action, viewed such activities as primarily within the province of I). C. Bevan and the finance department. Some time was also, of course, devoted by the company's legal department in respect to legal problems attendant to the specific acquisi- tions (principally the monitoring of the mechanics of the acquisition itself) , but other departments and/or officers of the company were clearly not involved in the acquisition program. In addition, S. T. Saunders and D. C. Bevan also served as the railroad's principal representatives on the boards of directors of the acquired companies. After acquisition, other than the participation on the subsidiaries' boards, what little control existed over the affairs of the non-rail subsidiaries was solely in the 74 Demonstrative of this point Is the fact that by the end of 1966 the capital structure of GSC, the railroad's principal real estate development subsidiary, had become so debt-ridden that a major Dallas bank (with whom it was even a depositor) would no longer loan funds to the corporation. (See letter dated 12/1/66 from D. C. Bevan to J. W. Aston, Chairman of the Board, Republic National Bank of Dallas, Appendix D, Exhibit 39, p. 564. Moreover, additional correspondence dated 9/22/67 from W. R. Gerstnecker, Treasurer of the PRR ; to C. J. Hodge reveals that within six months of the above Bevan letter the railroad hud not only arranged two three-year loans totaling $6 million and another short- term loan of $3 million for GSC. but had purchased $3 million of that company's preferred stock through the railroad's system companies and was contemplating purchasing $2 million more, Appendix D, Exhibit 40, p. 564. Furthermore, top management officials of the First National City Bank of New York candidly admitted to the Committee's special staff that substantial loans were granted to EJA not on its own credit standing, but as the result of arrangements made by D. C. Bevan or W. R. Gerstnecker of the railroad. These officials further state that the bank always considered that it was dealing with the railroad on such occasions and it was on its credit standing (or more accurately, that of the Ameri- can Contract Co. subsidiary and, later, the Pennsylvania Co., whose assets served as collateral when such loans were not secured by first equipment liens — where aircraft purchases were involved) that such loans were made. 422 form of (1) the submission of periodic financial reports (or more specifically, annual budgets and future planning and projections) to the railroad's finance department; (2) monthly meetings with the companies by D. C. Bevan and cer- tain members of the finance department staff to review operating results and future planning, and (3) the review of annual audited statements of financial results. As these limited control measures might suggest, the subsidiaries, in practice, ran their affairs virtually autonomously. The NYC management, on the other hand, expended little time or effort on diversification activities, making, of course, only the one acquisition of Strick in 1966 and also by giving great latitude to management of that subsidiary to control its own affairs. The merged company continued the same practices with respect to non-rail subsidiary control as were employed by the PER, with supervision of their ac- tivities given exclusively to D. C. Bevan and the financial department staff. Acquisition efforts were also continued by the same department in a manner similar to that of the PRR. Again, if anything, the same comment made in regard to too little control having been exercised by the PRR over its non- carrier subsidiaries can be made with equal application to the Penn Central. 75 Work in connection with the formation of the holding company primarily in- volved two members of the company's legal department and D. C. Bevan. Although certain officials (including S. T. Saunders and D. C. Bevan) did serve in dual capacities as officers and directors of both the railroad and the holding company, after formation of the latter in October, 1969, few activities were ever undertaken by it before the bankruptcy of the railroad nine months later and, correspondingly, few demands in connection with holding company matters were made upon the time of these officers. In order to ascertain the role of the ICC in connection with the railroad's acquisition program, it is first necessary to understand the Commission's pow- ers and responsibilities in regard to the regulation of the business and financial activities of the carriers within its jurisdiction, as well as its actions and policy determinations in regard to diversification by such carriers. A brief presenta- tion of this background information follows. Role of the ICC The role of the Interstate Commerce Commission in connection with rail- road diversification revolves around its function as the principal regulator of financial and business activities of the nation's surface transportation com- panies. Its specific powers, derived from the Interstate Commerce Act, are designed to keep it sufficiently informed of financial transaction details to fulfill its responsibilities, and are of two basic types: (1) provisions whereby the Commission can require the submission of certain operational (business and finance) information concerning the affairs of carriers within its jurisdiction, and (2) provisions whereby carriers within its jurisdiction are prevented from issuing securities in any form (whether equity or debt) without prior Commis- sion approval. POWERS More specifically, under the Act the Commission has broad powers to secure information of nearly every type respecting the business activities and financial condition of the carriers within its jurisdiction. Of particular importance in this regard is Section 20 which confers in paragraphs 1 through 10, among other things, specific authority to require annual, periodical and special reports of carriers, as well as to prescribe how they shall be made. The Commission is also granted authority to prescribe a uniform system of accounts, 76 The autonomous manner in which the acquired companies ran their affairs is demonstrated in part by the number of major acquisitions which they made themselves and manner in which completed. For example, Richardson Mobile Homes. Inc.. the nation's second largest manufacturer of mobile homes was purchased for in excess of $15 million by GSC in 19(>!t witli only a passing reference being made to the completion of the transaction at the Penn Central Board meeting (and with little, if any, apparent guidance having been given, or offered GSC by the railroad's finance department). For a more detailed discussion of the lack of control bv the Penn Central over its non-rail subsidiaries, see pp. 161-167 of "The Penn Central Failure and the Role of Financial Institutions," Staff Report of the Committee on Banking and Currency, U.S. House of Representatives, 92nd Cong., 1st Sess. 423 and to prescribe classes of properties for which depreciation charges can be included under operating expenses, including the rate of depreciation to be charged with respect to such property. In addition the section provides that all such accounts, books and records shall be open for inspection by the Commis- sion, its accountants or duly authorized representatives. In addition, Section 20a is of importance in regard to regulation of securities of such carriers. More particularly, carriers within the jurisdiction of the Commission are prohibited from issuing capital stock, bonds, or other evidence of indebtedness, or to assume any obligations or liability with respect to the securities of any other person without Commission authorization. Authorization of the issuance of any such securities or the assumption of liability may be granted by the Commission only upon investigation and a finding that: (a) the transaction is for some lawful corporate purpose; (b) the transaction is necessary or appropriate for or consistent with the proper performance by the carrier of service to the public as a common carrier; and (c) it will not impair its ability to perform that service. Quite obviously, the above powers are rather sweeping in scope, but are, as indicated, applicable only to carriers within the Commission's jurisdiction. In this connection a brief examination of the limitations on the Commission's powers to apprise itself of the financial condition of a "carrier," or its parent, or to impose financial controls through exercise of its securities provisions, is in order. LIMITATIONS ON POWERS Powers accorded the Commission over mergers or consolidations of carriers within its jurisdiction are broad. Any business consolidation of such carriers is clearly unlawful unless specifically authorized by the Commission. Along similar lines, a non-carrier (whether, e.g., a parent holding company or other- wise) may not acquire controlling interest of a carrier, if it already controls one or more other carriers, without Commission approval. Moreover, in the case where a holding company (or other non-carrier) controls two or more carriers, under the provisions of Section 5 (3) of the Act, it shall be considered a carrier, subjecting it to the reporting requirements (Section 20 (1) to (10)) and securities regulation provisions (Section 20a (2) through (11) ) described above, to the extent prescribed by the Commission. Thus, a non-carrier possessing multiple carrier controlling interests becomes a carrier itself to the extent the Commission deems necessary in regard to monitoring its business operations and financial activities. On the other hand Commission approval is not necessary where a non- carrier acquires control of one carrier. Furthermore, the Commission has also eschewed jurisdiction over any such non-carrier controlling but a single carrier and has therefore refused to subject it to the accounting and reporting provi- sions of Section 20 (with two limited exceptions) or the securities issuance requirements of Section 20a. OTHER APPLICABLE INVESTIGATORY POWERS Despite the above-mentioned limitations there are broad investigatory powers conferred upon the Commission by two other sections of the Act which could be employed in a case involving a non-carrier which controls a single carrier. For example, Section 12(1) confers upon the Commission authority to inquire into the business relationship between the non-carrier, or, more spe- cifically ". . . in order to . . . carry out the objects for which it was created . . . , to inquire into and report on the management of the business of persons controlling, controlled by, or under common control with, such carriers, to the extent that the business of such persons is related to the manage- ment of the business of one or more such carriers . . .." Moreover, Section 20(5) authorizes the Commission ". . . to inspect and copy any and all accounts, books, records, memoranda, correspondence, and other documents ... of any person controlling, controlled by, or under com- mon control with any such carrier, as the Commission deems relevant to such person's relations to or transactions with such carrier." 424 POLICY OF ICC TOWARD DIVERSIFICATION AND APPLICATION OF EXISTING POWERS The position taken by the Commission in regard to diversification by, or involving, carriers within its jurisdiction is perhaps best set forth in a brief case historv of the issue. For nearly 50 years the clear policy of the ICC was that the major en- deavors of a carrier should be confined to matters relating to transportation. Although there has been considerable refinement to this position, clearly this attitude has been primarily responsible for the creation of parent holding com- panies by carriers as the corporate instruments for implementing their diversi- fication programs. The initial attitude sprang from a 1913 investigation of the financial col- lapse of the New Haven Railroad — the conclusions from which asserted, among other things, that the problems of the company stemmed from the misfortunes and derelictions connected with its extensive extra-carrier activities. Finding that the railroad would not have been in financial difficulties had it not been for these outside undertakings, the Commission in that case stated : Every interstate railroad should be prohibited from expending money or incurring liability or acquiring property not in the operation of its railroad or in the legitimate improvement, extension or development of that railroad. 79 Acting upon these findings, Congress later adopted into law (in 1920) the securities monitoring provisions of Section 20a which have been set forth above. Such legislation clearly granted the Commission the right to prevent the issuance of securities or the assumption of financial obligations by a carrier unless it is found by the Commission that it is "necessary or appropriate for or consistent with a proper performance by the carrier of service to the public as a common carrier and . . . will not impair its ability to perform that service." Since that time, however, significant modifications of that initial rigid posi- tion have taken place. The first modification took place somewhat ironically in connection with another New Haven investigation years later. 77 While extend- ing the above-mentioned restriction in this ea c e to all raProad subsidiaries and reaffirming its initial position to the extent of stating that a railroad's resources should "ordinarily be devoted to the proper development of its own transporta- tion system," the Commission nonetheless held that under certain conditions non-carrier investment could be undertaken. These conditions briefly were that the Commission, in approving such investment, must find that it "constitutes a proper use of railroad funds or credit ; that the terms of the transaction are rea- sonable ; and that the investment is in the public interest." Specifically exempted from these restrictions were those "investments such as are permissible for sav- ings banks and trustees." 78 The two major cases having the most significant impact on the diversifica- tion issue were, however, to be decided in the early 1960's. The first of these in- volved the Bangor and Aroostock Railroad, a small Maine road, which formed the first of the modern-day parent holding companies, the Bangor and Aroostock Co. — which was then merged with the Punta Alegre Sugar Co. to form the Ban- gor Punta Co. In order to understand the significance of the next series of events it should be recalled that under Sec. 5(2) acquisition of a carrier is not subject to Commission approval unless the acquiring party is itself a "carrier" under applicable federal statutes (subjecting it to Commission jurisdiction — more specifically the provisions of Section 20a) or unless the non-carrier acquiring party's proposed acquisition involves control of two or more carriers (includ- ing in that number any already controlled by the acquiring party). At the time of the formation of the Bangor and Aroostock Co., in 1960, the B&A Railroad did control another carrier (the Van Buren Bridge Co.). How- ever, the Commission, establishing a precedent which it was to follow in the nu- merous holding company cases which have since arisen, held that the two car- riers were "constituents of a single integrated system" and shunned jurisdiction over the holding company (and its successor, Bangor Punta Co.). The princi- ■"> No. 4845 New England Investigation. 27 I.C.C. 560. ,„,» „„„ ,* ,,, A 77 Investigation of New York, New Haven and Hartford Railroad Co., 220 I.C.C. 505 (decided April 5. 1937). 78 Id. at p. 616. 425 pal effect of such decision was, of course, to make its prior non-diversification policy toward its regulated carriers inapplicable to such holding companies, a position which persists to the present time. A second important decision two years later involved what might well be construed as a reversal, or at least a major modification of the earlier Commis sion policy regarding diversification by a carrier itself. The specific case con- cerned an application by the Greyhound Corp. (while that company was still solely a carrier) — to issue a sufficient amount of its own stock to acquire con- trolling interest of Boothe Leasing Corp., an industrial equipment leasing company. In a narrow decision (with five of the Commission's members dissent- ing) , the ICC granted its approval of the transaction. The order of approval is of importance in this connection because of the majority opinions contained therein. 79 Recognition of diversification as a legitimate self-help measure to off- set unsatisfactory carrier revenues is inherent in the opinion. More specifically: The proposed acquisition by Greyhound of Boothe is part of a diversification pro- gram designed to stabilize and increase its earnings, and thereby improve its ability to provide the public with common carrier passenger service by bus . . . The Commission also noted that in other past instances it had granted ap- proval of non-carrier investment by carriers, but "in those instances in which management proposals for diversification appeared improvident, such proposals have been disapproved as not in the public interest." 80 Moreover, the majority cautioned that "In no event should a carrier be authorized to issue securities or use the proceeds therefrom, or assume obligations or liability with respect to the securities of any other person where it is not for some lawful object within its corporate powers; is not compatible with the public interest, and where it would impair in any respect the carrier's ability, financial or otherwise, to perform its service to the public as a common carrier . . ." 81 More importantly, the Commission observed : Judicious common-carrier investment in stable non-carrier business enterprises, if limited, would contribute to the provisions of a soundly financed common-carrier sys- tem, and would not do violence to the principle that corporations endowed with a public interest should direct their primary activities to the public-service nature of their operations. 82 The vigorous opinion of the five dissenting Commissioners, asserting that the ICC was mistakingly applying standards to a carrier that should be applied solely to a non-carrier holding company that was within the jurisdiction of the Commission, added this observation : If this precedent is to be followed, adequate supporting evidence at least should be required to inform the Commission as to the non-carrier business concerned, its financial condition and accounting methods, so that it [the ICC] might make an edu- cated appraisal of the "judiciousness" of the investment as support for the new standard. 83 However, despite this opportunity for diversifying within the confines of its own corporate structure, albeit in a somewhat circumscribed manner, car- riers for a variety of reasons (principal among them the desire to pursue diver- sification programs in a completely untrammeled manner) have resorted to the formation of parent holding companies over the past few years. 84 Adhering to its B&A precedent, the Commission has generally followed a policy of dis- missing all carrier applications for authority to make these corporate changes (i.e. the assumption of control by the holding company over the carrier) on the basis that the Commission lacks the jurisdiction to even consider them. In the two cases which were found to come within the jurisdiction of the ICC, in- volving Northwest Industries and Illinois Central Industries, the Commission has chosen to invoke but limited supervisory powers and has required the sub- mil tal of only a minimal amount of reports. « lr ™ Interstate Commerce Commission. Finance Docket No. 21801, Greyhound Corp. Stock, 90 M.C.C. 215, 218 (decided March 19, 1962). 80 Id., at p. 220. 81 Id., at p. 222. 82 Id., at p. 223. 83 Id., at p. 228. h. 3 Although the effect of the railroad's bankruptcy on its parent's financial strength is self- evident, (the stock of the railroad being nearly Its sole asset), nonetheless the holding company Itself Is not in bankruptcy. „„ "Interstate Commerce Commission, Finance Docket No. 23019, Pennsylvania Co. Stock, 324 ICC 275 (decided .Tulv 13, 19R4K c J!? 'Conglomerates and Public Responsibility," by Colin Barrett, Traffic World, March 1, 1969, pp. 86-91 ; reproduced in Appendix D, Exhibit 41, p. 565. 428 Acquisitions of real estate development operations by the Penn Central were exactly the type of capital-intensive companies mentioned here, and whose activities were hardly those of the "stable non-carrier enterprises" referred to by the Commission in the Greyhound case. Moreover, in another article by Alan Roth in The Institutional Investor in regard to the financial aspects of diver- sification by carriers, Mr. Roth pointed to some of the problems that could well arise, offering the observation that diversification "will be more difficult than the first blush of initial expectations would indicate." "Rail management," he further observed, "is on the whole inexperienced in the highly competitive and sophisticated acquisition business. Companies which have led the way in diver- sification have principally been managed by lawyers or investment bankers, as opposed to traditional railmen." 96 To this comment it might be added that even when such companies are managed or advised by "lawyers or investment bankers" there is no guarantee that noncarrier investments made will be sound ones taking into account the carriers objectives and needs — as witnessed in the PCTC case at hand. . Referring to the above-mentioned Barrett article again, it is stated therein by the author that "Virtually no one — and certainly no responsible person — is seeking to block all railroad expansion beyond the transportation indus- try. There are, however, many who are fearful that untrammeled expansion could bring railroads more trouble than benefits." 97 The Penn Central experience by itself does not suggest that an absolute prohibition of diversification is required ; but it does support observations such as those made by Mr. Roth and Mr. Barrett. Considering real needs of the car- rier in providing transport service, the Penn Central diversification program as conceived and implemented caused a loss of substantial cash to the railroad at the very time it could ill afford such loss. The loss was not offset by sufficient gain to justify the program. The Penn Central diversification program is a paradigm of what can happen (and has in other carrier situations) when car- riers, despite their demonstrated public interest nature, are permitted to invest their corporate resources in noncarrier business in a totally unrestrained manner. ASSESSMENT OF RELATIVE AND ABSOLUTE WEIGHT OP DIVERSIFICATION AS A FORCE LEADING TO BANKRUPTCY The diversification program of the railroad (s) was not a major cause of the bankruptcy. A summary of the findings leading to this conclusion are as follows : 1. By virtue of the earnings maximization policy of management the non- rail acquisitions gave the appearance of achieving a quite satisfactory return on investment in terms of reportable earnings from the inception of the program in 1964 through 1969, contributing substantial percentages of reported consoli- dated earnings in that period while rail operations continued at a deficit. With- out the benefit of these added reportable earnings it is probable that the rail plight would not have been obscured so successfully and, financial pressures would have been brought to bear much sooner resulting in an earlier bankruptcy. It was not until calendar year 1970, post-bankiiiptcy, that the principal real estate development acquisitions recorded their large losses. Investors and the public generally might find a delay in the bankruptcy of questionable value. 2. While the program as implemented, unquestionably precipitated a cash drain over the six year period (reflecting the inappropriateness of the types of investments made) such amounts were not significant by themselves when com- pared to the total funds which the railroad continued to reinvest in its rail plant over a good portion of the same period. 3. Although substantial amounts of time were devoted to the diversifica- tion efforts by certain members of the railroad's finance department and, to a much less extent, the Chairman of the Board, few other officials (none in the M "The Railroads : What Will Diversification Mean to Earnings?" by Alan Roth, The Institutional Investor, October 1968, pp. 74-75. " "Conglomerates and Public Responsibility," op. cit., at p. 89. 429 rail operating' departments) were involved to any extent. It is probable that such efforts did not measurably detract from management's capability to oper- ate the railroad. 4. The bank loans arranged by the parent company for its non-rail sub- sidiaries had little effect on lines of credit which the railroad could have used to forestall bankruptcy. This was because the railroad was for all practical pur- poses wholly reliant upon its Pennsylvania Company subsidiary as its principal credit generating corporate instrument — whose assets were in large part the stock of the non-rail subsidiary companies. The arranging of loans to improve the operating performance of its subsidiaries was an attempt to increase the value of its only pledgable assets since nearly all of the railroad's own assets already served as collateral for its prior loans. In relative terms the total impact of diversification was by itself a small factor in the bankruptcy of the railroad. At worst, the adverse effect on the cash position of the railroad it produced was no more significant than the inade- quate pre-merger planning by both railroads leading to the disruptive service problems faced by the company immediately after merger. The effects of the latter on existing and prospective shippers left a far greater impression in terms of total revenues lost than did the total cash expended during the seven year period on the diversification program. For that matter revenues lost from various industry strikes involving ship- pers, severe weather conditions during the short period of the merged company's existence, costs associated with the labor protective agreement (the latter of which were, however, minimal by the company's own admission) and the New Haven inclusion also contributed to the financial burdens of the merged company. For the reasons advanced above it is believed that the most appropriate solution to the adverse effects of the PCTC acquisition program may not be total prohibition of all outside investment, but rather the imposition of control by the Interstate Commerce Commission over the types of non-carrier invest- ment that a carrier or its parent holding company may be permitted. RECOMMENDATIONS The diversification program of the Penn Central is clearly a model for the prevention of untrammeled non-carrier investment by a carrier. Although it is acknowledged that some benefits may be achieved through a soundly con- ceived and implemented program of diversification, the Penn Central case (as well as several others examined by the ICC in studies over the past two years) strongly demonstrates the need for the imposition of standards and controls over such activity by carriers. It is, however, recognized that the mere extension of Section 20a to apply to non-rail cash acquisitions by carriers or the additional strengthening of the approval proceedings thereunder (including the prescribing of more comprehensive types of information to be submitted) would be largely useless today because of the advent of the holding company device to avoid Interstate Commerce Commission jurisdiction. Simply forming a holding company should not also have the undesirable side effect of insulating the carrier from the Inter- state Commerce Act. Because of the demonstrated opportunities for impair- ment to the financial condition and service ability of a carrier that ownership or control by a non-carrier presents (whether by creation of the carrier itself or not) and the evident public interest involved in maintaining the nation's existing rail resources, it is strongly recommended that the Commission use its existing power under the Act as outlined below or failing that, that it explain in detail how the Act is deficient and how it should be amended. The recom- mendations are as follows : (1) that any person controlling a carrier be subject to the provi- sions of Sections 12, 20 (1) through (10), and Section 20a (2) through ( 11 ) of the Interstate Commerce Act ; (2) that the Commission require the submission of any and all information deemed relevant to a proper assessment of the business 430 and financial activities of any such controlling person in order to carry- out its responsibilities under the Interstate Commerce Act (including e.g. the assessment of the effect of such activities upon the carrier and its ability to perform its service to the public) ; M (3) that the Commission require the submission of any and all information it deems relevant to making a determination as to the judiciousness of a non-carrier investment (including e.g. the nature of the non-carrier business concerned, its financial condition and account- ing methods) where the purpose of the issuance of the securities in- volved is that of (or assumption of financial obligation is related to) non-rail investment ; and (4) that the Commission examine proposed acquisition bj r car- riers (or controlling persons thereof) of any non-carrier business enter- prise by the utilization of cash as the sole means of consideration. The adoption of the above recommendations would not necessarily prohibit the continued use of diversification by carriers. But it would provide a con- trolled environment which would help prevent investment in business areas whose activities or financial demands are incompatible with the needs and ob- jectives of the carrier." It is noted that the ICC in late 1970 and in 1971 sub- mitted legislative proposals related to diversification. The Senate Committee on Commerce deferred action on any legislation pending the completion of this report. The second proposal (S. 2760 in the 92nd Congress — HR. 11030 in the House) represented a significant retreat by the ICC from its initial proposal introduced late in the 91st Congress in the House as H.R. 19720 Much could be achieved by the Commission under existing law, but the Congress should con- sider the necessity for new legislation in the light of ICC reaction to the recom- mendations of this report. 98 The present form (Form BF-6) used to request information Is so overly simplistic In regard to the type of information requested as to be of limited use. In addition, with the relatively small staff available for investigating even the information presently submitted, challenges by the government to the issuance rarely develop. Those that do are usually the result of opposition by some interested third party. (See Appendix, Exhibit 45 for a sample copy of Form BF-6 and general instructions). 06 The standard for investment might well encompass those advanced by the Commission in the Greyhound case : "In no event should a carrier be authorized to issue securities or use the proceeds therefrom, or assume obligation or liability with respect to the securities of any other person where it is not for some lawful object within its corporate powers ; is not compatible with the public interest, and where it would impair in any respect the carrier's ability to perform its service to the public as a common carrier." Finance Docket No. 21801. Greyhound Corp. Stock. APPENDIX A TABLE A-l.— INTERCITY FREIGHT BY MODES, 1939-70 i [Billions of ton-miles) Oil Rivers pipe- Great and Rail Percent Truck ' Percent line Percent Lakes Percent canals Percent Air Percent Total 1939. 339 62.3 53 9.7 56 10.3 1940 379 61.3 62 10.0 59 9.5 1941... 482 62.4 81 10.5 68 8.8 1942... 645 69.5 60 6.5 75 8.1 1943 735 71.3 57 5.5 98 9.5 1944 747 68.7 58 5.3 133 12.2 1945... 691 67.2 67 6.5 127 12.4 1946 602 66.6 82 9.1 96 10.6 1947 _ 665 65.3 102 10.0 105 10.3 1948 647 61.9 116 11.1 120 11.5 1949 535 58.3 127 13.8 115 12.5 1950... 597 56.2 173 16.3 129 12.1 1951 655 55.6 188 16.0 152 12.9 1952 623 54.4 195 17.0 158 13.8 1953 614 51.0 217 18.0 170 14.1 1954 557 49.6 213 19.0 179 15.9 1955 631 49.5 223 17.5 203 15.9 1956 656 48.4 249 18.4 230 17.0 1957--- 626 46.9 254 19.0 223 16.7 1958 559 46.0 256 21.1 211 17.4 1959 582 45.3 279 21.7 227 17.7 1960 579 44.1 285 21.8 229 17.4 1961 570 43.5 296 22.7 233 17.8 1962. 600 43.8 309 22.5 238 17.3 1963 629 43.3 336 23.1 253 17.4 1964 666 43.2 356 23.1 269 17.4 1965. 709 43.3 359 21.9 306 18.7 1966 751 43.0 381 21.8 333 19.1 1967- 731 41.4 389 22.0 361 20.5 1968 757 41.2 396 21.5 391 21.3 1969 780 41.0 404 21.3 411 21.6 1970(p) 773 40.1 412 21.4 431 22.4 76 96 114 122 115 119 113 96 112 119 98 112 120 105 127 91 119 111 117 80 80 99 87 90 95 106 110 116 107 112 115 116 14.0 15.5 14.8 13.1 11. 10. 11. 10. 11. 11 10. 10.5 10.2 9.2 10.6 8.1 9.3 8.2 8.8 6.6 6.2 7.5 6.6 6.6 6.5 6.9 6.7 20 22 27 26 26 31 30 28 35 43 42 52 62 64 75 83 98 109 115 109 117 121 123 133 139 144 152 164 174 179 188 190 3.7 3.6 3.5 2.8 2.5 2.8 2.9 5.6 6.2 7.4 7.7 8.0 8.6 9.0 9.1 9.2 9.4 9.7 9.6 9.3 9.3 9.4 9.9 9.7 9.9 9.9 3.01 .02 .02 .04 .05 .07 .09 .08 .11 .15 .20 .30 .34 .34 .37 .38 .49 .58 .68 .70 .80 .89 1.01 1.30 1.30 1.50 1.91 2.25 2.59 2.90 3.20 3.40 .01 .01 .01 .01 .01 .02 .03 .03 .03 .03 .03 .04 .04 .05 .05 .06 .07 .08 .09 .09 .10 .12 .13 .15 .16 .17 .18 544 618 772 928 1,031 1,088 1,028 904 1,019 1,045 917 1,063 1,177 1,145 1,203 1,123 1,274 1,356 1,336 1,216 1,286 1,314 1,310 1,371 1,453 1,543 1,638 1,747 1,765 1.838 1,901 1,925 (p)— Preliminary. 1 Includes both for-hire and private carriers. 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TABLE A-9.-ANNUAL FIXED CHARGES AS A PERCENT OF NET RAILWAY OPERATING INCOME, CLASS I RAILROADS, 1960-70 1 1964-67 pro forma. 2 Over 100 percent. 3 1964 pro forma. Year Percent Year Percent 1960... 63.8 1966 40.7 1961 68.6 1967. 68.1 1962 50.5 1968 7.14 1963... 45.7 1969 79.6 1964 46.5 1970 (') 1965 41.7 i Over 100 percent. Source: ICC and AAR. TABLE A-10.-OTHER INCOME AS A PERCENT OF PRE-FEDERAL INCOME TAX ORDINARY INCOME ' CLASS I RAILROADS, 1960-70 Year Percent Year Percent 1960 53.5 1966 36.7 1961 51.6 1967 .. r 73.8 1962 44.7 1968 79.3 1963 40.5 1969 81.4 1964... 44.1 1970 ( 2 ) 1965 37.3 1 Before 1967 reported as Net Income. 2 Over 100 percent. Source: ICC and AAR. TABLE A-ll— OTHER INCOME AS A PERCENT OF PRE-FEDERAL INCOME TAX ORDINARY INCOME,' REGIONAL DISTRICTS AND SELECTED RAILROADS, 1964-70 1964 1965 Year 1966 1967 1968 1969 1970 Eastern district Penn Central* Norfolk & Western K Southern district Southern Railway... Illinois Central Western district ... Southern Pacific Union Pacific. ( 2 ) 43.5 47.2 ( 2 ) ( 2 ) ( 2 ) < 2 ) 99.7 90.6 ( 2 ) ( 3 ) 0) 9.4 8.6 11.6 19.6 22.3 21.2 20.2 29.7 27.5 39.6 42.3 36.6 10.6 19.5 15.6 19.5 19.4 16.0 33.2 17.8 22.6 33.8 44.8 41.1 42.3 35.9 33.5 58.2 57.5 57.3 49.1 44.0 53.1 62.6 58.7 55.8 50.1 38.4 34.7 44.4 50.6 51.6 < 1964-67 pro to rma. 3 1964 pro for mc . ( 3 ) 18.9 42.4 26.5 70.4 65.9 74.4 57.4 i Before 1967 reported as net income. 2 Over 100 percent. 3 Not calculated because pre-Federal income tax ordinary income is a deficit amount. Source: Moody's Transportation Manual. 442 o — ' — 13 ° 000^-CM(J>(SJ — csjr-^otococoo^omu-) ro .to . o ,-h .o ^j-CTHOCNjr-»cooo-^r^tD -~- -CM -OO -U"> -H"> oo)Oono«(ouiroOiflinoioir .O -<>J - ■.«-« -<"> -r»* -csj -uj © — 0*>— OO^'CO— — —lilr- lOO—tO^H ■) ^ oi — «^, 3 -- «-*** — .ir>u">e\jr-.tf">r-«»- "oooOcnj , ro . r^ -to .to .01 _co -— -to -^j- -tn «/> — » <— « ■>to .O . 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C en u-> oo co ^h to oo -ui a> "> o> m = S = - 3 = ™-"K s — e 445 TABLE A-14.-FIXED CHARGES AS A PERCENT OF CASH FLOW, CLASS I RAILROADS AND SELECTED RAILROADS, 1964-70 1964 1965 1966 1967 1968 1969 1970 Class I railroads Perm Central' Norfolk & Western »_ Southern Railway... Slinois Central llouthern Pacific Union Pacific 27.5 26.3 26.0 35.2 35.5 51.6 46.8 54.7 77.1 < 2 ) 24.3 24.1 23.5 26.6 32.9 25.0 27.5 27.4 26.8 31.4 20.3 17.4 16.8 17.0 21.1 22.9 22.3 22.1 26.6 22.6 2.9 2.5 3.5 6.5 7.0 40.7 (') 34.8 30.5 22.6 22.8 7.3 58.0 34.3 31.8 27.6 26.8 14.3 ' 1964-67 pro forma. 2 Over 100 percent. 3 Not calculated because cash flow is a deficit amount. < 1964 pro forma. Source: Moody's Transportation Manual. TABLE A-15.-CASH FLOW AS A PERCENT OF NET WORTH, CLASS I RAILROADS AND SELECTED RAILROADS, 1964-70 1964 1965 1966 1967 1968 1969 1970 Class I Railroad Penn Central ' Norfolk & Western". Southern Railway. ._ Illinois Central Southern Pacific Union Pacific 7.8 8.6 9.0 7.3 7.6 7.2 5.9 < 2 ) 7.1 6.0 5.2 4.5 0.6 <*> 7.6 7.9 7.8 6.5 6.4 6.6 6.2 9.4 9.1 8.9 9.8 9.0 11.0 11.0 7.1 8.0 7.8 8.2 8.2 8.2 7.5 8.6 9.1 9.4 8.2 9.4 9.8 9.3 8.8 9.3 10.2 9.7 9.4 9.2 10.1 1 1964-1967 pro forma. 2 Not available. 3 Not calculated because Cash Flow is a deficit amount. * 1964 pro forma. Source: Moody's Transportation Manual. TABLE A-16.-CASH DIVIDENDS AS A PERCENT OF PRE-FEDERAL INCOME TAX ORDI ifARY INCOME ' AND AS A PERCENT OF CASH FLOW, CLASS I RAILROADS, 1960-70 Year 1960. 1961.. 1962.. 1963.. 1964. 1965. 1966.. 1967.. 1968.. 1969.. 1970. Percent of pre-FIT ordinary Percent of income cash flow 59.5 32.3 57.2 33.3 50.6 36.0 46.4 30.9 54.7 33.0 48.1 30.9 45.8 27.5 81.1 38.4 78.5 37.8 78.6 38.1 (?) 41.4 1 Before 1967 reported as net income. 2 Over 100 percent. Source: ICC and AAR. TABLE A-17.-CASH DIVIDENDS AS A PERCENT OF PRE-FEDERAL INCOME TAX, ORDINARY INCOME,' SELECTED RAILROADS 1964-70 1964 1965 1966 1967 1968 1969 1970 Penn Central 2 Norfolk & Western ». Southern Railway... Illinois Central Southern Pacific Union Pacific 54.5 67.0 66.6 < 3 ) ( 4 ) (*) (O 47.6 51.9 52.5 75.3 65.4 66.9 70.4 45.4 51.8 48.5 44.6 50.3 37.3 47.6 42.3 31.7 29.8 32.7 34.6 36.2 42.0 55.4 48.6 45.6 64.9 56.9 57.2 94.3 39.6 36.6 35.8 42.5 41.4 39.3 38.4 1 Before 1967 reported as Net Income. 2 1964-67 pro forma. 3 Over 100 percent. * Not calculated because pre-Federal Income Tax Ordinary In- come is a deficit amount. 5 1964 pro forma. Source: Moody's Transportation Manual. TABLE A-18.-CURRENT ASSETS AS A PERCENT OF CURRENT LIABILITIES,' CLASS I RAILROADS, 1960-70 Year Percent Year Percent 1960 163.5 1966 142.9 1961 150.8 1967 133.4 1962 158.5 1968 125.1 1963 162.4 1969 119.8 1964 154.8 1970 122.6 1965 152.1 1 Excluding long term debt due within 1 year. Source: ICC and AAR. 446 TABLE A-19.-CURRENT ASSETS AS A PERCENT OF CURRENT LIABILITIES,' SELECTED RAILROADS, 1964-70 1964 1965 1966 1967 1968 1969 1970 Penn Central 2 113. 4 Norfolk & Western' 164. 1 Southern Railway 125.9 Illinois Central... 136. 1 Southern Pacific. 177.2 Union Pacific 286.6 125.2 125.5 110.0 86.4 98.8 126.6 157.0 158.3 151.4 145.4 131.2 126.6 127.8 124.9 137.9 129.4 129.2 115.3 129.1 123.5 141.2 137.0 161.2 150.1 147.0 128.2 120.1 126.7 103.3 122.3 230.0 234.4 199.3 187.7 133.6 139.6 1 Excluding long-term debt due within 1 year. 2 1964-67 pro forma. 3 1964 pro forma. Source: Moody's Transportation Manual. TABLE A-23.-DEBT DUE WITHIN 1 YEAR AS A PERCENT OF PRE-FEDERAL INCOME TAX ORDINARY INCOME,' SELECTED RAILROADS, 1964-70 1964 1965 1966 1967 1968 1969 1970 Penn Central" Norfolk & Western «. Southern Railway... Illinois Central Southern Pacific Union Pacific ( 3 ) C) 93.9 6> ( ? 18.0 22.9 40. 1 56. 1 35.6 34.2 29.8 52.3 36.9 35.4 33.8 62.0 49.0 41.3 71.7 3.2 3.0 13.3 18.3 ( ! ) O ( 5 ) 57.0 70.1 79.5 54.7 37.5 53.9 56.8 55.8 59.9 90.1 55.1 62.4 21.4 24.8 17.3 ' Before 1967 reported as net income M964-67 pro forma. 3 Not available. 4 Over 100 percent. ! Not calculated because pre-Federal income tax ordinary income is debt amount. 11 1964 pro forma. Source: Moody's Transportation Manual. TABLE A-21.-NET WORKING CAPITAL' AS A PERCENT OF FIXED CHARGES, CLASS I RAILROADS, 1960-70 Year Percent Year Percent I960 155.0 1966.... 112.1 1961 138.4 1967 59.9 196? 176.3 1968 31.6 1963 225.0 1969 10.8 1%4 192.1 1970 18.5 1965 61.2 '.Excluding materials and supplies and long term debt due within 1 year. Source: I.C.C. and AAR. TABLE A-22.-NET WORKING CAPITAL' ASA PERCENT OF FIXED CHARGES, SELECTED RAILROADS 1964-70 Year 1964 1965 1966 1967 1968 1969 1970 Penn Central* Norfolk & Western*. Southern Railway... Illinois Central Southern Pacific Union Pacific ( 3 ) ( 3 ) ( 3 ) (O ( 3 ) ( 3 ) 17.7 224.1 179.1 122.6 83.5 80.6 28.9 29.6 69.2 75.9 63.9 121.2 101.6 79.1 1. . 146.2 56.9 20.1 149.7 121.0 249.7 209.7 375.4 232.1 123.6 71.0 120.5 ( 3 ) 80.6 (») (») ( 5 ) 976.5 812.6 450.6 288.5 ' Excluding materials and supplies and debt due within 1 year. 2 1964-67 pro forma. 3 Not calculated because net working capital is a deficit amount. ' 1964 pro forma. I Over 1,000 percent. Source: Moody's Transportation manual. TABLE A-23.-STATE AND LOCAL TAXES AS A PERCENT OF PRE-FEDERAL INCOME TAX ORDINARY INCOME ' CLASS I RAILROADS 1960-70 Year Percent Year Percent I960 61.2 1966 31.1 1961 60.9 1967... 58.5 1962 50.0 1968 55.4 1963 42.2 1969.. 62.1 1964 41.1 1970.. ( 2 ) 1965 36.1 1 Before 1967 reported as net income. 2 Over 100 percent. Source: ICC and AAR. 447 TABLE A-24. -STATE AND LOCAL TAXES' AS A PERCENT OF PRE-FEDERAL INCOME TAX ORDINARY INCOME,* SELECTED RAILROADS, 1964-70 1964 1965 1966 1967 1968 1969 1970 Penn Central 3 87.3 70.9 52.8 (*) Norfolk & Western « 20.7 20.2 18.8 29.2 Southern Railway... 25.0 28.5 28.1 24.5 Illinois Central.... 59.1 47.2 40.2 37.7 Southern Pacific 45.5 40.9 38.7 58.9 Union Pacific 18.4 16.9 15.5 17.4 < s > C) ( ! ) 27.4 30.9 35.5 28.3 21.7 24.0 42.3 41.5 48.6 44.2 44.2 57.8 18.4 17.8 18.7 1 Includes foreign taxes as well as U.S. Government taxes other than payroll and income taxes. 2 Before 1967 reported as net income. 3 1964-67 pro forma. 'Over 100 percent. s Not calculated because pre-Federal income tax ordinary income is a deficit amount. 11 1964 pro forma. Source ICC and AAR. 448 i-»r*.coro^ , r-»>-r-«^^ff»^ , r-.otoou">tn»i")tococM^-c oor^uacsj^-fsj— «or-.00r-.« — - ~hCMCMCMCMCMCMCM»-«--<-i.. ■) »■* ^h ^^ ^h O O O CD CD CD MO«m-H» « •— n>.ff>ff) eMfD^OtO^*"COCDCMOO">Or*»tOm ^OlDCM«5000>lCOW(^00tHr^-HO NH-t-iooooiaioi I I II c * IcgcMCsicsicgcsjevjc i i ~*ir>m^o">ir>CDir>.nr-.~-r^.c*s)0^-Oir)ror l-ooocooooo OOO o „ ■5 = o S oo-*u->*)-oooocJ 1 OcMr».0">r»«.r^tooCDoocDCDaoOo"3'0">oo CMrOooLOrocMCMCOCMCDoooor-tOtO^cocM'— 'OOo^Moo coc ^^ O LfS tO F-» lT> ^ CT» «*- ii"i v OOlDi/1 — O — OJ)r .^CMCMCMCMCMCM— " - i^rroCTJLf>CT>odtd«rror^'i. into I I st cm «* i/i co cm ir> O ^* r-. ~- co u"> o oo CD _ i-«r mtO--"tO~HtOCM'0-CMO— «(0-- , CDeMOOr-..-«0>00~-©U">«3'CM = of£ o r^-r^«d-ro — i ifiroiTio- . lo i-O * tn to to co cm cm cm cm cm jMstc^F-moOOioc - to r-." cd --« o c oo in **■ co «* o-mcMfOror— tor^-CD^OCMoin — ~h rOCSJCNJCMi— iOIOOOOI — tOii")*3-rOCSjC\J~-0 CJ>a>0"> I I EE ■jMOiooooiNoo^-CMinWi-iinfOF-oiifip ■j cm •«* eg ~-i cm c ■ 4 CM CM CM CM CMC rovoco 3 r< o o *t o ai "ooocnaioo to CO 7 1 ? CDCOtOr-.O^J-tOaOtOtOOOOtDtMtDCMtO-^'— »OOti r^ od r-^ to cm *r *r W to — * * ' cMrooooo*j-«3-«j-«3-«^- fCNKootor )^Hf0(SH000lfif0U10>OM' rmtDoai^o) r CM CD O lTI ^- ^- o a. lU"»mCDOO«— ■ --• — — DC E a> — ■£ M W cue 0> Q. '^ —> a> ^ ■o w c c a» tv e =>£ ro O -- o £ tDr*-00CT>O"— •CMCO*fli">lOr-~OOCDO ' O") Oi CT) CT> CD CD CD CD CD CD CD CD CD CD CD CD CT> CD CD CD CD CD CD CD CD ■ 449 TABLE A-26.-AVERAGE LENGTH OF HAUL IN MILES, NATIONAL RAIL SYSTEM AND SELECTED RAILROADS, 1961-70 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Class I national system Penn Central Pennsylvania New Yoik Central Norfolk & Western.. New York, Chicago & St. Louis. Southern Railway Illinois Central Southern Pacific Union Pacific... 452 461 464 466 477 484 485 495 303 497 294 499 298 275 281 282 287 292 291 289 . 249 244 244 242 262 278 288 . 281 283 288 284 290 297 304 311 313 322 ?V 233 219 233 224 219 225 228 231 230 233 238 239 260 271 261 264 278 280 268 283 293 270 474 501 492 498 501 525 548 528 510 515 579 582 585 588 599 615 620 641 653 640 Source: National Rail System, ICC and AAR; selected railroads; Moody's Transportation Manual. TABLE A-27.-AVERAGE LENGTH OF TRAINS, IN NUMBER OF CARS, CLASS I RAILROADS AND REGIONAL DISTRICTS, 1960-70 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Class I railroads 69. 6 Eastern district 71.2 Southern district 69. 8 Western district 68. 4 70.4 70.5 70.3 69.7 69.6 69.3 70.5 70.1 70.0 70.1 71.9 72.3 72.2 71.2 72.1 72.6 74.9 74.3 73.8 72.7 70.5 70.8 69.4 69.6 70.9 72.1 72.5 70.3 71.5 68.6 69.3 69.3 69.3 68.7 67.6 66.5 67.2 67.4 67.4 69.0 Source: ICC and AAR. TABLE A-28.-AVERAGE FREIGHT TRAIN LOAD', CLASS I RAILROADS, REGIONAL DISTRICTS, AND SELECTED RAILROADS, 1960-70 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Class 1 Railroads Eastern District.. 1,453 1,586 1,495 1,613 1,544 1,669 1,590 1,722 1,618 1,685 1,715 1,740 1,747 1,821 1,878 1,939 1,768 1,804 1,972 1,994 1,922 1,825 1,820 1,981 Penn Central.. . . 1,705 Pennsylvania 1,540 1,405 2,824 . 1,424 1,497 ( 2 ) ( 2 ) 1,350 ( 2 ) ( 2 ) 1,573 1,437 3,058 1,426 1,545 1,571 1,633 1,400 1,436 1,418 1,605 1,523 3,115 1,418 1,608 1,630 1,748 1,440 1,459 1,449 1,662 1,594 3,254 1,447 1,640 1,632 1,778 1,486 1,474 1,508 1.683 1 1,591 1 2, 095 2 1,690 1 1.684 1 1,827 1 1, 509 1 1, 495 1 1,541 1 ,783 1,864 1,936 . ,712 1,858 1,906 ,201 2,322 2,398 ,812 1,873 1,905 ,828 1,843 1,942 ,885 1,904 1,799 ,555 1,567 1,566 , 526 1, 538 1, 544 , 570 1, 552 1, 585 New York Central Norfolk & Western 2,449 2,512 1,874 1,951 1,977 1,917 1,794 1,954 1,614 1,649 1,716 1,741 1,585 1,718 2,545 New York, Chicago Southern District & St. Louis. 1,881 Southern Railway Illinois Central Western District 1,725 1,833 1,703 Southern Pacific. . 1,911 Union Pacific 1,343 1 Net ton miles per 2 Not available. train mile. SS TON-MILES PER 1 Sources: Cla: roads—Moody' : REIGHT TRAIN HOUR, CLASS 1 RAH is 1, Regional Districts— ICC and AAR; Selected Rail- s Transportation Manual. TABLE A-29.-GRO ROADS AND SELECTED RAILROADS, 1960-70 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 All class 1 railroads Penn Central 63 096 65, 598 67, 504 68,927 69, 724 71,222 73,183 75,103 76 72 , 222 76, 448 , 281 68, 883 , 690 93, 831 78,111 72,277 Pennsylvania New York Central... Norfolk & Western New York, Chicago & St. Louis 56, 134 59, 458 . 89, 564 59,013 (') (') (') (') 58, 858 60,056 94.731 59, 622 59, 490 63,413 79, 241 93,512 62,413 61,647 97, 688 56, 536 61,220 66, 092 80, 457 94,814 63, 790 62,716 99,416 56, 104 59, 604 65, 694 81,151 98, 633 64, 196 65, 959 82,131 66,176 69, 761 82, 772 69,441 71,550 .... 73,795 76,557 .... 82,002 91,133 92 92, 795 Southern Railway Illinois Central 60, 325 65,812 83, 064 104,226 57, 453 67,040 81,982 107,116 63, 794 66, 859 65, 230 67, 169 71,347 65,199 62,807 63,074 84,646 87,603 92,097 93,257 111,831 116,316 119,369 121,859 69, 002 52, 279 Southern Pacific Union Pacific 109,098 128,502 i Not available. Source: Moody's Transportation Manual. TABLE A-30— LOADED CAR MILES AS PERCENTAGE OF TOTAL CAR MILES, SELECTED RAILROADS, 1961-70 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Penn Central 58.7 58.5 64.1 Pennsylvania. . 60.4 61.8 56.9 53.9 62.2 59.5 64.2 64.4 61.8 57.6 53.7 61.4 58.9 64.1 64.1 61.3 57.4 61.6 57.6 61.9 58.0 55.2 60.6 57.0 53.8 New Yoik Central- 55.7 Norfolk & Western New York, Chicago & St. Louis 53.9 62.0 60.0 54.3 56.2 54.7 54.9 53.0 Illinois Central 58.5 63.8 63.4 60.2 64.2 63.8 59.2 64.4 62.0 56.6 62.4 60.6 56.5 62.2 60.6 58.3 62.9 60.1 55.3 Souther n Pacific Union Pacific 63.8 64.9 61.2 57.9 Source: Moody's Transportation Manual. 450 TABLE A-31— AVERAGE FREIGHT CAR CAPACITY, CLASS I RAILROADS, 1960 70 Year Tons Year Tons 1960 1961 55.4 55.7 56.3 56.8 58.3 59.7 1966 1967 61.4 63.4 1962 1963 1964 1965 1968... 1969 1970... 64.3 65.8 67.1 Source: ICC and AAR. TABLE A -32.-UNSERVICEABLE EQUIPMENT, CLASS 1 RAILROADS, 1960-69 Year Unserviceable freight cars as percent of total fleet Unserviceable locomotives as percent of total fleet Year Unserviceable freight cars as percent of total fleet Unserviceable locomotives as percent of total fleet 1960 1961 7.8 8.4 7.6 7.0 5.4 6.6 6.9 7.1 6.9 6.6 1965 1966. 5.1 4.4 4.6 4.8 4.9 6.0 6.2 1962 1963 1967 1968 6.7 5.9 1964 1969 6.3 Source: Moody's Transportation Manual. TABLE A-33.-AVERAGE FREIGHT TRAIN SPEED, CLASS I RAILROADS, 1960-70 Miles Miles per per Year hour Year hour 1960 19.5 1966 20.3 1961 19.9 1967 20.3 1962 20.0 1968 20.4 1963 20.1 1969 20.1 1964 20.2 1970 20.1 1965 20.1 •.. Source: ICC and AAR. TABLE A-34.- TIME AVERAGE LOCOMOTIVE SPENDS IN ROAD TRAINS,' CLASS I RAILROADS, 1960-69 (Hours; 1960 = 100) Hours per Hours per day in day in Year road train Index Year road train Index I960.. 7.34 100.0 1965 11.53 157.1 1961 7.38 100.5 1966. 11.40 155.3 1962 7.41 100.9 1967 10.80 147.1 1963 7.47 101.8 1968.. 10.76 146.6 1964 11.34 154.5 1969 10.80 147.1 1 Daily locomotive mileage times average freight train speed. Source: ICC and AAR. TABLE A-35.-PERCENTAGE SHARE OF TOTAL CLASS I RAIL TONNAGE (ORIGINATED AND RECEIVED) FOR SELECTED RAILROADS, 1961-70 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Penn Central' 12.6 Norfolk & Western 2 5.3 Southern Railway 3. 1 Illinois Central 3.0 Southern Pacific 4. 5 Union Pacific 2.6 12.8 12.6 12.5 12.6 12.2 12.1 11.0 11.3 5.3 3.2 3.1 4.4 2.5 5.4 3.3 3.2 4.4 2.5 ( 3 ) 3.3 3.0 4.3 2.5 6.6 3.5 6.4 3.5 3.0 4.6 2.6 6.3 3.7 3.1 4.4 2.6 6.4 4.0 3.1 4.7 2.6 6.4 4.1 3.1 4.9 2.7 10.8 6.3 4.1 3.3 4.8 2.8 1 1961-67 pro forma. ■ 1961-64 pro forma estimate. 3 Not available. Source: Moody's Transportation Manual. 451 52.1 51.1 52.6 53.2 52.9 51.7 62.0 63.0 62.0 41.6 43.0 ffl 45.1 47.2 50.7 51.9 51.4 54.3 57.5 57.3 58.6 58.1 58.8 61.1 59.7 59.4 57.8 58.2 58.0 56.7 53.4 55.4 55.9 59.1 56.5 56.7 62.3 61.0 60.8 60.7 62.4 60.0 61.0 63.4 63.7 62.8 63.1 63.3 62.6 60.3 60.6 59.9 58.8 57.2 64.6 65.9 68.2 68.9 71.2 72.3 ( 2 ) 74.1 75.1 59.1 44.5 ( 2 ) 60.0 59.5 60.5 62.0 63.5 63.7 70.6 70.2 70.0 69.2 69.2 67.3 62.3 61.9 63.8 65.2 65.3 66.8 63.2 67.0 69.6 69.9 71.0 74.4 75.5 73.4 74.9 76.4 79.8 80.2 80.2 80.3 81.1 46.7 46.8 46.1 45.9 47.4 49.1 47.9 49.2 49.2 TABLE A-36.-PERCENTAGE OF ORIGINATED TONNAGE TERMINATED, SELECTED RAILROADS, 1961-70 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Penn Central' 52.3 Norfolk & Western 2 41.2 Southern Railway. 57.1 Illinois Central 57.7 Southern Pacific 62.8 Union Pacific 62. 7 1 1961-67 pro forma. Source: Moody's Transportation Manual. • 1961-64 pro torma estimate. 3 Not available. TABLE A-37.-PERCENTAGE OF RECEIVED TONNAGE TERMINATED, SELECTED RAILROADS, 1961-70 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Penn Central ' 64.1 Norfolk & Western' 58.4 Southern Railway 71.0 Illinois Central 62. 1 Southern Pacific 70. 1 Union Pacific 44.4 1 1961-67 pro forma. 3 1961-64 pro forma estimate. 2 Not available. . .. . , _ Source: Moody s Transportation Manual. TABLE A-38.-PERCENTAGE OF TOTAL FREIGHT TERMINATED, SELECTED RAILROADS, 1961 AND 1970 1961 1970 Penn Central ' Norfolk & Western '.._ Southern Railway Illinois Central... Southern Pacific Union Pacific 1 1961 pro forma. Source: Moody's Transportation Manual. TABLE A-39.— TRAILER ON FLAT CAR CARLOADINGS AS A PERCENT OF TOTAL CARLOADINGS, CLASS I RAILROADS AND REGIONAL DISTRICTS, 1960-70 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Class I railroads 1.8 Eastern district 2. 2 Southern district. . 4 Western district. 2.1 Source: ICC and AAR. 59 69 46 57 64 61 60 61 66 62 55 59 2.1 2.5 2.8 3.1 3.5 3.9 4.3 4.7 4.8 4.7 2.7 3.2 3.4 3.8 4.2 4.6 4.9 5.4 5.2 5.0 .7 1.2 1.8 2.1 2.8 3.3 3.5 3.8 4.2 4.4 2.1 2.3 2.6 2.8 3.3 3.6 4.1 4.6 4.6 4.4 APPENDIX B Exhibit 1 Gross national product or expenditure in 1958 dollars, 1929-71 (Billions of 1958 dollarsi Year or quarter 1929. 1930. 1931. 1932. 1933. 1934. 1935. 1936. 1937. 1938. 1939. 1940.. 1941.. 1942.. 1943.. 1944.. 1945.. 1946.. 1947.. 1948.. 1949.. 1950.. 1951.. 1952.. 1953.. 1954.. 1955.. 1956.. 1957.. 1958.. 1959.. I960.... 1961.... 1962.... 1963.... 1964.... 1965.... 1966... 1967... 1968.... 1969.... 1970. 1971. Total gross na- tional prod- 203.6 183.5 169.3 144.2 141.5 154.3 169.5 193.0 203.2 192.9 209.4 227.2 263.7 297.8 337.1 361.3 355.2 312.6 309.9 323.7 324.1 355.3 381.4 395.1 412.8 407.0 438.0 446.1 452.5 447.3 475.9 487.7 497.2 529.8 551.0 581.1 617.8 658.1 675.2 706.6 724.7 720.0 739.5 Personal consumption expenditures Total 139.6 130.4 126.1 114.8 112.8 118.1 125.5 138.4 143.1 140.2 148.2 155.7 165.4 161.4 165.8 171.4 183.0 203.5 206.3 210.8 216.5 230.5 232.8 239.4 250.8 255.7 274.2 281.4 288.2 290.1 307.3 316.1 322 338.4 353.3 373.7 397.7 418.1 430.1 452.7 469.3 475.9 491.9 Dura- ble goods 16.3 12.9 11.2 8.4 8.3 9.4 11.7 14.5 15.1 12.2 14.5 16.7 19.1 11.7 10.2 9.4 10.6 20.5 24.7 26.3 28.4 34.7 31.5 30.8 35.3 35.4 43.2 41.0 41.5 37.9 43.7 44.9 43.9 49.2 53.7 59.0 66.6 71.7 72.9 81.3 84.8 81.4 89.3 Non- dura- ble goods 69.3 65.9 65.6 60.4 58.6 62.5 65.9 73.4 76.0 77.1 81.2 84.6 89.9 91.3 93.7 97.3 104.7 110.8 108.3 108.7 110.5 114.0 1'6.5 120.8 124.4 125.5 131.7 136.2 138.7 140.2 146.8 149.6 153.0 158.2 162? 170.3 178.6 187.0 190.2 197.1 202.7 Serv- ices 54.0 51.5 49.4 45.9 46.0 46.1 47.9 50.5 52.0 50.9 52.5 54.4 56.3 58.5 61.8 64.7 67.7 72.1 73.4 75.8 77.6 81.8 84.8 87.8 91.1 94.8 99.3 104.1 108.0 112.0 116.8 121.6 125.6 131.1 137.4 144.4 152.5 159.4 167.0 174.4 181.8 207.3 187.2 102.2 211.6 191.0 107.9 Gross private domestic investment Total 40.4 27.4 16.8 4.7 5.3 9.4 18.0 24.0 29.9 17.0 24.7 33.0 41.6 21.4 12.7 14.0 19.6 52.3 51.5 60.4 48.0 Fixed investment Total 69 70 60. 61. 59. 75. 74. 68. 60.9 73.6 72.4 69.0 79.4 82.5 87.8 99.2 109.3 101.2 105.2 109.6 36.9 28.0 19.2 10.9 9.7 12.1 15.6 20.9 24.5 19.4 23.5 28.1 32.0 17.3 12.9 15.9 22.6 42.3 51.7 55.9 51.9 61.0 59.0 57.2 60.2 61.4 69.0 69.5 67.6 62.4 68.8 68.9 67.0 73.4 76.7 81.9 90.1 95.4 93.5 98.8 103.2 99.9 105.9 Nonresidential Total 26.5 21.7 14.1 8.2 7.6 9.2 11.5 15.8 18.8 13.7 15.3 18.9 22.2 12.5 10.0 13.4 19.8 30.2 36.2 38.0 34.5 37.5 39.6 38.3 40.7 39.6 43.9 47.3 47.4 41.6 44.1 47.1 45.5 49.7 51.9 57.8 66.3 74.1 73.2 75.6 80.1 78.6 78.8 Struc- tures 13.9 11.8 7.5 4.4 3.3 3.6 4.0 5.4 7.1 5.6 5.9 6.8 8.1 4.6 2.9 3.8 5.7 12.5 11.6 12.3 11.9 12.7 14.1 13.7 14.9 15.2 16.2 18.5 18.2 16.6 16.2 17.4 17.4 17.9 17.9 19.1 22.3 24.0 22.6 23.4 24.5 24.2 22.4 Pro- ducers' durable equip- ment 12.6 9.9 6.6 3.8 4.3 5.6 7.5 10.3 11.8 8.1 9.4 12.1 14.2 7.9 7.2 9.6 14.1 17.7 24.6 25.7 22.6 24.8 25.5 24.6 25.8 24. S 27.7 28.8 29.1 25.0 27.9 29.6 28.1 31.7 34.0 38.7 44.0 50.1 50.6 52.2 55.7 54.4 56.5 Resi- dential struc- tures Seasonally adjusted annual rates 1970: 1 719.8 474.4 82.3 II.... 721.1 477.1 83.8 III.... 723.3 477.9 82.8 IV.... 715.9 474.2 76.6 1971: 1 729.7 484.8 85.9 II 735.8 489.4 87.8 III.... 740.7 494.3 91.2 IV»... 751.7 499.2 92.4 205.7 206.5 207.3 209.7 186.4 186.8 187.9 187.9 210.0 1188.9 211.5 ;i90.1 211.6 191.4 213.4 1193.4 10.4 6.3 5.1 2.7 2.1 2.9 4.0 5.1 5.6 5.7 8.2 9.2 9.8 4.9 2.9 2.5 2.8 12.1 15.4 17.9 17.4 23.5 19.5 18.9 19.6 21.7 25.1 22.2 20.2 20.8 24.7 21.9 21.6 23.8 24.8 24.2 23.8 21.3 20.4 23.2 23.1 21.3 27.0 Change in busi- ness inven- tories 3.5 -.6 -2.4 -6.2 -4.3 -2.7 2.4 3.1 5.5 -2.4 1.2 4.9 9.6 4.0 -.2 -1.9 -2.9 10.0 -.2 4.6 -3.9 8.3 10.9 3.3 .9 -2.0 6.4 4.8 1.2 -1.5 4.8 3.5 2.0 6.0 5.8 5.8 9.0 13.9 7.7 6.4 6.4 2.3 2.0 101.0 100.7 79.3 24.6 54.7 21.4 102.7 100.7 79.4 24.4 55.0 21.3 104.0 100.1 80.1 24.2 55.9 20.0 101.2 98.1 75.5 23.5 52.0 22.6 ! 104. 3 ! 101. 8 77.7 22.6 55.0 24.1 110.0 105.9 79.1 22.9 56.2 26.7 106.7 107.2 78.9 22.1 56.8 28.3 ill0.4 1108.6 79.6 21.8 57.8 28.9 0.3 2.0 3.9 3.1 2.5 4.1 -.5 1.9 See footnotes at end of table. Source: Council of Economic Advisers. Economic Report to the President, 1972, p. 196. (453) 454 Exhibit 2 INDEXES OF INTERCITY TON-MILES, INDUSTRIAL PRODUCTION, AND GROSS NATIONAL PRODUCT (LESS SERVICES], 1960-1970 Max 1917 = 100 110 j •*"">,*** Cross national product »^**i*a( (less services) \ J$ W 100 tatircity toi-niles // w 90 ^r s jr/ jf\ 80 J? «r )fc ^ / industrial production «■*" % »*** 70 y* *»•**** , , 1 1 1 1 Index 110 100 90 80 70 65 W0 1962 1964 19S6 1968 1970 1972 Soirees: Federal Reserve Beard, Office ef Business Economics, and Interstate Commerce Commission. Source: Interstate Commerce Commission, 85th Annual Report to Congress, 1971 , p. 139. 455 1939 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 Exhibit 3 Revenues of carriers and national income, 1939, 1959-1970 September-October 1971 Railroads - class I & II Class I, II and III Domestic scheduled air carrier Pipelines under I. C. C. Year Motor car- riers of Motor car- riers of National income property passengers operations jurisdiction (a) (b) (c) (d) (e) (f) millions millions millions millions millions billions 1939 $ 4,140.3 $ 792.2 ' $ 169.1 $ 55.9' $ 212.5 $ 72.6 1959 10,206.6 7,145.0 630.8 1,940. 8 3 765.2 400.0 1960 9,898.9 7,213.9 667.0 2,113.3 s 770.4 414.5 1961 9,540.3 7,462.7 689.5 2,245.5 786.7 427.3 1962 9,791.8 8,131.1 728.9 2,497.8 810.6 457.7 1963 9,921.5 8,548.3 758.9 2,722.5 840.3 481.9 1964 10,251.7 9,154.8 802.1 3,094.6 865.1 518.1 1965 10,702.3 10,068.2 885.1 3,608.5 903.8 564.3 1966 11,163.4 10,861.8 901.1 4,070.3 941.1 620.6 1967 10,848.7 11,308.4 945.3 4,886.6 994.5 653.6 1968 11,356.7 12,715.0 990.6 5,606.1 1,023.0 r 711.1 1969 11,951.0 13,944.0 1,007.0 6,857.0 1,103.3 r 763.7 1970p 12,500.0 14,400.0 1,037.0 Index 1967 = 7,130.7 100 1,188.0 795.9 1939 38.2 7.0 17.9 1.1 21.4 11.1 1959 94.1 63.2 66.7 39.7 76.9 61.2 1960 91.2 63.8 70.6 43.2 77.5 63.4 1961 87.9 66.0 72.9 46.0 79.1 65.4 1962 90.3 71.9 77.1 51.1 81.5 70.0 1963 91.5 75.6 80.3 55.7 84.5 73.7 1964 94.5 81.0 84.9 63.3 87.0 79.3 1965 98.7 89.0 93.6 73.8 90.9 86.3 1966 102.9 96.1 95.3 83.3 94.6 95.0 1967 100.0 100.0 100.0 100.0 ' 100.0 100.0 1968 104.7 112.4 104.8 114.7 102.9 108.8 1969 110.2 123.3 106.5 140.3 110.9 116.8 1970 115.2 127.3 109.7 145.9 119.5 121.8 5.7 2.6 2.4 2.2 2.1 2.1 2.0 1.9 1.8 1.7 1.6 1.6 1.6 Ratio to national income (100) 1.1 1.8 1.7 1.7 1.7 1.8 1.8 1.8 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.5 0.5 0.5 0.5 0.6 0.6 0.2 100 0.2 100 0.2 100 0.2 100 0.2 100 0.2 100 0.2 100 0.2 100 0.2 100 0.2 100 0.1 100 0.1 100 0.1 100 r Revised. p Preliminary. Current dollars. Includes all revisions through those reported in The Biennial Supplement to Survey of Current Business, 1967 and Survey of Current Business, August 1971. 3 Does not include Alaska and Hawaii. Source: (a), (b) , (c), and (e) , Interstate Commerce Commission data; (d) Federal Aviation Agency, Statistical Handbook of Aviation; and Department of Commerce, Survey of Current Business, September 1971. Source: Interstate Commerce Commission, Transport Economics, Sept. -Oct., 1971, p. 9. - 9 - 456 EXHIBIT 4 COMPARISON OF INDICES DEPICTING NATIONAL AND REGIONAL GROWTH PATTERNS WITH RAILROAD FREIGHT REVENUES GEN- ERATED BY THE PENNSYLVANIA AND NEW YORK CENTRAL RAILROADS 1954. 1955. 1956. 1957. 1958. 1959. 1960. 1961. 1962. 1963. 1964. 1965. 1966. 1967. 1968. 1969. Federal Re- Federal Re- serve Bank serve Bank of Boston GNP New York industrial industrial construct Pennsylvania Central production production 1958 dollars revenues revenues New Haven 85.8 91 91 90.9 98.0 99.8 96.6 98 98 104.0 109.1 198.1 99.9 102 100 111.0 112.2 110.9 100.7 100 101 110.8 107.7 110.7 93.7 93 100 91.9 93.2 95.2 105.6 107 106 97.4 99.1 94.1 108.7 109 109 92.3 97.0 85.9 109.7 112 HI 88.9 87.9 81.3 118.3 118 118 94.0 90.7 81.4 124.3 119 123 93.0 91.0 " 76.8 132.3 124 130 97.9 94.9 77.1 143.4 134 138 101.8 99.4 77.6 156.3 146 147 104.1 101.5 80.2 158.1 147 151 101.7 98.2 75.1 165.5 147 158 103.2... 77.2 172.8 147 163 110.8... Source: Columns 1 and 5— Selected issues of the Federal Reserve Bulletin. Column 2— Production Indices Supplied bytheFedera Reserve Bank of Boston. Columns 6, 7, and 8— pt. 1, Transport Statistics in the United States, ICC. EXHIBIT 5 TREND IN TONNAGE ORIGINATED-MANUFACTURES AND MISCELLANEOUS' 11 n thousands] EXHIBIT 6 INDEX OF TONNAGE ORIGINATED-MANUFACTURES AND MISCELLANEOUS' [1951-63 index (1957-59); 1965-70 index (1967)1 Total Eastern class I district railroads railroads New York Pennsyl- Central vania New Haven Total Eastern class I district railroads railroads New York Central Pennsyl- vania New Haven 1951.. 400,857 219, 561 30,870 49, 297 4,436 1952 . . 378, 927 198, 042 27, 992 42, 776 4,368 1953.. 389, 633 210,043 28,705 44, 488 4,683 1954.. 341,716 172,397 24, 797 34, 767 3,751 1955 __ 392, 592 207,068 29, 537 44, 190 4,085 1956.. 400,197 209, 678 28, 833 44, 571 4,121 1957.. 374, 332 193,711 26, 788 40, 140 3,647 1958.. 322,618 149, 265 21,960 29, 514 3,058 1959.. 354, 604 167,577 24, 151 34,675 3,420 1960.. 344, 284 161,914 23, 136 32, 699 3,100 1961 . . 332, 655 149, 774 21,534 30,927 2,881 1962 . . 349, 060 159,821 23, 948 33,081 2,721 1963.. 368,020 169, 564 25, 424 35, 644 2,654 1964.. 662, 328 259,601 ( 2 ) P) 1965.. 685, 987 272, 783 64, 335 97, 468 4,353 1966.. 703,999 274, 570 62, 828 99, 964 4,524 1967.. 697, 630 262,345 59,217 93, 440 3,670 1968.. 724, 942 273, 183 146, 294 1969.. 743, 098 274,707 153,314 1970.. 716, 103 256, 797 142, 537 114.4 129.0 127.0 141.8 131.4 108.1 116.4 115.2 123.0 130.0 111.2 123.4 118.1 127.9 138.8 97.5 101.3 102.0 100.0 111.1 112.0 121.7 121.6 127.1 121.0 114.2 123.2 118.7 128.2 122.1 106.8 113.8 110.2 115.4 108.1 92.0 87.7 90.4 84.9 90.6 101.2 98.5 99.4 99.7 101.3 98.2 95.1 95.2 94.0 91.9 94.9 88.0 88.6 88.9 85.4 99.6 93.9 98.6 95.1 80.6 105.0 99.6 104.6 102.5 78.6 94.9 99.0 ... 98.3 104.0 108.6 104.3 118.6 100.9 104.7 106.1 107.0 123.3 100.0 100.0 100.0 100.0 100.0 103.9 104.1 93.6 106.5 104.7 98.1 102.6 97.9 91.2 ' There are 2 separate trends (1951-63 and 1965-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region included in Eastern region so that data are comparable. 2 Individual reports are confidential for 1984. Source: 1951-63 manufactures and miscellaneous; 1965-70 includes all categories of traffic. 457 EXHIBIT 7 EXHIBIT 8 TRENDS IN TONNAGE TERMINATED-MANUFACTURES AND MISCELLANEOUS ' [in thousands) INDEX OF TONNAGE TERMINATED-MANUFACTURES AND MISCELLANEOUS! 11951-63, Index (1957-59); 1964-70, Index (1967)1 Total Eastern New Total Eastern New class 1 district York Penn- New class 1 district York Penn- New railroads railroads Central sylvania Haven railroads railroads Central sylvania Haven 1951.. 406, 388 213,661 30, 541 48, 610 9,405 114.0 126.3 126.1 139.5 112.0 1952.. 385,241 193,977 27, 085 43,281 9,030 108.1 114.6 111.8 124.2 107.5 1953.. 395,454 203, 792 28, 665 44, 387 9,723 111.0 120.4 118.3 127.4 115.8 1954.. 348, 659 169,759 24, 603 33, 739 8,598 97.8 100.3 101.6 96.9 102.4 1955.. 400, 364 205, 098 29, 609 43,345 9,611 112.3 121.2 122.2 124.4 114.4 1956.. 407, 760 207,715 28, 592 44, 034 9,896 114.4 122.7 118.0 126.4 117.8 1957.. 380, 598 190,924 26, 084 39, 464 9,346 106.8 112.8 107.7 113.3 111.3 1958.. 328,214 149,372 21,579 30, 078 7,908 92.1 88.2 89.1 86.3 94.2 1959.. 360, 427 167,550 25,019 34, 965 7,942 101.1 99.0 103.3 100.4 94.6 I960.. 350, 686 161,585 24, 271 32,635 7,310 98.4 95.4 100.2 93.7 87.0 1961.. 339, 608 150, 245 22, 193 31,176 7,179 95.3 88.8 91.6 89.5 85.5 1962.. 357, 420 160,434 25,011 33, 883 7,343 100.3 94.8 103.2 97.3 87.4 1963.. 375. 989 169,180 25,884 36, 260 7,376 105.5 99.9 106.8 104.1 87.8 1964 676, 107 272.478 ( 2 ) ( J ) ( 2 ) 95.3 98.1 . 1965.. 700, 122 287, 725 83,174 111,833 14,478 98.7 103.6 99.1 102.1 107.5 1966.. 715,817 289, 987 83, 584 116,346 14,704 100.9 104.4 99.6 106.3 109.2 1967.. 709, 297 277, 636 83, 898 109, 449 13,467 100.0 100.0 100.0 100.0 100.0 1968.. 741, 106 293, 048 190,916 104.5 105.6 92.3 1969.. 759, 647 296, 970 205, 373 107.1 107.0 99.3 1970.. 732, 252 281,123 192,025 103.2 101.3 92.8 i There are 2 separate trends (1951-63 and 1965-70) since the classification was revised in 1965. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region is included in eastern region so that data are comparable. 2 Individual reports are confidential for 1964. Source: 1951-63 manufactures and miscellaneous; 1965-70 includes all categories of traffic (products of forests, mines, etc.). EXHIBIT 9 TRENDS IN REVENUES-MANUFACTURES AND MISCELLANEOUS' [In thousands] EXHIBIT 10 INDEX OF REVENUES-MANUFACTURES AND MISCELLANEOUS' [1951-63 Index (1957-69); 1965-70 Index (1969)| Total Eastern class I district railroads railroads New York Pennsyl- Central vania New Haven Total Eastern class I district railroads railroads New York Central Pennsyl- vania New Haven 1951. . 4, 199, 573 1,803,448 317,458 415, 137 56, 560 1952. . 4,273,019 1,777,419 308, 027 406, 886 57, 506 1953. . 4,529,620 1,899,843 330, 939 426, 526 61,063 1954. . 3,808,064 1,551,575 273, 708 327, 579 50,914 1955. . 4,219,745 1,766,233 311,493 379, 156 55, 925 1956. . 4,353,051 1.827,509 308, 923 395, 029 59, 326 195/. . 4,383,839 1,840,016 305,718 398, 261 59, 385 1958. . 3,888,888 1,519,113 256, 747 325, 046 50, 401 1959. . 4,160,507 1,651,369 284, 361 367, 090 50,914 1960. . 4,016,056 1,588,396 279, 468 343, 107 46, 573 1961. . 3,928,368 1,491,298 253, 623 333, 287 44, 542 1962. . 4,171,339 1,600,621 275, 162 362,115 45,051 1963. . 4, 295, 581 1,644,660 282, 485 372,397 43, 630 1964. . 5,779,327 2, 185, 134 ( 2 ) ( 2 ) ( 2 ) 1964. . 6,144,301 1,917,889 554, 008 735,361 67,713 1966. . 6,457,856 1,300,825 567, 987 748, 734 70, 280 196/. . 6,435,454 940, 448 552, 969 723, 394 65, 709 1968. . 7,090,419 854, 921 1,323,388 1969. . 7,640,910 585, 955 1,447,817 19/0. . 7,739,328 321,266 1,47! 1,135 101.3 108.0 112.5 114.2 105.6 103.1 106.4 109.1 111.9 107.4 109.3 113.8 117.2 117.3 114.0 91.9 92.9 97.0 90.1 95.0 101.8 105.8 110.4 104.3 104.4 105.0 109.4 109.4 108.7 110.8 105.8 110.2 108.3 109.6 110.9 93.8 91.0 91.0 89.4 94.1 100.4 98.9 100.7 101.0 95.0 96.9 95.1 99.0 94.4 86.9 94.8 89.3 89.8 91.7 83.2 100.6 95.8 97.5 99.6 84.1 103.6 98.5 100.1 102.5 81.4 89.8 232.4 ... 95.5 203.9 100.2 101.7 103.0 100.3 138.3 102.7 103.5 107.0 100.0 100.0 100.0 100.0 100.0 110.2 90.9 98.6 118.7 62.3 107.9 120.3 34.2 110.1 ' There are 2 separate trends (1951-63 and 1965-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region is included in eastern region so that data are comparable. 2 Individual reports are confidential for 1964. Source: 1951-63 manufactures and miscellaneous; 1965-70 includes all categories of traffic. 458 EXHIBIT 11 TREND IN TONNAGE ORIGINATED-PRODUCTS OF MINES' [In thousands] EXHIBIT 12 INDEX OF TONNAGE ORIGINATED-PRODUCTS OF MINES I 11951-63 Index (1957-59); 1964 70 Index (1967)| Total Eastern class I district New York Pennsyl- New railroads railroads Central vania Haven 1951.. 819,373 434, 330 29, 001 59, 301 1,088 1952.. 752, 699 389,012 27, 970 52, 295 1,115 1953.. 754, 293 375, 244 28, 152 51,885 1,222 1954.. 650, 072 320,431 25,919 42, 736 926 1955.. 761,993 378, 322 29, 879 51,034 1,137 1956.. 796, 480 406, 738 34, 596 54,710 1,425 1957.. 769, 675 392, 712 31,075 53, 852 1,974 1958.. 628,911 309, 059 25, 300 43, 920 1,199 1959.. 632,870 313,720 26,958 45,134 1,045 I960.. 649, 227 309, 101 28, 754 43,673 987 1961.. 615,646 294, 350 27,210 38, 777 960 1962.. 634, 747 307, 688 28, 207 43,312 1,219 1963.. 662, 402 325, 202 29,535 44, 140 1,527 1964.. 475, 167 280, 448 ( J ) ( J ) < 2 ) 1965.. 482, 678 280, 660 21,789 40,131 281 1966.. 506, 487 285, 028 20,427 42,943 338 1967. . 494, 682 281,602 18,907 40, 646 216 1968.. 491,863 278, 160 53, 364 1969.. 510,692 277,240 56,915 1970.. 532,190 281,218 54, 427 Total Eastern class I district railroads railroads New York Central Pennsyl- vania New Haven 121.0 128.3 104.5 124.5 77.4 111.2 114.9 100.7 109.8 79.3 111.4 110.9 101.4 108.9 86.9 96.0 94.7 93.3 89.7 65.9 112.5 111.8 107.6 107.1 80.9 117.6 120.2 124.5 114.9 101.4 113.7 116.0 111.9 113.1 140.4 92.9 91.3 91.1 92.2 85.3 93.5 92.7 97.1 94.8 74.3 95.9 91.3 103.5 91.7 70.2 90.9 87.0 98.0 81.4 68.3 93.7 90.9 101.5 90.9 86.7 97.8 96.1 106.3 92.7 108.6 96.1 99.6 ... 97.6 99.7 115.2 98.7 130.1 102.4 101.2 108.0 105.7 156.5 100.0 100.0 100.0 100.0 100.0 99.4 98.8 89.3 103.2 98.5 95.2 107.6 99.9 91.1 • There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region is included in Eastern region so that data are comparable. 2 Individual reports are confidential for 1964. Source: Years 1951-63 "Products of Mines;" years 1965-70 "Nonmetallic Minerals, Coal and Petroleum and Petroleum Products," Freight Commodity Statistics, ICC. EXHIBIT 13 TREND IN TONNAGE TERMINATED— PRODUCTS OF MINES' [In thousands! EXHIBIT 14 INDEX OF TONNAGE TERMINATED-PRODUCT OF MINES' 11951-63 Index (1957-59); 1964-70 Index (1967)| Eastern Total Class District New York Pennsyl- I Railroads Railroads Central vania New Haven 1951 . . 698, 098 437,499 57, 120 80,909 5,589 1952.. 649, 235 390, 156 53, 685 71,909 4,913 1953.. 641,302 388,613 53.308 73,810 4,024 1954.. 562,203 316,979 42, 523 57, 253 3,855 1955.. 652,415 386, 854 47,497 70,247 4,047 1956.. 701,876 413,449 52, 828 70, 988 4,658 1957 . . 670, 646 401,862 46, 436 68, 777 5,224 1958.. 562, 480 307,700 37,758 49, 550 4,444 1959 . . 571,063 305,446 41,292 52, 507 4,246 I960.. 581, 204 315,551 41,449 52, 356 3,967 1961 . . 554,206 288, 102 36, 631 47, 720 4,094 1962.. 575, 336 302, 190 38, 054 49, 626 4,060 1963.. 596, 747 312,207 40,161 52, 220 3,993 1964.. 404,942 259, 988 O) ( 2 ) ( ! ) 1965.. 409, 787 265,631 35, 941 45,613 2,327 1966.. 433, 926 272,547 36, 063 48, 200 2,360 1967.. 434, 797 275,581 37, 553 46, 038 1,821 1968.. 421,856 262, 526 80, 556 1969.. 445,211 276, 278 82,412 1970.. 468, 535 275,477 77, 848 Total Class I Railroads Eastern District Railroads New York Central Pennsyl- vania New Haven 116.1 129.3 136.6 142.1 120.5 108.0 115.3 128.3 126.3 105.9 106.6 114.9 127.4 129.6 86.8 93.5 93.7 101.7 100.5 83.1 108.5 114.3 113.6 123.4 87.3 116.7 122.2 126.3 124.7 100.4 111.5 118.8 111.0 120.8 112.6 93.5 90.9 90.3 87.0 95.8 95.0 90.3 98.7 92.2 91.5 96.6 93.3 99.1 91.9 85.5 92.2 85.2 87.6 83.8 88.3 95.7 89.3 91.0 87.1 87.5 99.2 92.3 96.0 91.7 86.1 93.1 94.3 94.2 96.4 95.7 99.1 127.8 99.8 98.9 96.0 104.7 129.6 100.0 100.0 100.0 100.0 100.0 97.0 95.3 94.3 102.4 100.3 96.5 107.8 100.0 91.1 ' There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region included in Eastern region so that data are comparable. 2 Individual reports are confidential for 1964. Source: Years 1951-63 "Products of Mines;" Years 1965-70 "Nonmetallic Minerals, Coal and Petroleum and Petroleum Products," Freight Commodity Statistics, ICC. 459 EXHIBIT 15 TREND IN REVENUES-PRODUCT OF MINES' |ln thousands] EXHIBIT 16 INDEX OF REVENUES-PRODUCTS OF MINES' [1951-63 Index (1957-59); 1964-70 Index (1967 = 100)1 Total Eastern New Total Eastern Class 1 District York Pennsyl- New Class 1 District New York Pennsyl- New Railroads Railroad Central vania Haven Railroads Railroads Central vania Haven 1951 2, 236, 103 1,413,372 249, 202 12,814 105.6 109.0 112.2 114.2 1952 2, 184, 694 1,343,945 164,991 237, 807 12, 086 103.2 103.7 110.8 107.1 107.7 1953 2, 158, 693 1,312,086 166, 253 240, 230 10,472 101.9 101.2 111.7 108.2 93.3 1954 1,830,297 1,081,246 136, 279 187,618 9,544 86.4 83.4 91.5 84.5 85.1 1955 2,121,426 1,297,971 150,609 222, 571 9,848 100.2 100.1 101.2 100.2 87.8 1956 2, 358, 261 1,470,676 167, 381 251,902 11,116 111.4 113.5 112.4 113.4 99.1 1957 2, 390, 167 1, 503, 788 160, 268 258, 474 12,126 112.9 116.0 107.7 116.4 108.1 1958 1,985,404 1,199,656 139, 157 203, 178 10, 884 93.7 92.5 93.5 91.5 97.0 1959 1,977,773 1,185,464 147, 155 204, 562 10, 644 93.4 91.4 98.9 92.1 95.1 1960 1,969,462 1,179,853 146, 902 202, 545 9,751 92.3 91.0 98.7 91.2 86.9 1961 1,862,965 1,101,026 136,022 189, 829 9,932 88.0 84.9 91.4 85.5 88.5 1962 1,915,488 1,142,083 139, 084 199, 113 10,111 90.4 88.1 93.4 89.7 90.1 1963 1,966,288 1, 167, 305 137,452 194, 401 9,003 92.8 90.0 92.3 87.5 80.3 1964 1,404,765 982, 102 ( 2 ) 160, 272 ( 2 ) 97.6 99.0 . 1965 1,433,227 1, 000, 140 111,523 4,062 99.6 100.9 . 1986 1,454,023 996, 825 106, 173 161,658 4,059 101.0 100.5 . 1697 1,439,401 991, 586 103, 796 156 662 3,438 100.0 100.0 1968 1,435,222 983, 828 248, 908 99.7 99.2 94.3 1969 1,519,412 1,019,133 271,480 105.6 102.8 102.9 1970 1,719,533 1,132,422 289, 104 119.5 114.2 109.6 ' There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region included in Eastern region. > Individual reports are confidential of 1964. Source: Yearsl951-63 "Products of Mines;" years 1965-70 "Farm Products" less "Livestock and Livestock Products" and "Poul- try and Poultry Products." Freight Commodity Statistics, ICC. EXHIBIT 17 TREND IN TONNAGE ORIGINATED-PRODUCTS OF FORESTS' [In thousands] EXHIBIT 18 INDEX OF TONNAGE ORIGINATED-PRODUCTS OF FORESTS' [1951-63 Index (1957-59); 1964-70 Index (1967)| Eastern New Eastern New Total Class District York Pennsyl- New Total Class District York Pennsyl- New 1 Railroads Railroads Central vania Haven 1 Railroads Railroads Central vania Haven 1951. _ 86, 521 7,131 496 640 41 112.3 142.3 156.5 127.0 256.3 1952.. 83, 480 6,305 433 523 25 108.3 125.8 136.6 103.8 156.3 1953.. 82, 107 6,005 436 463 30 106.5 119.8 137.5 91.9 187.5 1954.. 75, 650 5,137 343 412 25 98.2 102.5 108.2 81.7 156.3 1955.. 82, 585 5,977 388 489 22 107.2 119.3 122.4 97.0 137.5 1956.. 87, 799 6,517 425 617 21 113.9 130.0 134.1 122.4 131.3 1957.. 77,498 5,493 332 559 20 IOC. 6 109. 6 104.7 110.9 125.0 1958.. 73, 287 4,485 286 447 11 95.1 89.5 90.2 88.7 68.8 1959.. 80,397 5,058 335 508 17 104.3 100.9 105.7 100.8 106.3 I960.. 79,211 5,521 371 534 15 102.8 110.2 117.0 106.0 93.8 1961.. 74,924 4,747 279 484 14 97.2 94.7 88.0 96.0 87.5 1962. _ 78, 104 4,971 314 520 14 101.4 99.2 99.1 103.2 87.5 1963.. 78, 222 5,132 309 606 K 19 101.5 102.4 97.5 120.2 118.8 1964.. 86, 071 6,106 o 789 8 92.9 79.0 .. 1965.. 88, 597 6,957 476 95.6 90.0 100.4 93.0 81.0 1966.. 94, 255 7,598 509 826 72 101.7 98.3 107.4 97.4 91.1 1967.. 92, 638 7,732 474 848 79 100.0 100.0 100.0 100. 100.0 1968.. 98, 877 7,453 1,268 106.7 96.4 90.5 1969.. 100,631 7,122 1,195 108.6 92.1 85.3 1970.. 102, 553 6,904 934 110.7 89.3 66.7 > There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Priortothattime the classification was based on product consumption. Subsequent data are based on production. Pocahontas region is included in Eastern region so that data are comparable. 2 Individual reports are confidential for 1964. Source: Years 1951-63 "Products of Forests"; Years 1965-70 "Forest Products" and "Lumber and Wood Products except Furniture." Freight Commodity Statistics, ICC. 74-924 O - 73 - 31 460 EXHIBIT 19 TREND IN TONNAGE TERMINATEO-PRODUCTS OF FORESTS' [In Ihousandsl EXHIBIT 20 INDEX OF TONNAGE TERMINATED-PRODUCTS OF FORESTS' 11951-63 Index (1957-59); 1964-70 Index (1967 = 100)1 Total Eastern Total Eastern class 1 district New York Pennsyl- New class 1 district New York Pennsyl- New railroads railroads Central vania Haven railroads railroads Central vania Haven 1951.. 92, 541 21,514 3,297 3,382 948 113.9 142.8 144.7 141.2 136.4 1952.. 88, 482 19, 335 2,878 2,977 928 108.9 128.3 126.3 124.2 133.5 1953.. 86,414 18,080 2,715 2,754 784 106.4 120.0 119.2 114.9 112.8 1954.. 79, 955 16,555 2,497 2,516 751 98.4 109.9 109.6 105.0 108.1 1955.. 87, 696 19,219 2,824 2,871 859 108.0 127.6 124.0 119.8 123.6 1956.. 91,943 19,475 2,315 2,952 859 113.2 129.3 123.6 123.2 123.6 1957.. 81,332 16,415 2,403 2,641 745 100.1 109.0 105.5 110.2 107.2 1958.. 77, 384 13,806 2,129 2,159 637 95.3 91.6 93.5 90.1 91.7 1959.. 84, 938 14, 976 2,303 2,389 703 104.6 99.4 101.1 99.7 101.2 I960.. 84, 055 14,872 2,219 2,281 749 103.5 98.7 97.4 95.2 107.8 1961.. 80, 009 13,544 1,980 2,164 721 98.5 89.9 86.9 90.3 103.7 1962.. 84,091 14, 782 2,155 2,279 789 103.5 98.1 94.6 95.1 113.5 1963.. 85, 169 15,165 2,134 2,492 801 104.9 100.7 93.7 104.0 115.3 1964.. 90, 538 91,490 16, 658 17, 702 ( J ) 2,412 2,723 999 93.7 94.7 92.6 98.4 1965.. 100.4 104.2 110.9 1966.. 97,718 18,312 2,426 2,735 963 101.0 101.8 101.0 104.7 106.9 1967.. 96, 652 17,992 2,402 2,612 901 100.0 100.0 100.0 100.0 100.0 1968.. 104,570 18,475 5,137 108.2 102.7 86.8 1969.. 106,587 17, 552 5,777 110.3 97.6 97.7 1970.. 107, 889 16,890 5,206 111.6 93.9 88.0 ' There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region is included in eastern region so that data are comparable and confidential. 2 Fundamental reports are confidential for 1964. Source: Years 1951-63 "Products of Forests"; Years 1964-70 "Forest Products" and "Lumberand Wood Products Except Furniture"; Freight Commodity Statistics, ICC. EXHIBIT 21 TREND IN REVENUES-PRODUCTS OF FORESTS' EXHIBIT 22 .. INDEX OF REVENUES— PRODUCTS OF FORESTS' (1951-63 Index (1957-59); 1964-70 Index (1967)| Total Eastern class I district railroads railroads New York Central Pennsyl- vania 1951.. 621,702 114,280 . 1952.. 656, 495 110,177 16,376 i 1953.. 654, 745 106,357 15,859 ; 1954.. 627, 755 97, 582 14,685 ) 1955.. 686, 821 110,903 16,899 ; 1956.. 696, 718 113,938 17,089 ; 1957.. 654, 214 102, 789 15,587 1 1958.. 646, 069 90, 969 14,263 ] 1959.. 707, 958 98, 869 15, 170 1 I960... 650, 722 93, 734 14, 396 1 1961.. 627, 587 86, 787 13, 192 1 1962.. 647, 233 92, 175 13, 580 1 1963.. 660, 993 93, 705 13,458 ] 1964.. 731,403 106, 601 < 2 ) 1965.. 747, 699 114,004 16,877 i 1966.. 760, 662 119,007 17,469 i 1967.. 739, 638 112,586 15,975 i 1968.. 824, 885 121,365 39,135 1969.. 817,317 120,329 41,612 1970.. 845, 730 122, 264 41,532 New Haven 23,216 3,847 21,942 3,448 20, 558 3,063 18,692 2,771 20, 939 3,093 21, 149 3,141 19, 305 2,878 16,941 2,527 18,384 2,834 16, 763 2,903 16, 193 2,810 17,375 2,906 17,948 2,885 21,290 ( ! ) 3,717 21,203 3,634 20, 073 3,412 Total Eastern class I district railroads railroads New York Central Pennsyl- vania New Haven 92.9 117.2 ... 127.5 120.5 127.0 98.1 113.0 109.1 125.6 97.8 109.0 105.7 112.9 111.5 93.8 100.0 97.9 102.6 100.9 102.6 113.7 112.6 115.0 112.6 104.1 116.8 113.9 116.1 114.4 97.7 105.4 103.9 106.0 104.8 96.5 93.3 95.0 93.0 92.0 105.8 101.4 101.1 101.0 103.2 97.2 96.1 95.9 92.1 105.7 93.8 89.0 87.9 88.9 102.3 96.7 94.5 90.5 95.4 105.8 98.7 96.1 89.7 98.6 105.1 98.9 94.7 ... 101.1 101.3 105.6 106.1 108.9 102.8 105.7 109.4 105.6 106.5 100.0 100.0 100.0 100.0 100.0 111.5 107.8 99.2 110.5 106.9 105.5 114.3 108.6 105.3 ' There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region has been included in eastern region so that data aie comparable. ■ Individual reports are confidential for 1964. Source: Years 1951-63 "Products of Forests"; Years 1965-70 "Forest Products" and "Lumber and Wood Products except Furniture" Freight Commodity Statistics, ICC. 461 EXHIBIT 23 TREND IN TONNAGE ORIGINATED— LCD (In thousands] EXHIBIT 24 INDEX OF TONNAGE ORIGINATED— LCL ' [1951-63 Index (1957-59 = 100); 1964-70 Index (1967)] Eastern Eastern Total class district New York Pennsyl- New Total class district New York Pennsyl- New 1 railroads railroads Central ' uania Haven 1 railroads railroads Central vania Haven 1951 10, 379 5,365 1,026 1 ,448 348 226.2 255.0 280.3 277.9 287.6 195? 9,310 4,572 868 1 ,201 299 202.9 217.3 237.2 230.5 183.4 1953.. 8,255 4,040 769 992 268 179.9 192.0 210.1 190.4 164.4 1954.. 6,964 3,155 605 752 206 151.8 150.0 165.3 144.3 126.4 1955.. 5,227 3,270 622 797 244 113.9 155.4 169.9 153.0 149.7 1956 6,485 3,068 575 777 182 141.3 145.8 157.1 149.1 150.4 1957.. 5,443 2,607 480 664 152 118.6 123.9 130.8 127.4 125.6 1958.. 4,402 1,959 338 482 111 95.9 93.1 92.3 92.5 68.1 1959 3,923 1,748 282 418 101 85.5 83.1 77.0 80.2 62.0 I960.. 3,213 1,361 221 329 79 70.0 64.7 60.4 63.1 48.5 1961.. 2,586 968 153 218 51 56.4 46.0 41.8 41.8 31.3 1962.. 2,183 643 HI 95 35 47.6 30.6 30.3 18.2 21.5 1963 1,678 351 30 22 23 36.6 16.7 8.2 4.2 14.1 1964 1,496 1,333 162 98 ( 2 ) 8 ( « 4 155.8 138.9 213.2 128.9 1965.. 400.0 100.0 133.3 1966.. 1,049 83 3 6 3 109.3 109.2 150.0 75.0 100.0 1967 960 76 2 8 3 100.0 100.0 100.0 100.0 100.0 1968. . 867 77 13 90.3 101.3 100.0 1969 837 74 19 87.2 97.4 146.2 1970.. 809 64 17 84.3 84.2 130.8 > There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region is included in Eastern region so that data are comparable. 2 Individual reports are confidential for 1964. Source: Years 1951-63 "ICC", years 1964-70 "Small Packaged Products"; Freight Commodity Statistics, ICC. EXHIBIT 25 EXHIBIT 26 TREND If 1 TONNAGE TERMINATED [In thousands! -LCLi INDEX OF TONNAGE TERMINATED— LCL > [1951-63 index (1957-59); 196470 index (1967)] Eastern New Eastern Total class district York Pennsyl- New Total class district New York Pennsyl- New 1 railroads railroads Central vania Haven 1 railroads railroads Central vania Haven 1951.. 9, 900 4,403 826 1,085 257 230.7 270.6 282.9 278.2 110.8 1952. 8, 909 3,727 702 889 207 207.6 229.1 240.4 227.9 89.2 1953.. 7,757 3,260 610 758 185 180.8 200.4 208.9 194.4 79.7 1954.. 6, 489 2,545 479 574 135 151.2 156.4 164.0 147.2 58.2 1955. 6,612 2,630 492 607 175 154.1 161.6 168.5 155.6 75.4 1956.. 6,053 2,425 459 583 122 141.1 149.0 157.2 149.5 52.6 1957.. 5, 104 2,042 381 494 100 118.9 125.5 130.5 126.7 411 1958.. 4,119 1,508 273 366 73 96.0 92.7 93.5 93.8 31.5 1959.. 3,652 1,332 222 311 59 85.1 81.9 76.0 79.7 25.4 I960.. 3, 005 1,040 177 245 47 70.0 63.9 60.6 62.8 20.3 1961.. 2,423 711 126 153 35 56.5 43.7 43.2 39.2 15.1 1962.. 2,034 456 86 51 23 47.4 28.0 29.5 13.1 9.9 1963.. 1,626 239 22 10 13 37.9 14.7 7.5 2.6 5.6 1964.. 1,470 1,341 111 73 °l 1 1 150.3 137.1 226.5 149.0 1965.. 300.0 75.0 100.0 1966.. 1,065 57 4 6 3 108.9 116.3 133.3 75.0 100.0 1967.. 978 49 3 8 3 100.0 100.0 100.0 100.0 100.0 1968.. 867 55 14 88.7 112.2 100.0 1969.. 870 65 21 89.0 132.7 150.0 1970.. 843 55 19 86.2 112.2 135.7 ■There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classi- fication was based on product consumption. Subsequent data are based on production. Pocahontas region is incloded in eastern region so that data are comparable. > Individual reports are confidential for 1964. Source: Years 1951-63 "LCL", years 1964-70 "Small Packaged Products"; Freight Commodity Statistics, ICC. 462 EXHIBIT 27 TREND IN REVENUES-LCL' Total class I railroads Eastern district New York railroads Central Pennsyl- vania New Haven 1951.. 351,432 171,654 35, 043 47, 554 9,085 1952.. 351,574 166, 175 33, 808 45, 233 8,472 1953.. 321, 198 153,152 31,953 39,731 7,960 1954.. 273, 541 123, 195 25, 773 31, 563 6,077 1955.. 201,590 126, 105 26,018 32, 529 7,146 1956.. 272, 314 123,550 25, 199 32, 856 5,676 1957.. 252, 045 114,919 22, 854 30, 894 5,132 1958.. 212,391 90, 667 17,264 24, 164 3,966 1959.. 183,927 77, 992 14, 137 20, 933 3,307 1960. . 152,891 63, 890 11,405 16,502 2,697 1961.. 125, 133 46, 874 8,167 11,542 1,915 1962. . 99, 663 30, 929 6,007 5,124 1,249 1963.. 74, 856 16,917 2,112 1,054 743 1964.. 60, 965 7,665 0) (*) ( 2 ) 1965.. 51,255 4,265 285 430 130 1966.. 40,071 3,721 160 391 121 1967.. 38, 190 3,297 116 398 110 1968. . 34, 963 3,438 581 1969. . 35, 020 3,299 714 1970.. 36, 488 3,062 669 Total class I railroads EXHIBIT 28 INDEX OF REVENUES-LCL i Eastern district railroads New York Central Pennsyl- vania New Haven 162.6 181.6 193.8 187.7 219.7 162.7 175.8 186.9 178.6 204.9 148.6 162.0 176.7 156.9 192.5 126.6 130.3 142.5 124.6 147.0 93.3 133.4 143.9 128.4 172.8 126.0 130.7 139.3 129.7 137.3 116.6 121.6 126.4 122.0 124.1 98.3 95.9 95.5 95.4 95.9 85.1 82.5 78.2 82.6 80.0 70.7 67.6 63.1 65.1 65.2 57.9 49.6 45.2 45.6 46.3 46.1 32.7 33.2 20.2 30.2 34.6 17.9 11.7 4.2 18.0 159.6 232.5 ... 134.2 129.4 245.7 108.0 118.2 104.9 112.9 137.9 98.2 110.0 100.0 100.0 100.0 100.0 100.0 91.6 104.3 93.1 91.7 100.1 114.4 95.5 92.9 107.2 1 There are two separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. 2 Individual reports are confidential for 1964. Source: Years 1951-63 "ICC;" Years 1964-70 "Small Packaged Products"; Freight Commodity Statistics, ICC. EXHIBIT 29 TREND IN TONNAGE ORIGINATED— PRODUCTS OF AGRICULTURE' EXHIBIT 30 INDEX OF TONNAGE ORIGINATED-PRODUCTS OF AGRICULTURE' [In Thousands] [1951-63 Index (1957-59); 1964-70 Index (1967)| Total Eastern New Total Eastern New class 1 district York Pennsyl- New class 1 district York Pennsyl- New railroads railroads Central vama Haven railroads railroads Central vania Haven 1951.. 140,810 26, 770 6,523 5,347 189 98.3 93.4 93.3 101.5 196.9 1952.. 138,416 27, 834 6,694 5,610 181 96.6 97.7 95.8 106.5 188.5 1953.. 131,137 28, 628 7,056 5,886 136 91.5 100.5 100.9 111.8 141.7 1954.. 131,736 28, 277 7,165 5,534 105 91.9 99.2 102.5 105.1 109.4 1955.. 133,790 30, 657 7,575 6,254 111 93.4 107.6 108.4 118.4 115.6 1956.. 138,093 32,437 7,895 6,414 102 96.4 113.8 112.9 121.8 106.3 1957.. 137,618 29, 135 7,262 5,635 107 96.0 102.3 103.9 107.0 111.5 1958. . 146, 746 28,012 6,939 5,232 87 102.4 98.3 99.3 99.3 90.6 1959.. 145,531 28, 333 6,773 4,935 94 101.6 99.4 96.9 93.7 97.9 I960.. 150,350 29, 588 7,139 5,503 92 104.9 103.6 102.1 104.5 95.8 1961.. 153,819 30, 572 7,189 6,089 92 107.3 107.3 102.8 115.6 95.8 1962.. 155,297 30, 648 7,180 6,116 103 108.4 107.6 102.7 116.1 107.3 1963.. 160, 580 31,684 7,028 6,168 77 112.1 111.2 100.5 117.1 80.2 1964 129,550 128,828 19,381 17,717 O) 3,406 ( 2 ) 2,961 ( J ) 7 106.4 118.7 1965.. 105.8 108.5 119.8 123.9 175.0 1966.. 143,111 17,793 3,286 2,930 9 117.6 109.0 115.5 122.6 225.0 1967.. 121,718 16,328 2,844 2,390 4 100.0 100.0 100.0 100 100 1968.. 114,759 15, 573 4,679 94.3 95.4 89.3 1969.. 118,199 13,207 3,879 97.1 80.9 74.1 1970.. 133,264 13,011 2,860 109.5 79.7 54.6 ■ There are two separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classifica- tion was based on product consumption. Subsequent data are based on production. Pocahontas region is included in Eastern region so that data are comparable. ' Individual reports are confidential for 1964. Source: Years 1951-63 "Products of Agriculture"; Years 1965-70 "Farm Products" less "Livestock & Livestock Products" and "Poultry Products"; Freight Commodity Statistics, ICC. 463 EXHIBIT 31 TREND IN TONNAGE TERMINATED-PRODUCTS OF AGRICULTURE' EXHIBIT 32 INDEX OF TONNAGE TERMINATED— PRODUCTS OF AGRICULTURE' 11951-63 Index (1957-59) 1964-70 Index (1967)| Total Eastern New Eastern Class 1 district York Pennsyl- New Total class 1 district New York Pennsyl- New railroads railroads Central vama Haven railroads railroads Central vania Haven 1951.. 144, 092 42, 787 7,489 10,137 1,530 99.7 106.5 102.9 111.6 111.0 1952.. 141,205 41, 586 7,238 9,635 1,528 97.7 103.5 99.5 106.1 110.9 1953.. 133, 052 41,778 7,001 9,711 1,527 92.1 104.0 96.2 106.9 110.8 1954.. 133,678 40, 909 6,772 9,569 1,540 92.5 101.8 93.1 105.4 111.8 1955.. 135, 280 42, 795 7,281 9,983 1,517 93.6 106.5 100.1 109.9 110.1 1956.. 139, 570 44, 532 7,933 10, 209 1,522 96.6 110.8 109.0 112.4 110.4 1957.. 138, 802 41, 398 7,610 9,334 1,464 96.1 103.0 104.6 102.8 106.2 1958.. 148, 542 40, 709 7,279 9,363 1,345 102.8 101.3 100.0 103.1 97.6 1959.. 146, 118 38, 435 6,940 8,546 1,326 101.1 95.7 95.4 94.1 96.2 I960.. 150,849 39, 587 7,099 8,741 1,297 104.4 98.5 97.6 96.3 94.1 1961.. 154, 204 40, 357 6,993 9,687 1,269 106.7 100.4 96.1 106.7 92.1 1962.. 155, 503 39, 496 6, 575 9,416 1,297 107.6 98.3 90.4 103.7 94.1 1963.. 159, 220 39, 728 6,469 8,802 1,329 110.2 98.9 88.9 96.9 96.4 1964 127,009 24, 772 ( 2 ) ( 2 ) ( 2 ) 106.4 113.3 1965.. 126, 149 22,141 3,489 5,096 822 105.7 101.2 127.9 107.4 79.2 1966.. 140, 531 24, 589 3,135 5,854 824 117.8 112.4 115.0 123.4 79.4 1967.. 119, 342 21, 872 2,727 4,744 1,038 100.0 100.0 100.0 100.0 100.0 1968.. 112,296 20,087 6,462 94.1 91.8 75.9 1969.. 115,917 17,948 6,787 97.1 82.1 79.8 1970.. 130, 683 17, 196 6,473 109.5 78.6 76.1 i There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964 Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region is included in Eastern region so that data are comparable. 2 Individual reports are confidential for 1964. Source: Years 1951-63 "Products of Agriculture"; years 1964-70 "Farm Products" less "Livestock and Livestock Products" and "Poultry and Poultry Products" Freight Commodity Statistics, ICC. EXHIBIT 33 TREND IN REVENUE-PRODUCTS OF AGRICULTURE' EXHIBIT 34 INDEX OF REVENUES-PRODUCTS OF AGRICULTURE! [1951-63 index (1957-59) 1964-70 index (1967)1 Total class 1 railroads Eastern district New York railroads Central Pennsyl- vania New Haven Total class 1 railroads Eastern district railroads New York Central Pennsyl- vania New Haven 1951.. 1, 159, 882 1,217,934 1, 182, 034 1, 146, 564 1, 133, 492 1,184.012 1, 209, 237 1, 286, 329 1, 226, 417 1, 192, 422 1,171,957 1, 163, 766 1, 192, 557 931, 320 899, 861 1, 006, 783 877,617 824, 279 883, 501 1, 046, 464 261, 220 273, 355 283, 782 276, 972 283, 121 303, 831 295. 399 302, 313 274, 424 271, 070 270, 348 267, 744 271,513 169,672 156, 300 165, 306 151, 476 142, 078 138. 235 146, 142 60, 319 42, 518 44, 504 42, 327 44, 790 48, 292 48, 178 48, 894 44, 974 46, 160 44, 065 42, 861 43, 547 ( 2 ) 25, 643 25, 036 21,774 50,! 52, f 58,1 6.814 7,439 7,534 7,356 7,120 7,348 7,307 6,820 6,497 6,378 6,056 6,016 5,955 ( 2 ) 3,532 3,380 4,311 93.5 98.2 95.3 92.4 91.4 95.4 97.5 103.7 98.9 96.1 94.5 93.8 96.1 106.1 102.5 114.7 100.0 93.9 100.7 119.2 89.9 94.0 97.6 95.3 97.4 104.5 101.6 103.4 94.4 93.2 92.3 92.1 93.4 112.0 103.2 109.1 100.0 93.8 91.3 96.5 127.4 ... 99.1 1952.. 61,033 63, 553 63, 309 64, 164 68, 303 65,914 69, 587 62, 367 59, 747 64, 234 64,061 61,438 (?) 35, 038 39, 177 34, 199 .18 106 102 89.8 108.2 1953.. 94.0 . 109.6 1954.. 89.4 107.0 1955.. 94.6 . 103.6 1956 102.0 .. 106.9 1957.. 101.6 106.3 1958.. 103.3 ... 99.2 1959 95.0 ... 94.5 1960 97.5 .. 92.8 1961.. 1962.. 1963.. 93.1 90.5 92.0 88.1 87.5 86.6 1964.. 1965.. 1966.. 1967.. 1968.. 1969.. 1970.. 117.8 115.0 100.0 83.8 87.6 96.4 102.5 114.6 100.0 81.9 76.7 100.0 i There are 2 separate trends (1951-63 and 1964-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region is included in eastern region so that data are comparable. 1 Individual reports are confidential for 1964. Source: Years 1951-63 "Products of Agriculture"; Years 1964-70 "Farm Products" "Poultry and Poultry Products" Freight Commodity Statistics, ICC. less "Livestock and Livestock Products" and 464 EXHIBIT 35 TREND IN TONNAGE ORIGINATED-COAL' |ln thousands] EXHIBIT 36 INDEX OF TONNAGE ORIGINATED— COAL' 11951-63 index (1957-59); 1965-70 index (1967)| Total class 1 railroads Eastern district railroads New York Central Penn- sylvania New Haven Total class 1 railroads Eastern district railroads New York Central Penn- sylvania New Haven 1951.. 439,471 396, 573 373, 831 331,943 384,312 415,833 402, 479 331,262 327, 584 321,340 311,847 327, 335 348, 232 357, 685 363,020 376, 320 384, 583 379, 125 383, 292 404, 622 330, 723 295, 550 275, 643 239, 779 279, 725 302, 682 294, 875 235, 084 232,812 225,876 217,409 228, 359 243, 650 251,087 253, 195 258, 326 258, 715 255,489 252,436 255,835 17,917 40,405 17,580 35,866 17,537 33,667 16,809 28,190 18,638 31,536 21,300 33,724 19,900 32,865 17,605 26,632 18,575 26,665 20,011 24,039 20,147 23,868 21,427 24,512 22,017 26,924 ( 2 ) ( 2 > 19,924 30,291 18, 539 23, 805 17,247 32,384 46, 256 47, 381 46,372 124.2 112.1 105.7 93.8 108.6 117.5 113.8 93.6 92.6 90.8 88.1 92.5 98.4 93.0 94.4 97.9 100.0 98.6 99.7 105.2 130.1 116.2 108.4 94.3 110.0 119.0 116.0 92.5 91.6 88.8 85.5 89.8 95.8 97.1 97.9 99.8 100.0 98.8 97.6 98.9 95.8 94.0 93.8 89.9 99.7 113.9 106.5 94.2 99.4 107.1 107.8 114.6 117.8 104.7 1952.. 124.9 1953.. 117.2 1954.. 98.2 1955.1 109.8 1956.. 117.4 1957.. 114.4 1958.. 92.7 1959.. 92.8 I960.. 83.7 1961.. 83.3 1962.. 85.3 1963.. 93.7 1964.. (') (') (') ( 3 ) 1965.. 115.5 107.5 100.0 93.2 95.5 93.4 93.5 1966.. 73.5 1967.. 100.0 1968.. 1969.. 1970.. 1 There are 2 separate trends (1951-63 and 1965-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production. Pocahontas region is included in eastern region so that data are comparable. 2 Individual reports are confidential for 1964. 3 Reports not available for inspection. Source: 1951-63 Anthracite coal NOS, anthracite coal to breakers and washeries, bituminous coal; 1965-70 bituminous coal and lignite, Freight Commodity Statistics, ICC. EXHIBIT 37 TREND IN TONNAGE TERMINATED— COAL ' [In thousands] EXHIBIT 38 INDEX OF TONNAGE TERMINATED— COAL' 11951-63 Index (1957-59); 1965-70 Index (1967)1 Total Eastern class I district New York Pennsyl- New railroads railroads Central vania Haven Total Eastern class I district railroads railroads New York Central Pennsyl- vania New Haven 1951.. 356, 449 265, 786 38, 627 41,778 4,129 1952.. 321,965 238, 050 36, 041 37, 890 3,588 1953.. 302,116 221, 707 34, 256 36, 033 3,762 1954.. 272, 279 195, 458 29,717 30, 209 2,623 1955.. 320, 395 232, 542 30, 762 34, 362 2,718 1956.. 353, 925 256, 604 33, 571 35,619 2,992 1957.. 345, 487 252, 668 30, 882 35, 235 3,019 1958.. 289, 343 201,175 27, 174 27, 450 2,935 1959.. 280, 749 190, 761 29, 070 28, 343 2,896 I960.. 282,419 189,217 27, 384 26, 932 2,621 1961.. 274,377 180, 226 26, 591 26, 032 2,795 1962.. 288, 450 189, 795 27, 971 26, 387 2,777 1963.. 301, 826 196, 526 29, 692 27, 997 2,390 1964.. 310,241 202, 449 ( 2 ) O < 2 } 2,316 1965.. 315,416 208, 070 33, 226 33,013 1966.. 326, 822 211,515 33,970 34, 623 2,350 1967.. 341,310 219, 148 35, 084 34, 169 1,810 1968.. 326, 804 206, 099 65, 949 1969.. 341,420 215,052 65, 565 1970.. 357, 623 218,901 62, 642 116.8 123.7 133.0 137.7 140.0 105.5 110.8 124.1 124.9 121.6 99.0 !03. 2 117.0 118.8 93.6 89.2 91.0 102.3 99.6 88.9 105.0 108.2 105.9 113.2 92.1 116.0 119.4 115.6 117.4 101.4 113.2 117.6 106.3 116.1 102.3 94.8 93.6 93.6 90.5 99.5 92.0 88.8 100.1 93.4 98.2 92.5 88.1 94.3 88.8 88.8 89.9 83.9 91.6 85.8 94.7 94.5 88.3 96.3 87.0 94.1 98.9 91.5 102.2 92.3 81.0 90.9 92.4 ... 92.4 94.9 94.7 96.6 128.0 95.8 96.5 96.8 101.3 129.8 100.0 100.0 100.0 100.0 100.0 95.7 94.0 92.8 100.0 98.1 92.3 104.8 99.9 88.1 > There are 2 separate trends (1951-63 and 1965-70) since the classification was revised in 1964. Prior to that time the classification was based on product consumption. Subsequent data are based on production Pocahontas region is included in eastern region so that data are comparable. 2 Individual reports are confidential for 1964. Source: 1951-63 anthracite coal No. 5, anthracite coal to breakers and washers, bituminous coal; Freight Commodity Statistics, ICC. 465 EXHIBIT 39 TREND IN REVENUES— COAL" (In thousands] Total Eastern New class 1 district York Pennsyl- New railroads railroads Central vania Haven 1951.. 1, 330, 747 1, 030, 798 (3 2 116,942 157, 145 8,390 1952.. 1, 270, 846 975, 110 150, 672 7,746 1953. 1,199,674 916, 195 115,938 145, 292 6,215 1954.. 1, 036, 320 782, 929 99, 236 120, 172 5,740 1955. 1,213,171 931, 533 104, 759 133, 520 5,779 1956.. 1, 389, 897 1, 077, 323 117, 265 154, 155 6,467 19b/.. 1, 395, 552 1, 094, 845 112, 257 154, 461 6,795 1958.. 1, 150, 576 879, 054 100, 801 124, 762 6,685 1959.. 1, 104, 579 842,661 104, 255 121,251 6,462 I960.. 1,072,581 815,818 99, 304 113,060 1,018 1961.. 1, 044, 057 790, 180 95, 090 114,443 950 1962.. 1, 069, 874 814, 374 97, 548 114,641 5,974 1963.. 1,103,944 834, 112 94, 898 112,958 4,626 1964.. 1, 103, 493 833, 649 ( 2 ) ( 2 ) ( 2 ) 1965.. 1, 128, 608 852, 286 94, 387 113,229 3,986 1966.. 1, 129, 546 846, 122 89, 750 114, 291 3,972 196/.. 1,151,847 860, 877 ( 3 ) 117,572 3,321 1968.. 1, 137, 252 849, 514 195, 559 1969.. 1, 190, 923 869, 418 206, 529 19/0.. 1, 381, 088 979, 409 226, 005 EXHIBIT 40 INDEX OF REVENUES-COAL' 11951-1963 index (1957-1959); 1965-1970 index (1967)] Total Eastern class I district railroads railroads New York Central Pennsyl- vania New Haven 109.3 109.8 117.7 126.2 104.4 103.9 110.6 112.9 116.5 98.6 97.6 109.6 108.8 93.5 85.2 83.4 93.8 90.0 86.4 99.7 99.2 99.0 100.0 86.9 114.2 114.7 110.9 115.5 97.3 114.7 116.6 106.1 115.7 102.2 94.5 93.6 95.3 93.5 100.6 90.8 89.8 98.6 90.8 97.2 88.1 86.9 93.9 84.7 15.3 85.8 84.2 89.9 85.7 14.3 87.9 86.7 92.2 85.9 89.9 90.7 88.8 89.7 84.6 69.6 95.8 96.8 -.- 98.0 99.0 96.3 120.0 98.1 98.3 97.2 119.6 100.0 100.0 100.0 100.0 100.0 98. 7 98. 7 103.4 101.0 119.9 113.8 i There are 2 separate trends (1951-1963 and 1965-1970) since the classification was revised i n 1964. Prior to that time the classifi- cation was based on product consumption. Subsequent data are based on production. Pocahontas region is included in eastern region so that data are comparable. - 2 Individual reports are confidential for 1964. * Data missing. Source: 1951-63 anthracite coal, 1964 anthracite coal to breakers and washers, bituminous coal; 1965-1970 bituminous coal and lignite; Freight Commodity Statistics. EXHIBIT 41 METHOD OF TRANSPORTING BITUMINOUS COAL AND LIGNITE FROM MINES [In thousands] Shipped by Shipped by rail and water and Trucked trucked trucked to final Used at Total to rail to water destination mine production 409, 111 81,337 73, 975 34, 376 602, 932 397, 863 71,037 66, 030 25, 575 560, 505 396, 443 66,885 61,753 20, 165 545, 245 404, 525 66, 792 62, 003 19, 127 552, 626 386, 958 62, 092 67, 026 17, 806 533, 881 3/1, 544 60, 289 68, 302 11,953 512,088 349, 377 59, 349 65, 532 12, 740 486, 998 333, 989 50,664 60, 901 13,374 458, 928 307, 328 48, 106 54, 853 11,862 422, 149 293, 546 46, 348 51,044 12, 039 402,977 303, 865 46, 784 52, 699 12,164 415,512 300, 763 45, 954 52,564 12, 747 412,028 305, 642 43, 899 50, 605 10, 300 410,446 380, 471 51.171 50, 334 10, 728 492, 704 390, 015 50, 732 49, 768 10, 359 500, 874 355, 924 47,476 51,607 9,626 464, 633 305, 918 32, 912 44, 689 8,187 391, 706 362, 133 35,648 47, 102 12,407 457, 290 375,911 27, 746 50, 231 12,953 466, 841 430, 387 29, 984 58, 132 15, 162 533, 665 417, 225 27, 583 58, 286 13,217 516,311 1970. 1969. 1968. 1967. 1966. 1965. 1964. 1963. 1962. 1961. 1960. 1959. 1958. 1957. 1956. 1955. 1954. 1953. 1952. 1951. 1950. Source: Vols. 1 and 11, metals, minerals, and fuels, "Minerals Yearbook" for appropriate years, Department of Interior. 466 EXHIBIT 42 INDEX OF COAL SHIPMENTS BY VARIOUS MODES 11957-59=1001 Shipped by Shipped by rail and water and Trucked to trucked to trucked to final Used at Total rail water destination mine production 1950.... 126.8 58.7 113.9 117.0 117.8 1951 130.8 63.8 113.6 134.2 121.7 1952 114.3 59.0 98.2 114.6 106.5 1953. 110.1 75.8 92.1 109.8 •104. 3 1954 93.0 70.0 87.3 72.5 89.4 1955..... 108.2 101.0 100.9 85.2 106.0 1956... 118.6 108.0 97.3 91.7 114.3 1957 115.7 108.9 98.4 95.0 112.4 1958 92.9 93.4 98.9 91.2 93.6 1959 91.4 97.8 102.7 112.8 94.0 1960 92.4 99.5 91.4 107.7 94.8 1961 89.2 98.6 99.8 106.6 91.9 1962 93.4 102.3 107.2 105.0 96.3 1963 101.5 107.8 119.0 118.4 104.7 1964 106.2 126.3 128.1 112.8 111.1 1965.. 112.9 128.3 133.5 105.8 116.8 1966 117.6 132.1 131.0 157.6 121.8 1967 123.0 142.1 121.2 169.3 126.1 1968. 120.5 142.3 120.7 178.5 124.4 1969... 120.9 151.1 129.0 226.4 127.9 1970 124.4 173.0 144.6 304.3 137.5 Source: Exhibit 41. MAP 1 467 468 Exhibit 44 Years 1966-1930 SO v„ 100 °/o INTERNAL COMBUSTION 1965 1970 1975 l 9»0 l 985 Based on Survey by Fossil Fuel Resources Committee Source: Federal Power Commission, National Power Survey, 1970, p. 11-4-37. 469 Exhibit 45 PERCENT GENERATION BY TYPE OF FUEL AND HYDRO POWER EAST CENTRAL REGION Years 1966- ! 990 IOO°/o 80 60 40 20 CHART 3 100 % i:\-yy.-y.-y- K>y-:-y-yy-l KX.* ' • IW> •■:•' : :4:: : yyy>% ■■> ■ j ■ I t' t " ■ ■ ■ ,■ i ili i , i t - . ■ , , J JL .v.-.-.-.-:-. .- HYDRO, ETC. 1965 Source: Federal Power Commission, National Power Survey, 1970, p. II— 4— 38. Based or, Survey bj Fossil Fuel Resources Committee 470 May 197] 5 Trt -P K s a s> H a, •^ to rs; to to ,3 r-i O t-i •s -p fc ^ « O a. X II d) o o t3 m o C ON H O H I 4-1 Vi MH M •H CO 0) O < (X CJ (X 01 4J O U co >-i o co a. X! 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Source: National Highway Carriers Directory, Inc., National Highway and Airway Carriers and Routes, Spring 1971, pg. 278. 74-924 O - 73 - 32 476 332 P. I.E. National Highway and Airway Carriers Exhibit 55 Special to freight expediters Here's the newest PIE coast-to-coast route map. Remember, when you're shipping to any of the more than 3,000 points served by P-l-E, it's your sure line. Coast to Coast ($) District Terminals • Branch Terminals the Fine Line of difference General Office • Pacific Intermountam Express Co. BB^P™"^ 1417 Clay Street • Oakland, California 94612 ^ ' Motor carriers Dot now listed, are invited to list their corporate setup, direct points, ter- minals and terminal telephones in the directory. There is no charge for this service. Source: National Highway Carriers Directory, Inc., National Highway and Airway Carriers and Routes, Spring 1971, pg. 332. 477 388 YELLOW National Highway and Airway Carriers 's***\. Exhibit 56 \v »>&•■; *■ 5 * », ?, 478 258 ASSOCIATED National Highway and Airway Carriers Exhibit 57 a g Source: Airway Carriers and Routes; Spring 1971, p. 342. 480 Exhibit 59 Merger, Acquisition History of Selected Carriers, 1955-1970 yellow freight system, inc. 1970 Norwalk Truck Lines 1968 Watson-Wilson Transportation System 1959 Central States Freight Service (subsequently changed to Yellow Forwarding Co.) 1956 Michigan Motor Freight Lines TIME DC 1969 DC International-Seattle Motor Express Inc. (carriers merged with Time Freight, Inc.) 1968 Texas-Arizona Motor Freight, Inc. 1963 Super Service Motor Freight Co. 1962 Constructors Transport Co. 1960 American Transfer Co. 1959 Powell Bros. Truck Lines, Inc. 1956 Southeastern Truck Lines, Inc. PACIFIC INTERMOUNTAIN EXPRESS 1967 Lower Transportation, Inc. 1967 Siebert Truck Service 1965 All States Freight, Inc. 1963 Tyro Industries, Inc. 1959 Bond Trucking Co. 1958 Union Transfer Co. 1956 M&M Fast Freight Lines 1955 Orange Transportation Co. Source: Trin&s Red Book of the Trucking Industry, Trlnc's Associates Ltd., Washington, D.C. Exhibit 59A [Ex Parte No. 270 (Sub-No. 2)] appendix a Shippers Evidence of Service Deficiencies Shipper nature of complaint of deficient service Coal Toledo Edison Company car shortages excessive time in transit Consolidated Edison Company of New York car shortages Niagara Mohawk Power Company car shortages The Property Owners' Committee car shortages Niagara Mohawk Power Company delays in pickup of loaded cars delays en route for lack of motive power untimely and late deliveries Public Service Electric and Gas Company car shortages Rochester Gas and Electric Co. lack of motive power inadequate roadbed maintenance inadequate supervision of local operations tendency of employees to thwart attempts of management to improve service 481 [Exhibit 59 A — Continued] Grain and grain products The Minneapolis Grain Exchange Agway, Inc. New England Grain and Feed Council, Inc. General Mills Peavey Company Maryland State Board of Agriculture Louis Dreyfus Corporation CPC International, Inc. Cargill, Incorporated Southern States Cooperative, Inc. Pillsbury Company Archer-Daniels Midland Company Southern States Cooperative, Inc. Continental Grain Company Garvey, Inc. Board of Trade of Kansas City, Mo. Anheuser-Busch unfit cars (most common defects: holes or leaks ; defective doors ; missing doors ; de- fective slides ; odors ; foreign material in cars including cement, coal dust, fertilizer, lime, meal, oil, and sand ; wrong type of car; and cars which could not be sealed) erratic transit times erratic and excessive transit times unfit cars (shipper at own expense performs routine cleaning, trash removal, patching and reconditioning rather than reject cars because of car shortage) erratic transit times erratic transit times delays in switching to linehaul carrier erratic transit times erratic and excessive transit times erratic and excessive transit times erratic transit times erratic and excessive transit times excessive transit times delays in moving leased cars into linehaul service terminal delays in switching and interchange of cars delays in delivering loaded cars and in pick- up of empty cars terminal delays and improper switching of inbound shipments at certain points and of outbound cars at other points terminal delays in delivering inbound ship- ments to grain elevators increased turn-around time on shipper's privately-owned cars Liquefied petroleum gas Kendall Refining Company Pennsylvania Refining Company Quaker State Oil Refining Corporation erratic and excessive transit times bunching of cars erratic and excessive transit times bunching of cars excessive transit times caused by delays en route Lumber and paper Southern States Cooperative The Fibre Box Association Simpson Timber Co. The Georgia-Pacific Corporation Boise Cascade Corporation terminal delays inadequate car supply excessive freight loss and damage erratic transit times excessive freight claims excessive delivery time excessive transit time Reynolds Metals Co. Aluminum ores and products excessive and erratic transit times Scrap iron and steel Institute of Iron and Steel Scrap Shippres excessive transit times terminal delays car shortages bad-order cars bunching of cars carriers increasing their tonnage capacity, without commensurate increase in the cubic carrying capacity of their cars 482 [Exhibit 59A — Continued] General Shippers of fresh fruits and vegetables from the West; and Northwest Horticultural Counsel Shippers of cement and aggregates United States Brewers Association Carling Brewing Company Adolph Coors Brewing Olympia Brewing Company Shippers of chemicals and allied products Kraft Foods Swift and Co. Shippers of fertilizer and potash erratic and excess transit times car shortages, particularly refrigerator cars car shortages unfit cars in need of repairs and cleaning erratic and excess transit times terminal delays terminal delays increased turn-around time increased turn-around time car shortages outmoded labor contracts excessive and unreliable transit times inadequate terminal, interchange and car repair facilities erratic and inconsistent transit times erratic and excessive transit time erratic and excessive transit times EXHIBIT 60 COMPARISON OF OPERATING RATIOS ACHIEVED BY INTERCITY MOTOR CARRIER SUBSIDIARIES CONTROLLED BY THE PENN CENTRAL AND THOSE ACHIEVED BY ALL CLASS I INTERCITY COMMON CARRIERS 1965-70 1965 1966 1967 1968 1969 1970 Merchants Trucking Co. 1 90.6 90.7 91.8 New England Transportation Co 101.7 99.4 100.3 All class I intercity common carriers 94.7 94.6 96.4 1 Merchants was merged into Pennsylvania Truck Lines, Inc., as of January 1, 1972. Source: "Trinc's Blue Book of the Trucking Industry," Trinc's Associates, Ltd. Washington, D.C. 93.7 99.3 95.2 93.5 96.5 96.0 95.2 103.1 96.6 EXHIBIT 61 COMPARISON OF REVENUE GROWTH ACHIEVED BY INTERCITY MOTOR CARRIER SUBSIDIARIES CONTROLLED BY THE PENN CEN- TRAL AND THOSE ACHIEVED BY ALL CLASS I INTERCITY COMMON CARRIERS, 1965-70 11967 equals 100] Merchants Trucking Co.i Revenues (thousands) Index New England Transportation Co. All class I intercity common carriers Revenues (thousands) Index Revenues (thousands) Index 1965 $516 93.0 $3,319 86.5 $5,053,856 1966. 620 111.7 3,633 94.6 5,574,885 1967... 555 100.0 3,839 100.0 5,914,296 1968... 724 130.5 4,040 105.2 6,392,211 1969.. 877 158.0 4,451 115.9 7,140,177 1970 885 159.5 4,560 118.8 7,312,208 93.0 111.7 100.0 130.5 158.0 159.5 ' Merchants has been merged into Pennsylvania Truck Lines, Inc. as of Jan. 1, 1972. Source: Trinc's Blue Book of the Trucking Industry, Trinc's Associates Ltd., Washington, D.C. for the individual carriers. EXHIBIT 62 COMPARISON OF OPERATING RATIOS ACHIEVED BY LOCAL MOTOR CARRIER SUBSIDIARIES CONTROLLED BY THE PENN CENTRAL AND THOSE ACHIEVED BY ALL GENERAL FREIGHT LOCAL CARRIERS 1965-70 1965 1966 1967 1968 1969 1970 New York Central Transport i 82.5 73.1 82.5 85.3 84.1 90.9 Pennsylvania Truck Lines Inc.' 93.3 90.8 97.1 99.4 99.6 103.2 PenntruckCoi _ 82.4 80.9 93.1 97.1 93.9 95.8 All General Freight Local Carriers.. 95.7 95.8 96.2 95.4 95.1 96.9 1 These carriers together with Merchants Trucking Co. have been merged into Pennsylvania Truck Lines, Inc. as of January 1, 1972. Source: "Trinc's Blue Book of the Trucking Industry," Trinc's Associates, Ltd., Washington, D.C— for appropriate years. 483 EXHIBIT 63 COMPARISON OF REVENUE GROWTH ACHIEVED BY LOCAL MOTOR CARRIER SUBSIDIARIES CONTROLLED BY THE PENN CENTRAL AND THOSE ACHIEVED BY ALL GENERAL FREIGHT LOCAL CARRIERS, 1965-70 [1967 equals 100] New York Central Transport' Pennsylvania Truck Lines, Inc. ' Penntruck Co.' All general freight local carriers Revenues (thousands) Index Revenues (thousands) Revenues Index (thousands) Index Revenues (thousands) Index 1965... 1966. 1967. 1968 1969... 1970— $15,259 19,522 23,291 36,424 53,723 34,358 65.5 83.8 100.0 156.4 230.7 147.5 $8, 767 9,009 9,001 8,747 9,955 9,822 97.4 100.1 100.0 97.2 110.6 109.1 $1, 334 1,406 1,385 1,796 2,287 2,417 96.3 101.5 100.0 129.7 165.1 174.5 $597, 200 675,018 704, 494 714,282 556, 236 317, 607 84.8 95.8 100.0 101.4 79.0 45.1 > These carriers together with Merchants Trucking Co. have been merged into Pennsylvania Truck Lines, Inc. as of Jan. 1,1972. Source: Trinc's Blue Book of the Trucking I ndustry, Trinc's Associates Ltd. , Washington , D.C. .appropriate year. EXHIBIT 64 COMPARISON OF REVENUES AND PRODUCTION GENERATED BY U.S. PIPELINES VERSUS BUCKEYE [Revenues and barrels in thousands! Buckeye pipe ines U.S. pipel nes Revenues Barrels 1 Revenues Barrels > $34, 645 343,111 $1,103,258 7,741,815 34, 264 334, 843 1,022,962 7, 268, 759 31,763 303,011 994, 520 6,800,424 30,991 290, 793 941,138 6, 238, 192 28, 812 280, 307 903, 817 5, 863, 651 28,288 270, 595 865, 079 5,565,112 27,751 266, 849 840, 260 5,321,661 25, 696 249, 322 810, 605 5, 108, 562 24, 833 238, 121 786, 718 4, 923, 296 21,651 232, 765 770,417 4,783,042 21,088 230, 251 765, 232 4, 659, 340 19, 684 210,225 720, 670 4,316,721 20, 116 223, 669 729, 952 4,472,426 20, 231 233, 780 737, 386 4, 457, 667 17,560 205, 908 677, 605 4, 038, 990 1969 1968 1967 1966 1965 1964 1963 1962 1961 1960 1959 1958 1957 1956 1955 1 Represents total delivered out of system. Source: Part 6, Transport Statistics in the United States, ICC. EXHIBIT 65 COMPARISON OF REVENUES GENERATED BY U.S. PIPELINES VERSUS BUCKEYE (THOUSANDS) U.S. pipelines U.S. pipelines (1957-59 = (1957-59 = 100) Buckeye 100) Buckeye 1955 91.7 86.5 1963 113.8 136.7 1956 99.8 99.7 1964 ._ 117.1 139.4 1957.... 98.8 99.1 1965.. 122.4 142.0 1958 97.6 97.0 1966 127.4 152.7 1959.... 103.6 103.9 1967 134.6 156.5 1960. 104.3 106.7 1968 138.5 168.8 1961 106.5 122.4 1969 ._ 149.4 170.7 1962 109.7 126.6 Source: Exhibit 64. 484 EXHIBIT 66 COMPARISON OF BARRELS' GENERATED BY U.S. PIPELINES VERSUS BUCKEYE [1957-59=1001 U.S. Pipelines Buckeye U.S. Pipelines Buckeye 1955 1956 1957 90.1 99.4 99.8 96.3 103.9 106.7 109.8 114.0 93.0 105.6 101.0 95.0 104.0 105.1 107.6 112.6 1963 1964 1965 118.7 124.1 130.8 120.5 122.2 126.6 1958 1959 1960 1961 1962 1966 1967 1968. 1969 139.2 151.7 162.1 172.7 131.4 136.9 151.2 155.0 1 Represents total barrels delivered out of the system. Source: Exhibit 64. EXHIBIT 67 COMPARISON OF PASSENGER REVENUES DURING THE PERIOD 1953-69 Class 1 railroads Eastern district Pennsyl- vania New York Central New Haven 1951 _.. 1952 1953. 1954. 1955. 1956. 1957. 1958. 1959. 1960. 1961. 1962.. 1963.. 1964. 1965.. 1966. 1967. 1968. 1969.. $841,961,640 767, 282, 708 742,944,763 756,582,035 735, 339, 490 675,295,593 651,168,032 640, 268, 065 624,688,484 619,056,203 588,104,351 577, 909, 949 553,056,215 543, 632, 408 485,369,136 444, 334, 454 438,666,911 $458,672,615 425, 280, 542 413,600,884 422,971,597 414,203,756 378,043,295 355,831,449 344, 593, 359 335,619,141 326,012,206 316,749,047 315, 222, 560 298,965,497 292, 784, 552 269,942,174 258, 406, 090 265, 326, 514 $142,097,087 126,503,784 121,156,635 123,782,131 121,739,972 108, 139, 738 103,952,598 99, 849, 348 99,138,710 93,164,417 90, 322, 234 88, 157, 634 82,956,647 81,046,658 73,963,433 105,087,068 147,111,527 $117,117,505 106, 568, 158 100, 663, 475 98, 593, 509 88,453,741 78, 294, 208 69,709,922 67, 936, 647 61,304,644 59,355,482 56, 266, 420 54,419,033 51,537,669 48, 614, 535 40, 998, 404 $51,407,538 49,886,419 47,773,559 51,518,043 53,661,892 50,595,456 45,441,102 44,441,369 42,515,891 41,277,646 41,137,020 40, 897, 240 38, 659, 273 37,652,322 36, 483, 609 36,371,646 EXHIBIT 68 INDEX OF PASSENGER REVENUES DURING THE PERIOD 1953-69 (1957-59=100) Class I railroads Eastern district Pennsyl- vania New York Central New Haven 1951. 1952. 1953. 1954. 1955. 1956. 1957. 1958. 1959. 1960. 1961. 1962.. 1963. 1964.. 1965. 1966. 1967. 1968.. 1969. 122.5 119.8 127.7 148.6 103.0 111.6 111.1 113.7 135.2 100.0 108.1 108.1 108.9 127.7 95.7 110.1 110.5 111.2 125.1 103.2 107.0 108.2 109.4 112.2 107.5 98.2 98.8 97.2 99.3 101.4 94.7 93.0 93.4 88.4 91.1 93.2 90.0 89.7 86.2 89.1 90.9 87.7 89.1 77.8 85.2 90.1 85.2 83.7 75.3 82.7 85.6 82.8 81.2 71.4 82.4 84.1 82.4 79.2 69.0 82.0 80.5 78.1 74.5 65.4 77.5 79.1 76.5 72.8 61.7 75.5 70.6 70.5 66.5 52.0 72.1 64.6 67.5 55.3 72.9 63.8 69.3 77.4 Source: Exhibit 67, Transport Statistics in the United States for appropriate years, ICC; Exhibit 68, Exhibit 67. 485 Exhibit 69 PIGGYBACK TRAILER AMD COWER TERMINATIONS REPORTED BY CLASS I RAILROADS BY PLAN, 1964-1970 tiiuiis 1600 1400 1200 1081 Pin V Pill IV Pill III PH. II', Pill II Pill I 1964 1965 1966 1967 1960 1961 1970 Sllltl Itrtu el Centimes. Stitiaiit Ni 11-1. Pifiykiek Tritfie Clinctirlstics |13IS| lit Tfiispirt Ecmaici Source: Interstate Commerce Commission, Annual Report , 1971, p. 138. APPENDIX C TABLE C-l.^NORTH-SOUTH TRAFFIC AND REVENUE AS A SHARE OF TOTAL TRAFFIC AND REVENUE IN OFFICIAL AND SOUTHERN TERRITORIES, 1953-69 OFFICIAL TERRITORY Official, southern traffic and Traffic and revenue between official territory Traffic and revenue between official territory revenue as a percent of and United States and southern territory official, United States traffic and revenue. Cars Tons Revenue Cars Tons Revenue Cars Tons Revenue 1953... 1963... 1965... 1966... 1969... 18,139,700 13,465,100 13,942,300 13,959,700 12, 564, 300 781,319,900 $4,949,071,000 629,358,700 4,256,912,200 683,019,400 4,613,492,800 693,051,600 4,766,721,900 663,316,600 4,919,710,100 1,872,500 1,485,700 1,651,000 1,667,900 1,850,600, 64,401,400 60,962,900 71,607,000 72,122,700 88, 199, 900 $710, 880, 400 610,794,700 709, 305. 700 742, 988, 200 915,403,300 10.3 11.0 11.8 11.9 14.7 8.2 9.7 10.5 10.4 13.3 14.4 14.4 15.4 15.6 18.6 SOUTHERN TERRITORIES Traffic and revenue between southern territory and United States Traffic and revenue between southern territory and official territory Southern, official traffic and revenue as a percent of southern, United States traffic and revenue Cars Tons Revenue Cars Tons Revenue Cars Tons Revenue 1953... 6,072,400 238,584,600 $1,564,975,200 1963. 1965. 1966 1969.. 5, 348, 400 5, 854, 700 5,956,700 6,959,100 255,018,300 292, 247, 700 304, 723, 990 354, 740, 400 1,506,955,100 1,702,196,100 1,796,711,600 2,183,993,800 1,872,500 64,401,400 $710,880,400 1,485,700 1,651,000 1,667,900 1,850,600 60,962,900 71,607,000 72, 122, 700 88, 199, 900 610,794,700 709, 305, 700 742, 988, 200 915,403,300 30.8 27.8 28.2 28.0 26.6 27.0 23.9 24.5 23.7 24.9 45.4 40.5 41.7 41.4 41.9 Source: Interstate Commerce Commission and Department of Transportation, carload waybill statistics. TABLE C-2, -TRANSCONTINENTAL TRAFFIC AND REVENUE AS A SHARE OF TOTAL TRAFFIC AND REVENUE IN OFFICIAL AND MONTAIN-PACIFIC TERRITORIES, 1953-69 OFFICIAL TERRITORY Traffic and revenue between Official Terri- tory and United States Traffic and revenue between Official Territory and Mountain-Pacific Territory Official, Mountain-Pacific traffic and revenue as a percent of Official-United States traffic and revenue Cars Tons Revenue Cars Tons Revenue Cars Tons Revenue 1953.. 1963.. 1965.. 1966.. 1969.. . 18, 139, 700 . 13,465,100 . 13, 942, 300 . 13, 959, 700 . 12,564,300 781,319,900 629, 358, 700 683,019,400 693,051,600 663, 316, 600 $4, 949, 071, 000 4,256,912,200 4,613,492,800 4,766,721,900 4,919,710,100 748, 600 692, 400 718,900 749, 700 660, 100 18, 348, 100 19,127,100 21,971,700 23, 126, 300 21, 638, 700 $720, 742, 700 767, 893, 600 848,891,400 886,131,300 879, 163, 900 4.1 5.1 5.2 5.4 5.3 2.3 3.0 3.2 3.3 3.3 14.6 18.0 18.4 18.6 17.9 MOUNTAIN-PACIFIC TERRITORY Traffic and revenue between Mountain-Pacific territory and United States Traffic and revenue between Mountain-Pacific Territory and Official Territory Mountain-I enue as Pacific-U revenue 'acific traffic and rev- a percent of Mountain- nited States traffic and Cars Tons Revenue Cars Tons Revenue Cars Tons Revenue 1953.. 1963.. 1965.. 1966.. 1969.. . 4, 299, 700 . 3,487,700 .. 3,818,300 . 3, 868, 000 . 3, 649, 000 150,444,400 141,223,100 171,025,300 174,935,700 175,942,900 $2, 059, 682, 100 2, 088, 850, 700 2,316,658,400 2, 436, 098, 100 2,581,263,100 748, 600 692, 400 718,900 749, 700 660, 100 18,348,100 19,127,100 21,971,700 23, 126, 300 21,638,700 $720, 742, 700 767, 893, 600 848,891,400 886,131,300 879,163,900 17.4 19.9 18.8 19.3 18.1 12.2 13.5 12.8 13.2 12.3 35.0 36.8 36.6 36.4 34.1 Source: Interstate Commerce Commission and Department of Transportation, Carload Waybill Statistics. (487) 488 TABLE C-3.-V0LUME AND DIRECTIONAL FLOW OF OFFICIAL-SOUTHERN TRAFFIC, 1953-69 Carloads Percent Tons Percent Revenue Percent 1953: Northbound 1,224,100 65 47,150,600 73 $424,549,200 60 Southbound 648,400 35 17,250,800 27 286,331,200 20 Total 1,872,500 100 64,401,400 100 710,880,400 100 1963: Northbound 859,100 58 38,485,900 63 347,442,300 57 Southbound 626,600 42 22,477,000 37 263,352,400 43 Total 1,485,700 100 60,962,900 100 610,794,700 100 1965: Northbound ... 945,200 57 45,292,100 63 394,330,500 56 Southbound 705,800 43 26,314,900 37 314,975,200 44 Total 1,651,000 100 71,600,700 100 709,305,700 100 1966: • Northbound 947,900 57 44,669,900 62 413,199,800 56 Southbound 720,000 43 27,452,800 38 329,788,400 44 Total 1,667,900 100 72,122,700 100 742,988,200 100 1969: Northbound.. 945,700 51 45,354,300 51 474,675,100 52 Southbound 904,900 49 42,765,600 49 440,728,200 48 Total 1,850,600 100 88,119,900 100 915,403,300 100 Source: Interstate Commerce Commission and Department of Transportation, Carload Waybill Statistics. TABLE C-4.-VOLUME AND DIRECTIONAL FLOW OF OFFICIAL-TRANSCONTINENTAL TRAFFIC, 1953-69 Carloads Percent Tons Percent Revenue Percent 1953: Eastbound... 456,600 61 12,293,200 67 $381,993,600 53 Westbound... 292,000 39 6,054,900 33 338,749,100 47 Total 748,600 100 18,348,100 100 720,742,700 100 1963: Eastbound _ 401,600 58 12,815,200 67 406,983,600 53 Westbound 290,800 42 6,311,900 33 360,910,000 47 Total 692,400 100 19,127,100 100 767,893,600 100 1965: Eastbound 409,800 57 14,501,300 66 449,912,400 53 Westbound. 309,100 43 7,470,400 34 398,979,000 47 Total 718,900 100 21,971,700 100 848,891,400 100 1966: Eastbound 427,300 57 15,263,400 66 469,649,600 53 Westbound 322,400 43 7,862,900 34 416,481,700 47 Total _ 749,700 100 23,126,300 100 886,131,300 100 1969: Eastbound 384,700 58 14,443,500 67 477,367,800 54 Westbound. 275,400 42 7,195,200 33 401,796,100 46 Total _ 660,100 100 21,638,700 100 879,163,900 100 Source: Interstate Commerce Commission and Department of Transportation, Carload Waybill Statistics. Table C-5 Chronology of Southern and Transcontinental Divisions Cases official — southern divisions on further hearing ^1959-65) November 1, 1956 : Petition of Eastern Roads for further hearing and Modification of 1953 Order. November 26, 1956 : Notice by ICC — Date for filing replies deferred until further notice. May 1, 1959 : Reply of Southern Lines to Petition for Reopening. July 20, 1959 : ICC Order Reopening for Further Hearing. November 16, 1959, to February 13, 1961 : Hearings on intermittent schedule for cross- examination of witnesses presenting Verified Statements as exhibits. (Transcript, 2,712 pp.) June 19, 1961 : Briefs filed. July 17, 1963 : Examiner's Report served. 489 October 25, 1963 : Exceptions filed to Examiner's Report. November 30, 1963 : Replies to Exceptions filed. February 18, 1964 : Oral Agrument before Commission. February 3, 1965 : ICC Report and Order on Further Hearing (325 ICC 1 to become effective April 20, 1965). April 1, 1965 : Petition of Norfolk Southern for Special Divisions. April 28, 1965: Reply of Eastern Roads consenting to Special Divisions for Norfolk Southern. May 18, 1965 : Supplemental Report and Order of ICC (325 ICC 449). COURT REVIEW OF ICC ORDER OF FEBRUARY 3, 1965 March 3, 1965 : Complaint of Southern lines to enjoin ICC Order filed in U.S. District Court at New Orleans. April 12, 1965 : Temporary Restraining Order granted. May 27, 1965 : Hearing before District Court on Interlocutory Injunction. June 3, 1965 : Order of Court denying Interlocutory Injunction on conditions and vacating temporary restraining order leaving ICC order effective as of April 20, 1965. March 29, 1966 : Pretrial Order of Court. May 15, 1966 : Plaintiffs Briefs filed. August 1, 1966 : Defendants Briefs filed. September 1, 1966 : Plaintiffs Reply Briefs filed. July 5, 1967 : Opinion of District Court— Aberdeen & Rockflsh v. U.S., 270 F. Supp. 695. August 8, 1967 : Final Decree of District Court Setting ICC Order aside and Remanding to ICC. August 8, 1967 : Order Staying Decree. October 2, 1967 : Notice of Appeal to Supreme Court by B&O et al. October 23, 1967 : Notice of Appeal of U.S.— ICC. IN U.S. SUPREME COURT December 18, 1967 : Jurisdictional Statement of Appellants B&O R. Co. et al. December 21, 1967 : Jurisdictional Statement of ICC filed. January 1968 : Motions of Southern Lines et al. to Affirm. February 1968 : Appellants Brief Opposing Motions to Affirm. June 12, 1968 : Appellants Brief filed (B&O et al.). July 1968 : Appellees Briefs filed. September 1968 : Appellants' Reply Brief filed. November 12, 1968 : Opinion of Supreme Court (B&O R. Go. v. Aberdeen & R.R., 393 U.S. 87) modifying District Court Order in part and affirming as modified. March 3, 1969 : Order denying Rehearing. RETURN TO U.S. DISTRICT COURT — FOLLOWING SUPREME COURT ACTION March 3, 1969: Motion of Defendant Railroads for Holding Case in Abeyance pending ICC Findings required by Supreme Court. March II, 1969: Plaintiffs Motion for Dissolving Stay, Modifying Final Decree, and Enforc- ing Protective Conditions. April 10, 1969 : Northern Lines' Brief Opposing Plaintiffs' Motion. April 24, 1969: Opinion and Order of District Court (301 F. Supp. 889) Dissolving Stay. Modifying Final Decree, and Enforcing Protective Conditions (and remanding to ICC for further hearings) and requiring resettlement of accounts within 90 days. July 23, 1969: Joint Motion of Plaintiffs and Northern Defendants for Entry of Orders which authorize compliance with resettlement order of Court as provided in Stipulation of this date. August 21, 1969 : Order of Court approving resettlement plan of Stipulation as compliance with its Order of April 24, 1969. [Pursuant to this Stipulation and Order, Northern lines paid Southern lines some $33 million.] March 17, 1970 : Notice by Plaintiff Southern Roads of pavments received under Stipula- tion of July 23, 1969. ICC PROCEEDINGS FOLLOWING SUPREME COURT OPINION Marcli 4, 1969 : Northern Lines Petition for Issuance of Report with Findings Required by Supreme Court filed ( Dated March 3, 1969) . Mav 20, 1969 : Reply of Southern Roads to Northern Lines' Petition dated March 3, 1969. June 6, 1969 : Northern Lines' Rebuttal Statement with Petition for Leave to File. June 25. 1969 : Southern Lines' Reply to Northern Lines' Petition for Leave to File. April 21, 1970: ICC Report and Order, 337 ICC 74, fixing new divisional basis (and giving Northern lines about 86% of 1965 prescribed divisions) . June 11, 1970 : Petition for Reconsideration filed by all parties. July 1, 1970 : Replies filed to Petition for Reconsideration. September 11, 1970 : Order of ICC denying reconsideration and fixing effective date as November 1, 1970. 490 FURTHER PROCEDURE BEFORE DISTRICT COURT October 8, 1970: Plaintiff Southern Roads' Motion to Set Aside ICC Order of April 21, 1970 and for Temporary Restraining Order. October 21, 1970: Northern Defendants' Answer & Opposing Plaintiffs' Motion — also Memo by ICC and Memo by U.S. confessing error. October 26, 1970 : Hearing before District Court. October 29, 1970: Order of District Court Setting Aside ICC Order of April 21, 1970 and remanding to ICC for further proceedings. November 12, 1970: Plaintiffs' Memo Opposing Limited Hearings. December 16. 1970 : Order of District Court Limiting further Hearings. December 28, 1970 : Motion of Southern Governors for New Trial, etc. January 4, 1971 : Reply of Northern Lines to Motion of Southern Governors. January 7, 1971 : Memo of U.S. -ICC Opposing Motion of Southern Governors. January 7, 1971 : Order of Court Denying Motion. March 8, 1971 : Notices of Appeal by Southern Lines and Southern Governors from District Court Order of December 16, 1970. ICC PROCEEDINGS ON SECOND REMAND February 11, 1971 : ICC Order reopening No. 29885 for further evidentiary hearings limited to matters specified in District Court remand order of December 16, 1970, and requiring parties to submit verified statements of evidence considered necessary to comply with Court's remand. March 23, 1971 : Northern Lines' Verified Statements filed. March 25, 1971 : Verified Statements of Southern Lines and Southern Governors filed. April 12, 1971 : Replies to Verified Statements filed — Also Petition of Southern Governors to Terminate Proceedings. Followed by Southern Lines Reply to Motion to Terminate. Motion of Northern Lines to Strike said Reply. August 10, 1971 : ICC Order Dismissing Investigation in No. 29885 without prejudice to filing new complaints based upon current evidence. SOUTHERN APPEALS IN THE SUPREME COURT May 6, 1971 : Jurisdictional Statements filed by Southern roads and Southern Governors et al. June 8, 1971 : Motion of Northern roads to Affirm. .July 1971 : Motion of U.S.-ICC to Affirm. July 1971 : Replies of Appellants to Motions to Affirm. September 1971 : Joint Memorandum of Appellants Suggesting Mootness. October 1971 : Memorandum from U.S.-ICC re Mootness. October 12, 1971: Order of Supreme Court vacating judgment of District Court (of De- cember 16, 1970) and remanding to that Court with directions to dismiss proceedings as moot insofar as they fix terms of remand to ICC. TIME REQUIRED 1. From ICC Order Reopening for Further Hearing to Effective Date of its Order of Feb- ruary 3, 1965 in 325 ICC 1 : 6 years. 2. For Judicial Review from filing Action before District Court through Appeal to Su- preme Court and back to District Court until its remand to ICC : 4 years, 2 months. 3. For ICC Handling on Remand to Effective Date of New Order : 1 year 6 months. 4. For District Court Review of New Order of ICC to denial of Motion of Southern Gover- nors for New Trial : 3 months. 5. For ICC Proceeding on Second Remand to Dismissal of Proceedings : 6 months. 6. For Southern Appeals from District Court Order of December 16, 1970, to Vacation account of Mootness : 7 months. 7. TOTAL time from ICC Reopening of No. 29885 for Further Hearing to its Order Dis- missing Proceeding Without Prejudice : 12 years. ICC NO. 31503 ET AL. — TRANSCONTINENTAL DIVISIONS April 5, 1954 : Complaint filed by Eastern lines. June 3, 1954: Complaint of MW lines filed as Sub. No. 1. (Also other subnumbered Com- plaints and cross-complaints). April 26, 1955, to December 11, 1959 : Hearings on intermittent schedule, mostly for cross- examination on Verified Statements. (Transcript 11,242 pages.) June 13, 1960 : Briefs filed. December 6, 1960 : Proposed Report of Examiners. April 3, 1961 : Exceptions to Proposed Report. May 26, 1961 : Replies to Exceptions. June 20, 1961 : Argument and Submission. 491 March 21, 1963 : Report and Order of ICC— 321 ICC 17— Order to become effective July 1, 1963. [Sec below for Court Action to Enjoin ICC Order] July 26, 1963 : Petitions of M-P lines et al. for Reconsideration. September 11, 1963 : Reply of Eastern Roads to Petitions for Reconsideration. December 31, 1963 : Supp. Report and Order, 322 ICC 491. BEFORE DISTRICT COURT June 25, 1963: Complaint of M-P Lines filed in District Court at Los Angeles (No. 63-745 EC) to set aside ICC Order. June 27, 1963 : Temporary Restraining Order of 3/21/63. July 11, 1963 : Hearing on Interlocutory Injunction. August 3, 1963 : Interlocutory Injunction Ordered. March 11, 1964 : Supplemental Complaint to Set Aside ICC order of 12/31/63. March 24, 1964 : Interlocutory Injunction ordered on ICC order of 12/31/63. April 20, 1964 : Plaintiffs' Brief filed. June 22, 1964 : Eastern Roads' Brief filed. August 10, 1964 : Plaintiff's Reply Brief filed. January 25, 1965 : Opinion District Court, 238 F. Supp. 528 Setting Aside. February 18, 1965 : Judgment and Order Staying Judgment. BEFORE SUPREME COURT March 15, 1965 : Notice of Appeal of B&O et al. April 16, 1965 : U.S.-ICC Notice of Appeal. May 14, 1965; Jurisdictional Statement filed by Eastern Roads. May 1965 : Jurisdictional Statement of C&NW et al. September 15, 1965: U.S.-ICC Jurisdiction Statement. [At this stage Eastern and Trans- continental Lines entered into Agreement of September 29, 1965, as result of which following action was taken before the ICC] : October 20, 1965 : Mountain-Pacific and Eastern Lines jointly petitioned ICC to vacate its order in No. 31503 prescribing divisions covered by agreement. January 7, 1966 : ICC granted petition and vacated its order with exceptions. At this stage the further procedure in the Supreme Court was as follows : February 15, 1966: Motions to Affirm filed by appellees on appeals. February 15. 1966 : Memo, suggesting Mootness. March 4, 1966 : Briefs of C&NW Opposing Motion to Affirm. March 1966 : Memo for U.S.-ICC re Mootness and Opposing Motion to Affirm. April 4. 1966: Supreme Court in Eastern appeal vacated Judgment and remanded with instructions to dismiss case as moot. April 4. 1966 ; Supreme Court noted Jurisdiction in C&NW and U.S. Appeals. April 19, 1967 : Appeals Argued before Supreme Court. May 29, 1967: Opinion Supreme Court, 387 U.S. 326 sustaining ICC orders prescribing divisions as between Midwestern and M-P lines. TIME REQUIRED 1. From filing of Eastern Complaint to Initial Report of ICC : About 9 years. 2. From Court Action to Enjoin to Order of District Court : About 1 year. 8 months. 3. From Appeal to Supreme Court to Dismissal of Case as Moot (account Settlement) : About 1 year. 4. TOTAL for Litigation from filing Complaint with ICC to Supreme Court Dismissal as Moot : 12 years. Source : Penn Central. 74-924 O - 73 - 33 APPENDIX D Exhibit 1 July 28, 1960. Confidential Mr. David C. Bevan, Financial Vice President, The Pennsylvania Railroad Co. Philadelphia, Pa. Dear Dave : The Committee of Potential Pipelines in the Pennsylvania Railroad system has discussed in the past various proposals all of which proposals have been items which were small, and in most cases, independent promotions. With the exception of a proposal discussed on the 26th of July, these proposals have not been worthy of favorable recommendation. This memorandum has a two-fold purpose; (1) to recommend a basic approach to pipelining in the Pennsylvania Railroad system, and (2) a specific recommendation for an acquisition. We believe the approach to the pipeline situation in the Pennsylvania should be one of a positive nature wherein the Railroad system, with premeditation, will cause a pipeline management unit to be contained within the Pennsylvania Railroad system. The purpose of this unit will be to acquire and/or construct pipeline systems within the area covered by the Pennsylvania Railroad and its subsidiaries and/or area covered by any possible future consolidations. The point mentioned in the previous paragraph is vitally important because it activates, In a practical manner, that which up to this point has been a passive type of Committee action. This nucleus of pipeline management will have as its objective the creation of the maximum pipeline transportation system within the confines of the area served and perhaps at a later date, to spill over to adjacent areas. This will attempt not only to profit by pipelin- ing transportation within its areas but to recapture transportation income which has been lost to the Railroad through changes in methods of transportation. The specific recommendation made herein is for Pennsylvania Railroad to acquire the Buckeye Pipe Line Company. The Buckeye Pipe Line Company is a common carrier line. There is no known stock control of the Buckeye Pipe Line. The Buckeye Pipe Line Company will fit in and dovetail with the Pennsylvania Railroad system as is now constituted. The Buckeye Pipe Line Company is a going concern having a gross income for the year 1959 of $22,600,000 ; a net income of $3,400,000 and a cash flow of approximately $6,200,000, earnings of $2.62 per share with dividends in 1959 at $1.45 a share. The recent quote on the New York Stock Exchange was 31-31%. There are issued and outstanding 1,310,672 shares of Buckeye Pipe Line Company Common Stock of no par value. The total debt of the Pipe Line at the end of 195!) was $23,200,000. Cash and equivalent at the end of 1959 amounted to approximately $3,500,000. The acquisition of the Buckeye Pipe Line Company would provide the Pennsylvania Railroad and its system with: (a) a management team for pipelining; (b) a basic system for covering their area and a system which could be expanded in the Pennsylvania Rail- road area; (c) It is believed that this acquisition would allow constructive planning to be made with a view to the erection of more industrial properties on the Pennsylvania system which we are sure is a goal of the management of the Pennsylvania : (d) The probabilities are that savings will be made to the Pennsylvania Railroad's fuel cost: (e) In all proba- bility, would allow the Pennsylvania Railroad to serve industry, including the public utility industry with fuel and standby fuel in the form of propane. AVe believe this to be important as our approach is that the Railroad is in the transportation business and they should take part in transporting, in a modern way, portions of the fuel now needed and that which will be needed in the future: (f) Inasmuch as this is a going company the Pennsylvania system will not be putting out money on a promotional basis, but will have a return on its money from the very moment it commences acquisition; (g) Under the tax laws, it is probable that the net income of $3,436,000 will be substantially increased due to the tax haven that may be provided by the Pennsylvania Railroad system. We have taken the liberty of discussing this matter with a large institutional investor ; namely, the Northwestern Mutual Life Insurance Company, which company, in addition to owning debt of the Buckeye Pipe Line Company, owns 103,000 shares of the Common Stock. The Financial Vice President of the Northwestern Mutual Life Insurance Company, Mr. Peter B. Langmuir, agrees with us that there is an opportunity here for the Railroad to commence the building of a substantial pipeline empire under the guidance and owner- ship of the Pennsylvania Railroad system. Mr. Langmuir has told us that he will cooperate with us. The method of acquisition, in our opinion, would be: (a) an understanding with the Northwestern Mutual Life Insurance Company, which means that the Pennsylvania at (493) 494 this point would not have to buy the 103,000 shares of Common Stock, but could accept a partnership type of operation with the Northwestern with the view to building a bigger pipeline system; (b) a gradual and confidential market acquisition of the Buckeye stock, together with the purchase of any blocks which may become available would be the second step. This amount of stock to be acquired in the open market should probably be in the neighborhood of 250,000 shares to 350,000 shares which, along with the 103,000 of North- western, would assure working control; (c) the third step would probably be an offer to stockholders to tender for cash or for stock additional shares of Buckeye. Depending on the desire of the Pennsylvania management, additional tenders or additional cash acquisi- tions of the stock could be made until the Pennsylvania Railroad System had acquired 80% or higher, at which time they would consolidate. When, as and if acquisition or control has been established, it is our belief that there will be numerous opportunities to extend the present Buckeye operation. The question as to whether the commencement of the acquisition should be dis- cussed with the present management of Buckeye or whether acquisition should be com- menced without discussion is a matter of managerial decision. The management of the Buckeye Pipe Line Company headed by Mr. George Patterson is believed to fall in the category of very satisfactory, not excellent. The depth and operational capacity of the management is sound ; the only real question being as to whether or not the President is strong enough or dynamic enough to proceed with strong purpose for the creation of the pipeline system which is envisioned here. He may be, but a careful analysis of his potential should be conducted. If he is not, in the opinion of your management, we can assure you that there are available personnel who could fulfill the function of strong, energetic and far-seeing management. This memorandum must be considered extremely confidential. Copies of the latest Annual Report of the Buckeye Pipe Line Company are attached hereto. In addition to the Annual Report, a proxy statement dated March 31, 1960 is also attached. Respectfully submitted, Charles J. Hodge. Exhibit 2 [From the Baltimore Sun, May 14, 1968] Penn Central "Will Diversify — To Spend $500,000,000 in Variety of Fields Philadelphia, May 14 (A.P.) — The Penn Central Company plans to diversify by spend- ing about $500,000,000 in a variety of fields in the next six years, according to chairman Stuart T. Saunders. Saunders, speaking Monday at a meeting of business and financial leaders, said the money to diversify would come from the disposition of 1,700,000 shares of Norfolk & Western stock and "other sources." "We expect to replace these assets with sound investments that will become addi- tional sources of growth and stability of earnings," Saunders said. "We are continuing to seek companies with imaginative management with the promise of expanding profits." Saunders said, however, diversification would not come "at the expense of our trans- portation business. "We are totally committed to our responsibilities as a common carrier and we are convinced that we can make our railroad operations stand on their feet." Exhibit 3 [From the Philadelphia Bulletin, November 7, 1963] Pennsy Eyes Diversification, Saunders Says New York. — Stuart T. Saunders, board chairman of Pennsylvania Railroad, reports the road is actively considering a variety of diversification proposals. In his first news conference since becoming the Pennsylvania chief executive officer five weeks ago, Saunders outlined plans for giving the nation's largest railroad "a new look." He said railroad operations, in the red in 1962, will yield a profit in 1963. Saunders refused to be drawn out on what sort of diversification ideas were being explored, saying they were embryonic. He indicated some of them might lie outside transportation. Exhibit 4 [Memoranda dated May 10, 1963, from P.R.R. Finance Department] Through a combination of forces with which we are too familiar, competing modes of transportation have cut deeply into railroad traffic, thus imparing the earning capacity of many railroads. The current pattern of railroad mergers reflects the fact that in certain areas the railroads are overbuilt in relation to present and anticipated traffic potential. To some degree at least, railroad managements are confronted with the alternatives of oper- ating within the present scope on the most economic basis attainable, or of using capital 405 reserves and credit to diversify into other industries of greater profitability or indicated growth potential. Logically, diversification should be into an industry which supplements or complements the basic operation, and one which in concept and philosophy is readily under- stood by the management of the parent company. By any approach to the question, pipe lines appear to offer a most promising avenue for diversification by railroads and in con- junction with our forward planning, on the recommendation of the Financial Department for the past few years we have utilized the services of a firm of consultants, Pipe Line Tech- nologists, Inc., of Houston, Texas, to assist us in exploring the possibilities of pipe lines, including how best to utilize our right of way for this purpose. Merger developments in the East point to the ultimate divestment of our interest in the Norfolk & Western and we have publicly announced and have gone on record with the Iterstate Commerce Commission that, upon consummation of the P.R.R.-N.Y.C. merger proposal, we were prepared to dispose of our entire holdings over a period of time in an orderly manner. With N. & W. Common now selling around 118, our present holding of N. & W. stock have a market value of approximately $290 million and our option to exchange our Wabash Common for N. & W. Common at any time after the sixth year of the lease of the Wabash would add close to $80 million to this value at current prices. About 70% of our present holdings are currently pledged to secure Pennsylvania Company debt. At 1962 levels, our N. & W. holdings provide annual income of almost $13.5 million and the stock which we would receive in connection with the Wabash transaction would increase this annual income to almost $17 million. Although this dividend income is not now subject to any Federal income tax because of our current lack of taxable earnings, it is important to remember that a substantial difference exists tax-wise between dividend income and other types of income. From this brief review of our holding of N. & W. stock, it can be seen that its liqui- dation poses some difficult problems and it may well be that we will be allowed less time to liquidate than we believe is desirable. Considering the two factors — divestment of our interest in the N. & W. and diversifica- tion into pipe line transportation — time would be conserved and industry status more quickly attained by acquiring a strong position in a well-known and firmly established pipe line com- pany, preferably in the territory served by the Pennsylvania. Our studies lead us to believe Buckeye Pipe Line Company is best suited to our objectives. The Buckeye system and the areas served are shown on the attached map, market Exhibit A. Specifically, the apparent advantages of Buckeye may be summarized as follows : (1) Buckeye is strategically located in the industrial heart of the nation where a normal but continuous rate of growth may be reasonably expected. (2) The Company has a long history of acceptance by shippers, consignees and con- necting carriers. (3) The territory served by Buckeye generally conforms with the service areas of the P.R.R. and New York Central. (4) Buckeye is an important crude oil carrier to oil refineries in Michigan, Ohio, western Pennsylvania and western New York. (5) In recent years, 1953 to date. Buckeye has directed its major expansion efforts to the movement of refined products, including motor fuels, aviation fuels, burning oils and LPG's, the latter having excellent growth potential. Presently, Buckeye has basic coverage in the states of Indiana, Michigan, Ohio, Pennsylvania, New York and New Jersey. (6) Buckeye is a relatively large pipe line carrier in terms of transportation area, tonnage, and scope of services. It is unlikely that, at the present level of economic development, any part of the United States could support a new carrier system com- parable with Buckeye. (7) Buckeye's operations over the past several years reflect experienced and capa- ble management. Unfortunately, earlier management was neither alert nor aggressive, allowing competition to establish strong positions, particularly in product transporta- tion. Indications are that present management is gradually overcoming inherited handicaps. (8) With our extensive right-of-way, the acquisition of an old established company would provide an excellent springboard for further penetration into the pipe line transportation industry. At the current price and based on the regular quarterly dividend of $1.25 per share, N. & W. Common is selling on about a 4%% basis, or 4.65% based on the total dividends of $5.50 per share paid in 1962. At the present quarterly rate of 50tf per share, Buckeye stock is selling at slightly over a 3% basis. Aside from the growth pattern reflected in Buckeye's volume and earnings, there are two areas in which control by Pennsylvania could act to increase Buckeye's earnings and dividends. The first stems from the possible utilization of Pennsylvania system tax losses in the future through acquisition of 80% or more of the Buckeye stock. (At the present market, all of Buckeye's outstanding stock has a value of approximately $87 million.) In the past five years, Buckeye incurred Federal income taxes averaging $3.08 per share per year ; in the past three years, the average was $3.27 per share ; and in 1962, such taxes amounted to $3.46 per share. These amounts are indicative of the potential increased income available to a parent company with a tax situation similar to ours. We would have to be unduly pessimistic with respect to the benefits to be derived from our merger 496 with the New York Central if we were to assume we could remain indefinitely in a tax loss position. However, it is a fact that we have accumulated a large carry-forward loss and none of our system companies have paid Federal income taxes subsequent to 1953. Prior to that time, our effective rate generally was substantially below the indicated rate. Furthermore, in the more recent years we have not claimed all permissible deductions and, thus, there are options available to us with respect to additional deductions which we can exercise when our earnings position so warrants. Therefore, it seems apparent that a considerable portion of the tax liability of Buckeye could be avoided through acqui- sition of at least 80% of its stock by Pennsylvania with a corresponding increase in the earnings available to Pennsylvania. The second area of potential increased earnings to Buckeye involves the pipe line movement of diesel fuel to railroad fueling points contiguous to the pipe line system. An accurate evaluation of benefits in this area would necessitate a study in considerable detail ; however, some general conclusions can be drawn from information at hand, including Inter- state Commerce Commission reports and Buckeye tariffs. The routes of a number of Buckeye's lines follow generally the patterns of the Pennsyl- vania and New York Central systems. Buckeye publishes rates to Altoona, Pittsburgh, Terre Haute, Indianapolis and Columbus. In addition, deliveries are made at Inglehook (about 15 miles north of Harrisburg) and Enola. The pipe line crosses the Pennsylvania main line at Freeport, about 20 miles north of Pitcairn. Through interconnection with the Atlantic Pipe Line system, deliveries are made in the Buffalo area to Tonawanda. Short laterals to railroad fuel stations at these and other points would permit direct deliveries of diesel fuel to existing storage tanks. This type of operation would probably decrease the costs and losses associated with loading, handling and unloading tank cars of diesel fuel ; however, if there are benefits in this area so far as railroad operating costs are concerned, it would seem to follow that they are available to us without regard to our acquiring an interest in Buckeye and, therefore, this phase should not have any significant bearing on the matter of acquiring an interest. Fundamentally, the majority of costs associated with the operation of pipe lines are fixed. Incremental throughput volume on a pipe line, up to the capacity of the installed facilities, requires principally only additional fuel or electric power for pumping equipment. Thus, if we measure expenses on an incremental basis, we have a basis to judge the optimum results to Buckeye of moving diesel fuel over their system. To measure minimum results, we can assume that some new construction would be necessary and that the associated ex- penses are equal to the system-wide average, including depreciation, state and local taxes, interest, and other fixed charges for trunk line movements over the Buckeye system. Present daily consumption of P.R.R. is about 15,600 barrels a day and New York Central 15,100 barrels. A review by our fuel purchasing people indicates that in all proba- bility, the maximum daily potential for pipe line delivery of the P.R.R. and N.Y.C. as now constituted would be about 17,000 barrels per day. In the case of P.R.R., this would involve only a change in the method of bulk deliveries. For the N.Y.C, it would mean a substitution of bulk for tank car or truck deliveries. Every railroad operating in the Buckeye area is a source of potential traffic. No doubt some railroads are now using Buckeye and other lines in the area for some of their fuel requirements but no information is available on the extent to which this traffic potential has been developed. Exhibit B reflects the additional earnings which might be expected at various levels if diesel fuel movements based on system-wide average expenses of Buckeye, as mentioned previously, while Exhibit B-l reflects the additional earnings which might be expected at similar levels of diesel fuel movements based on incremental expenses. Such expenses are assumed to equal one-half of average system-wide trunk line costs for such items as pipe line operating: and maintenance expenses, general office salaries and some miscellaneous costs. Depreciation, state and local taxes, interest and other fixed charges have been eliminated. Summarized, these exhibits show potential additional earnings from the transportation of diesel fuel, as follows : EARNINGS PER SHARE Average cost basis Incremental cost basis Barrels per day Before Federal income tax After Federal income tax Before Federal income tax After Federal income tax 5000 $0.10 $0.05 .09 .14 .19 .23 $0.19 .39 .58 .78 .97 $0.09 10 000 .19 .19 15000 - .29 .28 20 000 _ .39 .37 25000 .48 .47 A general review of the Buckeye Pipe Line Co., including some pertinent figures on their financial results over the past ten years is attached as Exhibit C. Financial Department, May 10, 1963. 497 Q 5 >- <"8 < 3 2 2 cc = 2guj Z £C UJ ZO>- m >- in a. * £ o Ul 3 Z CD 498 EXHIBIT B BUCKEYE PIPE LINE CO. -EFFECT OF ADDITIONAL RAILROAD DIESEL FUEL VOLUME [Based on average costs) Buckeye, 1962 5,000 Additional barrels per day- 10,000 15,000 20,000 25,000 Revenue 27,393,000 310,000 621,000 931,000 1,241,000 1,551,000 Expenses: Operating expenses 11,313,000 105,000 210,000 314,000 419,000 523,000 Depreciation.. 4,085,000 43,000 87,000 131,000 174,000 218,000 Interest and other charges 1,378,000 15,000 30,000 45,000 60,000 75,000 State and local taxes 1,742,000 18,000 36,000 55,000 73,000 91,000 Total expenses Income before income taxes Federal income taxes. Net income Net income per share: > Before Federal income taxes.. $6.67 $0.10 $0.19 $0.29 $0.39 $0.48 After Federal income taxes 3.21 .05 .09 .14 .19 .23 18,518,000 181,000 363, 000 545, 000 726,000 907,000 8, 875, 000 129,000 67,000 258, 000 134,000 386, 000 201,000 515,000 268, 000 644 000 4, 604, 000 335,000 4,271,000 62, 000 124,000 185,000 247, 000 309, 000 1 Based on 1,331,057 shares outstanding, December 31, 1962. EXHIBIT B-l BUCKEYE PIPE LINE CO.-EFFECT OF ADDITIONAL RAILROAD DIESEL FUEL VOLUME IBased on incremental costs) Buckeye, Additional barrels per day- 1962 5,000 10,000 15,000 20,000 25,000 Revenue $27, 393, 000 $310,000 $621, 000 $931,000 $1,241,000 $1,551,000 Expenses: Operating expenses 11, 313,000 Depreciation 4, 085, 000 Interest and other charges.. 1,378,000 State and local taxes 1,742,000 52, 000 105, 000 157,000 210,000 Total expenses 18, 518, 000 52, 000 105, 000 157,000 210, 000 Income before income taxes. Federal income taxes. 8, 875, 000 4, 604, 000 258, 000 134,000 516,000 268, 000 773,000 402, 000 i Based on 1,331,057 shares outstanding, Dec. 31, 1962. Estimated earnings per barrel (cents) Revenue 17.000 Expenses: Operating expenses 5. 735 Depreciation 2.389 Interest and other charges .820 State and local taxes .998 Total expenses 9. 942 Income before income taxes 7. 058 Federal income taxes 3.670 Net income 3. 388 1,031,000 536, 000 262, 000 262, 000 1,289,000 670, 000 Net income 4,271,000 124, 000 248, 000 371,000 495, 000 619, 000 Net income per share: ' Before Federal income taxes After Federal income taxes $6.67 3.21 $0.19 0.09 $0.39 0.19 $0.58 0.28 $0.78 0.37 $0.97 0.47 Pipeline rate (cents per Mileage barrel) Selected railroad diesel fuel movements: Linden, N.J. , to: Inglehook (Harrisburg), Pa 169 15 Pittsburgh, Pa 347 24 Lawrenceville, ill, to: Indianapolis, Ind 124 12 Detroit, Mich., to: Columbus, Ohio 204 18 Average 211 17 Note: The above tabulation represents an arithmetical average rather than a weighted average. 499 [exhibit b-i continued] Estimated earn- ings per barrel (cents) Mil eage Pipeline rate (cents per barrel) Revenue _ Expenses: 17,000 2.868 Selected railroad diesel fuel movements: Linden, N.J. , to: Inglehook (Harrisburg) Pa Lawrenceville, III., to: Indianapolis, Ind Detroit, Mich., to: Columbus, Ohio.. 169 124 204 Interest and other charges _ 14 State and local taxes !2 Total expenses 2,868 18 Income before income taxes Federal income taxes _ 14,132 7,349 Average 211 17 6.783 Net income. . Note: The above tabulation represents rather than a weighted average. ai arithmetical average exhibit c Buckeye Pipe Line Co. — General Review of Operations and Financial Results 1953-62, Inclusive The Company was incorporated in Ohio in 1886 and was originally controlled by Standard Oil Company (N.J.). In 1911, with the dissolution of the Standard Oil Trust, the stock of Buckeye was distributed to Standard Oil stockholders and Buckeye was then operated under common management with three other Standard Oil throw-offs — Indiana Pipe Line Co., Northern Pipe Line Co. and New York Transit Co., Inc. (a pipe line). In 1943, Indiana Pipe Line was merged into Buckeye and the other two companies became wholly-owned subsidiaries. Buckeye has two other affiliates, neither of which has thus far made any significant contribution to earnings : (a) Everglades Pipe Line Co. (41% interest with Cities Service Co. the other principal owner) which owns a pipe line completed in 1959, running from Port Everglades, Fla., t» Miami International Airport. (b) Buckeye Tank Terminals Co. (joint ownership with Chicago Bridge & Iron Co.) which was organized in 1958 to construct, own and operate fuel terminals and related facilities. Late in 1960, Buckeye purchased Esso's Tuscarora Pipe Line running from Allentown, Pa., to Midland, Pa., which is near the Pennsylvania-Ohio line, about 10 miles west of Conway, Pa. This purchase enabled Buckeye to link together its Eastern and Mid-West products systems. Another important expansion move was made in 1961 through a joint undertaking with Texas Eastern Transmission Corp. involving the construction of a 96- mile products line from Lebanon, O. to Lima, O. This link with Texas Eastern has enabled Buckeye to move into the growing and profitable area of liquified petroleum gas transportation. operations Although originally a crude oil gathering system. Buckeye has directed its major expansion efforts in recent years toward the movement of refined products and in 1962 more than 40% of its volume as measured by barrel miles was represented by products movements. Table I shows how Buckeye's crude movements have tended to stabilize in recent years and it also illustrates the tremendous growth in products movements. Basically, Buckeye is a common carrier operating a 7,500 mile system in seven states (Illinois, Michigan, Indiana, Ohio, Pennsylvania, New York and New Jersey) generally corresponding to the geographical area served by the Pennsylvania and New York Central railroads. It is an important crude oil carrier to oil refineries in Michigan, Ohio, western Pennsylvania and western New York. It publishes local rates and publishes or participates in joint rates for the transportation of petroleum products in two areas. In the East, the movement is generally west and north from Linden, Newark, Paulsboro, N.J , to Pennsyl- vania, New York and to Cleveland, O. In the Mid-West, the system operates around a hub at Lima, O., handling products in all directions between points in Illinois, Indiana, Ohio and Michigan. 500 TABLE l.-BUCKEYE PIPE LINE CO., DAILY AVERAGE DELIVERIES [Thousands of barrels! Year Crude Products Total Year Crude Products Total 1951 437 55 492 1958. 411 165 576 1954 421 104 525 1959. 449 182 631 1955 446 119 565 I960. 434 200 634 1956 486 153 639 1961. 431 217 648 1957 454 158 612 1962 443 235 678 As of December 31, 1962, there were 1,331,057 shares of stock outstanding and held by 5,544 stockholders, with 2,000,000 shares authorized. However, on May 1, stockholders, approved a proposal to increase the authorized shares to 4,000,000 to effect a 2 for 1 stock split. The stock has been listed on the New York Stock Exchange since June 25, 1956. The price range for the years 1958 to date is shown below with current sales running near the 1963 high. Year High Low 1958. 1959. 1960. 1961. 1962. 1963. 30 22% 33K 28% 38% 28 59 35 61« 45% 67 % 57 Month-by-month prices and number of shares traded on the New York Stock Exchange from January 1962 through March 1963 are listed in Table II. At the close of 1962, about 2% of the Company's stock was held by the trustees of the Company's Thrift Plan. In 1959, the shareholders approved a restricted stock option plan involving 75,000 shares of stock. At the close of 1962, options involving 20,385 shares had been exercised, 2,250 shares were reserved for issuance under the plan, and options to purchase 52,365 shares were outstanding, of which 9,015 shares were exercisable. TABLE II. -BUCKtYE PIPE LINE CO. PRICE RANGE AND NUMBER Of- SHARtS TRADED ON NEW YORK STOCK EXCHANGE (BY MONTHS) Month High 1962 Low Number of shares High 1963 Low Number of shares January 61 J-g 55% February 60% 58% March 60% 59 April 60% 55% May 58 47% June... 50 45^ July 48 46% August 51% 46% September.. 55 51% October 52% 49% November... 55% 51% December 58% 55% Total 18,800 59 57 86,300 7,200 61 58 12,200 8,100 62 58% 8,700 27,600 17,600 7.600 6,100 23,000 ---. 5,700 7,600 6,500 22,200 158,000 EARNINGS Buckeye has directed its major expansion efforts in recent years toward the movement of refined products and, as a result, the company's growth in sales and earnings has been impressive. Furthermore, in the face of generally declining profit margins elsewhere, it has been able to show a modest but generally constant improvement in its profit margin. In 1952, the company reported sales of $12.4 million and net income of $1.6 million, equivalent to 13.2% of sales. By 1962, sales had increased to $27.4 million with net income of $4.3 million being equivalent to 15.7% of sales. Table III-A shows the sales and net income, be- fore and after Federal income taxes, for the ten-year period 1953 to 1962, inclusive, as well as the relationship of earnings to sales and to shareholders' equity. Table III-B pre- sents these same figures in the form of three-year moving averages. Per share earnings, before and after Federal income taxes, for the ten-year period are shown in Table III-C while the cash throw-off, in the aggregate and on a per share basis, is covered in Table III-D. 501 TABLE III A. BUCKEYE PIPE LINE CO., SALES, EARNINGS, AND SHAREHOLDERS' EQUITY AND RELATIONSHIP OF EARNINGS TO SALES AND SHAREHOLDERS' EQUITY 1953-62, INCLUSIVE [In millions of dollars] Net income before Net income after Net income Federal income tax Federal income tax Before After As percent As percent As percent As percent Federal Federal Share- of sales of share- of sales of share- income income holders' holders' holders' Sales tax tax equity' equity equity 13.1 2.8 1.5 18.4 21.37 15.22 11.45 8.15 17.1 4.1 2.0 19.2 23.98 21.35 11.70 10.42 19.1 4.7 2.2 20.3 24.61 23.15 11.52 10.84 21.9 6.5 3.0 23.6 29.68 27.54 13.70 12.71 21.9 5.6 2.7 26.8 25.57 20.90 12.33 10.07 21.3 6.4 3.0 27.8 20.05 23.02 14.08 10.79 22.7 7.3 3.4 29.2 32.16 25.00 14.98 11.64 23.2 7.3 3.5 30.6 31.47 23.86 15.09 11.44 26.5 8.5 4.0 32.2 32.08 26.40 15.09 12.00 27.4 8.9 4.3 34.4 32.48 25.87 15.69 12.50 1953. 1954. 1955. 1956. 1957. 1958. 1959. 1960. 1961. 1962. i Average beginning and end of year. TABLE lll-B.— BUCKEYE PIPE LINE CO., MOVING 3-YEAR AVERAGES, SALES, EARNINGS, AND SHAREHOLDERS' EQUITY AND RELATIONSHIP OF EARNINGS TO SALES AND SHAREHOLDERS' EQUITY 1953-62, INCLUSIVE [Millions of dollars) Period Net income Shareholders' equity ' Sales Before F.I.T. After F.I.T. $16.4 $3.9 $1.9 $19.3 19.4 5.1 2.4 21.0 21.0 5.6 2.6 23.6 21.7 6.2 2.9 26.1 22.0 6.4 3.0 27.9 22.4 7.0 3.3 29.2 24.1 7.7 3.6 30.7 25.7 8.2 2.9 32.4 1953 to 1955. 1954 to 1956. 1955 to 1957. 1956 to 1958. 1957 to 1959. 1958 to 1960. 1959 to 1961. 1960 to 1962. 1 Based on average beginning and end of year for each year. Net income before F.I.T. Period As percent of sales As percent of shareholders' equity Net income after F.I.T. As percent of sales As percent of shareholders' equity 1953 to 1955 23.78 1954 to 1956.. 26.29 1955 to 1957 26.67 1956 to 1958 28.57 1957 to 1959 20.09 1958 to 1960 31.25 1959 to 1961. r._ 31.95 1960 to 1962 31.91 20.21 24.29 23.73 23.75 22.94 23.97 25.08 25.31 11.59 12.37 12.38 13.36 13. 64 14.73 14.94 15.18 9.84 11.43 11.02 11.11 10.75 11.30 11.73 12.04 TABLE lll-C. BUCKEYE PIPE LINE CO. EARNINGS PER SHARE BEFORE AND AFTER FEDERAL INCOME TAXES, 1953-62, INCLUSIVE Net income per share Year Before After Federal Federal income income taxes taxes Number of shares (Dec. 31) 1953... $2.57 $1.39 1, 094, 456 1954 3.78 1.80 1,094,456 1955 4.34 2.05 1,094,456 1956... ... . 4.97 2.25 i 1,310,672 1957 4.29 2.02 1, 310, 672 1958 4.87 2.26 1, 310, 672 1959. _. 5.59 2.62 1,310,672 1960 5. 56 2. 65 1, 310, 672 1961 6.47 3.02 1,312,942 1962 6.67 3.21 1,331,057 > 216,216 shares issued as result of conversion of $4,000,000 convertible debenture bonds issued in 1953. 502 TABLE IH-D.— BUCKEYE PIPE LINE CO.-CASH THROWOFF, 1953-62, INCLUSIVE (In millions) Per share Year Cash Cash throwoff throwoff Deferred before before Federal Federal Federal Federal Net Depreci- income Cash income income Number of Cash income income ation tax throwoff tax tax shares throwoff tax $1.5 $1.5 $0.2 $3.2 $1.1 $4.3 1,049,456 $2.93 $3.92 2.0 2.1 5 4.6 1.6 6.2 1,094,456 4.20 5.66 2.2 2.3 7 5.2 1.8 7.0 1,094,456 4.77 6.45 3.0 2.4 8 6.2 2.8 9.0 1,310,672 4.72 6.84 2.7 2.5 8 6.0 2.1 8.1 1,310,672 4.59 6.22 3.0 2.7 6 6.3 2.8 9.1 1,310,672 4.80 6.91 3.4 2.8 4 6.6 3.6 10.2 1,310,672 5.04 7.75 3.5 3.4 1 7.0 3.7 10.7 1,310,672 5.33 8.13 4.0 4.0 1 8.1 4.4 12.5 1,312,942 6.18 9.55 4.3 4.1 a 9.2 3.7 12.9 1,331,057 6.93 9.74 1953. 1954. 1955. 1956. 1957. 1958. 1959. 1960. 1961. 1962. DIVIDENDS Dividends have been paid in every year since the Company went public under the U.S. Supreme Court disintegration order in 1911. In the ten-year period 1953 to 1962, incl., the quarterly rate has been increased from 20tf per share to 45<- per share with the result that in each year, except 1958, the annual payments show an uninterrupted increase. In the first quarter of 1963, the rate was increased to 50^ per share, or $2 on an annual basis. On the average, about 57% of earnings have been paid out in dividends. The dividend record over the ten-year period 1953-1962, inch, is contained in Table IV. Certain long term debt obligations contain provisions under which earnings retained in the business are restricted at December 31, 1962, in the amount of $6,900,306. However, retained earnings on that date were close to $19 million and. from a practical standpoint, the restrictions contained in the debt instruments do not appear to present any problems so far as the Company's dividend policy is concerned. TABLE IV.-BUCKEYE PIPE LINE CO. DIVIDENDS, 1953-62, INCLUSIVE Year Dividends paid Dividends Quarterly — as percent of rate Per share Total Net income net income $0.20 $0.80 $875, 565 $1,515,921 57.76 . 20-. 25 .90 985,010 1,972,431 49.94 .25 1.00 1,094.456 2, 242, 027 48.82 .30 1.20 1.426,860 2,954,212 48.30 .35 1.40 1,834,941 2,653,613 69.15 .35 1.40 1,834,941 2,959 894 61.99 . 35-. 40 1.45 1.900,475 3,436,181 55.31 .40 1.60 2.097,075 3, 473, 503 60.37 . 40-. 45 1.70 2, 229, 733 3,970,676 56.15 .45 1.80 2, 385, 244 4,271.346 55.84 1.33 1.59 . 1.70 1,666,430 2, 089, 494 2,237,351 2,944,980 3,622,320 3,905,175 56.59 57.68 57.29 1953... 1954 1955 1956 1957 1958 1959 1960... _ 1961..... 19S2 Averages: 10 years— 1953 to 1962 5 years— 1958 to 1962.. 3 years— 1960 to 1962.. DEBT CAPITALIZATION At the close of 1962, the outstanding long term debt of Buckeye amounted to $35,801,000, as shown in Table V, with $2,353,000 due in 1963 and the balance of $33,- 448,000 maturing, as follows : Year: Annual amount Year: 1979-84 1985 — 1986 __ 1987 — Annual amount 560, OOO 660, 000 260, OOO 520, OOO 1964-69 $2,275,000 1970 3.873,000 1971 5,943,000 1972-77 693,000 1978 966,000 The relationship of debt to total capitalization during the past ten years is covered in Table V-A. As of December 31, 1962, debt represented about 50% of total capitalization. 503 BUCKEYE PIPE LINE CO.— LONG TERM DEBT, DEC. 31, 1962 [Includes portion due in 1 year] Issue Interest rate (percent) Due Callable Outstanding Dec. 31, 1962 Consolidated sinking fund debentures ($30, 000,000 dated Sept. 1, 1951). Promissory notes ■ Notes— 1958 ($2,000,000) Notes-1960 ($7, 500,000). Notes— 1962 ($6,500,000) Total. 314 Sept. 1, 1971 i Yes. 2.85 Serially to Dec. 1, 1970.. Mi Serially to May 1, 1978.. 514 Serially to June 1, 1985. 47.0 Serially to June 1, 1987. (?)-- Yes. Yes. Yes. $15,600,000 4, 300, 000 2,401,000 7, 000, 000 6, 500, 000 35, 801, 000 i Annual sinking fund payments of $1,600,000 through 1963 and $1,250,000 thereafter (bonds callable at par for sinking fund purposes) 2 $4,930,000 assumed by Buckeye on acquisition of assets of Tuscarora Pipe Line Co. in 1960. TABLE V-A.-BUCKEYE PIPE LINE CO. RELATIONSHIP OF DEBT' TO TOTAL CAPITALIZATION, 1953-62, INCLUSIVE IDollar amounts in millions! Year end Debt as percent Shareholders' Total of total Debt equity capitalization capitalization $33.5 $18.7 $52.2 64.2 32.4 19.7 52.1 62.3 30.8 20.8 51.6 59.7 25.2 26.4 51.6 48.9 23.6 27.2 5C.8 46.5 24.8 28.4 53.2 46.6 23.2 29.9 53.1 43.7 33.9 31.3 65.2 52.0 31.9 33.1 65.0 49.0 35.8 35.6 71.4 50.2 1953.. 1954... 1955... 1956 '. 1957... 1958... 1959... 1960... 1961... 1962... 1 Includes portion due in 1 year. 2 $4,000, COO convertible debentures issued in 1953 converted into 216,216 shares of stock. CAPITAL EXPENDITURES At the close of 1952, Buckeye's investment in property, plant and equipment amounted to $51 million gross — $26.1 million net after depreciation and amortization. At the end of 1962, this investment had increased to $119 million gross — $71 million net after deprecia- tion and amortization. As shown in Table VI, capital expenditures in this ten-year period (1953-1962, incl.) aggregated $72.2 million. While most of this money was spent in the expansion of its products division, the crude division has been upgraded. During this period. Buckeye borrowed a total of $40.5 million so that 44%, or $31.7 million, of the total capital expenditures was financed initially from internally generated funds. Exhibit 5 New York Central System, Collinwood, Ohio, November 8, 1963. Mr. J. O. Boisi, Vice President, Real Estate, New York, N.Y. In line with our discussions of areas of diversification for the Railroad, we are enclos- ing a preliminary study which indicates that transmission and sale of raw water can be extremely profitable and can be accomplished with little or no land acquisition. Benefits to the Railroad include : 1. Profits from the sale of water. Actual operating statements in the report prove this profitability. 2. A distinct advantage in the attraction of industry to location on the Railroad where water is immediately available. 3. Profits to be made in sale of real estate which will appreciate in value when water is made available. The report points out that the Great Lakes Drainage Basin is the only area in the United States having the necessary water for unlimited industrial expansion and that the 504 Central is unique in having the real estate to provide water distribution throughout the entire basin. The concept is particularly timely in view of the recent serious drought throughout the Eastern United States. In many communities in the Northern Ohio Study area, this was the major issue in last week's elections and administrations are committed to provide water in some way. If the Central could step in with a master plan to provide raw Lake Erie water to these areas (and to industrial sites), we would receive immediate support from all levels of state and local government. By limiting our activities to wholesale raw water (required by industry), we would permit local governments to own and operate their treat- ment and distribution facilities. We would welcome the opportunity of discussing this further with you, because we believe that the future will prove that water is the greatest single asset enjoyed by the New York Central. We also enclose as information an article from the Cleveland Plain Dealer of November 7. Mr. W. R. Gbant : J. J. Wright. proposal 1. The New York Central to enter a program of transporting water from Lake Erie along its rights of way to the back areas of the watershed. 2. Acquisition of Ohio Water Service Company to achieve entry into this program. ADVANTAGES TO NEW YORK CENTRAL 1. Revenue will be produced from sale of water to industry, municipalities and agri- cultural activities. 2. Realization of increased tonnage from industry and commerce which must locate in the areas where water has been made available. 3. With confidential knowledge as to routing and scheduling of transport main construc- tion, land can be purchased beforehand and disposed of at substantial profits after water improvement has been completed. CONCLUSION It is evident by the scope and nature of the first above proposal, that a comprehensive study by competent personnel would be required in order to fully evaluate the potential of this program. Most of the study areas are outlined in Mr. J. .T. Wright's letter dated Oc- tober 8, 1965 under Feasibility Studies. Letter is attached. Some areas could be studied by Central's personnel in the real estate, law and engineering departments before soliciting outside advice. A preliminary evaluation of the water of Lake Erie should be undertaken as a first step. The potability of this water could be of long range significance to the overall success of a water transport system. Both Time magazine and U.S. News and World Report have in- dicated that Lake Erie is polluted. One source estimated that pollution control could cost the bordering states of Lake Erie a billion dollars apiece. An article in the September, 1965 issue of Water Works and Wastes by Dr. Emmett W. Arnold, Director of the Ohio Department of Health indicates that Ohio is amply supplied with water at present and it doesn't seem likely that Ohio should experience serious trouble in the near future. (Part of this article is reproduced as Exhibit I, attached). This adequate supply of water exists with only a 2% utilization of Lake Erie water in the Lake Erie watershed area. This situation could detract from the value of our proposal, unless this project supplies the few areas in Ohio that have experienced water shortages. Other areas that warrant examination are as follows : 1. Procedures involved in obtaining a water utility franchise from the State of Ohio Public Utilities Commission. 2. Estimates of increased tonnage and commerce which could relocate on our lines. Our examination of Ohio Water Service Company indicates that this Company does not offer any unique investment value at this time. Should this Company prove of value in sup- plementing the overall system, further study of its franchise position should be made. Ohio Water Service Company is currently contesting two franchise cases in the courts. Some study can be made of alternative methods of solving the water problem currently facing the United States as they may reflect the profitability of a transport system. Some solutions other than a transport system are saline water conversion, conservation and devel- opment of available fresh water supplies through construction of dams and reservoirs, con- servation practices and programs, pollution control, industrial re-use of water and reclaim- ing sewage. [EXHIBIT i] September 1965, Issue of Water Works and Wastes by Dr. Emmett W. Arnold, Director of the Ohio Department of Health Ohio is blessed with an average annual rainfall of 36 to 38 inches, about 75 billion gal- lons daily, or for a one third available run-off. the average daily supply is about 25 billion gallons. Present domestic and industrial water usage is about 12 billion gallons a day. As- suming that the population of Ohio will double in 25 to 30 years, the total water usage then would be equivalent to the average daily run-off. This, however, is not the limit of Ohio's 505 water supply. Some 120 billion gallons of water a day flow past Cleveland in Lake Erie, and some 60 billion gallons a day flow past Cincinnati in the Ohio River. Much of this of course is run-off from other states. In addition Ohio also has a rich underground supply of water. Despite these blessings of rich water supply, Ohio already has had some problems of water shortage in a few areas, principally near water divides. Additional water storage will be necessary in the future and the state has encouraged not only the building of storage dams but also the protection of possible future water reservoir sites from encrouchment. Ohio Water Service Co. Current Price — 32. Earned Per Share (1964 Earnings) — $1.99. Payout Ratio— 80%. Price Earning Ratio — 16. BUSINESS Supplies treated water without competition for domestic and industrial purposes to various cities and communities located in Ohio including Massillon, Marysville, Washing- ton Court House, Struthers, Poland, Campbell, and other communities adjacent to Youngs- town in Mahoning County. The total population served is 175,000. The Company also oper- ates an untreated water supply system serving 18 industrial customers and railroads in Youngstown and a 12 mile stretch along the Mahoning River Valley with non-potable water. Non-potable water sales provided 16% of 1964 water revenue. Of 1964 water revenues, residential and commercial sales accounted for 71%, industrial 22% and all other 7%. Steadily growing residential services and lessened dependence on highly cyclical non-potable water sales to Youngstown area steel-mills has been a stability factor. The Company is contesting in the Courts two actions of the City of Willoughhy applica- ble to 1,200 customers served. These are a reduction in rates of $35,000 a year so that the Company's tariff would not exceed that of municipal water and proceedings to munici- palize the Willoughby water system that could reduce gross revenues by an additional $35,000. Ohio Water Service has maintained a liberal payout ratio above 80% for the past 7 years. These are dividend restrictions on the stock but they are of no consequence at present. This Company has a convertible 6% bond issue due in 1977. Bonds are convertible if called into 40.10 shares per $1,000 bond and such conversion would dilute earnings per share 21.2%. It is not likely that Ohio Water Service Co. would force conversion by exercising this call feature. RECOMMENDATION Ohio Water Service has increased total operating revenue in each of the past ten years at a ten year growth rate of 9.5%. This improvement has continued in the first six months of 1965. Earnings have experienced a somewhat lower growth rate of 4.7% through- out this same period. Ohio Water is burdened with a very high debt as a percent of total capital, 68% in 1964 ; fixed charges earned has consistently approximated two times since 1959. The Company has had a deficit in working capital in eight of the past ten years; the 1964 deficit was $1,790,051. Although this working capital position is somewhat typical of water utility companies, this Companv has not been able to make improvements since 1961. Ohio Water Service Co. could prove to be a suitable investment if New York Central RR decides to enter the water business in the Lake Erie watershed area in the proportion outlined by the Preliminary Study of a Water Transport System. Further study of the franchise position of this Company would be necessary if purchase is further considered. R. P. Stockman. Exhibit 6 New York Central System, Collinwood, Ohio, October 8, 1965. Mr. A. E. Perlman, President, Neiv York Central System, Netv York, N.Y. : In view of the investments that the Pennsylvania is making in real estate, we think it might be time to reconsider the possibility of using railway rights-of-way as a water distribution network. Please refer to Mr. J. O. Boisi's letter of February 20, 1964 on this subject, copy attached. At a later date we discussed this matter with him personally. With the con- centration of population building up in the New York Central territory it may be well to restudy this matter. Considering northern Ohio as an example, we are enclosing a map indicating principal streams and their drainage areas on which we have noted numerically and circled the major drainage basins, the Central's trackage, and the specific areas referred to in our suggestions below. Drainage Basins Nos. 1, 2, 3, and 4 are well traversed by our rights- of-way while we have a minimum ownership in Nos. 5 and 6. Area No. 5 affords the least potential for establishing a water transport system since the greater portion of the 506 land area is served by the municipally-owned water systems of Cleveland and Akron. Area No. 6 has, in the past few years, experienced a rapid growth of heavy industry and our comments under Ohio Water Service Company pertain to this area. We have the following suggestions for concurrent action to he taken : /. Acquisition of Ohio Water- Service Company. — Brief reference was made in our report of November 8 to two firms engaged in the distribution and sale of water in Ohio. Further study of their operations leads to the recommendation that the Central purchase the Ohio Water Service Company to achieve immediately the following benefits : a. The Company's operations have consistently yielded adequate returns. These returns would bolster the Central's water program in the early days of formation and construction. Details of the Company's earnings and related information appear on the latest stock report compiled by Standard & Poor's which is enclosed. b. The areas indicated in red on the attached map may have, in our opinion, the greatest growth potential in the study area and the cities of Mentor and Geneva-on- the-Lake presently served by the Ohio Water Service Company provide an ideal nucleus for development of one of these areas. c. The Company's administrative and operating personnel would assure Central's orderly entry into the water transport program and would provide the nucleus for training additional personnel. 2. State of Ohio Water Survey. — The State, through its Department of Development, has in recent days authorized a study to determine the feasibility of constructing a 240-mile water supply system in the Maumee River Basin. This area is delineated in yellow on the enclosed map. We understand a preliminary report was due in April 1964 and a final report in December 1964. We would recommend that a close examination be made of the content of the final report in the following areas : a. The use of the Central's right-of-way. b. Routing which would enhance the value of our properties in the area. c. Possible ownership of a part of a network. 8. Feasibility Studies. — The area shaded in blue on the enclosed map represents the remaining portions of the Lake Erie watershed area located in Ohio which have not been subjected to comprehensive studies and for which no master plan exists. We would recommend that selected portions of this area plus the areas indicated in red be studied in detail to determine its potential and our best course of action. Such a study could include : a. Study of industrial and associated population growth along with projections to the year 2000. b. Study of the water resources of the United States and the translation of the effect of its diminishing per capita availability on the growth of the Great Lakes area and specifically the study area. c. An analysis of existing surface transportation which would contribute to accel- erated growth in any given locality. d. A survey of communities and areas which experienced severe water shortages during the record drought of 1963. This survey would produce consumption data which would determine in part the initial elements of construction. It is noted that the drought-stricken communities are currently negotiating with central water authorities. However, actual service appears to be years in the future due to the traditionally slow-moving pace of governmental units. e. Determination of those areas which are to receive raw water service and those where it is economically feasible to construct treatment of local distribution facilities, if any. f. Preparation of a water transport system designed in preliminary form based on current and projected requirements. Inspection of various features and ownership status of our rights-of-way. Such a design would also consider the status of abutting lands with an eye to real estate sales and freight traffic development to produce the highest over-all rate of return. g. Preparation of preliminary construction cost estimates and rate schedules. It is our estimate that such a study could be accomplished by a competent engineering organization for approximately $25,000. If. Industrial Development. — Concurrent with the above, it would be possible to place greater emphasis in our industrial development program on the utilities' features of sites and their realtionship to municipal ownership and corporate boundaries. This point can best be illustrated by examining in some detail the parcel designated as Site A in the New York Central brochure entitled "The Greater Lorain-Elyria-Sandusky. Ohio Area," Exhibit A-l enclosed. The total site contains 370 acres of which 150 are in the city of Elyria and the remaining 220 in the city of North Ridgeville. Exhibits A-2 and A-3 illustrate the preliminary subdivision layout prepared by a local engineering consultant for a group of realty interests examining this site. The water and sewer services are owned by the city of Elyria and it is the availability of water which makes the site particularly attractive and valuable. It is the concensus of opinion of realtors and pro- fessional planners that the promotion and development of the site can be accomplished only when considering the entire 370 acres and it is materially less attractive when restricted to the area in Elyria. The rail frontage in Elyria is not sufficient to attract the type of heavy industry which would in turn necessitate the support of auxiliary enter- prises in other areas of the parcel. The realty interests further state that the profits realized from development would not adequately balance the promotional costs where only the Elyria parcel is involved. 507 Various groups have, in the past, attempted to develop the total parcel but have been invariably frustrated by Elyria's refusal to extend its services to that section lying in North Ridgeville. At this point, it appears that the solution to the development of the 370 acres lies in the private ownership of utility systems which are not encumbered by corporate boundaries or municipal antagonisms. J. J. Wright. New York Central System, New York, February 20, 1964- Mr. J. J. Wright : This will acknowledge receipt of your letter dated February 17th concerning the article appearing in Engineering Outlook published by the University of Illinois dealing with the growing shortage of potable water. Upon receipt of your letter of November 8th, I arranged with our legal counsel to investigate the legal ramifications involved in engaging in the operation of a water distri- bution system. I have also discussed with several investment bankers the economic feasi- bility of such an arrangement. General discussions have also been held with private water companies concerning the use of our right-of-way properties. As a matter of fact, intensive negotiations are presently going on with the Onondaga Water Authority for the use of our right-of-way for the transmission of water from Lake Ontario. All of the work we have done so far on this subject indicates that although the idea is a capital one, it is replete with problems — not the least of which involves the title to our right-of-way. From all corres- pondence, I am certain that you are not aware of the fact that a good portion of our right- of-way is not owned outright in fee by us. In your letter of the 17th, you have made some general comments concerning the need for action on this subject. I would welcome clear-out, specific suggestions on the subject J. O. Boisi. Exhibit 7 [Memorandum of S. T. Saunders used at P.C.T.C. Board of Directors Meeting, June 1968] Kayser-Roth Before proceeding with the regular business of the meeting, there is a preliminary matter of importance that I would like to present for your consideration and appropriate action. At our meeting in March management was authorized to negotiate with representatives of Kayser-Roth Corporation as a potential acquisition in our long-range diversification program. In the intervening months, Dave Bevan, Bill Gerstnecker and our lawyers have been actively studying this company. Yesterday, they reached final agreement with the Kayser-Roth management on the terms of a proposed plan which will be presented for your consideration in just a moment. Technically, the proposed transaction calls for merger of Kayser-Roth into the Penn- sylvania Company, so, assuming favorable action on the part of this Board, we will recess this meeting and present the matter to the Directors of the Pennsylvania Company (all of whom are present), then reconvene this Board to conclude the Penn Central business. Simultaneously, the plan is being presented to the Directors of Kayser-Roth, who are now in session at their executive offices at 640 Fifth Avenue. Assuming all necessary- approvals are obtained, Chester Roth and several of their officers will come here to 230 Park Avenue to execute the agreement. Although we are not anxious to generate a lot of fanfare about the transaction, following the signing we will issue a press release to comply with S.E.C. and Stock Exchange rules concerning public disclosure. Before going into the details of the plan, I would like to mention some of the funda- mental objectives of our diversification program which have served as guideposts in investigating the merits of this particular investment. First, of course, are the minimum requirements of profit, growth potential and beneficial use of our tax shelter. Next, we feel that a company must be sufficiently large and established as a going concern to insure perpetuation and growth with existing management. In other words, we are seeking to become investors in profitable firms, not managers. Transportation com- panies and basic industries which are large users of railroad service are not prime candi- dates because of potential conflict with certain anti-trust theories and regulatory policies of the ICC. In addition, we have no desire indeed, cannot compete with some of our best customers. Another objective is to coordinate our diversification program with the requirement that we divest ourselves of our N&W holdings within the next seven years. This accom- plishes two results in one transaction. It also improves acceptability of the diversification in the eyes of the Government, at whose insistence the divestiture is taking place. More- over, there are the obvious advantages in using securities, rather than cash, in a trans- action of this size. Another requirement is to make the acquisition in a clear-cut, business-like way, in order to eliminate the prospects of proxy fights and price competition. In this connection, the people with whom we are dealing control 40% of the outstanding stock of Kayser-Roth, and there is every reason to believe that we can successfully consummate any transaction that is agreed upon today within ninety days. 74-924 O - 73 - 34 508 In our opinion, the transaction that Mr. Bevan will describe to you will meet each of the objectives that I have outlined. I have met Chester Roth and members of his manage- ment on only one occasion, but I was favorably impressed by the calibre of the people and what they had to say. Moreover, I am impressed with Kayser-Roth as a company. It is unquestionably a leader in its field. It operates 119 plants— mostly in the Carolinas, but it also has a number of licensees abroad. Kayser-Roth is not in the high-fashion business, and it is not a maker of suits and dresses, which are the volatile segments of the clothing industry. Rather, it manufactures and markets standard apparel products and accessories under some of the best known brand names in the business, including — Kayser and Shiaparelli hosiery ; Catalina and Cole-of-California sportswear ; Esquire and Interwoven socks ; Excello shirts ; Paris belts ; and Kayser and Majud gloves. The company is right now in the process of acquiring Commonwealth Shoe Company. With this short introduction, Mr. Bevan, won't you please fill the members of the Board in on the details of the proposed acquisition. Exhibit 8 August 14, 1968. D. C. Bevan : What is your schedule for submitting the Kayser-Roth proxy material to the SEC and filing the ICC application ? It would be helpful to be in a position to include the income in our consolidated third-quarter earnings. S. T. Saundebs. Exhibit 9 May 28, 1968. Mr. Saunders : You will recall that we obtained clearance from members of the Finance Committee to discuss with Kayser Roth possible acquisition terms to determine whether a transaction could be recommended. Since then, I understand from you some Board members have expressed doubt as to the advisability of such transaction. Yesterday afternoon, I indicated that the discussions with their chief executive would be completed very shortly and this occurred last evening. In my judgment, if both Boards approve, we could reach an understanding that would be extremely attractive, and would add sub- stantially to our earnings, and would continue to do so in the future, and should thus have a favorable effect on the market value of our stock. I would like to sit down and review the situation with you in detail as quickly as possible so you can determine whether the terms discussed should be recommended to the Committee and the Board or whether the matter should be dropped. Obviously, the time factor is very important and the decision will be equally important. David C. Bevan. Exhibit 10 [Tabular information and attachments submitted by railroad pursuant to request of Committee's special staff] Selected Subsidiaries — Analysis of Purchase of Investments — Period 1964-69 PURCHASE OF INVESTMENTS, 1964-69 [In thousands] Owning company Investment— nonrailroad Cash Noncash Tota Pennsylvania Co Buckeye Pipe tine, 100 percent $30,381 $69,912 $100,293 Do Arvida Corp., 58 percent. 22,046 22,046 Do Great Southwest Corp. L. 51,826 51,826 Do MaccoCorp.i 39,451 39,451 GSC and Macco total 91,277 91,277 Pennsylvania Co. total 143,704 69,912 21,361 P.C.T Strick Corp., 100 percent 24,437 24,437 American Contract (P.C.T.) Executive Jet Aviation— nonvoting interest . 20,497 20,497 P.C.T Madison Square Garden, 23 percent. 6,697 21,000 27,697 Total, nonrailroad investment.... 195,335 90,912 286,247 1 82 percent combined. 509 PENNSYLVANIA CO.— INVESTMENT IN BUCKEYE PIPE LINE CO. [Dollars in thousands] Purchases Shares Cost (thousands) 171,200 $5, 029 28, 100 891 4,000 117 633, 260 22, 132 1963: 1st quarter 2d quarter 3d quarter _. 4th quarter Year 1963 total _. 1964: 1st quarter 3d quarter _ Total holdings 1964: July merger plan— shares exchanged (100 percent). 836, 560 54, 054 1,815,905 2, 706, 519 14, 000 28, 169 1,859 70, 265 100, 293 100, 293 Note: The initial holdings in Buckeye were acquired through cash purchases of stock in 1963 and early in 1964 approximating $30,- 000,000. In July of 1964 Pennsylvania Co. issued $70,000,000 of preferred stock in exchange for the balance of the Buckeye stock outstand- ing. The preferred stock was issued convertible into Norfolk & Western stock held by Pennsylvania Co. ($317 par of Pennsylvania Co. for each N. & W. share). The cash used for the initial stock purchases was available from working capital sources of Pennsylvania Co. PENNSYLVANIA CO.-INVESTMENT IN ARVIDA CORP. Purchases 1965: 3d quarter 1966: 1st quarter 2d quarter 3d quarter 4th quarter Year 1966 total.. Total (58 percent) Shares Cost (thousands) 3, 055, 877 $18, 335 128, 600 225, 600 91, 700 27, 500 1,044 1,920 579 168 473, 400 3,711 3, 529, 277 22, 046 Note:The initial acquisition of Arvida stock was made in July 1965 (as shown above— 3d quarter 1965) from the estate of A. V. Davis A cash payment of $5,215,000 was made and a note given for the balance which has since been redeemed from funds obtained out of work- ing capital. The other smaller purchases of stock were made in the market for cash from working capital sources. Pennsylvania Co. investment in Great Southwest Corp. Purchases : Coat Preferred stock $6, 880, OOO Common stock 83, 344, OOO Convertible bonds 53, OOO Total investments 91, 277, OOO PENNSYLVANIA CO. INVESTMENT IN GREAT SOUTHWEST CORP. (INCLUDES MACCO CORP.) Purchases Shares Cost (thousands) $3, 500 Series A 6 percent cumulative preferred stock: 1966 4th quarter (conversion of debt) _ _ 350,000 1969 2d quarter (10-for-l split) 3,150,000 Series A 6!^ percent senior cumulative preferred stock: 1967 4th quarter 1969 2d quarter (10-for-l split) Series B 7 percent cumulative preferred stock: 1969 2d quarter (Macco merger and 10-for-l split). Series C 7.6 percent cumulative preferred stock: 1969 2d quarter (Macco merger and 10-for-l split) Total 3,500,000 3,500 50,000 500 450, COO 500,000 3,650,000 16,410,980 500 513 2,367 6,880 510 PENNSYLVANIA CO. INVESTMENT IN GREAT SOUTHWEST CORP. (INCLUDES MACCO CORP.) Purchases Common stock: 1963: 1st quarter _ 3d quarter _ 4th quarter Year 1963 1964: 1st quarter.. _ _ _ 2d quarter 3d q uarter _ 4th quarter _ Year 1964 _ _ 1965: 1st quarter 2d quarter 3d quarter (includes 210,211 warrants at a cost of $2,550,000)... 4th quarter _ Year 1965.. 1966: 1st quarter 2d quarter _ _ _ 3d quarter _ _ 4th quarter Year 1966 _ 1968: 1st quarter _ 4th quarter _ Year 1968 1969: 1st quarter: Macco merger _ Do 2d quarter (10-for-l split) _. 4th quarter Year 1969. Total 23,828,850 > 84, 344 ' 82 percent. NOTES The initial acquisition of 3,500,000 shares of 6 percent cumulative preferred stock was the result of the conversion of debt for stock and a 10-for-l stock split. In connection with the merger of Macco into Great Southwest in March 1969, 3,650,000 shares of its series B, 7 percent cumulative preferred stock, and 16,410,980 shares of its series C, 7.6 percent cumulative preferred stock were issued. The 6H percent nonvoting, A, preferred stock was purchased from working capital funds in December 1967 and subsequently adjusted for a 10- to-1 stock split. Controlling interest in Great Southwest stock was made in the 3d quarter 1964 by the piecemeal purchase of 574,367 shares in the market for cash of $13,071 with funds obtained from working capital. The 60-percent interest in common stock acquired by the end of 1964 increased to 75 percent by the end of 1966. These additional purchases of stock were made in the market for cash from working capital sources. In December 1968, 6 percent subordinated convertible notes of $297 were converted into common stock (as shown above— 4th quarter 1968) for 9,473 shares. In March 1969, in connection with the merger of Macco into Great Southwest, 577,303 shares of common stock were issued to the Pennsylvania Co. In April 1969, Pennsylvania Co. converted Great Southwest series D 4j4-percent preferred stock (received in connection with the Macco merger) into 8,060,950 shares of common. During the same month a 10-for-l stock split increased the number of common stock owned by 12,857,661 shares. In December 1969 Great Southwest issued 1,400,610 shares of its common stock to Pennsylvania Co. in consideration of the cancellation of debt aggregating $25,211. This debt resulted from advances (1967 through 1969) by Pennsylvania Co. to Great Southwest of $23,058 and income-tax allocation of $2,153. The $23,000,000 of advances was obtained from Pennsylvania Co. working capital. PENNSYLVANIA CO.-INVESTMENT IN MACCO REALTY CO. Purchases Shares Cost (thousands) Common stock: 1965: 3d quarter _ 8,000 $8 4th quarter. 72,000 72 Shares Cost (thousands) 1,200 4,000 2, 500 22 66 46 7, 700 134 300 5 2,000 39 574, 367 13,071 92, 500 1,762 669, 217 14,877 53, 455 1,082 32, 640 681 25, 450 3,153 33, 800 1,207 145, 345 6,123 6,731 278 13,860 579 1,200 41 2,800 83 24, 591 981 3,100 149 9,473 297 12,573 446 577, 303 15, 268 8, 060, 950 21,304 12,930,561 1,400,610 25,211 22, 969, 424 61,783 Total 80,000 80 Class 8, 6 percent cumulative preferred: 1965: 4th quarter 2,812,193 39,371 Total.... _ 39,541 Note: In March 1969. Macco merged into Great Southwest, In connection with the merger. Great Southwest issued 577,303 shares of its common stock, 3,650,000 shares of its series B, 7 percent cumulative preferred stock, 16,410,980 shares of its series C, 7.6 percent cumulative preferred stock in exchange for Pennsylvania Co.'s investment in Macco (as shown above). The $39,400,000 required for the purchase of Macco was obtained from the proceeds of sale by Pennsylvania Co. to the transportation company of $40,000,000 of bonds of the transportation company. 511 Penn Central Transportation Co. investment in Strick Companies Purchases : Common stock : 1966 4th quarter (note— paid in cash in 1967) $4, 200, 000 1967 1st quarter 10,800,000 Note: 1968 4th quarter 9,437,000 Total 24, 437, 000 AMERICAN CONTRACT-INVESTMENT IN EXECUTIVE JET AIRWAYS, INC. Purchases Shares Cost (thousands) Common stock: 1965: 2d quarter - 655,960 $328 4th quarter (110,000) (55) Year 1965 total _._. _ 545,960 273 1966: 1st quarter (legal fees). 4 1967: 2d quarter... 3,445 2 4th quarter. 110,000 66 Year 1967 total 113,445 68_ Total 659,405 345 Note: The acquisitions of common stock from 1965 through 1967 were made with working capital funds. Advances: 1968-69 $6,287 Notes: 1967 13,865 Total. 20,497 PENN CENTRAL TRANSPORTATION C0.-INVESTMENT IN MADISON SQUARE GARDEN CORP. Purchases Shares Cost (thousands) Common stock: 1968: 4th quarter _ 1969: 1st quarter 2d quarter 3d quarter Year 1969.. Total 2,500,202 27,697 Note: The initial acquisition of Madison Square Garden Corp. was made in December 1968 (as shown above, 4th quarter 1968) with the exchange of the outstanding shares of Pennsylvania Terminal Real Estate Corp.. 25 percent of the outstanding stock of Madison Square Garden Center, Inc., and the forgiveness of certain indebtedness due from Pennsylvania Terminal Real Estate Corp. for 2,319,664 shares of common stock. The acquisition cost of $25,697 included a cash investment of $4,697 and a profit of $21,000 resulting from the exchange. The initial cash investment and subsequent purchases made in 1969 were from working capital funds. PENN CENTRAL CO., INVESTMENT IN SOUTHWESTERN OIL & REFINING CO., AND ROYAL PETROLEUM CORP. Cost Purchases Shares (thousands) Percent Common stock (1970 1st quarter): Southwestern Oil & Refining Co Royal Petroleum Corp _ 2,319,664 $25, 697 85, 756 950 18, 054 200 76, 728 850 180, 538 2,000 400,000 $21,083 400, 000 5,114 Total 800,000 26,198 100 Note: In February 1970 Penn Central Co. purchased Southwestern Oil & Refining Co. and Royal Petroleum Corp. through the issuance of 400,000 shares of its $3 cumulative preference stock. GREAT SOUTHWEST CORP.-COMMON STOCK PENNSYLVANIA CO. Date Purchased from— Shares Cost 1964 July 2 Hemphill, Noyes & Co . 2,500 $53,750 15 Rockefeller Center Inc.. . 170,851 3 844,148 15 First National Bank of Dallas . 347,516 7 819,110 15 Glore Forgan, Wm. R. Staats Inc : ._ _ 259,183 ?2 do ._ 2,000 41,500 Aug. 14 do _ _ _ 34,500 721,482 25 do _ 2,000 40,000 512 GREAT SOUTHWEST CORP.-COMMON STOCK-Continued PENNSYLVANIA CO.-Continued Date Purchased from- Shares Cost Sept. 1 8 15 18 28 30 Oct. 14 19 Nov. 17 18 30 Dec. 4 1965 Jan. 21 25 25 Feb. 1 Mar. 9 11 15 19 25 29 30 31 5 5 do do do do do .do. do .do. .do. .do. Apr. Oct. Republic National Bank of Dallas. First National Bank of Dallas 14 20 20 30 May 3 4 10 12 19 June 1 9 11 21 21 23 23 July 6 9 13 20 Aug. 3 4 4 5 12 11 25 Sept. 1 13 16 21 23 23 4 18 19 26 Dec. 3 6 13 28 28 31 1966 Jan. 13 Feb. 9 Mar. 3 11 24 30 31 Apr. 11 18 21 22 May 3 5 9 10 12 16 17 18 23 June 20 29 Glore Forgan, Wm. R. Staats Inc Merrill Lynch, Pierce, Fenner & Smith, Inc.. Carrington, Johnson & Stephens— Legal fee. Merrill Lynch, Pierce, Fenner & Smith, Inc... Glore Forgan, Wm. R. Staats Inc Merrill Lynch, Pierce, Fenner & Smith, Inc.. Glore Forgan, Wm. R. Staats Inc ....do do ....do Silberberg & Co Merrill Lynch, Pierce, Fenner & Smith, Inc.. do First National Bank of Dallas Merrill Lynch, Pierce, Fenner & Smith, Inc.. Glore Forgan, Wm. R. Staats Inc Merrill Lynch, Pierce, Fenner & Smith, Inc.. Glore Forgan, Wm. R. Staats Inc Merrill Lynch, Pierce, Fenner & Smith, Inc.. Carrington, Johnson & Stephens— Expenses. Bruce Benjamin Merrill Lynch, Pierce, Fenner & Smith, Inc.. Glore Forgan, Wm. R. Staats Inc Merrill Lynch, Pierce, Fenner & Smith, Inc.. Eppler, Guerin & Turner, Inc Merrill Lynch, Pierce, Fenner & Smith, Inc.. do Glore Forgan, Wm. R. Staats Inc Merrill Lynch, Pierce, Fenner & Smith, Inc. Eppler, Guerin & Turner, Inc Merrill Lynch, Pierce, Fenner & Smith, Inc.. Glore Forgan, Wm. R. Staats Inc Merrill Lynch, Pierce, Fenner & Smith, Inc.. Eppler, Guerin & Turner, Inc do _ Glore Forgan, Wm. R. Staats Inc do Eppler, Guerin & Turner, Inc do Merrill Lynch, Pierce, Fenner & Smith, Inc. do do Eppler, Guerin & Turner, Inc Glore Forgan, Wm. R. Staats Inc Eppler, Guerin & Turner, Inc Dewar, Robertson & Pancoast Eppler, Guerin & Turner, Inc Glore Forgan, Wm. R. Staats Inc do do Merrill Lynch, Pierce, Fenner & Smith, Inc. Glore Forgan, Wm. R. Staats Inc do do do do do Eppler, Guerin & Turner, Inc Glore Forgan, Wm. R. Staats Inc .do. do _do Angus G. Wynne, Jr Glore Forgan, Wm. R. Staats Inc. do Pennsylvania RR Eppler, Guerin & Turner, Inc Glore Forgan, Wm. R. Staats Inc Eppler, Guerin & Turner, Inc do do do - Merrill Lynch, Pierce, Fenner & Smith, Inc. Eppler, Guerin & Turner, Inc Merrill Lynch, Pierce, Fenner & Smith, Inc. Eppler, Guerin & Turner, Inc Blyth & Co., Inc - do Glore Forgan, Wm. R. Staats Inc Republic National Bank of Dallas Eppler, Guerin & Turner, Inc 2,000 2,000 4,000 2,000 2,000 3,000 2,500 2,000 4,000 2,500 71,350 10, 200 24,000 9,555 3,100 1,500 2,075 2,000 3,000 3,000 2,000 1,000 1,725 240 8,600 200 2,500 500 4,500 200 4,000 600 5,000 200 500 700 1,800 1,500 200 500 900 4,000 900 500 600 2,000 5,500 2,000 3,000 100 350 400 1,500 1,000 1,000 1,000 500 1,100 5,000 9,500 1,000 1,000 2,000 1,000 10, 100 3,000 700 500 1,000 1,000 31 2,000 700 2,000 5,500 430 2,500 200 590 200 100 500 1,300 100 1,200 200 40 500 5,000 1,000 39, 750 39, 500 77, 500 38, 750 38, 500 58,125 49, 062 38, 750 77, 000 48, 125 1,355,650 193, 800 462, 000 181,618 3,794 58,923 32,813 47,300 45, 500 68,625 67,125 44,000 21,500 37,147 5,140 163, 400 4,307 54, 062 10,766 96, 896 4,^07 965 85,000 12,844 106,875 4,231 10,625 15,161 38,986 32, 250 4,281 10,812 19,607 80, 000 19, 266 10,688 12,900 47,000 129,938 46,750 70,500 2,456 8,554 10,327 40, 500 25,375 27,312 27,625 13,875 29.975 2, 550, 000 158, 609 326, 421 34, 250 35,500 78, 000 39, 000 385, 618 107, 500 24, 850 17, 375 38, 500 41,000 1,193 84, 901 29, 400 83, 500 231, 000 18, 006 104,688 8,279 24, 780 9,275 4,642 23,210 61,100 4,391 50,650 8,480 1,700 20,752 200, 000 39, 000 513 GREAT SOUTHWEST CORP.-COMMON STOCK— Continued PENNSYLVANIA CO.-Continued Date Purchased from— Shares Cost July 5 GloreForgan.Wm. R. Staats Inc 500 19,500 25 Eppler.Guerin & Turner, Inc .-... 300 10,275 Sept 19 GloreForgan.Wm. R. Staats Inc 400 11,900 Oct. 3 Yarnall.Biddle&Co 200 6,000 3 Glore Forgan, Wm. R. Staats Inc 1,000 29,750 10 do -- 1,000 29,275 25 do - - --- 600 17,700 1968 Dec. 9 Conventional 6 percent notes 9,473 357,101 1969 Mar. 21 Received in exchange for Macco securities at time of merger into GSC _ 1,383,398 36,570,801 Total _..- 2,234,724 59,085,458 Apr. 21 10 for 1 stock split 22,347,240 Dec. 31 Exchange of debt held by Pennsylvania Co., for stock 1,400,610 25,210,980 Total 23,747,850 84,296,438 PENNSYLVANIA RR. CO. Date Purchased from— Shares Cost Feb. 26,1962 Glore Forgan, Wm. R. Staats Inc July 25,1963 do.... _ Dec. 20,1963 Yarnall, Biddle & Co Dec. 23,1963 Hemphill, Noyes & Co Dec. 27,1963 GloreForgan.Wm. R. Staats Inc do Brooke, Sheridan, Bogan & Co., Inc Jan. 3,1964 Fulton, Reid & Co.. Inc June 19, 1964 Vlore Forgan, Wm. R. Staats Inc. June 25,1964 do... Mar. 8,1965 do Jan. 18,1968 ....do Jan. 31,1968 do Mar. 29,1968 do do Eppler, Guerin & Turner, Inc _ Total Mar. 31, 1966 Sold to: Pennsylvania Co.CProceeds— $231,000). Apr. 21,1969 10 for 1 stock split 1,200 $21,900 4,000 66,000 500 9,250 500 9,250 1,000 18, 500 500 9,250 300 5,550 1,500 28,975 500 9,812 500 11,250 1,000 43,500 1,000 43,000 500 28,500 600 33, 800 13,600 338,537 5, 500 100,387 8,100 238, 150 72,900 81,000 238,150 GREAT SOUTHWEST CORP. Date: Purchased from— Shares Cost SERIES A SENIOR 6 l A PERCENT PREFERRED STOCK Penn Central Transportation Co.: October 3, 1967: Great Southwest Corp 50,000 $500,000 April 25. 1969: 10 for 1 split 450,000 Total 500,000 500,000 SERIES A 6 PERCENT PREFERRED STOCK July 15, 1966: Great Southwest Corp.... 350,000 3,500,000 125,]""' Pennyslvania Co.: July 15,1966: April 25, 1969: 10 for 1 split ..'. _ 3, 1501000 Total _ , 3,500,000 3,500,000 SERIES B 7 PERCENT PREFERRED STOCK Pennsylvania Co.: March 21, 1969: See note _ 3,650,000 512,859 SERIES C 7.6 PERCENT PREFERRED STOCK Pennsylvania Co.: March 21, 1969: See note 16,410,980 2,367,042 Note: Received in exchange for Macco securities at time of merger into Great Southwest and adjusted for 10 for 1 split. 514 ARVIOA CORP.-PENNSYLVANIA CO. PURCHASES Date Shares Cost Purchased from: Aug. 19,1965 R.S. Hudson & Co., Inc Sept. 30, 1965 Pennsylvania RR Jan. 7,1966 Glore Forgan, Wm. R.Staats Inc Feb. 28,1966 do Mar. 31,1966 Andresen & Co Do Glore Forgan, Wm. R.Staats Inc Do Silberberg & Co Apr. 13,1966 Glore Forgan, Wm. R. Staats Inc Apr. 20,1966 Carl M. Loeb Rhoades & Co June 7,1966 do.. June 9,1966 Dooly, Gerrish & Co. Inc . . . June 10,1966 State Street Investment Corp Do Silberberg* Co.. June 14,1966 Dominick & Dominick June 21, 1966 Silberberg & Co July 5,1966 Glore Forgan, Wm. R. Staats Inc July 15,1966 do Do do.... . . July 20, 1966 do.... July 25,1966 do ... July 27,1966 Blyth & Co. Inc Aug. 24,1966 do... Sept. 1,1966 Glore Forgan, Wm. R.Staats Inc Sept. 2,1966 Blyth & Co. Inc Oct. 27,1966 Cyrus J. Laurence & Sons Dec. 15,1966 do Dec. 28,1966 Silberberg & Co 3,800 $22, 800 3,052,077 18,312,462 14,000 133,000 8,000 62,000 85, 500 684, 000 6,000 46, 500 15, 100 118,913 2,000 16, 500 100,000 916,000 2,500 20,059 15,600 124,800 99, 000 792.000 1,400 11,375 2, 500 19,063 2,600 20, 150 2, 500 19,063 1,000 7,250 1,000 7,250 2,000 14, 500 1,000 7,000 5,000 35,000 3, 500 23,187 71,700 439,521 4, 000 26, 250 20, 000 122,600 5,000 30,650 2, 500 15,000 Total 3,529,277 $22,046,893 PENNSYLVANIA RR. CO. PURCHASES July 26,1965 Purchased from: Estate of A. V. Davis 3,274,428 $19,646,568 Sold to: July 26,1965 Stockton, Whatley, Davin & Co .' 222,351 1,334,106 Sept. 30, 1965 Pennsylvania Co... 3,052,077 18,312,462 Total 3,274,428 $19,646,568 MACCO REALTY CO., COMMON STOCK-MACCO DEVELOPMENT CORP (A SUBSIDIARY OF PENNSYLVANIA CO.) Purchased from: Oct. 15,1965 Tenderoffer 1,930,665 $27,484,548 Oct. 25, 1965 Kidder Peabody & Co 500 7,000 Nov. 1,1965 Glore Forgan, Wm.R. Staats Inc 700 9,948 Nov. 5,1965 do 50 712 Nov. 9,1965 do 211 2,998 Nov. 16,1965 do 80 1,136 Nov. 17,1965 ....do 745 10,586 Nov. 18,1965 do 200 2,842 Nov. 24,1965 ..do 25 354 Nov. 26,1965 .do. 40 568 Nov. 30,1965 .do 135 1,918 Dec. 2,1965 do 6 85 Dec. 3,1965 do 28 396 Dec. 7,1965 ...do 30 426 Dec. 9,1965 do 805 11,439 Dec. 14,1965 ...do 50 711 Dec. 17,1965 ...do 57 810 Dec. 20,1965 do - 50 707 Dec. 23,1965 Kindel & Anderson— legal fees 100,765 Dec. 15,1965 Cost of warrants purchased and canceled: Mitchum, Jones & Templeton -- Kidder, Peabody & Co 62,195 Jan. 4,1966 Glore Forgan, Wm. R. Staats Inc 47 668 Jan. 6,1966 .do.. 21 298 Jan. 12,1966 ..do. 342 4,860 Jan. 14,1966 .do 150 2,132 Jan. 24, 1966 do - 2,249 31,958 Jan. 25,1966 do 25 355 Feb. 4,1966 .. .do 100 1,421 Feb. 9,1966 ....do 114 1,620 Feb. 4, 1966 Printing and other expenses related to tender offer 5,217 Feb. 28, 1966 Glore Forgan, Wm. R. Staats Inc 45 640 Mar. 4,1966 do 50 711 Mar. 25,1966 .do. 10 142 Mar. 29,1966 do ...- 25 355 Apr. 1,1966 ..do 100 1,421 Apr. 28,1966 do... - 30 426 July 11,1966 do 115 1,634 July 22,1966 Great Southwest acquisition costs 129,227 Converted into Great Southwest stock 1,937,800 27,883,229 515 SIX-PERCENT CONVERTIBLE SUBORDINATED DEBENTURES DUE APR. 1, 1977-MACCO DEVELOPMENT CORP. (A SUBSIDIARY OF PENNSYLVANIA CO.) Date Par value Cost Purchased from: Oct. 15,1965 Tender offer $3,117,000 Oct. 18, 1965 Glore Forgan, Wm. R. Staats Inc Oct. 21,1965 do Oct. 22,1965 do..._ Nov. 10,1965 do Nov. 12, 1965 do Dec. 3,1965 do _ Dec. 8,1965 do Dec. 9,1965 do Dec. 30,1965 do - Apr. 18,1966 do Apr. 26,1966 do Converted into Great Southwest stock $3,117,000 $3, 796, 506 4,000 4,882 11,000 13, 425 7,000 8,544 1,000 1,221 6,000 7,323 1,000 1,220 2,000 2,436 2,000 2,441 6,000 7,323 1,000 1,221 10,000 12,205 3,168,000 3,858,747 SIX-PERCENT CONVERTIBLE SUBORDINATED DEBENTURES DUE DEC. 1, 1978 Purchased from: Oct. 15,1965 Tenderoffer 2,949,000 5,862,612 Oct. 18,1965 Glore Forgan, Wm. R. Staats Inc 4,000 7,962 Oct. 22,1965 do .... 3,000 6,032 Adjustment for interest (360) Nov. 10,1965 Glore Forgan, Wm. R. Staats Inc 5,000 10,052 Nov. 22,1965 do 10,000 20,105 Dec. 15,1965 do ._ 1,000 1,991 Apr. 1,1966 do 3,000 5,972 June 2,1966 do 5,000 9,952 Converted into Great Southwest stock 2,980,000 5,924,318 SIX-PERCENT CONVERTIBLE SUBORDINATED DEBENTURES DUE DEC. 1, 1979 Purchased from: Oct. 15,1965 Tenderoffer.. 993,000 1,918,476 Feb. 4,1966 Glore Forgan, Wm. R. Staats Inc 1,000 1,935 Converted into Great Southwest stock 994,000 1,920,411 BUCKEYE PIPE LINE CO. -PENNSYLVANIA CO. Date Shares Cost Purchased from: Nov. 29,1963 Delbay Corp 203,300 $6,037,221 Nov. 13,1963 Butcher & Sherrerd 1,000 31,848 Nov. 14,1963 ....do.... 1,000 31,973 Nov. 15,1963 ....do 6,800 214,943 Do. Pension Trust of Bethlehem Steel Corp 100,000 3,500,000 Nov. 18,1963 Butcher & Sherrerd ._ 2,900 91,152 Nov. 20,1963 Glore Forgan, Wm. R. Staats Inc. 78,800 2,882,127 Do Butcher & Sherrerd 900 28,550 Nov. 21,1963 Glore Forgan. Wm. R. Staats Inc 57,816 2,044,668 Do Butcher & Sherrerd _ 2,200 70,065 Do Provident Mutual Life Ins. Co 54,000 1,890,000 Nov. 22,1963 Butcher 8 Sherrerd 300 9,516 Nov. 25,1963 ....do 2,200 69,914 Nov. 26,1963 ....do 300 9,517 Nov. 27,1963 ....do 1,500 47,633 Nov. 29,1963 ....do _ 300 9,630 Dec. 2.1963 Independence Foundation 30,000 1,050,000 Dec. 3,1963 Butcher & Sherrerd 4,000 125,945 Dec. 4,1963 Brown Brothers Harriman & Co 106,680 3,745,938 Do Goldman, Sachs & Co 34,660 1,217,048 Do Glore Forgan, Wm. R. Staats Inc ._ 48,304 1,695,438 Dec. 23,1963 Fiduciary Trust Co 14,000 486,500 Dec. 27,1963 The First Boston Corp 13,000 451,750 Dec. 31,1963 Supplemental Pension Plan (P.R.R.) 50,200 1,744,450 Do The First Boston Corp 21,400 743,650 Jan. 7,1964 Massachusetts Mutual Life Insurance Co. _. 54,054 1,858,712 July 24, 1964 Issuance by Pennsylvania Co. of its 4% percent cumulative preferred stock of $100 par value per share to various holders of Buckeye common 1,815,905 70,250,348 Total 2,706,519 July 25,1964 14, OOOsharesof New Buckeye issued in exchangefor 2,706, 519sharesof Old Buckeye 14,000 1965 Cost of surveys and documentary stamps, etc 14,681 Total. 14,000 100,293,217 516 BUCKEYE PIPE LINE CO.-DELBAY CORPORATION PURCHASES' te Shares Da Cost Jan. Jan. 1963 7 8 9 14 15 8 11 13 15 19 20 26 5 17 18 19 22 24 25 26 29 2 8 10 20 23 28 31 23 10 11 12 14 17 18 19 20 )o 3 26 29 Purchased from: All purchases were made from Glore Forgan, Wm. R. 1 do Staats Inc 500 19,500 57,600 800 10C 900 100 1,900 300 2,700 100 1,100 500 100 200 100 8C0 100 500 300 ICC 100 600 4,900 200 800 700 300 94,900 .. 900 100 1.000 200 700 300 5,100 200 500 1,800 1,700 $29, 286 1.144,617 3,381,022 47, 284 5,920 53, 266 5 895 Jan. do.... Fen do.... Feh do.... Mar do.... Mar. do.... Mar do.... 112,002 17 760 Mar. do.... Mar do.... 160, 337 5,920 65,644 31 476 Mar do.... Mar. do.... Apr. do.... Apr. do.... 6 345 Apr. do.... 12,691 6 345 Apr. do.... Apr. do.... 6,345 53, 816 32, 778 19, 336 6,420 6,445 38, 672 Apr. do.... Apr. do.... Apr. do.... Apr. do.... May do.... May do.... May do.... 315 825 May do.... 12 791 May do.... 50,913 May do.... 22, 067 May do.... 9 404 May 2 for 1 split do.... June 27,984 June ....do . . 3 109 June do.... 30 842 June do.... 6,118 June do.... 21,138 June do.... 9,027 June do... 154,709 June do.... 6,018 1 do.... 14.919 Inly .. do. . 52,652 Inly do.... 50. 083 Sold to Pennsylvania Co Nov. 203, 300 6.037,221 PENN TOWERS, INC.-PENNSYLVANIA CO. Dec. 31, 31, 1963 1964 Purchased from: Penn Towers Sold to: Penn Central Transpo Total , Inc. shareholders . 13, 200 3,600 .. $1 Dec rtation Co. (proceeds, $1). . 9,600 1 PENN CENTRAL TRANSPORTATION CO. Apr. Dec. 27, 31, 28, 1961 1964 1965 Purchased from: Penn Towers, Inc Pennsylvania Co Total 6,000 3,600 .. $1 9,600 9,600 1 Dec. Sold to: Tracco- -Gateway, Inc, (proceeds, $1).. 1 EVERGLADES PIPE LINE CO.-BUCKEYE , PIPE LINE CO. PURCHASES July 22,1957 2 Purchased from: Original issue i of Everglades 1,640 $164, 000 1 3 An indirect subsidiary of Penn Central T Incorporated. ransportation Co. Exhibit 11 News From the Pennsylvania Railroad For Release Friday, July 24, 1964 Acquisition of the Buckeye Pipe Line Company by the Pennsylvania Company, a wholly-owned subsidiary of the Pennsylvania Railroad Company, was completed today, Stuart T. Saunders, chairman of the board of the railroad, and George S. Patterson, presi- dent of the pipe line company announced. 517 Under terms authorized by the shareholders of Buckeye, each share of Buckeye common stock has been converted into 0.385 of a share of a new issue of 4% per cent cumulative preferred stock of Pennsylvania Company, $100 par value. Pennsylvania Company has issued 699,123 shares of the new preferred stock for the 1,805,905 shares of Buckeye stock in the hands of holders other than the Pennsylvania. The new Pennsylvania Company preferred issue will be traded on the New York Stock Exchange beginning Monday, July 27, and trading in Buckeye stock will be discontinued then. Buckeye shareholders are being notified in a letter from Mr. Patterson that they should send their Buckeye certificates for exchange to Chemical Bank New York Trust Company in New York, which has been designated the exchange agent. Acquisition of Buckeye was described by Mr. Saunders as "an important step in a long-range program of diversification" for the railroad. The 7,500-mile pipeline network distributes crude oil and petroleum products in New York, New Jersey, Pennsylvania, Ohio, Michigan, Indiana and Illinois. The Pennsylvania reported last November that it had purchased about 30 per cent of Buckeye shares, and terms for acquisition of the remaining shares outstanding were announced February 6. The terms were accepted at the Buckeye annual meeting May 6 by 93 per cent of the stock voted. The transaction was approved by the Interstate Com- merce Commission on July 16. At a meeting today to consummate the acquisition, David C. Bevan, chairman of the Finance Committee of the Pennsylvania, reaffirmed that Buckeye will continue to be oper- ated as a separate company with the present management. He and Mr. Saunders recently were elected to Buckeye's eight-member board of directors. Buckeye reported earnings of $2,346,163 or 870 a share on revenues of $14,405,848 for the first six months of 1964. The company has declared 500 per share in regular divi- dends this year plus a final dividend of 160 per share payable August 12 to shareholders of record July 23. Buckeye has announced plans to spend approximately $10.5 million to expand exist- ing pipeline facilities in Pennsylvania. As of the end of 1963, Buckeye had total assets of $86.4 million, long-term debt of $31.3 million, and reported 1963 earnings of $4.7 million or $1.76 per share after adjustment for a 2 for 1 stock split in May, 1963. Exhibit 12 From the Pennsylvania Railroad For Immediate Release, Wednesday, June 24, 1964 Purchase by the Pennsylvania Company, a subsidiary of the Pennsylvania Railroad, of more than 500,000 shares of stock for controlling interest in the Great Southwest Corporation of Arlington, Texas, was announced today by Stuart T. Saunders, chairman of the board of the Pennsylvania, and Toddie L. Wynne, chairman of the Texas-based diversified real estate development firm. Great Southwest has 1,078,501 shares outstanding and reported earnings of $1,552,445, or $1.44 a share, on revenues of $13,307,085 for the fiscal year ending last September 30. The Pennsylvania's purchase represents about 50 percent of the stock. The principal property of Great Southwest is a 6,500-acre industrial park midway between Dallas and Ft. Worth. The company also operates warehousing facilities, a luxury motor hotel and a 115-acre family recreation area featuring "Six Flags Over Texas," a Disneyland-type amusement park. The chief element in the real estate complex is the Great Southwest Industrial Dis- trict. Some 819 acres have been fully developed, w 7 ith another 371 acres partially developed. More than 120 industries, many of them operating nationally, have plants, offices and other facilities in the district. Plans are well advanced for development of 240 acres as a commercial area for retail shops, including a 100-acre regional shopping center with approximately one million square feet of store space surrounding an air-conditioned mall. The first stage in this project is planned for completion in 1966. Mr. Saunders said that the stock purchase is being made from a group of stockholders associated with Toddie L. Wynne. In addition to the Wynne interests, one of the group is Rockefeller Center, of New York, holder of 170,851 shares. Mr. Saunders called the investment "a major step in the Pennsylvania's long-range program of diversification." He expressed confidence in the "exceptional growth potential" of the company. "We regard the management of Great Southwest as excellent. The leaders have done an outstanding job in building up the company, and we are glad that they will continue to be associated with this enterprise. It will be operated as a separate entity. We do not contemplate making changes in the operating management, although we will have repre- sentation on the Board of Directors," Mr. Saunders said. 518 Exhibit 13 Globe, Fobgan & Co., Jntee-Office Memobandum Februaby 18, 1964. To: CJH Re : Great Southwest Corp. Dear Mr. Hodge: Enclosed is a copy of the draft of the second part of the letter to the PRR. If they have not already received a copy, it might be worth while enclosing a copy of the aerial photograph of the Dallas-Fort Worth area which I have also enclosed. The Memorandum for Prospective Underwriters which we used in connection with the last public offering might also be helpful. There are copies in your files. Some aspects of the situation which might be included in your section of the letter could be the experience of the railroad in industrial property management (through its Industrial Development Department) ; the knowledge of the I'ennsy of distribution and transportation methods which are such an important element of the operations of Great Southwest ; the ability of the PRR to use its contacts to accelerate the growth of GSC ; the strong cash flow position of GSC so that it would not be a drain on the finances of PRR; the stability and growth of GSC operations which could help overcome the cyclical character of the railroad business ; and the opportunity to participate in the growth of an area which is expanding at a much faster rate than the operating territory of PRR. WDS. We believe that an appropriate vehicle for your initial venture in real estate invest- ment would be the common stock of Great Southwest Corporation (GSC). This company is developing approximately 5,700 acres of land located midway between Dallas and Fort Worth, Texas, about 16 miles from the business center of each city. Since a great deal of background information on GSC is already available to you in the 1963 annual report and prospectus, we will summarize here only the principal elements of the situation which make it appear particularly attractive. basic policy As you know, the prime objective of the company is appreciation in the value of its land and buildings and realization of a higher rate of return on its investment as a result of this appreciation. All elements of the development program are designed to promote these values while retaining ownership of the increasingly valuable real estate. By means of its development program and through emphasis of lease rather than sale transactions, Great Southwest anticipates developing a substantial cash flow without resorting to liquidation of its properties. LOCATION The Company's properties are well situated to take advantage of recent growth in the Dallas-Fort Worth area. During the decade from 1950 to 1960 the population of Dallas County increased 54.8% and Tarrant County (Fort Worth) 49.1% while for the United States the increase was only 18.5%. During this period Dallas had the fourth fastest and Fort Worth the ninth fastest growth rates among the 40 largest cities in the county. The population of the two towns in which the company's properties are located. Arlington and Grand Prairie, increased 482.17c (to 44,775 persons) and 108.2% (to 30,386 persons), respectively, during the 1950's. It appears that this growth is continuing at a rapid rate. The properties are strategically located with regard to transportation facilities. The principal highways connecting Dallas and Fort Worth serve the District. The Chicago, Rock Island & Pacific Railroad and the Texas & Pacific Railway are connected through the property by the Great Southwest Railroad. Greater Southwest International Airport (for- merly Amon Carter Field) and Love Field, the principal airports for Fort Worth and Dallas, are located approximately five and 15 miles, respectively, from the center of the company's development. INDUSTRIAL DEVELOPMENT The company has made excellent progress in its industrial development program. In- dustrial lease income has increased from $152,000 in fiscal 1960 (year ended September 30) to $249,000 in fiscal 1961, $396,000 in fiscal 1962 and $639,000 in fiscal 1963. Among the more than 100 present occupants of the industrial district are such well known companies as Armour, Bell Aerospace, Borg-Warner, Container Corporation, Fieldcrest Mills, General Aniline & Film, General Foods, Ling-Temco-Vought, National Cash Register, Sperry Rand, Sun Chemical, U.S. Steel, Westinghouse Electric and Xerox. BECBEATION PARK The park has been extremely successful in accomplishing the objectives for which it was designed; namely, providing a cash flow to permit accelerated industrial development and creating a large flow of traffic to the property with the attendant advertising value. It is anticipated that this project will hasten development of the commercial aspects of the property. 519 MANAGEMENT The management has the broad experience essential to the orderly development of an operation which has become as diverse as that of GSC. Each activity is directed by men of extensive experience who appear to possess the ability to capitalize on the potentials in- herent in these well-located properties. The management group combines both youth and experience. None of the principal officers of the company are over 50 years of age. FINANCIAL GSC has made substantial progress in its development program. Revenues and earnings in all segments of the Company's operation improved during fiscal 1963. Net income in- creased from $565,246 ($.53 per share) in fiscal 1962 to $1,562,455 ($1.44 per share) in fiscal 1963. Federal income taxes were not payable in either year as a result of prior years' losses brought forward. Operating cash flow (net income plus depreciation) increased from $1,238,897 ($1.15 per share) in fiscal 1962 to $2,401,503 ($2.23 per share) in fiscal 1963. At the end of fiscal 1963 the working capital of the company was $3,465,000 compared with a working capital deficit of $22,000 at the end of fiscal 1962. Because of the strong financial position and cash flow of GSC, the company does not anticipate additional external financing in the foreseeable future except for mortgages on newly improved properties. Such improvement mortgages generally are self-sustaining in that lease rentals are more than sufficient to cover the debt service requirements. CURRENT EVALUATION The average cost of the land owned by GSC is about $2,000 per acre. Most of this land was purchased in 1956 and is carried on the balance sheet of the company on the basis of its original cost. By the end of fiscal 1963 a total of approximately $20 million had been spent by GSC for the development and improvement of land and the construction of buildings and other facilities thereon. Based on the original cost of the properties, the September 30, 1963 balance sheet showed a book value per share of stock of $9.93. This included all land under leased buildings, the recreation park, warehouse facilities, the Inn and other completed projects on an original cost basis. Based on the shares outstanding at the end of fiscal 1963, each $1,000 per acre of appreciation in land values which has occured since the original pur- chase of land at an average cost of $2,000 per acre would result in an addition of approximately $4.50 per share to the underlying equity of the stockholders. This attributes all appreciation to land and assumes no increase in the value of building equities as a result of debt retirements or other means. As of August 1, 1959, Property Counselors, Inc. of Dallas, Texas conducted appraisals of the property of GSC. The conclusions which they reached were that "the aggregate of the present worth, or discounted use values, i.e., market value" as of August 1. 1959 was in excess of $37 million, or an average of more than $7,000 per acre for the land then owned by the Company. This appraisal developed certain of the "market values" based upon assumed land uses which may or may not be different from those ultimately decided upon. In any case, if the properties of GSC were assumed to be worth $7,000 per acre now, four and one-half years later, this would mean that the underlying value per share of stock would be $9.93 plus $22.50 (reflecting the $5,000 assumed appreciation in land values), or $32.43. The land owned by GSC undoubtedly has increased substantially in value since 1959 as a result of the company's development efforts. Although it is difficult to determine a precise value for the land without a complete appraisal, current sales activity of the company is revealing. At the present time the minimum price at which non-frontage industrial property in the primary development area is being sold is $17,400 per acre. From commencement of operations to the end of fiscal 1963 the average sales price for industrial land was $18,808 per acre. For fiscal 1963 the average sales price was $21,674 per acre for the 19 transactions that year. Prices have ranged from $7,000 per acre to $85,000 per acre with only three sales made at less than $16,000 per acre. At the present time land owned by investor builders within Great Southwest Industrial District is being offered for sale by them at prices ranging from about $20,000 per acre to $35,000 per acre. Recent sales of land in the immediate vicinity of the Company's properties have been made at prices substantially above the minimum selling price of GSC land. As a result of the foregoing, we believe that the common stock of Great Southwest is selling at a substantial discount from the value of the underlying properties. FUTURE POTENTIALS It appears likely that industrial growth of the Dallas-Fort Worth area will continue in the future at close to its present rate. The economics of regional distribution centers have proven themselves so that the demand for good locations should become even more pressing. Judging from the experience of other industrial districts in Dallas and Fort Worth this im- proving demand will permit higher prices for land to be sold. Since lease income of GSC is based primarily upon a predetermined rate of return on the retail value of land, any in- crease in land values will be reflected in the return on new and renegotiated leases of the company. 520 As mortgages are paid off the company's equity in improvements will be increased. After amortization of a mortgage is completed the company will own outright a building in which it has invested no capital and whose value may be at or near the original cost of the building. At this point GSC may find it advisable to refinance the mortgage in connection with a new or extended lease. Great flexibility exists in the actions which might be taken in view of the circumstances at a particular time. Fiscal 1964 pre-tax earnings for GSC are expected to exceed those of fiscal 1963 sub- stantially. While it is unlikely that this performance can be continued indefinitely, it does appear that both net income and operating cash flow should progress in an entirely satis- factory manner. In conclusion, we believe that the properties of Great Southwest are well located and well managed and that the current market evaluation of the company's common stock does not take into consideration either current values or the substantial potentials which are inherent in this situation. Very truly yours, Walter D. Scott. PROFIT AND LOSS PROJECTIONS [In thousands of dollars] 1962 1963 1964 1965 1966 1967 Industrial rentals i 575 796 1,048 Six Flags: 1,270 1,605 1,733 Hotel' (125) (60) Warehouses* (310) (60) 150 Sales' 835 300 250 Total GSC costs ' Pre-tax net Tax Net profit 540 708 1,117 1,348 1,708 1,837 1,910 300 350 250 250 250 987 724 723 2,228 1,948 350 250 2,245 1,705 2,581 1,873 3,181 2,064 3,735 2,498 4,218 2,771 4,776 3.166 540 708 1,117 1,237 1,447 1,610 805 805 i Includes I ease i ncome from GSW to IIP, Inc., as follows: $152,000 in 1962 and $190,000 from 1963 through 1967; also includes GSC office rental to IIP, Inc. as follows: $23,000 in 1962 and $37,500, 1963-67. 1 As per estimates of Chas. Thompson based upon 1961-62 actual figures. Assumes i ncrease in price from $2.75 -$2.25 to 53.50-J2.50. and increased attendance as follows: 1963=100 percent of 1962; 1964=108 percent of 1963; 1965=106 percent of 1964; 1966 = 104 per- cent of 1965; 1967 = 102 percent of 1966. » Estimates beyond fiscal 1963 indeterminate. « Excludes rental paid to IIP, Inc. (per No. 1 above) and assumes gross revenues of $3,000,000 in 1964 and 1965, $3,500,000 in 1966. and 1967, plus a 5 percent pre-tax profit margin in 1964 and 10 percent 1965-67. 1 Gross profit after deducting cost of land and/or buildings sold. 1 Includes office rent of $23,000 in 1962 and $37,500 1963-67 (per No. 1 above) and assumes a per annum amount to cover addi- tional interest, depreciation, insurance, taxes, salaries and wages, etc., equal to 76 percent of the annual lease income increase. 521 10.— LEASE RENTAL INCOME AT FISCAL YEAR-ENti i i 1959 62 '63 "64 522 EXPLANATION OF CHART Curve "a" plots actual lease income as of September 30th of each year, 1958 through 1962, and estimated amounts 1903 through 19(57. This curve does not include Intercompany transactions, such as rent from GSW and GSO to IIP, Inc. Of $175,000 in 1902 and $227,500 1963-67. Curve "a" indicates the following (in .fOOO's). 1958 — 40 1959—84 an increase of 110% 1960—152 an increase of 81% 1961—248 an increase of 63% 1962 — 400 an increase of 61% 1963—568 an increase of 42% 1964 — 820 an increase of 44% 1965 — 1,120 an increase of 37% 1966—1.480 an increase of 32% 1967—2,000 an increase of 35% Curve "b" plots the addition of intercompany rents from 1962-67. For instance, 1962 — 575 ; 1963—796 ; 1964—1,048, etc. GREAT SOUTHWEST CORP., ANALYSIS OF DISCOUNTED PRESENT VALUES, AS OF SEPT. 30, 1962 Land acquired prior to: Acres Market value acre Market value Discount Discount value acre Total North property: Fully developed: Frontage. _ Nontrontage Not fully developed, but in present development program: Frontage Nontrontage. Not fully developed and in future development program: Frontage Nontrontage 49.6 185.6 114.6 508.4 82.1 1,190.75 $30, 000 17, 400 27, 500 14,900 15, 000 12, 000 $1, 488, 000 3, 229, 440 3,151.500 7,575,160 1,231,500 14, 289, 000 Total Less applicable purchase money mo rtgage. 2,131.06 30, 964, 600 282, 193 Total 6 flags land Improvements at 80 percent. Value of leaseholds 2,131.06 105. 298. 61 30, 682. 407 2, 100. 000 4, 000, 000 1,000 298,610 20, 000 Total north property . 37,081,017 South property Less applicable purchase money mortgages 1,906.65 3,500 6, 673, 275 Total south property.. _. Value of Equities: Leased land and buildings at 50 percent 1,906.65 6, 673, 275 2, 600, 000 Total valuation ot property under the indenture 46, 354, 292 H H H a $20, 000 12, 000 13, 750 7,450 7,500 6,000 10,000 2.334 $9, 920, 000 2, 227, 200 1,575,750 3, 787, 580 615, 750 7,144,500 16, 342, 780 282, 193 16, 060, 587 1, 050, 000 3. 200, 000 298,610 20, 609, 197 4,450,121 222, 869 4, 227, 252 1, 300. 000 26, 136, 449 GREAT SOUTHWEST CORP., ANALYSIS OF DISCOUNTED PRESENT VALUES, AS OF SEPT. 30, 1962 Land acquired subsequent to Acres Market value acre Market value Discount Discount value acre Total North property: Not fully developed. 106. 92 436. 94 $8, 000 1,500 $855. 360 655,410 M - H Partially subject to overflow Total Money 1 510 770 Less applicable purchase. mortgages.. 777 716 Total 543.86 .. 733. 054 South property: Not fully developed 74.6 7,500 559, 500 126 660 X - Less applicable purchase. mortgages Money Total ed sub- 74.6 618. 46 435 840 Total valuation land acquir 1, 165,894 .. 523 Exhibit 14 [Minutes — N.Y/.C. Board of Directors meeting, May 4, 1966] Board of Directors, Wednesday, May 4, 1966; the Chairman presented the following Cash statement as of April 30, 1966 ; Final operating results for the Quarter ended March 31, 1966, compared with the same period of last year ; Income statement for the three months ended March 31, 1966, compared with the same period of last year ; General balance sheet as of March 31, 1966 ; Freight traffic situation for New York Central Railroad Company and Leased Lines for the week ended April 30, 1966 ; Freight traffic situation for Pittsburgh and Lake Erie Railroad Company for the week ended April 30, 1966 ; and Memorandum of Cars Loaded and Received during April 1966, compared with April, 1965 ; which statements were placed on file. A general discussion of the affairs of the Company ensued. The President asked Mr. Isaac Grainger to report for the Committee appointed at the meeting on March 10, 1966 to investigate the request by The Pennsylvania Railroad Com- pany that this Board consent to an anticipated increase in the aggregate debt of the Pennsyl- vania Group of companies. Mr. Grainger read the report of the Committee, consisting of Messrs. Grainger, Graham and Odell. A copy of the report was submitted for, and is filed as part of, the minutes of this meeting. Under the terms of the merger agreement between Pennsylvania Railroad and New York Central, neither company could increase its group indebtedness more than $100,000,000 above the December 31, 1961 base without approval of the directors of the other railroad. On March 2, 1966, Pennsylvania advised that their new indebtedness was not in excess of $100,000,000 but that their group requirements would cause an increase of approximately $100,000,000 above the allowance and requested the New York Central board to approve this increase (now revised to $95,000,000). Such request was submitted to the New York Central board on March 10, 1966, and a Committee composed of directors Graham, Odell, and Grainger was appointed to consider the appropriateness of the proposal and recommend to the board a course of action. There were only three areas for the Committee's consideration : I. Composition of the group indebtedness above the merger limitations. Schedule attached. II. The major causes of such increase. III. The effects of this excess debt incurrence upon the merged system. The Committee has had a meeting with Chairman Saunders and Finance Committee Chairman Bevan of the Pennsylvania Railroad and has discussed the findings with General Counsel Gray and Vice President-Finance Grant. Since such meeting, the Committee Chair- man has conferred a number of times with both Pennsylvania Railroad representatives to gain additional facts as well as to clarify those given at the conference. Investigations have been made to learn more about the new acquisitions by Pennsylvania Company (holding company through which all subsidiaries are held for the Pennsylvania Railroad). Independent opinions were exceedingly favorable for the Buckeye property and for the most part favorable for the real estate acquisitions. However, questions were raised over short-term prospects for the Arvida properties, and there were negative views expressed in connection with the California properties. Therefore, the Committee cannot give a defini- tive appraisal of the over-all diversification program of the Pennsylvania Company. While there is a feeling that real estate investment at this time would not be the Committee's choice, nevertheless, it has confidence in the judgment of its partners in the merger. It is the Committee's view that while the unexpected $65,000,000 cash from the sale of the Long Island Railroad may have been put to different use by the New York Central directors, the contemplated borrowings in excess of the merger limitations are not suffi- ciently significant or adverse to the interests of the merged systems to cause the directors of New York Central to decline the Pennsylvania Railroad's request. To do so would cause a default in the merger agreement with a resulting collapse of the merger on the eve of its consummation. The benefits of consummation far outweigh any possible adverse results from investments made by the Pennsylvania Railroad especially when neither the Railroad nor its wholly-owned subsidiary is responsible for any of the debts incurred through investment acquisitions. We therefore recommend that the request of the Pennsylvania Railroad be granted. R. Walter Graham, Jr. Robert S. Odell, Isaac B. Grainger, Chairman. 74-924 O - 73 - 35 524 Whereupon, after full discussion, upon motion duly made and seconded, the following resolution was unanimously adopted : Resolution Whereas, the merger agreement dated January 12, 1962 between this Company and The Pennsylvania Railroad Company (Pennsylvania) provides that neither party, without the consent of the Board of Directors of the others, will permit an increase after December 31, 1961 of more than $100,000,000 in the debt, as defined therein, of the party and its majority- owned subsidiaries (excluding The Long Island R.R. Co., Wabash R. Co., Lehigh Valley R. Co. and Pittsburgh and Lake Erie R. Co.) defined as a Group; and Whereas, Pennsylvania, since December 31, 1963, has acquired a majority interest in Arvida Con>oration, Buckeye Pipeline Corporation, Great Southwest Corporation and Macco Realty Company which, on the date of the acquisition of said majority interest, those subsidiaries and their majority-owned subsidiaries, had debt outstanding as follows and it is estimated by the Pennsylvania that the debt of each will be increased since acquisition as follows : Anticipated net increase Debt on in debt after Company acquisition acquisition Arvida.. _ _ $36,514,000 '$514,000 Buckeye Pipe Line _. 35,741,000 21,259,000 Great Southwest Corp 23,045,000 16,955,000 Macco _ 39,358,000 4,642,000 Total.. 134,658,000 42,342,000 1 Decrease. Whereas, it is estimated that the Pennsylvania Group (other than subsidiaries acquired after December 31, 1961) will increase its debt as defined in the agreement after Decem- ber 31, 1961 in the amount of $152,735,000 and substantially all of such increase will be the result of expenditures for equipment and other transportation purposes ; and Whereas, the anticipated increase in debt of the Pennsylvania Group other than sub- sidiaries acquired since December 31, 1961, when considered with the debt owed by such subsidiaries at the time of acquisition and the increase in the subsidiaries' debt anticipated thereafter, will exceed the $100,000,000 limitation provided by said merger agreement ; and Whereas, Pennsylvania has requested the Board of Directors of this Company to con- sent, as provided in Article X of the merger agreement, to an increase of debt of the Penn- sylvania Group. Now, therefore, it is hereby resolved that, in accordance with Article X of the merger Agreement, dated January 12, 1962, between this Company and The Pennsylvania Railroad Company, this Company hereby consents to an increase in the debt of the Pennsylvania Group, as defined in said Article X, in the amount, of $195,077,000 in excess of the ag- gregate debt of such Group outstanding on December 31, 1961 and outstanding in each subsidiary heretofore acquired since December 31, 1961 on the date of such acquisition. Mr. Robert S. Odell here left the meeting. After statements by the Chairman, on motion duly made and seconded, the following resolution was unanimously adopted: Resolved : That an expenditure of $195,847 of which $119,223 is chargeable to Capital Account, for the replacement of cross ties on the Canada Division during the year 1965, be, and the same hereby is approved. After statements by the Chairman, the following resolution was, on motion duly made and seconded, unanimously adopted : Exhibit 15 Maech 29, 1965. Mr. Alan T. Brown, Sales Administrator, Arvida Realty Sales, Inc., Miami, Fla. Dear Mr. Brown : In answer to your letter regarding Mr. and Mrs. David C. Bevan, I am verv happv to submit the following information : I have known Mr. and Mrs. Bevan for twenty years. I am acquainted with their two sons and consider mvself a friend of the family. Socially, I would consider them top flight. As to Mr Bevan's business affiliations, he is a director of the Pennsylvania Railroad Company and Chairman of the Finance Committee of the Pennsylvania Railroad. He is also a director of several other companies and is considered an outstanding success in the busi- ness community. Very sincerely yours, Charles J. Hodge, Chairman, Executive Committee. 525 Abvida Realty Sales, Inc., Miami, Fla., March 25, 1965. [Attachment to above letter] Mr. Charles J. Hodge, Glore, Forgan & Co., New York; N.Y. Dear Mr. Hodge : Mr. and Mrs. David C. Bevan have made application to purchase an apartment in Sabal Point Apartments, a condominium located in Boca Raton, Florida. Arvida Corporation of Miami, Florida, a publicly held corporation, is the sponsor and Arvida Realty Sales, Inc., a wholly owned subsidiary, the the exclusive sales agent. Mr. & Mrs. Bevan have given your name as a business reference. We would like you to give us, in confidence, specific information relative to character, personal habits, and abilities in regard to compatibility with their social and/or business associates. We appreciate the information which you may care to furnish concerning Mr. & Mrs. Bevan. We feel sure also that they will appreciate your assistance in this regard. A self- addressed, stamped envelope is enclosed for your use. Sincerely yours, Alan T. Brown, Sales Administrator. Exhibit 16 [Attachment to letter below] Letter from Martha Fonner to C. J. Hodge, Sept. 29, 1965 and attachments September 29, 1965. Mr. Hodge : Mr. E. K. Taylor, Six Penn Center Plaza, Room 1138, Philadelphia, Pa., called re : title policy on Sabal Point Apartment. The Commonwealth Title is the parent co. of Louisville Title Insurance Co. He suggested getting standard type of title policy. He is doing this for Dave Bevan. He asked that we send in your policy to him. M.F. October 5, 1965. Mr. E. K. Taylor, Legal Division. The Pennsylvania Railroad Co., Philadelphia, Pa. Dear Mr. Taylor: Sorry I didn't take care of this sooner, but Mr. Hodge has been up to his neck and I just got around to telling him how nice you were to suggest that you would take care of getting him the standard type of title policy, which you are doing for Mr. Bevan. Mr. Hodge wishes me to convey his sincere thanks for your efforts on his behalf. Kind regards. Sincerely, Martha Fonner Secretary to Charles J. Bodge, Chairman, Executive Committee. Edwin K. Taylor, Esq., Attorney-at-Law, Philadelphia, Pa. Dear Mr. Taylor : Your letter of October 14th together with Mr. Charles J. Hodge's new title insurance policy covering his Sabal Point Condominium apartment in the amount of $48,795.00 was received this morning in his absence. Mr. Hodge is very grateful for your kind cooperation and efforts expended by you in his behalf, and I wish to express his thanks. Kind regards. Sincerely yours, Martha Fonner, Secretary to Charles J. Hodge, Chairman, Executive Committee. Philadelphia, Pa., October 14, 1965. Mr. Charles J. Hodge, Chairman, Executive Committee, Glore, Forgan, Wm. R. Staats, Inc., New York. N.Y. Dear Charlie : I enclose your new title insurance policy for your condominium. Com- monwealth Land Title Insurance Company controls Louisville Title Insurance Company, which originally issued the policy to you. I am returning to Commonwealth the policy issued to you by Louisville. Sincerely yours, Edwin K. Taylor. 526 Exhibit 17 [From flies of C. J. Hodge— "Pinnacle Farm Dlnner-Cafe-Boat," August 26. 1965] Glore, Fokgan, Wm. R. Staats, Inc., New York, N.Y., July 28, 1965. Messrs: Bevan ; Bevan ; Bodman ; Cannon; Gerstnecker ; Hendrickson ; Kling • Sawin • Seward; Stevens; Tiernan. The 26th of August is the date of the dinner for the Pinnacle Farm and their guests My turn has finally caught up, and I can find no valid way of getting out of giving the dinner so that I am inviting each of you and one guest to a dinner at Pinnacle Farm on the 26th of August. The bar opens at 4 :00 P.M. in the afternoon. Inspection tour 4 :00 P.M. to 6 :00 P.M. Cocktails 6 :00 P.M. to 7 :00 P.M. Dinner 7 :00 P.M. to 9 :00 P.M. Will you please advise me at my office of your acceptance, and whether or not you will have a guest. I might add that I have arranged with Oscar who owns Delmonico's Restaurant in New York to put on a superb dinner. I certainly hope that all of you can attend. Charlie. [Attachment to above correspondence] SlLVERFISH Bevan, D. C. (Dave), Room 1846, 6 Penn Center Plaza, Philadelphia, Pa. Bevan, T. R. (Tom), Duane, Morris & Heckscher, Land Title Bldg., Broad & Chesnut, Phila., Pa. 19110. Bodman, W. (Warren), Tarnell, Biddle & Co., 1528 Walnut St., Philadelphia, Pa. Cannon, F. A. (Bill), 1st Boston Corp., 20 Exchange Place, New York 5, N. Y. Gerstnecker, W. R. (Bill), Room 1334, 6 Penn Center Plaza, Philadelphia, Pa. Hendrickson, W. (Bill), Welding Engineers, Box 391, Norristown, Pa. Hodge, C. J. (Charlie), Glore, Forgan-Wm. R. Staats, 45 Wall St., New York, N.Y. Kling, V. G. (Vince), 917 Corinthian Ave., Phila., Pa. 19130. Sawin, B. F. (Ben), Provident National Bank, Broad and Chesnut St., Phila., Pa. Seward, C. (Carroll), Yarnall, Biddle & Co., 1528 Walnut St. Philadelphia, Pa. Stevens, L. M. (Larry), Hornblower & Weeks — Hemphill,, Noyes, 1401 Walnut Street, Philadelphia, Pa. Tiernan, W. F., Jr. (Bill), Franklin Printing Co., Bunting Lane, Primos, Pa. Exhibit 18 Hotel Excelsior, Rome, Italy, October 16, 1961. Mr. David Bevan, Financial Vice President, Pennsylvania Railroad, Phildelphia, Pa. Dear Dave : I hope that you received my cable. I met with the Union Bank in Zurich and I was quite firm with them. I established that between themselves and the other two banks they control one million three hundred thousand shares. I explained to them that the management of the Pennsylvania was the best in the East, and that the solution to the railroad picture in the East was one of mergers and not the selling off of assets further related to them. While the New York Central might have sufficient real estate holdings the Pennsylvania had done all they could with their real estate holdings and that their Crown Jewel was the North Western which was valued at about $350,000,000. I went into some of the possibilities of merger on a confidential basis explaining to them that my firm was in the middle of most of them. I then told to Saacher that whoever had been pumping him full of mis-information obviously could not be a man of any great responsibility, and that, in fact, I could see that this person had no idea of what he was talking about. I further said to him that I would be pleased to have Saacher quote me to this unkown very emphatically, and that I really thought that the Union Bank and the others were handling themselves in a manner which gave no evidence of fundamental knowledge as pertains to the situation. The upshot of all this was they were very red-faced, and asked me to assure the management that no steps would be taken of any sort until we had met. I told them that if they wanted representation on the Board of Directors, providing that their representative was not an Investment Banker, they should bring this point to the management and I was sure that the management would give this consideration. I 527 further stated that the Chairman of the Board and the Financial Vice President would be happy to come to Zurich if the Bank wanted them to do so. Saacher answered me by saying they would do nothing and that they were happy I had come to see them and to assure you again that no steps would be taken. He further stated that he with one of his associates was coming to New York in the early part of November, and would at that time like to meet with the Pennsylvania management. I said that I would provide a dinner or luncheon wherein this meeting could take place. To wrap this up it would have been absolutely unnecessary for you and for Jim to have come to Switzerland after my conversation with them. You realize I am sure that with the usual speed we have served your railroad. In the meantime I am having a very good time except getting a little fat. With best regards to all. Charlie. Exhibit 19 schweizerische bankgesellschaft, November 15, 1961. Mr. Francis N. Rosenbaum, c/o Messrs. Goodwin, Rosenbaum, Meacham & White, Counsellors at Law, Washington, B.C. Dear Frank : I refer to your letter concerning the visit of General Hodge with our Mr. Saager. Mr. Saager wants me to tell you, that the meeting with General Hodge was very short and that it should not be too largely interpreted. Mr. Saager assured General Hodge, that our bank will not participate in a Proxy Fight. On the other hand we had of course some interest to learn General Hodge's points of view. It is important to know, that Mr. Saager gave no assurances as to the assisting of the present Management of Pennsylvania Railroad, although General Hodge offered the bank a seat in Penna's' Board of Directors. Mr. Saager has not yet made any plans as to his next visit to the United States. Sincerely yours [Signature illegible] Exhibit 20 [From files of C. J. Hodge, Chairman of the Executive Committee, Glore, Forgan, Wm. R. Staata & Co.] Dinner Given by J. Russell Forgan and Charles J. Hodge, The Links Club — October 30, 1963 Stuart T. Saunders, Chairman, Pa. RR David C. Bevan, Chairman, Finance Comm., Pa. RR Herman H. Pevler, President, Norfolk & Western Ry JRF, JFF, CJH Thomas S. Gates, Morgan Guaranty Trust, 23 Wall Street, N.Y. Henry C. Alexander, Morgan Guaranty Trust, 23 Wall Street, N.Y. Wm. H. Moore, Chairman of Board, Bankers Trust Co., 280 Park Ave., N.Y. Wm. S. Renchard, Pres., Chemical Bank New York Trust, 20 Pine St. Harold H. Helm, Chairman of the Board, Chemical Bank N.Y. Trust, 20 Pine St. George D. Woods, Pres., International Bank for Reconstruction & Finance, 1818 H. Street, Washington, D.C. (N.W.) L. B. Worthington, Pres., U.S. Steel, 71 Broadway, N.Y. Robert C. Tyson, Chairman, Finance Comm., U.S. Steel, 71 Broadway AVm. H. Lang, U.S. Steel, 71 Broadway, N.Y. M. J. Rathbone, Chairman, Standard Oil Company (N.J.) 30 Rockefeller Plaza John A. Mayer, Pres., Mellon Bank, Mellon Square, Pittsburgh, Pa. Orville E. Beal, Pres., Prudential Insurance Company, Newark Dudley Dowell, Pres., N.Y. Life, 51 Madison Avenue Cecil J. North, Pres., Metropolitan Life, 1 Madison Ave.. N.Y. George P. Jenkins, Fin. V.P., Metropolitan Life Ins. Co.," 1 Madson Ave Eugene A. Schmidt, Jr., V.P. & Treas., Metropolitan Life Ins. Co. W. Paul Stillman, Chairman & Pres., National State Bk, Newark Robert A. Love, Brown Brothers Harriman, 59 Wall Street, N.Y. Walter E. Dennis, Exec. V.P., Chase Manhattan Bk., 1 Chase Manhattan Plaza \\ alter W. Wilson, Morgan Stanley & Co., 2 Wall Street, N.Y. John M. Schiff, Kuhn Loeb & Co., 30 Wall Street, N.Y. Albert II. Gordon, Chairman, Kidder Peabody & Co., 17 AVall St., N.Y. James F. Oates, Jr., Chairman & Pres., Equitable Life Assur., 1285 Ave. of Americas N.Y Grant Reehn, Exec. V.P., Equitable Life Assur., 1285 Ave. of Americas, N.Y. Peter B. Langmuir, V.P., Northwestern Mutual Life Insurance Co., Milwaukee Chas. Glavin, First Boston Corporation, 15 Broad St., N.Y. Harold J. Berry, Harriman, Ripley & Co., Inc., 63 Wall St., N.Y 528 M. J. Warnock, Pres., Armstrong Cork, Liberty & Charlotte Sts., Lancaster, Pa. Hobart C. Ramsey, 5 Delbarton Drive, Short Hills, N.J. George J. Leness, Pres., Merrill Lynch, etc., TO Pine St., N.Y. George Leib, Chairman, Blyth & Co. Inc., 14 Wall St., N.Y. Charles B. Harding, Smith Barney & Co. Inc., 20 Broad St., N.Y. 5 Joseph H. King, Eastman Dillon, Union Securities & Co., 15 Broad St., N.Y. Frederic II. Brandi, Pres. & Dir., Dillon Read & Co. Inc., 46 William St. Sidney J. Weinberg, Goldman, Sachs & Co., 20 Broad St., N.Y. 5 Robert Lehman, Lehman Brothers, 1 William St., N.Y. Edward K. Van Home, Pres., Stone & Webster Securities Corp., 90 Broad St. Frederic G. Donner, Chairman, General Motors Corp., 1775 Broadway, N.Y. John E. Bierwirth, National Distillers Joseph F. Cullman, III, Pres., Philip Morris, 100 Park Ave., N.Y. Lewis A. Lapham, Chairman, Bankers Trust Company George A. Murphy, Chairman, Irving Trust Co., 1 Wall St., N.Y. 5 R. E. McNeill, Jr., President, Manufacturers Hanover Bank, 40 Wall St. Benjamin J. Sawin, Provident & Trust Savings Bank, Phila., Pa. Richard K. Paynter, Jr., Chairman, N.Y. Life, 51 Madison Ave., N.Y. Dinner at the Links Club — October 30, 1963, Messrs. Saunders, Bevan, Pevler Acceptances : Orville E. Beal, President, Prudential Insurance Company, Newark Harold J. Berry, Exec. V.P., Harriman, Ripley & Co., Inc., 63 Wall Street Frederic H. Brandi, Pres. & Dir., Dillon Read & Co. Inc., 46 William St. Walter E. Dennis, Exec. V.P., Chase Manhattan Bank, 1 Chase Manhattan PI. Charles D. Dickey, Chairman, Comm. on Trust Matters, Morgan Guaranty Trust Dudley Dowell, President, New York Life Insurance Co., 51 Madison Ave. Charles C. Glavin, V.P., First Boston Corporation, 15 Broad St., N.Y. Charles B. Harding, Partner, Smith Barney & Co., 20 Broad St., N.Y. Stewart S. Hawes, President, Blyth & Co., 14 Wall Street, N.Y. George P. Jenkins, Fin. V.P., Metropolitan Life Insurance Co. Everett G. Judson, V.P., First National City Bank, New York Grant Keehn, Exec. V.P., Equitable Life Assurance Co., 1285 Ave. of Amer. Joseph H. King, Partner, Eastman Dillon, Union Securities & Co., 15 Broad Lewis A. Lapham, Chairman, Bankers Trust Company William H. Lang, Adm. V.P. & Treas., U.S. Steel R. E. McNeill, Jr., President, Manufacturers Hanover Bank, 40 Wall Street William H. Moore, Chairman of the Board, Bankers Trust Co., 280 Park Ave. George A. Murphy, Chairman, Irving Trust Co., 1 Wall Street, New York 5 Richard K. Paynter, Jr., Chairman, New York Insurance Co. William S. Renchard, President, Chemical Bank New York Trust, 20 Pine St., N.Y. James S. Rockefeller, 399 Park Avenue, New York, Chairman of the Board, First National City Bank Benjamin F. Sawin, Vice Chairman, Tradesmens Bank & Trust Co., Phila., Pa. Arthur D. Schulte, Partner, Lehman Brothers, 1 William St., N.Y. John M. Schiff, Partner, Kuhn Loeb & Co., 30 Wall Street, N.Y. Eugene A. Schmidt, Jr., V. P. & Treas., Metropolitan Life Insurance Co. Dale E. Sharp, Vice Chairman, Morgan Guaranty Trust, 23 Wall Street W. Paul Stillman, Chairman & Pres., National State Bank, Newark Robert C. Tyson, Chairman, Finance Comm., U.S. Steel, 71 Broadway Edward K. Van Home, Pres., Stone & Webster Securities Corp., 90 Broad St Sidney J. Weinberg, Partner, Goldman, Sachs & Co., 20 Broad Street, N.Y. Walter W. Wilson, Partner, Morgan Stanley & Co., 2 Wall Street, New York L. B. Worthington, President, U.S. Steel, 71 Broadway, New York Not heard from — Wm. Boyer, Fin. V.P. & Treas., Republic Steel, Cleveland Exhibit 21 [Letter from flies of C. J. Hodge, Chairman of the Executive Committee. Glore, Forgan, Wm. R. Staats & Co.] April 6, 1965. Mr. David C. Bevan, Chairman of the Finance Committee, The Pennsylvania Railroad Co., Philadelphia, Pa. Dear Dave : As you know, Stuart. Saunders is going to be in Europe, including Spain during part of May, and has kindly called to advise me of this. Alfonso Manero and I are very anxious to have him meet some of our friends in Europe, and particularly, our friends in Spain. We understand that Stuart will have Mrs. Saunders with him, and perhaps, another couple. 529 Alfonso has just returned from Spain and we find it necessary that Alfonso and I go to Spain again on approximately the 18th of April, and will remain there for about a week. During Alfonso's recent trip to Spain, our friends, who are of the highest order, indicated that they wish to consult with us on various matters. One of the prime matters they wish to speak of is to expand a manufacturing facility for freight cars in Madrid which is owned by a company called Euskalduna. This company owns one of the largest shipbuilding plants in Bilbao, in addition to the freight car facilities in Madrid. The Spanish people have asked us to recommend to them a company or companies in the United States who can advise them as to the expansion of the manufacturing facilities for freight cars. Both Alfonso and I feel that a conversation between Stuart and the group in Spain (to include Carlos Mendoza, the head of RENFE, which is the government controlled railroad monopoly in Spain) would be a proper platform for the building up of simpatico between Stuart, the Pennsylvania and the Spanish. We, therefore, of course, will refrain from speaking to anyone else until you can advise me as to whether Stuart and yourself feel that this would be a desirable move. There is no question here of requesting financing. Any money required will be avail- able in Spain from the Spanish. This is merely an effort to bring the Spanish closer to the Pennsylvania Railroad. I wish you would ask Stuart about this and advise me at your earliest opportunity. Best regards. Sincerely, The Pennsylvania Railroad Co., Philadelphia, Pa., April 80, 1965. Mr. Charlie J. Hodge, Chairman of Executive Committee, Olore, F organ, William R. Staats, Inc., New York, N.Y. Dear Charlie : I now find that by reason of some very urgent developments in our Pennsylvania-New York Central merger that I have to postpone my trip to Europe for several months. My present plans are to go to Europe this Fall. When our plans crystallize, I will let you know, with the hope that we can get together with some of your friends in Spain. Won't you please let your friends in Spain know of this change. Sincerely, Stuart T. Saunders. [Telegram] To : Fieldglow NYK COR 825 Bruxelles 28 31 1356 Lt Glostaats New York Charles Hodge dinner November 17th, Saunddrsxx Saunders. Please advise Verhaegen Belgebank if 8:15 possible instead of 9:00. Stop Belgian personalities used to earlier dinner-time regards. Rik. [Telegram] Glore, Forgan, Wm. R. Staats, Inc., _ Tr , November 3, 1965. To : Verhagen Belgebank Brussels Re dinner November seventeenth Brussels Saunders stop They will try to make it as close to eight thirty as possible. Attending cocktail party in their honor. Please call them at Hotel am on seventeenth. Fonner Glostaats. [Telegram] October 19, 1965. Rik Verhagen : Pursuant to our conversation of this morning with regard to making the necessary arrangements for Mr. and Mrs. Stuart T. Saunders and Mr. and Mrs A 1 aul Funkhauser, I wish to give you the following dates for dinner, around nine o'clock in the eyening as they will be attending cocktail parties before having dinner- Monday November 15th, Hamburg, Hotel Vier Jahrezeiten, 9-14 Neuer Jungfernstieg \Vednesday, November 17th, Brussels, Hotel Westbury, 6 Rue Cardinal Mersier. inank you very much for your cooperation. Martha Fonner. 530 HOTEL ACCOMMODATIONS— NOVEMBER, 1965 (Arrival and departure times are approximate, subject to adjustment due to local traffic conditions] Number of nights Date of week Date Arrive City Hotel, telephone number, and address Depart 3 Tuesday 2 8:30a. m London Claridge's, Brook St., London W. 1 7'45am Wednesday.... 3 England (Mayfair 8860). Thursday 4 Friday 5 4 Friday 5 12:00 noon Paris Plaza Athenee, 25 Avenue Montaigne, 8:15am Saturday 6 Paris 8, France (ELY 85-23). Sunday 7 Monday.. 8 Tuesday 9 1 Tuesday 9 11:30a. m Luxembourg Kons Hotel, Avenue D'Alsace, Luxem- 8:15a.m. bourg, Luxembourg (40461). 1 Wednesday.... 10 6:00 p. m Zurich Baur Au Lac, 1 Talstrasse, Zurich, 3:00 p.m. 1 Wednesday.... 10 Switzerland (23-57-33). 1 Thursday 11 5:00p.m.. Venice Danieli Royal Excelsior, Riva deg 2:00p.m. 1 Thursday 11 Schiavoni, Venice, Italy (26-480). Friday 12 2 Friday 12 5:00 p. m Florence Excelsior Italie Hotel, 3 Piazza Ognis- 12:00 noon. Saturday 13 santi, Florence, Italy (29-43-01). Sunday 14 2 Sunday 14 3:30p.m Hamburg Vier Jahrezeiten,9-14 Neuer Jungfern- 8:30a.m. Monday 15 stieg, Hamburg, Germany (34-10-14). Tuesday 16 2 Tuesday 16 8:47 p. m Brussels.. Westbury, 6 Rue Cardinal Mersier, 8:30a.m. Wednesday 17 Brussels, Belgium, (02/136480). Thursday 18 1 Thursday 18 12:30 p. m Milan Continentale, 7 Via Manzoni, Milan, 8:00a.m. Friday 19 Italy (807-641). 2 Friday 19 5:00 p.m .Cannes. Majestid, Boulevard de la Croisette, 12:00 p.m. Saturday 20 Cannes, France (39-17-92). Sunday 21 3 Sunday 21 4:00p.m .Rome Hassler Villa Medici Hotel, 6 Piazza 8:30 a.m. Monday 22 Trinita dei Monti, Rome, Italy (67- Tuesday 23 26-51). Wednesday 24 1 Wednesday 24 2:30p.m Madrid Ritz, Plaza de Lealtad, Madrid 5, Spain 4:45p.m. Thursday 25 (221-28-57). 1 Thursday 25 7:00 p.m Lisbon Ritz, Rua Rodrigo da Fonesca, Lisbon, 12:00 noon. Friday 26 Portugal (68-41-31). 15th Hamburg dinner. 17th Brussels dinner. Mr. and Mrs. Stuart T. Saunders, Chairman of Board. Mr. and Mrs. A. Paul Funkhauser, Vice Pres. Coal & Ore Traffic. Mr. Gross, Seoy. to Mr. Saunders. The Pennsylvania Ratxhoad Co., Philadelphia, Pa., December 15, 1965. Mr. Charles J. Hodge, Glore, Forgan, Wm. R. Stoats, Inc., New York, N.Y. Dear General Hodge : This is just a note to tell you how much Rodie and I appreciated the arrangements you made for the Saunders and us on our recent European trip. We had delightful evenings with Dr. Brinckmann and Dr. Wuttke in Hamburg and with the Verha- gens in Brussels. Incidentally, my wife is the daughter of Ed Gamble who tells me he is an old friend of yours. I am under the impression you served together in the OSS during the war. Xext time I am in New York I would like to come by and meet you and thank you per- sonally for your kindnesses. Sincerely, A. Paul Funkhauser. Stuart T. Saunders. Ardmore, Pa., December 6, 1965. Mr. Charles J. Hodge, Glore, Forgan, Wm. R. Staats, Inc., New York, N.Y. Dear Charlie : I thought that you were almost with us on our European trip, as you were so thoughtful in sending us flowers and arranging for us to have dinner with some of your lovely friends. You certainly added a great deal of pleasure to our trip, and we are most grateful. I hope that some day Dorothy and I will have an opportunity to reciprocate in some measure. My kindest regards. Sincerely, Stuart T. Saunders. 531 Exhibit 22 August 3, 1964. Personal and Confidential Mr. David C. Bevan, Chairman, Finance Committee, The Pennsylvania Railroad Co., Philadelphia, Pa. Dear Dave : Under separate cover I have submitted a bill for our work on The Buckeye Pipeline Company. This bill is for the total amount of $200,000, and is submitted at your request. In addition to this, you asked me to write you a personal and confidential memorandum citing the details concerned with this deal. I have attempted to set down what I believe to have been the main work formed by Glore, Forgan & Co. in the last eighteen months to two years. 1. As you know, we have been working on pipe line considerations for your Company for the last seven years, which we have been glad to do. 2. Finally, you recognize, I am sure, it was Glore, Forgan & Co. and myself who pro- posed this acquisition to you. 3. I think that we have performed an excellent job in acquiring the stock of Buckeye from the beginning. 4. You will remember that we arranged the sale of 53,000 shares of Buckeye from the Massachusetts Mutual to yourselves. Due to existing conditions, it was considered unwise to cross it on the New York Stock Exchange and, therefore, we put you in direct contact with the Massachusetts Mutual and the transaction was arranged at a price of 35 less commis- sion, as your cost. At that time it was said that we would be reimbursed for the double com- mission. You and I realize that to date it has been difficult to do this, so that it has not come about. 5. I had mentioned to you earlier a fee of $200,000. and this, of course, was excluding the commissions which had been paid or were to be paid, and as pointed out above, we were not paid the $38,000. on the Massachusetts Mutual business. 6. We continued our effort of advising you and working for you to include carrying out negotiations with Kuhn Loeb & Co. acting in your behalf and with, in some cases, the man- agement of Buckeye. I am sure you are aware of the amount of money paid Kuhn Loeb by Buckeye for the work done. I think the above presents, in short form, a rather concise history of this piece of busi- ness. The $200,000. includes the $38,000. involved in the Massachusetts Mutual transaction. This amount in my way of thinking is a most reasonable amount of money when one con- siders the history and the time involved. I believe, personally, that it is on the minimum side as compared with other transactions of this nature. I hope that you are in accord with this, and look forward to seeing you soon. Sincerely yours, P.S. Enclosed is the schedule of fees of the deals. [First draft notes attached to above letter] Charles J. Hodge. August 3, 1964. 1. Have been working on the pipe line situation since 1950. 2. Totally and personally responsible for the suggestions of Buckeye. 3. We think we did an excellent job of buying the stock in the first instance. 4. We arranged a cross of 53,000 shares of stock from Massachusetts Mutual. Due to conditions, it was more convenient for the stock to be purchased by you directly from the Massachusetts Mutual. We arranged this and you paid 35 less 36.50 per 100 shares, as you were going to send us a deed for $38,160.00 covering the two commissions. This has not been done, and while I am sure the intent was to reimburse us in some way, it has been difficult to do so. You realize that we actually paid the salesmen involved. I had mentioned that a $200,000. fee was what I considered appropriate for the job, excluding the commissions that had been paid or were to be paid. The effort that we have put out in attempting to secure stockholders' approval, in- cluding work done with Kuhn Loeb is also included. You are aware of what Kuhn Loeb charged Buckeye for practically a week's work. To sum it all up, we brought you this deal and continued to advise you in all factors relating to acquisition and we succeeded in getting a block of stock and we entered into the final negotiations as your adviser, this over a period of almost two years. I feel that a bill of $200,000, to include the $38,160.00 commissions due us is a very reasonable bill for the work accomplished. Charles J. Hodge. [Attachment] August 3, 1964. Pennsylvania Co., Wilmington, Del. For financial advice and other services rendered in connection with the acquisi- tion of the Buckeye Pipe Line Co $200, 000. 00 532 August 21, 1964. Mr. David C. Bevan, Chairman of the Finance Committee, The Pennsylvania Railroad Co., Philadelphia, Pa. Dear Dave : I am submitting the list of merger fees, as requested by you. I have in- cluded the Pennsylvania-Buckeye as suggested. I am also submitting a new bill, breaking the .$200,000 into its proper factors. I look forward to the Florida trip with you. See you soon. Sincerely, Charles J. Hodge. August 3, 1964. Pennsylvania Co. Wilmington, Del. For financial advice and other services rendered in connection with the acquisition of the Buckeye Pipe Line Co $162, 000. 00 Commissions due in connection with purchase of 53,000 shares of the Buckeye Pipe Line Co. common stock from Massachusetts Mutual Life Insurance Co 38, 000. 00 Total 200, 000. 00 MERGER FEES Company Banker Amount Fees Percent Crown Zellerbach, Gaylord Container Blyth & Co $123,000,000 $280,000 0.227 Continental Can Co., Hazel Atlas Glass Co Goldman, Sachs & Co 49,000,000 '250,000 .561 Whirlpool, Delaware Appliance ._ Goldman, Sachs & Co., Fulton, Reid 40,000,000 100,000 .25 Pabco, Fiberboard Products Blyth & Co 38,000,000 175,000 .46 Cerro de Pasco, Consolidated Copper Mines Smith, Barney & Co., Morgan Stanley 35,000,000 350,000 1.00 &Co. Diamond Match (Diamond National), General Pack- Morgan Stanely & Co 30,000,000 200,000 .667 aging. Flintkote.Calaveros Cement Glore, Forgan & Co 30,000,000 450,000 1.5 Ideal Cement, Volunteer Portland Cement Kidder, Peabody & Co 22,000,000 334,000 1.52 Material Service, General Dynamics Lehman Brothers-Blyth & Co... 100,000,000 260,000 .26 Electric Storage Batteries, Ray-0-Vac Smith, Barney & Co 17,000,000 125,000 .735 Miehle-Goss Dexter Inc. ...do 14,000,000 100,000 .714 Average... .718 Pennsylvania Co., Buckeye Pipe Line Glore, Forgan & Co 70,000,000 162,000 .231 •Plus $29,000 financing fee. Exhibit 23 September 28, 1964. [Memorandum from D. C. Bevan, Chairman of the Finance Committee, P.R.R. to S. T. Saunders, Chairman of the Board, P.R.R. ] Personal and Confidential Re: Buckeye At the present time, we have 2 investment bankers on the board of Buckeye, Bob Brown, semi-retired partner of Kuhn, Loeb and Bob Gardner, partner of Reynolds & Co. Bob Brown, at this point, does not add much either to the prestige or the working knowledge of the board, but in view of his previous importance at Kuhn, Loeb and the fact that he is an extremely high type person, I would hesitate to remove him at this time. I would guess that in 2 or 3 years he would quit of his own accord. Bob Gardner is a personal friend of George Patterson and to my mind adds nothing to the board from the standpoint of knowledge or prestige. There were also a number of unconfirmed rumors around that he profited very heavily on buying Buckeye stock prior to our acquisition. I would strongly recommend that we replace him with Charles Hodge who brought us the Buckeye business, who has a very substantial background in pipe lines, knows the business well and should be placed in a position to handle the financing of Long Island Pipe Line next year. Everyone in the financial world knows that he brought us this business and the more we show that we stick with the people who bring us business the more favorable deals we are likely to have brought our way. If you approve, I will be glad to work this out with George Patterson. July 19, 1965. [Memorandum from D. C. Bevan, Chairman of the Finance Committee, P.R.R. to S. T. Saunders. Chairman of the Board, P.R.R.] Personal and Confidential Subject : Arvida Corporation. Arvida Corporation will have a meeting on July 26th. They can't hold it before because to accomplish some of the things need ten out of twelve members. We will have to caution all members of the Executive Committee to be extremely careful until that time. Their by-laws call for fifteen directors, they have twelve. They have offered to reduce the number to ten to allow us to put five on if this is satisfactory to you. I think it would be a good first step. 533 My recommendations as to nominees would be as follows : S. T. Saunders ; D. C. Bevan ; C. J. Hodge ; W. R. Gerstnecker ; and Angus Wynne. I think Hodge should be a member of the board. He brought us the deal, knows a lot about the company and from time to time we will need the advice of a good investment banker who is familiar with the situation. I feel W. R. Gerstnecker should be included to provide the necessary continuity in the supervision of our investment. This is in line with the duties and responsibilities I have recommended that he should ultimately have. As our top real estate expert I recommend Angus Wynne. His advice should be in- valuable after he gets a feel of the Florida situation. I believe our directors should be elected at the July 26th meeting. Is this satisfactory with you? D. C. B. Exhibit 24 William R. Staats & Co., Inc., Los Angeles, August 4, 1965. To : Charles J. Hodge I received Tom Mann's memo of July 25 advising us of the purchase by Pennsylvania Railroad of 51 per cent of the interest in Arvida. I was talking with Maury Sunday and he mentioned just what this meant to the firm in dollars and cents. Congratulations, Charlie, on the fine piece of business you were responsible for. I won't be seeing you at the Director's meeting since I will be with my family in Hawaii, however, I look forward to talking with you when I am in New York sometime in October. R. W. G. /gv cc : MHS, PSN Glore, Forgan, Wm. R. Staats, Inc., Los Angeles, July 30, 1965. Mr. Charles Hodge, New York Office Dear Charlie : Again I want to congratulate you on the Arvida deal. It certainly comes at a time when we can use the fee and I know what a tremendous amount of work this must have required on your part during the past year. This will confirm my agreement for you to serve as director of the company. With best regards, I am Sincerely, Donald Royce, Sr. Exhibit 25 [Letter, from files of C. J. Hodge, Chairman of the Executive Committee, Glore, Forgan, Wm. R. Staats & Co.] August 19, 1964. Mr. Stuart Saunders, Chairman of the Board, The Pennsylvania R.R. Co., Philadelphia, Pa. Dear Stuart : I hope this note will convey to you my thanks for a very pleasant evening last night. I think the turn-out was remarkable and certainly everything was done to the Queen's taste. I particularly wish to thank you for going to the effort, after your small operation, to be present. I assure you that the group from Texas is of the highest standard. I repeat to you that I have dedicated myself to the service of yourself and to Dave, and to the Pennsylvania in attempting to help you build a real great empire. Again thanks. I hope to see you soon with a pack of cards in your hand. Best wishes. Exhibit 26 Partners Memorandum August 22, 1958. Memorandum to Partners Herbert Herff, who has been introduced to this firm by Clare Kramer, came to J.R.F. with the following proposal : 1. The Great Southwest Development Corporation owns large portions of land on the Turnpike between E't. Worth and Dallas, Texas. The Great Southwest is owned by the Wynne, Rockefeller Brothers and certain others. 534 2. Wynne have decided to extract approximately 150 acres from the property owned by Great Southwest and to construct on this acreage a typical amusement type area which will correspond in many ways to Disneyland. 3. Approximately 150 acres will come in title free as an asset. The Wynne will put $1,000,000 up in cash. They wish to borrow, for approximately thirty months, $2,750,000. Herff made the deal with them that if he succeeded in getting the $2,750,000, the new subsidiary or amusement corporation would pay back $1,000,000 as a bonus for that $2,750,000 in approximately thirty-six months. It turns out that this had to be decided quickly and Herff said to me that he was going to take the deal himself unless he could close it by this morning, the 22nd of August. We have finally agreed Zilkha will lend the money receiving 45% of the bonus as com- pensation. Herff will receive 45% and Glore, Forgan will receive 10%. All this is to be worked out on a capital gains basis. Each has given his word to the other subject only to the provisions and investigation of the collateral involved. It is my opinion that Glore, Forgan, for the work of six or seven days, was very fortu- nate to come out with this amount of money as a profit. It would have been impossible to get any more unless we, ourselves, were willing to commit for a portion of the $2,750,000. You may consider this a profit which will come in to Glore, Forgan & Co. after the $2,750,000 is paid off, and this profit will be on a capital gains basis. C. J. H. [Attachment to above memorandum] Gkeat Southwest Corporation Great Southwest Corporation now around 15, compared with the original May, 1960 offering price of 18 and a low around 10 bid, merits attention at the present time due to recent developments which are calculated to increase cash flow in the near term and enhance equity values over the years. Thus ownership of the stock enables the holder to participate along with the Wynne and Rockefeller families in the long range development of the Corpo- ration's real estate holdings located approximately midway between Dallas and Fort Worth, Texas, one of the fastest growing areas in the United States. Incidentally the fact is note- worthy that these two dominant groups of stockholders paid an average of about $10 per share for their holdings which comprise about 80% of the 1,037,662 ($1 par) common shares outstanding. The basic philosophy of the Wynne management is to lease the properties to be devoted to commercial and industrial use, so that prospective increment in the equity, if realized, will inure to the benefit of the stockholders. In order to use the accumulated tax loss and to in- crease working capital, however, some ' commercial and industrial land is being sold to "name" buyers at prices which average nearly $17,000 per acre compared with a $6,400 per acre average developed cost for that land. When the residential segment of the District is ready for development, sales of these parcels will be made also. Recent purchasers : B-J Service, a Borg- Warner subsidiary which services oil wells, paid about $17,500 per acre for a fixe-acre tract where a regional laboratory and office covering 15.000 square feet has been completed. The new structure houses general offices, sales training and credit operations previously carried on at other locations. The Frito Company paid approximately $10,000 per acre for a 25-acre parcel : plans call for eventual construction of a processing facility and distribution center to serve the market in the southwest. National Cash Register has bought for about $22,000 per acre an eight-acre site on which there is to be erected initially a factory covering 40,800 square feet. In February. 1961 Falvey Container Corporation completed a plant occupying 30,000 square feet of space on its property in the District which the Company says is an ideal location for its operations. Earlier purchasers mentioned in a previous circular include United States Steel, Con- tainer Corporation and Sun Chemical now established in the District. Unitex Industries which bought property some time ago has had such success with its operations in the District that its facility is being expanded 50% to a total of 75,000 square feet. Leases entered into include an 80.000 square foot plant for Vought Electronics Division of Chance-Vought Corporation on a 12.5 acre site; a 58.000 square foot diesel engine rebuild facility for Cummins Engine Company and a regional distribution center for Lever Brothers covering 50.000 square feet of warehouse space. The move will represent a departure from Lever Brothers historical practice of maintaining 38 distribution sub-stations in a five-state area. Other tenants are Rich Plan which has moved into a new 10.000 square foot building under lease. Rich is a pioneer in processing and distributing frozen foods. In prospect is an office building occupying 30.000 square feet of land to be built by the Corpora- tion for lease and occupancy by Texas Industries manufactures of concrete building prod- ucts. Another important tenant is the Ozalid Division of General Aniline and Film Corpora- tion which has a manufacturing plant under lease in the District and which has been opera- ating since December 15, 1960. General Aniline hopes to expand its facilities in the District in the near future. While cash flow will increase over the years from various sources the most immediate source of such funds is expected to come from the entertainment center. "Six Flags Over Texas" scheduled for operation in August of this year, just in time to benefit from visitors 535 to the September Texas State Fair the grounds of which are in the vicinity. This center is planned as a high caliber family show and, according to Mr. Wynne, will be comparable to no other existing entertainment and will feature special attractions including music, good food, and continual activity. „.„,». * According to an article in The Dallas Times Herald, Sunday Magazine section of February 12 1961. the principal exhibits will depict the periods of development of the State of Texas under the flags of France, Mexico, Spain, the Confederacy, the Republic of Texas and the United States. Development of the 105-acre tract is expected to cost somewhat less than $4 million excluding the value of the land which is being acquired by the amusement company at cost. The Corporation will hold all the stock of the amuse- ment company. Admission charges will be $2.50 for adults and $2 for children ; these entitle the customer to use all the facilities except food for as many times in one day as the patron desires. In view of the low construction cost of the exhibits and the attrac- tive price, very substantial patronage is expected. These rates compare with Freedomland where a separate charge is made for each exhibit and each ride and where it is reported one may readily spend $40 or $50 on only one visit. While Disneyland also charges for each ride separately we understand that the rates are lower than at Freedomland. Capitalization consists of $9,900,000 of long term debt, and common stock and surplus of about $8,500,000 as of 8/31/60. The apparent book value of around $8.20 per share on the 1,037.662 common shares ($1 par) outstanding 8/31/60 is not indicative of the basic realizable value in the tract, in our opinion. Taking current sales prices of around $20,000 per acre and assuming availability of 3,000 acres for ultimate sale, a gross of about $60 million could conceivably be realized, equivalent, after deducting long term debt, to approx- imately $48 per share current liquidating value. Specific data concerning prospective cash flow from real estate operations and the amusement center are expected to be made available soon. When we have the information we shall pass it along to the registered representatives. We understand that thhe supply of stock "around the street" is drying up as the shares are being placed in strong hands. For investors interested solely in long term gains without likelihood of current return by way of cash dividend payments, the shares appear to offer considerable attraction at present price levels. HORNBLOWER & WEEKS, Underwriting Department. Exhibit 27 February 18, 1969. Mr. Kaier : Won't you please arrange for the preparation of a list of reasons why railroad diversification into other forms of transportation should benefit the public, as requested by Mr. Langdon in the attached copy of his letter to Mr. Saunders, dated February 10. Basil Cole. Office of Vice President, Operation Diversification, March 10, 1969. To all department heads : Jervis Langdon of the Rock Island, pursuant to an assignment from the AAR Board of Directors, has asked Mr. Saunders for reasons why railroad diversification into other modes of transportation would benefit the public. Attached is a list of reasons suggested by the Legal Department. Won't you please read it and let me have your comments so that Mr. Saunders can respond to Mr. Langdon as quickly as possible. Basil Cole. Reasons Why Transportation Diversification Should Benefit the Public 1. Shippers will have available a transportation department store where they can satisfy all of their transportation needs instead of dealing with a large number of smaller companies. 2. Transportation costs should be reduced by simplifying interchange between the modes. 3. The containerization of freight will be greatly expedited and facilitated. 4. Tariff simplification should be possible and the quotation of transportation prices made easier. 5. The tracing of shipments requiring transportation by several modes will be easier and more efficient. 6. The broader use of computers and computer programs will be economically sound because of larger universes. This, in turn, will result in greater transportation efficiency and better utilization of equipment. 7. The imbalance of traffic, a chronic problem with the present small transportation companies should be greatly reduced with resulting improvement in equipment utilization and lower transportation costs. 8. By improving all around efficiency and simplifying interchange of traffic, time in transit should be reduced. 536 9. By funneling traffic to the most efficient means of transportation, much wasteful and excessively expensive use of transportation facilities should he eleminated. 10. The cost of generating traffic, including advertising expenses, should he reduced since sales personnel will he in a position to offer comprehensive transportation service. 11. Some cost savings should he accomplished hy reducing executive, legal and overhead expenses. 12. Transportation research should be more extensive and more productive since the emphasis would he upon the best solution to transportation problems in contrast to the present research which is largely channeled along single mode lines. 13. Since the remaining companies offering comprehensive services would have lower costs and greater efficiency, funds would he generated for capital expenditures, thus pro- ducing further efficiencies and more effective use of transi>ortation resources. 14. The international movement of freight would be expedited and simplified. Foreign shipping agencies would have all the benefits the domestic shippers would enjoy. 15. Government regulation of transportation would be greatly simplified and expedited since many of the very difficult and complex intermodal problems would be eliminated. 16. Taxation of the diversified companies should be somewhat easier because the diffi- cult problems of maintaining competitive balance by tax adjustments would be eliminated. For example, many user taxes are not imposed because of the intermodal competitive prob- lems they would create. 17. Much discriminatory legislation which results in higher transportation charges could be eliminated. For example, there is a great deal of legislation applicable solely to one mode which results in costs being higher than those of industry generally. A typical example is the Federal Employers Liability Act. and the Railroad Retirement Legislation which do not apply to all transportation activities but principally to those of one mode. IS. Many duplicate facilities could be eliminated ; freeing land for housing, parks, recreational use, etc. 19. The development of entirely new means of transportation would be stimulated. For example, under the present system which tends to restrict each mode to its own field, there is little incentive to develop entirely new transportation methods and techniques. A railroad has little desire to develop vehicles that will be capable both of operating on the rails and on the highways when it is precluded from operating such vehicles on the highways. 20. By combining companies operating in different fields, opportunities will be afforded management and technical personnel to function in larger universes with a resulting better use of the relatively limited pool of skilled people that presently exists. For example, the manager of a small trucking company has a small field in which to function and produce. In the larger diversified company, his horizons would be broader and his potential produc- tivity increased. 21. The diversified company with its larger resources could work much closer with shippers in solving production problems which are transportation oriented. Too often, under the present system, the individual company's stake in a particular shipper is not large enough to justify an allocation of resources to solve the snipper's production prob- lem. By bringing transportation closer to the production of goods, the public will receive its products faster and cheaper. 22. The movement of agricultural products should be greatly improved with resulting benefits to the farm community and the consuming public. 23. The financing of transportation activities should he improved. Lnder the present system, many transportation activities present very difficult financing problems because the individual companies are too small and too closely held. 24. Transportation to the smaller communities should be improved. Under today's system with its large number of smaller transportation units, the tendency is to concen- trate efforts in the larger metropolitan markets to the exclusion of the smaller communities. March 25, 1969. Basil Cole: This refers to your memorandum of March 10. 1909, requesting comments on the list of reasons why railroad diversification into other modes of transportation would benefit the public. We offer the following comment : First, by way of omission, it is noted there is no reference or inference to modes of transportation other than rail. Also, no mention is made of fulfilling passenger transporta- tion needs. A completely coordinated transportation company should encompass these. Second, the following might be noteworthy in connection with each of the items listed by the Legal Department : Item 5 — with an efficient transportation system, the necessity of tracing would possibly be eliminated. Items 6, 7 and 9 — relate to improved efficiency. This should produce improved service and this point should be stressed. Item 10 — assumes that advertising and sales expenses would he reduced. This is not necessarily true since stronger companies and increased competition might well increase expenses particularly advertising. Item 11 — might be well to translate "cost savings" to public benefits through more coor- dinated and effective management. Item 12 — might be expanded to cover public and employee safety research in all modes of transportation to develop the best possible approach : grade closing problems being one example. 537 Item 17 — relating to elimination of discriminatory legislation seems impractical and may be dangerous at this time. Historically, we have been required to retain the legislation, contract or policy which provided the highest benefit to the user or employe. Item 20 — appears an attempt to answer criticism that larger transportation companies would "swallow up" the smaller independents. I would either be silent, or if it is a fact, develop statistics to show that within each mode of transportation the bulk of the business is being handled by a small number of very large companies. This would emphasize the goal of integration of different modes of transportation to give better and more complete service to the shipping public. Item 21 — diversification will not release resources to develop any shippers' "production" problems. It can develop answers to shippers' "distribution" problems. A diversified com- pany can direct its all-encompassing engineering and marketing resources to work much closer with the shipper in solving his distribution problems. The predecessor companies normally recognized their own selfish interests which did not necessarily result in the best distribution system for the shippers. Item 22 — we question the advisability of highlighting one group of commodities to the exclusion of all others. Item 24 — we question the validity of the statement. In retrospect, both the railroads and the airlines made the mistake of offering service to communities in which the market was too small to generate profitable operations. In addition, integration of the transportation companies should result in more efficient use of our land and air space resources, freeing funds for the economic development of transportation systems for urban areas. R. G. Flannery. March 20, 1969. R. G. Flannery : Yours of March 12 asking for my comments as to why railroad di- versification in other modes of transportation would benefit the public : I believe the reasons cited in Mr. Cole's attachments are generally good. I have the following comments : Item 1 implies freight service only. We could mention such things as airlines, busses and car rental businesses which would in addition offer a transportation department store for all transportation needs. Item 5 implies that tracing all shipments is necessary. With an efficient transporta- tion system conceivably the necessity of tracing would be eliminated. Items 6, 7 and 9 relate to improved efficiency. This should produce improved service. That point should be stressed. The assumption that advertising and sales expenses would be reduced may not be valid. With stronger transportation companies and increased competition between the companies, the expenses, particularly advertising, might well increase. As to Item 11, it might be well to translate "cost savings" to public benefits through more coordinated and effective management. As to Item 12, this might be expandable to cover public and employee safety research in all modes of transportation to develop the best possible approach ; grade closing prob- lems being one example. Item 17 relating to elimination of discriminatory legislation seems impractical and may be dangerous at this time. Historically, we have been required to retain the legislation, contract or policy which provided the highest benefit to the user or employee. Item 20 appears an attempt to answer criticism that larger transportation companies would "swallow np" the smaller independents. I would either be silent, or if it is a fact, develop statistics to show that within each mode of transportation the bulk of the business is being handled by a small number of very large companies. This would emphasize the goal of integration of different modes of transportation to give better and more complete service to the shipping public. As to Item 21, diversification will not release resources to develop any shippers' "pro- duction" problems. It can develop answers to shippers' "distribution" problems. A diversi- fied company can direct its all — encompassing engineering and marketing resources to work much closer with the shipper in solving his distribution problems. The predecessor companies normally recognize their own selfish interests which did not necessarily result in the best distribution for the shippers. I question the advisability in Item 22 of highlighting one group of commodities to the exclusion of all others. As to Item 24. I question the validity of the statement. In retrospect, both the rail- roads and the airlines made the mistake of offering service to communities in which the market was too small to generate profitable operation. In addition, integration of the transportation companies should result in more efficient use of our land and air space resources, freeing funds for the economic development of transportation systems for urban areas. R. D. Ttmpany. March 19, 1969. R. O. Flannery : In response to your request for comments on the list of reasons why railroad diversification into other modes of transportation would benefit the public, made by Mr. Jervis Langdon (reference your March 12, 1969 footnote to memorandum by Basil Cole, dated March 10, 1969) , we have the following to offer : 538 The basic proposition involved here is that the public would benefit from such diversi- fication in that coordinated transportation service provided by one organization would become available. In general this would facilitate providing the best service most suited to the transportation requirements while reducing the overhead cost burden. It should be noted that this will apply to both freight and passenger transportation needs and to the various modes : rail, air, highway, waterway, or sea. One omission we note from the list prepared by the Legal Department is any refer- ence or inference to modes of transportation other than rail, such as air, highway, or water. Moreover, no mention is made of fulfilling passenger transportation needs. A com- pletely coordinated transportation company should encompass these. Suggestions of more minor nature are : 1. The use of a coordinated transportation company would permit the shipper of freight to reduce his traffic staff. This elaborates on the Legal Department's sug- gestions Nos. 1 and 10. 2. A coordinated transportation company is in a better position to provide more punctual service through its ability to arrange diversions when weather or similar problems interfere with regular routes. 3. As jetports are moved further from the city-centers, and jet aircraft become larger a coordinated air, rail, highway capability as suggested will help solve the problems of space, air pollution and noise harassment. A. M. Schofield. Penn Central, March 19, 1969. R. G. Flannery: You requested comments on reasons why railroad diversification into other modes of transportation would benefit the public. The list which was attached to Basil Cole's memo of March 10 appears to adequately cover all facets of the subject. We have nothing to add. G. C. Vaughn. March 18, 1969. R. G. Flannery: This refers to your notation of March 12th on Basil Cole's memo- randum of March 10th regarding reasons why railroad diversification into other modes of transportation would benefit the public. We concur in the reasons advanced by our Legal Department and have nothing addi- tional to suggest. E. L. Claypole. [From files of A. E. Perlman. President, P.C.T.C] Farsighted railroading and fledgling aviation combined at this station 40 years ago today to begin America's first coast-to-coast rail-air passenger service. On the evening of July 7, 1929, a group of passengers, including Amelia Earhart, embarked from Penn Station on the Pennsylvania Railroad's Airways Limited for Col- lumbus, Ohio. This was the first leg of an exciting new journey by air and rail across the continent. Forty-eight hours later, they arrived in Los Angeles in a Ford tri-motor plane, piloted by Colonel Charles A. Lindebergh for Transcontinental Air Transport, now Trans World Airlines. From this beginning, a new era of travel was opened. Within four decades, all corners of our globe have become accessible in a matter of hours. It was no accident that one of Penn Central's two predecessor lines participated in this historic precedent. Both the Pennsylvania and the New York Central have long believed that railroad companies should offer their customers complete, fully integrated transportation service. This concept put Penn Central in the vanguard of railroads that formed the Railway Express Agency in 1929, the nation's first organization to encompass all modes of trans- portation. The Pennsylvania and the New York Central also played significant roles in the early growth of Greyhound Bus Lines throughout the east. The New York Central some years ago was active in steamship operations both in the Great Lakes and between New York and Galveston. The Central, in conjunction with the Flying Tiger Lines, established the first rail- air freight service in this country. The Pennsylvania entered the petroleum pipeline transportation field in the mid- 1960's with its acquisition of Buckeye Pipe Line Company. More recently, the Penn Central Company made a substantial investment in Executive Jet Aviation, which provides leased aircraft service to many American corporations. Penn Central is also one of the nation's largest motor carriers, with five wholly owned trucking companies onerating over 23.000 miles of certified interstate routes. We would like to continue such pioneering initiatives into other modes of transport to provide more efficient use of rail-water-air and motor carriers in an integrated trans- port Hon scheme. Unfortunatelv. the tight regulation of administrative law has kept us from pursuing these objectives more effectively, and we even have been forced to withdraw from some of the ventures entered into over the years. 539 With the advent of new technology, the age of containerization and major advances in transfer techniaues in handling and storage methods, the dead hand of outmoded regu- lation is denving the American public vast benefits that could be achieved through the growth of true integrated transportation companies. Each mode of transport has its inherent advantaces. but these cannot lie utilized to the best interests of the shipping and traveling publics unless they are linked into a co- ordinated pattern. And the best way to do that, of course, is to permit common ownership of diverse modes of transportation. In this day of sharply rising demands for increased and improved transportation, it no longer is possible for any single mode to dominate the field. Consequently, anachronistic restraints upon transport diversification, originally erected to curb monopoly, handicap and penalize our entire transportation system, and should be removed. These barriers were created generally by judicial and administrative bodies and they must be eliminated by action of the legislative and executive branches of government. But such action can be motivated only if the public is aroused to the need for progressive changes. And meanwhile, the United States remains the only nation in the world in which fully integrated transportation companies are not permitted to exist. On this occasion, we commemorate the combined efforts 40 years ago of two far- sighted companies. Today, however, we live in a much more complex society in which corporations cannot easily undertake such collaboration. And this restrictive situation cannot change without enlightened action by the Congress and administrative agencies in Washington. Progress toward balanced transportation companies calls for the coopera- tion of many modes of transport, shippers who realize the advantages of common owner- ship and the public, which will benefit by such a step. A concerted drive toward this goal would give our nation the efficient transportation network it, must have to support its growing needs. The benefit of such a course to our national economy, to America's shippers and to the public at large is an objective worthy of a high national priority. Exhibit 28 [Attachment to B. Cole Memorandum dated 3/10/69 supra (Exhibit 27)] W.A.L.— I reviewed the attached and I have one additional suggestion for consideration To quote Mr. Saunders' New York Traffic Club speech of February 20 : "Unless railroads are permitted to diversify into other forms of transportation, within a relative short period of time air cargo will have the same effect on railroad freight traffic as passenger airlines have had on long-haul and intermediate-range rail- road passenger service since World War II. "The impact of airborne freight could be the last straw for railroad freight service except certain bulk commodities, and railroads cannot survive on this sort of traffic alone. This imminent new threat underscores the need for the revision of laws and regulatory practices which prohibit railroads from ownership of other modes of transportation." This is probably one of the most urgent reasons "why railroad diversification into other modes of transportation would benefit the public." Bill C. [William Cunitz, Public Relations Department, P.R.R.] Exhibit 29 [From files of S. T. Saunders. Chairman of the Board, P.R.R.] The Pennsylvania Railroad Co., Office of the Chairman. Philadelphia, Pa., January 23, 1967. Hon. Alan S. Boyd, Secretary of Transportation, Department of Transportation, Washington, D.C. Dear Mr. Secrf.tary : Thank you for your letter of January 14 stating that you would be glad to receive reactions to the points discussed at your Washington meeting on January 5. I offer the following comments : passenger travel The Federal Government should, I think, adopt at a fairly early date an overall policy for transporting people. There has been during the past several decades too much emphasis, in my judgment, placed on the highways and airways for mass transportation of people and too little emphasis upon the role that the rails can play, particularly in urban and relatively short-haul, say up to 400 to 500 miles, passenger travel in heavily populated areas. The 90-10 contribution formula which the Federal government, has pursued with refer- ence to highway construction has tended to encourage state and local governments to try to solve their transportation needs too much on the basis of highway transportation. There is growing recognition now that this trend has gone too far and is responsible for much 74-924 O - 73 - 36 540 of the t raffic strangulation in many of our cities. I, of course, know that both highway and air transportation are absolutely Indispensable in meeting our transportation needs, but I do feel that too little attention has been given to the role the rails can play. In this connection, r should say that I do not believe there is any future for long-haul rail passenger travel in competition with jot aircraft in high- volume service with great efficiency and economy. As for urban and short-haul rail passenger travel in congested areas, it. has been author- itatively stated that the Government can buy 20 times as much transportation with its tax dollars by upgrading existing rail systems as contrasted with building new highways. And this does not take into account such matters as safety, air pollution, tax losses mi property used for highways and airports, loss of industrial sites, and the sheer fact that we are run- ning out of space that can be utilized for these purposes. I am firmly convinced that contributions on the part of the Federal Government to the development of rail transportation in these respects is a vital public function, one that can produce great economy for the taxpayers and will leave more money to he spent for high ways and airports in areas where they can make their greatest contribution to an inte- grated national transport system. As for long-haul rail travel, if such travel is deemed necessary in the public interest in the future, the railroads should only be required to furnish it if these losses are absorbed through government support. In considering this problem, I think consideration should also be given to the policies of the Post Office Department in the handling of mail. Many of that Department's present practices are calculated to reduce rail passenger service or downgrade it. SAFETY I believe a careful study should be made to determine whether adequate progress is being made in this field and if not what is deterring the necessary progress. If such study reveals the need for corrective measures, then I think that a joint committee of labor and management should consider the problem with the hope that recommendations could be made as to what should be done. Many of the statistics in this area may not reflect the true situation and they must be carefully examined, particularly as to the causes of such accidents. In making such a study, consideration should be given to make-work regulations which are too frequently suggested by labor unions before public service commissions and else- where which are not calculated to produce safety but merely to make work. LABOR-MANAGEMENT RELATIONS In view of the relatively ambiguous language in the statute creating the Department and the nebulous character of many aspects of this relationship, I do not look upon this as a matter for immediate action except possibly in the field of strikes involving public service industries. I gather, however, that your Department will not directly concern itself with this matter at the present time. A long-range objective of your Department should be manpower needs and adjustments in connection with technological advances. DIVERSIFICATION AND COORDINATION While I feel there will be several years before any great progress can be made in this regard, I think it is absolutely vital that we move toward integrated transportation in this Country as soon and as rapidly as possible. To my mind, this holds the greatest promise of developing a sound, efficient, and economical transportation system for our Nation. MERGER I was glad to hear you say that your Department will take an active hand in considering all future merger cases. I would hope that your Department could become the spokesman for the Government in this area. It would certainly produce a broader and sounder consideration of such mergers in light of the public interest and the Nation's transportation needs. TAXES I think that your Department should give early consideration to tax policies on both the Federal and state levels which thwart or slow down technological progress or retard the acquisition of the equipment which our transportation industry needs. I have especially in mind the supsension of investment credit and guide lines for accelerated depreciation. There are numerous instances of discriminatory state and local taxation against rail- roads. In the development of a sound national transportation system, serious study should be given to this problem. USER CHARGES I am sure that your Department will give consideration to this very knotty problem. It is certainly one that requires a high priority. I recognize, of course, that it is permeated with political considerations, but that should not deter an early effort to find some satisfac- tory solution. RATE MAKING While I do not believe your Department should concern itself with ordinary rate prob- lems, I think it should give prompt attention to overall rate-making procedures, particularly 541 to the end that adequate revenues are produced to enable the transportation industry to earn a reasonable rate on its investments to encourage research and technological improvements. RESEARCH As you know, the Federal Government has spent practically no money in this field so far as the railroad industry is concerned. The only major projects in this century are those authorized by the Mass Transportation Act of 1964 and the Research and Development in High-Speed Ground Transportation Act of 1965, and only a small portion of the funds are earmarked for railroad research and development. The Federal Government has, of course, for many years been spending vast sums for research in connection with highway, air, and water carriers. The time is overdue in my judgment, for the Federal Government to make substantial sums available for research and technology advancement in the rail industry. Such expenditures will pay handsome returns in terms of cheaper and more efficient transportation. I greatiy appreciate this opportunity to express my views on these subjects and, of course, stand ready to assist you in any way that I can in carrying out the terrific re- sponsibilities which you have assumed. My highest regards, and best wishes for success in your challenging assignment. Respectfully, Stuart T. Saunders. The Under Secretary of Commerce, for Transportation, Washington, D.C., January 14, 1967. Mr. Stuart T. Saunders, Chairman of the Board, Pennsylvania Railroad Co., Philadelphia, Pa. Dear Stuart : Your attendance at our Washington meeting was a great help and your fine contribution is deeply appreciated. I hope we can continue to co-operate on this same basis of candor and openness. Your suggestions on federal aid to rail transportation in congested areas will receive full consideration here. I would be delighted to receive any additional reactions to the points discussed in our meeting or any suggestions you may have come up with since. Our minds as well as our doors will always be open to you. Sincerely, Alan S. Boyd. Exhibit 30 New York Central System, New York, November 23, 1966. Memorandum for Mr. A. E. Perlman : I attach a letter dated November 11, 1966, addressed to Mr. Grant from Mr. Martin Bachman, Vice President-Finance, Strick Holding Company, requesting an advance to Strick of $1,100,000, for the purpose of redeeming Strick preferred stock (called for redemption on December 2. 1966) and to repay loans as listed in the letter. Mr. Grant asked me to arrange to place this item on the agenda for the Central Board meeting on December 8th. May I have your approval? R. N. Carroll, Secretary. December 1, 1966. Mr. Walter R. Grant, Vice President-Finance The Neiv York Central Railroad Co., New York, N.Y. Subject : Requiset for Advance to Strick Holding Co. Amount of request : $1,897,000. Date required : December 30, 1966. Purpose : (Numbers refer to items on list of Cash Requirements) . Nos. 2 and 3: Strick Corp. — Increase in Receivables and Inventory $1,000,000 No. 5: Transport Pool, Inc. — Equipment Financing 560,000 No. 6 : Company owned distributors : Universal Transportation 80, 000 Rojo Trailer Service 62, 000 Trailcon 128, 000 U.S. Transportation 67, 000 Total 337, 000 Grand total 1, 897, 000 542 Submitted by : Martin Bachman. Approved by : W. R. Grant Funds will be transmitted on December 30, 1966. January 4, 1967. Mr. Waiter R. Grant, Vice President-Finance, The New York Central Railroad Co., New York, N.Y. Subject : Request for Advance to Strick Holding Co. Amount of request : $2,000,000. Date required : January 31, 1967. Purpose: Item No. 1: Strick Finance Co., subordinated loan $2,000,000 Submitted by : Martin Bachman. Approved by W. R. Grant. Funds will be transmitted on January 31, 1967. New York, N.Y., March 8, 1967. Memorandum for Mr. A. B. Perlman : I attach a letter dated February 10, 1967 addressed to Mr. Grant from Mr. Bachman, Vice President-Finance, Strick Holding Company, requesting an additional advance to Strick of $2,000,000. Mr. Grant has asked me to arrange to place this item on the agenda for the Central Board Meeting on March 9th. May I have your approval? Secretary. The New York Central Railroad Co., Board of Directors, Thursday, March 9, 1967 [Suggested insert for minutes of meeting of Board of Directors] After statements by the Chairman and the Vice President-Finance and upon motion duly made and seconded and after discussion, the following resolutions were unanimously adopted : Resolved : That the proper officers of this Company are hereby authorized, in the name and on behalf of this Company, to make additional advances to Strick Holding Company ("Strick") in the aggregate amount of $4,000,000, with interest at the rate of 1% over the prime rate of interest in effect at leading commercial banks in New York City from time to time during the period the advances are outstanding, such funds to be used for the cor- porate purposes of Strick ; and Further resolved : That any action authorized by the foregoing resolution which shall heretofore have been taken is hereby in all respects ratified, confirmed and approved. The New York Central Railroad Co., Board of Directors, Thursday, April 27, 1967 After statements by the Chairman and the Vice-President-Finance and upon motion duly made and seconded, and after discussion, the following resolutions were unanimously adopted : Resolved : That the proper officers of this Company are hereby authorized, in the name and on behalf of this Company, to make additional advances to Strick Holding Com- pany ("Strick") in the aggregate amount of $2,000,000, with interest at the rate of one per cent over the prime rate of interest in effect at leading commercial banks in New York City from time to time during the period the advances are outstanding, such funds to be used for the corporate purposes of Strick ; and Further resolved : That any action authorized by the foregoing resolution which shall heretofore have been taken is hereby in all respects ratified, confirmed and approved. Secretary. President Perlman Vice President Grant Vice President Minor Comptroller Kappauf Treasurer McCron Director of Taxes McEvoy March 28, 1972. Mr. Walter Grant, Vice President-Finance, The New York Central Railroad Co., New York, N.Y. 10017 Subject : Request for Advance to Strick Holding Co. Amount of request : $2,000,000 Date Required : $1,000,000 April 1, 1967 ; $1,000,000 May 15, 1967. 543 Purpose : Item No. 1 : Strick Finance Co. subordinated loan. Submitted by : Martin Bachman. Approved by : W. R. Grant. Funds will be transmitted as follows : April 1, 1967 $1,000,000 June 1, 1967 1, 000, 000 Mat 24, 1967. Mr. Walter R. Grant, Vice President-Finance, The New York Central Railroad Co., New York, N.Y. 10017 Subject : Request for Advance to Strick Holding Co. Amount of request : $440,000. Date required : July 1, 1967. Purpose : Item No. 5, Transport Pool Inc., equipment financing. Submitted by : Marten Bacbman. Approved by : W. R. Grant. Funds will be transmitted as follows : July 1, 1967 440,000 New York Central Ststem, New York, N.Y., May 29, 1967. Memorandum for Mr. A. E. Perlman : Mr. Grant has requested that I place an item on the agenda for the next meeting of the Board of Directors of The New York Central Railroad Company authorizing an advance to Strick Holding Company for $440,000. May I have your approval? R. N. Carroll, Secretary. Strick Corp.. Fairless Hills, Pa., May 31, 1967. Ulrich Schweitzer, Esquire, General Corporate Attorney, The New York Central Railroad Co., New York, N.Y. Dear Ulrich : The government investigator who is looking at Strick's financial condi- tion prior to our being awarded a government contract for some $15,000,000, has insisted that both Strick Holding Company and the New York Central Railroad Co. guarantee the performance of the contract. The guarantees are apparently required because the total of all intangible assets is greater than net worth. The first of the five copies of the Guaranty Agreement for Corporate Guarantor is filled out as the Government wants it. If the agreement is satisfactory would you please fill out the remaining copies and send four of them back to me. Also enclosed is a draft of a Board Resolution that is also required. Speed is essential because the contract award is ready to be made immediately upon receipt of these papers. I will execute the agreement and have a Board Resolution made for Strick Holding unless yon have any objections. Sincerely, Martin Bachman. [Letter from W. R. Grant, V. Pres. Finance N.Y.C. to S. Katz, President, Strick Corp.] New York Central System, New York, N.Y., May 26, 1967. Mr. Sol Katz, President, Strick Corp., Fairless Hills, Pa. Dear Sol : This is in reply to your letter of May 25. I agree with you that your industry has been hard hit by business conditions in the past five or six months, and in times such as these it is difficult to maintain morale and motivate people. However, I think you should know that we have exactly the same problems on Central. One of our largest wage increases in history was forced on us this year, and this is coupled with a sharp downturn in business. Almost daily we are turning down worthy projects offering a good rate of return on Central in the interests of conserving cash during this critical period. At the same time, almost 2,000 people have been released from Central's pay rolls. Needless to say, this has created for us some very real problems in morale of our em- ployees. This is made doubly difficult when we advance funds to Strick for projects that are not currently showing a rate of return — i.e., both the Finance Company and Transport Pool. I have no doubt that these enterprises will turn around and begin to show a satisfac- 544 tory profit, but I think you can see the position I am in in attempting to explain this to Central executives. Now, with respect to the latest request for Transport Pool. At no time during the dis- cussions I had with you and Marty concerning the subordination of our debt in Transport Pool was any indication given to me that you were going to request more funds than were in the original projection given to the New York Central Board, and it was on this basis that I told Marty that we could not exceed the million dollars which we originally agreed to advance for Transport Pool operations. I just have no logical answer to give Central executives who are being refused funds on projects that could be immediately profitable, while advancing funds to Strick. Our cash has dropped some $15 million in the past few months, $9 million of which is in advances to you. I think you must agree that this is evi- dence of our support during a period when we could ill afford to reduce our c;ish resources. As I wrote you earlier this week, if the large Philadelphia Parts Warehouse will re- quire additional advances from Central, this matter should be reviewed at a Strick Board meeting before we proceed. We agree with your statement that these business turn-downs are beyond our control. We are currently in a recession, whether the Administration thinks so or not, and these are problems which we will have to face together. We are just as anxious as your management team is to see Strick prosper, but with our earnings off $10 million in the first four months we are facing a storm that both Central's and Strick's management teams are going to have to weather, even if it means the deferment of many cherished projects. Sincerely, Walter. [Letter from W. R. Grant, V. Pres. Finance, N.Y.C. to M. Bachman, V. Pres. Finance, Strick Corp.] New York Central System, New York, N.Y., May 25, 1967. Mr. Martin Bachman, Strick Corp., Fairless Hills, Pa. Dear Marty : As I advised you by phone yesterday, we cannot approve your request for $1,000,000 for further investment in Transport Pool, Inc. Your original projection, which we presented to our Board, called for a total of $1,000,000 to be advanced by Central for Transport Pool, of which $560,000 has already been advanced. I am therefore changing this request to $440,000. At our last Board meeting, I told the Directors there would be no further advances to Strick during 1967, unless there was a large surge in business that required greater in- vestment in receivables and inventories. The whole program of advances as presented to our Board at the time they approved the acquisition of Strick was on the basis that such advances would be made to assist Strick in handling its increased sales volume. With sales volume down, I cannot justify additional advances. As we discussed yesterday, if the large parts and service center proposed in Phila- delphia at a cost of $860,000 will require additional advances from Central, I think we should defer this until the Strick Board can review the matter. Sincerely yours, Exhibit 31 May 6, 1969. Mr. Perry M. Shoemaker, Transportation Consultant, Tampa, Fla. Dear Perry : I enjoyed hearing from you and appreciated your comments about our operations. We have things turned around now, and we look for continued improvement. You may have missed it in the papers, hut the end of last year we disposed of our Interest in Strick. The trailers we acquire are being obtained through financing arrange- ments completed by Dave Bevan. I am told we do not have to put any money down, which helps us at the present time, and they are paid for similar to equipment trusts. In effect, they are ours, and I am advised it is more economical to acquire them in this fashion than to lease this type of equipment. Mrs. Perlman joins me in sending warm regards to Mrs. Shoemaker and you. Cordially, A. E. Peblman. 545 Exhibit 32 [From flies of S. T. Saunders, Chairman of the Board, P.C.T.C.] BOARD MEMORANDUM New York City, Wednesday, April 23, 1969 first quarter — 1969 Consolidated Earnings for the First Quarter were $4,001,000 or 19 cents per share. 1 New Haven results are included in these figures for the first time. Last year Penn Central reported earnings of $13,388,000 for the first quarter but when restated to reflect the loss of $6.5 million for the New Haven, the comparable figure for 1969 is $6.9 million. On this basis, our earnings were $2.3 million (33.5%) below last year. Railroad results were far better than some observers have been predicting, despite strikes in the ports and coal fields and continuation of heavy start-up costs in connection with the merger. As you know, the first quarter is historically the low point for railroads in this section of the country, 2 and this year we incurred a deficit of $12.8 million compared with a loss of $5.4 million in the same three months of 1968 (including the New Haven). Last year's results were strongly influenced by gains from two real estate transactions and tax credits amounting to $9.2 million, 3 however, indicating that operating results were much more comparable than these net figures suggest. New Income Statement. — Many business commentators, analysts and investors con- tinue to judge Penn Central primarily as a railroad despite the fact that only half of our assets are devoted to operations and that our diversified activities produce the preponder- ance of our earnings. In an effort to overcome this tendency and to portray more accurately the diversified nature of the Company, we have revised the form of the consolidated income statement to accompany the quarterly public release on earnings (See Attachment A, here- to). A copy of this new form is enclosed in the Section of your folder. Formerly we pub- lished rather complete revenue and expense detail for the railroad, but only a net income summary on consolidated earnings, with no further breakdown covering subsidiary opera- tions. This new statement presents revenue and expense data for each of our three primary areas of activity — Transportation, Real Estate and Financial — subdivided into the major functional categories. 1 1st quarter results (dollars in thousands): 1969 1968 Variance Percent Railroad PC ($11,504) 1,026 (12,530) Railroad NH (1,260) (6,489) 5,229 80.6 Railroad total (12,864) (5,443) (7,321) (134.5) Subsidiaries. 17,365 12,362 5,003 40.5 Consolidated 4,601 6,919 (2,318) (33.5) 2 Going back to 1963, the companies which now comprise Penn Central reported a combined 1st quarter net railway operating deficit in 3 of the last 6 years. M oreover, they had an aggregate 1st quarter deficit of $2,800,000 for those 6 years although, on an annual basis, they produced a total net railway operating income in excess of $223,000,000, as indicated by the following: 1st quarter Year 1963.. ($10,049) $39,843 1964 7,514 56,299 1965.. 5,639 79,843 1966 13,076 100,615 1967 (9,199) (2,654) 1968 (9,784) (51,208) 6-year total (2,802) 222,733 6-year average (467) 37,123 3 1st quarter 1968 railroad results included: Sale of Albany passenger station $3,480 Sale of Mott Haven 3,326 Tax credit adjustment 2,400 Total 9,206 546 One advantage of this new format is that it permits evaluation of each type of activity in the context of the entire enterprise, thus eliminating misimpressions thai may be gained when overall results are ignored and undue significance is attributed to individual trans- actions. For example, the sain or loss resulting from a multi-million dollar sale of property would be regarded a.s extraordinary to a smaller concern, but not one with revenues from real estate operations of $4(> 15 million in a single quarter. This new form of statement is entirely consistent with the concept of the parent Holding Company. It will be necessary to continue reporting to the I.C.C. on the traditional basis for the railroad companies, of course, but absent, some unforeseen development, we plan to switch to this new type of statement for the information to be made available to stockholders and the newspapers. With reference to the Railroad revenue and expense data shown on this statement, the figures are greatly influenced by inclusion of the New Haven in 19(59 but not 1968. As 1 previously indicated, the New Haven lost $6.5 million in the first quarter of last year, which, on a comparable basis, brings the 1968 net income down to $6.9 million. Start-up Costs and Savings. — Merger start-up costs and losses in the first quarter, while not as heavy as in the last half of 1968 4 had an $8 to $10 million effect on the first quarter results. On the other hand, merger savings were approximately $5.5 million 6 and these will be recurring year after year whereas the costs will not. The greatest impact has been from loss of revenues, which we estimate at $6.5 million as the result of service problems. Service. — We continue to receive assurances from shippers that our service has im- proved markedly" and we are continuing our contact program. Since the last meeting I have personally called on the top executives of Bethlehem Steel, American Car, and other important customers. Carnation Company, U.S. Borax, Kaiser Aluminum, and other major concerns have been covered by our top Traffic and Operating Officers, and Mr. Perlman has just returned from a tour of the West Coast where he talked with many of our off-line shippers at luncheons and dinners in Los Angeles, San Francisco, Portland, Seattle, Dallas and Houston. Operating Revenues 7 — Considering only Penn Central and New Haven, operating rev- enues during the first quarter were about $6 million or 1.4% below 1968 (despite the 5% freight rate increase which yielded about $15 million in additional freight revenues) as a result of the following : Strikes on the docks and in the coal fields adversely affected revenues by ap- proximately $5.1 million. 8 Weather conditions were unusually mild over most of the System this winter, but record snowstorms in New England cost us about $1 million in revenues. Mail revenues for the first quarter were down $2 million, or 11.7% from 196S. Express traffic also continued to erode at an accelerated rate, declining $2.6 million in the quarter, which is a 68% drop from the previous year. 4 See Attachment B, hereto, for tabulation of 1968 Merger Start-up costs. E Source of estimated savings in First Quarter 1969 — Million Consolidation of offices and fixed facilities $3. 2 Maintenance of Equipment and Roadway 1.7 Train Operations — . 6 Total 5. 5 9 Excerpts from letters reproduced on Attachment <\ hereto. i Operating revenues (thousands) including New Haven (but excluding D.T. & I.. P. & L.E.. and other railroad subsidiaries whose revenues are included in the consolidated income statement: Variance 1st quarter (from 1968) Percent Freight Passenger Mail Express. Other... Total 405,953 (5,953) 1.4 » Strikes: Began Settled Cost in 1969 Longshoremen's Dec. 20,1968 Feb. 25,1969 $3,000,000 Coal miners' black lung Feb. 21,1969 Mar. 11,1969 1,600,000 Philadelphia ore pier _ Sept. 18, 1968 Mar. 9, 1969 200,000 Others Mar. 3, 1969 Mar.21,1969 300,000 5, 100, 000 331,533 (2, 931) (0.9) 35,631 1,217 3.5 14,834 (1,964) (11.7) 1,265 (2, 647) (67. 7) 22, 690 372 1.7 547 Passenger revenues were about $1.2 million, or 3.5% ahead of last year. The Metroliner operation contributed an estimated $882,000. The continued decline in long-haul passenger service was offset by the 10% interstate fare increase that became effective in March, plus volume gains in commuter operations. Overatina costs for Penn Central, including New Haven 9 were seriously affected by the forces of inflation although we were able to hold them fairly well in line by improve- ments in productivity and merger savings. . Labor costs in the first quarter were up $7 million due to increased wage rates aggregating 5.5% and higher payroll taxes." However, this figure is $12 million lower than it would have been had it not been for the contraction in our work force of 4,85o pill I'll ov £(3S * Grand Central Terminal— Tower Building.— It has been reported in the press that we have submitted a new plan for the tower building over Grand Central Terminal. Our first proposal, which was designed to preserve the facade of the station, was rejected last September by the New York Landmarks Preservation Commission. At that time an influ- ential group known as the Urban Design Council spoke out against the scheme and sug- gested that if there was to be a building it should be built from the ground up. Adopting that suggestion, our second offering rises from ground level without regard for the facade. However, its design preserves the main concourse, the most important architectural feature of the terminal. Moreover, the plan endeavors to meet complaints regarding further crowding of the area by modernizing and improving the terminal facili- ties for pedestrian traffic. Hearings began before the Landmarks Preservation Commission on April 10 and the Tower's creator, Marcel Breuer, presented a statement describing the many advantages of the new design. While the City Planning Commission immediately repeated its opposition to any con- struction over Grand Central, we are hopeful that Mayor Lindsay can be persuaded to support the new building. To that end, last week I visited with Mr. W. S. Paley, Chairman of the Urban Design Council to urge his intercession with the Mayor. PASSENGER — LOSSES AND METROLINER Our passenger service losses in the first quarter were $26 million as compared with $28.8 million in the same three months of last year. The seriousness of this situation, and the difficulty of making any headway in reducing this deficit, is demonstrated by the fact that rising costs associated with passenger service permitted us to cut our losses by only $2.8 million under the First Quarter of last year, despite train discontinuances and other economies made during 1968, which were projected to produce savings of about $40 million on an annual basis. Thus far in 1969, we have managed to discontinue 15 intercity passenger trains at an annual savings of $1,092,776. At present we are preparing or have pending applications involving 31 trains and approximately $6.9 million in annual savings. These measures are inadequate in the face of rising costs and loss of long-haul revenues, however, and we have undertaken a study of the potential passenger market for the purpose of restructuring operations so as to improve the service we provide and minimize losses. Tentatively, we believe that we can reduce the number of intercity trains now operated by about 50%, resulting in a reduction of about 5.9 million train miles annually. 8 Operating expenses (thousands) including New Haven (but excluding D.T. & I., P. '. 1965. D. C. B. : I approve the program outlined in your letter of the 15th with reference to consolidated financial statements to include all majority-owned subsidiaries which we control. You will, of course, see that this program is carried out. Stuart T. Saunders Exhibit 34 Chicago, Rock Island and Pacific Railroad Co., Chicago, III, May 26, 1969. Mr. Stuart T. Saunders, Chairman of the Board, Penn Central, Philadelphia, Pa. Dear Stuart : At Friday's AAR Board meeting you asked me for a copy of the remarks I made on the subject of diversification for railroads into nontransportation fields at a re- cent dinner of the Minneapolis Traffic Club. I am sending you a copy herewith. I appreciate that my "logic" and conclusion have been challenged by at least one rail- road president, and undoubtedly there are others who would disagree. In summary, my point is this: Railroads, unlike other corporate undertakings, must work together if their public service obligations are to be discharged satisfactorily, and yet for forty years at least, they have been unable to agree on such vital issues at (1) rational- ization of the industry through merger, (2) terms to govern the establishment and operation of an adequate national car pool, with through service routes and rates, (3) research pro- grams designed to point the way for the full development of the rail form of transportation, etc., etc., etc. Why has this been so? The answer seems to be that individual railroads have been run primarily for the assumed benefit of stockholders, with the result that they have not felt free (particularly the fortunately situated ones) to make the adjustments necessary to formulate balanced railroad systems capable of working harmoniously together as a system. And so with diversification. Obviously it is in the interest of railroad stockholders, but what is it. doing to the railroad business? For one thing, capital that is urgently needed for railroads is being used for other purposes. Management talent, such as we have, is not con- centrating on the railroad problem but trying to develop greener pastures — all in the inter- est of railroad stockholders. Earnings from outside sources seems to support a continued independence on the part of individual railroads in dealing with problems that should be dealt with cooperatively If, in the final analysis, the interest of railroad stockholders and the interest of the public in a sound national rail system cannot be reconciled, a choice will become inescap- able. Either we stay in the railroad business, devote our total resources to it, and try to run that business as it should be run in the interest of the public, or we move to more lucrative endeavors and let our public service obligations be assumed by the government. I do not think, in the long run, there is any middle ground. In any event, the railroads are in no posi- tion in this present industry crisis to go to the government for help when their record of helping themselves is so poor. Please forgive the length of this letter but as the head of a highly marginal railroad in the middle of a bitter merger fight that could be resolved overnight if the principal western railroads, most of them well padded with diversified interests, could only agree on a merger pattern, my feelings on the subject are strong. Sincerely, Jervis Langdon, Jr., Chairman and President. Enclosures. 552 THE RAILROADS AND CONGLOMERATES This is a challenging subject and open to serious debate. t , °? £ ne P ° int however I am clear - During the very difficult period my company, Rock island has been going through, an opportunity to diversify into another business and to bring about an improvement in earnings and particularly cash flow would have been most welcome and received with open arms. In fact, Rock Island, in a precarious financial con- dition, would have jumped at such a chance. But with little cash, and its stock irrevocably assented to one or both of two conflicting merger proposals which have remained unresolved for a much longer time than originally anticipated, Rock Island has hardly been in a posi- tion to take the lead in diversifying. Nor has it been a promising candidate for inclusion in a conglomerate organized by others. In this area, Rock Island has been and remains— for the time being — immobile. It follows that I thoroughly understand and appreciate the reasons for diversification on the part of the C&NW and MKT and other marginal railroads. In their case, earnings from non-transportation sources have been important in maintaining viability. There has been no reason to consider the long term implications of conglomerates or whether, on principle, they should be encouraged or not. With these carriers, the choice was clear: diversify or else. I only wish that Rock Island could have traveled in the same direction, or could do so today. But this enthusiastic endorsement of conglomerates in the case of the marginal railroad should not be misunderstood. Everyone is interested in survival, even for the short term, and if conglomerates spell survival, they certainly serve a purpose, at least for those who want to survive. The infinitely tougher question is, how are conglomerates to be viewed from the point of view of railroads generally, particularly for the long term? In no sense has diversification been limited to the marginal railroads. Many important railroads, re- garded as prosperous in our industry, have embraced the concept. Indeed, the conglomerate is rapidly becoming a way of life. Is this movement well conceived? In trying to answer this question 1 am not concerned with the controversy presently surrounding the conglomerate as a concept. Everyone in Washington seems to he questioning whether the conglomerate is either (1) in violation of the antitrust laws, (2) unsoundly financed, (3) receiving tax benefits that should be curtailed, or (4) generally in conflict with business practices that should prevail in our country. Whether these charges, emanating from many sources including Congressional leaders, the Justice Department, Federal Trade Commission, Securities Exchange Commission, and the New York Stock Exchange, have validity I do not know and do not propose to consider here. On the contrary, I am prepared (at least for the purposes of the discussion this evening) to accept the conglomerate as representing a valid approach to the common control of different business enterprises, with benefits to stockholders, and will concentrate my attention on the single point : Is inclusion in a conglomerate good for railroads generally? I must confess some doubt. To begin with, the ordinary conglomerate is apt to include subsidiaries that are users of rail service, perhaps heavy users, and to have an operating railroad in the same corpo- rate home (with users and railroad under the same management control) raises special problems under the provisions of the Interstate Commerce Act and is probably at variance with sound public policy. But the principal reason for my doubt is that railroads with earnings from con- glomerates may find it easier to avoid the tough decisions that are necessary to solve the railroad service problem, and the service problem must come ahead of everything else — even earnings. Let me be more specific. Car supply is probably the most important aspect of the railroad service problem. Each railroad of course has its own cars which, being freely interchangeable, constitute its con- tribution to what is loosely regarded as a national freight car pool. Although there are many special purpose cars in the service of individual railroads, most of the cars in the national fleet are general purpose cars and in demand throughout the country. And yet there is no industry determination of the size of the general service fleet that is required to meet the country's needs. On the contrary, its level is determined by what each individual line concludes to be necessary for its own account, or can afford. The result is a national fleet which at times is inadequate. Moreover, with each line having a voice in its distribu- tion and use, it is also a poorly managed fleet with a level of utilization which, from an industry standpoint, has produced a steadily declining return on investment. Tf the private managements of individual railroads are to solve this industry problem of car supply, they must learn to work together, face up to the hard realities of the situ- ation, and pool there resources in finding an answer. The problem must be looked at as an industry problem, and an industry solution must be found even if concepts heretofore re- garded as objectionable, including a real pool of general purpose cars managed in the interests of the industry from one control point, have to be resorted to. But what are the chances of such an approach by railroads with easv earnings from non-transportation sources? T would suspect that they are poor. The trouble is that earn- ings, whatever the source, produce a sense of well-being, and railroads that satisfv their shareholders in this manner are not likelv to want to deal with tough service problems from an industry standpoint, particularly if tbev detect the slightest chance of a compro- mise of their own competitive standine. After all. earnings from outside source are not novel in the railroad business, and yet how many of the railroads in the country with large 553 non-transportation earnings have been willing to come to grips with this crucial service problem? Often their only contribution has been precipitate a continuing controversy over the level of per diem rates — a controversy which, in my opinion at least, does not reach the basic problem. Railroads, with the help of earnings from non-transportation sources, will be inclined to avoid other aspects of the railroad service problem. For instance, what incentive would there be for a railroad in a prosperous conglomerate : (1) To work together with other lines in the development of merger patterns on a regional, or preferably national, basis in which special interests might have to be sub- ordinated to the attainment of common goals? Everyone agrees that this country has far too many railroads, and that the present systems are poorly balanced. (2) To work together with other lines in the maintenance and operation of through routes with the same clock-like precision that is sometimes found with service between sta- tions on one railroad only, and with the internal accounting performed by one clearing house in accordance with pre-arranged formulae? (3) To help with the organization of an industry board where internal disputes, such as the proration of revenues arising under joint rates, could be arbitrated? (4) To work cooperatively in the development and marketing of railroad service in order to stop the erosion of traffic to other modes and to permit the railroads to grow with the economy of the country? (5) To work together with other lines in a determined effort to have removed those restraints, whether legislative or otherwise, which operate to prevent the full development and economic use of the rail form of transportation? It may be said that for individual railroads to be operated as integral parts of a na- tional system compromises their standing as separate corporate enterprises responsible to their own stockholders, and that such a compromise cannot be demanded in the Ameri- can tradition of free enterprise. Again the answer is that the railroads are public service companies, and the assumed competitive rights of individual carriers must be responsive to the needs of the public. If railroads in their present form cannot provide an efficient national system, then obviously the form will have to be changed. I realize that lack of capital for improvements running into the billions has a direct bearing upon the railroad service problem, and that conglomerates, with their promise of greater earnings and financial strength, should be able to help in this connection. But would they really help when the choice is between a railroad investment which produces a small return and another investment which promises a much greater return? I wonder to what extent conglomerates, with earnings from diverse sources, can afford to pump into their railroad subsidiaries the kind of money that is required, particularly when there are so many attractive investment opportunities outside the railroad business. What it comes down to in the final analysis is this : The railroad service problem is tough and calls for heroic measures. Only the full and undivided attention of the first team of railroad management, with a willingness truly to cooperate, can possibly come to the rescue. The problem will never be solved if regarded as only another routine problem for someone else to worry about while the first management team is preoccupied with more acquisitions for the conglomerate and more earnings from non-transportation sources. And if the service problem is not solved, the shippers of the country, finally losing all patience, will demand a change, and what change can there be other than nationalization even though nationalization has not always been a satisfactory answer in other countries? Moreover, if the railroads in the meantime have become conglomerate subsidiaries, a gov- ernment take-over might be highly welcome. In the history of our country there have been many instances of the spinning off by private enterprise of public service undertakings, and they have invariably ended up in public ownership. There is ample precedent in our own country for the public ownership of railroads. If this happens, the great pity would be that our American railroads became nation- alized because they proved incapable of working together effectively in the interest of an efficient national railroad system. And it would never be known whether the railroad form of transportation, fully developed and exploited by private management, was capable of holding its own in a competitive transportation market or not. Exhibit 35 Illinois Central Railroad, Chicago, III, May 19, 1962. Mr. Thomas M. Goodfellow, President, Association of American Railroads, The American Railroads Building, Washington, B.C. Dear Tom : I have been shown a copy of a letter May 8 from Mr. Hollis G. Duensing addressed to the Subcommittee on Legislation relating to the acquisition and control of carriers and enclosing a copy of remarks delivered by our friend Jervis Langdon before the Minneapolis Traffic Club on April 10, 19G9. Mr. Jeramiah C. Waterman also was given a copy of Mr. Duensing's letter and enclosure. I have not yet inquired as to the procedure being followed by the Subcommittee or by Mr. Duensing but I have read Jervis' statement and, as you might suspect, I myself am in disagreement with his logic and the implied conclusions. 554 The principal point seems to be that railroad diversification into non-railroad fields will produce "easy earnings" and a "sense of well being" to the degree that the railroad management in a diversified group of companies will not have desire, incentive or a feeling of necessity to solve difficult railroad problems which have plagued the industry for many years. Personally I don't think we need try so hard to cling to poverty as Hie only stimulus for solving our urgent and ancient problems. The solution to many of these problems will be much easier if diversification should help to improve our access to capital markets and if we can generate enough earnings to retain some of the loyalty «nd steadfastness of our stockholders. The second point is the frequently heard suggestion that a diversified management would not be likely to put capital into railroads if in the same family there are opportunities for non-railroad investments producing a greater return. There arc two answers to this observation. First, the return on many railroad investments, on an incremental basis, is very great indeed and is certainly not to be judged by the statistics of average return on total existing rail investment. For instance, we are making many investments on the Illinois Central currently which produce between 20% and 657r return, which is generally in con- siderable excess of the return on investments in our manufacturing companies. The second answer is that good earning railroads must continue to invest in their properties in order to protect those good earnings. Thus the good earners in the railroad industry have con- siderable incentive to place additional capital in the railroad properties, simply to protect existing good earnings. Paradoxically, referring to the first argument mentioned above it is the poorer rail- roads which do not have that incentive and which more quickly might look for opportunities to di sin vest. As might be suspected, we believe strongly in the advantages of diversification into non-transportation fields and I would not want my silence, after reading .Tervis' remarks of April 10, to be misunderstood to the contrary. Rearing in mind the new action of the Union Pacific, Southern Pacific, Seaboard Coast Line and Penn Central, as well as the exist- ing holding company organization of the KCS, M-K-T, and C&NW and ourselves, I suspect that others in the industry might also favor an attempt in earnings improvement through non-transportation diversification as distinguished from a choice of relative poverty as a desirable incentive for the solution of problems. Indeed, I believe that diversification is the single most useful goal of a railroad who can achieve it so long as we are unable to make major changes in existing disadvantageous and burdensome government policies. We have been trying to make those changes for a long time' and have not succeeded. I believe we should continue trying but at the same time self-help in the form of diversification seems to me to be the path of prudent management. Sincerely, William B. Johnson. [Memorandum W. R. Gerstnecker, Vice President and Treasurer, P.C.T.C. attached to above letters] July 22, 1!)G!>. Basil Cole: I am returning the papers you left with me including letter of May 26 from .Tervis Langdon and a copy of Bill Johnson's letter of May 19 to Tom Goodfellow. I was not sure what [ was supposed to do with them except probably give you my comments. Of course, 1 agree with Bill Johnson's point of view. Historically, T don't know where the PRR or NYC would have been were it not for the huge investment the Central had in New York real estate and the very sound investment we had in N&W. These, over the years, supplied us with considerable income and gave both of us sources of credit we would not otherwise have had. To a degree they represented benefits from diversification and provided us with solid earnings when rail earnings were down for one reason or another as a result of cyclical downturns in business or inflationary pressures. From the standpoint of Penn Central, we have agreed and have been ordered by the ICC to divest ourselves of our N&W. It seems to me that based on past experience, management in the interest of both stock- holders and its transportation function has an obligation to reinvest the funds in a way which will protect the kind of income and asset values we had through our ownership in a company like the old N&W. The railroad business has habitually been one of feast or famine, depending upon vol- ume or economic conditions. Lately it seems we are suffering from the famine side and until something is done ratewise or otherwise to provide us with the earnings and capital we need, diversification and protection of our income seem vital to me. W. R. Gerstnecker. Exhibit 36 [From files of D. C. Bevan, Chairman of Finance Committee, P.R.R.] October 25, 1966. S.T.S. : In view of yesterday's discussion, we believe that it is advisable for everyone to have a full recognition of why we are facing the current problem to the extent if is a problem. At the same time, I would like to reiterate that to the best of our knowledge the 555 total budget of the New York Central for 1967 is in the neighborhood of $80 to $85 million, and we are talking about having an acute problem because our equipment budget alone is in that area, not to mention a request for an all time record road budget. 1. Although we pointed out in both 1964 and 1965 that we thought we were spending money too rapidly despite the overall desirability of the long term objectives, the Financial Department went along with near record capital programs. It was also pointed out that we would be faced with trouble in staying within the debt limitation beyond December 31, 1965. In 1966 we objected as strenuously as we could to the level of capital expenditures because of the effect on the debt limitation and because of the failure of the operating peo- ple to meet their commitments of $50 million net income in each year. For the three year period there is a cash deficiency of approximately $45 million. This amount alone would be almost enough to give the Operating people the amount they now wish for equipment. 2. In the Northeast Corridor, we started out with a proposal of spending $10 million on the road and the Federal Government providing almost $10 million for cars for a limited experiment. Very quickly we boosted the level of expenditures on cars to $21 million, thus increasing our commitment to the extent of $11 million. Our original estimate of the cost of road expenditures has soared from $40 million to $33 million, or a total of direct cash drain involved on our system of $44 million, $34 million more than originally contemplated. 3. It now appears we will exceed the original cost of our participation in the Madison Square Garden development by $8 million minimum. 4. If you add all of these together, plus the $10 million increase in inventories, the Op- erating people in the three years 1964-66, aside from keeping capital expenditures at near record levels, have directly been responsible for an additional cash drain on our resources of $97 million. 5. It is also obvious that some very serious mistakes have been made in our program of acquisition. The reasons for this are hard to ascertain but it may be because of the rapidity with which money has been spent in recent times. (a) The Berwind-White program which in total represents an expenditure of $2.8 million was outlined as a must by the Operating people, including the sales organization. This has obviously been a fiasco. (6) While we still have been unable to get full details, it appears likely that the Asso- ciates of the Jersey program, which involves $19.5 million will unfortunately substantially fall into this same category. Herein lies the truth why today the financial resources of the company have been stretched further than at any time since I have been with the railroad. Throughout this entire period, and the last twelve months money has been scarcer than at any time in my business career, the financial side of the business has met every demand and has initiated a number of unique approaches which although in accordance with good accounting prac- tices are unique and which have materially aided in the expansion of our earnings. The foregoing are the reasons for our present difficulties, but we should also look at some other aspects of the situation. 1. During the ten year period 1956-65 total capital improvements of the New York Central totaled $545 million, those of the Pennsylvania $1 billion 86 million, or twice as much. During this period, or any shorter period that anyone may care to select, we have likewise outstripped the New York Central in expenditures by a wide margin and this is also true for almost any of the other Eastern roads proportionately, and basically the same may be said on a national basis. 2. As indicated by the attached figures, the improvements in our earnings situation has not been material. (See Exhibit I). 3. For the last ten years the average life of our equipment has steadily declined from about 27 years to an estimated 14.8 years at the end of 1966. but despite huge sums spent on equipment, during the first six months of 1966 our share of the Eastern markets was 20.1% as compared to a high in the 60's of 20.9%, in 1962, and, if it is said this was a poor and unusual six months, our share for the first six months of 1965 was 20.5% which com- pares with the 20.5% in 1961. As indicated by the attached figures, if even in 1965 we had been able to maintain our position in the Eastern markets, we would have had over $5 mil- lion more revenue in 1965 than we did. (See Exhibit II). 4. Our current requested program of approximately $58 million for new freight cars in 1967 shows only a return of 6.9%, based on a 20 year life as compared to an average life of ->ur present cars of 14.8%. Using these figures, in the development of which the Traffic De- partment participated, after we put in an estimated cost of money of about 6%%. there is virtually no return indicated and a great many categories are actually losing money and the general average of 6.9% is up substantially because of the wide margin of profit of bi- level and tri-level racks included in the program. 5. As has been pointed out many times in the past three years, we have rapidly reached a very serious danger point with respect to our ability to carry on new financing. At any time, because of the serious maladjustment in the ratio of equipment depreciation to ma- turities, Moody's may drop our rating from A to Baa and if this happens our abilitv to finance eouinment. even at a substantially advanced cost, would become extremely diffi- cult, if not impossible, in the present tight money market. Attached hereto is a list of some 74-924 O - 73 - 37 556 of the companies with Baa ratings which will give you some indication as to how far down the quality of our equipment certificates could drop. At the present time our equipment depreciation amounts to about $35 million as compared to average equipment maturities of about $57 million. As contrasted to this, New York Central's equipment depreciation is about $30 million as against maturities of $20 million. Overall our maturities in 1966 were $34 million as compared to depreciation of $54 million. New York Central had combined de- preciation of $40 million and total maturities of $20 million. (See Exhibit III). 6. In the three year period 1964-66 it is estimated that our interest charges and de- preciation will have increased $17% million, or about $1.26 per share, and our consolidated debt on the old basis, which excludes recently acquired companies, will have increased by $240 million. During the same period, New York Central's debt is estimated to have in- creased by $25 million and we estimate their interest and depreciation charges will increase by $4 million. 7. Despite the huge outlays for equipment there still has been no noticeable improve- ment in our per diem situation during the year 1966. The only decrease in equipment rentals that has occurred is decreased rentals from leading companies and has nothing to do with utilization of our equipment. I think that everyone realizes, but if not they should, that the analysts have become increasingly critical of our ability to carry through gross to net as contrasted with the New York Central and at least a half dozen investment houses have commented quite un- favorably on the rapid increase in our debt as contrasted to that of the New York Central. In addition, just recently the Morgan Guaranty Bank which is now a very substantial holder of our stock has manifested great interest in obtaining figures showing projected maturities of Pennsylvania Railroad in relation to our projected cash flow. While I believe it is highly desirable that we have an efficient fleet, I think the time has come that at least until the merger we are going to have to allow ourselves a breathing spell and go forward on a much more modest basis until the operating people can show a satisfactory return on capital expenditures already made. I believe we are in a very serious position financially from the standpoint of an acute shortage of cash and high maturities in relation to depreciation. Basically there is no question that we still have very substantial underlying strength primarily because of our outside investments of which, of course, the Norfolk & Western is the major one, but this can easily be dissipated if we continue on the road we have been pursuing recently. In summary, even if we should be successful in obtaining an increase in the debt limit, this would not effectively solve our problem. 1. Even in the present tight money market we have no definite assurance that we are going to be able to raise $85 million next year. For the first time since I have been with the railroad there is a real risk involved from this standpoint. 2. We are facing an acute cash shortage next year for which we have found no solution as yet and any increase in our borrowings to the extent they are obtained from banks will require additional cash for the maintenance of compensating balances in our banks. 3. The most basic and serious problem has to do with our ratings for Moody's. The greater the increase they see in our debt, the more likely they are to analyze our equipment situation and the more vulnerable we are to having our ratings decreased. If this happens, not only will our ability to raise money be curtailed next year, but it will be virtually im- possible for us to continue to borrow in future years at the rates we have been accustomed to in the past. The market for the equipment is not good and very very much smaller than the market in which we have been operating. PENNSYLVANIA RR. CO. Pennsylvania Co. Supplemental dividends pension past Adjusted net Capital and lease Year Reported earnings included service liability earnings expenditures 1965 $33,896,504 $23,000,000 '$6,917,000 $3,979,504 $244,236,000 1964 29,132,927 20,000,000 '6,423,000 2,709,927 100, 343, 00n 1963" 9,158,870 14.000,000 '6,918,000 26,121,130 82, 391, 00o 1962 " 2 3,209,885 14,000,000 3 5,750.000 2 17,208,885 62,951. OOo 1961 "" 3,515,586 19,000,000 3 6,200.000 2 15,484,414 60,869,000 I960 2 7,819,112 13,000,000 '7,100,000 2 20,819,112 174, 854, 00o 1959 " 7,267,135 13,000,000 3 6,500,000 2 5,732,865 124, 560, 00 n 1958" 3,544,073 13,000,000 3 7,400,000 2 9,455,927 60, 241, OOo 1957 19 056, 885 13, 000, 000 3 5, 400, 000 6, 056, 885 91, 705, OOo I95B™II™™II""""I™ 41,545,435 12,000,000 3 5,200,000 29,545,435 86,090,00 ' The amounts for 1965, 1964, and $1,280,000 for 1963 represent charges against earnings, comparable to the basis of earlier years if the plan was not in a fully funded position. > Deficit. 3 Memorandum— provided for in "Reported earnings." 557 FKtlUi: CM HUT DATA 195C - I9fc6 LXKIIUT II B. ►. i A. IO/S5/C4 EXHIBIT III PENNSYLVANIA RAILROAD CO.— GRAND TOTAL FREIGHT CARS OWNED AND LEASED, 1966 Month end balance January February March April May June July... August September Source: Financial review statement. Total freight cars Serviceable units Percent un- serviceable 122, 246 121,613 121,345 121,354 121, 196 120, 850 120, 466 119,838 519, 620 112,065 111,062 110,644 110,531 110,031 109, 448 108, 959 107, 953 107, 641 8 9 9 9 9 9 10 10 1U 558 PENNSYLVANIA RAILROAD CO., EFFECT ON 1965 REVENUES FROM CHANGES IN 1965 MARKET POSITION VS. 1964 [Dollars in thousands] P.R.R. N.Y.C. B. & 0.- C. SO. N. & W. Other Total Eastern District Coal ($1,108) ($3,665) $5,284 $8,18 ($8,693) Ore (2,367) 473 961 (281) 1,214 Grain 342 (895) (265) (669) 1,487 Food and kindred products,. (1,306) (1,004) 837 (904) 2,377 Pulp, paper, and paper products (388) (1,079) 2,416 (65) (884). Chemicals, rubber, and plastic 506 1,118 (905) 373 (1,092) Stone, clay, and glass products (334) 652 184 1,520 (2,022) Iron and steel (including scrap) (103) 2,436 4,109 (2,073) (4,363) Machinery and appliances (140) (1,908) 1,250 399 399 Motor vehicles and parts 4,924 2,127 (4,283) 175 (2,943) Allother (4,723) 660 (2,714) (5,572) 12,349 Total (4,703) (1,085) 6,874 1,085 (2,171) Note: Figures in parentheses are unfavorable. PENNSYLVANIA RAILROAD CO.-1967 NEW FREIGHT CAR PROGRAM RATE OF RETURN STUDY Type and description X58a— Noninsulated grocery X58c— Lading straps adjustable Total, X58 X61c— Fisher body 60-70 ton X61d— Double door 60-70 ton Total X61... X60— 86 foot box (Chevrolet) X60— 86 foot box (Oldsmobile) X60— 86 foot box (Chrysler) X60-86 foot box (Ford) Total, X60 Grand total, boxcars Covered hopper— 4,600 cubic foot. Covered hopper— 3,000 cubic foot. Total, covered hopper 6-43 — 52 feet 6 inches gondolas.. G-41— ICO-ton coil covered gondolas Total .gondolas H-43— 100-ton hoppers Racks— Bilevel Racks— Trilevel Total racks Grand total, new freight car program Cars Racks.. Rate of return (percent) 14-year life 20-year life 25-year life Initial Before After Before After Before After Quantity cost taxes taxes taxes taxes taxes taxes 150 $2,842,500 7.0 3.6 9.0 4.7 9.9 5.1 300 4,800,000 10.9 5.7 12.9 6.7 13.8 7.2 3, 149 362 57,571,500 11.0 25.7 13.2 2 6.9 13.9 7.2 450 7, 642, 500 9.5 4.9 10.7 5.5 11.6 6.0 200 80 4, 000, 000 1, 988, 000 9.9 6.7 5.1 3.5 11.8 8.6 6.1 4.5 12.7 9.5 6.6 4.9 280 5, 988, 000 8.8 4.6 10.0 5.2 10.9 5.7 49 10 200 2, 058, 000 420, 000 7, 600. 000 .2 17.7 .1 9.2 2.1 19.6 1.1 10.2 3.0 20.5 .6 9.7 1.6 10.7 .3 18 720, 000 6.9 3.6 8.8 4.6 5.0 277 10,798,000 . 1.5 .8 2.4 1.2 1, 007 24, 428, 500 4.9 2.5 6.9 3.6 7.8 4.1 160 2, 576, 000 1, 445, 000 9.5 17.6 4.9 9.2 11.4 20.4 5.9 10.6 12.3 21.3 6.4 100 11.1 260 4, 021, 000 12.4 6.4 14.2 7.4 15.1 7.9 600 82 8, 400, 000 1, 640, 000 6.4 17.2 3.3 8.9 8.3 19.7 4.3 10.2 9.2 20.6 4.8 10.7 682 10, 040, 000 16, 380, 000 8.2 9.9 4.3 5.1 11.8 11.8 6.1 6.1 12.7 12.7 6.6 1,200 6.6 125 687, 500 2, 014, 500 73.6 84.4 38.3 43.9 73.6 84.4 38.3 43.9 73.6 84.4 38.3 237 43.9 362 2, 702, 000 81.7 M2.5 81.7 • 42.5 81.7 42.5 1 Rate of return on racks based on 7-year life. 2 Excludes cost of money. [From files of D. C. Bevan, Chairman of Finance Committee, P.R.B.] November 8, 1967. Mr. Saunders : There follows an analysis of our financial position as it exists today divided into three major areas: (1) Cash Needs, (2) Financing Possibilities, and (3) Debt Limitation Under Our Merger Agreement. Cash Needs The Pennsylvania Railroad Company requires, in order to maintain adequate balances in its banks to cover activities and loans, an average cash balance of somewhere between $45 and $50 million. We have not had balances in this area at anytime this year and at the end of October our cash balance amounted to roughly $8,500,000. In order to augment it 559 we had borrowed funds from Pennsylvania Company and others amounting to approximately $14 million or a total of only $22 million. Based on current estimates of cash flow, this balance will be reduced by the end of November to $20 million, including borrowed funds and by December 31 to zero. Because of heavy cash requirements in the first quarter of the year, the zero balance will deteriorate by the end of January to minus $6 million ; to minus $19 million by the end of February and to minus $22 million by the end of March. This means that we must augment our cash as quickly as possible. At least $45 million must be raised within the next 30 or 40 days and an additional $20 million early in 1968 to see us through the first quarter. This is necessary to provide protection against low cash balances which occur at times other than the end of the month because of large pay-roll, maturity, traffic settlement and dividend requirements. In order to protect our cash position, we have expedited the sale of capital assets and utilized other means wherever they have been available. This includes the sale of the N&W debentures we have received in exchange for N&W stock ; temporary loans from banks against expenditures made in building the Waynesburg Southern and expenditures made to rehabilitate freight cars under Equitable leases ; the sale of Macco receivables under a complicated arrangement to avoid increasing our debt ; and the declaration out of Richmond Washington Company of dividends in R.F.&P. stock which we sold. "We recently have agreed with the N&W to take down $10 million additional of their debentures in the so-called floater we had with them and have prevailed upon them to accelerate the delivery of the 1968 debentures from June to January. In view of the current market condi- tion and the price of N&W stock, it is estimated we can raise approximately $17,500,000 through the sale of these debentures when we receive them in December and January, respectively. These debentures are owned by Pennsylvania Company and that Company will have to retain approximately $2.5 million of the proceeds for its own cash purposes so that the net amount available to augment PRR's cash, if such sales are made, will be approxi- mately $15,000,000 and about $9 million of this will not become available until January when the second group of N&W debentures is scheduled to be delivered to us. We have explored thoroughly with investment bankers in New York the possibility of selling a Pennsylvania Company preferred stock. It is apparent that such sale in the amount we require would be extremely difficult to market even at an unreasonably high dividend rate. Furthermore, a preferred issue would of necessity contain extremely burden- some conditions and eovenents which would limit Pennsylvania Company's future financial activities and dividend policy. In addition, the issuance of preferred stock, which would have to be non-callable for at least 10 years, would be highly disadvantageous from an income tax standpoint because the dividend on preferred would have to be earned without the income tax deduction for interest available through the issuance of debt. Therefore, this means of financing had to be discarded. Investigations have been made of the possibility of selling the dividends Pennsylvania Company will receive over the next three years prior to the termination of the Wabash lease with N&W without success. These dividends would amount, over the next three years, to approximately $21 million and if they could be sold on a reasonable discount basis, the net proceeds would have been about $19 million. No practical way has been found to do this without such a sale being construed as debt and it would require the repayment over the next three years of $7 million a year. In view of the fact that our total annual maturities now equal or slightly exceed our depreciation, any financing or raising of funds which would require additional annual maturities over the next three years of $7 million would not be a sound move. It is not feasible to liquidate N&W stock at the present time because we do not have a sufficient number of shares free of pledge which could be sold and we cannot sell our Wabash stock which eventually will be converted into N&W because such sale would take the Wabash out of our consolidated tax shelter thereby cutting the present rent in half. In summary, we believe it is necessary to issue and sell debt securities. As mentioned above, our cash needs total $65 million and if $15 million of this can be raised through the sale of N&W debentures, we should issue and sell at least a $50 million Pennsylvania Company debenture. This will require I.C.C. approval and take a considerable while to do, which means that we may have to draw on our revolving bank credit as an interim measure to cover our cash requirements pending receipt of the proceeds of the debenture sale. In any event, we will require an increase in the debt limitation provided in our merger agree- ment as explained in more detail below. Debt Limitation Under Merger Agreement (See Exhibit Attached) Our merger agreement with the New York Central restricts the amount of debt which can be issued by P.R.R. and New York Central prior to our merger. Originally this limita- tion provided a margin of $100 million increase in debt subsequent to the date of the merger agreement. The Boards of Directors of each company authorized an increase in the $100 million limitation to $195 million and the latter figure is now the controlling factor. Up to a fairly recent date, we have been able to live within this limitation primarily because of two actions we took to provide relief, namely (1) the sale of 2 Penn Center which reduced our outstanding debt by the amount of mortgages outstanding on that property and (2) the conversion of equipment debt owned by our Pension Fund into pre- ferred stock. You are familiar with these transactions which provided about $28 million of additional leeway. In addition, we planned to stretch out the debt issuance for a sub- stantial part of our 1967 equipment program until we could absorb it as a result of maturities next year. However, the recent ordering of 100 diesels, costing $28 million, to be 560 delivered in December, January and February and the agreement to take eleven high speed cars originally intended for SEPTA into our Northeast Corridor program in Decem- ber has made it impossible for us to stay within our debt limitation. The amount by which we will overrun our limitation is further increased by the financing we now must do to meet our cash needs. In addition, debt financing for other capital expenditures in our 1968 program will undoubtedly be moving in on us. As we now stand, at the end of 1967 based on the debt which will be outstanding at that time, we will be under our debt limitation by only about $16 million. With deliveries of the balance of the diesels in January and February and the balance of the Northeast Corridor cars, as well as the financing of the 1967 carryover expenditures, we will be somewhere in the area of $22 million beyond our debt limit by the end of February. If we add to this the $50 million to be raised from the sale of Pennsylvania Company debentures, our excess debt will be $72 million. Assuming that our merger will not take place before the end of March 1968, we should promptly request additional authority from the New York Central for at least $75 million. David C. Bevan. On the basis of Exhibit 2 in the papers distributed at July 29 meeting, consolidated net earnings, without a steel strike, are estimated at a loss of $36,227,000 for the third quarter as against an announced target by Mr. Saunders of $15 million. In a plan outlined by D. E. Smucker at the meeting, going through Phase I, savings of $10,750,000 would be effected or at the balance of the third quarter $21,500,000. In addition, other ways and means of bridging the gap were considered and as of now the figures would appear as follows : Estimated consolidated losses, $36,277,000. Savings by D. E. Smucker $21,500,000 Discount bond purchases 2,000,000 Additional real estate sales* 4,300,000 Additional revenues from H. W. Large 15,000,000 Savings on expense accounts 500,000 10% reduction from departments other than operations 1,400,000 Increased earnings from subsidiaries** 5,000,000 Total 49, 700, 000 *S. H. Hellenbrand only has potential sales on the horizon for a total of $4,500,000 or $2,800,000 not contained in the above figures. **D. C. Bevan checking. Note. — Gap yet to be bridged, $1,500,000 — based on above figures. Exhibit 37 [From files of D. C. Bevan, Chairman of Finance Committee, P.R.R.] August 30, 1968. Mb. Saundebs : Primarily because of the delay in consummating our merger the net working cash 1 of the Pennsylvania Railroad on February 1 was at an all time low of $5.5 million. On the same date the New York Central had net working cash of $7.8 million, giving Penn Central combined working cash of $13.3 million, obviously totally inadequate for the operation of a corporation of our size, and also to maintain proper compensating balances with our banks. Coupled with this, a capital budget for over $300 million was approved for the year 1968. All of these factors combined created a very difficult situation both from a cash stand- point and also from the standpoint of financing requirements of the merged company. De- spite these problems, we probably could have worked out this situation gradually over n period of some months, but the gravity of our situation has been compounded by the fact that Penn Central had a $48 million deficit from railroad operations in the first six months of this year and a cash loss of $88 million. Further cash losses have occurred in both July and August in an estimated amount of $43 million. This drastic cash drain is going to have a very serious effect, not only this year, but certainly through 1969. Our best estimate at the present time indicates by the end of this year we will have $100 million of commercial paper outstanding, we will have used up our entire $100 million revolving credit with the banks, and we will still be short somewhere hetween $125 and $150 million. We only have a limited number of ways of closing the gap : (1) A further reduction in expenses and this does not appear feasible in light of plans already in process for retrenchment which have been taken into account in our cash flow estimates. (2) Sale of assets. Increased sales of real estate is one possibility, but it seems un- likely that we can realize a substantial amount during the balance of the year over and above present estimates. Another possibility is the sale of Strick. It will be difficult to accomplish this without a loss that would be charged against our operating income since at the present 1 Net working cash Is after deducting the temporary bank loans which have been converted Into Commercial Paper or our Revolving Credit. 561 time its level of earnings is not on a satisfactory basis. However, initial steps have already been taken to explore this possibility with three potential purchasers. Another possibility for a source of funds is the sale of the TP&W, the Santa Fe being the most likely pur- chaser, and this will be explored with them promptly. Walter Grant has been asked to explore the seal of Toronto, Hamilton & Buffalo with N. R. Crump, Chairman and Chief Executive Officer of the Canadian Pacific. Obviously, we are hopeful that we will be able to improve our position somewhat through some of these possible sales but at the time time it is evident that there is no hope of substantially closing the gap from this source. (3) An immediate and drastic reduction comparable to what we are doing on the expense side on capital expenditures where cash is involved. (4) Additional financing other than equipment financing. We hope to have our blanket mortgage ready to allow the sale of possibly $50 million of bonds before the end of the year but with a new mortgage of this type and with current conditions in the bond market, this is probably the most we can do initially. If, as and when we solve the problem of finding the required $125 to $150 million, we are still faced with the necessity of placing on a long term basis as quickly as possible the $200 million of short term maturities in the form of bank loans and commercial paper, plus a cash deficit of an undetermined amount during the first half of next year. The latter will undoubtedly be substantially above that for 1968 if we take over the New Haven as of January 1. If we assume in 1969 the Penn Central on a parent company basis reports $40 mil- lion net income, and there are reasons to believe this may be on the optimistic side, only about $30 to $33 million of this at best will represent true cash flow. If you add to this $100 million of depreciation and possibly $20 million from the liquidation of assets, we will only have a total of about $150 million of cash resources. Against this amount are re- quirements consisting of $100 million for maturities of which approximately $74 million is equipment debt. The total amount of maturities will absorb our total depreciation of $100 million. In addition to the maturities $8 million will be needed in connection with the New Haven settlement if this occurs on January 1 or thereafter, and $55 million for common stock dividends or approximately $58 million if the New Haven is acquired in January. In other words, there will be a cash deficiency of about $15 million before any allowance is made for road capital expenditures. In my judgment, we are faced with the most serious problem, from a financial viewpoint, that I have encountered since I have been with the railroad. Ways and means must be found to resolve them, but under the most favorable circumstances it is going to take a substantial amount of time. In the mean- time, I see no alternative but to stop all capital expenditures which represent a cash drain until such time as we can re-establish a positive cash flow. It is my recommendation that we have a small meeting immediately to determine how drastically retrenchments can be made which I believe will require complete cooperation from management at all levels. I would suggest that in addition to you, Mr. Perlman and myself, such a meeting should include Messrs. Smucker, Grant, Gerstnecker and Hellen- brand. If the foregoing has your approval may I distribute copies of this memorandum to the individuals mentioned on a personal and confidential basis prior to the meeting. David C. Bevan. Exhibit 38 [Prom files of S. T. Saunders, Chairman of the Board, P.R.R. and for use at August 1964 P.R.R. board meeting] Memorandum for the Directors Net income for July was $1,500,000, slightly less than the forecast. Total revenues of $73,900,000, increased $3,300,000, over the forecast, which increased was more than offset by increases in operating costs including an accrual of $2,300,000 for retroactive increased wages and fringe benefits. Assuming that the current trend in traffic volume continues, August revenues could exceed the forecast and the August net income forecast of $3,000,000 could be realized. The earlier than usual resumption of automobile production in August has assisted in increasing revenues by an estimated 3% over a year ago. Coal loaded on line has shown above average increases with 351 unit trains scheduled for operation during the month. Travel to the World's Fair increased further in August. There have been 160 extra trains to and from New York on account of the Fair through August 16, carrying 113,900 passengers. By the end of August, it is expected that $3,000,000 added revenue will have accrued as a result of the World's Fair. The Boy Scout Jamboree proved to be quite successful. Travel to Valley Forge in July is estimated to have produced revenues of $375,000. CASH SITUATION Net cash at the end of July totaled $5,400,000, which is about what was estimated. Our estimate of net cash for the end of August is $5,000,000, which compares with $13,200,000 at the end of August 1963. 562 LABOR STATUS On August 7th, a Presidential Emergency Board made its recommendations in connec- tion with the Shop Crafts Organizations' engineers provide that $23 per month will be set aside for each qualifying employee for health and welfare beginning in June of this year. It also grants the engineers, effective June 1st, an increase in the basic daily rate of $1.75 and to engineers in road freight and yard service an additional $1.50 for each day they are required to work without fireman. Demands for increased pay, job stabilization, etc. filed by the a number of other labor organizations are in various stages of handling. N&W-NICKEL PLATE-WABASH UNIFICATION As you know, the Interstate Commerce Commission on July 13th released its order conditionally approving the N&W-Nickel Plate-Wabash unification. Among the conditions of approval is the requirement of complete divestiture by the Pennsylvania of its financial interests in the Norfolk and Western and Wabash within a ten-year period during which all voting rights in N&W stock must be transferred to three independent voting trusts. We are required to notify the Commission not later than September 17th as to our intent to proceed with a plan of divestiture. The order also directs that all Board and manage- ment relationships between PRR and N&W must be severed by October 17th and that con- summation of the transaction take place by November 16th. The Erie-Lackawanna, Delaware and Hudson, and Boston and Maine were given five years in which to file petitions for affiliation with the N&W. PENNSYLVANIA COMPANY — BUCKEYE MEBGEB The Interstate Commerce Commission on July 15th approved the issuance by Pennsyl- vania Company of 707,626 shares of 4%% cumulative preferred stock, clearing the way for the merger of The Buckeye Pipe Line Company into Pennsylvania Company, effective July 24th. GREAT SOUTHWEST CORPORATION Pennsylvania Company on July 15th purchased 518,367 shares of stock of Great South- west Corporation bringing the System holdings to 532,867 shares, or 49.4% of the total outstanding stock, at an aggregate cost of $12,196,000. MASS TRANSIT BILL The Mass Transit Bill signed by the President on July 9th authorizes a total of $375,000,000 over the next three years for grants to state and local bodies on a % Federal Vn state or local basis. However, the money must still be appropriated by Congress. ADDITIONAL MU CABS FOR PHILADELPHIA ABEA An agreement has been reached with the City of Philadelphia, subject to approval by City Council and our Board of Directors, providing for the lease from the City of 20 more new electric commuter cars for use in the Philadelphia area under contract with the Passenger Service Improvement Corporation (PSIC) and Southeastern Passenger Trans- portation Compact (SEPACT). Under the new agreement, the fleet of such cars will be increased to 58 and rental will be changed from a mileage basis to a flat payment of $60,000 a year, which should provide greater flexibility in the use of the cars. UNIT TRAINS Unit train operations continue to grow. During June we handled a total of 327 such movements. All but 16 of these were coal trains averaging 7,000 tons with several train- loads of 9,400 tons and one of 14,800 tons. Joint studies have been initiated with the United States Steel Corporation for the purpose of establishing in August a "Unit [sic] , Merger Some thirty parties filed briefs in our merger case on June 1. Many of these briefs supported the merger and generally all of them were about what we expected. The Depart- ment of Justice continues to oppose the merger basically along anti-trust lines. Its anti- merger position is based on the premise that the public interest would be better served if the two lines remainded independent of each other. While admitting that the two roads have been going through a difficult period, which would be for the most part solved by the merger, the government, nevertheless, maintains that the nation's expanding economy and the railroads' own vigorous self-help plans will ease their difficulties. Since the filing of the Justice Department brief, I have received a telephone call from Attorney General Kennedy who invited me to come to Washington to talk to him concerning our case generally. I expect to do this in the next few days and am hopeful that we may be able to modify the department's position. The State of New York filed a generally helpful brief and did not oppose the merger itself. It did insist on inclusion of the Erie-Lackawanna in the Norfolk and Western system and suggested that our record be held open for five years to consider the inclusion of other railroads. 563 The Bureau of Inquiry of the Interstate Commerce Commission filed a very helpful brief which assumed the merger would take place. In addition, it suggested that the peti- tions for inclusion of the Susquehanna, the Brooklyn Eastern District Terminal and the Erie-Lackawanna be denied. It recommended retention of I.C.C. jurisdiction for five years to consider inclusion of the New Haven, Boston and Maine and Delaware and Hudson, indicating that they could not be included at this time. The Transport Workers Union included with its brief a motion to have the record reopened to consider the effect of the work rules settlement. We intend to reply to this motion this week and do not anticipate that the record will be reopened for this purpose. On June 8, the New Haven requested a hearing before the Commission for considera- tion of our proposals to solve the New England rail problem which were included in our brief. We conferred with New Haven representatives last week and they have submitted to us an alternate proposal for the purchase by the Penn Central system of the New Haven's operating and various other assets incident thereto. In brief, their proposal contemplates the sale to us of the New Haven's assets free and clear of all liens, except equipment trusts liens in the amount of approximately $22 million, which could be disaffirmed if the equip- ment is not desired, for a purchase price of roughly $80 million. A condition of the sale would be the elimination by the New Haven trustees of all New Haven passenger service prior to the transfer of the assets. Obviously, this new proposal has great responsibilities and I am hopeful that we can reach some agreement with the New Haven trustees concern- ing this property in the reasonably near future. If we agree to absorb the New Haven, we would, of course, expect the Boston and Maine to become a part of the N&W-NKP- Wabash system. Labor We continue to make progress under Arbitration Award No. 282. As of June 15, we were operating an average of almost 500 assignments a day without firemen and had gross wage savings of approximately $468,000. As of this date, we had operated a total of 10,455 yard crews and 3,619 road crews without firemen. We also had terminated the services of 717 firemen. As of June 21, we had paid severance allowances in the amount of roughly $60,000 to 65 people. We estimate that by the end of the first year we will have annual wage savings from the elimination of firemen of [sic] have vigorously opposed any sale of R.E.A. stock to Greyhound, indicated they may be willing to have Greyhound obtain some interest in the company. In sum, for the first time progress is being made in obtaining carrier agreement to disposing of at least a portion of the stock of this company. Mr. Carpi will continue his efforts to achieve a solution to this problem. As you know, our stake could amount to about $11 million. Transcontinental Divisions You will recall that our case seeking increased divisions on transcontinental traffic, which has been pending before the Interstate Commerce Commission for several years, was decided favorably to the Eastern lines in March 1963. The decision will mean approximately $24 million annually in increased revenues to the Eastern lines. The Western lines have appealed the case to the Courts and a hearing is expected to be held some time in October. Since the I.C.C. decision, we have discussed the case informally with one of the larger Western roads which has indicated a disposition to settle the matter. Subsequently, the Western lines held a meeting to consider the matter and while there was no unanimity among the group, they will meet again to consider the matter further. We are, of course, hopeful that some compromise may be reached in order that we may start dividing trans- continental revenues on a more favorable basis than present. Our interest amounts to be- tween $5 and $6 million annually based on the I.C.C. decision. Commuter Service The Pennsylvania Public Utility Commission released its order yesterday permitting the discontinuance of our 19 local trains in the Pittsburgh area. This order, unless appealed to the Courts, becomes effective in 60 days and will amount to the complete withdrawal of all our Pittsburgh commuter service. Greyhound Proposal to Purchase Railway Express Agency Stock As you know, the Greyhound Corporation has been trying to buy an interest in Hallway Express. At the present time, it is negotiating for 500.000 shares of authorized but its unissued stock at $20.00 a share. The proposal would also include an offer by Greyhound to purchase a million of the approximately 1,999,000 outstanding shares now held by railroads at the same price. However, Greyhound says that it will not go through with this offer unless at least 80% of the REA stockholders favor the transaction. At present, 73.5% of the REA stockholders are favorable to the proposed purchase. There is some opposition remaining among the Western lines which believe that control by Greyhound will adversely affect their freight forwarder business. We should know shortly whether the required 80% will be achieved. As a matter of fact, it is now up to the Milwaukee Road and the Hill Lines, i.e., the Great Northern, Northern Pacific and Chicago, Burlington and Quincy, which own 8.3% of the REA stock as to whether the transaction will be con- summated. It now looks as if there is a 50-50 chance of approval with a decision within a matter of a week or two. 564 Our interest in the Express Agency amounts to nearly $9,000,000. Of this amount approximately $3,600,000 is in deferred notes and the remainder of over $5,200,000 in com- mon stock (at $20.00 per share). The notes are not payable at the present time. If the transaction goes through, we could probably sell as much of our stock as we desired. There is a strong feeling that under Greyhound's management the stock will appreciate. At present we are thinking in terms of selling approximately half our stock for $2,600,000 and retaining the other half in the hope that it will appreciate. Exhibit 39 [From flies of D. C. Bevan, Chairman of Finance Committee, P.R.R.] December 1, 1966. Mr. James W. Aston, Chairman of the Board, Republic National Bank of Dallas, Dallas, Tex. Dear Jimmy : I am really rather disturbed and at the same time puzzled by a recent conversation I had with Angus Wynne with respect to his inability to borrow money at your good bank. There is one cardinal principal I have had in all the years I have been with the Pennsylvania Railroad and that is I would not maintain any bank relationship where we do not at the same time have the ability to borrow. I am sure that is not the case here, but certainly it is something we must get straightened out. The Great Southwest Corporation has its principal account with you and I think I have said before I thoroughly believe that we should have at least two accounts in each city where we do business. In addition to Great Southwest having an account with you and in order further to improve the situation, we have several times honored requests from Norman Ramsey to purchase certificates of deposit and only recently purchased one. I plan to be in Texas next Wednesday for a Great Southwest meeting and perhaps we can find a few minutes to get together to clarify the situation. I would also like to have the opportunity to have W. R. Gerstnecker, our Treasurer, and myself talk to your Trust Department people since we would greatly appreciate their acquiring some of conditional sales contracts of the Pennsylvania Railroad in January and which I might say will be at a most liberal rate of interest and far above that which I have been use to paying and that which I expect to pay after the first half of 1967. Best regards. Sincerely, Dave. bcc : Mr. Angus G. Wynne, Jr. Exhibit 40 [From files of W. K. Gerstnecker, Treasurer, P.R.R.] The Pennsylvania Railroad Co., September 22, 1967. Reply to : 1334 Transportation Center, 6 Penn Center Plaza, Philadelphia, Pa. Mr. Charles J. Hodge, Glare, Forgan, Wm. R. Staats, Inc., New York, N.Y. Dear Charlie : Attached is a brief description of the new Great Southwest preferred stock we have been working on. You will recall in Great Southwest we have arranged two 3-year loans at banks for a total of $6 million ; one short-term loan for $3 million ; and we are taking $3 million of this preferred in our System companies and funds. We are plan- ning to issue it in the first week of October. We could use $2 million more in the preferred and I thought you might see whether you can find any interest in that amount. Actually, if you can find more than $2 million it would be helpful to us to take less in our funds. We want to keep the total at no more than $5 million. I am sending a copy of this to Bill Loesche at Penn Mutual just to see whether he has any interest and I certainly have no objection to you or your people talking to him about it. If you have any questions or make any progress in this matter, please call Bob Loder our Assistant Treasurer here in the office at 594-3231, who is entirely familiar with this matter. This is more or less my swan song for the next three weeks or so and I hope during that time things straighten out a bit for you and give you more breathing space. Sincerely, W. R. Gebbtneokeb, Treasurer. 565 Great Southwest Corp. series a senior 6.5 percent preferred stock Amount : 500,000 shares, $10 par value each, or a total par value of $5,000,000. Dividend : 6%% per annum cumulative, payable quarterly. Voting Rights : Non-voting, except as specifically set forth in the Articles of Incor- poration or as provided by law. Position : Senior to present voting preferred which totals 350,000 shares with total par value of $3,500,000. Stock on a parity with the Senior Preferred is limited to an additional 1,100,000 shares unless approved by vote of at least two-thirds of the Series A, Senior Preferred. Stock ranking prior to the Series A, Senior Preferred cannot be issued unless approved by holders of at least four-fifths of the Series A, Senior Preferred. Optional Redemption : All or part of the stock may be called for redemption at any time after September 30, 1972 upon not less than twenty or more than fifty days prior notice. The premium is 5% for redemption during the first year following September 30, 1972 and de- creases by % of 1% each year thereafter until after September 30, 1992 when it becomes redeemable at par. Mandatory Redemption (Sinking Fund) : On the last day in September of each year commencing in 1971 such number of shares shall be redeemed as may be necessary in order that the number of shares of Series A Senior Preferred outstanding shall be reduced each year by 5% of the total number of shares issued prior to September 1, 1971. The mandatory redemption price shall be par plus accrued unpaid dividends. Exhibit 41 [From Traffic World, Mar. 1, 1969] (By Colin Barrett) 'Conglomerates' and Public Responsibility The decades-old issue of regulatory benefits versus liabilities is being raised in a new guise, as railroads find shelter, in cor- porate restructuring, from traditional limitations on their non- transportation activities. Recent diversification efforts by the U.S. railroad industry have evoked considerable speculation as to the amount of control — if any — the Interstate Commerce Commission should exercise over these moves. Railroad industry leaders contend that any ICC interference would "effectively destroy the most efficient method by which the railroads can diversify." And diversification, they add, is of vital importance to provide a broader and more secure financial base for their rail operations. Detractors, however, feel that the roads' expansion into other businesses may relegate their railroad operations to a position of secondary importance in complex, multi-faceted "conglomerate" corporations, to the possible detriment of their rail service. Among those urging ICC action of some sort on this subject are its Bureau of Enforcement and one of its most respected hearing examiners, as well as both the chairman and a ranking member of the House interstate and foreign commerce committee. Inherent in the diversification controversy is the dualistic status of the railroads. On one hand, they are regarded as a public utility, and regulated as such, while on the other they are viewed as independent businesses in a free-enterprise economy. Creation of the conglomerates, involved in railroading as only one of many diverse business activities, serves to add yet another element to this already problematic situation. The railroads are accomplishing their expansion by creating "parent" holding com- panies, which then reach out into other businesses to become true conglomerates. The purpose of this inverse type of business "genetics" — a "child" fathering its own "parent" — is to free the railroads themselves from what they regard as crippling ICC supervision of their nontransportation activities. The advantages of this kind of diversification, from a strictly business vantage point, are numerous. Comparative to other U.S. industries, the railroad industry has been classed by financial experts as "stagnant," or even "moribund." By failing to progress at the same rate as other industries, railroads have fallen to next to last on a list of U.S. industries compiled by the First National City Bank of New York and based on rate of return on net investment ; only investment trusts, of all major U.S. industries, rank below the railroads on this list. According to spokesmen who presented the railroads' successful case for their latest rate increase (in Ex Parte 259, Increased Freight Rates, 1968) at the Commission, labor 566 cost increases and spiraling prices are keeping the railroads from improving their position (T."W., March 30, 1968, p. 185). Meanwhile, an inflationary economy is pushing other in- dustries not hampered by regulatory restraints further and further ahead of the railroads. Alan Roth, a partner and railroad analyst at the New York firm of Itoth, Gerard & Co., Inc., described the situation this way in a recent article in The In8titutional Investor: "The roads' normal economic uncertainty has been reinforced by the negative effects of recent sharp wage inflation in an industry which cannot easily raise prices. With longer- term earnings prospects dimmed, management has begun to look around for more aggres- sive businesses. Also, there is increasing interest in what diversification for its own sake can mean for common share prices. Finally, the roads have come to realize that they them- selves may be vulnerable to takeover by more aggressive outside groups." The response of the financial community to the railroads' diversification efforts has thus far been enthusiastic. Mr. Roth noted that "shares in acquisition-minded roads . . . have been bid to significant premiums over conventional rail multiples." This enthusiasm is enhanced by figures such as these, applied to the largest of the present rail conglomer- ates. Northwest Industries, Inc. (parent of the Chicago & North "Western Railway) : On the basis of its present consist, Northwest Industries would have produced pro forma earn- ings of $54 million in 1967, despite a $12 million rail operating loss. To an individual railroad, standing alone, persistent operating losses spell financial disaster and eventual bankruptcy. Yet, to a conglomerate, losses incurred by its railroad component can benefit the balance of the corporate structure by providing "tax shelters" for other, profitable members of the complex. Moreover, the conglomerate parent can supply funds for needed capital expenditures — fund's that the railroad itself simply could not afford. ICC Hearing Examiner Henry A. Darmstadter, in his recommended report approving the proposed C & N W-Chicago, Milwaukee, St. Paul & Pacific railroad merger, noted that diversification can provide an otherwise weak railroad with the support it needs to revitalize its operations (T.W., Dec. 21, 1968, p. 63). This point was reinforced by the Commission itself in another context, as it considered formation of a holding company by the Missouri-Kansas-Texas Railroad (T.W., Jan. 6, 1968, p. 32) : "Katy's management and principal stockholders are convinced that only by formation of a non-carrier holding company to own the stock of Katy will the equity interest of stockholders prove sufficiently attractive to make possible favorable investments in non- transportation enterprises. The new holding company would be able to issue both equity and debt securities not presently possible, and would, in turn, permit funds generated by non-transportation enterprises to be made available for Katy's rehabilitation." Simply increasing their size through acquisitions, too, gives the railroads an advantage. Banks make size a principal factor in their consideration of loan requests, for example. Furthermore, the conglomerate is becoming more and more common in the U.S. economy, and the railroads feel they must grow in order to compete. Another element, albeit a limited one, must also be mentioned. The Penn Central, under orders from the ICC to dispose of its stockholdings in the Norfolk & Western, is able to use its N & W stock as currency in acquisition transactions, thus protecting itself from the problems and attendant monetary disadvantages in disposing of the enormous number of N & W shares on the open market. NEW HAVEN PEOBE For all of these advantages, however, diversification is not without its dangers. It was recognition of these dangers that originally caused the ICC to propound its oft-restated policy that "a carrier's major endeavors should ... be confined to matters related to transportation." This attitude is primarily responsible for the railroads* choice of parent holding companies as instruments for their diversification. It stems from a 1913 investigation of, among other things, the New Haven Railroad's financial problems (No. 4845, New England Investigation, 27 ICC 560). "... The outside financial operations of the New Haven for the last nine years," the Commission said in that report, "have been wasteful in the extreme, and ... the methods by which those operations have been conducted are unnecessarily involved and complex. "The present management started out with the purpose of controlling the transporta- tion facilities of New England. In the accomplishment of that purpose, it bought what must be had and paid what must be paid. To this purpose and its attempted execution can be traced every one of these financial misfortunes and derelictions. "Assuming that [the New Haven] had expended upon [its railroad property] the amount actually expended ; that this money had been raised by the issue of stock and' bonds in equal amounts, the bonds bearing that rate of interest which the New Haven has actually been compelled to pay; that the same amount of traffic had been handled (for up to the present time, these outside operations have not added to the traffic of that road), and that the same rates had been charged, it appears that for the year ending June 30 1912 that ^" 3 £ a ^L could have paid a divif l en d of 8 per cent upon its stock and carried to surplus $1,(94,000, instead of showing a deficit of $930,000. . . . "The New Haven, within the last nine years, has materially advanced both its freight and passenger rates. There is no evidence to show the gross amount resulting from this increase, but it is probable that this company could have done business without any ad- vance in its transportation charges, and have continued to pay its stockholders a dividend 567 of 8 percent, had it been content to confine itself to the mere operation of its railroad prop- erty. No more conspicuous examples can be found of the disastrous results which may flow from these outside operations." The effect of these nine years of "outside operations" by the New Haven continued to haunt New England transportation for the next 56 years. Unable to cope with the fluctua- tions of the volatile railroad industry, the railroad went through two reorganizations in bankruptcy, and was on the verge of liquidation when its service was "saved" by an ICC requirement that it be included in the Penn Central system as of January 1, 1969. "evils" of diversification Even though it found, in 1913, no cause for "hysteria" in the New Haven's financial condition at that time, the Commission took a serious view of the problem. In its report on the investigation, it reached the following conclusion, which has forced rail management to be almost super-cautious in expansion efforts ever since : "No student of the railroad problem can doubt that a most prolific source of financial disaster and complication to railroads in the past has been the desire and ability of rail- road managers to engage in enterprises outside the legitimate operation of their rail- roads . . . "The evil which results, first to the investing public and finally to the general public, cannot be corrected after the transaction has taken place ; it can be easily and effectively prohibited. . . . Every interstate railroad should be prohibited from expending money or incurring liability or acquiring property not in the operation of its railroad or in the legitimate improvement, extension or development of that railroad." (Emphasis added.) Seven years later, in 1920, Congress enacted legislation to implement this conclusion. It gave the ICC veto power over a railroad's issuance of securities or assumption of any financial obligations and liabilities, and provided that, before approving any such action, the ICC must find that it "is necessary or appropriate for or consistent with the proper performance by the carrier of service to the public as a common carrier, and . . . will not impair its ability to perform that service." In later years, the ICC modified its stand somewhat. Another New Haven investigation case (New York, New Haven & Hartford Railroad Co., Investigation, 220 ICC 505) led the Commission, while reiterating that "the resources of a railroad ordinarily should be devoted to the proper development of its own transportation system," to add : "If they [the railroad's resources] are to be invested in an outside activity, it should be after a finding that such investment constitutes a proper use of railroad funds or credit ; that the terms of the transaction are reasonable ; and that the investment is in the public interest." The Commission concluded that restrictions imposed on railroad investment in non- railroad enterprises should not preclude "investments such as are permissible for savings banks and trustees." At the same time, however, the ICC extended its restrictive approach to the railroads' subsidiaries, thus approving only very limited diversification by the rail- road industrial complexes. In the early 1960s, however, two events occurred that completely altered this situation, and have together been responsible for the railroads' current move toward conglomerate form. The first, and most significant, involved a small (557 total track miles) road serving northern Maine, the Bangor & Aroostook. Under the guidance of Nicholas Salge, president of the Punta Alegre Sugar Co., the B & A in rapid succession created the first of the modern conglomerate holding companies, the Bangor & Aroostook Co., and then merged its parent with Punta Alegre to form the present Bangor Punta Co. To understand the importance of this move, the observer must remember that the Commission is empowered to impose both the securities provisions and certain reporting requirements (albeit in somewhat lessened form) on railroad holding companies, as well as on the railroads themselves. However, as a prerequisite to imposition of these obligations on the parent companies, the statute requires the ICC to first assert jurisdiction over the holding company's acquisition of control of the railroad, and it may not do so unless control of more than one carrier is involved. In 1960, the B & A Railroad controlled the Van Buren Bridge Co., another carrier. The Commission, however, found that these two companies "are constituents of a single inte- grated system." It eschewed jurisdiction over the B & A Co., and, bv extension, over Bangor Punta (T.W., Aug. 20, 1960, p. 83). Thus, Bangor Punta is completely free from any ICC supervision of its activities, although its railroad subsidiary, of course, remains under Commission jurisdiction. The Commission's policy of sharply inhibiting railroad expansion into non-transportation endeav- ors, accordingly, was (and still is) inapplicable to Bangor Punta. Two years later, in another context, the Commission issued a decision which financial analysts saw as virtually an open invitation to transportation firms to diversify. The land- mark quality of this decision is indicated by the fact that five of the 11 ICC members dis- sented on the ground that the majority was proposing to vitiate, a single blow, the Commis- sion's 48-year-old policy of antipathy toward such activities. Before the Commission was an application of the Greyhound Corp. (at that time an active carrier, not the holding company it subsequently became) for authority to issue con- siderable amounts of stock. Purpose of the proposed issue was to allow Greyhound to gain 568 control of Boothe Leasing Corp., an industrial machinery leasing company not involved in transportation in any way ; furthermore, Boothe insisted on a stock-exchange arrangement to protect its shareholders from tax liabilities, thus making the ICC's decision on the stock question determinative of the fate of the entire transaction. The Commission approved the stock issuance in its report and order in Finance No. 21801, Greyhound Corp., Stock, 90 MCC 215 and, along the way, made a number of signifi- cant comments on transport diversification in general (T.W., March 31, 19G2, p. 224) : "The proposed acquisition by Greyhound of Boothe is part of a diversification program designed to stabilize and increase its earnings, and thereby improve its ability to provide the public with common carrier passenger service by bus. . . . "The prime objectives of sections 20a and 214 [of the interstate commerce act, which set forth the previously mentioned securities provisions] is the establishment of a soundly capitalized transportation industry, capable of adequate service at reasonable rates. Gen- erally, it has been found that it is not compatible with the public interest for a carrier to issue securities, the proceeds of which are to be invested in property not to be held for, or used in, the service of transportation. . . ." The Commission went on to note that in several past instances it had approved similar issuances by non-carrier holding companies which (unlike Bangor Punta) were subject to the securities provisions. However, it said, "in those instances in which management pro- posals for diversification appeared improvident, such proposals have been disapproved as not in the public interest." "As a general rule," the majority concluded, "it. is clear that the issuance by a carrier of securities, or the use of the proceeds from such issuance, generally should be authorized only in those instances where it would be of benefit to or enhance its carrier transportation. "In no event should a carrier be authorized to issue securities or use the proceeds there- from, or assume obligation or liability with respect to the securities of any other person, where it is not for some lawful object within its corporate powers ; is not compatible with the public interest, and where it would impair in any respect the carrier's ability, financial or otherwise, to perform its service to the public as a common carrier. A carrier's major endeavors should continue to be confined to matters related to transportation, and no authorization should be granted where the effect of the issuance of securities, or assumption of obligations or liability, would materially affect the promotion of such major activity. . . . "Judicious common-carrier investment in stable non-carrier business enterprises, if lim- ited, would contribute to the provisions of a soundly financed common-carrier system, and would not do violence to the principle that corporations endowed with a public interest should direct their primary activities to the public-service nature of their operations." The five dissident commissioners, led by Commissioner Kenneth H. Tuggle, argued that the majority was applying to Greyhound — a carrier — the standards properly applied only to non-carrier holding companies that had been subjected to ICC jurisdiction. In this respect, they argued : ". . . The intent of Congress as to holding companies was not, and could not have been, to preclude the non-carrier from issuing securities in furtherance of its non-transportation businesses, but only to insure that such issuance would not harm the carrier or carriers controlled by the holding company." The minority concluded by saying, respecting the Greyhound-Boothe transaction : "If this precedent is to be followed, adequate supporting evidence at least should be required to inform the Commission as to the non-carrier business concerned, its financial condition and accounting methods, so that it [the Commission] might make an educated appraisal of the 'judiciousness' of the investment as support for the new standard." RAILS ACCEPT "INVITATION" With the incentive of the Bangor Punta and Greyhound cases to spur them on, more and more railroad managements during the past few years have abandoned their traditional conservative attitudes to enter the conglomerate movement. Among others, the Illinois Central ; the C & N W ; the Katy ; the Atchison, Topeka & Santa Fe ; the Seaboard Coast Line ; the Kansas City Southern ; the Boston & Maine ; the Union Pacific, and even the Penn Central, largest of all U.S. roads, have either already formed parents or have announced plans for such a step in furtherance of diversification programs. For the most part, the ICC has followed its B & A precedent and has dismissed appli- cations for authority to make the corporate changes on the ground that it lacks jurisdic- tion to consider them. Two of the holding companies were found for various reasons to come within the Commission's purview: however, in both cases (Illinois Central Industries and Northwest Industries), the Commission has limited its supervision of these firms' activities to imposition of minimal reporting requirements. Within the past two months, however, three separate events have brought considerable pressure to bear on the ICC to at least review its noninterference policy respecting these conglomerate activities. Perhaps unfairly, the C & N W and Northwest Industries have been singled out for special attention in all three cases. After concluding that the proposed C & N W-Milwaukee merger should be approved. Hearing Examiner Darmstadter urged the Commission to make a complete investigation of the conglomerate question. In particular, he said. Northwest Industries should at the least be required to file more complete reports of its activities with the ICC. The same position respecting Northwest Industries' reports was taken by the Com- mission's Bureau of Enforcement in a brief filed in connection with the complex Rock 569 Island control cases. In that brief — in which it declined to review the merits of the rival applications, including that of the C & N W, for authority to take control of the Chicago, Rock Island & Pacific Railroad — the bureau suggested that any approval of the C & N Ws application be conditioned on subjection of Northwest Industries to more extensive report- ing requirements (T.W., Feb. 1 p. 75, and Feb. 8, p. 73). Significantly, neither Examiner Darmstadter nor the Bureau of Enforcement made any mention of the securities provisions of the interstate commerce act. The B. F. Good- rich Co., however, devoted an entire petition to this subject, arguing that Northwest In- dustries should be required to seek Commission approval of any securities issuance or any assumption of obligation or liability respecting others' securities. The petition was filed by Goodrich after Northwest Industries announced that it is attempting to take over the company. Goodrich's management is opposed to any such takeover, and avowedly used its petition to the ICC as a vehicle to further its opposition. In its plea, Goodrich asserted that its acquisition by Northwest Industries would raise Industries' indebtedness by several hundred million dollars. It suggested that this might result in a significant weakening of Industries' financial position — and, through Indus- tries, of the C & N W Railway's financial position — and urged the ICC to take jurisdiction to insure that such a result would not obtain (T. W., Feb. 1, p. 16). Replying to the petition, Northwest Industries asserted that it is perfectly capable of absorbing the additional obligations attendant to the proposed Goodrich takeover. It warned the ICC that any enforcement of the securities provisions of the act on it, or on any of its fellow railroad "parents," would have an enormously detrimental effect on their diversification programs. "The delay that would attend a section 20a proceeding [in connection with securities issuance] would deprive Industries and all similarly situated companies of any hope of successfully competing for the acquisition of non-transportation companies," it said. "The purpose and effectiveness of all railroad holding companies created in recent years to bring to the transportation industry the benefits of diversification would be destroyed" (T.W., Feb. 8, p. 58). In this statement, Northwest Industries struck at the heart of the conglomerate con- troversy. Virtually no one- — and certainly no responsible person — is seeking to block all railroad expansion beyond the transportation industry. There are, however, many who are fearful that untrammeled expansion could bring railroads more trouble than benefits. In his recent article discussing the financial aspects of the railroads' diversification programs, Mr. Roth pointed out some of the pitfalls in this course of action. Diversification, he said, "will be more difficult than the first blush of initial expectations would indicate." "Rail management," he continued, "is on the whole inexperienced in the highly com- petitive and sophisticated acquisitions business. Companies which have led the way in diversification have principally been managed by lawyers or investment bankers, as op- posed to traditional railmen. Also, most managements have little ownership in their com- panies, and therefore may have limited entrepreneurial incentive to take risks or make aggressive moves." DETRIMENTAL POSSIBILITIES Opponents of unregulated rail diversification amplify on this topic by contending that creation of the conglomerate holding companies could afford a perfect opportunitiy for the "milking" of a railroad. A holding company, they say, might "siphon off," via inter- corporate transactions, most of the wealth and disposable non-transportation assets (such an real estate, etc.) of the railroad — and then cast it adrift to fend for itself with greatly de- pleted resources. Another possibility, they continue, requires no nefarious conduct by the management, but only poor judgment. It is entirely possible, they say, that inexperienced railroad men might enter into a series of ill-advised transactions which could dissipate the conglom- erate's — and, through it, the railroad's — assets to the point where serious financial problems might arise. It is precisely this argument that was raised by Goodrich in its opposition to Northwest Industries' takeover attempt. Even relatively experienced managements in the conglomerate field have, on occasion, run into financial problems in connection with expansion. Often, the conglomerate opponents say, over-ambition is the cause. In its rush to diversify, a company may "bite off more than it can chew" in terms of obligations, and be forced to undergo extensive retrenching in order to right itself. In this connection, the opponents cite the case of DC International, Inc., one of the nation's largest trucking firms. Problems attendant to its expansion efforts produced con- siderable publicitv at the time, and resulted in minor changes in its managerial set-up (T.W., July 30, 1966, p. 25). The eventual fate of the company was its merger with two other major trucking firms to create the new T.I.M.E.-DC, Inc., under the control of National City Lines (T.W., Jan. 4, p. 31) . Another fear expressed by opponents of the conglomerate scheme in its present format is that the parent holding companies may become so large, and so diversified, that the oper- ations of its railroad subsidiary may suffer from inattention, if nothing else. A railroad's princinal duty, they say, is to transportation, not to a complex multi-business conglomerate structure. Bangor Punta, these opnonents argue, has already gone much of the way toward this situation. This company — "dean" of the modern conglomerates — now owns about 20 com- panies, only one of which (the B & A) is engaged in railroading. It had total sales in 1968 570 of about $258 million, and the I960 prediction is for nearly $100 million above that amount ; of this, the railroad's total contribution was a $100,000 profit. Bangor Punta spokesmen rank the company first in the nation in manufacture of public security equipment, and second in boatmaking; the B & A, of course, occupies nothing like a comparable position in the rail industry. These arguments are at least somewhat vitiated, however, by the absence of any serious complaints about B & A service. In fact, it can be argued with some justice that B & A service is better because of the capital available for its activities from Bangor Punta— capital which the small road itself, standing alone, could not generate. Delving somewhat into the realm of the hypothetical— since the short history of rail conglomerate operations leaves a paucity of actual examples — the opponents suggest that future problems might arise if one of the conglomerates acquired a highly "capital-intensive" company (i.e., one requiring a high level of capital investment for optimum performance). Such a firm, they say, would stand as a great incentive for the conglomerate to divert into its operations, rather than to the less profitable railroad activities, available capital funds. Rail financial analysts retort that there are very few industries more "capital-inten- sive" than railroading, which requires a considerable level of annual investment simply to maintain a consistent level of service, without regard to improvements. They find it more likely that the capital generated by the conglomerate's non-transportation subsidiaries will be channeled into the railroad, rather than the other way around. Furthermore, they add, normal business acumen also provides a measure of insurance against injury to the railroad as a result of conglomerate activities. For various tax reasons, even an unprofitable railroad can be, in the hands of an otherwise viable conglomerate, a very valuable property, and the conglomerate can be expected to treat it as such. "There are three principal tax advantages," said Mr. Roth in his analysis of the rail- roads' diversification. "None but a handful of the strongest roads can fully utilize invest- ment tax credits generated by high capital expenditures relative to revenue. Unless rail earnings improve, acquired earnings can be sheltered to the limit of the credit. Also, many companies have large investment credit carry-forwards to apply. "Poorer roads have the option of adopting fast depreciation lives and procedures to road and equipment accounts whenever sufficient earnings are created to justify the shelter. Large abandonment credits on non-depreciable property are another important tax shelter, particularly where mergers release duplicable facilities. "These tax advantages will generate tax savings of roughly $500 million for Penn Central and $250 million for Northwest Industries, depending in part on future equipment purchases. In the case of Katy and Boston & Maine, there are also large but perishable operating carry-forward losses which could well be used to shelter acquired earnings." For all of these incentives to the conglomerates to preserve and protect their rail sub- sidiaries, even the most outspoken of the diversification advocates admit there can be no guarantee that they will operate perfectly. And it is just this lack of a "guarantee" that forms the crux of the arguments of pro-regulation spokesmen respecting the conglomerates. PUBLIC UTILITY STATUS A railroad, they say, is on an entirely different level from the normal, self -regulating (through competition, as enforced by federal antitrust statutes) business. The inherently monopolistic nature of the industry, coupled with the public-service character of its opera- tions, give it a public-utility status as well, just as similar (although not identical) factors bestow the same status on telephone companies, power firms, etc. And the purpose of regulat- ing utilities, they say, is to provide, as much as is feasible, a "guarantee" of continued (and, if possible, improving) service. As a utility, these spokesmen point out, the railroads have a number of advantages under the provisions of the interstate commerce act. Such things as price-fixing— anathema in other industries — are specifically permitted in the form of "collective rate-making" for railroads, subject to ICC supervision. The Commission also affords existing companies protection against deterioration in their competitive situation through mergers of other railroads, or through entry of late-comers into the industry. Numerous other advantages, they say, accrue to the railroads from regulation. As a result of the 1913 New Haven investigation, the Commission formed its policy — subsequently given a congressional stamp of approval — that one of the prices railroads must pay for these advantages is regulation of their financial activities, the conglomerate de- tractors continue. Yet today, they argue, the railroads are balking at paying this price while still retaining all of their regulatory advantages. The "horrible example" of the New Haven is still staring the ICC in the face, these opponents say. The Commission has never reversed the policy it formed in that 56-year-old investigation, they add; in fact, the recent Greyhound-Boothe decision served to reinforce that policy, although approving "limited" and "judicious" carrier investments outside the field of transportation. 571 Under these circumstances, they conclude, it is quibbling for the ICC to take a "hands- off" attitude toward the modern conglomerates simply because corporate restratification removes diversification activities one step from the railroad company itself. They argue that a repetition of the 1913 New Haven situation is not precluded simply because it is the railroad's parent, rather than the railroad itself, that is participating in the actual business transactions. The New Haven analogy, the proponents of diversification contend, is hopelessly in- apposite today. The economy has changed almost beyond recognition since 1913, they argue, and these changes are ample to forestall any recurrence of this situation. Stricter antitrust statutes, careful enforcement of these statutes by the U.S. Department of Justice, and the regulatory influence of the Securities and Exchange Commission provide ample govern- mental protection against such a problem, they say. They also question the ICC's competence to regulate the activities of the parent conglomerate firms, which touch on transportation — the area of the Commission's ex- pertise — only peripherally. The activities of the railroads, they say, are painstakingly di- vorced from the operations of the parent companies, and regulation of the parents would lead the Commission into the forests of business finance, in which it is not credited with possession of any particular expertise. This view was also implicit in the five-member dissent to the Commission's Greyhound-Boothe decision. OTHER PROBLEMS The financial problems, say opponents of the rail conglomerates, are only one aspect of the problems deriving from this type of diversification. Another difficulty arises from the "commodities clause" in section 1(8) of the interstate commerce act. This section prohibits railroads from transporting "any article or commodity, other than timber and the manufactured products thereof, manufactured, mined or produced by it [i.e., the railroad], or under its authority, or which it may own in whole or in part, or in which it may have any interest, direct or indirect, except such articles or commodities as may be necessary and intended for its use in the conduct of its business as a common carrier." This clause was originally enacted in the first few years of this century to prevent flagrant favoritism by the railroads, who were gaining marketing advantages for their own traffic by abusing their transport duties. After a flurry of early cases on the topic, the clause has become more or less dormant in terms of cases prosecuted. The modern conglomerates, however, could at one time revitalize the clause and make it virtually impossible to police, say opponents of the diversification movement. Court and ICC decisions have held that applicability of the clause in parent-subsidiary corporate situations depends on the "intimacy" of the interrelationship between shipper and carrier, a factor exceedingly difficult to determine. Furthermore, they say, failure of the ICC to assume any jurisdiction, even for reporting purposes, over the conglomerates means that the Commission might not even know when possible violations of the commodities clause were taking place, because of its lack of information about the railroad's nontransportation affiliates. Considerable public furor has been raised recently as to the ownership of the nation's railroads, the opponents add. Ownership of a rail subsidiary by a conglomerate holding company, or course, is not in doubt — but ownership of the holding company itself may be. And, the opponents say, the Commission's considerable powers to study ownership of the railroads (T.W., Sept. 16, 1967, p. 101) are inoperative respecting the parent holding com- panies, unless these companies are subjected to ICC reporting requirements. The railroads have at least a partial rebuttal to this point available to them as a result of the recent activities of Illinois Central Industries. In connection with the Illinois Central Railroad's proposed merger with the Gulf. Mobile & Ohio, opponents to the merger have once again questioned the possibility that the Union Pacific Railroad may, through its heavy stock interest in ICI, control the IC Railway, ICI was able to show, however, that its recent merger with the Abex Corp., a non-transportation firm, resulted in considerable dilution of the UP's stock interest and thus diminution in the UP's putative opportunity to exercise control over the IC Railroad (T.W., Feb. 8, p. 68). Thus, while virtually all concerned can agree on the merits of the railroads' recent diversification moves, there is considerable diversity of opinion as to the methodology of this diversification. Opponents urge that the problem is much too complex, and involves far too many harmful possibilities, for the perfunctory treatment accorded it so far by the Commission. At the very least, they say, a full-scale ICC investigation should be instituted to determine whether, and to what extent, the conglomerates should be subjected to regulation. Support for this viewpoint was recently advanced by Representative Keith (R-Mass. ), a leading member of the House interstate and foreign commerce committee. It was perhaps significant that the congressmen's action followed hard on the heels of the Penn Central's announcement of its plans for creating a parent holding company. 74-924 O - 73 - 38 572 Representative Keith introduced in Congress a resolution calling for a multi-agency investigation to resolve some of the conglomerate questions — an investigation that would cover not only transportation, but all other regulated industries as well. Participants in the probe envisioned by the Massachusetts congressman would be, in addition to the ICC, the Civil Aeronautics Board ; the Securities and Exchange Commis- sion ; the Federal Trade Commission ; the Federal Power Commission, and the Federal Communications Commission. The agencies would be directed to examine the "effects of conglomerate activities on the transportation and communications industries, the securities markets, and interstate and foreisn commerce" (T.W., Feb. 1, p. 91). Following Representative Keith's proposal, Chairman Staggers of the same House committee announced that his unit will make its own investigation of the conglomerate problem. Purpose of the investigation, he said, is to determine "whether a railroad or other carrier which Is acquired by a person that is not a carrier can fulfill its obligations and responsibilities to the public in providing the kind of service that a common carrier is charged with providing the public (see story elsewhere in this issue). There also remains the possibility that the ICC may act independently, either to in- stitute a separate investigatory proceeding or to utilize some pending case (such as the C & N W-Milwaukee merger case, in which Examiner Darmstadter made his recommenda- tion) as a vehicle for such a study. Meanwhile, however, for good or ill — and there is much to be said on both sides — rail conglomerate activities are expected to accelerate as more roads adopt this course in the future. Exhibit 42 [Memorandum of B. Cole, Vice President Administration, and Executive Assistant to Chairman of Board, P.C.T.C, to S. T. Saunders] Re Creation of a non-carrier parent for Penn Central. It is suggested that action by the Board at its meeting tomorrow on the creation of a non-carrier parent is not advisable from the legal standpoint. 1. Action on this subject by the Board at tomorrow's meeting could be regarded as inconsistent with provisions of the other transaction to be approved. Such transaction has covenants applicable to Penn Central during the period between the signing of the merger agreement and consummating the merger, which prohibit changing the character of Penn Central's business and acquisition by Penn Central of its stock. 2. If Board action is taken, we would be obligated to disclose such action to the New York Stock Exchange and the public in accordance with the listing agreement of the Stock Exchange. 3. Pennsylvania Company and the Company it is acquiring in the transaction to be submitted to the Board tomorrow will each be soliciting shareholder approval pursuant to a proxy statement. (The consent of the holders of a majority of Pennsylvania Company's preferred stock is required.) Such proxy statements, because of S.E.C. regulations, would have to disclose any action taken by the Board to create a new parent for Penn Central. Such disclosure could create serious problems before the I.C.C., which Commission must authorize the new securities to be issued In connection with tomorrow's acquisition. Although there are several important questions relating to creation of a parent cor- poration to be reviewed with the I.C.C. staff, it is recommended that such discussions not take place until the proposed Pennsylvania Company acquisition is accomplished. This would eliminate the danger that discussions with the I.C.C. staff may adversely affect the Pennsylvania Company acquisition. I.C.C. approval of the acquisition is not required ; but since I.C.C. must authorize the issuance of new Pennsylvania Company stock, it will, as a practical matter, pass upon the terms and form of the acquisition. It is recomended that we proceed at this time with an internal review and studies of procedures and problems in connection with creating a parent for Penn Central. This will place us in a position to move off promptly in whatever way is determined to be appropriate after the Pennsylvania Company acquisition has been completed. Exhibit 48 [Memorandum of E. K. Taylor, P.C.T.C. legal department] June 5. 196*. Re Diversification by Penn Central. David C. Bevan : The purpose of this memorandum is to point out that Penn Central Company as presently constituted is not a suitable corporation for the purpose of carrying out a large-scale program of corporate diversification and to discuss the creation of a corporation which would acquire control of Penn Central Company. 573 A. THE I.C.C. IS RELUCTANT TO PERMIT DIVERSIFICATION BY A RAILROAD Penn Central, as an operating railroad, must obtain the approval of the Interstate Commerce Commission pursuant to section 20a of the Interstate Commerce Act prior to the issuance or guaranty of any securities in connection with a corporation acquisition. Although the Commission has approved the issuance of securities by carriers to carry out their corporate diversification, it has done so reluctantly and has indicated that it will limit the amount of securities a carrier may issue for non-carrier purposes. This reluctance of the Commission is particularly evident where the business being acquired is not related to the business of the carrier issuing the securities. It is clear that unless the I.C.C. reverses its prior decisions it is not feasible for a railroad to issue securities in the quantity which would be needed to carry out a major diversification program. B. OTHER RAILROADS HAVE CIRCUMVENTED I.C.C. JURISDICTION OVER DIVERSIFICATION The difficulty described above has been recognized by several railroads, such as the Bangor & Aroostook, Chicago & Northwestern, Illinois Central, Kansas City Southern and Santa Fe. They have created, or in the case of the Santa Fe are in the process of creating, non-carrier parents for their respective railroad corporations. In two of these cases ; namely, the Bangor and Aroostook and Kansas City Southern, the I.C.C. held that it had no juris- diction over the issuance of securities by the non-carrier parent ; because the carriers con- trolled by it constituted a single integrated system. The parents of the other railroads previously named have followed, and will follow, this same path of issuing securities with- out having to obtain I.C.C. approval thereof. The mechanics used normally consist of, (1) an exchange offer by a new corporation to the stockholders of the railroad which offer is accepted by the mailing of letters of ac- ceptance by such stockholders, (2) when letters of acceptance are received for over 80% of the outstanding stock of the railroad, the accepting stockholders are notified to deposit their shares for exchange for stock of the new corporation and (3) if 80% of the shares are so deposited, the exchange offer is declared effective by the board of directors of the new corporation and the railroad has a parent company. The stock of the parent company is listed on the New York Stock Exchange; the ex- change is tax free to the holders of the stock of the railroad; no meeting of stockholders of the railroad is necessary to make the transaction effective since the charter and out- standing stock options of the railroad to be assumed by the new corporation before the exchange offer is made. The new corporations controlling the Bangor and Aroostook, Chicago & Northwestern, etc., may issue securities in connection with the non-railroad corporate acquisitions with- out prior I.C.C. approval. Such securities must be registered with the Securities and Ex- change Commission, and S.E.C. approved prospectuses must be used. This S.E.C. require- ment will apply to the initial issuance of securities in exchange for the outstanding stock of the railroad. These parent corporations can, in my opinion, avoid regulation by the S.E.C. as holding companies. C I.C.C. PROBLEMS FACING PENN CENTRAL COMPANY Assuming that a non-carrier corporation acquires control of Penn Central, there is a substantial legal question as to whether such parent corporation can issue its securities without prior I.C.C. approval. The question arises as follows : 1. Under Section 5(2) of the Interstate Commerce Act, Commission approval must be obtained before a non-carrier may acquire control of two or more carriers. When the I.C.C. approves such control, it may, but it not required to, subject the non-carrier to I.C.C. reg- ulation, including Commission approval of its securities issues. Pennsylvania Company was subjected to I.C.C. jurisdiction in 1942 when it obtained authority to control Wabash Railroad Company in addition to Pennsylvania Railroad system carriers. However, I.C.C. has decided in the two cases mentioned in "B" that it will not retain jurisdiction over se- curity issues of the parent corporation if the carriers controlled by it constitute a "single integrated system." In view of Pennsylvania Company stock control of Wabash and Lehigh Valley, the I.C.C. may determine that the new corporation will control more than a single integrated system of rail carriers and retain jurisdiction over the issuance of securities by the new corporation. 2. Even if the parent company is not subjected to I.C.C. jurisdiction over its security issues when it acquires control of Penn Central, the parent will have to file applications with the I.C.C. for authority to acquire control of additional railroads, due to the provi- sions of section 5(2) of the Interstate Commerce Act that non-carriers may not control more than one carrier without I.C.C. approval. The filing of such an application will afford to the I.C.C. an opportunity to take jurisdiction over security issues of the parent com- pany, if it wishes to do so. This very issue is before the I.C.C. at this time in connection with an application of Illinois Central Industries to acquire control of the Gulf, Mobile and Ohio, and in connection with acquisition of control of the Chicago, Milwaukee, St. 574 Paul & Pacific by Northwestern Industries. The Penn Central parent will face the same problem if it acquires control of Penn Central before the latter acquires control of the assets of the New Haven Railroad. (It should be noted that the New Haven Trustees or the New Haven creditors may desire to have stock of the parent company in place of the 950,000 shares of Penn Central Company stock presently agreed upon.) it can also arise If the parent company will be acquiring direct or indirect control of New York, Susque hannn and Western Railroad Company. It would be desirable to explore these problems informally with the I.C.C. staff to ascer- tain whether it would be legally possible to create a parent corporation for Penn Central Company which would be free of I.C.C. control. D. I.C.C. WILL PERMIT DIVERSIFICATION BY NON-OARRIER PARENT CORPORATION It should be noted that the I.C.C. will approve the issuance of securities by a non-carrier parent corporation to carry out a diversification program. Pennsylvania Company was able to obtain I.C.C. approval for the Buckeye acquisition. Greyhound Corporation, a non- carrier parent corporation, has been able to obtain I.C.C. authority to issue securities to carry out its diversification program. Although the terms of each proposed transaction must undergo I.C.C. scrutiny, the Commission so far has not indicated any intent to limit the amount of diversification to be undertaken by non-carrier parent corporations. However, in passing upon a proposed security transaction, I.C.C. must consider the "anticompetitive consequences" of the transaction. This I.C.C. jurisdiction will give to the Department of Justice a forum in which to raise antitrust issues. In doubtful cases the I.C.C. may not act promptly in order to give the Department of Justice ample time to come into the case. I.C.C. approval of a security issue does not confer immunity from subsequent prosecution for an antitrust violation, but it should lessen the likelihood of such a prosecution. E. TIME ESTIMATES FOR ESTABLISHING A NON-CARRIER PARENT CORPORATION FOR PENN CENTRAL COMPANY From a timing standpoint, if the I.C.C. does not have jurisdiction over the transac- tion and if the New Haven Trustees, or other persons, do not interfere, I would estimate that the exchange of Penn Central stock for stock of a non-railroad corporation can be accomplished in approximately four months. This schedule allows six weeks to do pre- liminary legal work and to prepare and file a registration statement for an exchange offer, four weeks to clear the registration statement with the S.E.C. and make the exchange offer effective, and six weeks to solicit and carry out the exchange of stock. If I.C.C. approval is necessary and the I.C.C. proceedings are not contested, the timing again would be about four months. If it is desired to have the parent company free of I.C.C. jurisdiction, and the I.C.C, or the I.C.C. staff, desires to impose I.C.C. jurisdiction, the time period could be longer, de- pending upon what events take place E. K. Taylor. Exhibit 44 [Memorandum of B. Cole, Vice President Administration, and Executive Assistant to Chairman of Board, P.C.T.C., to S. T. Saunders] January 20, 1969. Mr. Saunders : Following, for your reference at the meeting at 10 :15 this morning, is a list of the issues that are raised by the proposal to create a Parent Holding Company : 1. What are the reasons for creating a holding company and what functions will it perform? (a) Greater availability of capitalizable assets, and (&) More appeal to investors because non-railroad earnings direct to parent, rather than through railroad company. This also clarifies rate of return and other regulatory problems, and (c) Other. 2. Will assets be transferred to the Parent Company? (a) Real Estate companies ; (6) Buckeye; (c) N&W stock; (d ) Park Avenue properties subject to mortgage ; (e) Other. 3. Certain legal and technical considerations — (a) State of incorporation, Delaware or Pennsylvania? (6) If Pennsylvania, will Business Corporation Law be adopted? 575 ( c) What charter powers and capitalization ? (d) Will ICC or SEC have jurisdiction? What is anticipated effect of Darmstadter's report concerning North- west Industries, Inc? (e) What will be the source of retained income — ability to pay dividends? (/) Other. 4. Have names for new Parent and Railroad been researched and reserved? 5. Board of Directors of Parent — how many Directors? (a) What effect will the Gilberts proposals as to classification and cumulative voting have? Also, proposed Stock Exchange rule on limiting classes of directors? 6. Will the holding company have an active management? If so, how will it be organized and staffed ? Basil Cole. 576 Exhibit 45 Form BF-6 Form approved. Budget Bureau No. 60-R250.5 Before the INTERSTATE COMMERCE COMMISSION Washington, D. C. APPLICATION UNDER SECTIONS 20a OR 21*+, INTERSTATE COMMERCE ACT, FOR AUTHORITY TO ISSUE SECURITIES, OR TO ASSUME OBLIGATION OR LIABILITY IN RESPECT OF SECURITIES OF ANOTHER PERSON (Read General Instructions on page 8) FINANCE DOCKET No. CAPTION In the matter of application of: A. State full and correct name and business address of applicant. B. State whether applicant is a carrier by railroad, a common or contract carrier by motor vehicle, a corpora- tion organized for the purpose of engaging in transpor- tation as any such carrier, a sleeping-car company, or a holding company, as defined in the General Instructions, subject to the securities provisions, as provided in section 5(3) of the Act. Motor Carriers: State leading docket number. C. Describe briefly the securities proposed to be issued or obligation or liability proposed to be assumed. D. List the states in which the applicant carrier operates or is authorized to do business, or the applicant holding company is incorporated or authorized to do business . E. Refer to related Finance proceedings, if any, pending (by Docket Number) or to be filed. F. Furnish name, title and business address of the person to whom correspondence with respect to the application should be addressed. To the INTERSTATE COMMERCE COMMISSION, Washington, D. C. The following statements and information, identified by numbers and letters corresponding to those used herein, are submitted by applicant in support of the authority sought: 577 Form BF-6 Page 2. Item 1 . General information respecting applicant . (a) Date and State of incorporation, or other organization. (1) If applicant is incorporated or organized under the laws of, or authorized to operate in, more than one State, give all pertinent facts as to such incorporation or organization. (2) If authorization to a new, reorganized, or consolidated corporation which is not in existence is sought, name the jurisdiction under the laws of which the corporation would be organized, reorganized, or consolidated. (3) If applicant is a trustee, receiver, assignee, or other fiduciary, name the court, if any, under the direction of which applicant is acting, and state the nature of the proceeding, if any, in which the applicant was appointed. (b) Subject to the rule regarding incorporation by reference, file with the original application, but not with the copies, one or more of the following documents as may be appropriate: (1) Copy of charter or articles of incorporation, with amendments to date, duly certified by the appropriate public officer; and copy of bylaws, with amendments to date. (2) If applicant is not a corporation, copy of articles of agreement, or association, or trust agreement, evidencing organization. (3) If applicant is a trustee, receiver, assignee, or other fiduciary, copy of duly certified order of the court, or instrument of appointment. Item 2. Financial statements. (a) Applicant's general balance sheet as of the latest practicable date. (b) If applicant is a carrier by motor vehicle, a corpora- tion organized for the purpose of engaging in transportation as such carrier, or a motor-carrier holding company, and the value (fair market value as of date of issue, or par value, whichever is greater) of its capital stock outstanding as of the date of said balance sheet alone does not exceed $1,000,000, furnish a statement showing as of said date the extent to which its liabilities other than capital stock are or are not represented by notes or other securities, and description thereof. (c) Applicant's income and profit and loss statement for the last calendar year, unless such copy is on file with the Commission in its annual report or another proceeding to which reference is made, and a copy of such statement for the current calendar year to the latest available date. 3 578 Form BF-6 Page 3. Item 3. General description of the securities with respect to which the application is made. (a) If the application covers the issue of stock, the description should include: (l) The kind and class of stock, (2) the number of shares authorized, outstanding and to be issued, (3) par value of each share and/or stated value, if having no par value, (h) amount, (5) voting rights, (b) preferences, (7) conversion privileges, (8) call provisions, (9) liquidation rights, and (10) whether it is assessable. (b) If the application covers the issue of securities other than stock, the description should include: (1) Full title of the securities, (2) title and date of the indenture, if any, under which the securities are to be issued and the name of the trustee or trustees under .the indenture, (3) principal amount authorized, previously issued, and proposed to be issued under the indenture, (k-) denominations of the securities to be issued, (5) date of the securities. (6) interest rate or rates, (7) interest payment dates, (8; date or dates of maturities, with amounts maturing on each date, if maturing serially, and (9) reference to provisions of the indenture, if any, under which the securities will be issued, permitting the proposed issue of securities thereunder, and relating to sinking funds, redemption features, and conversion rights. (c) Specimens, or forms where specimens are not available, of all securities with respect to which the appli- cation is made. (d) In case of the issue or assumption of bonds or evidences of indebtedness, a copy of the mortgage or indenture by which secured or proposed to be secured. Item U. Purposes of the proposed issue or assumption, and uses of the proceeds. Statement showing with respect to one or more of the purposes specified below, the amount of the net proceeds intended to be used for such purpose, also: (a) The acquisition of property other than equipment: A statement containing — (1) A general description of the character, size, and location of the property, and the name and address of the person from whom it is to be acquired; and (2) The actual or estimated costs to applicant of acquisition of the property, classified by Interstate Commerce Commission primary accounts; full terms of the contract, if any has been made, for such acquisition; and data necessary for a determination of the reasonableness of such costs. 579 Form BF-6 Page k. (b) The acquisition of equipment : A statement containing — (1) A full description of the equipment by type or design of unit, size, capacity, builder, year built, and name and address of the person from whom it is; to be acquired. (2) The unit prices paid or to be paid free on board builder's plant; whether the equipment was purchased through competitive bidding; and, if the unit prices shown are not the lowest bids received, the reason for accepting a higher bid. (c) The construction, comPletlon t extension t or improve- ment of facilities, or additions and betterments thereto bv a common carrier bv railroad (accomplished expenditures or expenditures not yet made): A statement showing — (1) The period covered by the expenditures. (2) The purposes of the expenditures. (3) The amount of proposed expenditures or expenditures made but not yet capitalized and credits by reason, of retirements within the period. (k) The distribution of the total cost by the primary accounts of the Commission's classification of investment in road and equipment. (d) The discharge or refunding of existing obligations (including notes maturing not more than two years after the date thereof, issued under paragraph (9) of section 20a or the $200,000 exemption applicable to such notes under section 21^): A statement containing a full description, together with terms and conditions (including discounts and commissions, counsel fees, and all other expenses) of sale or other disposition of such existing obligations. (e) The reimbursement of money expended from Income or from other monies in the treasury o f the applicant (including proceeds of notes maturing and issued as described in the preceding paragraph), not yet capitalized : A statement showing — (1) The period covered by the total disbursement. (2) The purposes of the disbursements. (3) The amount of disbursements (gross capital charge) and all credits to capital account within the period. 580 Form BF-6 Page 5. (*+) The primary accounts of the Commission's classification to which the disbursements or retirements were charged or credited. (f) Other purposes : A statement containing complete details of the purposes of the proposed issue or assumption. Item 5. The facts and circumstances on which the applicant relies. (a) If the applicant is a carrier or corporation organized for the purpose of engaging in transportation as a carrier — To establish that the proposed issue or assumption (l) is for some lawful object within its corporate purposes, and compatible with the public interest, which is necessary or appropriate for or consistent with the proper performance by the carrier of service to the public as a common (or motor contract) carrier, and which will not impair its ability to perform that service, and (2) is reasonably necessary and appropriate for such purpose. (b) If the applicant is a non-carrier person, which is authorized by an order entered under section 5(2) of the Act to control a carrier or carriers — To establish that the proposed issue or assumption is consistent with the proper performance of its service to the public by each carrier which is under the control of such person, and will not impair the ability of any such carrier to perform such service, and is otherwise consistent with the public interest. (c) If the application is filed with respect to a class of railroad securities as to which competitive bidding is prima facie required, 1 and exemption from such requirement is sought — ' To show that competitive bidding should not be required in the sale or other disposition of the proposed securities, including a statement that applicant has not entered into any discussion or any negotiations with respect to the terms of sale with any prospective purchaser of its securities. (d) If the application is to sell railroad securities without competitive bidding on the ground that such securities come within one of the specific exemptions — To show that the exemption applies ^Pertinent conclusions and the requirements are set forth in the Commission's report, In Re Competitive Bidding In Sale of Securities . 257 I.C.C. 129, as modified by findings in Atlantic Coast Line R. Co. Competitive Bidding Exemption. 282 I.C.C. 513, and further modified In Re Competitive Bidding in Sale of S ecurities . 307 I.C.C. 1. 581 Form BF-6 Page 6. Item 6. Terms of s ale or other disposition, and estimate of expenses . (a) At what price or prices, rate or rates, and upon what terms and conditions it is proposed to sell or otherwise dispose of the securities. (b) An estimate of the expenses to be incurred by applicant in connection with such sale or other disposition, i temlzed to show — (1) The commissions to be paid, discounts to be allowed, and the total of commissions and discounts. (2) Legal expenses, accounting expenses, engineering expenses, expenses for certification, expenses for authentica- tion, other expenses, and the total expenses. Where the amounts of the items grouped under "other expenses" are relatively substantial, they should also be itemized under that general item. (3) The grand total of commissions, discounts, arid expenses. Item 7 . Contracts, underwri tines, and other arrangements. How and to whom, and by or through whom, it Is proposed to issue the securities, with details of all contracts, underwri tings, and other arrangements made or proposed to be made in connection with the issue. Ite m 8. Resolutions and other authorizations . (a) Copies of all resolutions of directors authorizing the proposed issue of securities or the proposed assumption of obligation or liability for which authority is requested. (b) If the charter or bylaws require approval by stockholders, copies of resolutions of stockholders, authorizing such issue or assumption, all such resolutions of stockholders to be accompanied by sufficient transcripts of the minutes of their meetings to show the number of shares voted for and against the resolutions, and the number of share-votes required to adopt the resolution. (c) Copies of resolutions of stockholders or directors, or duly authorized committee thereof, authenticated by a proper executive officer of applicant, designating by name and for that purpose the executive officer by whom the application is signed, verified, and filed on behalf of the applicant. (d) If applicant is an association or other organization except a corporation, documentary evidence showing authoriza- tion of the proposed issue or assumption and designation of the individual signing, verifying, and filing on behalf of applicant $ and 582 Form BF-6 Page 7. (e) If applicant is a trustee, receiver, assignee, or other fiduciary, a certified copy of the order, if any, of the court having jurisdiction, authorizing the proposed issue or assumption, and the filing of the application. Item 9 . Opinion of counsel . That the issue or assumption with respect to which the application is made meets the requirements of the law as set forth in Item 5» and will be legally authorized and valid if approved by the Commission, with specific reference to any specially pertinent provisions of charter or articles of incorporation or association. WHEREFORE, Applicant prays that the Commission enter an order under sections 20a or 21*+ of the Interstate Commerce Act authorizing the proposed issue or assumption as described in the application. Dated this day of , 19 By. Title OATH County of )ss: State of ) (Name of official) being duly sworn, states that he is the of ; (Title of official) (Name of applicant) that he is authorized on the part of said applicant to sign and file with the Interstate Commerce Commission this applica- tion and exhibits attached thereto; that he has carefully examined all of the statements contained in such application and the exhibits attached thereto and made a part thereof; that he has knowledge of the matters set forth therein and that all such statements made and matters set forth therein are true and correct to the best of his knowledge, information, and belief. (Signature of affiant) Subscribed and sworn to before me, a in and for the State and county above named, this day of , 19 • ( SEAL ) My commission expires 583 Form BF-6 Page 8. CERTIFICATE OF SERVICE .certifies that upon the _day of , 19 » a copy of the foregoing application was mailed or delivered in person to the Governor and Public Service Commission or other appro- priate authority of each State in which the applicant operates or is authorized to do business, or in the case o.t holding companies, of each State in which the applicant is incorporated or authorized to do business, as follows: (Signature) (Date) GENERAL INSTRUCTIONS 1. Use of Form BF-6 . All carriers and other persons subject to sections 20a and 21^ of the Interstate Commerce Act making application for authority (a) to nominally issue securities, (b) to sell, pledge, repledge, or otherwise dispose of securities nominally issued or assumed or nominally outstanding, (c) to actually issue securities, or (d) to assume any obligation or liability as lessor, lessee, guarantor, endorser, surety, or otherwise in respect of the securities of any other person, natural or artificial, actually outstanding, shall make such application substantially in the form of application designated Form BF-6. 2. Definitions, (a) The term "carrier" includes a common carrier by railroad (except a street, suburban, or inter- urban electric railway which is not operated as a part of a general steam railroad system of transportation) which is subject to part I of the Act, a common or contract carrier by motor vehicle subject to part II, a corporation organized for the purpose of engaging in transportation as any such carrier, and a sleeping-car company which is subject to part I. (b) The term "holding company" means a person which is not a carrier, but which is authorized by an order entered under section 5(2) of the Act to control a carrier or carriers and, as provided in section 5(3) s is to be considered a carrier subject to the provisions of sections 20a or 21 l +. (d) The terms "nominally issued", "nominally outstanding", "actually issued" and "actually outstanding" are used herein as they are defined for purposes of Railroad and Motor Carrier Uniform Systems of Accounts and Annual Reports. 584 Form BF-6 Page 9- 3. Applicati on of general rules and regulations. Before undertaking the preparation of the application, reference should be made to the rules and regulations governing the filing of applications under sections 20a and 21*+, and list of forms, published in the Code of Federal Regulations as Title if 9, Part 51. 585 PENNSYLVANIA CO. Dividends Declared on 4-625 Percent Cumulative Preferred Stock — Period: January 1, 1964 to December 31, 1970 Year: Dividends 1964 $1, 529, 785 1965 3,267,542 1966 3,264,778 1967 3, 264, 779 1968 3,264,441 Year: Dividends 1969 $3,264,305 1970 1, 632, 152 Total 19,487,782 586 60 O 'Q ■ a> , 2Q- "2.d J2 E| Nfl-Oi-OoO' s 'J)OlOOOOOOOOrsOrtOMfsJOOOO^ ^NfOCftOOOi/JtNOOOOrNfJirtOOO^OO-* lOr-iC^ r»r-iNOUJoi^OrNOCN' — j o o o ^4 .— r^, JS. o^«3 . — ^IT> "">*£> OiT>CM~^OOU-lC7>rO — . .OOOfOWr r-O(DOO00 r moo r-. c OO — ■ — " CM ~- OOU"> 000 cm*co ^-T-hVh'io ^-> cm" CM O") i O O O O O iOU">*0^0 30000000— *0 ^o"o"o"o*o"rooiO(COMCOfo i^-moicn ^ o ^-C or ooo o oo OOO oooooo^o - 3000o»tMrt lOICOfOOlDOCMOOfO rToo'o ^"irT oo" rC rC iOOO loot iOO ,oo .CM CO I t !°»*b : = _J ="K ,* :°8or ^ - « j" 08 . 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J) 0) n) id c u> en-? H 5 o> a> 4J 3 C o w It 14 ll ll Vl 14 14 3 01 O i* O O o varl tender Am eric 0> C>- b. L, [i* u* U, II. to c I-l •H 0) o (!) « C tl (1 > !l Ij -O 14 14 !l 14 14 « a o o t; t-t p-4 -.1 O 41 to f-4 rt #-t rH r-I I4 H o o X O O O O O 13 •-1 c tu -4 44 1-1 2 6 •0 u 3 C •H e 4J £ C ■-4 O _x u rj 5E u > c c K ■H a 44 t : u U -to «*1 W i s o 14 to u 598 o — o* c c ff\ s c 6 u ,_7 H c. •A & g •A a. 3 s ►J a «i a 5 1 c a; r> 4J ".1 w 1 7> u 3 ■i r o £ c Tl r X V >t i >: u > c % £ i 4J I '/! u CO til 1) r-t H H 14 o -u 91 E a. 3 -^ -u 13 V) >. § § 01 C M 41 U c: u c c c V --I -1 -( r-t 4-t -U 4J 3 8 8 8 fri 01 iO to 599 Penn Central Transportation Co. dividends and interest from subsidiaries period 1964 thru 1969 penn central transportation co. dividends from subsidiaries, years 1964-69 I In millions of dollars) 1969 1968 1967 1966 1965 1964 Total RAILROAD RELATED American Contract Co 3.3 Clearfield Bituminous Coal Corp .7 Despatch Shops, Inc 1.0 Mahoning Coal Railroad Co 1. 7 Manor Real Estate Co 2.0 Merchants Despatch Transportation Corp.. 4.7 New York Central Transport Co. 14. 5 Pittsburgh & Lake Erie Railroad Co 4.6 Toronto, Hamilton & Buffalo Railway Co .3 Other 1.6 Total INVESTMENT RELATED Pennsylvania Co Strick Holding Co Total Grand total... 63.2 1.5 3.1 0.3 0.3 1.0 .8 .7 .6 .6 .3 \.i i."7 i.6 i~5 i.T 2.4 '.%".'".'.'.'.'". .T .~6~ 1.0 4.3 4.0 4.0 3.9 3.1 .3 .8 1.2 1.5 1.7 1.4 1.3 3.2 1.6 1.7 37.4 37.9 34.9 33.0 29.6 9.5 3.7 1.0 9.4 2.0 9.1 15.5 23.9 5.8 10.8 34.4 13.4 12.4 10.9 10.0 9.6 90.7 24.0 24.0 25.5 24.0 23.0 20.0 140.5 4.8 .. 4.8 28.8 24.0 25.5 24.0 23.0 20.0 145.3 236.0 SELECTED SUBSIDIARIES, PENNSYLVANIA CO. CASH DIVIDENDS AND INTEREST, YEARS 1964-69 Dividends Interest Received from Buckeye.. Macco GSC Strick EJA $33,515,000 " ""4," 266," 441 " $2, 458, 592 460, 333 1, 223, 241 624, 046 Total 37,781,441 4,766,212 Detroit, Toledo & Ironton RR D.T.I. Enterprises, Inc. Montour RR. Co Montour Land Co. Penn Central Transportation Co American Contract Co. Do Chicago & Harrisburg Coal. Do Clearfield Bituminous Coal Corp. Do Cleveland Technical Center. July 1965.. February 1969.. October 1969.... August 1970 December 1962.. December 1963.. December 1964.. December 1967.. December I960.. December 1961.. December 1962.. December 1963.. December 1964.. February 1965.. December 1965.. December 1966.. January 1967... December 1967.. February 1968... July 1969.. do November 1961. November 1963. February 1966.. February 1967.. February 1968.. March 1969 April 1970 . July 1960 July 1961 November 1961. January 1964 January 1965... February 1966.. February 1967.. February 1968.. August 1968 March 1969 . December 1962.. December 1963.. December 1964.. December 1965.. December 1966.. January 1968... March 1969 $1, 140, 000 360, 000 225, 000 75, 000 160, 000 100, 000 75, 000 75, 000 100, 000 150,000 500, 000 100, 000 500, 000 500, 000 300, 000 250, 000 2, 750, 000 350, 000 1, 450, 000 2 326, 100 3, 000, 000 30, 000 50, 000 125, 000 125, 000 125, 000 125, 000 125, 000 250, 000 250, 000 250, 000 300, 000 600, 000 600, 000 700, 000 700, 000 100, 000 700, 000 15,000 20, 000 50, 000 60, 000 60, nOO 50, 000 40, 000 600 TABLE V.-DIVIDENDS PAID BY NONRAIL SUBSIDIARIES TO PENN CENTRAL TRANSPORTATION CO., ITS RAIL SUBSIDIARIES AND PENNSYLVANIA CO-PERIOD: JAN. 1, 1960 TO JUNE 20, 1970 Company receiving dividend Company making payment Date Amount 1 Do Despatch Shops, Inc May 1960 $825,000 July 1960 825,000 July 1961 825,000 November 1961. 800,000 February 1962.. 825,000 July 1962 800,000 July 1969 1,000,000 Do Great Southwest Corp July 1968 4,050 August 1968.... 27,084 November 1968. 8,125 January 1969... 4,050 February 1969.. 8,125 May 1969 8,125 August 1969.... 8,125 Do do September 1969. 4,650 November 1969. 8,125 December 1969. 4,050 February 1970.. 8,125 May 1970 8,125 Do Manor Real Estate Co _ November 1969. 2,000,000 Do Merchants Trucking Co December 1969. 50,000 Do New York Central Transport Co.. October 1968.... 1,000,000 April 1969. 6,000,000 July 1969 6,000,000 December 1969. 2,500,000 Do Pennsylvania Truck Lines, Inc December I960. 320,076 December 1961.. 371,992 December 1962. 466,973 December 1963.. 268,230 December 1964.. 268,230 December 1965.. 268,230 December 1966.. 450,000 December 1967.. 190,461 December 1968.. 82,449 December 1969.. 52,205 Do Penntruck Co do 100,000 Do Strick Holding Co November 1969. 4,812,708 Pennsylvania Co Buckeye Pipe Line Co September 1964 350, 000 December 1964.. 2,500,000 March 1965 1,430,000 June 1965 1,200,000 September 1965. 1, 500, 000 December 1965.. 1,835,000 Do do September 1966. 1,600,000 June 1966 1,300,000 September 1966. 1,600,000 December 1966.. 1,300,000 March 1967 1,800,000 June 1967 1,300,000 September 1967. 1,700,000 December 1967.. 1,500,000 March 1968 1,800,000 June 1968 1,300,000 September 1968. 1,600,000 December 1968.. 1,600,000 March 1969 1,800,000 June 1969 1,300,000 September 1969. 1, 600, 000 December 1969.. 1,600,000 March 1970 1,800,000 June 1970 1,300,000 Do Great Southwest Corp. July 1967 219,781 June 1968 420,926 July 1968 210,000 December 1968.. 425,663 July 1969.. 302,722 August 1969.... 452,625 September 1969. 1,117,362 December 1969.. 1,117,362 1 Amount represents the carrying value of the investment in the capital stock of Merchants Trucking Co. and Penntruck Co. on the books of American Contract Co. Both investments wree distributed as a dividend to Penn Central Transportation Co. 2 All dividends, with the exception of dividends of $326,100 (see note 1) were received in cash. 601 PENNSYLVANIA CO. DIVIDEND INCOME 1965 1966 Rate Amount Rate Amount 1967 Rate Amount Buckeye Pipe Line Co.. $5,965,000 $5,555,000 Detroit, Toledo & Ironton R.R. Co. $15.45 Great Southwest Corp. Preferred Macco Realty Co. Perferred Norfolk & Western Ry. Co. Common (1).. 6. 50 Toledo, Peoria & Western R.R. Co 5.00 Wabash R.R. Co. common (2) 22.84 Other (3) Total. 3,527,425 15,228,096 225, 000 13,595,181 4, 893, 684 $12.40 i6 '6 6.50 5.00 19.25 3, 042, 080 6J.500 1, 040, 480 15,068,096 225, 000 11,458,659 4, 608, 368 43,434,386 41,085,183 (1) Interest— N. & W. debentures. (2) Includes special dividends account: D.T. & I. stock 7.94 Ann Arbor stock 1.25 (3) Principally Leased Line stocks and Wabash preferred. 120,250 4, 725, 881 744, 069 3. 75 2, 232, 206 '6 > 6 6.50 5.00 15.30 $5,600,000 210, 000 2, 362, 242 14, 428, 096 225,000 9,107,402 4,593,915 36,526,655 761, 577 ' Percent. Financial Department, Sept. 15, 1966. PENNSYLVANIA CO.-DIVIDENDS RECEIVED FROM BUCKEYE PIPE LINE CO. AND GREAT SOUTHWEST CORP., JAN. 1, 1964, TO DEC. 31, 1970 Year Buckeye Pipe Line Co. G-eat Southwest Corp. 1964.. $2,850,000 1965 5,965.000 1966 5,800,000 1967 6,300,000 1968 6,300,000 1969... 6,300,000 1970 3,100,000 Totals 36,615,000 $219, 781 1,056,589 2,990,071 4, 266, 441 PENNSYLVANIA CO. AND PENN CENTRAL TRANSPORTATION CO. SUMMARY OF INTEREST RECEIVABLE FROM SELECTED SUBSIDIARIES— JAN. 1, 1964 TO DEC. 31, 1969 [Dollars in thousands except per share data] Year Pennsylvania Co. Penn Central Transportation Co. Macco Great South- Realty Co. west Corp. Executive Jet Aviation, Inc. Strick Holding Co. $1, 297 $195 571 200 104 57 310 8 $136 370 118 $690 533 495 1969. 1968. 1967. 1966. 1965. 1964. 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S. : An analysis of the proposal to go to complete dieselization would appear to divide itself into two parts — (I) An analysis of the savings to be realized by such a pro- gram, and such a review has been made by the Operating Department, and (II) in the event of a decision in the affirmative to go ahead with such a program, the method to be employed in financing such a sizeable amount. The latter also involves the question of timing. I. REVIEW OF SAVINGS TO BE EFFECTED (1) It appears that the cost of such a program would be approximately $33,000,000, including additional diesel facilities to be added. (2) The indicated net savings before taxes is about $7,000,000, or after taxes about $3,250,000, on an annual basis. However, J.P.N, points out "that one savings is to a certain extent theoretical — fuel transportation savings of $1,160,000." Also included in the savings is the elimination of a charge for depreciation on the steam locomotives in the amount of approximately $465,000. This is pure theory, since no cash whatsoever is involved and actually the only reason it is even permitted by the I.C.C. is because it is done on a group basis ; and in the long run to the extent that we do continue to charge it on locomotives which have long since been charged off, in the ultimate, an adjustment will have to be made as has been done in the past from time to time because overall depreciation must be kept in line with the composite group of equipment. Finally, we are not clear on the item of steam locomotive repairs which is included in the savings in the amount of $1,400,000. It appears that this represents complete elimination of all steam locomotive repairs, whereas even under this program it is indicated that as reserve power we must keep about 250 steam locomotives, and under I.C.C. regulations specific items of work are required periodically. Perhaps this is exclusive of the $1,400,000, but it is not clear to us. (3) From the foregoing it is clear that there is an indicated savings within a range, dependent on certain things and based on present levels of traffic. The next question is to what extent these savings can be maintained in the event of a further decline in traffic, and if they can be maintained how much of a cushion is there? It is not as yet at all clear that we have reached a leveling off point in traffic and in business in general, and if any further drop would eliminate these savings, this factor should be seriously evaluated. (4) It is our understanding that in the past there has been a limit to the number of additional locomotives that can be added at any given time for maximum efficiency and savings to be realized. We assume this still holds true, and the question therefore arises as to what is the maximum rate at which these can be added efficiently. II. METHOD OF FINANCING (1) Assuming that the desirability of acquiring these diesels over "X" period of time is decided in the affirmative, the question arises as to the method of financing to be employed. At the outset, to avoid any possible confusion in anyone's mind, leasing is just another method of financing. Other than variations in the accounting treatment and the vesting of title, it is identical with 100% conditional sales financing. (2) All three methods — equipment trust financing, 100% conditional sales financing, and leasing — involve a principal cash outlay on our part. The only difference between equipment trust financing and the other two methods is that there is an initial down pay- ment. In the case of 100% conditional sales and leasing, this initial down payment must be made up over the initial 15-year period, and in most cases there is an insistence that a high percentage be made up in the first few years. In other words, generally speaking the recovery of the initial down payment is not spread out equally over the 15-year period. Therefore it should be recognized that even in the first year there will be a substantial cash outlay on account of principal in the event of either conditional sales financing or leasing. Over the first five years, in either 100% conditional sales or leasing, generally speaking you will catch up and pay out the initial down payment. (3) There is no advantage in trying to work the financing through one of the diesel manufacturers. They merely act as a middleman in working out an arrangement with an insurance company or bank, and there is no reason to believe that they can do this any more successfully than can we, and based on past experience there is considerable danger that our credit will be stopped and the waters muddied. (4) It is estimated that the interest cost of equipment trust financing as against leasing will be approximately % of 1% cheaper, which in the case of an expenditure of $32,000,000. represents an interest differential, in round figures, of $2,000,000. (5) Looking at the situation from a tax standpoint, there is considerably more flexibil- ity in equipment trust financing than offered by a lease arrangement. Unfortunately, none of us is in a position to predict what tax bracket we are going to be in in each of the next 15 years, and based on past experience it appears that at least in some years our effec- tive tax rate may well be 8.1%. In the case of lease rental, the actual charge cannot be varied depending on variations in your income. In the case of equipment trust financing, however, assuming that we receive accelerated amortization in the amount of 55%, the capi- tal portion can be varied between 3.88% and 12.746%, depending on how much accelerated amortization we keep. (6) Ideally, we should build up our equipment depreciation to a point where it is suf- ficient to throw off sufficient cash to meet annual maturities, plus sufficient cash to make down payments on the average amount of equipment financing that we will do each year. 611 Leasing does not help us move in that direction, which is particularly bad since at the moment, because of accelerated amortization still being charged, we are moving away from our goal looking ahead several years. (7) With respect to General Motors, we know of no way of carrying out a lease ar- rangement with them, if we did so desire, except by going through the most unsatisfactory procedure in this case of Anti-Clayton routine. (8) Creditwise, we are very close to the edge of having the ratings on our securities further reduced, and if this should occur it would add materially to our cost of financing, which could run into millions of dollars. It also would very materially injure the standing of our stock, which is not too good even now, and would in turn tend to put it more and more into the hands of speculators rather than investors ; and this was one of the outstand- ing weaknesses in the position of the New York Central management in the recent proxy battle. It is incumbent on us to guard our credit carefully and one of the essential factors which is helping us at the moment is the confidence on the part of many that we are going to steadily reduce our debt. This year because of the business situation we have had to conserve cash and have been able to do very little in the way of bonded debt retirements, and therefore we are dependent on having a good showing in equipment debt reduction to get the overall required debt reduction. If the business situation clarifies, next year we should be able to do more bonded debt retirements and consequently it will not be necessary for us to show such a substantial reduction in equipment debt. (9) The demands on us for cash through July 1st in 1955 are very heavy. Next year we have estimated maturities of $52,000,000, of which $45,700,000, as indicated on the attached schedule, comes due by July 1st. In addition, in the first six months of 1955 we will have to pay 100% of our federal income taxes for 1954. Therefore spreading of our capital requirements is desirable. III. RECOMMENDATIONS (1) Based on the figures submitted by J.P.N., there appear to be desirable savings involved, subject to the question we have already raised as to how well these can be main- tained in the event of a further decline in business. This again brings up the question of timing. (2) From the standpoint of our program of reducing debt, it would now appear that we should be able, subject to business conditions, to spend about $28,000,000 on equipment next year, which would mean the issuance of $21,000,000 of equipment trust certificates. An orderly marketing program for this amount would involve three or four issues, dependent on market conditions at the time, but tentatively perhaps we could do three, placing them in the months of January, May, and September. We could accelerate the acquisition of the equipment somewhere between 60 and 90 days prior to these dates by the use of tem- porary leases. Whether or not business will be such, or our other equipment requirements would dictate, that the entire $28,000,000 be spent on diesels, of course is something that will have to be decided. Necessity might well dictate that a portion of this go for freight cars, and with Mr. Young at the New York Central it is quite possible that we may feel called upon to buy some additional passenger equipment, particularly on the New York- Washington run. This is another overall policy matter. Therefore perhaps it might be well also from the standpoint of ability to assimilate this number of diesels, to spread the program over the years 1955 and 1956, but this can be discussed further. Under a program such as is proposed, it should mean that we could acquire roughly $9,000,000 to $10,000,000 of locomotives in October and November as a first step in the program, with the financing in January. By that time we would have gotten over the period when we do not know whether or not we are going to have a steel strike, and we do not know what the prospects are going to be for July, when business is in a very uncertain position. By then we may have a very much better idea as to where business in general is going as well. (3) In H.H.P.'s memorandum we noticed that the savings before taxes on some of the diesel acquisitions were as low as 4%. I think it would be well to make a very close analysis as to whether or not the acquisition of the entire number of diesels is justified from an economic standpoint ahead of some of the important capital expenditures we still have to make, such as Conway and Holidaysburg. Perhaps something short of complete dieselization would produce proportionately greater savings. On the other hand, which we do not pretend to know, perhaps while the savings on the individual locomotive are small, the overall gain of being completely dieselized would add a certain increment to the savings. We think this should be very carefully weighed. (4) From an overall standpoint, it also seems to us that we must, where possible, adopt a middle-of-the-road policy on capital expenditures, doing things gradually, because it is apparent from the letters we have already received that the stockholders are highly critical of the fact that we have spent such vast sums of money on the railroad. If we spread a program, it is going to be much less criticized than if we go out and do the whole tremendous amount at one time. (5) It is recommended that the program as a whole be discussed in general with the Board in June, but that we merely get authority to go ahead with some portion of this program, if it is later deemed advisable, after approval by both the Finance Committee and the Executive Committee. After all, there is a very vital financial question involved and I think that it is highly desirable that all the facts be laid before the Finance Committee in detail before a final decision is made. It could then, if they are satisfied, be confirmed by the Executive Committee. D. C. B. Original on temporarary Diesel File No. 0166. 612 Exhibit 48 October 22, 1965. S. T. S. : In view of the fact that it will not be possible for me to be at the Budget Meet- ing on Monday, I have the following comments to make : 1. CAPITAL BUDGET FOR 1966 At the present time it appears that we will show a net increase in system debt in 1965 of approximately $165 million and on an annual basis an increase in interest charges of almost $8 million. When increased depreciation is taken into consideration, our earnings are not increasing rapidly enough as far as the railroad is concerned to offset the increase in equipment charges. On the basis of the present proposed equipment program for 1966, there will be an additional net increase in system debt next year of about $80 million and a further increase in fixed charges of approximately $4 million. It should also be noted that in our judgment 1966 is going to be a most expensive year for financing and we will find money very scarce and, therefore, financing itself will be difficult to obtain. Coupled with this, we must consider the fact that we are going to have capital expenditures in connection with the merger over and above those now included in the budget and the same applies to capital expenditures in connection with the government experimental high speed passenger program. All in all I believe that the year 1966 is one in which we should attempt to hold down in every way possible our capital expenditures to the extent that we can do so without impairing our service. With respect to Road Budget, I think there is much to be done. Last year, after the Operating Department had insisted that they had cut expenditures to the bone, it became obvious very quickly that the approved program could not be accomplished during the year. The $49 million Road program proposed for next year is even higher than the 1965 approved program. I believe it can be cut substantially by a searching review of the eco- nomics of each item. For example, although the proposed program includes $12 million for the Penn Station project, there are six additional items included in the Eastern Region figures aggregating an excess of $800,000, for escalators, elevators, lighting modernization of rest rooms, etc. at Penn Station. With the large overrun in this project already recog- nized and reflected in our estimates, I think we should not add to it by allowing items of this nature to be done outside the confines of the estimated amount of the total project. In addition, from a timing standpoint, this work should be performed as near as possible to the completion of the new station and, therefore, deferred until 1967. In many cases the savings contemplated are not very attractive. As I understand it, as a result of attending the Central's Budget Meeting, they will not entertain capital ex- penditures, other than for safety, where the labor savings are less than 20% and if labor only is involved less than 30% after consideration of attrition payments. I think that except for the safety items, our people should be made to go back and figure out the savings in- volved with particular emphasis on labor. I hope that the total for road this year (exclu- sive of Fenn Station and Corridor expenditures) can be kept between $25 million and $30 million and I believe in all probability that we could limit our capital expenditures for equipment to a maximum of $110 million, particularly if we sincerely believe we are going to be merged in the first half of the year. This would allow for another $25 million over the $85 million which we have previously approved. Also, this is predicated on elimination of $18 million to replace Norfolk and Western cars which I will comment on next. 2. INFORMATION ON EASED NORFOLK AND WESTERN COAL HOPPER CARS In this analysis there is an indicated saving by replacing the Norfolk and Western cars of approximately $12 million. This is predicated on, among other things, a deprecia- tion of 2.07%. This is purely and simply an historic figure as far as the Pennsylvania Railroad is concerned and is not a true measure of the actual depreciation and is belied by practically every figure used in the formulation of the proposed 5 year program. There is no question that to the extent that we use such a rate, it will be more than offset by an increase in estimated repair expenses. I do not believe there is anyone who sincerely be- lieves that the economic life of these hopper cars is approximately 45 years. As a matter of fact, the depreciation rate charged by the N&W, C&O and Southern is significantly higher than our 2.07%. In view of the foregoing together with the fact that the rate of return to us in requiring our own cars to replace the N&W cars is only about 4% and the increase in our debt and interest charges is already disproportionately large, I think the proposal to return N&W cars and buy our own should be deferred until some future year. Also, I think it would be wise to defer a decision in this matter until we have determined in a more scientific way what our various car requirements should be over the next few years as is discussed next in this memorandum as part of Item #3. 3. THE 5 TEAR EQUIPMENT PROGRAM First of all, the mere fact that the operating people have attempted to develop an equipment program for a 5 year period in the future is a major step forward. This is some- thing we have advocated for at least 10 years. We believe it is feasible to do this and also essential and necessary to good planning. However, we believe that the program itself has not been soundly conceived and needs a very substantial amount of work done on it. We also are strongly of the opinion that there is a more scientific approach to the whole 613 problem. There are major discrepancies in the program. As mentioned in arriving at savings with respect to replacement of Norfolk and Western cars, a depreciation rate of 2.07% was used. As contrasted to this, if we figure on a fleet of approximately 120,000 cars, a 5% depreciation rate would mean the annual replacement of only 6,000 cars as compared to the 7,280 projected in the program. It should also be noted that under the proposed program 36,400 cars will be installed during 5 years 1966 to 1970. If you add to this the 7,700 which will be installed in 1965, this brings the total to 44,100 which for the 6 year period is 38*4% of the estimated serviceable fleet as of the end of 1970. Further, if we should install the 7,280 new freight cars in each of the 5 years and capitalize the cost of rehabilitation on the average of 7,400 cars a year and finance this requirement, over the next 5 years equipment expenditures alone would require a net increase in funded debt of between $400 and $500 million without the purchase of a single new locomotive. The proposed program, of course, naturally cannot give any consideration at the moment to our merger and integration of our fleet with that of the Central. Also, no consideration appears to be given to greater utilization of equipment through control of our computer system. Basically we believe that we should continue to work strenuously on a 5 year equipment program but that this should be done in conjunction with the Central and that we develop it based on our inventory of cars and theirs. However, we believe that some such basis as the following should be used to approximate our requirements. We, in many respects, are similar to an industrial manufacturing company. Our product is revenue ton miles. Our fleet should be broken down by classes of equipment and a study should be made in the case of each class as to how many revenue ton miles in the past these cars have been capable of producing and allowing a factor for increased efficiency what each car acquired should mean in added revenue ton miles. Another weakness in the present proposed program is that it deals only with the num- ber of cars and give no recognition to increased capacity. By developing our requirements on this basis, we will also have a far better gauge as to our so-called manufacturing effi- ciency and we can see which classes of cars are showing increases in production of ton miles and which are showing decreases. There are so many discrepancies in the proposed program that it appears that figures have almost literally been picked out of the air. There is obviously no pressing need for immediate approval of a 5 year program. Even though we do not think much of the soundness of the program. I wish to reiterate that we consider it a major step forward. Immediate steps should be taken to get together with the Central and start developing a really sound program which will allow us to pro- gram our equipment building and financing on an even keel. The equipment financial situation is very serious. Over a long period of years it can be easily demonstrated that the Pennsylvania spent (whether wisely or not) more money on its equipment than any other railroad in the United States. As a result, we are approaching a very serious situation where our annual equipment maturities very quickly are going to equal or exceed not only our equipment depreciation, but our total depreciation. This is almost unheard of in the railroad industry and unless corrected promptly will do more to hurt our credit than almost any other factor. If our credit is damaged this, in turn, will have a very serious and substantial effect on the value of our stock. D. C. B. ROADWAY AND EQUIPMENT EXPENDITURES 3 years 1963-65 Pennsylvania RR. New York Central RR. Pennsyl- vania RR. percent of New York Central 2 years 1964-65 Pennsylvania RR. New York Central RR. Pennsyl- vania RR. percent of New York Central Operating revenues $2,605,905,258 $1,926,306,356 Gross ton-miles— Freight-passenger (thousands) 411,033,187 297,163,067 Equated track-miles (average) 16,152 14,148 Gross ton-miles per equated track-mile 25,448,000 21,004,000 Roadway expenditures: Operating expenses $189,715,506 $160,802,129 Capital 92,756,000 49,001,000 Total 282,471,506 209,803,129 Equipment expenditures: Operating expenses . 345,140,730 253,873,109 Capital (including lease obligations) 334,714,000 179,755,000 Total 679,854,730 433,628,109 Total expenditures: Operating expenses 534,856,236 414,675,238 Capital 427,470,000 228,756,000 Total 962,326,236 643,431,238 135.3 $1,765,793,604 $1,302,973,594 138.3 114.2 121.2 278,478,861 16,042 17,359,000 201,590,279 14,039 14,359,000 118.0 189.3 $131, 733, 850 79,151,000 $107, 170, 336 34,800,000 134.6 210,884,850 141,970,336 136.0 186.2 227,508,089 265,928,000 168,455,132 154, 407, 000 156.8 493,436,089 322,862,132 129.0 186.9 359,241,939 345, 079, 000 275, 625, 468 189, 207, 000 149.6 704, 320, 939 464, 832, 468 135. 138.1 114.3 120.9 122.9 227.4 148.5 135.1 172.2 152.8 130.3 182.4 151.5 G14 ROADWAY AND EQUIPMENT EXPENDITURES 10 years 1956 to 1965 5 years 1961 to 1965 Pennsylvania New York RR. Central RR. Operating revenues $8, 830, 767, 173 $6, 705, 596, 213 Gross ton miles— Freight-passenger (thou- 1,357,739,676 1,030,868,974 sands) Equated track miles (average) 16,717 15.330 Gross ton miles per equated track mile 81,219,000 67,245,000 Roadway expenditures: Operating expenses 680,023,796 563,079,738 Capital _ 211,304,000 185,469,000 Total 891,327,796 748,548,738 Equipment expenditures: Operating expenses 1,279,505,463 918,581,198 Capital (including lease obligations) 875,328,000 395,579,000 Total 2,154,833,463 1,314,160,198 Total expenditures: Operating expenses 1,959,529,259 1,481,660,936 Capital 1,086,632,000 581,048,000 Total 3,046,161,259 2,062,708,936 Pennsylvania RR., percent of New York Pennsylvania New York Central RR. Central RR. 131.7 $4,276,702,023 $3,160,859,438 131. 7 664, 781, 526 489, 267, 507 109.0 120.9 16, 364 40, 625, 000 120.8 113.9 306, 008, 675 116,083,000 119.1 422,091,675 139.3 221.3 584, 045, 284 435, 207, 000 164. 1, 019, 252, 284 132. 3 890, 053, 959 187. 551, 290, 000 147.7 1,441,343,959 14,417 33, 937, 000 264,603,061 77,316,000 341,919,061 431,321,233 223,657,000 654, 978, 233 695, 924, 294 300, 973, 000 996, 897, 294 Exhibit 49 EQUIPMENT LEASE AGREEMENTS Dated : Lessor/agent Effec- tive Expiration date date (per- cent) Equipment covered Rent due Original after Dec. Pas- Freight cost 30, 1970 senger cars Locos cars Other Renewal option May 11, 1950: Equitable Life Aug. 3, 1975 Assurance Society. Aug. 8, 1950: Equitable Life Sept. 1, 1975 Assurance Society. Sept. 1, 1950: Equitable Life Mar. 28, 1976 Assurance Society. Nov. 1, 1950: Equitable Life May 25, 1976 Assurance Society. Feb. 1,1951: Equitable Life June 9,1977 Assurance Society. Mar. 1, 1952: Equitable Life June 25, 1977 Assurance Society. Apr. 1, 1952: Equitable Life July 14, 1978 Assurance Society. Feb. 1, 1956: Chase Manhattan Apr. 1,1971 Bank Nov. 1, 1957: Morgan Guaranty Jan. 1,1973 Trust Co. Dec. 20, 1957: Manufacturers Han- July 1,1973 over Trust Co. Nov. 1, 1958: Greenville Steel Car Nov. 1, 1978 Co. May 1, 1959: Morgan Guaranty Dec. 31, 1979 Trust Co. May 15, 1959: First National City Aug. 1, 1979 Bank. June 1, 1959: Harris Trust Co Oct. 1,1979 June 15, 1959: First National Bank Nov. 1,1979 of Chicago. Aug. 1, 1959: St. Louis Union Trust Feb. Co. Nov. 1, 1959: Morgan Guaranty Apr. Trust Co. Jan. 1, 1960: Morgan Guaranty Mar. 1,1980 Trust Co. Mar. 24, 1960: General Electric Co... Sept. 1, 1978 May 31, 1960: First National City May 31,1980 Bank. May 23, 1961: Port of New York Authority. Apr. 24, 1962: City of Philadelphia.. Apr. 24,1991 Sept. 24, 1963: Port of New York Feb. 1,1989 Authority. Sept. 30, 1963: Chase Manhattan Dec. 1,1983 Bank Dec. 16, 1963: Chase Manhattan Sept. 1,1979 Bank. Jan. 21, 1964: Chase Manhattan Jan. 1,1972 Bank. Feb. 14, 1964: National Bank of Feb. 15, 1972 Detroit. Mar. 11, 1964: Chase Manhattan Jan. 1,1972 Bank. 1, 1990 1, 1980 O) 6.15 (') (') (0 (') (') 3.46 4.49 3.79 4.73 4.37 4.93 5.13 4.63 5.50 4.88 5 5.38 5.38 $7, 237, 500 53, 029, 000 5, 169, 000 5, 281, 000 5, 004, 000 2, 903, 500 5, 005, 200 2, 408, 342 32, 325, 795 5, 866, 375 2, 928, 730 18, 350, 000 84, 840, 000 9, 975, 000 16, 354, 000 3, 567, 000 10, 250, 000 39, 800, 000 32. 699, 634 3, 106, 600 $374, 865 8, 592, 142 364, 597 367, 462 74, 560 33, 852 308, 016 73, 008 5,791,703 1, 778, 435 175, 200 5, 447, 812 40, 131, 677 3, 482, 046 6, 249, 317 2, 928, 355 3, 399, 693 25, 229, 239 18, 506. 871 1, 475. 635 1,324 None. 7,138 897 900 165 70 552 20 Do. Do. Do. Do. Do. Do. Do. 174 10 years. 25 350 1,958 9,265 1,000 1,700 299 989 10 years. 3,931 Do. 66 Do. J 7 5 years. Do. Do. Do. Do. Do. DO. None. Dec. 15,1987 2.72 8,165,172 7,014,523 53 25 years. 3.75 2.72 4.38 4.63 4.63 4.50 4.63 4, 868, 653 2, 400, 000 6, 400, 000 27, 503, 347 474, 349 900, 504 422, 552 3,917,020 5, 520, 240 4, 999, 819 14, 671, 773 93, 054 175, 518 82,893 17 34 50 109 3,531 23 3 127 30 None. 24 years. None. Do. Do. Do. Do. 615 EXHIBIT 49-Coutinued EQUIPMENT LEASE AGREEMENTS Date: Lessor/grant Effec- tive Expiration (per- dite cent) Equipment covered Rent due - Original after Dec. Pas- Freight cost 30, 1970 senger cars cars Locos Other Renewal option Nov. 30, 1964: National Bank of Newark. Dec. 18, 1964: City of Philadelphia. Feb. 1, 1965: First National City Bank. Mar. 26, 1965: National Commercial Bank & Trust Co. Apr. 1, 1965: Morgan Guaranty Trust Co. Apr. 1, 1965: Pittsburgh National Bank. Apr. 15, 1965: Morgan Guaranty Trust Co. Apr. 23, 1965: Continental Illinois National Bank. May 25, 1965: First National Bank of Cincinnati. May 20, 1965: First National Bank of Chicago. June 22, 1965: Huntington National Bank. June 30, 1965: National Bank of Indianapolis. July 30, 1965: Manufacturers Na- tional Bank, Detroit. Aug. 6, 1965: First National Bank of Cincinnati. Sept. 15, 1965: Merchants National Bank of Indiana. Sept. 20, 1965: American National Bank & Trust Co. Nov. 15, 1965: Chase Manhattan Bank Dec. 15, 1965: National Boulevard Bank of Chicago. Dec. 15, 1965: National Bank of Detroit. Feb. 1, 1966: First National Bank of Erie. Mar. 15, 1966: First National Bank of Chicago. Mar. 24, 1966: Equitable Life Assurance Society. Sept. 8, 1966: Northern Trust Co... Sept. 15, 1966: Chemical Bank Jan. 16, 1967: U.S. Railway Equip- ment Co. May 22, 1967: Continental Illinois National Bank. May 23, 1967: Fidelity Bank.. June 1, 1967: Irving Trust Co Aug. 11, 1967: U.S. Leasing Inter- national, Inc. Oct. 16, 1967: Equitable Life Assurance Society. Oct. 20, 1967: U.S. Leasing Inter- national, Inc. Dec. 1,1967: C.I.T. Corp. Dec. 1, 1967: U.S. Leasing Inter- national, Inc. Dec. 1, 1967: U.S. Leasing Inter- national, Inc. Dec. 1, 1967: U.S. Leasing Inter- national, Inc. Dec. 1, 1967: First Pennsylvania Bank. Jan. 2, 1968: U.S. Leasing Inter- national, Inc. Mar. 1, 1968: Provident National Bank. May 15, 1968: American Security & TrutCo. Mey 12, 196 J : American Security & i rust Co. Aug. 1, 1968: U.S. Leasing Inter- national, Inc. Aug. 15, 1968: U.S. Leasing Inter- national, Inc. Aug. 15, 1968: Mercantile Safe Deposit & Trust Co. Aug. 15, 1968: U.S. Leasing Inter- national, Inc. Oct. 10, 1968: U.S. Leasing Inter- national, Inc. Oct. 15, 1968: Merchants Despatch Trans. Corp. Oct. 15, 1968: New England Mer- chants National Bank. Nov. 30, 1979 4.63 $1,418,496 $1,059,722 Dec. 18 May 27 Sept. 7 Apr. 1 Dec. 18 May 1 Oct. 10 Dec. 31 Dec. 18 Mar. 8 Aug. 28 Dec. 14 Dec. 26 Dec. 26 Dec. 27 Dec. 31 Mar. 12 Apr. 26, May 29 July 27 Oct. 30, Nov. 26 Dec. 13 Mar. 22 Oct. 31 July 24 Sept. 17 Sept. 28 Dec. 2 May 20 Jan. 13 Jan. 17 Jan. 17 Jan. 29 Jan. 13 Feb. 21 Feb. 1 May 6 May 16 Dec. 31 Mar. 12 Sept. 15, June 10 Dec. 20 Oct. 14 July 1 1989 1980 1973 1980 1977 1980 1979 1975 1977 1978 1980 1980 1975 1980 1977 1980 1978 1978 1978 1978 1978 1978 1986 1975 1979 1982 1979 1977 1982 1983 1980 1980 1980 1983 1988 1976 1976 1976 1980 1983 1983 1980 1968 1976 1983 3.75 4.73 4.90 4.85 4.20 4.85 4.87 4.04 4.20 4.52 3,23 3.46 3.90 3.41 3.75 3.74 3.95 3.95 4.92 4.24 4.78 5.32 4.20 4.48 9, 250, 441 5, 458, 860 1,711,350 22, 440, 300 3, 966, 000 5,651,684 1,657,128 3, 107, 916 4, 637, 885 2, 463, 468 3, 112, 764, 3, 286, 526 851, 788 2,813,180 2,181,000 5, 460, 572 805, 406 805, 406 402, 703 3, 690, 000 10, 783, 000 3, 052, 000 8, 936, 240 2, 237, 500 9, 834, 966 4,078,400 652, 254 16, 846, 647 2,769,410 4, 241, 589 1,226,367 1,616,270 3,153,010 1,980,467 2,490,091 2, 366, 298 482, 265 1, 746, 740 1,716,863 4, 289, 820 628, 128 628, 128 304, 642 3,241,980 10 38 461 99 487 381 561 497 294 15 15 87 295 25 187 189 96 437 8,601,943 1,384 2, 553, 504 10,031,193 1,481,896 1979 4.49 1,625,000 2,886,120 4.74 5.27 5.32 4.67 4.28 5.69 4.28 5.27 5.13 5.69 5.12 7 7.50 6.50 5.31 5.3 5.94 5.75 5.60 7.75 5.70 2,331,250 11,205,800 4, 029, 250 3, 000, 000 11,407,009 14, 162, 384 3, 107, 000 2,520,000 5, 785, 800 11,205,012 881, 000 1, 689, 432 321, 668 841,943 1, 995, 000 1, 384, 391 21,476,713 6, 283, 000 3, 218, 000 674, 700 5, 058, 940 3,018,025 11,387,512 3,775,941 . 2,050,119 11,215,942 . 22, 192, 194 3, 128, 825 2,656,080 5, 178, 642 14, 382, 169 1, 149, 225 1, 312, 768 266, 480 389 482 489 391 245 246" 398 50 20 492 50 50 30 598 50 50 3 227 3 51 431,012 3 126 2,115,400 1,913,243 29, 422, 538 6, 528, 533 3, 217, 640 807, 669 6, 729, 432 12 13 89 594 326 3 90 20 10 years. None. 10 years. None. 10 years. 5 years. 10 years. None. 5 years. Do. 4 years. None. Do. 5 years. None. 5 years. None. Do. Do. Do. Do. Do. Do. Do. 5 years. None. Do. Do. Do. 2 years. None. Do. Do. Do. Do. 5 years. . None. Do. Do. Do. Do. 5 years. Do. None. Do. Do. Do. 616 EXHIBIT 49 Continued EQUIPMENT LEASE AGREEMENTS Date: Lessor/grant Expiration date Effec- tive (per- cent) Original cost Rent due after Dec. Equipment covered Pas- Freight 30, 5970 senger cars cars Locos Other Renewal option $16, 70 13, 13, 1, 171 $25, 577, 183 49 570 18,942,717 ,240 6. 43 3, 521, 400 3, 593, 128 Oct. 15, 1968: New England Mer- Dec. 15, 1988 5 chants National Bank. Nov. 1. 1968: Mercantile-Safe Jan. 15, 1984 5. Deposit & Trust Co. Nov. 1,1968: C.I.T. Corp.. Jan. 15,1984 6 Nov. 1, 1968: Merchants Despatch Dec. 19, 1976 7 Trans. Corp. Nov. 13, 1968: U.S. Leasing Inter- Dec. 20, 1980 national, Inc. Nov. 10, 1968: Fidelity Bank Jan. 1,1981 6.56 2,191, Jan. 9, 1969: Merchants Despatch Dec. 31, 1976 7.50 1,642, Trans. Corp. Feb. 1,1969: Merchants Despatch June 15, 1977 7.50 995, Trans. Corp. Mar. 10, 1969: Merchants Despatch Apr. 30, 1977 8. 25 797, Trans. Corp. Apr.25, 1969: Bankers TrustCo.... May 15,1981 8.75 15, May 15, 1969: Chemical Bank Nov. 15, 1978 8.25 11, June 9, 1969: U.S. Leasing Inter- Dec. 2,1987 8.12 12, national, Inc. Aug. 1,1969: C.I.T. Corp Dec. 11,1984 7.39 16,188,478 29,262,913 Sept. 15, 1969: C.I.T. Corp.. Oct. 14, 1984 6.26 7,483,502 11,542,904 Dec. 11, 1969: C.I.T. Corp ...Dec. 1,1984 6.28 5,000,285 8.875,921 Jan. 10, 1970: Ford Motor Credit Co. Jan. 30, 1985 8.63 19,193,503 34,139,688 Mar. 1, 1970: First Pennsylvania Apr. 28, 1985 7. 60 16, 278, 810 26, 548, 574 Bank. Nov. 3, 1970: Mercantile-Safe May 15, 1985 7.40 26,405,373 44,208,845 Deposit & Trust Co. Dec. 5, 1970: EL-PC Leasing Corp... Dec. 15, 1985 7.27 30,000,000 50,734,570 570 18,905,415 55 1,151,221 3 185 10 years. None. Do. Do. 198 026 576 300 895 3,550,772 282 2,037,744 »212 1,306,305 3 130 1,208,130 > 136 260 19,416,000 1,240 30 550 13,660,000 1,487 404, 613, 082,257 20,930,093 265 . 246 . 8669. 909 . 60 79 U0 «74 112 137 Do. Do. Do. Do. Do. Do. 5 years. None. 3 years. None. 25 years. 15 years. Do. 5 years. 10 years. 1 These agreements are presently on an extended term at the nominal rate of $0.20 per car per day. 2 Tugs. 3 Racks. ' Work. Note: $61,917,051 will be paid in rent due during 1971 under the foregoing agreements. Exhibit 50 Novembee 21, 1966. S. T. S. : Any sound comparison of the earnings of the Pennsylvania Railroad and the New York Central can only be made if it is fully realized and recognized that qualitatively there is a very substantial difference in composition. Basically, from a policy standpoint, there are two perfectly proper approaches to the income statement which may be made by any top management. 1. A policy may be instituted of attempting as far as possible to keep net income and cash flow as closely together as possible without regard to what the immediate effect is on earnings. Up to several years ago this was basically the policy pursued by the Pennsylvania Railroad. 2. The policy may be instituted of maximizing earnings to the greatest extent possible within the limits of good accounting practices. In the last several years this has been done on the Pennsylvania in accordance with your expressed desires. It does mean, however, that we tend to create a wider and wider difference as between reported income and cash flow. Today the cash flow of the Pennsylvania Railroad is substantially less than its reported income. We changed the basis of consolidation and, therefore, a substantial amount of earnings of subsidiaries are now included in our reported income but are not actually avail- able to us from the standpoint of dividends. We were the first railroad in the United States to capitalize overhead in conjunction with capital expenditures and numerous other changes have occurred. Over the short term today the New York Central earnings as reported are much more real and tangible from the standpoint of an ability to pay dividends than are those of the Pennsylvania. Virtually all of their earnings are actually available for the payment of dividends, i.e. the rentals received from real estate are in no way required to be ploughed back into the existing properties in order to have them maintained. These are net rentals and are available immediately for dividend payments. On the other hand, much of Penn- sylvania Railroad's income is in this form of income of subsidiary companies which, in turn, have their own requirements for the plough back of money. From the longer term standpoint our situation is better. New York Central rentals are subject to the full corpor- ate income tax of 48% and as a consequence. New York Central operating by itself will run out of tax carry forward loss sooner than the Pennsylvania. We in turn pay only a 7.2% tax on dividends received from companies which are not our consolidated tax return and it will be a long time before we by ourselves would have to pay taxes. Examining the statement attached on a consolidated basis, there is very little to choose between our respective payouts. Currently, based on our 1966 assumptions on a 617 consolidated basis, we will pay out a slightly higher percentage but not significantly. How- ever, the real test is in the payout of the Pennsylvania Railroad itself as contrasted with New York Central and this is where the ability to pay is crucial. You will note that over the six year period we have paid out over 75% of our earnings. The same is true for five years and for the latest three years it will be over 70%. As contrasted to this, New York Central's percentage has ranged from 48% or less than half down to a three year average of about 40%. When these facts are borne in mind, it is easy to see that New York Central is paying dividends well within its capacity whereas in the case of Pennsylvania, we are stretching our financial resources to the limit. 1. Our maturities equal our total depreciation as against New York Central maturities equaling about only one-half their total depreciation. 2. Our capital expenditures over a long period of time are almost double those of the New York Central. 3. Their percentage of payout in dividends is far below that of the Pennsylvania Railroad and far more conservative. D. C. B. DIVIDEND PAYOUT Company Year Net income Dividend Percent payout Consolidated Net income Dividend Percent payout Pennsylvania RR.: 1961 $3,515,586 $3,291,939 93.64 $17,229,491 $3,291,939 19.11 1962 . (3,209,885) 3,362,289 20,522,243 3,362,289 16.38 1963 9,158,870 6,755,458 73.76 31,834,930 6,755,458 21.22 1964 29,132,927 17,176,338 58.96 60,097,048 17,176,338 28.58 1965 33,896,504 27,661,346 81.61 70,113,462 27,661,346 39.45 1966 .145,000,000 131,250.000 69.44 190,000,000 131,250,000 34.72 Averages: 6-year average (1961-66) 19,582,334 14,916,228 76.17 48,299,529 14,916,228 30.88 5-year average (1962-66) 22,795,683 17,241,086 75.63 54,513,537 17,241,086 31.63 3-year average (1964-66) 36,009,810 25,362,561 70.43 73,403,503 25,362,561 34.55 1961 (12,549,048) (10,334,489) 1962 (3,835,538) 2,126,642 210,218 2,126,642 1963.... 7,039,843 3,271,414 46.47 13,825,544 3,271,414 1964 27,046,846 11,798,258 43.62 35,511,376 11,798,258 1965 41,518,728 17,725,564 42.69 52,355,635 17,725,564 1966 ....158,000,000 122,200,000 38.28 169,000,000 122,200,000 AvorssGS' 6-year average (1961-66) _ 19,536,805 9,520,313 48.73 26,761,381 9,520,313 35.57 5-year average (1962-66) _ 25,953,976 11,424,376 44.02 34,180,555 11,424,376 33.42 3-year average (1964-66) 42,188,525 17,241,274 40.87 52,289,004 17,241,274 32.97 1,011.64 23.64 33.22 33.86 32.17 Note: Assumptions for 1966— Pennsylvania RR. dividend— 85 cents in December, $2.25 for year. New York Central earnings: consol- idated at $10 per share with subsidiaries contributing approximately same as in 1965 ($10,800,000). Dividends: December dividend 1.3 times Pennsylvania RR. or $1,105, total for year, $3,225. ■ Estimate. PENNSYLVANIA CO. DIVIDEND INCOME 1965 1966 1967 Rate Amount Rate Amount Rate Amount Buckeye Pipe Line Co _ $5,965,000 $5,555,000 Detroit, Toledo* Trenton RR. Co $15.45 3,527,425 $12.40 3,042,080 Great Southwest Corp. preferred (•) 87,500 Macco Realty Co., preferred (i) 1,040,480 Norfolk & Western Hy. Co. common 2 6.50 15,228,096 6.50 15,068,096 Toledo, Peoria & Western RR. Co 5.00 225,000 5.00 225,000 Wabash RR. Co. common 3 _._ 22.84 13,595,181 19,25 11,458,659 Other* 4,893,624 4,608,368 Total 43,434,386 41,085,183 $5, 600, 000 (0 (1) $6.50 5.00 15.30 210, 000 2,362,242 14,428,096 225, 000 9,107,402 4,593,915 36, 526, 655 ■ Six percent. » Interest— N. & W. debentures: 1966, $120,250; 1967, $761,577. 3 Includes special dividends account: 1965 1966 1967 Rate Amount Rate Amount Rate Amount D.T. and 1. stock... $7.94 $4,725,881 Ann Arbor stock 1.25 744,069 S3. 75 M. 232. 206 . • Principally leased line stocks and Wabash preferred. 618 1964 1965 1966 (estimated) 1. Net income, Pennsylvania Railroad Co {29,133,000 $33,897,000 $45,000 000 2. Total capital expeditures 100,843,000 244,236,000 185,000.000 3. Capital expenditures, financed 53,073,000 226,276,000 127,524 000 4. Capital expenditures, cash... 47,770,000 17,960,000 57,476,000 5. Outstanding debt. 933,930,000 1,188,409,000 1,290,800,000 Exhibit 51 MEMORANDUM Date: September 12, 1969. To: Mr. David C. Bevan. From: William C. Baker. Subject: Tax Allocation Agreement Between GSC and Penn Central Company. In preparing our new Form S-l Registration Statement, it was necessary for our coun- sel to review the subject Tax Allocation Agreement in order to fully disclose its terms and its effect upon GSC's tax picture. This led us to a reexamination of the reasons and business justification for the existence of such Agreement between our two companies, and raised certain new issues which I now consider to be very pressing. While I was not actually a director of GSC at the time its Board approved this Agree- ment, our files indicate the possibility that insufficient facts were known to such directors, and insufficient consideration was given by them, to the business justifications for, and the consequences of, such Agreement, prior to their approval of same. This is not to say, and I certainly do not contend, that such Agreement was improperly or inadvisedly ap- proved, in light of the then existing circumstances, or that compelling reasons do not still exist which justify and/or require its continued existence. As you well know, we clearly recognize the Penn Central's ownership and control of GSC, and readily acknowledge that there may be facts and circumstances unknown to us which absolutely require Penn Central's imposition of this Agreement upon GSC. However, if there are no such compel- ling unknown reasons, and if the continued existence of this Agreement is a matter which rests within the sound business judgment of the GSC management, I seriously believe that the matter requires further examination and consideration, in the light of subse- quent events, new legal authorities furnished us by counsel, and the possibility of new developments in GSC's tax picture. For that reason, I submit herewith our most recent findings and conclusions, including the latest findings of our legal counsel, and respect- fully request your careful consideration of the issues herein raised. Prior to original GSC Board approval of the Agreement, attention was given, and counsel's opinion was sought and obtained, as to whether, in approving and executing such an Agreement, the directors of GSC, and Penn Central, in its capacity as majority shareholder, would satisfy their respective fiduciary responsibilities to the minority share- holders of GSC. The GSC Board had been furnished a legal opinion on the subject by the New York law firm of Sullivan & Cromwell dated April 24, 1968, which specifically dealt with, and relied upon, an almost identical agreement theretofore approved by the New York Courts between Mahoning Coal Railroad Company and the New York Central Railroad Company ; such case being styled Case v. New York Central Railroad Company, 15 N. Y. 2d. 150 (1965). By the same token, the GSC Board sought and obtained an opinion of its own corporate counsel. Both opinions reached the same conclusion, i.e, that the Penn Central would not be taking "undue advantage" of its position as majority share- holder in executing the Agreement, and that the directors of the subsidiary would not thus violate their obligations of good faith and reasonable care in the discharge of their duties if they approved and executed such agreement "in the exercise of their reasonable business judgment." I quote and emphasize this last phrase because the identical language was used by both law firms in their opinions and in arriving at their conclusion. It is now my sincere belief that subsequent events, both of a business and corporate nature, as well as recent tax developments and legislative proposals, have cast considerable doubt upon whether the Tax Allocation Agreement between the Penn Central Company and GSC is any longer supported by "reasonable business judgment," whether certain factual assumptions made by the aforesaid legal counsel still exists, whether the Penn Central Company would still be held (by a court) not to be taking "undue advantage" of its position as majority shareholder of GSC, and whether the directors of GSC have sufficient factual data upon which to exercise their "reasonable business judgment" in this regard. For example, and taking these issues in inverse order, the Sullivan & Cromwell Opinion noted that while the New York Court in the Case suit did not expressly make its holding dependent upon a finding that the parent would have subsequent income against which the losses for which it was being paid could be offset, the court nevertheless suggested, and Sullivan & Cromwell concluded, that whether the advantage realized by the parent from payment by the subsidy for use of its losses was permanent or illusory might well depend upon there being a substantial certainty of the parent's future tax liability increas- ing by an amount at least aqual to the subsidiary's payments. In other words, the Court referred to the parent's losses, which it was allowing the subsidiary to utilize, as a "poten- tial asset" to Central and assumed (as did Sullivan & Cromwell) that no loss carryovers of the Penn Central affiliated group would expire if the income of the affiliated subsidiaries with substantial minorities were excluded. Stated another way, an intermediate New York Court had reached an opposite result in the Case suit, because "although the use of Central's losses to offset Mahoning's profits deprived Central of their availability for carryforward or carryback purposes, it seemed unlikely at the time that Central would have sufficient profits in the foreseeable future to necessitate carryforward of present losses for tax liability to be avoided. Absent the expectation of future profits, the consolidated return provided immediate gain without attendant risk of future loss." See 77 Harvard Law Review 1142 (1964). Therefore, apparently the New York Court in the Case suit, and certainly Sullivan & Cromwell, concluded that the parent's reasonably certain future profit situation was an important factor in determining whether or not the Agreement was fair and just to the subsidiary's minority shareholders. In this connection, we have no data from which to answer this question. GSC has never been told, or even given a real estimate, indicating how long the tax loss carryover will last, or how long such loss benefits might be available to GSC. This leads us to the conclusion that the GSC directors were and are lacking facts which the New York Courts and Sullivan & Cromwell considered to be a very important consideration in determining whether the execution of such an Agreement was the exercise of "reasonable business judgment." Quoting further from Sullivan & Cromwell, its writer voiced his belief that the Penn Central Directors would be derelict in their responsibility if they did not insure that it would receive "adequate compensation" for the utilization of a group asset (the tax loss carryovers) from subsidiaries having substantial minority interests. I quote this comment to emphasize that the writer of such opinion did not imply any duty on the part of Penn Central to sell its "potential asset" (the tax loss carryover) to its subsidiaries, or to receive a cash payment therefor, but only that they had a duty to insure receipt of "adequate compensation." This naturally raises the question of just what constitutes "adequate com- pensation" to Penn Central for GSC's use of the consolidated group's tax shelter position, and I suggest the distinct possibility that adequate compensation to Penn Central can better be obtained by outright elimination of the agreement, as opposed to its continued imposition upon GSC. As just one illustration, GSC stock has been selling since July 1st of this year at an average price of $29.25 per share. Most, if not all analysts, agree that the market value of a stock is ordinarily determined by capitalization of after-tax earnings. GSC's after-tax earnings for the six-month period ended June 30, 1969, were released to the press as $20,700,689 (or $.68 per share) ; producing a price-earnings ratio of 43 to 1, considering only these six-months earnings and the ensuing market price. Therefore, assuming $55,000,000 pre-tax earnings in the year 1969, and $36,000,000 after-tax earnings under the present tax allocation agreement in the same year, the market price of the stock (using only the same multiple of 43 times after-tax earnings) could well reach $53.00 per share. On the other hand, if the tax allocation agreement were lifted this year, and pre-tax earnings (or non- taxable earnings) were capitalized at the same multiple, the minority shareholders market equity could well increase from $239,400,000 to $365,900,000 (at a price per share of $53 and $81 respectively). Further, the Penn Central's own market equity in GSC stock could well increase from $1,189,394,000 to $1,817,753,000. (Assuming the above-cited per share figures and total con- version of Penn Central's convertible notes). Now, of course, this would not increase the balance sheet assets of the Penn Central, because of its inability to write up its investment in the stock to its increased market value. However, I would remind you that, as a result of the acquisition of Macco by GSC, Penn Central now owns or controls, or has the right to own or control, some $5,000,000 shares of GSC stock more than is necessary for it to file con- solidated tax returns, and for it to retain absolute voting control of the corporation. This fact presumably, allows Penn Central eventually to sell off, by way of secondary offering, or otherwise, some $405,000,000 of GSC stock and still retain 80% ownership of" such sub- sidiary, assuming such an increase in its market equity. While not trying to tell the Penn Central Directors how to run their company, or how to exercise their own business judgment, I do seriously question whether Penn Central would be more "adequately compensated" by this result, and its possible realization of $405,- 000,000 actual cash receipts ; as opposed to leaving the tax allocation agreement in effect which can reasonably be expected to realize Penn Central, upon sale of the same amount of stock, a probable maximum of $265,000,000, plus a paper account receivable from GSC of approximately $19,000,000 which GSC is certainly not in a position to pay at the present time. I have heretofore quoted the observation of Sullivan & Cromwell that Penn Central would be derelict to its own shareholders if it failed to receive "adequate compensation" for allowing its subsidiaries use of this "potential asset" of tax loss carryovers, solely for the purpose of showing that its application to our relationship does not necessarily, if at all, require the imposition of the Tax Allocation Agreement upon GSC. In so doing, I did not intend to, and emphatically do not, accept, adopt or agree with such conclusion voiced by the writer of that opinion. I have great respect for the firm of Sullivan '& Cromwell, which is very competent, capable, and distinguished. However, you will note that the par- ticular conclusion in question was gratuitously inserted in the opinion and was not sup- ported by the citation of any authorities. In reconsidering this Agreement, and the question of its reasonableness under present circumstances, we have had counsel research this point and have found competent judicial authority which not only casts considerable doubt upon the said conclusion, but one case which flatly contradicts the Case decision and reaches the exact opposite result. 74-924 O - 73 - 41 620 In Alliegro v. Pan American Bank of Miami, 136 So. 2d 656, cert. den. 149 So. 2d 45, the Florida Appellate Court held that the payment of tax benefits by a profit-subsidiary to its loss-parent was the equivalent of illegal dividends which could not be paid to the exclusion of minority shareholders, or without their unanimous consent. In the case of Meyer son v. El Paso Natural Gas Company, 246 A. 2d 786 (1967), the Delaware Chancery Court reviewed the Case decision, the Alliegro decision, and the case of Western Pac. R. R. Corp. v. Western Pac. R. Co., 197 F. 2d 994, stating that they were the only authorities dealing with the question of the right of a "loss" corporation to participate in tax savings resulting from the filing of consolidated income tax returns. Meyerson was a case where El Paso Natural Gas Company (a profit-parent), owning in excess of 80% of the common stock of Northwestern Production Corp. (a loss-subsidiary), filed consolidated income tax returns which resulted in substantial tax savings, all of which were retained by El Paso. A minority shareholder of Northwestern brought suit for an accounting of such tax savings and for the imposition of a fair allocation agreement between El Paso and Northwestern. The Court denied the plaintiff any relief primarily because it was held to be beyond the power of a court to create an agreement between the two parties, and also be- cause it was said to be the sole function of a court in such a dispute to determine the "fair- ness" of any such agreement already made. The Delaware Court agreed with the Ninth Cir- cuit Court of Appeals in the Western Pacific case (see following page) that the test to be applied, in all such situations, is one of "fairness" and, in analyzing Case v. New York Central Railroad Company (cited and relied upon by the Sullivan & Cromwell Opinion) concluded that the New York Court reached its result because the "majority felt itself unable to say what would be a fair proportion of the distribution of Central's tax loss looking forward from the date of judgment." In other words, the Delaware Court concluded (unlike Sullivan & Cromwell) that the New York Court had not just put its stamp of ap- proval, per se, upon the legality of the Central-Mahoning Agreement, but had merely re- fused to rescind the subject agreement, as requested by the plaintiff, because the record was totally devoid of any evidence to indicate that the "stronger side" (Central) had taken from the "weaker side" (Mahoning) its advantage by reason of its stock control and domi- nation. However, the Court noted that two justices in the Case decision had dissented, commenting that the agreement was obviously not the result of a "arm's-length transac- tion". By the same token, the Delaware Court itself noted that it also found the "arm's- length, measure unacceptable in the parent-subsidiary relationship." The case of Western Pac. R.R. Corp. v. Western Pac. R. Co., 197 F. 2d 994, cited and relied upon by the Delaware Court in the Meyerson case, was decided by the United States Court of Appeals for the Ninth Circuit on October 29, 1951. The case is certainly not directly in point with our situation because of a very unusual, and even bizarre, set of facts. There, a parent corporation had filed consolidated income tax returns over a period of years for itself and certain of its affiliates, including the defendant corporation, the stock of which had been owned 100% by the parent. The net operating loss and tax loss carryovers of the parent and certain of its other affiliates, on a consolidated return basis, resulted in several millions of dollars in tax savings to the defendant subsidiary corpora- tion (which I again remind you was wholly owned by the parent corporation). Through a very complex set of circumstances (involving the bankruptcy of the wholly owned defend- ant subsidiary, the parent's loss of its stock interest in such defendant subsidiary by reason of it being ruled worthless in the bankruptcy reorganization proceeding, and a subsequent very substantial financial rehabilitation and recovery of the defendant subsid- iary as an active operating company), the court-appointed receiver for the parent corpora- tion, and certain of its shareholders, later filed an action against the rehabilitated former subsidiary, claiming that the parent was entitled to be compensated or reimbursed by the former subsidiary for the tax savings it had achieved by use of the parent corporation's tax losses during the affiliated and consolidated tax return periods. While no fraud, deceit or over-reaching was alleged by the plaintiffs, they did contend, among other things, that there were certain dual officers of both the parent and the subsidiary who were derelict in their duties to the parent by filing consolidated returns, and by failing to exact an agree- ment from the subsidiary requiring the payment of money to the parent as a condition to the filing of such consolidated returns. In other words, the Plaintiffs made the exact con- tention as Sullivan & Cromwell, i.e., that the tax loss carryover of a parent made available to a profit-subsidiary results in the loss of a "potential asset" of the parent, for which the subsidiary should be required to compensate the parent. The plaintiffs in this case were denied any recovery or reimbursement whatsoever and the Court, in a lengthy opinion, made several observations and comments which are directly pertinent to the points now being raised here. For instance, the Court noted that the consolidated returns had been filed by the parent for itself, as well as its subsidiaries, and under the guidance of inde- pendent tax experts employed by the parent ; noting that here, as in the usual case, the tax saving which n profit-subsidiary gains by such transactions will inure to the parent by way of increasing the value of its stock and/or by way of dividends. However, the plaintiffs contended specifically that the parent, being under no obligation to file consoli- dated returns, could have demanded that the defendant subsidiary enter into an agreement to pay the parent a sum of money as a prerequisite to the filing of such returns, and that the failure of the dual officers to exact such an agreement from the subsidiary was a breach of their obligation to the parent, and "unfair" to the parent's shareholders. In making such assertions, the plaintiffs cited three decisions of the Securities and Exchange Commission in support of their views that the rationale of the tax laws requires that any benefits resulting from the tax loss should go to the parent. In answer and rebuttal, the Ninth Circuit Court held that the three decisions of the 621 Securities and Exchange Commission not only wholly failed to support the plaintiffs' contention, but that all three decisions made clear that the company whose loss was utilized for the benefit of the group does not have a right to compensation from those who benefitted. The Court also said that such decisions presented "a decided view point that the tax savings from consolidated returns shall not be paid over to the parent if this would in any way endanger the position of the creditors of the subsidiaries." At this point, I would like to parenthetically point out that our present Tax Allocation Agreement was executed long prior to GSC's acquisition of Macco, and its resulting assumption of all of Macco's liabilities. Prior to the merger or acquisition, GSC's total indebtedness to creditors other than its Penn Central parent amounted to $56,155,000. At the present time, and having assumed all of Macco's liabilities, GSC's total indebtedness to creditors other than its Penn Central parent amounts to $157,472,351. Therefore, it can hardly be gainsaid that, in the light of subsequent developments, the imposition of the tax allocation agreement upon the present GSC clearly endangers the position of its creditors ; of especially in view of our almost constant tenuous cash position. The Ninth Circuit went on to make certain other general observations about the relationship of a parent and subsidiary, their fiduciary relationship one to the other, and the result and effect of filing or not filing income tax returns on a consolidated basis. While I hate to bore you with all of these quotas, since some of them only restate well settled corporate principles, I nevertheless believe that they deserve repetition here in this context, and I quote: "The Corporation was the sole owner of the subsidiary's capital stock. As such it was under a duty to deal fairly with the subsidiary having full regard to the interests of the creditors and holders of other securities. Consolidated Rock Products Co. v. DuBois, 312 U.S. 510, 522, 61 S. Ct. 675, 85 L. Ed. 982. It owed a duty not to require its subsidiary to forego a legitimate tax saving and could not bargain to perform its duty. A parent company is not acting in the best interests of its subsidiary when it seeks to appropriate to itself an advantage which the tax laws give the subsidiary. (Emp. Supp.) The dual officers owed fiduciary duties to both corporations to promote the interests of both and to obtain for each what it was entitled to under the tax laws. Under this state of facts these officers had a positive duty to make use of the loss as they did, that is, to offset the income of members of the affiliated group with deductible losses of other members .... Indeed, this very thing had occurred in previous years of the affiliation and [parent] had effected substantial tax savings (Def. Ex. 46) by reason of filing consolidated returns. The record is clear that on none of these occasions was tribute paid to a subsidiary which which had suffered a loss. There is nothing in the Code or Regulations that compels the conclusion that a tax saving must or should inure to the benefit of the parent company or of the company which has sustained the loss that makes possible the tax saving. If [parenf} had required tribute as a condition of its cooperation, then it xoould have been acting with less than the required standard of fairness to the subsidiary's creditors." (Emp. Supp.) The next factor bearing upon whether our execution of this Agreement is a reasonable exercise of business judgment, and whether same is fair and just to the minority share- holders, is again illustrated by a passage from the Sullivan & Cromwell Opinion which directly quotes an observation by the court in the Case suit, noting that a majority share- holder is required not to "use its power to gain undue advantage at the expense of the minority . . . and to follow a course of fair dealings toward minority shareholders in the way it [manages] the Corporation's business." I am confident that you realize I personally am not about to criticize Penn Central's management of GSC, vis-a-vis the minority share- holders or otherwise, to accuse it of being unfair to us or them, or to accuse it of trying to take any undue advantage. However, issues such as these do get examined in the context of assertions that can be made by a disgruntled minority shareholder, possibly in a share- holder's derivative action, and, as always in such situations, with the benefit of 20/20 hindsight. Any such litigation would presumably be predicated upon an assertion by such a share holder that the alleged 5% tax saving afforded GSC by filing consolidated Federal Income Tax returns with the Penn Central group, and utilizing the group's tax loss carry- overs, is more than offset by the tax liability incurred by GSC in failing to avail itself of all possible tax savings in an effort to produce needed profits for its controlling shareholder. In any Such suit, I would certainly testify that I have always been advised by officers of the Penn Central that I had a duty to avail myself of all tax minimizing devices possible, and that I have certainly never been coerced to produce profits at the expense of tax savings. However, and by the same token, I would have to admit under oath that GSC has always had, and we certainly value, an excellent day-to-day working relationship with our Penn Central parent, take great pride in our contributions to its earnings, and consistently make 622 every effort possible to increase that contribution. While such evidence should conclusively show that the Penn Central has never forced GSC, through its majority control, to produce profits against the best interests of the subsidiary's minority shareholders, I can neverthe- less foresee a judge and/or jury concluding (with that famous 20/20 hindsight) that we, as officers and directors of GSC, had been guilty of a conflict of interest between our major- ity and minority shareholders, to the detriment of the minority. A perfect example of a transaction which might give rise to such a conclusion is the sale of the Georgia and Texas amusement parks. Although both sales made excellent sense, for all the reasons previously advanced to you, and while I have no reservations about their economic validity, a dis- gruntled minority shareholder could nevertheless easily argue that GSC, at the direct instance of the Penn Central, sold two of its substantial and profitable assets solely to produce substantial profits for its majority shareholders within given financial periods. In making the sales, and as a necessary consideration to the investing syndicates for achievement of such substantial profits, GSC gave up all depreciation which had theretofore been available to offset the income from such profitable and productive assets. Therefore, and again with the benefit of 20/20 hindsight, a group of minority shareholders could well argue that, not only was GSC's income from such assets reduced, but there was no longer available any depreciation whatsoever to offset such income ; the result being that every dollar of the substantial tax savings that would otherwise be lost to the Internal Revenue Service by GSC (on a separate return basis), now amounts to a loss of 95 cents to Penn Central, at least in the form of an account payable (on a consolidated return basis), as a result of the Tax Allocation Agreement. By the very nature of GSC's real estate operations, it operates in a constant tenuous cash position. This is nothing peculiar to us, but is a fact inherent in our business. Thus, the necessary effect of the Tax Allocation Agreement is to drain resources from one of the major earnings contributors to the consolidated group ; thereby hindering and restrict- ing its ability to continue being a major contributor of such earnings. As I noted earlier, if called upon immediately to pay its full account payable to the Penn Central, arising from the Tax Allocation Agreement, GSC would be unable to do so, because it just does not have the cash. By the same token, we are expected to independently finance our own operations insofar as possible, but, at the same time, our ability to do so is lessened by the fact that our balance sheet must show this resulting substantial account payable to our Penn Central parent. Again, therefore, I personally question whether, in the exercise of reason- able business judgment, this is proper utilization of group financial resources. Heretofore, I have dealt with our current corporate structure, our existing Tax Alloca- tion Agreement, previous opinions on the subject legal counsel, and with events occurring since the original execution of such Agreement. However, before closing, I would like to also call your attention to the possible or even probable consequences to GSC, and the effect of the Tax Allocation Agreement upon it, if the anticipated new tax legislation is enacted into law as now proposed. In that event, GSC will be subjected to added tax burdens, by the very nature of its business, illustrated by the following examples ; certainly none of which were contemplated at the time the original Tax Allocation Agreement was executed. a. The use of exeelerated depreciation on new commercial property will be curtailed by termination of the use of the double declining balance method of depreciation. This will certainly have an extremely adverse effect on all new commercial properties owned and held by GSC, whether under lease or for investment purposes. b. The depreciation recapture provisions are to be changed, with the result that sub- stantially more ordinary income will be realized upon the sale of depreciated real property. c. The proposed complete repeal of the investment credit would have increased GSC's tax liability by approximately $1,000,000 in 1968. d. While it cannot be termed new tax legislation, the recent change in the IRS ruling on deduction of prepaid interest has already adversely affected GSC's ability to make and consummate certain profitable real estate transactions, both as vendor and vendee. In conclusion, I want to again emphasize my awarenes sthat I am not privy to all the problems of the Penn Central which may bear upon this issue. On the other hand, Sullivan & Cromwell ,as well as the Courts of Florida, Delaware, New York, and the Ninth Circuit all agree that the real issue is one of "fairness", and leave the determination of that issue to the "reasonable business judgment" of the respectively concerned Board of Directors, in the exercise of their good faith and their use of reasonable care in the discharge of their duties. Therefore, unless there are compelling reasons not now known to me which offset or counterbalance the foregoing facts, circumstances, developments and authorities, I must personally question whether this Agreement constitutes the exercise of "reasonable business judgment" on the part of GSC. under present circumstances. At the very least, I think that the entire GSC Board must be advised of the possibility of this Agreement creating or giving rise to a potential conflict of interest, however remote. Therefore. I would certainly feel derelict in my responsibilities to our directors if the foregoing facts and conclusions were not promptly called to their attention, and would be strongly reluctant to take any action to perpetuate the existence of this Agreement without giving our Board adequate opportunity to reconsider their prior approval of same. In view of the foregoing, I sincerely hope that you will appreciate my position in this regard. William C. Baker. P.S. I apologize for the rough nature of this memorandum, which was hastily prepared upon short notice, and I will be happy to have same resubmitted in a more comprehensive and neater form, if you so desire. 623 Exhibit 52 June 1, 1967. Mr. Saunders : We spent virtually all yesterday afternoon reviewing the operations and results for the 2nd quarter. The situation is not good. Starting with the Pennsylvania Railroad itself we had a deficit of $1,060,000 in April. We had forecast a profit of $1.3 million in May. It now appears tentatively that we are going to have a loss of $500,000. It is estimated that revenues will be $1.5 million less than anticipated and that operating expenses may be $300,000 over. The revenue figure is still not firm and it is possible it might be worse than this. On the other hand the estimate on ex- penses could be cut somewhat by decreases in maintenance work, M. of E. or M. of W. At the moment, we are using the June estimate of $3,260,000. However, with the current trend in revenues and expenses this appears optimistic unless it is possible to make very substan- tial reductions in maintenance expenses. On this basis, before adjustments Pennsylvania Railroad will then have earnings of $1.7 million in the 2nd quarter. In reviewing the severance pay situation and making charges to income only on the basis of actual cash payments made, we can come up with a credit of $360,000 on severance pay in view of the fact these payments will not be made until July, and applying the same policy to net charges, we can pick up another $879,000, or a total of $1,239,000. This will give us income of $2,939,000 in the 2nd quarter as compared to $13,001,600 in the 2nd quarter of last year, or a decrease of 77.4%. Turning to the consolidated picture, we have a possible credit in Buckeye of $932,000 which is being reviewed and we hope that it can be used, increases of $61,000, for D.T.&I. and $130,000 for Great Southwest, giving total adjustments if the $932,000 holds up of $1,123,000. Arvida had already been improved by $35,000 and it is possible we may get some small additional improvement. With the $9,932,000 previously forecast plus the $1,123,000 discussed above we come up with a figure of $11,086,000. It should also be noted that in the $9,963,000 of other income we are including about $880,000 as a result of the contemplated sale of additional Wabash to maximum extent possible. The $11,086,000, compares with $12,725,000 in the 2nd quarter of last year, a decrease of 12,9%. The two areas in which we are most hurt in other income are Macco and D.T.&I. On this basis we would have for the 2nd quarter consolidated income of $14,025,000 as compared to $25,726,000 for the 2nd quarter last year, a decrease of 45.5%. Comparison of figures for the 1st quarter, 2nd quarter and the 6 months with comparable periods last year and the percent of decline are set forth in the attached table. This is not a particularly bright picture but my guess is that it will compare favorably with that of other Eastern railroads. We have included everything that we can think of in the parent company and consolidated, and we know of no other steps to take from an ac- counting standpoint. We have pushed credits and revenues to the limit. As indicated previ- ously, I think the only possible way at this late date to improve the situation is for very drastic cuts in maintenance, if this is feasible. Actually this is undoubtedly going to have to be done to make the June figures. David C. Bevan. Exhibit 53 LaBrum & Doak, Philadelphia, Pa., February 15, 1972. Mr. George Deller, Six Penn Center Plaza, Philadelphia, Pa. Dear Mr. Deller : Enclosed herewith are David Bevan's answers to the questions which jou left with me the other day. We have added two paragraphs in connection with the pension fund and have attached certain enclosures referred to in the answers. Very truly yours, LaBrum & Doak, r „ By Edward C. German. [Enclosures.] Answers of David C. Bevan 1. Q. What was the dividend policy of the PER, PCTC and the Penn Central Co? A. The Penn Central Company never got to the point of paying dividends. As far as the P.R.R. and later the P.C.T.C. was concerned, I think it is fair to state that all members of the Board recognized the intangible value of the long unbroken dividend record of the P.R.R. and that over a period of years it did add something to the way investment analysts regarded it from a quality standpoint. Therefore, there was a desire to maintain this unbroken record if feasible and in a number of years so-called token dividends of 25 cents per share were paid. The ultimate goal, I believe it is fair to say, was to set dividends, as far as possible, at a level that could be maintained on a regular basis year in and year out barring some catastrophe. The emphasis was on the regularity of dividends rather than the payment of extra dividends. 2. Q. Was this policy articulated in writing? v., u'r. N< i\ because the dividend policy was too flexible and involved too many factors which had to be considered. The answer to No. 1 is probably an over-simplification of the dividend policy for this reason. 624 3. Q. Did board members fully understand the dividend policy, particularly those members who were on the finance committee f A. In my judgment, based on discussions both at finance committee and at board meetings, I believe the members were fully conversant and basically in agreement with the so-called dividend policy. k. Q. How thorough and searching were finance committee decisions of quarterly dividend payments? A. I cannot answer this question. It is a matter of opinion and degree and the number of questions and discussions varied from time to time. 5. Q. What dividend proposals were being discussed by the finance committee, were related matters discussed in detail — availability of cash? Debt maturity payments? Pro- jected future earnings? Past earnings? A. During the tenure of Stuart Saunders as chief executive officer, I presided at finance committee meetings, but generally at his request I would turn the meeting over to him to discuss the results of earnings, prospective earnings and various background material and then he would make the recommendation as to the dividend. The Treasurer's Report, which is part of the board docket, was presented monthly showing the cash and- working capital position on various bases as shown below. From the time of the merger until the fall of 1969, accounting was under the jurisdiction of Mr. Perlman, but after accounting was placed under my supervision in the fall of 1969, certain formats were changed and more information was provided to the directors than previously. This is par- ticularly true of certain subsidiary companies. 6. Q. Who usually proposed the amount of the dividend to the finance committee? Was there dissent? Frequently or infrequently? A. During the regime of Mr. Saunders, almost invariably the dividend recommenda- tion was made to the finance committee by him. As far as I can recall there were always questions and discussion, but I cannot remember any dissent by anyone to the action taken. 7. Q. Who usually proposed the amount of the dividend to the full board? A. Almost invariably Mr. Saunders gave a resume of the current situation and prospec- tive outlook, advised the board as to the recommendations of the finance committee and then requested approval by the full board. 8. Q. Were there any discussions about dividend recommendations by the full board? Was there dissent? Frequently or infrequently? A. As was the case with the finance committee, there were frequent questions and discussions, but I can recall no dissent by anyone at the action taken. I was not a board member from Feb. 1, 1968 until the fall of 1969, but did attend most board meetings. 9. Q. In 1969 was there consideration given by either the finance committee or the full board to curtailment of the dividend payment prior to the fourth quarter? If yes, how thoroughly was this considered? Were cash figures available at these meetings? A. There was considerable discussion at the finance committee meeting in June 1969 as to whether a declaration of dividend should be considered at that meeting or whether there should be a special meeting in July or August and it was finally decided that June was the customary time and that it should be decided then. I think it is fair to say that there was some hesitation as to just what action should be taken, but the recommendation of the Chairman was finally approved without dissent. 10. Q. Did the preponderance of bank interlocks affect dividend policy? A. I never saw the slightest indication of any effect because of so-called bank inter- locks. 11. Q. Did bank related directors press for high or continued dividend payments? A. I do not think that being a director of a bank, at least as far as I could tell, ever came into consideration in the minds of the members of the board in the discussion of dividends. 12. Q. Were board and finance committee members fully aware of the critical cash position of the company in 1968 and 1969? If not, why was this information withheld? If yes, then who pressed to continue the dividends in spite of the poor cash position? A. There was never really a time when the cash position of the railroad was not poor either before or after merger. It was always a matter of degree. As a matter of fact, having gone with the PRR in the spring of 1951, upon analysis I was so impressed with the poor working capital position, not only of the PRR, but of the entire industry that I arranged a so-called standby revolving credit agreements with our banks, the first com- pany in the industry to do so in 1954. This action was taken in order to supplement our weak working capital position in the event of an emergency by having this credit to call upon. The cash position of the railroad was always available to the directors, it was pointed out that it was weak and as stated previously, it was always shown to the board on the Treasurer's Report each month. (A copy of February 1968 is attached as an example. ) IS. Q. Were dividend declarations discussed with bank related directors prior to finance committee meetings or board meetings? A. Naturally I have no way of knowing what discussions were carried on by either Mr. Saunders or Mr. Perlman, but I have no definite recollection of any real discussions held by me with any of the directors on this point except prior to the consideration of the fourth quarter dividend of 1969 and there is correspondence covering this. 14. Q. Did you feel that full and adequate information was presented to the board in regards to all matters brought before the board? Was ample time allowed for discus- sion and review? Were directors who dissented from the chairman's recommendations or viewpoint given the opportunity to fully present their dissenting viewpoint? 625 A On a number of occasions I felt that certain presentations made were overly opti- mistic. However, I think there was an honest effort made by everybody concerned to allow sufficient time for discussion and review and on a number of occasions the method of report- ing was changed in order to reduce the reporting of minor matters and allowing more discussion of the important subjects. In my opinion, all directors were given a full oppor- tunity to express their opinions. After one presentation by myself, which was certainly not on the optomistic side with respect to the operation of the railroad, Mr. Perlman stated that he was not a harbinger of gloom like one or more of his associates and that he was looking ahead and not concerned about current results. 15. Q. Can you give us some background on John Sea brook's election to the board of directors of the New York Central Railroad? Do you know if his election was at the behest of Howard Butcher III of the investment firm of Butcher and Sherrerdt A. I know nothing about the background concerning Mr. Seabrook's election to the board of New York Central. 16. Q. When Mr. Butcher resigned from the PCTC board in September 1968, was there any discussion as to removing Mr. Seabrook from the PCTC board also? A. There was some discussion to this effect. 11. Q. Did Mr. Perlman press to have Mr. Seabrook resign? Did any other directors join Mr. Perlman' s effort? A. I do not recall which directors were involved. I know the question was raised, but I do not know whether anybody really pressed the matter or not. 18. Q. Did you consider that Mr. Butcher continued to have representation on the PCTC board through Mr. Seabrook? A. No, Mr. Seabrook was an independent thinker. 19. Q. Were you told why you were excluded from the board of the merged company in 1968? A. I was given no explanation, but since a very substantial number of my duties and responsibilities were taken away from me, it seemed all part and parcel of some action decided upon by Messrs. Saunders and Perlman. 20. Q. Can you tell us what the explanation was and by whom it was given? A. In view of the answer to 19, this does not require an answer. 21. Q. Did you believe this explanation or did you feel there was some other reason for your exclusion? A. In view of the answer to 19, this does not require an answer. 22. Q. Can you give us some background on your reappointment to the board in August 1969? A. During the spring of 1969 on a number of occasions, Mr. Saunders pressed me to go back on the board of directors and on the Executive committee and I refused. I agreed to go back on the board in August 1969 when I had reluctantly under pressure agreed not to resign. 28. Q. Did you write a letter of resignation to Stuart Saunders in the summer of 1969? What was your reason for wanting to resign? Why did you not do so? A. I wrote a very definitive letter of resignation to Stuart Saunders in June of 1969. The letter of resignation speaks for itself. A number of directors and Mr. Saunders pressed me not to resign and emphasized the harm it would do to the company if I took such action and insisted that I had a responsibility to the bankers lending us money, to our stockholders. I further discovered that despite my request to the contrary, the new President who agreed to come in, Mr. Paul Gorman, had not been advised of my decision to resign. 2Ji. Q. In a letter dated 11/21/66, you attribute a policy of maximization of earnings to Mr. Saunders. Did you understand this policy to emanate from Mr. Saunders? Was it in writing? If not, in what manner was this policy circulated? A. The fact that this was the accepted policy is well indicated by the fact that Mr. Saunders never contradicted my memorandum of 11/21/66 and it was impossible to attend budget or staff meetings for any discussion involving earnings without knowing what his clear policy was. 25. Q. We are aware of a considerable amount of correspondence from you, spanning a period of years, advising Mr. Saunders of the critical and difficult cash position of the rail- road. Did you ever advise Mr. Saunders to abort the maximization policy and report earn- ings more in line with cash flow? In writing? A. I had a number of verbal discussions with Mr. Saunders on the maximization of earnings policy and in writing pointed out on at least several occasions that our reported earnings and cash flow were getting further and further apart. However, Mr. Saunders as chief executive officer was within his rights to set the policy and it was my duty to conform as long as we stayed within the bounds of good accounting practice. While accounting was under my jurisdiction, no accounting action was ever taken with my knowledge that did not come within the bounds of sound accounting practice. 26. Q. Do you believe that the following are some illustrations of the implementation of this policy? (a) Write off of passenger facilities and equipment? (b) Sale of Clearfield Bituminous Coal Co.? (c) Exchange of Madison Square Garden stock? (d) Use of the merger reserve? (e) Capitalization of New Haven car repairs? (f) New York Central Transport dividends? (g) Washington Terminal dividends? (h) Strick Holding Co. dividend? (i) Others? 626 A. (a) I think that the write off of passenger facilities was a realistic and sound move somewhat similar to that recently taken by RCA in writing off huge amounts in connection with its data processing business. No one can deny at the same time that in future years earnings would be helped by the reduction in depreciation charges, but the actual write off was made very clear to both stockholders and the public. (b) This was done primarily for the purpose of making it possible through proper corporate procedure to transfer cash from Pennsylvania Co. to PRR. It is true that it had the effect of increasing the earnings of the railroad, but it had no effect on a consolidated basis. (c) We exchanged a 25% interest in Madison Square Garden, Inc. which was a non- marketable stock and a 55% equity interest in an office building for Madison Square Gar- den stock which gave us a participation in the whole project and, most important, a marketable security. This was the primary purpose. Here again, it is true that it increased the earnings of the owning company, but had no effect on the consolidated statement. (d) I think the establishment of a major reserve was sound and proper because it was in no way hidden from either the stockholders or the public. It also meant that we could compare earnings or losses before and after the merger on a comparable basis not obscured by non-reoccurring items. I do think that undue pressure was exerted from time to time to charge items to the reserve which did not belong there. (e) I am not familiar enough with this to comment. (f ) I was not a member of the board of New York Central Transport and was not consulted about this transaction. I was told it was done to minimize taxes, but it is true that it improved the earnings of the railroad but had no effect on the consolidated earnings. (g) I think this transaction was handled properly accountingwise except as to whether or not it was ordinary or extraordinary income and I did not participate in the latter discussions. (h) I do not recall what was involved in the Strick Holding Co. dividend, and to the best of my recollection I was not involved in this. 27. Q. To your knowledge, was the board of directors aware of the policy of maximi- zation of earnings; if not do you think they should have been ? A. It is my judgment that the directors were aware of the policy of maximization of earnings within the bounds of good accounting practices which were being employed. 28. Q. Did PMM ever take a diverse viewpoint to that of the railroad in any of the transactions resulting in maximization of earnings? How were the differences resolved* A. On some occasions when questions were raised with PMM they decided against the railroad, but I of course did not participate in all discussions. When accounting was under my jurisdiction before the merger and again starting in the fall of 1969, when any real question arose we would sit down and discuss the matter with Peat, Marwick & Mitchell and accept their conclusions as to what was proper accounting practice and always followed their recommendations. 29. Q. Were you a member of the budget committee? Did you attend budget meetings? Were the monthly or periodic meetings concerned with ways and means of maximizing earnings? Who chaired the meetings? Were minutes of the meetings maintained by a sec- retary or someone appointed to act in that capacity? Did you keep notes of these meetings? If so are they available? A. Yes. Meetings prior to merger were more truly budget meetings in my opinion than after merger primarily because after merger we operated with estimates month by month for two or three months ahead rather than through carefully prepared income budg- ets because Mr. Perlman claimed that it was not practical to make true income budgets for a railroad. However, maximization of earnings was involved in discussions almost in- evitably at most of the meetings. Mr. Saunders. I do not recall. No. Not necessary to answer in view of previous answers. 50. Q. Was Alfred E. Perlman aware of the policy of maximization of earnings? A. Yes. It was impossible for anyone from the level of upper middle management to the top not to be aware of the policy of maximization of earnings. 51. Q. From the date of merger (2/1/68) until shortly before Mr. Perlman became vice- chairman (12/1/69), Mr. Perlman was in charge of the accounting function of the railroad. Was there any doubt in anybody's mind that Mr. Perlman, was, in fact, in charge of the accounting functions? A. There is no doubt in my mind and I never heard any doubt expressed by anyone. 52. Q. Are you aware of any effort on anyone's part to withhold accounting or financial information from Mr. Perlman? A. I am not only not aware of anyone withholding accounting information from Mr. Perlman, and I believe it would have been impossible. After all Mr. Perlman was the Presi- dent. In addition, Mr. Cook, who was Vice President of Accounting reported to Mr. Walter Grant, who was Executive Vice President and formerly with the New York Central and he in turn reported to Mr. Perlman. Mr. Perlman received the same information that all board members received and he received all information received by members of the Executive Committee, the Finance Committee and the Budget Committee. As far as financial infor- mation is concerned, I personally never refused any financial information to Mr. Perlman. nor to the best of my knowledge did anybody in my department do so. SS. Q. Did you hear or become aware of an incident at one of Mr. Perlman' s staff meet- ings where Mr. Perlman asked Mr. Hill (Controller) for certain figures and was denied such figures by the response, "I am proscribed from giving you those figures?" A. I have no knowledge with respect to this situation. I did not attend Mr. Perlman's staff meetings. 6Q7 84- Q- To your knowledge, were major GSC/Macco sales, and the accounting therefor, approved in advance by PCTC officers? If so can you identify such officers? A. Sales over a certain amount were approved by the Board of Directors of Great South- west and Macco. With respect to accounting, after merger, accounting came under the juris- diction of Mr. Perlman until the fall of 1969 when, as stated before, it was returned to me. Before the end of 1969, at my request, Mr. Hill and perhaps one or two others went to the west coast to review major transactions with the staff of Great Southwest and with Peat, Marwick & Mitchell. 35. To your knowledge, were detailed GSC/Macco income forecasts or budgets presented to the railroad or Pennsylvania Company'? Did the forecasts project earnings by project? A. Yes, the forecasts did not however contain breakdowns by individual projects. 36. Q. Were you aware of pressure brought to bear on GSC/Macco officers to maximize earnings? How was this pressure brought to bear? By wlwm? A. As far as I was concerned I always advised them that our policy was to earn as much money as possible, but no improper accounting should be involved, nor should any sales be made hastily at a sacrifice in order to increase earnings. Mr. Saunders frequently called the top officers of various subsidiaries directly in regard to earnings and although I was not a part of these conversations, my impression was that pressure was applied. In the last report by the ICC, there were a number of statements critical in nature that we consider unjustified, but since they have been answered elsewhere it would be repetitious to do so again here, except for the matter of investments. In various places it has been alleged that the investment of the pension fund was completely under the control and domination of Robert Haslett, Investment Vice President, myself and Mr. Hodge of the firm of Glore Forgan. Mr. Hodge has also been characterized as Chief investment adviser of the pension fund. Actually, neither Mr. Hodge nor his firm ever had any connection whatsoever as investment adviser to the fund. Since its inception, Drexel & Co., up until quite recently, was the one and only investment adviser to the pension fund. Further, the operation of the pension fund has always been under the direct supervision of the Pension Committee of the Board of Directors and every purchase and sale was reported and approved by them quarterly. Actually, the operation of this pension fund under the supervision of Mr. Haslett and myself was one of the most successful of any pension fund in the country. Attached hereto is a report made by me to the Board of Directors covering the operation of the pension fund from the time it came under my supervision through the close of 1968 and this record speaks for itself. Memorandum April 21, 1969. This memorandum contains the highlights of the administration of our Pension Fund since I became Chairman of the Managers of Pensions eighteen years ago. Attached is certain backup information which gives additional details in connection with the operation of the Fund. At the end of 1950, the Fund at cost totalled $22,359,000 and the market totalled $22,- 001,000, slightly less. Approximately 97% was invested in fixed income securities, preferred stocks and bonds, and 3% in common stocks. At the end of 1968, on a cost basis the Fund aggregated $268,000,000 and on a market basis $376,000,000. On a cost basis, approximately one-half was invested in bonds and preferred stocks, and one-half in common stocks. On a market basis 34% was invested in bonds and preferred stocks and 66% in common stocks. During this period the unfunded liability of the Pension Fund reached a peak of $96,462,000 in 1956, as contrasted to total assets in the Fund of $68,173,000 at that time. Since then increased benefits built into the plan to make it competitive with other Pension Funds have added estimated actuarial liabilities of $53,400,000. Despite this, at the end of 1968, on an estimated basis, there was an over-funding of the plan on a market basis of $8,200,000 or a net overall improvement in the unfunded liability of $158,000,000. Charges to operating expenses for current and past service on an actuarial basis reached a peak in 1958 of $9,700,000 and have been reduced to an all time low of $1,147,000 last year. It should be noted that the last figure is for the combined Penn Central Railroad as contrasted to $9,700,000 in 1958, a charge solely against the Pennsylvania Railroad. Finally, as of December 31, 1950, on a cost basis 32% of the Fund was invested in Pennsylvania Railroad or affiliated company securities and, as of February 28, 1969, on the same basis, ownership in company and affiliated securities had been reduced to 7%. David C. Bevan. |°i 628 [EXHIBIT I] v> A o CO ■o v> z *"? < > ^ *o IN CN fi. c o 3 o z z UJ < D LU u rn u. >- o < Z O 2 O u a. 5 z <) z (J Cu ^,'> ■ 5 s ("0 •— z ° O a: 5 £ 5 8- O CK t^ e? pq fr? V) 7 n -0 UJ :: tt n -: U. 7 o u a. w> % mi PENN CENTRAL SYSTEM PLAN FOR SUPPLEMENTAL PENSION PLAN COMPOSITION OF SECURITIES IN FUND-MARKET BASIS (1950-68, INCLUSIVE) [In thousands of dollars! Bonds Preferred stock Common stock Total Dec. 31: 1950.. 1951- 1952.. 1953.. 1954.. 1955.. 1956.. 1957.. 1958.. 1959.. 1960... 1961.. 1962... 1963... 1964... 1965... 1966... 1967... 1968 2. 18, 961 2,265 775 22,001 19,715 2,878 3,618 26,211 24, 249 4,670 5,723 34,642 29, 505 6,497 6,213 42,215 31,622 9,714 12, 734 54, 070 34, 404 8,752 20, 091 63, 247 38, 423 7,736 23,393 69, 552 45,632 8,169 23,840 77,641 51,833 8,287 38, 239 98,359 60,913 9,267 51, 753 121,933 72,919 9,309 60, 708 142,936 73, 474 10, 520 85, 663 169,657 75, 323 11,107 83, 284 169,714 84, 528 9,200 100, 707 194,435 83, 704 7,134 115,030 205, 868 80, 707 5,530 136, 051 222, 288 81,195 4,205 115,964 201,364 77,567 9,937 127,934 i 215, 438 107, 999 20, 188 247, 723 375,910 1 Excludes Long Island RR. a/c withdrew from joint administration Sept. 30, 1967— $12,824,098. J Includes former New York Central funded plan assets. 629 [EXHIBIT II] PENN CENTRAL SYSTEM PLAN FOR SUPPLEMENTAL PENSIONS— UNFUNDED LIABILITY |1950 to 1968, inclusive, in thousands of dollars] Dec. 31 All companies Dec. 31 All companies 1950 $51,722 1960 52,505 1951 60,020 1961 30, 752 1952 74,578 1962 35, 561 1953. 77,541 1963 9,052 1954 81,617 1964 (7,346) 1955 85,738 1965 7,316 1956 96,462 1966 22, 234 1957 95,189 1967 14,746 1958 82,969 1968 (8, 181) 1959 68,169 Estimated. Includes former New York Central Funded Plan. Note: Figures in parentheses denote surplus. 630 [EXHIBIT III] AMENDMENTS TO SUPPLEMENTAL PENSION PLAN, MAY 1, 1961 TO APRIL 1, 1969 July 1, 1954- — Compulsory retirement for officers scaled down to age 65 by 7-1-58 adopted ; Optional retirement on scaled down ages also provided ; plan amended to corre- late with Railroad Retirement base increase from $300 to $350, and a 12 month withdrawal period approved ending 12-3-55 for members whose average compensation dropped below 350. Estimated Cost— $1,500,000. January 1, 1955. — Prior service credits eliminated for employees becoming members of the plan on and after 1-1-55 ; eliminated credit for future non-contributory service ; estab- lished after retirement options (100%-75%-50%-25%) ; established vesting provision for members leaving service after completing 120 months of contributory membership and either attaining age 55 or having 240 months of compensated service ; contributions and service credits eliminated for members over age 70. Estimated Saving — $20,100,000. January 1, 1958. — Vesting at age 60 permitted if member had 30 years of service. Es- timated Cost — Minimal. January 1, 1959. — Contributions and service credits restricted to age 65. Estimated Cost — None. June 1, 1959. — Plan amended to correlate with Railroad Retirement base increase from $350 to $400, and a 12 month withdrawal period approved ending 6-30-60 for members whose average monthly compensation was below $400. January 1, 1961. — Membership closed to agreement employees hired on and after 1-1- 61 ; new membership permitted on a calendar year basis — January 1st only ; provision made for widow's pension of 25% or 50% in event of member's death between ages 60-65 ; pro- vision made to permit withdrawal with refund of contributions and interest at any time. Estimated Saving— $40,500,000. October 1, 1961. — Established retirement for members with less than 30 years of service between ages 62-65 on a reduced basis, to correspond with similar change in Railroad Re- tirement Act also effective 10-1-61. June 1, 1962. — Continuance of service beyond age 65 authorized with approval of Board of Directors, but no additional service or earnings credits permitted. Estimated Cost — None. December 19, 1962. — Occupational disability approved — under 65, with 30 years of serv- ice no reduction ; with less than 30 years of service credit is given for 30 years and reduc- tion of 1 /180th for each month under 30 years applied to pension. Authorized Managers of Pensions to change or cancel member's survivorship option prior to age 63. Various other technical amendments. Estimated Cost — Minimal. November 1, 1963. — Plan amended to correlate with Railroad Retirement base increase from $400 to $450. February 1, 1965. — For non-agreement employes, plan made non-contributory and pen- sion formula changed to 1%% credit for each year of service, times average earnings during final five years, less 80% of Railroad Retirement annuity payable (using $400 RRA base). Estimated Cost — $33,100,000. July 1, 1965. — Provision made for election of widow's survivorship option which could become effective prior to retirement from age 55 instead of age 60 and the period during which proof of health is required reduced to six months prior to effective date of option. Estimated Cost — None. January 1, 1966. — Plan amended to correlate with Railroad Retirement base increase from $450 to $550. November 1, 1961. — For non-agreement employes only, provision made for retirement at age 62 or over regardless of service, or between 60 and 62 with 30 years of service, with- out reduction ; between ages 60 and 62 with less than 30 years of service pension is reduced l/180th for each month under age 62. Xon-agreement employes creditable service percentage factor raised from l 1 / 4% to 1%%. Pensions of non-agreement members retired before 11-1- 67 increased by 10%. Estimated Cost— $22,000,000. January 1, 1968. — Plan amended to correlate with Railroad Retirement base increase from $550 to $650. February 1, 1968.— Plan revised to pick up New York Central Funded Contributory Retirement Plan members ; all non-agreement employes of merged company made members of plan, even though they had previously declined, failed to subscribe, or withdrawn, with service creditable only from 2-1-65 (PRR members) or 3-1-65 (NYC members). Disability computation no longer subject to reduction. Estimated cost $7,200,000. 631 EDUCATIONAL INSTITUTION AND COMMON TRUST FUNDS IN PHILADELPHIA AND NEW YORK BANKS Indexes Supplemental June 30 July 31 Oct. 31 Nov. 30 Oct. 31 pension plan (A) (B) (O (D) (E) (F) Aug. 31, 1956 100 100 100 100 100 100 100 Aug. 31,1957 _ 97 94 95 93 96 93 97 Aug. 31,1958 105 98 99 108 113 108 100 Aug. 31,1959 117 99 114 114 116 113 114 Aug. 31,1960 121 99 111 113 115 114 113 Aug. 31,1961 139 104 128 133 137 138 125 June 30, 1962 129 103 118 121 130 116 121 June 30, 1963 153 115 132 138 139 139 132 June 30, 1964 170 118 145 150 150 155 142 June 30, 1965 181 120 145 154 152 167 145 June 30, 1966 189 110 135 137 137 146 138 June 30, 1967_ 208 110 144 139 138 175 143 June 30, 1968 231 106 148 152 165 182 150 PENNSYLVANIA NEW YORK CENTRAL TRANSPORTATION CO. REPORT OF TREASURER, PERIOD FEB. 1-20, 1968, INCLUSIVE Feb. 20, 1968 Jan. 20, 1968 Feb. 20, 1967 Working cash position: Gross cash $59,209,266 Less outstanding paychecks, vouchers, dividend checks, etc 33, 938, 425 Net working cash 25,270,841 Net working cash Dec. 31,1966 $93,641,034 Dec. 31,1967 55,171,955 Jan. 31,1968.. 46,517,847 D $29, 489, 552 I 4,078,051 D 33, 567, 603 Working capital $22,583,315 i 8,606,051 2 26, 279, 095 D $56, 090, 878 D 2, 599, 512 D 53,491,066 Working capital less materials and supplies > $67, 968, 128 i 100, 208, 772 M21,342,095 ' Deficit. 2 Estimated deficit. 632 Exhibit 54 in the united states district court for the eastern district of pennsylvania In the Matter of In Proceedings for the Reorganization of a PENN CENTRAL TRANSPORTATION : Railroad COMPANY, Debtor No. 70-347 REPORT OF TRUSTEES ON REORGANIZATION PLANNING FEBRUARY 15, 1972 The Court on November 3, 1971, extended the time within which to file a plan of reorganization to April 1, 1972, and instructed the Trustees to file by February 15, 1972, a report on the prospects for reorganization of the Debtor (Order No. 475). This is that report. SUMMARY The basic question put to the Trustees by the Court is whether, in their judgment, a successful reorganization of Penn Central* is probably feasible. The short but carefully considered answer to this question is that in the Trustees' judgment Penn Central can be successfully reorganized. The rest of the answer is that this conclusion is based on and depends on two elements which must be made unequivocally clear. One is the attainment of the projec- tions which have now been made regarding the volume of traffic and freight revenues which can be reasonably forecast for Penn Central during the next five years — taking account of (i) prospective general business conditions, and (ii) Penn Central's ability to advance in the highly competitive transportation market. The other is the accomplishment of three basic changes in the Penn Central situation which will require action beyond the sole competence of the management, the Trustees, or this Court: rationalization of the Penn Central plant, removal of unnecessary labor costs, and full compensation for continuing passenger service losses. Since the prospects of a successful reorganization depend on making these three clearly basic changes, a serious time factor is involved here. The changes require the concurrence in one form or another of various interests, government and private. The benefits of some of the changes will by nature of the circumstances be postponed, in part, even after the arrangements are completed and authorized. And additional obligations (for currently deferred taxes, interest charges, and other claims) are being incurred by the Debtor at the rate of approximately $ 1 00 million each year. This means an accumulation of prior charges against the estate before values available for pre-bankruptcy interests. The Trustees' conclusion regarding the prospects for reorganization gives full account to these time factors. We believe that there is reasonable prospect that the three changes can be accomplished in substantial part during 1 972 and 1 973, and that virtually full benefit from the changes can be realized by the end of 1975. Accomplishment this 'As used in this Report, the term "Penn Central" refers to the Debtor in reorganization: Penn Central Transportation Company. -1- 633 year or next would enable the Trustees promptly to begin at least partial payment of obligations now deferred {e.g.. current state and local taxes). On these assumptions, the Trustees now conclude that Penn Central may be expected (i) to begin generating substantial income available for fixed charges' in 1974, and (ii) to show, by 1976, income available for fixed charges of between $220 million and $290 million. This provides, in the Trustees' judgment, a basis for reorganizing the Debtor and for preparing their plan of reorganization. If these three changes were not to be made — or if there were undue delay in making them — there would not be, in the judgment of the Trustees, the basis for reorganizing the Penn Central as a private enterprise. This conclusion is based on studies and analyses which show that maximally effective self-help measures alone — taken with the most reliable available estimates of traffic increases in the future — would result in continued losses during the next four years and would show only marginal earnings by 1976. That would be too little and too late — for there would have been unconscionable and possibly unconstitutional erosion of the Debtor's estate in the meantime. This judgment could only be invalidated by an unlikely confluence of favorable developments including a spectacular and sustained increase in revenues far beyond what is here forecast. The prospect of reorganization therefore hinges on achieving, in significant degree, the three changes which have been identified as requiring the participation and cooperation of interests other than the Penn Central management, the Trustees, or the Court, as well as, of course, the utmost efforts on the part of the management and the Trustees. 1. The proposed rationalization of the Penn Central plant involves (i) taking advantage of the potential for increased efficiency made possible in theory by the 1968 merger but never realized in fact, (ii) abandonment of those freight lines which have neither business nor public service justification, and (iii) making appropriate arrangements for continuing those freight lines found to be essential to the public service but inoperable on a sound business basis. The Penn Central system presently covers approximately 20,000 route miles. Approximately 80% of Penn Central's freight business comes from 1 1 ,000 of those route miles. This is graphic reflection of the fact that the Penn Central system has the lowest freight revenue per mile of line of any major railroad in the East. Thus, 1 1,000 miles have been taken, for purposes of this reorganization feasibility determination only, as a "core" system — with full recognition that this alone would not constitute a full-service system, taking all interests into account. Similar analyses are being made of larger "core" systems. With respect to the remaining 9,000 route miles, virtually all shippers have abandoned well over a third of them. This should be recognized by appropriate abandonment certificates from the Interstate Commerce Commission, and its newly revised procedures should expedite this result. The remaining route miles which still serve a useful purpose can continue to be operated — some of them, hopefully, by a revitalized Penn Central itself, some with help from those interests, either public or private, which are prepared to underwrite the losses. A particular branch line may be of sufficient importance to the shippers or communities it serves that contracts assuring continued service at a price that makes Penn Central whole can be negotiated. Under these circumstances, the Trustees would not be compelled to seek abandonment of any mileage which serves a substantially useful purpose. *As used in this Report, "income available for fixed charges" is calculated after deduction of equipment lease rentals. -2- 634 No simple or single quantification of the benefits of the rationalization we propose is possible — there are too many variables. 2. The proposal with respect to personnel reductions is that only those train and engine service employees determined to be necessary to safe and efficient freight operation be employed. Collective bargaining on this issue is now in progress. If it fails, as it has in the past, the Trustees will accept — as has already been indicated to the National Mediation Board — an independent third-party determination of the issue. The issue here is whether approximately 9,800 employees presently required to be employed by prior labor agreements (and by "full-crew" laws) are necessary for safe and efficient operation. The cost involved here, at 1972 levels, approximates $150 million per year. The Trustees propose that the reductions in question will be gradual and that protection will be afforded present employees. 3. The proposed change in compensation for providing passenger service is that Penn Central be fully reimbursed for the costs of providing that service. The reorganization of Penn Central can and should provide whatever passenger service is necessary in the public interest. At the same time, the burden which that service imposes on the system should be eliminated as present arrangements are renegotiated or new ones entered into. Present arrangements with Amtrak fall far short of enabling Penn Central to recover its current costs, even aside from any return on its investment. It should be recognized, for example, that passenger service as a whole in the Washington-New York-Boston corridor is not provided as a by-product of freight service but is, rather, the principal service and should be paid for accordingly. Even greater losses are being sustained in commuter service. The reimbursement factor involved here amounts to $87.2 million on a 1 972 basis (exclusive of return on investment). • • • • The Trustees fully appreciate the significance of these three proposed changes. They are commended by the dictates of that fairness and equity which must characterize any plan of reorganization. Major progress in these areas, along with increased business volume, means the difference between viability and non-viability, between feasibility and non-feasibility of a successful reorganization. So far as the more immediate cash flow prospects are concerned, the Trustees believe that Penn Central will remain from here on — barring unforeseeable adverse developments — in a position to continue operations, but only on a bankruptcy basis. The timing of its ability to do better, and to meet presently deferred obligations such as taxes, will depend on the promptness with which the three essential changes described above are made. The remainder of this Report details what is summarized here and considers additional matters identified in Order No. 475, including the alternatives to reorganization. The question of alternatives warrants particular notice, and it has played a significant role in the Trustees' consideration of this matter. The Trustees oppose the alternative of nationalization. The bill for it would be billions of dollars. It would embalm present inefficiencies and inadequacies which the Trustees' proposals would correct. We have developed an alternative to nationalization which requires simply tough, spartan, private self-discipline, and the cooperation of those public and private agencies and groups whose interests are involved here. Nationalization would be a sorry, needless price to pay for lack of the exercise of common, ordinary good sense and responsibility. - 3 - 635 I. PROGRESS IN ELIMINATING OBSTACLES TO THE VIABILITY OF THE DEBTOR Penn Central's problems lie in two areas. Some obstacles to a successful enterprise are within management's competence to overcome. But there are certain conditions with regard to which self-help — in the present context, by management, the Trustees, and the Court — can be effective to only a limited degree because of constraints imposed by law, regulation, or other external factors. A. Management Accomplishments Where obstacles to viability can be overcome by better management, progress has been substantial. Stricter internal controls have enabled the Trustees to curtail the rate of cash attrition which they encountered at the beginning of their stewardship. The Court, acting under the Bankruptcy Act, has permitted the deferral of both post- and pre-bankruptcy expenses which could not have been met out of operating revenues. Tighter controls have brought the railroad's operating ratio (percentage of operating revenues consumed by operating expenses) for the first 1 1 months of 1971 down to 88.32%, compared with 92. 1 1 % for the same period in 1 970. Employment, which was 90,319 in January 1971, was reduced to 83,322 by January 1972, or by 7.7%. Equipment utilization has been substantially improved. The railroad is making more use of its own cars and correspondingly less use of foreign line equipment, and is handling more net ton miles per average car day on line. Faster turnaround for repair work has sharply increased locomotive availability. All this, plus equipment acquisition and improvement of roadway and facilities, now gives the railroad the capacity to solicit and handle an increased volume of traffic. Further details are set out in "A Report on 1971," issued on December 22, 1971 by Mr. William Moore, president of Penn Central, a copy of which is attached hereto as Exhibit A. This is not to suggest that we have any feeling of complacency, or that the possibilities for progress have been exhausted. Railroads, and Penn Central in particular, have lost much ground which can and should be recovered. Of the total ton miles of freight in the United States, the share carried by railroads declined from 62.0% immediately prior to World War II to approximately 40% in 1970. The eastern railroads' share of the total United States rail revenue ton miles declined from 38.6% in 1958 to 33.3% in 1970. Penn Central (that is, the three systems which preceded it) had 34.9% of the ton miles carried by eastern railroads in 1958, but only 33.0% in 1970. Between 1966 and 1970, originating tonnage on the Penn Central fellby 1 4.8%, while on other eastern railroads it decreased by only 0.6%; on southern and western lines it rose by 12.0% and 4.6% respectively. While Penn Central's tonnage decreased from 282 million in 1970 to approximately 261 million in 1971, freight operating revenues increased from $1,392 million to approximately $1,535 million. The competitive picture is starting to change. Penn Central handled 34.8% of the net ton miles of rail traffic in the eastern district during the first nine months of 1971, compared with 32.9% during the same period in 1970. Penn Central is now making important exceptions to across-the-board freight rate increases. Moreover, it is reducing rates selectively whenever the evidence indicates that this will result in greater contribution to earnings by attracting more volume. At the same time, it has not hesitated to file increases in those instances in which rates are below costs. Penn Central is becoming a more effective competitor. Divergence of views regarding piggyback service on the part of the former New York Central, Pennsylvania, and New Haven, and unfulfilled commitments after the merger — along with increases in 74-924 O - 73 - 42 636 piggyback rates almost twice as great as increases in truck rates — resulted in a post- merger drop in Penn Central piggyback business from 520,000 trailers in 1968 to 420,000 trailers in 1 97 1 . In the last half of 1971, when Penn Central's new services and reduced rates began to take effect, that trend was reversed. It could be reversed faster if transportation costs could be cut by 10 to 15 percent by using three-man train and engine crews. The Trustees have moved vigorously to achieve the objective of divesting the estate of non-rail assets without sacrificing maximum realization of values. Principal efforts are reflected in proposals, to be brought before the Court, for the sale of certain Park Avenue properties and the transfer of the Trustees' stock in Pennsylvania Company. Other major real estate sales have been made, although, because of encumbrances, there has not been material progress thus far in making the proceeds of sales available for capital expenditures. B. External Constraints Given the volume of traffic which can reasonably be projected for Penn Central over the next five years, as explained below, the principal obstacles to viability involve elements beyond the exclusive control of management and the Trustees. While self-help is required in these areas as well, outside cooperation and assistance is necessary to achieve (1) changes regarding the physical plant, (2) the complete elimination of redundant labor, and (3) full reimbursement for the costs of furnishing passenger service. There has been some, although relatively little, progress regarding these obstacles. A good deal has been done about each of them, but the results as of now fall far short of the goals. Most progress has been procedural. 1 . Plant Rationalization. So far as restructuring Penn Central's plant is concerned, applications have been filed, since January 1, 1971, to abandon 995.7 route miles, and approvals covering 350.9 miles have been received. Filing of applications to abandon an additional 829.2 miles has been approved by the Trustees. This piece-meal approach obviously is not the answer. Even the new and welcome streamlined Interstate Commerce Commission procedures are not enough to fully achieve the plant rationalization which is a necessary part of a Penn Central reorganization. 2. Surplus Personnel. So far as concerns Penn Central's redundant manpower situation, the Trustees' report of August 31, 1971 covers most of what has taken place — and has not taken place. Negotiations at the national level regarding the fireman manning issue have not been active. The procedures of the Railway Labor Act have been exhausted, and either party is free to resort to self-help measures. The critical train crew consist negotiations are proceeding under the rules of the Railway Labor Act and have been carried forward diligently. The National Mediation Board has now, as the last step in the mediation process, urged both parties to submit the dispute to binding arbitration. Penn Central has agreed to do so. The United Transportation Union has not yet responded. We mark time — at an estimated unnecessary cost of almost a half million dollars a day. Agreement has been reached with the United Transportation Union and the Brotherhood of Locomotive Engineers to change several outdated work rules regarding interdivisional assignments, the elimination of radio arbitraries as such, and a liberalization of road-yard, switching limits and interchange rules. The contract with the Union has been signed (on January 27, 1972), and the Trustees have been authorized by the Court to implement these work rule changes. The ultimate annual savings that will result from these changes will be approximately $ 1 5 million. Full realization of the benefits will be achieved in progressive stages. - 5 637 Under the several 1971 — 1972 labor contracts, most of the other work rules in dispute are referred to various labor-management Standing Committees. In general, there has been little progress through the Standing Committees procedure. The New York "full-crew" law has been repealed. The Ohio legislature is considering repeal, but there can be no further action now until it reconvenes on March 8, 1972. In Indiana, the legislature amended the full-crew law on February 9, 1 972, in a manner which would materially improve the situation in that State. 3. Passenger Losses. There has been partial progress regarding the passenger service drain on Penn Central's resources. The Amtrak contract of April 1 97 1 provides for reimbursement of expenses which are "solely for the benefit of Intercity Rail Passenger Service. ..plus all other costs reasonably and necessarily incurred in connection therewith. ..which are shown. ..to be avoidable costs" (Sec. 5.1). The Trustees accepted this formula as an interim measure pending establishment of a long-run basis for continuing inter-city service. Under this contract, Penn Central is currently receiving, in addition to reimbursable expenses which are "solely for the benefit" of intercity passenger operations, $7.9 million annually as supplemental payments. The Trustees cannot accept these supplemental payments as an equitable measure even of "avoidable costs" — that is, costs which could be eliminated if the service were terminated. Preliminary studies of avoidable maintenance-of-way costs in the Boston-Washington corridor are now being reviewed by Amtrak. The contract provides for arbitration if agreement cannot be reached. But, in any event, it should be noted here that, as discussed below, "avoidable costs" are not an appropriate basis for compensation in the case of Penn Central. Penn Central also continues to sustain heavy losses in commuter service. Even where some reimbursement is being received, it does not in most areas cover the full costs of operating the service, much less a return on investment. The Trustees are aggressively attempting to cure this situation. 4. Other external constraints. P-enn Central's competitive position could be further improved if it had more freedom to control its own rates. Managerial initiative and judgment, within reasonable limits, no longer need to be frustrated by a regulatory scheme adopted in an era of monopoly, which has now been replaced by vigorous intermodal competition. Canada, Great Britain, and most of Europe now permit contract rates in varying forms, in return for shipper commitments to use rail services. United States railroads should be free to enter into similar arrangements. Divisions of rates for traffic moving between the East and points in the South and certain areas of the West are disproportionate to the service rendered by the Eastern lines, at a cost to Penn Central of tens of millions of dollars annually. The Trustees have proposed an amendment to Section 15(6) of the Interstate Commerce Act — not to change the present standards for fixing divisions, but rather to provide a faster procedure for resolving divisions disputes on their merits. With respect to taxes, the Trustees note that railroads generally bear an unreasonable burden of property taxes, impairing their ability to compete for freight traffic now moving on the highways. The practice in most States of taxing railroad property as though it could be sold for other use costs Penn Central many millions each year. Moreover, railroad rights of way are generally taxed while those of the trucks and barges are not. • • • • In short, there has been progress — real progress — in areas within management's control. Penn Central "made do" in cash flow terms to such an extent in 1971 that not going back to the Congress for more money — as had been expected — was one of the significant, unnoticed "non-events" of the year. There are critical areas which require the cooperation and assistance of others. Nevertheless, the progress management has made is the basis for combining our response to the Court's question about the future viability of the Debtor with our advice 6 - 638 regarding the probable feasibility of reorganization to which we now turn. We understand the term viability, and use it in this Report, as referring to an economically successful railroad enterprise which generates enough earnings to provide for a reasonable level of fixed charges, to permit reinvestment as necessary in rolling stock and fixed plant, to provide a reasonable rate of return for an equity interest, and by virtue of all that to attract new capital as necessary. We find no obstacles to viability in those terms, or to a feasible plan of reorganization, which appear to us insurmountable. II. THE PROBABLE FEASIBILITY OF SUCCESSFUL REORGANIZATION The probable feasibility of successful reorganization — or the creation of a viable railroad enterprise — necessarily involves two questions. The first is whether a plan can be devised which will, when consummated, result in a viable railroad company; the second is whether, assuming such a plan, it can be consummated within a reasonable period of time — that is, soon enough so that continued operations before consummation do not so erode the Debtor's estate as to be either practically or constitutionally impermissible. It is not enough simply to see light at the end of the tunnel; the length of the tunnel is also critically important. A. Can a successful reorganization plan be devised? The Trustee's answer is Yes. Two possible sets of assumptions must be dealt with here. 1. It would be one matter whether, assuming maximum self-help efforts alone, and without the cooperation of others in removing or reducing external constraints.tbe railroad would become viable in a reasonable time. The Trustees' considered conclusion is that on this assumption there would be no reasonable prospect of a successful reorganization of the Debtor. The present Penn Central plant, burdened with uneconomic lines, manned by redundant labor, and absorbing continued passenger service deficits, could not be put back in shape within the time available, or perhaps ever. This conclusion is based essentially on a study forecasting Penn Central's revenues and expenses up to 1976 on the assumption that there would be no important progress in dealing with the three principal external constraints previously referred to. The study has taken into account (i) predictions as to future traffic on a detailed commodity by commodity basis, checked against inquiries as to the expectations of major shippers; (ii) various available economic models providing overall predictions as to the economy, with particular reference to the northeastern United States; (iii) the vulnerability of rail traffic generally to competition; and (iv) the probable effects of wage and price inflation on the .Debtor and on competitive modes of transportation. The study hypothesizes significant increases in traffic — which are believed reasonable. The key element in such projections is, of course, the volume of traffic to be expected in future years. The Trustees have retained the firm of Temple, Barker & Sloane to project traffic and business trends over the next decade. For purposes of this Report, it was necessary to make the best informed judgment possible on the short-term prospects of volume. After exhaustive discussions and analyses with the management, staff and independent consultants, it appears reasonable to the Trustees to predict that freight volume will reach between 307 million and 322 million tons annually by 1976. A continued growth is anticipated beyond that time, but at a slower pace. While the study predicts some net railway operating income for the first time in 1975 and 1976, the amount is not large enough, soon enough, or certain enough to permit - 7 639 serious consideration of reorganization on the existing system basis. Major unpaid post- bankruptcy claims would continue to accumulate until 1975. The study does not project sufficient income available for fixed charges in 1976, in the judgment of the Trustees, to support new securities sufficient, after post-bankruptcy claims and equipment debt were satisfied, to assure anything of substance for pre- bankruptcy interests. 2. The key question thus becomes whether Penn Central can be successfully reorganized, if reasonable and reasonably attainable success is achieved in dealing with the three principal external constraints previously referred to — a task which will require continuing maximum efforts of management and Trustees and critically necessary cooperation of others. The Trustees advise the Court that the Penn Central canbe successfully reorganized if the requisite changes are made, and furthermore that there is reasonable prospect of their being made. As to that prospect, however, it is the Trustees' understanding that the Court contemplates — by the procedure prescribed for the distribution of this Report — that a fuller basis for evaluating that prospect will be obtained from the reactions to the Report. Successful reorganization depends, then, on achieving, in significant degree, three changes. (a). Plant Rationalization. The Penn Central track system must be restructured (i) to realize the increased efficiency made possible by the 1968 merger, (ii) to eliminate those freight lines the operation of which cannot be justified in terms of either sound business practice or the necessities of public service, and (iii) to make appropriate arrangements for the operation or underwriting of those freight lines which the public interest warrants maintaining but which cannot be operated by Penn Central for its own account. Penn Central's plant has a much lower traffic density and a much lower freight revenue per mile of line than any other major eastern railroad. When compared with the C&O/B&O and N&W, for instance, Penn Central is lower by 16% to 44%. Penn Central's business volume is too low, and its plant too large. Approximately 80% of the Debtor's 1970 freight operating revenues can be identified with movements between origins and destinations on the railroad (including interchange points with other railroads) linked by approximately 11,000 of the railroad's approximately 20,000 route miles. Had such a "core" been in existence in 1 970, it would have had high traffic density and a revenue level per mile of line in keeping with the leading eastern railroads. Further analysis of this theoretical higher-density "core" in relation to operating practicalities appears to indicate (the studies are still in progress) that a great preponderance of the Debtor's freight traffic could continue to be realized from this "core" system. There is basis for the expectation that further development of this approach, including more refined marketing and operating analysis, will result in some enlargement of the present hypothetical "core" system. Calculation of the cost of operating such a freight "core" is an extremely complex matter, and the continuing studies will produce more sophisticated estimates on that question. Those studies will also permit a more precise identification of potential revenues and costs of additional lines. Up to now, because of time pressures, the allocation of costs among the various lines has had to be on a generalized basis, involving system averages in many instances, which may distort the results so far as particular lines are concerned. The Trustees are preparing analyses of larger "core" systems. The analysis made thus far indicates that, had a "core" freight railroad system of approximately 1 1,000 route miles been in operation in 1970, and had it retained some 80% of the freight revenues of that year, it would have produced net railway operating income in the neighborhood of $94 million, which, after addition of an approximate $37 million (non-operating income less miscellaneous deductions), would have resulted in 640 some $131 million of income available for fixed charges. The $94 million income figure contrasts with an actual net railway operating loss for that year from freight operations on the existing system of approximately $104 million. These calculations have been made on the basis of income from freight operations alone, and thus do not reflect the existing losses from passenger service. They also assume various operating efficiencies and economies which were not in effect in 1 970, but which have since been put into effect. The "core" concept does not assume termination of all facilities on the remainder of the Debtor's present system. Other lines in the system may, on the basis of the studies presently under way, properly form part of, or be operated by, a reorganized Penn Central. They may, in the alternative, remain in operation through acquisition or underwriting either by other interests including shippers, or by local governmental bodies. In the latter case, the rail service could be operated either independently or by Penn Central under contract, or through other arrangements which would be fully compensatory. In addition, piggyback arrangements can be expanded to provide freight service to many localities and industries presently served by uneconomic branch lines. The plan of reorganization itself, when approved, as it must be, by the Interstate Commerce Commission, can provide the necessary authority and procedure for much of this restructuring. The Commission can approve a plan of reorganization which authorizes the abandonment of lines if no compensatory basis can be obtained for their continuance. The plan can provide, in order to protect the public interest, that any line so designated for abandonment be operated for a reasonable time to enable interested parties to submit proposals for compensating Penn Central for continued operations. It can provide, to the extent necessary, renegotiated arrangements with leased lines to permit operations on them to continue. And it can provide for sale to or operation of segments by other interests whenever specific terms have been arrived at prior to approval of the final plan. The Trustees recognize that the feasibility of contract services with public bodies depends on requisite appropriations being made at the local, state, regional or perhaps Federal level. (b). Work Force. A second condition which must be met to achieve a successful reorganization of the Debtor is a major reduction in its work force. Management has recognized this, and in respect of employment within its control, has achieved significant reductions, as indicated above, and contemplates further reductions. Excess manpower remains in areas where Penn Central confronts restraints imposed both by labor agreements and by state "full-crew" laws. These agreements and laws involve outdated requirements for the use of firemen on locomotives in freight and yard service, and constraints against reducing the number of trainmen or yardmen assigned to road and yard crews. The Penn Central position is that normal freight road and yard operations require a train and engine crew of no more than three men. On this basis, Penn Central employs approximately 9,800 crewmen in excess of those needed for safe and efficient operation. Almost half of these 9,800 train and engine service crewmen are in Ohio and Indiana. The Trustees' evaluation of this situation is reinforced by the results of the national manning dispute which culminated in the 1963 award of Arbitration Board No. 282 created by Act of Congress. That award found that firemen were not required in yard and freight service except on a relatively few engine assignments. It also found substantial over- manning of trains and established a procedure, which expired in 1966, for independent third-party determination of the consist of yard and branch line freight train crews. Arbitrations under this procedure, including many on lines of the Penn Central, found two trainmen appropriate in most instances. Operations pursuant to these awards were entirely satisfactory from the standpoint of safety and efficiency. 641 In the case of excess firemen, the history and current status of this long-standing dispute was described in the Trustees' Report of August 31, 1971 to the Court. It will suffice to note here that Presidential Emergency Board No. 177 concluded that: "It was unanimously found by the public neutral members of all previous boards that there is no need for firemen on freight and yard diesel locomotives except under rare operating conditions. "The new evidence presented to this Board is not sufficiently compelling to warrant a contrary conclusion Neither the new evidence relating to safety or work burden supports the asserted need for restoration of firemen." At projected 1972 wage and employment levels, excess labor adds about $150 million to the Penn Central's annual costs. (c). Passenger Service. The third change required for a successful reorganization is the elimination of the large continuing drain from passenger service, both intercity and commutation. The Trustees do not seek to discontinue such service. Their position is simply that the passenger service which is to be continued cannot be permitted to remain a financial burden. It is widely assumed that Amtrak has relieved the railroad of unprofitable intercity passenger service. However, Penn Central is in fact subject to a continuing major drain on its resources in supplying this service. While the Trustees will continue their efforts to secure proper reimbursement under the present Amtrak contract, they believe that its terms do not reflect accurately the special characteristics of the Boston-Washington corridor. The present contract, for example, does not provide for any sharing between Amtrak and other services of common maintenance- of-way costs — despite the fact that passenger service accounts for more than two-thirds of the train miles operated in the corridor. With only minor exceptions, all main trackage is used jointly by intercity, commuter and freight services. Even on that part of the corridor where freight traffic is the heaviest, two main tracks would suffice for that traffic; but the demands of the passenger service are such that up to six tracks are required. Nor does the present contract permit any charge to Amtrak for common costs incurred in providing passenger service. The "avoidable cost" concept now incorporated in the Amtrak contract means that in situations in which Penn Central's tracks are used for freight, intercity passenger, and commuter service, Penn Central has to pay 100% of the costs which ought to be allocated among all three services. Finally, the present Amtrak contract gives no recognition whatever to investment in property used in the passenger service. The basis of compensation in the present contract is subject to change July 1, 1973, for which purpose negotiations may begin in May 1972. The Trustees will seek appropriate changes in the Penn Central contract. They recognize that Amtrak has not been adequately funded to meet the additional reimbursement which is warranted. Some form of relief from the burdens of intercity passenger service must nevertheless be provided. Until it is, the contract payments fall short, on the basis of fully allocated costs, by approximately $32.5 million per year at 1972 levels of service, wages and prices, exclusive of return on investment. There is increasing recognition that commuter services are indispensable to many major metropolitan areas. In spite of this, the Trustees estimate that at 1972 levels of service, wages, and revenues from all sources, Penn Central's commuter service was rendered at a loss of $54.7 million relative to fully allocated costs, exclusive of return on investment. (Fare increases pending or in preparation, if effectuated promptly, would reduce this figure by an estimated $10 million.) The combined effects of intercity and commutation passenger service are thus imposing a burden of $87.2 million, not including return on investment. 10 642 This analysis of what is required to put Penn Central on a viable basis is regrettably involved. But there are no short-cuts to the right answers — except across quicksand. What this all comes down to is that on the "core" basis described above, with passenger costs fully compensated (exclusive of return on investment) and unnecessary labor costs eliminated, Penn Central would have produced, on 1970 traffic levels, net railway operating income of approximately S181 million — instead of the S237 million net railway operating loss actually incurred in that year. This analysis has been prepared entirely on the basis of 1970 freight rates, revenues and costs. It remains to project its results to 1976. On an extremely rough basis it can be estimated that, with the plant rationalized and all passenger costs compensated and unnecessary labor costs eliminated, income available for fixed charges by 1976, including non-operating income, will be — depending on the traffic volume assumed — between S220 million (at 1970 traffic levels) and S290 million (at management's 1976 projected traffic levels). These figures assume that the changes are made promptly enough to make their effects fully available by the beginning of 1976. Because of the time required to realize those effects, implementation of the Trustees' proposals will have to begin promptly in order to produce the indicated results by 1976. Elimination of the further constraints on viability which are referred to in Section I would contribute further to a successful reorganization. The figures projected in this section as income available for fixed charges exclude income from assets owned by Pennsylvania Company but include income from the Debtor's other non-rail assets. The continued availability of such income for railroad operations cannot be ensured if the railroad cannot ultimately be made viable. The Trustees have proceeded aggressively toward the liquidation of non-rail assets, on the basis that the implementation of the proposals in this Report will create a situation in which the proceeds from the sale of such assets may be used for purposes relevant to the restoration of the viability of the Penn Central. B Can Such a Plan Be Consummated Soon Enough To Be Practicable. Fair and Equitable, and Constitutional? The second aspect of feasibility — whether a plan can be consummated within an acceptable period of time — raises additional questions. The Trustees believe, however, that it can be, // the necessary changes are made promptly. The problem arises from the continuing accumulation of unpaid administration claims which has been taking place since bankruptcy. Although the rate of operating losses has decreased, service of equipment debt has been maintained and the cash position has stabilized, the estate available for pre-bankruptcy creditor and equity interests has been diminished through the end of 1971 by approximately S 100 million in accumulated post- bankruptcy real estate and corporate taxes, S75 million thus far in the Trustees' Federally guaranteed borrowing, and up to $50 million in leased line rentals under leases which may eventually be affirmed. Thus, the estate available for such pre-bankruptcy interests has already been diminished by up to $225 million from these factors. On the present basis, unpaid administration claims are continuing to accumulate at the rate of about $ 1 00 million per year. This diminution of value affects most adversely the junior pre-bankruptcy interests which are not protected by liens. It should be recognized that asset values have been enhanced by capital improvements and reductions in the principal indebtedness on equipment obligations. Yet continued accumulation of high priority administration debts cannot continue indefinitely. 11 643 On the other hand, if there is, as the Trustees believe, a reasonable probability that a plan of reorganization can be formulated which will both provide for the post-bankruptcy obligations, including equipment debt, and produce adequate values for pre-bankruptcy interests deferral of administration claims can continue for a reasonable time so as to permit attainment of that prospect. In a plan of reorganization, the values for pre-bankruptcy interests should be at least in a fair equivalence to the liquidation value of the estate. Those who invested in or lent money to a regulated utility may be forced to make some sacrifice, but it is not acceptable that the entirety of pre-bankruptcy interests be wiped out if substantial values could have been preserved for them by liquidation. The Trustees have given careful but not as yet fully conclusive consideration to the remarkable, indeed startling, variety of valuation estimates which result from invoking one theory of valuation or another. Although cessation of rail operations over the entire Penn Central system is an unreal prospect, the Trustees have for purposes of analysis commissioned studies of the scrap value of physical assets and the present discounted value for non-rail purposes of other assets in order to provide the Court and interested parties with the basis for a judgment as to the minimum values which are approached as a limit as one assumes less and less of the Penn Central system continued in rail service. As is summarized in Exhibit B, the present discounted value of the Penn Central Transportation Company for scrap and other non-rail purposes, plus the net value of its interests in other companies, is in the range of $1,427 billion to $1,858 billion. Yet it is possible, on a reproduction-cost-less-net-depreciation theory approach, to reach a figure as high as $14 billion for the entire Penn Central system, including leased lines and operating subsidiaries. That figure has no presently practical meaning. The liquidation value of the property owned by the Debtor, including the net value of its interests in other companies, depends in large part on what assumptions are made as to how much of the existing Penn Central system would be taken and continued in operation for railroad purposes by governmental agencies, other private-enterprise railroads, or both. Portions of the Penn Central system may have substantial enterprise values, particularly if there is taken into account, in assessing such values for purposes of a governmental taking, those elements of value which have been reduced or eliminated as a result of governmentally imposed constraints. It might be assumed, if only for purposes of analysis, that rail service would be continued on portions of the system on a basis involving reasonable compensation. It is also possible that substantial prices might be paid for individual segments by other railroads. On the other hand, liquidation values for portions of the system where rail service would not be continued would be held down by a number of factors. Most of the bridges and tunnels and some of the buildings in the Penn Central system have no value for purposes other than railroad purposes, and a substantial portion of the real property interests is held under easements or other titles providing for reversions if and when rail operations cease. Furthermore, the very substantial real property assembled in the Penn Central system could not be disposed of for non-rail purposes except over a substantial period of time and with substantial expenses for holding and disposition. As a result, the discounted present value of real property interests for disposition for non-rail purposes would be far less than the aggregate present value of the parcels to be disposed of. Assuming the actions identified in this Report as necessary are taken within a reasonable time, the accumulation of prior charges against the estate available for pre- bankruptcy interests could be stopped. The benefits of passenger service relief would reduce losses from the moment such benefits were obtained, even though the benefits from concentration of plant and changes in work rules would take some time to be fully realized after the right to make the changes had been established. 12 - 644 Once the benefits from the action proposed by the Trustees have been substantially realized, there will be significant income available for fixed charges. All projections are subject to infirmities. However, the order of magnitude of projected income available for fixed charges — from $220 million to $290 million — would support a new capital structure for a reorganized Penn Central adequate to cover post-bankruptcy claims and equipment debt and still provide pre-bankruptcy interests protection greater than they would receive from any assured liquidation value of the estate. The values to be achieved for pre-bankruptcy interests in the proposed reorganization cannot be attained, however, unless the three obstacles to viability are substantially and promptly overcome. It should be possible for Federal, state and local governments and all interested parties to analyze the situation as presented in this Report and to come to conclusions as to whether they are prepared to cooperate in achieving the changes necessary to allow the Penn Central to continue as a private enterprise. If an adequate response should not be forthcoming, the Trustees will be prepared to advise the Court that this reorganization proceeding is producing a result for which Section 77 was not intended and could not constitutionally have been intended. We do not expect that default. III. VARIOUS ALTERNATIVES IN THE EVENT A TYPICAL. INCOME-BASED REORGANIZATION APPEARS UNLIKELY The Trustees have stated their firm belief that an income-based plan of reorganization is feasible. It clearly is, unless there is a failure of response and cooperation. Nationalization of the Penn Central would be error compounded. Nationalization of this railroad in its present condition would as a practical matter perpetuate the inefficiencies and inadequacies which the Trustees' proposals would eliminate. The cost to the American taxpayers would be, furthermore, literally billions of dollars. Even if the Government moved in such a way as to hold the cost of acquisition to the lowest possible level, the value of Penn Central's assets for further railroad use would be enormous. There are "intermediate" possibilities of one kind or another which would arguably not involve, in themselves, "nationalization." But if they were taken it would be, as the Trustees view this situation, only the consequence of failure to face up to the hard but plain imperatives that the right things be done. They would be in essentially the same pattern of improvisation — resorting to interim patches and palliatives in order to postpone the day of ultimate reckoning — which carried the Penn Central into bankruptcy. The reorganization approach proposed by the Trustees is simply to make Penn Central a system which makes sense and to operate it with the employees It needs. It would be the worst mistake, with the Penn Central in its present extremity, not to use that extremity to do all that needs to be done. Resorting instead to measures which would only buy a little more time would be wrong. Although the Trustees have necessarily and properly focused their consideration on the interests directly involved in these proceedings, they have recognized this case as presenting — in the public's mind and indeed in fact — the issue of whether free enterprise, incorporated and unionized, is going to work. 645 A country which may have momentarily lost some of its essential self-confidence would take what could well prove infectious pride and satisfaction from seeing this crippled corporate giant put back on its own feet and made to stand upright. That just makes sense. Respectfully submitted, /s/ George P. Baker /s/ Robert W. Blanchette Robert W. Blanchette Counsel for Trustees /s/ Covington & Burling Covington & Burling Special Counsel for Trustees February 15. 1972 George P. Baker /s/ Richard C. Bond Richard C. Bond /s/ Jervis Langdon, Jr. Jervis Langdon, Jr. /s/ Willard Wirtz Willard Wirtz - 14 - 646 Exhibit A A REPORT ON 1971 by William H. Moore President Penn Central Transportation Company FINANCIAL PICTURE The year 1971 was marked by a careful husbanding of Penn Central's cash resources. While the railroad is still suffering a cash drain, a spartan management program has resulted in noteworthy progress since the railroad's reorganization began. As a result, the Trustees were able, on December 9, 1971, to advise United States Senator Vance Hartke, Chairman of the Senate Subcommittee on Surface Transportation as follows: "So far this year Penn Central has drawn down $75 million of the $ 1 00 million guaranteed loan made possible by the Emergency Rail Transportation Act of 1 970, and our planning had contemplated that the remaining $25 million would be needed in the month of December, 1971. The present prospect is, however, that we can forego the $25 million credit in 1971 and have $35 million in cash at the end of the year. "It is still contemplated that Penn Central will have a sizeable cash drain in the first quarter of 1972. With the availability of the $25 million credit just referred to, Penn Central, given reasonably good luck should be able to survive this first quarter without further borrowing, although, in order to be safe, we may be compelled to seek the Court's permission to apply for a so-called Amtrak loan under the Rail Passenger Service Act of 1970. "Once past the first quarter, Penn Central should be able to make the rest of the year but only on a bankruptcy basis with the continued deferral of State and local taxes, leased line rentals, and other obligations. When such additional payments can no longer be deferred, Penn Central faces another cash problem which we are planning to deal with in the reorganization plan to the filed April 1, 1972." There has also been improvement in reducing deficits. For the entire year 1971 the deficit, on a fully accrued basis and before extraordinary items, is estimated at $275,000,000 as compared with a deficit of $325,739,148 for 1970. Because of freight rate increases granted during the year and a more favorable traffic mix, revenues for the first 1 months of 1971 (latest figures available) were $1,290 millions compared to $1,176 millions for the same 1970 period. This, however, was greatly offset by a sharp decline in traffic volume and staggering increases in wage rates and cost of materials. In the generally slack national economy, freight traffic volume for the first 10 months of 1971 decreased 6.5 per cent in net ton miles, or from 72 to 67 billions. For the full year the decrease, including the devasting effect of the coal and dock strikes, may be even greater. Penn Central was faced with the following cost increases: 647 Increased Costs 1971 Over 1970 1. Wage increases $86.9 (million) 2 Material price increases 9.3 3. Payroll tax 7.1 4. Health and Welfare 7.0 Total $110.3 It is significant that Penn Central has shown any improvement in the face of these two adverse factors (decline in volume and cost increases). A significant reason for the improvement is a close control of expenses which for the first ten months of 1971 produced a reduction in the operating ratio (percentage of operating revenues consumed by operating expenses) from 9 1 .76 to 88.06 per cent. Most of this improvement occurred in the freight transportation ratio, down from 48.2 to 44.6 per cent. Reflected in these improved ratios are reductions in personnel. The average employment in 1 970 was 93,788 and our target for 1 97 1 has been an average of 87,900. But so far Penn Central is ahead of target. We should end the year with an employment of about 84,300, or 1,000 less than our year-end goal of 85,300. The financial drain from passenger service was partially curtailed during the year. In addition to an estimated $ 1 6 million in net cash payments during the year from Amtrak, the National Railroad Passenger Corporation, the railroad also realized net benefits of approximately $8.5 million on an avoidable cost basis from discontinuance of unprofitable intercity passenger trains not selected for the Amtrak network. We are definitely making progress — solid progress. But it cannot be concluded that the Penn Central crisis has passed. Our progress must not obscure the fact that the railroad is deferring many priority claims, principally taxes, for which provision on a current basis cannot be indefinitely postponed. As noted earlier, we expect a temporary financial crunch to occur sometime in March or April of 1 972. However, if the 2.5% emergency freight rate increase and further selective increases are granted without undue delay and if business picks up as predicted by many economists, the railroad should be able to operate through 1972 without infusion of cash from outside sources. EQUIPMENT ACQUISITION AND REPAIR Two key steps in restoring good service to the railroad are: 1. Equipment acquisition and repair to meet customer requirements. 2. Increased property maintenance for greater transportation speed and efficiency. The added financial stringencies imposed, as the year progressed, by a discouraging national economic picture and strikes in key industries, forced us to curtail some programs of equipment and roadway maintenance. Nevertheless, Penn Central will begin 1972 with sufficient transportation capacity to handle substantially more traffic — which we are determined to get. A continuing program of equipment acquisition and maintenance of right-of-way has been laid out for 1972, within our financial limitations. During the past year, Penn Central acquired some 7,500 new freight cars and 1 87 locomotives through long-term lease arrangements. By the end of 1971 we will have rebuilt and made heavy repairs on some 1 1,400 freight cars, and upgraded and additional 1 1 ,470 freight cars, a total of 22,870 cars. The $39.6 million spent for these programs was paid out of operating revenue, whereas in 1970 much of this work was financed with borrowed funds. In 1972, we plan to acquire, through long-term leasing, 6,700 new freight cars, including general service box cars, equipped cars (for high value merchandise), covered 648 hoppers (for grain), and some 1,500 open top hoppers (mainly for coal and ore), valued at $130 million. The railroad plans to rebuild 1,000 freight cars, make heavy repairs on 6,940 and upgrade 6,900 more, for a total of 14,840 in 1972. These amounts are calculated to meet volume forecasts, taking into account that during the year Penn Central will also scrap 8,200 freight cars which are beyond repair. The railroad also plans long-term lease of 200 new locomotives in 1972 valued at $47.8 million. IMPROVEMENT OF ROADWAY AND FACILITIES The railroad has continued to make essential improvements in plant despite severe restrictions imposed by bankruptcy law on the normal use of proceeds from sales of real estate and other assets for such purposes. This year we laid 53,000 tons of new rail ( or 218 miles) vs. 49,000 tons (or 200 miles) in 1970. We plan to match our 1971 program in 1972. In 1972 we are budgeting $15.5 million for yard improvements, including continued work at our key Midwest gateway classification yard at Elkhart, Ind., our Selkirk, N.Y., classification yard, and our Buckeye Yard at Columbus, Ohio. TRANSPORTATION SERVICE The vast improvements in our service made during 1971 have restored the respect and confidence of shippers. We are delivering their cars without delays, and have greatly reduced costly derailments. Post-bankrtupcy claims are now being settled on a current basis. We initiated a quality control system using computer analysis to monitor our daily performance and are now checking tens of thousands of cars each week, moving from 232 terminals which originate volume shipments. This enables us to pinpoint trouble spots immediately and take quick corrective action. We are running more and shorter trains which speed delivery to terminals and interchange connections. This gives us faster turnaround of equipment, and in turn, greater car utilization. It also reduces yard congestion and overtime expenses. Even with substantially more train service and increased wage and material costs, total transportation expenses in 1971 were about the same as in 1970. In the first 1 1 months of 1971 the railroad ran 20,000 more trains than for the same period in 1 970, or an increase 5 per cent. Our average train speed has increased by about 12 per cent. Our car days on line per loaded cars handled decreased by 7.5 per cent. Our on-time performance in making interline connections has improved sharply. In the first nine months of 1971, for example, Penn Central trains made connections at Chicago 82 per cent of the time, vs. 55 per cent in 1970, and at Cincinnati, 88 per cent of the time in 1971 vs. 72 per cent in 1 970. Greater availability of locomotives helped to make this possible. Working on a much faster turnaround time for equipment repair, cur shops reduced locomotives undergoing and awaiting repairs by some 36 per cent (October 31, 1 97 1 , vs. October 31,1 970). The percentage of locomotives out of service of the total fleet was 6.5 per cent vs. 10.1 per cent for the same time in 1970. The same program of speeded-up repair and better utilization of equipment made the equivalent of many hundreds of extra operable freight cars available to customers. The increasing effectiveness of Penn Central's maintenance and inspection program helped the railroad cut its major accidents for the first nine months of the year by almost 50 per cent, as compared to the same period in 1970. One of the most gratifying results in 1971 railroad operations is our growing file of complimentary letters from shippers. During the year, our service complaints have declined from an average of 50 a week to four or five a week at year-end, with steady improvement throughout the year. 649 SALES AND MARKETING PROGRAMS With first-rate service to sell, the company launched an innovative sales and marketing campaign — including selective rate reductions, new services and more trains, and new opportunities in industrial development for our customers. Our objective is to meet and outperform competitors. Selective Rate Reductions On June 19, 1971, we made across-the-board cuts in our TrailVan (piggyback) Plan II 1/2 and III ramp-to-ramp rates, averaging about 6 per cent. Since that time a 6.1 per cent cumulative decrease in this type traffic (compared to the same period in 1970) has turned into a slight cumulative increase (as of the end of October), despite the dock strike and depressed economy. We expect to strengthen this upswing in 1972. More recently. Eastern railroads (including Penn Central) jointly approved a new scale of iron and steel hauling rates, with an average rollback of 8 per cent. Penn Central hauls $ 100 million of this traffic annually, and with the new rates tailored to be competitive with truck industry rates in quantities of 40,000 pounds or more, we stand to gain a great deal more of this traffic. We will implement the new rate structure on January 8, 1972. Grain hauling has benefited from the virtual doubling of our fleet and from substantial rate changes to accommodate our shippers. This is sparking a strong comeback in recovery of grain tonnage, which is best indicated by the fact that in the last quarter of 1971 our grain business will have doubled, vs. the same period of 1970. More Trains and New Services In 1971 Penn Central was able to schedule 42 new trains — all aimed at either substantially improving present service or at offering new service where volume potential exists or new services to specific customers. We are rebuilding our TrailVan (piggyback) service which dropped in volume during 1970 and early 1971. As noted, we cut rates in several areas and we also improved our overall on-time performance by 30 per cent. We increased our all-TrailVan trains by more than 15 per cent, adding six new schedules in the past year. Examples are new services between New York and Boston, between New York and Rochester-Buffalo, and between Chicago and Cincinnati. In preparation for an expected substantial upturn in TrailVan traffic, we are doubling our capacity to handle traffic at the Kearny TrailVan terminal near New York. We have expanded our Kearny gatehouse from four to seven lanes, and have provided space for 40 more working car spots to be serviced with four "piggypacker" loading cranes. We are completing an additional 50-car track at North Kearny for loading and unloading, with storage space for 400 additional trailers. In another area, Penn Central increased its Flexi-Flo tonnage more than 30 per cent in 1971, and has even greater expectations for 1972. Flexi-Flo is a coordinated rail- highway service for high-value bulk commodities such as chemicals, foods and cement, and is operated to and from 12 key geographical distribution points. In 1972, we will substantially expand the Flexi-Flo program, by establishing terminals in several more cities (including Philadelphia), and enlarging our existing terminals. Penn Central has started and will expand in 1972 an entirely new service to its shippers called FACTerminal. Freight agents serving specified territories will be able to move about freely to render "on-the-ground" services to shippers. Backup computer and communications equipment to support these agents will be installed in key cities across the railroad system in "Freight Agency Coordinated Terminals" (FACT) to centralize all paperwork. We will better serve our shippers through more efficient use of our employees and improved supervision of transportation functions. We estimate that the FACTerminal program can save the railroad several million dollars annually. 650 Industrial Development In the first 10 months of 1971 Penn Central helped locate on its lines 41 1 new, temporary or expanded industrial facilities, with investment totaling $668 million. These plants create jobs in local communities, as well as build our traffic volume. For 1972, some 295 industries have already expressed bona fide interest in locating along our lines. We expect continuing heavy activity as the year goes on. We are making a special effort to encourage new industrial parks along our lines. We now serve 302 industrial parks, which have some 70,000 acres available for plant locations. Also, our Penn Central "land bank" offers 188 separate parcels in 14 different states totaling about 20,000 acres for new industries. EXCESS CREW LAWS In collaboration with other railroads, we are continuing our vigorous efforts to obtain repeal of antiquated state laws requiring unnecessary personnel on freight train operating crews. In Penn Central territory, these laws are now in force in only two states, Ohio and Indiana. A New York law requiring a freight train crew of five men was repealed during 1971. Ohio requires a five-man crew. Indiana requires a six-man crew on freight trains of 70 cars or more. These two laws cost Penn Central approximately $25 million in 1971. A Bill to repeal the Ohio law has passed the House and has been carried over for action in January, 1972, by the State Senate. A repeal Bill has been filed with the Indiana General Assembly and will be before the 1972 Session when it convenes in January. Savings inherent in repeal of these laws will not be realized until settlement on a national basis of the locomotive firemen issue and displacement through attrition of employees involved. PROGRAM TO RATIONALIZE THE PLANT Studies are underway to determine the viable sections of the Penn Central. In this regard more than 90 per cent of our gross ton miles is handled on about 60 per cent of our route mileage. However these studies may come out, it is vitally important that we discontinue non-productive lines which cannot be justified. To date, we have determined there are 163 such lines covering 1,732 miles of railroad. Applications for abandonment of 1 1 7 of these lines have already been submitted to the Interstate Commerce Commission. We have orders approving 45 of them. Approximately 3,000 additional miles of line are being studied to determine whether abandonment should be proposed. In continuing studies, we will consider several thousand miles of feeder and tributary segments of our railroad. We need to weed out functionally duplicative lines and mileage not required in terms of future traffic patterns. AMTRAK CONTRACT SERVICE Since May 1 , payments from Amtrak for intercity passenger service have aided our cash flow. By the end of the year we will have received an estimated $16 million in net cash payments, after provision for our monthly payments on purchase of Amtrak stock in order to join the corporation. We feel there is inadequate compensation for us in the present contract especially in the Northeast Corridor for passenger expenses we incur which are common with freight service such as maintenance of way, signaling, communications, etc. We hope during 1972 to being renegotiating our present contract with Amtrak to provide more adequate compensation for our costs of these operations. COMMUTER SERVICE During 1971, Penn Central continued to move in all of its commuter areas toward the assumption by public authorities of total financial responsiblity for providing these essential passenger services. Until this objective is accomplished, our commuter service deficits are being minimized through a variety of contractual agreements with State or 651 regional transportation authorities in Boston, New York, Philadelphia, and northern New Jersey. We are trying in Boston and northern New Jersey to have reinstated fare increases granted but suspended because of the national economic program. A 3 per cent increase on the New Haven Division will become effective on January 1 and a fare increase in the Philadelphia area is pending. On January 1 , 1971, we entered into agreement with the States of New York and Connecticut for these States to assume the former New Haven commuter service between New York City and New Haven, Connecticut. A similar agreement with New York State for commuter services on our Hudson and Harlem branches was recently disapproved by the U. S. District Court in charge of our reorganization. We are now working to resolve this problem. In the Philadelphia area, the Southeastern Pennsylvania Transportation Authority has recognized in our 1970—71 contract many more of our avoidable expenses. Our current contract includes an understanding that SEPTA will assume full financial responsibility for operating this service after July 1, 1972. In northern New Jersey, where 83 passenger cars nave been purchased with State funds, we are negotiating for additional State aid and have begun work on a plan for takeover by the State of the North Jersey Coast service. In Boston, we are negotiating with the Massachusetts Bay Transportation Authority for continuation of that city's rail commuter network on a permanent basis. At the same time, we are working out arrangements for keeping this service operating until a takeover is accomplished. BUSINESS AND LABOR CLIMATE — 1972 In 1971 Penn Central received $170 million less in revenues than originally projected, mainly because of strikes in key industries and the generally sluggish national economy. The 1972 outlook in this regard is much brighter. All major industries served by the Penn Central (such as autos, steel, coal) have contracts with labor unions which run at least through the whole year. Moreover, many economic experts in the nation look for a business upturn in 1972, and this should add to the railroad's gross revenues. A 5 per cent increase in gross revenues would bring in approximately $90 million more. Each percentage point increase above that could add $18 million. Penn Central would be a major beneficiary if 1972 brings good business and peaceful labor relations. SALES PROSPECTS FOR 1972 Penn Central is geared in 1972 to handle a much greater volume of business while sustaining the same high standards of service the railroad achieved in 1971. In the year ahead, we will seek greater, profitable traffic volume, for we now have the capacity to handle substantial increases with a minimum increase in transportation expense. We intend to be fully competitive vis a vis other modes of transportation by selective freight rate increases and decreases (where warranted), in combination with special services tailored to individual shipper and commodity requirements. In summary, during 1971 Penn Central became notably more competitive in all aspects of its operations. Our sales program in 1 972 will reflect our renewed capabilities. December 22, 1971 74-924 O - 73 - 43 652 EXHIBIT B PRELIMINARY STUDY OF VALUE FOR NON-RAILROAD PURPOSES OF PENN CENTRAL TRANSPORTATION COMPANY ASSETS AS OF DECEMBER 31. 1970 The following analysis assumes a complete cessation of operations by Penn Central Transportation Company and its leased lines. Substantial continued railroad service is a much more likely assumption which would produce higher values, but the extent of the increase would depend on how much railroad service would be continued and on what basis. Where indicated, a discount has been applied to the disposition price to reflect not only the estimated expenses of holding and disposing of the assets, but also the present value of future receipts from non-productive property. Two alternative discounts have been applied to real property. Each represents different assumptions as to the present value of future money, expenses to be incurred, and the length of time it would take to dispose of real property held by all companies within the system. No additional discount has been applied to reflect economic disruption which would result if there actually were a sudden and complete cessation of rail operations on the Penn Central system. System-wide assumptions as to disposition time and selling expenses for real property have been used, even though quite different times and expenses may be expected for property of different values and different locales. A more precise analysis could produce materially different results as to individual mortgage segments and individual leased lines 1. Assets owned directly by Penn Central Transportation Company: a. Real property exclusive of investment properties in the vicinity of Grand Central Terminal on Park Avenue, New York City, after applying a 50% discount to account for time and expenses of disposition. $631,000,000 a.(i) Same as above with a 72% discount. b. Investment properties in the vicinity of Grand Central Terminal based on capitalization of earnings for properties subject to long-term lease, and, for other properties, highest and best use less a 15% discount to account for disposition time and expense. c. Buildings after applying a 61% discount to account for time and expenses of disposition. $354,000,000 $153,000,000 $ 34,000,000 653 d. Owned operating equipment before deduction of equipment financing liens, discounted 18% to account for time and expenses of disposition. e. Track discounted 50% to account for time and expenses of disposition. f. Materials and supplies discounted 5% to account for time and expenses of disposition. g. Other miscellaneous physical assets, all of which could be disposed of without substantial expense. $476,000,000 S 51,000,000 $ 40,000.000 $ 28,000,000 h. The closing or dismantling expense for tunnels, bridges and electrical traction facilities after deducting the scrap value of the materials. ($166,000,000) i. Net current assets at December 31, 1970. j. Deferred charges and other miscellaneous assets. 2. Interest of Penn Central Transportation Company (as a stockholder and in some cases a creditor) in subsidiaries other than leased lines that would probably be liquidated upon the cessation of PCTC operations, the assets of each subsidiary having been valued in the same manner as were the assets owned directly by Penn Central Transportation Company, after applying a 50% discount to the subsidiaries' real property to account for time and expenses of disposition. 2.(i) Same as 2 above with a 72% discount. $ 25,000,000 nominal $ 12,000,000 $ 7,000,000 654 3. Interest of Penn Central Transportation Company (as a stockholder and in some cases a creditor) in subsidiaries other than leased lines that would probably not be liquidated in the event of cessation of PCTC operations, the value of the equity ownership having been based upon capitalization of earnings plus, where appropriate, the value of non- income-producing properties, and after applying a 30% discount to account for the time and expenses of disposition of such interests. (Pennsylvania Company, a wholly owned subsidiary, has been excluded because negotiations are under way which may result in the disposition by the Trustees of all of the stock of that company, all of which stock is presently pledged to secure indebtedness.) 4. Interests of Penn Central Transportation Company (as a stockholder and in some cases a creditor) in companies that are the lessors of rail- roads leased to it and operated as parts of the Penn Central railroad system, assuming complete cessation of operations would result in termination of the leases and therefore valuing the assets of each company on the same basis as were the directly owned assets of Penn Central Transportation Company, with a 50% discount having been applied to real estate to account for the time and expenses of disposition. 4.(i) Same as 4 above with a 72% discount. Total value of Penn Central Transportation Company assets with a 50% discount applied to account for time and expenses of real estate disposition as indicated above. $270,000,000 $304,000,000 $155,000,000 $1,858,000,000 Total value of Penn Central Transportation Company assets with a 72% discount applied to account for time and expenses of real estate disposition as indicated above. $1,427,000,000 655 Exhibit 55 in the united states district court for the eastern district of pennsylvania In the Matter of In Proceedings for the Reorganization of a PENN CENTRAL TRANSPORTATION : Railroad COMPANY, : Debtor No. 70-347 TRUSTEES' INTERIM REPORT OF OCTOBER 1, 1972 The Plan for Reorganization filed by the Trustees on April 1 , 1972 depends on timeJyjeJief in eliminating^ unnecessary employee expense, lossejon^ass^ejnger service^ am&meconnmic fr eight lines . an{fen progress in attracting more traffic and moving it with greater efficiency. The first of the periodic reports on these matters, filed on July 1, 1972, "and supplemented on August 2, 1972, dealt particularly with the progress which had been made in the labor area on the critical crew consist issue. This, the second of the periodic reports, deals particularly with the specific lines to be included in the Trustees' proposed reorganized system. I THE PROPOSED FREIGHT SYSTEM Wyer, Dick & Co. has analyzed and compared hypothetical Penn Central freight systems of approximately 15,000 and 1 1,000 miles. These studies are now as complete as they can be made from presently available data. The analysis is attached as Annex 1, and income statements based on it are attached as Annex 2. The studies, it must be emphasized, assume substantial _attainment_pf__ttie__ preregjjLsites-which the Trustees believe essential to a successful private-income-based reorganization. On those assumptions, set out hereafter at page 2, the 1 5,000 mile system would produce income available for fixed charges of some $243 million in 1976. This figure is within the range of $220 million to $290 million in income available for fixed charges which the Trustees have stated permits reorganizing the Debtor on a private-income basis.' On the same assumptions as are made for the larger system, the 1 1 , 000-mile system would produce only $4-&2- million available for fixed charges in 1 976, which is below the minimum the Trustees believe to be necessary, even though operationally the 1 1 , 000-mile system is superior to the 1 5,000-mile system. The earnings potential of the smaller, more efficient system is impaired by the vastly increased cost of "labor protection": $ 1 77 million in 1976 as compared with $18 million for the 15,000-mile system. This reflects the 'The Trustees' April 1 , 1972 Plan for Reorganization uses as a reorganization goal income available for fixed charges "not materially less than $275 million, provided further that reasonably anticipated income available for fixed charges in the year in which the reorganization is consummated and subsequent normal years is not less than $275 million." In view of the inherent uncertainties of long-range forecasts, the Trustees do not consider the difference between $243 million and $275 million sufficient to warrant a material departure from their Plan for Reorganization. Their financial advisors are of the opinion that the $243 million figure will, with minor adjustments, support the capital structure proposed in the April 1, 1 972 Report. Further, the benefits of attrition beyond 1976 would, all else being equal, improve the earnings picture. Finally, any material improvement either in the rate of future inflation or in the railroads' ability to absorb inflationary costs through timely rate increases would bring the figure above $275 million. At all events, barring any developments which permit an upward revision of the $243 million figure by the time the April 1 , 1973 final Plan is filed, the Trustees will then make the necessary adjustments in the proposed capital structure. 656 expense of retaining on the payroll during a period of attrition employees rendered unnecessary by the reduction in the size of the system. In time, of course, as attrition took place, all these labor protection costs would disappear. However, attainment of the full benefits of the 1 1 , 000-mile system would delay implementation of a reorganization plan well beyond 1976 and would expose the estate to substantial erosion in the meantime. Recognizing this, and recognizing that a longer system will provide greater service, the Trustees have concluded that the 15,000-mile system identified on the map forming part of Annex 1 is the system for which they will plan reorganization. This is essentially the present Penn Central system less the lines identified as "clear losers" in the Trustees' April 1 Report, and also less a few hundred miles of other losing lines. Despite their conclusion, the Trustees remain very much aware of the superior operating profitability of a higher density system. 2 In the event that labor protection costs could be assumed or mitigated through public assistance, a smaller system would have substantially greater long-term viability. That fact may become significant if the assumptions on which the studies are based fall short of realization. The results stated for 1976 can be achieved only if the following five objectives, detailed in Annexes 1 and 3, are met: (1) Realization of the increased freight traffic in the most recent projection by Temple, Barker & Sloane, Inc. 3 (2) Recapture, through increased freight rates, of a high proportion of inflationary costs. (3) Complete relief from all burdens attributable to passenger service. The Wyer, Dick studies assume this by identifying the system studied as a "freight only" railroad. (4) Progress on abandonments sufficiently rapid to reduce the present Penn Central system to the 15,000-mile system by 1976. (5) Continued elimination through 1976 of all unnecessary trainmen on an attrition basis. The Trustees are pursuing these objectives as their primary reorganization effort. If in the light of future developments — which will be assessed constantly as they occur — it becomes apparent that realization of these objectives is falling short of expectations to a significant degree, the Trustees will propose an alternative method of dealing with the problem of continuing the operation of the railroad. A further word is warranted on the current status of the abandonment program. Between July 1970 and September 15, 1972, the Trustees have been authorized by the Court to proceed with abandonment applications covering 3,670.5 route miles. During the same period, the Trustees have applied to the Interstate Commerce Commission for leave to abandon 2,4 1 0.8 route miles. Only 685.5 miles have been approved. At that pace, the 15,000-mile system cannot be achieved by 1976. The Commission has proposed standards which would significantly speed up the process. If and when the court challenge to these more liberal abandonment procedures is disposed of, the picture could change. 2 Certain features of the analysis suggest that maximum operating profitability — on the assumptions made in the Wyer, Dick report — would be achieved by a system somewhere between 1 1,000 and 15,000 miles. The Trustees have therefore requested study of a system approximately midway between those figures. There is no reason to believe, however, that such an intermediate system would produce as much income available for fixed charges by 1976 as would the 15,000-mile system — again because of labor protection costs 3 The TBS forecast filed with the Trustees' April 1, 1972 Report has been updated by TBS at the request of the Trustees. The most recent report, attached as Annex 3, reduces total tonnage estimates slightly. -2- 657 However, if it becomes necessary, the Trustees will propose to achieve the required level of abandonments either as a part of the plan of reorganization or as one step of such a plan. ELIMINATION OF UNNECESSARY EMPLOYEES At the time of the Trustees' July 1 Report, negotiations on the crew consist issue were in progress, but no agreements had been reached. The labor section of that Report, in consequence, was very brief. An agreement was later achieved on the firemen issue, and an interim agreement negotiated on the trainmen issue. It seems appropriate, therefore, to include the details of these settlements in this Report, together with such developments as have since occurred. 4 1. As to firemen, a final settlement has been achieved on a national basis. On July 1 9, 1 972, the railroads signed an agreement, effective August 1, 1 972, the essential terms of which are: (a) Firemen will be employed in numbers adequate to fulfill the carrier's operating needs "for training, qualification and promotion to the craft of locomotive engineers" and to fulfill the carrier's needs for passenger crews and for hostlers and hostler helpers. (b) The number of firemen in each seniority district to meet those needs will be determined by a formula, to be recalculated quarterly. If the number of firemen employed in a seniority district exceeds that required under the formula, no additional firemen need be employed in that district, and as attrition occurs the number will be reduced to the formula level. (c) Existing work rules which impose restrictions on work which can be performed by a fireman will be referred to a Standing Committee (one carrier and one Union member) for examination. (d) Retirement of firemen at age 65 will be compulsory beginning January 1, 1974. The carriers and the Union have also entered into an agreement establishing a program to accelerate the training, qualifying and promotion of firemen to the craft of engineer. These agreements will ultimately reduce the number of engine service employees on Penn Central by about 2,700, with a resultant annual saving in employee costs of $40.2 million at present wage rates. 2. As to excess trainmen, an Interim Agreement has been negotiated which the Trustees hope will lead to a satisfactory final settlement. In June 1971, the Trustees instituted collective bargaining procedures under the Railway Labor Act to eliminate arbitrary and unnecessary requirements as to the number of trainmen needed on freight trains. After all procedures under the Act had been exhausted without reaching agreement, the Court, on July 12, 1972, approved the Trustees' petition for authority to promulgate their notice, and the Trustees announced that the new rule would become effective on July 26. The Union announced it would strike, and also sought an injunction against promulgation in the United States District Court in Washington, D. C. In its order of July 1 2, the Court had directed the Trustees to continue to negotiate for a settlement of the issue, and specifically to propose to the Union that some crew reductions be effected during an interim period and that a committee be created to recommend, on the basis of the interim experience, a permanent solution. The Trustees promptly sought further negotiations, and, on July 21, 1972 an arrangement of this sort was agreed to. The substantial terms of the agreement are: "The details of the agreements have been included in a report to the Court dated August 2, 1972 -3- 658 (a) As attrition occurs, 285 crews now manned with two brakemen will be reduced to one brakeman between August 1 and November 30, 1972 (or later, if attrition does not reach 285 by November 30). (b) The 285 crews to be reduced will be designated from throughout the Penn Central system by the Union. To be excluded from that designation are crews in commuter service, crews which cannot be reduced by reason of "full crew" laws, and crews on those trains in branch lines or yard service which management believes cannot, having regard for safety and workload, be operated with one brakeman. (c) A Standing Committee of five, two designated by Penn Central, two by the United Transportation Union, and a Neutral Chairman selected by the parties, is established to encourage further collective bargaining, and in the event no final settlement is reached by November 30, 1972, to set guidelines for a permanent settlement on the basis of the experience with the reduced crews. The parties have agreed on the Rt. Rev. Msgr. George G. Higgins as Neutral Chairman. Monsignor Higgins, of the U. S. Catholic Conference, has an extensive background as impartial chairman and mediator in labor-management matters, especially in the railroad industry. The Court has approved the agreement and directed the Trustees to report to the Court, by December 11,1 972, their recommendations for further action in the event the efforts of the Standing Committee do not result in a settlement of the dispute. The Interim Agreement will reduce operating expenses for 1972 by approximately S1.0 million. (On an annual basis, reduction of 285 trainman positions would lower operating expenses by approximately $4.2 million at current contract rates.) As of September 22, 138 crews have been designated to operate with a conductor and one brakeman pursuant to the July 21 Agreement. Collective bargaining by the Standing Committee with regard to the final solution of the crew consist issue is continuing. The Trustees are also able to report that except in Indiana there are now no state "full crew" laws imposing unnecessary employees on Penn Central. The Indiana law was amended early this year to permit reduction of crews in that state to the size provided for in collectively bargained agreements, subject to review and approval by the Indiana Public Service Commission. Hearings before the Indiana Commission are now in progress. If the Commission approves, the law will permit without further negotiation the reduction by attrition of one trainman from trains which heretofore were required to be operated in that state with three trainmen. This would result in an annual saving, at current rates, of approximately $4.1 million. In addition, the Massachusetts Department of Public Utilities has modified its regulations to permit the reduction of one brakeman from crews designated for such reduction under the Interim Agreement of July 21, 1972 between the Trustees and the United Transportation Union. A further comment is appropriate. While there has been progress, each of the agreements mentioned above, and each of the recently amended "full crew" laws, permits reduction from prior requirements only by attrition. As a result, unnecessary employees will continue in service for many years. An increase in traffic would, of course, absorb some otherwise unnecessary employees. However, the program for reduction of uneconomic freight lines will create even more unnecessary employees, most of whom must, under present labor contracts, be continued in employment until death, resignation or other separation from service. The figures stated at page 1, above, in connection with the proposed freight system, indicate the magnitude of the latter problem. Those figures, however, include only the costs attributable to retention, until reduced by attrition, of employees rendered unnecessary by reductions in the size of the system. The costs of employees who are unnecessary whatever the size of the system, but who can be reduced only by attrition, are not separately identified but are included in "railway operating expenses" in Exhibit II of Annex 1. Finally, it should be added that reductions in nonoperating employees continue, although in some aspects of the Company's business the limit has been reached. Total employment, which was 95,772 as of June 1970, and had been reduced to 82,818 on June 1 5, 1 972, has been reduced to 82,328 as of August 1 5, 1 972. 659 in PASSENGER DEFICITS The Trustees continue to believe that, while Penn Central desires to provide passenger transportation service and is able and willing to do so, continued passenger services must produce enough revenue to cover their full costs. Implementation of that policy requires cost studies, particularly in the Boston — Washington corridor. That corridor is primarily a passenger railroad, with freight activity being conducted alongside Amtrak intercity passenger traffic and local commuter traffic. Since passenger traffic is not a marginal activity, the avoidable-cost approach to subsidy, which presupposes that passenger traffic is a marginal activity, is inappropriate. A study of the corridor, including the line from Philadelphia to Harrisburg, is being made by De Leuw Cather & Company and Haskins & Sells, and separate studies of the Philadelphia and Boston commutation service are being made by Klauder Associates. These studies, basically completed during September but undergoing further refinement, will form the basis of negotiations with Amtrak and various local commuter authorities in the northeastern corridor. The Trustees and Penn Central management have invited Amtrak and the various commuter authorities to assist in evaluating and refining the results of the cost studies. The Trustees believe that Amtrak and local commuter authorities should have ample opportunity to analyze their approach and take positions in regard thereto in the remaining months of 1972. In their January 1, 1973 Report, the Trustees should be able to state whether the responses provide a satisfactory answer to the passenger aspect of the obstacles preventing viability of the Penn Central. In the meantime, some progress has been made. The problems concerning Amtrak rights with respect to former Boston & Providence properties to be sold to the Commonwealth of Massachusetts, which had held up that sale, have been resolved. Currently taking place are discussions concerning possible public acquisition of the Penn Station passenger complex in New York City and the rehabilitation of the Newark passenger station. Recent meetings with officials of New Jersey concerning full cost reimbursement or takeover of various northern New Jersey commuter lines have been encouraging. Discussions with Southeastern Pennsylvania Transportation Authority concerning possible SEPTA takeover of facilities used in the Philadelphia — SEPTA commuter service are also proceeding. Discussions with respect to commuter services in the Chicago, Detroit and Baltimore-Washington areas are being initiated. IV TRAFFIC VOLUME AND REVENUE The Trustees' July 1 , 1972 report referred to "a steadily growing volume of profitable freight business" as an indispensable foundation for a private-income-based reorganization and described the results through May of 1972 as "inconclusive". It added that "by the end of the year (1972) the Trustees should be able to report as to whether this essential element (of an income-based reorganization) can be realized or not." Three months later the results, while still far from conclusive, appear to demonstrate an upward trend along the lines forecast in the Trustees' report of April 1. Carloadings, after lagging 1971 for seven months of 1 972, were 6.8% ahead in the month of August. September is showing even greater gains over 1971, and the latest forecasts by Temple Barker & Sloane and Penn Central Management indicate that the railroad will experience a traffic increase of 3% to 5% for the full year. Freight revenues are ahead of those in 1971, principally because of rate increases and an improved commodity mix favoring higher-rated commodities. Assuming that traffic continues to build in the fourth quarter as forecast, freight revenues for the full year should show a 4% to 7% improvement over 1971. It should be noted, however, that these current forecasts of both traffic and revenues fall below the levels forecast in the Five-Year Base Plan study filed with the Court on February 24, 1972. The differentials in the original and current forecasts are primarily 660 explained by two developments. The reduced levels of freight tonnage and revenues are traceable to three commodities or commodity groups — coal, iron ore, and iron and steel. In addition, the recent hurricane and floods and strikes (including strike threats) affected freight tonnages and revenues adversely, causing the following losses during the period through August: Tons Revenues Flood Loss 1,100,000 $8,200,000 Strike Loss 500,000 $4,000,000 1,650,000 $12,200,000 Looking beyond 1972, the upward business trend so crucial to an income-based reorganization is not so firmly established that the Trustees can feel fully confident that present growth in traffic and revenues will continue unabated. The revenue level originally projected for the 1972—1976 period for coal, a mainstay commodity for Penn Central, has been revised downward because of anticipated slackening in the use of high-sulphur coal. The Trustees continue, however, to see evidence of offsetting gains in many other commodities, some of them highly rated. In the first thirty-seven weeks of 1972, Penn Central increased its share of Eastern District traffic by 3% over the same period one year ago. In respect of some commodities, Penn Central has shown increases over 1971 (and in certain cases, over the forecast) during the first 8 months of the current year. Reported Est. 1972 1971 (tons) (tons) Stone, Clay & Glass Prods 7,200,000 7,084,000 Autos & Parts 7,460,000 7,182,000 Grain 3,900,000 2,682,000 Grain Products 4,980,000 4,968,000 Misc. Food Products 7,510,000 7,499,000 Lumber & Wood Products 4,610,000 4,133,000 Pulp & Paper 9,300,000 8,750,000 Chemical & Allied Products 11,000,000 10,662,000 Petroleum Products 2,000,000 1,871,000 Forwarder-Shipper Assoc. 1,700,000 1,518,000 In addition, the prospects for solid growth in piggyback service constitute Penn Central's best hope for sustained overall increases in volume. So far this year piggyback traffic is up 1 8 percent over 1971. Within the last month, Penn Central has been authorized by the Interstate Commerce Commission to publish round-trip rates on solid 30-car (60 trailers) piggyback trains between New York and Chicago, and service began on September 15. So far the demand is heavy and increasing. Piggyback is the area where, as previously reported to the Court, there is an enormous potential for gain in transferring trailers presently on the highway to lower-cost transportation by rail. Penn Central's rates must reflect this cost advantage and, even more important, its service must continually improve. + 1.6 + 3.9 + 45.4 + 0.2 + 0.1 + 11.5 + 6.3 + 3.2 + 6.9 + 12.0 661 v OTHER REORGANIZATION MATTERS Taxes. The Trustees had earlier hoped to recommend to the Court a program for partial resumption of payment of state and local taxes in the last quarter of this year. Cash flow problems, notably those wrought by the recent hurricane and floods, have thus far frustrated this objective. The Trustees remain nonetheless concerned about the impact, upon the other claimants against the estate as well as upon taxing bodies, of continued deferral of taxes. They are presently exploring a variety of avenues which would permit them to tender partial tax payments at the earliest feasible time. If cash flow permits, their program will not await their January 1, 1973 interim report; at all events, developments in this area will be separately reported on in each of the Trustees' future submissions to the Court on the status of the reorganization. Claims. Following a hearing on August 28, 1972, the Court approved certain future steps in the Proof of Claims program. The Court has now ordered that — (a) a claimant who files a proof of claim or amendment thereto after the applicable deadline is to be excluded from consideration or participation in any plan of reorganization except where the claimant affirmatively demonstrates to the Court good cause for exemption from the deadlines; (b) claimants (other than dividend claimants) who were previously omitted from the proofs of claim program are to be given further notice of the requirement of filing proofs of claim and a period of 60 days within which to file; (c) dividend claimants, most of whom the Trustees cannot locate, are to be exempted from the requirement of filing proofs of claim; (d) the Trustees are to investigate and report on the claims of each claimant; each claimant is to be afforded an opportunity to establish his entitlement to any amount (or status, or priority) not acknowledged by the Trustees; continuing differences are to be resolved by settlement or liquidation by the Court or a special master, and interested claimants are to be given an opportunity to object to the resolution of the claims of other claimants; (e) there is to be established, for the coordination of the many activities involved in the proofs of claim program, a Proofs of Claim Office, Office of the Trustees, Penn Central Transportation Company, 1 5 North 32nd Street, Philadelphia, Pennsylvania 1 9 1 04, along with an Administrator thereof; and (f) the Administrator of the Proofs of Claim Office is to maintain a public claims register containing the essential terms of the liquidation of the claims of each claimant as such liquidation occurs, and is to report to the Court monthly on the status of the liquidation of pre-bankruptcy claims. Leased lines. Progress continues toward resolution of the difficult problems posed by the need to adopt or reject leases of various lines of railroad. A petition has been filed seeking authority to adopt the lease of the Erie & Kalamazoo Railroad. The lessor has filed an answer consenting to such adoption. The hearing on the petition to comply with the agreement to operate the Peoria & Eastern Railroad has been postponed due to the uncertainties surrounding the Debtor's cash position in the aftermath of the recent hurricane and floods, but will be rescheduled as soon as possible. The Interstate Commerce Commission has affirmed the decision of Division 3 gra nting th e__aep!Jcation of the Providence & Worcester Company for a certificate authorizing the P&W to commence independent operation of its line of railroad, and the P&W hasTiTed with the Court the notice required under Order No. 1 70 stating its intention to retake its property and commence operation in accordance with the order and certificate of the Commission. The Court has extended the stay imposed by Order No. 170 until October 13, 1972, to afford the Trustees time to decide on any further steps which may be appropriate with respect to the P&W. -7- 662 The decision by the Court on the agreement to settle the PCI loan matter, described in earlier reports of the Trustees, and now pending before the Court, will remove some of the uncertainties with respect to the leases of Penndel Co. and The Philadelphia, Baltimore & Washington Railroad Company. A Court decision on the settlement with pledgees of Pennsylvania Company stock will likewise remove some of the uncertainties with respect to several leases. The studies which bear on decisions whether to adopt or reject various leases are proceeding as scheduled. As already reported, the study of the costs of providing passenger service in the northeast corridor has been substantially completed, and Wyer, Dick & Co., having completed its viability study, is now turning its attention to the allocation of projected earnings to leased lines and other segments included in the 15,000-mile system proposed for reorganization. Completion of these studies will greatly aid in deciding whether to adopt or reject particular leases. A method of allocating system revenues and expenses among leased lines and other segments of the Debtor's system has been proposed and is being tested for reliability. For reasons of economy and practicability, initial application of the system will be limited to leased lines. The new record keeping required is scheduled to be placed in effect as of January 1 , 1973, and the formula for allocating revenues and expenses will be completed and ready for application to the results of operations in the first quarter of 1973. The situations of the leased lines not discussed herein, and of the Pennsylvania- Reading Seashore Lines, have not changed materially since the Trustees' July 1, 1972 Report. The Trustees believe, for the reasons set forth here and in their prior reports on executory contracts and leased lines, that prudent action is not yet possible with respect to those leases and agreements as to which no petition to adopt or reject has been filed. They recommend, therefore, that the Court extend until further order the Trustees' time to adopt or reject those leases and agreements, provided that the Trustees will include a further report thereon in their report due January 1, 1973. VI ALTERNATIVES TO AN INCOME-BASED REORGANIZATION In their July 1, 1 972 Report, the Trustees, while noting the progress which had been made toward achieving a conventional private-income-based reorganization, recognized that a range of alternatives should be formulated in case future developments force the Trustees to the conclusion that such a reorganization is not possible. This is not a position of pessimism but one of prudence so that the Court, the public and all interested parties may begin to consider the alternatives. The Trustees will be doing likewise during the coming months, and will welcome further suggestions. At the risk of stating the obvious, the alternatives to a private-income-based reorganization are by no means limited to complete government ownership and operation — nationalization — or cessation of service — liquidation. In between are a wide variety of possibilities, and an even wider variety of combinations of such possibilities. What follows, therefore, in the first part of this section are basic elements of alternative plans based upon public assistance. These include those that involve public funds or credit, and those that do not. A second part illustrates how some of these elements could be combined in a plan of reorganization. The Trustees have reached no conclusion, even tentative, on the most desirable alternative. Their evaluation continues and will be obviously benefited by responses to this submission. They will continue to evaluate the elements and combinations of elements. 1. Elements of Alternative Plans A. Assistance Involving Public Funds Public assistance could be used to support operating costs, or to supply capital needs. In the former category are: S- 663 1 . "Need" subsidy. Such a subsidy would make up any short-fall between income and expenses, including some reasonable compensation to claimants against the bankrupt estate. Analogies are the manner in which the Federal Government supports local service private-enterprise airlines, what foreign governments do when they pick up the "bottom line deficit" of their nationalized carriers, and essentially the way in which, until recently, the United States Postal Service was supported. The amount of the subsidy may also be on some type of formula set in advance, such as the Class Subsidy Rates for local airlines or the Index Subsidy for shipping, which is designed to build in an incentive for efficiency. 2. "Ad hoc" subsidy. This is paid for specified purposes, services or objectives. Such a subsidy might be paid either for maintaining a particular line or for carrying certain types of traffic. In the former category would fall a subsidy for maintaining service over some of the lines excluded from the system which the Trustees have selected, but which are deemed essential, or branch lines which state or local governments or shippers wish to continue in operation. In the latter category would be a subsidy for handling recyclable material at non-compensatory rates or for encouraging export trade. Canada has used subsidies of the latter sort for certain rates on export grain, and for maintaining rail service in the Maritime Provinces. In many countries a considerable portion of passenger service is operated at a loss and is subsidized in such a way. 3. "Unloading" relief. A variant of "ad hoc" subsidy is what may be called "unloading" relief — taking over from the railroad various activities which it has been required to perform at a loss. The financial consequences are similar, but in "unloading" relief, as distinguished from "ad hoc" relief, the railroad is no longer in a position of primary responsibility; some governmental or quasi-governmental agency is interposed. The obvious examples are Amtrak and urban transit authorities, but the pattern could be extended — for example, to grade crossing elimination, maintenance of overpasses and bridges by state highway authorities, public ownership and operation of branch or secondary mileage. "Unloading," in a somewhat special sense, would also include abatement of all real estate taxes on railroad right-of-way (many states already abate such taxes) and on some or all yard facilities. Any such "unloading" would doubtless require a sharing of the tax burden by the Federal Government, since many local taxing authorities are now heavily dependent on railroad real estate taxes. "Unloading" would also include an assumption by the Federal Government of all or a part of the costs involved in reduction of the labor force — the labor protection liability which is now involved in the present gjiataotg e of a lifetime Job for most o _f_ the railroad's employees. Such assistance could be either a one-time payment (if the claims were liquidated ffuough negotiation on a lump-sum asis) or as a diminishing payment over a period of 10—15 years. 4. Segregation of "corridor" railroad. One particular form of "ad hoc" subsidy requires a more elaborate explanation. The northeastern corridor from Boston to Washington has important characteristics quite different from those of the rest of the system. As is suggested elsewhere, the general inability of passenger service to be supported from the fare box, plus the huge capital costs and substantial additional maintenance of way and signaling expenditures associated with present and future high-speed corridor passenger service will require heavy public support of as much as two-thirds of the corridor's activities. Given present inadequate divisions, the cost of operating major East Coast freight terminals and the cost of dovetailing corridor freight service with the high volume of priority passenger service, corridor freight service would probably continue to be less profitable than that on the remainder of the Penn Central system. Despite its financial problems, however, the northeastern corridor is clearly essential in the national and regional interest for both economic and environmental reasons. The rest of the Penn Central system is primarily a freight railroad with relatively marginal intercity passenger service and commuter service. Although under present conditions the rest of the system loses money as a whole, it can be made self-supporting with much less difficulty than the corridor. The foregoing considerations suggest that the operating property and facilities of the northeastern corridor could be segregated from the balance of the railroad tiy_co_nyeyjng them to a separate corporation or otherwise, in order that public funds could be directed 664 toward this portion of the system in any of the variety of ways stated in this Report. Participation in such subsidies by state and local agencies as well as by the Federal Government might well be anticipated. In the category of public assistance in meeting capital costs are the following: 5. Acquisition of right-of-way. Partial government ownership rather than complete nationalization could be achieved by government purchase of the railroad's right-of-way, with a provision for the railroad's use of the line. The purchase could be of the entire right- of-way or only a part of it; it could be of all railroads or only of those in the part of the country where present railroad bankruptcies are concentrated. The acquisition could be limited to the underlying right-of-way, or could include improvements and auxiliary plant facilities such as freight terminals. The essential feature is a governmental taking over the costs associated with the basic "right-of-way," as is the case, in one way or another, with highways, waterways and airways. 6. Car supply. Government assistance in providing freight cars is another possibility. The perennial shortage of cars at the right place at the right time, compounded by the present strong trend toward special or specially equipped cars that move under load in only one direction, has prompted a variety of proposals for government assistance — by way of cheaper or more available credit or^eyen a publicly owned freight car flee t. A correlative approach would be government funds to develop and install a computerized car control system on a nationwide basis, since improvement in freight car utilization would have the same effect as adding more cars to the nation's fleet. 7. Loans and guarantees. Loans or loan guarantees offer a different means of assistance. The United States has already guaranteed a loan to the Trustees from private investors of $100 million. Loans and loan guarantees were the devices used by the Reconstruction Finance Corporation when a third of the railroad mileage of the United States was in bankruptcy. They are being proposed as a basis for some relief from the costs of repairing the damage caused by the recent hurricane and floods. Loans or guarantees might also be made available for the purpose of retiring existing debt and claims at less than face value, with the consequent reduction of fixed charges and, doubtless, of litigation in the bankruptcy proceeding. B. Assistance Not Involving Public Funds The possibilities involving no government funds, now to be discussed, are nonetheless primarily within the power of government to grant, or require the active cooperation of government and other parties, such as other railroads. 1 . Equitable relief. There are a number of areas in which some legislative action could correct inequities. The Congress appears to be willing to move, for example, against local taxes which discriminate against railroad property. In only one of these areas, however, would there be a prospect of material improvement for Penn Central — legislation designed to permit a prompt resolution of the inequity resulting from the present division of rates between the southern and certain western railroads, on the one hand, and the eastern railroads, including Penn Central, on the other. Present Interstate Commerce Commission procedures and practices result in inordinate delays, and delay itself is one of the inequities. Penn Central has already urged a partial remedy in addition to present court remedies — that any change in divisions be made retroactive to the commencement of the ICC proceeding in order to reduce the incentive to prolong the proceeding. Legislation might also direct a prompt Commission decision, with retroactivity to the date of the legislation, and with an appropriation of the extra funds needed by the Commission to make promptness possible. 2. Segregation of non-rail assets. The Trustees' Plan for Reorganization of April 1, 1 972 presupposes that substantial benefits from the development or sale of Penn Central non-operating real property would accrue to the reorganized railroad. (The discussion in this section excludes Pennsylvania Company properties, which would be disposed of.) Under the Plan, the lien of New System Mortgage Bonds is limited to operating property; this would make it possible to form a separate real estate subsidiary of the reorganized -10- 665 company which could maximize the development potential of these properties. If a private- income-based reorganization is attained, the benefits from real estate rents, sales or development could provide a valuable cushion protecting the long-term viability of the reorganized railroad under cyclical changes in the economy. The Real Estate Reorganization Board created by the Trustees in July has identified 338 parcels of non-operating real estate at various locations scattered over the Penn Central system with a probable individual value of more than $100,000 each, and with an aggregate value in the range of 5600,000,000 to $650,000,000. This total, which includes seven mid-Manhattan properties under contract of sale subject to Court approval, comprises income-producing properties already developed to their highest and best use; other properties yielding less than optimum income pending redevelopment planned or in progress; abandoned yard and terminal facilities producing little income but suitable for development over time; and vacant parcels whose location is valuable in relation to the plans of other developers. The current cash flow from the income-producing properties is between $25 and $30 million annually before property taxes. State and local taxes on these properties are currently running at the rate of $12.5 million a year. Redevelopment of properties might cause property taxes to rise, but any such increase should be modest in relation to the attendant enhancement in values and in cash flow. Kuhn, Loeb & Co. and Jackson-Cross Co., financial and real estate consultants to the Trustees, believe that a real estate entity formed to hold, manage, develop and — where appropriate — sell Penn Central non-operating properties would be financially viable. An alternative, therefore, is such a separation of the non-operating real estate from the railroad. The proposed real estate company could be a wholly owned subsidiary of the railroad, or it might be less than wholly owned, with a portion of the equity securities distributed to claimants or made available on appropriate terms to unaffiliated interests such as co-venturers in development projects In the opinion of Kuhn, Loeb & Co., real estate placed in a separate company would produce substantially greater values in new senior and junior securities for distribution to claimants than would obtain without such a separation. Furthermore, if a purely private-income-based reorganization is not feasible, the additional values created by separation of non-rail assets could make a substantial contribution towards satisfying the claims against Penn Central. To the extent this is done, the public contribution required for the railroad from government agencies or shippers would be reduced. The Trustees have reviewed current sales under consideration as well as the proposed disposition of their stock interest in Pennco in the light of this possible alternative. Since litigation is pending or may be brought in connection with those transactions, it is appropriate only to comment that the Trustees find no inconsistencies^ 3. Eastern railroad restructuring. That most eastern railroad mileage is now in bankruptcy necessarily suggests that the problems to be solved are regional and that a regional approach — a restructuring of the entire eastern railroad system — would be an alternative, perhaps requiring a quasi-government corporation with opportunity for private participation. ' 4. Sales to others. One alternative short of outright liquidation would be the sale of all or of some Penn Central lines, appropriately grouped, to any prospective purchaser offering a reasonable price. Lines for which no such purchaser came forward would be dealt with under other alternatives. 2. Possible Combinations As already indicated, the elements or alternatives can be combined in a variety of ways. The three combinations which follow are stated generally and only for purposes of illustration. A. "Intermediate" Mileage. As already noted, there is considerable mileage in the present Penn Central system which falls in what may be described as an intermediate category. This is mileage which produces net operating losses but which cannot be -11- 666 eliminated without also producing, in the short term, labor protection costs .eyenjjreater tKarTlhe present losses. Some of this mileage could well be deemed "essential," in any governmental evaluation of "essential railroad mileage," and some of it might well not qualify for abandonment under the current abandonment standards of the Commission. A combination of elements could permit Penn Central to take advantage of the greater net operating income potential of the smaller system. A subsidy might be provided by the Federal Government for those portions of this intermediate mileage deemed essential, in whatever amount was necessary to bring the contribution of that mileage up to the level of the remainder of the system. If revenues on a portion increased, the subsidy would decrease or terminate entirely. Alternatively, such essential mileage could be acquired by the government outright. In either event, this mileage would continue to be operated, and the labor protection costs which would result from its abandonment would be avoided. Whatever part of the "intermediate" mileage was neither subsidized nor acquired would be abandoned, and the Federal Government would undertake to assume the resulting labor protection costs. A combination of federal and state or local funds to achieve all this could be worked out. This combination of elements could of course be combined with other forms of relief, which would reduce the amounts necessary for subsidy. This combination could also provide for a reexamination by the Federal Government at periodic intervals to determine whether particular intermediate mileage being subsidized should be purchased or abandoned. It is likely that the same combination of elements could be used in a coordinated way for all bankrupt eastern railroads. B. "Corridor" acquisition. The separation of the northeast corridor portion of the present Penn Central system referred to at pages 9 — 10 could be combined with government acquisiton of the right-of-way and fixed plant in that corridor. Much of the mileage in the northeast corridor is now primarily used by Amtrak or one of the urban transit authorities or both, and thus is already devoted to non-commercial, quasi- governmental use. The viability of the remainder of the present Penn Central system would be enhanced if the corridor burdens were entirely eliminated. Freight operations in the corridor would be preserved and paid for. This alternative could be combined with the alternative mentioned in the preceding section A. V s " the northeastern corridor and the separation of the non-operating real estate described at pages 10— 1 1 . This would result in three components: the northeast corridor rail system, the balance of the rail system, and the non-operating real estate. As already indicated, the rail system in the northeast corridor would be subsidized. The remaining privately owned rail system would be able to stand on its own feet, or could be enabled to do so by some of the alternatives already noted. The real estate component, as a separate entity, would provide a substantial amount for the claimants against the bankrupt estate, reducing the amount of compensation required from other sources. CONCLUSION Many interests in this reorganization, especially those involved with creditors' rights, have expressed impatience at the progress made towards attaining the prerequisites of a successful reorganization. Many also have interpreted the Trustees' willingness to develop and explore alternatives to a conventional plan as an expression of doubt that a successful reorganization can be achieved. Such reactions are not surprising, but in view of the magnitude of the problems, the Trustees believe their approach is the correct one. As noted in the Trustees Preliminary Report of February 10, 1971, "the conditions to Penn Central's viability are hard and introduce factors that go far beyond the normal boundaries of a railroad reorganization proceeding under Section 77." In the main, the Trustees consider progress to date satisfactory. -12- 667 Further, the exploration of alternatives cannot be considered as any indication of a retreat from the Trustees' unequivocal preference for a reorganization within private enterprise. Nor can it be interpreted as a lack of confidence in the feasibility of such a reorganization. Creative government involvement has always figured in the Trustees' plans. Again, as early as their February 10, 1971 Report, the Trustees noted that an overriding problem of Penn Central is its "obligation to perform as a public service company in certain areas and under certain conditions which simply do not lend themselves to profitable operations, no matter who the operator is, or how efficient. The only possible remedy here is for public authority to lend its hand to a speedy elimination of the conditions which produce the losses, or respond with adequate compensation if it insists upon a continuance of the conditions." Finally, whatever the precise form the plan of reorganization finally takes, it will be based upon a continuation of the bulk of the railroad's services. Penn Central is simply too important in the national transportation system for any other result seriously to be considered. For that reason, steps taken in the interim to improve the railroad's plant and service can only serve to enhance its value, for the benefit of its owners no less than for the public good. Respectfully submitted, GEORGE P. BAKER, RICHARD C. BOND, JERVIS LANGDON, JR. AND WILLARD WIRTZ, TRUSTEES OF THE PROPERTY OF PENN CENTRAL TRANSPORTATION COMPANY, DEBTOR. By /s/ Jervis Langdon, Jr. One of the Trustees /s/ Robert W. Blanchette Robert W. Blanchette Counsel for Trustees /s/ Covington & Burling Covington & Burling Special Counsel for Trustees Dated: October 2, 1972 13 74-924 O - 73 - 44 668 ANNEX 1 W2> VIABILITY STUDIES PENN CENTRAL TRANSPORTATION COMPANY wyer.dick « co. September 25. 1972 TRANSPORTATION CONSULTANTS Prepared by Wyer, Dick & Co. Newark. New Jersey I. DESCRIPTION OF STUDIES At the request of the Trustees we have studied the potential viability of Penn Central freight rail networks of approximately 1 1,000 and 15,000 road miles in size. The 1 1,000 mile system consists of major through routes and known high-density feeder lines. The 15,000 mile system is the railroad that results after abandonment of approximately 5,000 route miles which are included in the present Penn Central abandonment program. The detailed parameters of each network studied are shown in Exhibit I, attached, and are portrayed on the accompanying map. It should be clearly understood that the systems represented on the map are hypothetical and were established for study purposes only. External forces, such as hurricane Agnes and the normal management decision process, preclude this map's being used beyond its described purpose. In brief, it was assumed that the 1 1 ,000 mile system came into being instantaneously at midnight on December 31, 1971. For comparative purposes, a similar assumption was made with respect to the 15,000 mile system. Finally, the 15,000 mile network was achieved by gradual reduction, in steps that gave effect to various phases of the abandonment program through the year 1975, so that the ultimate configuration existed for the entire year 1976. The studies assign revenue to each segment based on an analysis of actual origins and destinations, plus an evaluation of traffic which otherwise might be lost through abandonment to determine that which might be retained through alternate origins and destinations. Operating costs were assigned by a formula which reflected the size of the road, the volume of operations and anticipated density of traffic. A sophisticated computer Model represented the lines to be studied and was used to accumulate revenue and related transportation units. The base year for the studies was 1971 and the traffic and revenue projections made by Temple, Barker & Sloane were applied to produce results for the years 1 973 to 1976, inclusive. The results, thus attained, include: estimated cost escalation, gains in productivity, and crew manning assumptions based on current labor agreements and negotiations. The studies also include estimates of non-recurring expenditures to stabilize maintenance levels and to provide for the cost of labor protection. It should be understood that the rail networks described above are not comparable to any existing railroad, particularly in the territory served by Penn Central. The 1 1,000 mile road to a great degree, and the 1 5,000 mile road to a lesser degree, represent a new type of transportation system consisting of main lines and high density feeder lines. The concept requires scattered shippers not located in highly industrialized areas to come to the railroad rather than having the railroad pome to_ _them. The economic burden of pas^eTrg^r^s^?vTce~s"¥ssumled _ l6 _ He borne elsewhere; and the ability to abandon lines which do not fit the concept is a sine qua non. Finally, rationalization of labor's "rights" and the railroads "needs" is considered as achievable. (131.9) (55.4) 31.3 102.7 (51.6) 33.8 130.8 212.4 (67.6) 26.6 120.4 212.4 669 II. SUMMARY OF RESULTS The results of the several studies (shown in detail in Exhibit II) are summarized in the table below: NET RAILWAY OPERATING INCOME (In Millions of Dollars) System 1973 1974 1975 1976 1 1,000 MILES 15,000 MILES 15,000 MILES - IN STEPS ( ) — Denotes Deficit III. ASSUMPTIONS The following assumptions were made: 1. Each rail network will handle freight only and passenger operations will not constitute a burden in any way. This assumption goes beyond the concept that passenger service is self-sustaining; it assumes, in essence, that the passenger service does not exist. 2. The allocation of revenues and costs between freight and passenger services, shown in the Form A Report to the Interstate Commerce Commission for the year 1971, was used as a base for all studies. If other studies now in progress substantiate different allocations, modifications can be made to reflect these changes. 3. The studies are based on 1971 revenues and unit costs except for specifically described adjustments for improvements in efficiency and labor productivity which reflect either changes already put into effect at the time the study was made or future changes which are believed to be reasonable and obtainable. Adjustments were made to 1971 revenues and traffic levels to reflect increased tonnage, change in traffic mix and change in rate levels as projected by Temple, Barker & Sloane, Inc. Adjustments were made to 1971 costs to reflect: a. Higher average gross tons per locomotive unit on main line and primary feeder lines where daily service is involved. b. Greater average number of cars per train obtainable on a higher density railroad. c Reduced number of car handlings reflecting the continuing trend of greater use of assigned equipment. d. Reduced number of intermediate switches per loaded car handled due to higher ratio of through traffic and empty car blocking efficiencies. e. Improved car utilization to reflect improvements already achieved. f Increased average net tons per carload due to the continuing trend toward increased average car capacity, g. Increased labor productivity reflecting historic trends and the effects of continuing capital expenditures, h Estimated savings from implementation of the current labor agreements and negotiations relating to crew manning. i. Normalization of maintenance costs. 4. Appropriate factors were applied to operating expenses, rents and taxes, to provide for the escalation of costs in the years 1973 through 1976. 670 IV. DESCRIPTION OF COMPUTER MODEL The Rail Freight Model is designed to facilitate evaluation of the effect of various alternatives in rail freight plant and/or operations. It is a hypothesis-testing model, combining management judgment and computer analysis to maximize operating income. The Model is comprised of data describing the system under study, and a series of programs to operate on the data. The data include: 1. A numeric description of the rail network. The network is represented as an ensemble of nodes and segments, with pertinent characteristics assigned to each node and segment. 2. A numeric description of the traffic handled by the system during a base period. The traffic is represented by records describing the revenue, carloads, and net tonnage for each type of traffic between each origin-destination pair Processing is performed in three major steps: 1. Routing of Traffic. A route is developed for each origin-destination pair, in accordance with a transportation policy specified for the run. Classification yards are identified for each route. 2. Traffic Analysis. The loaded car movements are accumulated by segments and nodes, and procedures are applied to develop other characteristics such as empty car, locomotive and train densities, gross tonnages, and fuel consumption. Totals are generated by segment, node, yard, and for the system. Additionally, the network may be divided into regions, and region summaries produced. 3. Cost Analysis. Application of appropriate cost factors to the data developed in the traffic analysis produces the operating cost Cost summaries are prepared by ICC account code V. ESTIMATED REVENUES 1. Bases of Estimates. Revenue estimates were based on an analysis of the summarized Freight Revenue Accounting (FRA) tapes for the year 1971. Revenue movements were sorted by origin and destination and revenues for each movement where both the origin and destination were on the road being studied were accumulated. For this purpose a junction-on was considered to be an origin and a junction-off was considered to be a destination At the same time that the revenues were collected, traffic was sorted into basic commodity groups to permit projection of the future and better analysis of potential traffic retention. 2 Traffic Retention Studies. In preparation for this study. Traffic Department field representatives were furnished with maps and descriptions of networks being studied and were asked to evaluate the possibility of retaining traffic originating or terminating on lines in their district which were proposed to be abandoned. These estimates were reviewed and in some instances revised by department officials and were used as a basis for judgments with respect to individual moves. All off-line traffic movements were printed out and were individually examined by a special team with traffic and operating experience. This team used the prior evaluations, referred to above, to determine what portion of the traffic might be retained through new origin, destination or junction stations. In each case the mileage and revenues were revised to reflect the changed movement. Overall retention ranged from 21% to 25.8% of the gross revenues that had previously been excluded. 3. Method of Revenue Statement. Since the FRA tape records gross revenues, it was necessary to equate such revenues to Account 101, which is the level reported to the Interstate Commerce Commission. The 671 difference is accounted for by absorptions, adjustments, etc. The 1971 actual relationship of 95.38% was used. 4. Projections of Future Traffic Levels. Future traffic levels were projected on the basis of the report made by TBS and reflected changes in traffic mix as well as total projected tonnage for the years 1973 through 1 976. TBS estimates were expressed in terms of percentage changes which were then applied by major commodities to the base year traffic handled on the several roads, including traffic retention. 5. Projections of Future Rate Levels. Future rate levels and therefore the amount of total freight revenue were projected on the same basis used by TBS in their report. It was assumed that rate levels would increase sufficiently to absorb most of the projected cost escalation for each year over and above that portion absorbed by improvements in productivity. The assumed absorption was 90% in 1973, 92% in 1974, 95% in 1975 and 97% in 1976. Such absorption was assumed to be at the rate of 50% in the first year following and full recovery in the second year following. 6. Other Revenues. Joint facility Debits and Credits (Accounts 1 5 1 and 1 52) were adjusted to reflect a point by point analysis to determine what joint facilities would be on the several networks. The remaining revenue accounts making up total freight revenues, i.e.: Mail (Account 106), Express (Account 107), Switching (Account 1 10), Water Transfers (Account 1 13), Storage-Freight (Account 135), Demurrage (Account 137), Rents (Account 142) and Miscellaneous (Account 143) were expressed as a ratio to Account 101 in the base year for each of the study networks and were assumed to remain unchanged through 1976 since these accounts are not normally affected by general freight rate increases. VI. ESTIMATED OPERATING COSTS 1. Description of Costing Procedures. The costing procedures in essence involved the assignment of a portion of the total freight expense shown in Penn Central's Annual Report Form A to the Interstate Commerce Commission for the year 1971 to each of the systems studied to reflect the effect of anticipated changes in size of the plant, traffic volume, methods of operation and resulting traffic density. In order to approximate reality and to reflect the changes outlined above, the primary accounts were separated into special study groupings with the accounts in each group having a homogeneity which demands like treatment and analysis. 2. Key Sub Studies requiring separate handling are the following: Organizational Analysis The accounts in this study, which have to do with supervision, management and traffic, are not considered to be variable with moderate increases or decreases in traffic. Their size is established by the overall size of the plant to be supervised and by management philosophy. Studies were made to establish the organization management and supervision necessary to operate the basic networks. In so doing, the management philosophy of Penn Central was adopted. Normalized Maintenance of Way Maintenance of Way expenditures for road and track accounts only have been normalized. Such expenses vary from year to year, and the actual requirements in any one year depend in large measure upon the amount of material applied in previous years in relation to the volume of traffic handled. The actual expenditures in any given period are affected by weather, by the appropriate cycle of maintenance for a particular element of property and by economic factors. 672 Normal or average annual maintenance represents the average expenditures required over the years to maintain the property efficiently and takes into account the estimated life of the various elements over their full life cycle. Stabilization of maintenance levels was handled in a separate study which will be discussed later. Joint Facility Analysis Joint facilities were analyzed on a location basis to establish which joint facilities were on each of the networks. Valuation Study Analysis A special analysis was made of the previously completed valuation studies to permit the apportionment of certain maintenance of way accounts on a location basis. Since detailed maintenance data were not available by location, it was assumed that the maintenance on and off the networks being studied was in proportion to valuation. Management Center Location Analysis This analysis was used to place such expenses as drawbridge operation and operating floating equipment on a location basis. Distribution of Overheads Items of this type, such as stationery and printing, are not directly variable with traffic but are affected by other accounts which may be either fixed or variable. They were allocated in proportion to such accounts as a group. Operations Model The operations model as described in IV above produced operating units such as car miles, unit miles, yard engine hours, train miles, etc. Costs for each of the systems for those accounts which are 1 00% variable with such operating units were computed, based on the relationship to the base year. For example, yard operating expenses vary with yard engine hours. VII. ESTIMATED RENTS & TAXES Equipment rents were initially developed for each of the roads studied by applying use factors to the equipment and equipment costs that existed in 1971. Subsequently, the Penn Central Director of Planning Coordination made a revised equipment acquisition forecast which resulted in the adjusted net rents shown in Exhibit II. State and local taxes are presently represented by order of magnitude estimates based on preliminary results. VIII. COST ESCALATION Cost escalation factors were developed for these studies on the same basis that was used for the Base Plan Study. A combined cost escalation factor covering wages, fringes, materials, rents, and taxes was applied to total operating expenses including rents and taxes. IX. MAINTENANCE STABILIZATION STUDY A study was made to determine the expenditures (above normalized) necessary to place the physical plant facilities in an adequate condition to handle traffic with a minimum of interruptions from derailments and slow orders. This study was conducted in the following manner: 1. Track Structure. An analysis of expenditures and material installations over a 17 year period was made and these figures were compared to reasonable expected service life of materials and certain conclusions were drawn. Spot field checks were made in order to check the accuracy of the conclusions. 673 2. Depreciable Accounts. Study was made from an analysis of expenditures over a 1 7 year period and general spot field checking to arrive upon certain conclusions. 3. Maintenance of Roadway Machinery. Comparison was made of the increase in capital account to the rate of maintenance expense in order to arrive at a conclusion as to whether machinery is receiving adequate maintenance. It was assumed that the required work could be performed over a period of eight years. X. LABOR PROTECTION Estimates of the cost of labor protection were based on the assumption that the work force could only be reduced by attrition. For train and engine crews an attrition rate of 5% was applied by the Penn Central Labor Relations Department and their conclusions were adopted for this study. Attrition for all other employees was taken at 60% of 5% or an effective rate of 3% to reflect the difficulty of filling jobs vacated by attrition with available and qualified employees. Labor protection cost estimates, including fringe benefits and payroll taxes, are set forth below: 1973 1974 1975 1976 (millions of dollars) $193.7 $196.5 23.8 20.0 188 20.0 Labor protection cost is defined as the cost of continued employment, reduced only by attrition, of those employees who would be made unnecessary because of reduction of the existing system to the 11,000 and 15,000 mile systems, respectively. Labor protection cost, as thus defined, does not include the cost of excess trainmen on crews to be retained. That cost is included in railway operating expenses. 1 1 000 MILES $190.9 $193.0 15 000 MILES 33.1 28.9 15 000 MILES in steps 16.0 19.5 674 CDr-kDk£)H(NC0OfMO LnuicoorH^DOOrnmas — * ~ en o o 3 o o 1 ►J S H V) C W 4J ■0 ~l n H +J n HI H Ui m III g M C a u u is o H D >- w 675 n IH M O (-1 CM H IB 4J M (U SSJi W to (N m cr> ■^(Niono o> o to ^ in '^'Hr-O'-i -tf in r-n r- o*» COfN^DOOO -* n CO (N (N r-nHincN^D T >— i co fH r^ CT>mcoorn cOtN^men m co n h h ~-~ « ^ (0 o O o o o CD o o o o III H o a o o 0) •H 0) 01 ^ — - 1— i s in ID ID 0) -H CD CO C iH (0 10 s c rH CD •H u) H -H •e CD -H cn , ,h m c* er< m cn >£> -SSI m CO in cr» r- CO ^J" O f) m r- fN (S an CO H m m in (N 111 ri o O <-* CTi cr> in vO CM ^0 . O -~ o o o o w o o o in to w w <-* 0) Q> H •-H -rH T3 (i) s s a) X 4J o o n a: eh o -M J 2 U) O O 3 0) o o O ^-i — o X i m u a) tn c c t-l Eh S -H C s w tn c ■P T) .. C n) (J U Z O E-i 3 >< H H 4^ O « ro nj d> in 1-t 677 r-t r- 0> m >-\ CO O u-J r* cm r- vd (7* m .-< *t LI V § X 5 - .xx * s r- r- m CO CO CT* C •H (J e Ul rd q> o> M u 3 W 01 0) c C C a E M 0) ft -P Cn 1) X 0) 0} c c SU >, H ■H u K (0 ■p en o> 3 01 10 c c c e In C u ■H -H •H 4J +J H u O ■P ft nj id P «H < Q o h h U U 0) 01 0) 01 X a >< ft ft p 3 ro a IS o o c E- o U) 3 in 0) JJ >, Si Q. > Si >< C •rH (0 10 0) 10 10 ai 10 3 3 M a 3 3 K a r-H r-H f-i ■H -H ,Q •P •H -rH ■P ■p 01 rO 10 01 01 a « j z s K z z 678 H &H fN aj 4J M 0) a 0J M en ^ o o cn co m co m O vO H N "* \£) H vO (D m N N w H H 2 Q Q 3 CO B O •P c O c ui u 0) -l-t < m 3 ►J o H u ■a c a z 0) H < H ■p ^H M > E O \£> O *t vD «^> \D m 't OIN H c^ m ^t co rH c^ r* o r- r»i o CN CO m >~i ^H 0"» c c a 0) 1) to o > Q. -P eg X 0) OS U >. u a. tr CP c c c E ■H •H 4J +J H L, m flj -P . >. 0< > ig ig 0) * H 3S K •H ■H ,Q 4J rg m a (U a 05 iJ Z 679 en o o c^ co m co 1/1 3J! d> cr> co <— i 00 *tf* «h cn o m in O en i^) 2 Q 5 o c U -0 H en p^ *tf ■^ (N H O ^H CO in CO m m rH .H (N •H OJ JJ E to (0 O dl (1) u 3 in a +> Dl a x in ca c C a u o >i iH H ■H u a 10 *J Dl 0< 3 Dl IS C C C e lH c VH •H -H ■H OJ 4J JJ -H M +> ft 10 (0 H-> m < 10 O h >< (J S-l CD CJ 0) a> X ai >i a a v 3 10 Oh n o o c H O 01 3 M OJ ■P »H >, >, a. > >i >c c ■H (0 ro V rO 10 0) 10 3 3 n a. 3 3 a a M .-t •H -H Si +i ■rH -H ■p •P 10 (0 (0 o 10 (0 0) OJ a « j z a: a z z 680 Annex 2 Page 1 of 3 PENN CENTRA L TRANS PORTAT I ON CO 1 IP At; Y Pro Forma Income Statements Based en Viability Studies (a) 11,000 Miles (Dollars in Millions) 1973 1974 197 5 1976 Set Railway Operating Income - $(131.9) $(55.4) $31.3 $102.7 Freight Service (b) Net Railway Operating Income - Passenger Service (c) (c) (c) (c) Trustees Administrative Expenses 6.5 6. 5 6.5 6 . 5 Sub Total (138.4) (61.9) 24.8 96.2 Non-Operating Income Less Miscellaneous Deductions 36.9 36.9 36.9 36.9 S(25.0) $61.7 $133.1 Income Available for Fixed Charges $(101. 5) (a) Excludes impact of property retirements or sales of lines outside system studied. Also excludes profit from major sales of non-operating property. (b) Includes deduction of the follow- ing items: Depreciation of property used in freight service - road $19.7 $19.7 $19.7 $19.7 - equipment 45.5 47.0 47.2 47.*8 State and local taxes on prop- erty used in freight service 46.6 48.2 49.7 51.2 Lease rentals for freight service equipment 90. 1 94.6 97.7 100. (c) Assumed to be sufficient to cover return on capital investment in passenger service. KUHN , LOEB & CO. 681 P£NN CENTRAL TRANSPORTATION COMPANY Pro Korma Inccr^ Stater-enCs Based on Viability Studies (a) Anno; 2 Page 2 of 3 Het Railway Operating Income - Freight Service (b) Net Railway Operating Income - Passenger Service Trustees Administrative Expenses Sub Total Non-Operating Income Less Miscellaneous Deductions 15,000 Miles .lars in Millions ) 19n 19 7 A 1975 1976 $(51.6) $33.8 $130.8 $212.4 (c) (c) (c) (c) i 6.5 6.5 6.5 6.5 (58.1) 36.9 Income Available for Fixed Charges $(21.2) 27.3 36.9 $64.2 124.3 36.9 $161.2 205.9 36.9 $242.8 (a) Excludes impact of property retirements or sales of lines outside system studied. Also excludes profit from major sales of non-operating property. (b) Includes deduction of the follow- ing items: Depreciation of property used in freight service - road $23.0 - equipment 52.7 State and local taxes on prop- erty used in freight service 53.1 (c) Lease rentals for freight service equipment Assumed to be sufficient to cover return on capital investment in passenger service. 94.1 $23.0 53.6 55.1 104.1 $23.0 54.3 55.1 110.8 $23.1 55.0 58.5 116.8 KUHN, LOEB & CO. 682 PENN CENTRAL TRANSPORTAT ION COMPA NY Pro Forma Income Statements Based on Viability Studies (a) 15,000 Miles -'.In Steps (Dollars in Millions) Annex 2 Page 3 of 3 Net Railway Operating Income - Freight Service (b) Net Railway Operating Income - Passenger Service Trustees Administrative Expenses Sub Total Non-Operating Income Less Miscellaneous Deductions 1972 1974 1975 1976, $(67.6) $26.6 $120.4 $212.4 (c) (O (c) (c) 6.5 6.5 6.5 6.5 (74.1) 36.9 Income Available for Fixed Charges $(37. 2) 20.1 36.9 $57.0 113.9 36.9 $150.8 205.9 36.9 $242.8 (a) Excludes impact of property retirements or sales of lines outside system studied. Also excludes profit from major sales of non-operating property. (b) Includes deduction of the follow- ing items: Depreciation of property used in freight service - road $24.2 - equipment 54.2 (c) State and local taxes on prop- erty used in freight service Lease rentals for freight service equipment Assumed to be sufficient to cover return on capital investment in passenger service. 53.1 94.1 $23.6 $23.2 $23.1 54.6 54.6 53.9 55.1 58.5 55.1 104.1 110.8 116.8 KUHN, LOEB & CO. 683 Exhibit 56 January 4, 1961. J. D. M. : Perhaps you have not seen the statement of July 12th, prepared by the Director of Taxation, showing the effect of removing one mile of track on our property taxes. Note that the abandonment of track in any state in which we operate increases our taxes in Maryland. On the other hand, the abandonment of track in Maryland proposes a savings 2 to 4 times that obtained in any other state, even if the land is retained — and only a nominal increase in taxes occurs in New Jersey with no increase in other states. This statement vigorously demonstrates the need to eliminate as much track as is possible within the State of Maryland. Are you satisfied that your Region, within the State of Maryland, has been thoroughly and carefully analyzed in order to determine the maximum amount of track that can be abandoned? If not, such action should be taken immediately. Please advise. J. P. N. Exhibit 57 File 073. Tax savings to be derived from abandonment of all necessary tracks and/or facilities. Tax Savings Savings in state and local taxes are uncertain and cannot be predicted. Because State and local governments are constantly in need of new and additional revenue, lower taxes that might have been expected from actions we have taken in the past, are not being realized. Administrative rulings, revised assessment formulae, and increased tax rates have wiped out the prospective reductions even where the property tax base has been diminished by abandonment. It is also a fact that track abandonments in one state that might generate tax savings there, would so increase taxes in other states as to result in an overall tax increase. Further, it must be noted that changes in income have a direct effect on the property tax valuation of two-thirds of our line. Increased income that must be expected from our program could result in increased state and local taxes. AVPOP— February 20, 1970. Philadelphia. November 24, 1969. R. G. Flannery (1740) : The attached study of the effect on our over-all taxes of abandonments in different states should be of interest and of value in appraising the savings as a result of proposed abandonments. It is startling to note that as a result of abandonment of line in one state, we can substantially increase our taxes in numerous other states. H. Large. Penn Central, Philadelphia, October 21, 1968 Mr. D. E. Smucker : In spite of the fact that we would like to get tracks off the tax rolls in New Jersey and to get cash in the treasury the work of taking up tracks on the New Jersey Division is proceeding at a snails pace. I asked the people on the trip last week to arrange to sell to scrap dealers much of the yard tracks which are in place so that we can get the cash this year and get the tracks off the tax rolls. Will you please follow up on this matter. A. E. Perlman. October 23, 1963. Mr. Saunders : This refers to discussion on our recent inspection trip with respect to the effect of track abandonments on State and local taxes in the various States in which we operate. I am attaching hereto an interesting statement on the subject, prepared by our tax people at my request several years ago. Mr. Warner tells me that, while the figures are necessarily based on a number of arbitrary assumptions, they are still generally valid. It will be noted that abandoning track in the State of Delaware not only increases taxes in that State, but in Maryland and New Jersey as well — with an over all adverse effect systemwise. While track abandonments in other States have the effect of increasing taxes in Mary- land and New Jersey, the net effects are nevertheless favorable in all States except Dela- ware and Pennsylvania. Actually, the adverse effect in Pennsylvania (when land is re- tained) is on the assumption that the underlying property ceases to enjoy its tax-free status as operating property and is placed on the tax list as other than operating property. In actual practice, however, this does not occur when one of two or more tracks is abandoned — only when a single track is abandoned. A. J. G. 74-924 O - 73 - 45 684 Exhibit 58 October 13, 1970. J. R. Sullivan : It appears from the Third Quarter 1970 Branch Line Abandonment Program report that Mr. Musslewhite's and my letters to you and your letter to Mr. Kreyling have no effect on the Vice President — Operation's office as only two lines total- ling 5.1 miles were removed from the list of "ICC Petitions Being Prepared" while 41 lines totalling 698.6 miles were added to this list, none of which we have been consulted on. One of these lines has even proceeded to the point where a hearing was held last month. In addition, none of the lines to which objections were raised have had any change made in their status. Further, one petition has been filed which according to the Second Quarter report hadn't even reached the "Under Study" level. While we, and I am sure you, appreciate being consulted on abandonment matters, we would feel somewhat better if we weren't merely wasting time and paper by replying. T. B. Graves, Jr. Exhibit 59 J. R. Sullivan — 1534: This is in response to your request for memorandum on the Master Abandonment Program covering over 6,000 miles of our line currently underway on the Penn Central. I am strongly of the view that this program is wrong in conception and impetus. The 6,000-mile-plus total figure was arrived at over a year ago with minimal consultation with the various interested departments. It is proceeding at an active pace with the only planning that is visible to us being in the desire to abandon as much trackage as possible. This may not be so, but the lack of comprehensive analysis, particularly on the present and potential earning aspects, give rise to a recommendation that the whole Branch Line Abandonment policy be reviewed by top management with an idea to establishing guidelines that will optimize our probable corporate result. It would seem reasonable that analysis of branch line abandonment should include consideration of the following factors : 1. The relationship between the money invested in the branch, its present or poten- tial ability to earn revenue, and the possible actual net salvage money (not bookkeeping figures) which would result from abandonment. This is important since if there is any reasonab'e probability of future traffic, the relatively small amount of reclaimable capital compared to the capital represented by a line of railroad still intact is almost certainly unimportant relative to the incremental value of additional revenue, provided this pos- sibility exists at all. 2. If there is present revenue, the actual expenses of the branch must be subtracted and the estimated contribution of this traffic to the rest of the railroad must be evaluated and its amount of contribution dollarized. 3. If there is a favorable balance from this procedure, the branch is profitable from a short-range marginal standpoint until such time as unusual expenses or new capital are required to keep it in operation. It should not be abandoned until that time, or until the traffic mix changes adversely. 4. If the overall out-of-pocket expenses of the branch, plus the estimated expense of carrying the freight beyond, exceeds the total revenue for the branch, the branch is a candidate for eventual abandonment. At this point, Sales, Marketing, Coal & Ore, etc. should evaluate the potential of the branch and provide a set of figures upon which other departments could base possible abandonment studies. 5. If the gross revenue of the branch is less than the actual out-of-pocket expenses for running the branch, it is of course a priority target for abandonment, subject to any indi- cation of a highly probable favorable change in revenue level or an impending reduction in the amount of expense. 6. In addition to evaluations currently being made as to net salvage, etc., any branch that serves as a link must be evaluated from the standpoint of our requirement to maintain existing routes and junctions. This evaluation should be made for the purpose of deter- mining the alternative costs of handling the traffic via alternative routes. 7. In some circumstances, the effect of abandonment on the terms of leases, contractual arrangements with underlying companies, mortgages, etc. have to be considered. Proceeds from an abandonment that must be moved into the hands of a trustee for a mortgage rather than being made available for general railroad purposes requires a Financial Department decis'on ns to the desirability of such a course. 8. Still to be reconciled is the effect of increasing circuity of mileage on our costs. As we have already pointed out, abandonments and other decisions resulting in circuitous movement are undertaken by the Operating Department supposedly to reduce costs below those existing over presently effective routes of movement. However, when translated by the Cost Department, they invariably increase our costs and show up in the guise of lessened profitability, lessened incentive for investment, inability to quote competitive rates, etc. This question has to be answered. It does not make sense to make operating decisions to cut costs that result in increased costs ; and wherever the proposed abandonment involves a link in our present network, this problem is present. The following comments are oriented toward the present procedure from a specific rather than a general point of view : In order to effectively analyze and determine the possible side effects in actual operat- ing mileages, routing, junctions, present and potential traffic flows, possible indicated rate adjustments, we require access to supporting papers for each abandonment project. We re- ceive this material only on some projects at the present time. 685 In addition to the ordinary course of protest before regulatory bodies, there are often special circumstances such as those pertaining to the end of the Madison Branch (Item 8-34 of the current abandonment project). A few years ago, the City of Madison, Indiana, advanced funds to the former PRR to rehabilitate this line after a washout, bringing into question the feasibility of the abandonment and the probable financial outcome in the event of protest. We note several inconsistencies in the current project report — such as Items 8-2 and 8-13. The first proposes to tear up one of two tracks on the former NYC's Indianapolis- Cincinnati Main Line which is "plagued with very unfavorable grades and tonnage freight trains use the route via Richmond, Ind." Item 8-13, however, suggests abandonment of the ex-PRR line between Richmond and Cincinnati which is now handling the same tonnage trains. The latter action would require extensive rebuilding of the Cincinnati Northern Branch between West Manchester and Carlisle Junction, Ohio, and necessitate detour of these trains in a more indirect manner. Such traffic would then add to the congestion of the already busy former NYC Main Line between Cincinnati and Middletown, which is also handling Cincinnati-Columbus trains rerouted from the old PRR C&X Branch now up for abandonment. We do not have the resources within this Department to generate all of the material needed to make the type of study indicated by the criteria set forth above, which we believe to be the prudent abandonment procedure for the Penn Central, nor if we did is it likely that it would in all cases create acceptance of the recommendations so generated. We be- lieve, however, that the importance of getting the abandonment program on the corporate "track" is fundamental to the future health of the Company. George R. Wallace. 686 Exhibit 60 IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA In the Matter of PENN CENTRAL TRANSPORTATION COMPANY, Debtor In Proceedings for the Reorganization of a Railroad No. 70-347 TRUSTEES' PLAN FOR REORGANIZATION (April 1, 1972) The Trustees file herewith their proposed Plan of Reorganization, Part I, with a schedule for filing the remaining provisions and comments on the present state of reorganization planning. Plan of Reorganization PART I 1. Statement of Conditions for Reorganization The conditions on which this Plan of Reorganization is based are as follows: A. The Debtor will secure relief from the burden of continued employment of train service employees unnecessary for safe and efficient operation. B. The Debtor will secure relief from the financial burden of operating freight service on uneconomic lines, many of which are identified on Attachments 2 and 3 with others to be identified by amendment to the Plan. C. The Debtor will secure relief from the financial burden of operating all passenger service, both inter-city and commuter, for which it is not fully compensated. D. The volume of freight traffic handled by the Debtor will increase substantially to the levels forecast by Temple, Barker & Sloane (TBS) in Attachment 4 adjusted to take into account the effect of the relief described in B above. 2. The effective date of the Plan will be January 30 of the year which follows a calendar year during which ail administration claims other than Trustees' Certificates shall have been substantially discharged, and the Debtor shall have earned income available for fixed charges' not materially less than $275 million, provided further that reasonably anticipated income available for fixed charges in the year in which the reorganization is consummated and subsequent normal years is not less than S275 million. 3. If income available for fixed charges has not reached $275 million per year by the calendar year 1976, then this Plan shall be deemed withdrawn and alternative proposals will be made. If at any time it shall appear to the Trustees that the Debtor will not succeed in reaching such a level of earnings by 1976, they will promptly so inform the Court and the Interstate Commerce Commission (ICC). 4. On July 1, 1972, October 1, 1972 and January 1, 1 973, the Trustees will file with the Court reports assessing progress towards realization of the Conditions for Reorganization and proposing any necessary reassessment of their reorganization planning. The July 1, 1972 Report will deal particularly with Condition A (surplus employees); the October 1, 1972 Report will deal particularly with Condition B (uneconomic freight lines); and the January 1, 1973 Report will deal particularly with Condition C (passenger service) and will report on further progress on uneconomic freight lines. A final report of the Trustees, to be filed on April 1, 1973, will, unless otherwise ordered by the Court, complete this Plan of Reorganization. 'As used in this plan, unless stated otherwise, income available for fixed charges is calculated after deduction of equipment leased rentals but before federal income taxes. -1- 687 5. If the Court directs that the completed Plan be filed with the ICC, the ICC will schedule hearings to determine whether the conditions for reorganization have been or promptly will be accomplished in sufficient degree to make feasible this Plan of Reorganization. If the ICC finds in the negative, it will so report to the Court, which may then direct the prompt filing of another plan, including a plan for liquidation, or may dismiss the proceeding. If the ICC finds in the affirmative, it will promptly schedule further hearings on such other issues as may be raised with respect to the Plan. 6. Reorganization of the Debtor will be accomplished by cancellation of outstanding securities other than Trustees' Certificates and equipment debt, satisfaction of claims against the Debtor according to their priorities, and corporate simplification, all as hereinafter provided. Upon consummation, the Debtor will be discharged of all claims and liabilities as provided in Section 77. 7. As part of the Plan, the Debtor is authorized to abandon any uneconomic route miles of line, those identified on Attachments 2 and 3 and those to be identified by amendment to the Plan which by the effective date of the Plan (a) have not been abandoned, or (b) have not been made subject to arrangements relieving the Debtor of continuing losses. As conditions to abandonments effected by the Plan, the Debtor will be required (1) to maintain service on each line for six months following approval of the Plan by the ICC; (2) to sell the entire line or any part thereof to any purchaser offering within the six-month period no less than fair value and desiring to purchase the line for continued railroad use; (3) to continue the line in service for a contract period if any person or entity, within the six-month period, offers to execute a contract with the Debtor by which the Debtor contracts to operate specified freight service over such line in return for full compensation for the service contracted for. The Court will have reserved jurisdiction to determine, at the request of either the Debtor or any person or entity claiming to have made an offer hereunder, whether the offer is adequate. 8. As part of the Plan, the Debtor is authorized to terminate any passenger service for which it is not fully compensated. As a condition of such right to terminate, the Debtor will be required to continue to provide any passenger service for a contract period if any person or entity offers to execute a contract with the Debtor by which the Debtor contracts to operate the specified passenger service in return for full compensation for the service contracted for. The Court will have reserved jurisdiction to determine, at the request of either the Debtor or any person or entity claiming to have made an offer hereunder, whether the offer is adequate. 9. Upon reorganization, and provided that the Internal Revenue Service rules prior to the effective date of the Plan that income tax losses of the Debtor may be carried forward by the reorganized Debtor for the period provided in Section 1 72 of the Internal Revenue Code, the capital structure of the reorganized Debtor will consist of the following classes of securities: (a) Trustees' Certificates. (b) Equipment Obligations. (c) New System Mortgage Bonds. (d) New Common Stock. New System Mortgage Bonds and New Common Stock of the reorganized Debtor will be distributed among those having interests in the Debtor's estate on a fair and equitable basis, as will be provided in the completed Plan. In addition, a portion of such securities may be issued in exchange for outstanding securities of the Debtor's subsidiaries (including leased lines) which may be merged into the reorganized Debtor. (a) Trustees' Certificates. Trustees' Certificates previously issued are restricted as to prepayment by their terms and thus will remain, until paid, a lien on the assets of the reorganized Debtor prior to the New System Mortgage Bonds. $50 million of such Trustees' Certificates bearing interest at 6— 1/8% will become due 688 in 1976, and the remaining S50 million bearing interest at 7.05% will become due in 1986 but are redeemable beginning in 1981. 2 (b) Equipment Obligations. The amount of equipment to be retained and acquired by the reorganized Debtor, and thus the level of its equipment obligations, will be determined on the basis of the anticipated operating needs of the reorgan ; zed railroad. This determination will be affected by the size of the reorganized railroad and its level of traffic. In order to allow for the maximum amount of equipment which might be needed, it is presently assumed that the reorganized railroad will need as much equipment as the Debtor's management projects for the existing system operating at the increased level of traffic predicted for 1976 by TBS in Attachments On that basis, the outstanding amount of equipment obligations (equipment trust certificates and conditional sales agreement obligations) is projected at S436 million at the beginning of 1976. Interest on equipment obligations is projected at $35 million for 1976. In addition, rentals payable under equipment leases are estimated at $132 million in 1976. Based on the formula presently approved by the ICC, one-third of such lease rentals, or about $44 million, would be considered as equivalent to interest for the purpose of calculating fixed charge coverage. (c) New System Mortgage Bonds. The reorganized Debtor will convey to a mortgage trustee to secure New System Mortgage Bonds such of its real estate, track, bridges, tunnels, buildings and structures as are necessary for future railroad operations. The security conveyed by such mortgage will exclude air rights, mineral rights and such other subsurface rights as are not needed for railroad operations, and will also exclude both rolling stock and any other equipment and facilities for which separate financing is customarily available. Apart from the coverage of capital assets to be financed in whole or in part by subsequent issues of System Mortgage Bonds, the mortgage indenture will not have after-acquired property coverage provisions. All New System Mortgage Bonds issuable under the indenture will be entitled to a sinking fund calculated to retire them over a period not in excess of 25 years after issuance. In other respects, the New System Mortgage Bonds and the mortgage indenture will contain provisions customary in such documents, the precise provisions to be determined by the reorganization managers. New System Mortgage Bonds will be issuable as follows: (i) The initial issue will be made at the time the Plan of Reorganization becomes effective. Most or all of the New System Mortgage Bonds will be issued to holders of pre-bankruptcy interests in the Debtor, but a portion may be issued to holders of outstanding securities of the Debtor's subsidiaries (including leased lines) which may be merged into the reorganized Debtor. A small amount may be issued for cash, to be applied to final settlement of unpaid administration claims. The aggregate amount of New System Mortgage Bonds initially issuable upon reorganization would be limited to an estimated $800 million. On the assumption that such bonds would bear interest at 7—1/2%, first-year interest charges on the initial New System Mortgage Bonds would be $60 million. The amount of New System Mortgage Bonds initially issuable will be adjusted if other provision in the nature of fixed charges is made for the holders of debt of merged subsidiaries assumed by the reorganized Debtor or for lessors of leased lines in cases where such leases are affirmed in the Plan and such lessor companies are not merged into the Debtor. (ii) In addition to the foregoing, refunding bonds will be issuable to refund New System Mortgage Bonds, to refinance Trustees' Certificates at maturity or upon optional redemption if applicable, and to refinance maturing issues of subsidiary debt assumed upon merger into the reorganized Debtor. 2 Trustees' Certificates may be refinanced by New System Mortgage Bonds. See 9(c)(ii). -3- 689 (iii) Additional bonds would also be issuable to finance railroad additions and betterments. The amount of bonds so issuable will be limited in order to protect the credit rating of the reorganized Debtor. (iv) All series of New System Mortgage Bonds will share pro rata with earlier issues in the overall security provided by the New System Mortgage. (d) New Common Stock. The reorganized Debtor will issue a single class of New Common Stock with an aggregate value of $1.4 billion. 10. Pending consummation of the Plan, cash not needed for railroad operations and capital expenditures will be applied, as the Court may from time to time direct, to the discharge of administration claims. Further Provisions Parts II, etc. A. A report with respect to the size of, and specific lines on, the system to be reorganized will be filed by October 1, 1972. B. Provisions relating to the treatment in the Plan of affiliated companies, including leased lines and operating subsidiaries, relating to classes of claimants and allocation among them of interests in the reorganized Debtor, and the mechanics of the Plan, such as execution, reorganization managers, etc., will be filed on April 1, 1973. II. Summary of Trustees' February 15 Report and Comments Thereon On February 15, 1972, the Trustees filed, as directed by the Court, their Report on Prospects for Reorganization of the Debtor. The Trustees concluded that a successful reorganization is feasible dependent (in addition to maximum efforts of self-help by the Trustees and management), on increases in freight traffic and all-important relief, necessarily requiring the cooperation and efforts of others, to alleviate the burdens of (a) unnecessary employees, (b) operating freight service on lightly patronized, unprofitable lines,' and (c) providing passenger service in return for less-than-adequate compensation. The Trustees estimated on the basis of preliminary studies that if these conditions were substantially realized the Debtor might reasonably anticipate by 1976 income available for fixed charges within the range of $220 million to $290 million. They expressed their opinion that such a level of income will be adequate for an income-based reorganization provided such necessary relief becomes available quickly enough to stop and to reverse the accumulation of unpaid administration claims (and consequent erosion of the estate available for pre-bankruptcy interests) in the intervening years. As the most extreme alternative to such an income-based reorganization, the Trustees mentioned nationalization, which they opposed. On February 24, 1972, the Trustees filed a further Report Filing Certain Studies in Connection With Reorganization Planning. This report made available, to the extent then possible, the studies on which the Trustees based their conclusions (a) that an income- based reorganization is not feasible without substantial realization of the conditions mentioned above, and (b) that with such realization, an income-based reorganization will be feasible. Seventeen separate comments were filed on the Trustees' February 1 5 Report. Both the United States Department of Transportation (DOT) and the ICC say they agree with its basic conclusions, including the necessity for substantial realization of the basic conditions for reorganization, and indicate their willingness to assist in achievement of those conditions. DOT, however, takes issue with the Trustees' view that a constitutionally adequate income-based reorganization must produce values for pre-bankruptcy interests -4- lilH) which are "at least in a fair equivalence to the liquidation value of the estate" (February 15 Report, p. 12). The Department of Justice briefly takes issue with the Trustees' suggestion that nationalization of Penn Central in its present condition could "perpetuate the inefficiencies and inadequacies which the Trustees' proposals would eliminate" (February 15 Report, p. 13). The ICC suggests that the Trustees should accelerate and strengthen their abandonment program, but questions, even if that is done, their estimate that the necessary streamlining can be accomplished "in substantial part" in 1972 and 1973. The Commission also expresses willingness to re-examine the la.bor protective conditions imposed in the Penn Central merger proceeding to determine whether they now appear "unduly burdensome." The investor interests express considerable skepticism as to whether the needed relief can be realized substantially enough and soon enough to make feasible a reorganization along the lines proposed. 3 The investors generally criticize the studies and forecasts presented by the Trustees as probably too optimistic. (The ICC, on the other hand, regards the Five-Year Base Plan Study as "conservative.") The investors urge that more specific and detailed studies be submitted to include an identification of the lines which the Trustees plan to abandon, and seek additional information regarding the form of the proposed capitalization of the reorganized company and the specific governmental action which the Trustees require to achieve the relief they say they need. Some of the investors say the Trustees should accelerate the disposition of non-rail properties, but others contend that these assets should be retained and that the Debtor should somehow rid itself of the burden of railroad operations and reorganize essentially around its non-rail assets. Some investors criticize the Trustees for making inadequate progress to date on realization of the conditions for reorganization. The Institutional Investors Penn Central Group proposes that the Trustees make periodic reports over the next year stating in detail what progress has been made, and propose April 1 , 1973 for a final decision as to whether the progress realized makes it appropriate to continue efforts towards the type of reorganization proposed by the Trustees. Only two of the parties assert that it can now be determined that an income-based reorganization is not feasible. Several of the investors ask that the Trustees be directed to report more fully on the alternatives to an income-based reorganization. But DOT believes that consideration of such alternatives would be premature at this time. Reuben R. Robertson, III, et al. make extended comments in support of the view that the nationalization alternative is worthy of more serious consideration. This review does not purport to refer to all the important points and questions raised by the various pleadings, but merely summarizes those which the Trustees find particularly material to their reorganization planning. III. Progress Made in Definition and Achievement of the Conditions for Reorganization The February 1 5 report did not detail the progress made to date in specific definition and achievement of the conditions for reorganization. The comments filed indicate that a further statement is appropriate. The Trustees are fully aware that the viability (in the private enterprise system) of the rail form of transportation in the northeastern states (and ultimately in the entire country) is at stake in these proceedings. They believe that, given reasonable time and help from others, such viability will be established, and Penn Central will emerge as a strong carrier with sufficient earning power to operate with confidence in the future. In the progress report that follows, the performance of the Trustees so far is set forth as well as their planning for the future If this planning succeeds, as the Trustees are 3 The Trustee of the New Haven goes so far as to suggest: "Even if an income plan could be devised which carried the hope of some interim success by 1976, the adverse character- istics of the Penn Central system service area, to which the Trustees themselves have previously adverted in detail, flash all the signs of the New Haven's own prior experience. The New Haven was successfully' reorganized in 1947 after a proceeding which began in 1938, only to become bankrupt again in 1961." -5- 691 confident it will, the public and private interests in strong rail transportation in the northeastern region of the country will be served, and everyone will gain. Freight Volume and Revenue Increases To reorganize Penn Central, a primary condition precedent is an increase in freight revenues, supported by volume increases in the years to come. The firm of TBS, consultants to the Trustees, have recently presented in definitive form their study forecasting the Debtor's freight traffic through 1976, and that study is filed as Attachment 4 hereto. The TBS forecast is incorporated in the revenue side of the income and expense projections for the years 1971 — 1976 which was Exhibit 1(b) to the Trustees' February 24 report. This forecast projects a 9 percent increase by 1976 over freight traffic moved in 1970. It forms the basis for the revenue ingredient of the preliminary figures used in Part D of the Freight Core Study (Exhibit 2, p. 8 to the February 24 report), which estimates income available for fixed charges at approximately $275 million with all the conditions for reorganization substantially realized. That projected income, in turn, forms the basis for the capital structure incorporated in the proposed Plan of Reorganization outlined herein. The reasons why the Trustees believe that traffic increases of at least the order of magnitude projected by TBS are reasonable are as follows: First. In the past 1 5 months the quality of Penn Central's freight service has improved to the point where it is generally regarded by the shipping public as first-class. One of the reasons for the precipitous and disporportionate decline in Penn Central's freight volume, particularly following the merger, was atrocious service which users of transportation avoided like the plague. In the future, Penn Central's presently good service will be made even better. This is bound to put more tonnage on the railroad and should allow Penn Central to grow with the economy instead of going downhill. Second. In the past, also, competitive business was driven away by Penn Central's rigid pricing policy, which set the pattern for the other railroads in the east. From 1965 through June 1 97 1 cumulative rate increases aggregating 39% (as compared with 1 8% to 24% increases in competing truck rates) were directly responsible for the loss by the eastern railroads of an estimated 100,000 trailers per year in piggyback service with the loss to the Penn Central amounting to an estimated 50,000 trailers. To attract new business, and to hold old business, the Trustees since January 1 , 1971, have made more than 100 major individual rate adjustments (some of them reflecting new marketing techniques) on a variety of commodities including rock salt, grain, crude oil, soda ash, semi- finished steel, manufactured iron and steel, potatoes, cement, wall board, asbestos sheeting, wood pulp, alcoholic liquors, motor vehicles, auto parts, carbolic acid, sand, paper, sugar, magnesium, limestone, frozen citrus concentrates, buses, turbines, and piggyback traffic. The Trustees intend to pursue the course of improving Penn Central's competitive position by supporting its better service with realistic (and innovative) pricing. In countless instances, net earnings can be improved in this manner. Third. Progress is also being made in the gradual elimination of traffic carried for less than cost. A detailed analysis of 1 969 figures (the full details of which were submitted to the ICC for review at its request early last year) showed a loss from this source aggregating $80 million using long-term variable costs. On the basis of 1970 figures, a loss of $25 million was incurred on traffic which did not even earn its short-term variable costs, thus producing a cash drain. Such losses must, of course, be eliminated. Certain rate increases have already become effective. A 25% increase in rates on cereal traffic (light-loading yet requiring high quality box cars) is an example. Other increases, opposed vigorously by consumer groups, have been suspended by the ICC, including increases in citrus rates from Arizona and California to the east, vegetable rates from the southwest, and increases in protective service charges. Further increases of rates, minimum weights, or charges for services on canned goods, household appliances, light loading papers and maximum absorptions for the loading and unloading of water-borne freight have been proposed by Penn Central and -6- 692 are under consideration by the ICC. In the aggregate these increases should reduce the loss by several millions. General rate increases both in 1971 and again in 1972 are giving, and will give, further help. The one area where skepticism is possibly justified is in the prospect for fairer and more realistic divisions of freight revenues. Non-compensatory divisions cannot be eliminated by Penn Central acting alone. Cooperation of connecting lines is required. If Penn Central received divisions on interterritorial traffic (between the east and the south and between the east and the west) in keeping with the standards set forth in the Interstate Commerce Act, its revenues would be sharply increased — by tens of millions of dollars annually. Attainment of fairer divisions is, however, most difficult. The southern and western lines refuse to submit the issue to arbitration, and Penn Central has filed with the ICC a complaint against the southern lines. This course has led in the past to interminable litigation (which, based on the precedents, could consume 10—12 years). Penn Central requested the ICC to sponsor legislation which would expedite such litigation (by giving the ICC power to make its findings on divisions retroactive, and by confirming its power to set interim divisions subject to later adjustment and to participate actively in the litigation), but the ICC declined. The Trustees see little chance for an early settlement of these divisions disputes unless the suggested legislation could be enacted. Fourth. If Penn Central's service area were outside the northeastern region, there would be little question as to its prospects for traffic growth. But even in New England and the North Atlantic States of New York, New Jersey, and Pennsylvania — where Penn Central has 47% of its mileage — the outlook is favorable if Penn Central, while holding its own with bulk and other traditional rail traffic, can penetrate that enormous transportation market which connects the great industrial centers — a market with hauls between 300 and 700 miles which is dominated by highway carriage. Penn Central, with much to learn in offering the right kind of service and pricing it correctly, has already begun the attempt to penetrate it. The objective is to furnish a cheaper "highway," and to persuade all of the different categories of highway freight users, including regulated motor carriers, to take full advantage of it. Upon the outcome of this undertaking may depend more than upon any other condition the long-term viability of Penn Central and the other railroads in the northeastern states. The Trustees are confident of ultimate success because the economics (to be significantly contributed to by the operation with 3-man crews) are with them and so are important aspects of the public interest. The System to Be Reorganized Some creditors have reacted to the abandonment program of the Trustees by suggesting that it is too large to be accomplished in the near future. A further explanation of the program is appropriate. The Freight Core Study included with the February 24 Report was both preliminary and incomplete since it included only rough figures for total revenues and costs, and did not attempt to identify the lines included in the hypothetical core. This made detailed assessment and evaluation of the Trustees' proposal difficult. The Trustees are refining the Freight Core Study, both to identify lines to be included and to provide a basis for projecting operating and non-operating revenues and expenses for each year from 1972 to 1976. As stated in the February 15 report, this study identified approximately 1 1,000 route miles which incorporate origin and destination points between which traffic in 1970 produced about 80 percent of the railroad's freight operating revenues. Attachment 1 hereto is a map showing in detail the 1 1,000 route miles which were studied* 'The actual number of route miles on Attachment 1, is approximately 10,820. For convenience this Report shall continue to refer to an 11 , 000-mile core. This mileage does not include mileage separately operated by subsidiaries such as the Pittsburgh and Lake Erie Railroad. -7- 693 In pointing to a hypothetical core of 1 1,000 route miles, the Trustees did NOTsay that the remaining 9,000 miles in the 20,000 mile system should be abandoned. On the contrary, the Trustees were careful to point out that an 1 1,000-mile core "would not constitute a full-service system, taking all interests into account", and that studies of "larger cores" were under way. The 1 1,000 mile core — on the basis of the studies still going on — represents a system where the utilization of Penn Central's plant, equipment and personnel appears to peak. The Trustees are proceeding as rapidly as possible to identify those additional lines which will be added to the 1 1,000-mile core, without substantially dissipating the benefits to be realized from more efficient operations with higher density. J The task is proving extremely complex, particularly as detailed consideration is given, as f it must be, to practicalities of operation, future traffic potential and special characteristics )| of the various lines. The information presently available to the Trustees suggests that the emerging system may well be substantially larger than 1 1,000 route miles. Accordingly the map in Attachment 1 mustbe considered as a hypothesis for reorganization planning. The detailed studies now under way of the probable operating and financial results of the 11,000-mile hypothetical system and of substantially larger systems are being carried out by Wyer, Dick & Company, consultants to the Trustees, with the cooperation and participation of several departments of the railroad. These studies are scheduled for completion by September 1, 1972. They will permit a decision by the Trustees as to the size of the system which should be proposed as a basis for reorganization. Once that decision is made, the consultants and staff can analyze each leased line and mortgage segment of the Debtor's system to determine its prospective going-concern value on the basis of the system finally selected for the proposed reorganization. These studies are scheduled for completion by December 1, 1972. The result of these studies will be of critical importance to decisions on affirmance or disaffirmance of a number of leases and to the allocation among the various interests of securities of the reorganized company. In rationalizing Penn Central's plant, the immediate concern of the Trustees is to eliminate the lines that are clear "losers" — lines which, in looking to the future, promise to hurt rather than help in the struggle for earning power. Under a standard proposed by the ICC — but now under suspension as the result of a court order sought by railroad labor and the Commonwealth of Pennsylvania 5 — a total of 3,900 miles of line would qualify for abandonment because traffic is less than 34 cars per mile per year. Under a different standard of one million gross ton miles per mile of line per year, incorporated in legislation proposed by DOT, 7,000 route miles would qualify. These results are based on past performance and cannot be regarded as dispositive. A line that is a "loser" today may be a "winner" tomorrow, or vice versa. Before the Trustees move on an abandonment, future prospects must be studied. The present planning of one of the nation's largest shippers could transform two Penn Central branches, now total losers, into important feeder lines; and other branches, also present losers, could spring into life overnight in serving new or relocated mining operations in the bituminous coal fields. In addition, the use of 3-man crews would have a profound effect upon the revenue- cost relationships of some of these marginal lines. On the other hand, there are factors (including continued inflation, if not offset and deferred maintenance), which could have an adverse impact. It follows, then, that an abandonment program — a program that is an integral part of the rationalization of Penn Central's plant — is necessarily a continuing one. The "Commonwealth of Pennsylvania, Pennsylvania Public Utility Commission, and Congress of Railway Unions v. United States of America and Interstate Commerce Commission, Civil Action No. 72 — 63, United States District Court, Middle District of Pennsylvania. 694 Trustees have now identified a total of 3.922 route miles (including the 1,345 miles already filed with the ICC, of which 492 miles have been approved for abandonment) which are clear, undisputed losers and should be abandoned as soon as possible. These 3,922 miles are identified on the map of the Debtor's system which is Attachment 2 hereto and are listed individually in Attachment 3. Under the present ICC procedure, requiring a detailed application on each individual line, an average of ten applications per month have been filed averaging ten miles per application. The pace would have been faster had the Trustees not tried, in many instances, to compromise with the threatened opposition before filing and also had there not been legal problems concerning leased lines. The Trustees have had a special team at work on this project, which team is again being expanded and will be taken off all other duties. The Trustees' objective is to have all 3,922 miles of clear losers on file with the ICC at the earliest practicable date, with the bulk of the applications targeted for filing before the end of the year and the work completed in 1973. In addition to these 3,922 miles, the Trustees believe that studies now in process will enable them to identify at least 1,600 miles of additional lines which will qualify for abandonment in 1974 and 1975. Slow as the progress on abandonments appears to be so far, it threatens to become even slower if the 34-car rule referred to in the ICC comments is not implemented; the enactment of legislation now pending would also be of great assistance. The reason why the program will otherwise falter is that, in the applications already filed with the ICC, the Trustees started with the obvious abandonments — where the line was not in use and there was no real chance of any business in the future — and the ICC responded, in most instances, with prompt approval without hearing. But the Trustees quickly ran out of the "easy" cases and, when the applications to abandon lines still in use (although heavy losers) began to be filed, the pace slowed to a crawl. Nineteen such applications were assigned to the ICC's so-called modified procedure (involving an exchange of statements of fact and arguments by the parties but no public hearing), but the ICC has decided only 6 of these applications (and one of these is under reconsideration). In addition, five applications have been set for public hearing; in total, 52 applications are pending, including 34 without any indication as to further ICC procedure, including these important ones: Termini Filed (Originating or Terminating) Mileage 3_31_71 Remsen-Lake Placid, N.Y. 118.4 3_31_71 Brocton-Blasdell, N.Y. 43.6 3-31-71 Oil City-Tidioute, Pa. 33.6 3-31-71 Chambersburg-Waynesboro, Pa. 19.1 8-26-71 Churubusco-Auburn Jet., Ind. 14.1 8-27-71 Waveland-Crawfordsville, Ind. 14.1 8-31-71 Clyde-Berwick, Ohio 21.1 10-15-71 Carthage-Greensburg, Ind. 27.8 10-18-71 Fredonia-Falconer, N.Y. 29.0 10-26-71 Newton Falls-Alliance, Ohio 17.4 TOTAL 338.2 The ICC refers to the Trustees' program of abandonments as "a substantial program — one large enough to arouse forceful opposition." The Trustees are convinced that the program will move faster once the ICC's 34-car rule and pending legislation becomes effective. -9- 695 Labor Conditions At the time of bankruptcy Penn Central was burdened by "full crew" laws in three of its most important states: New York, Ohio, and Indiana. Since then, the New York law has been repealed, and similar action has been taken in Ohio. Earlier this year Indiana relaxed the binding effect of the "full crew" law in that state. This is solid progress. All that remains is for the collective bargaining process under the Railway Labor Act to work. More will be known about this in the next several months. In one of the creditor comments the Trustees are criticized for not specifying the legislation required to resolve their labor problems. Now that the "full crew" laws are gone or modified, federal pre- emption may no longer be necessary. Moreover, if the disputes over the employment of firemen and the consist of train crews can be resolved under the provisions of the Railway Labor Act, no legislation will be needed in respect to those issues. Passenger Deficits DOT "supports the Trustees' position that Penn Central should be fully reimbursed for the cost of providing passenger service, both intercity and commuter" (emphasis added), and the ICC points out that "as to any part (of the passenger service) that is not fully supported, it is. ..obvious that Penn Central cannot consistently provide the subsidy" (emphasis added). It is particularly encouraging that DOT should include in its comments that: "The Trustees' position relating to the basis of compensation for Amtrak passenger operations in the Boston-Washington corridor appears consistent with the principles upon which Amtrak was founded." Accordingly, Penn Central's program for full compensation for passenger services is upheld by these government agencies, and both of them point out the procedures to be followed in bringing about such a result. The Trustees intend to follow their advice and to negotiate with the public bodies with a view to being relieved of these deficits. IV. Proposed Schedule for Completion of Reorganization Planning The Trustees have submitted those portions of their actual Plan of Reorganization which can be articulated on the basis of the studies and other information presently in hand. A schedule for completing the remaining aspects of the Plan is also offered. That schedule incorporates, in the Trustees' judgment, the earliest dates at which those aspects of the Plan can be presented — simply because before those dates vitally necessary information will be lacking. The Trustees continue to believe that the Plan suggested in their February 1 5 report and outlined here is feasible. They recognize, however, as the February 15 report emphasized, that its feasibility depends first on the degree of relief that will be forthcoming in the areas of critical concern. Secondly, it depends on the progress which the Trustees and management can make in further improving efficiencies and attracting more traffic to its system. Above all, feasibility depends on the speed with which these things can be accomplished. The Trustees accept the point, made by many of the investor interests, that specific, rapid and steady progress must be shown in these areas if the Trustees' Plan is not to be frustrated. The Trustees, therefore, propose on July 1 , 1972, October 1 , 1972, and January 1, 1973 to report on precisely what has been accomplished and what may then appear to be reasonably within reach of accomplishment, to reassess their reorganization planning as may be required by developments up to each date, and to report to the Court any alternatives suggested by required reassessments. They then propose to file a report with a completed Plan of Reorganization on April 1, 1973. The Trustees recommend that all parties be invited to comment on each report, and that this Court hold 10- 696 hearings on any of them if it sees fit. If in the Trustees' judgment, or in that of the Court, less than adequate progress has been shown at any stage, the Trustees propose either to modify their Plan, if possible, or to discard it and to propose alternatives to an income- based reorganization. Moreover, it seems both practicable and desirable that each report concentrate on particular aspects of the conditions for reorganization on which it is reasonable to expect that significant progress will have been made by the date in question. The Trustees therefore propose that, in addition to treating all developments of significance by the respective report dates, each periodic report be focused as follows: The July 1, 1972report will deal particularly with progress made towards elimination of unnecessary employee expense. As matters now stand, by July 1 the Trustees should be able to advise the Court whether acceptable progress has been or will be made on the crucial crew-consist issue. The October 1, 1972 report will focus particularly on the Trustees' decision, made on the basis of studies which will be completed before that date, as to the specific lines to be included in the reorganized system which they propose, together with financial projections for operation of such a system through 1976. The January 1, 1973 report will focus on progress towards achieving adequate compensation for passenger service, both inter-city and commuter, and on progress made and to be expected towards the realization of the restructured system which the Trustees will have proposed in October. Before that date, the Trustees will have presented their detailed proposals to Amtrak, and Amtrak should have decided whether or not to accept those proposals for inclusion in its forthcoming budget. Negotiations with several of the commuter entities should also be far enough along to permit an assessment of whether the condition for reoganization with respect to passenger service is reasonably possible or not. This schedule should also give adequate time both for an appraisal of the results of the accelerated abandonment program which the Trustees have undertaken and for a judgment as to whether the reaction of the ICC and other interested parties in this area makes further efforts along those lines worthwhile. The April 1, 1973 report will complete the Plan of Reorganization by adding provisions regarding treatment of leased lines and operating subsidiaries, provisions relating to classes of claimants and allocation among them of interests in the reorganized Debtor, and other necessary provisions. After the Plan has thus been completed, the Court would presumably hold hearings to determine whether the plan is sufficiently feasible to warrant submitting it to the ICC. In the event that either the Court or the ICC finds that the Plan is not feasible, the Court would reassess the situation in the light of that determination. The Court could conclude, depending on then-existing circumstances, to permit filing by the parties of alternative plans, either for reorganization or for liquidation, or it could dismiss the proceeding. The projected schedule of dates for completing the details of the plan is realistic, since by the dates suggested the Trustees should have the information necessary for decision, and counsel will have time to prepare the appropriate portions of the Plan reflecting those decisions. The extended date for dealing with leased lines and operating subsidiaries reflects the complexity of isolating and evaluating segments of a system which until bankruptcy had not been considered as separate. The extended date for allocation of interests in the reorganized Debtor reflects both these same problems and similar problems in evaluating mortgage segments of the Debtor's system, as well as the need for further analysis and evaluation of claims generally. Corporate Simplification The Trustees believe that the corporate structure of the reorganized Debtor should be greatly simplified. It is presently contemplated that subsidiaries whose business activites relate to trucking, and other subsidiaries with businesses related or complementary to the Debtor's railroad, will retain a corporate existence separate from -11- 697 that of the Debtor, unless on further investigation specific characteristics of individual companies or their operations make merger with the Debtor appear desirable. With respect to leased lines, proposed solutions for corporate simplification must await a decision on the size of the system to be reorganized. Only then can a meaningful analysis be made of the income-producing potential and other aspects of particular segments. Similarly, such analysis must await information which will be supplied by application of the segregated accounts formula now being prepared. During the next twelve months, the Trustees expect not only to arrive at the decisions outlined above, but also to pursue matters concerning claims which must ultimately be settled and which may require litigation. Attachment 5 hereto is a report which describes the nature and amount of those claims which have been filed with the Trustees pursuant to the Court's order No. 1 64 and compares these claims with the Debtor's corresponding liabilities as shown on its books. The Trustees propose to file further reports in which they will describe each separate claim and state whether they object to it. The first such report will be filed not later than July 1, 1972. V. Explanation of Financial Provisions of the Plan The Plan provides that reorganization will be consummated not earlier than the year after the first year in which the Debtor has achieved income available for fixed charges not materially less than $275 million, and assumes that prior to consummation enough cash will have been generated so that all real estate taxes and other administration claims other than Trustees' Certificates not then due and equipment obligations will have been discharged either by payment in full or by compromise. If future developments make it appropriate to reorganize when the income level is still materially below $275 million but that level is projected with reasonable certainty, the Plan could be amended accordingly. Some explanation is necessary as to why the Trustees presently regard such a reorganization as reasonably capable of achievement, why the Trustees regard this particular level of income and accomplishment as a desirable goal, and what the Trustees presently think could be accomplished by reorganization on such a basis. The sum of $275 million of annual income available for fixed charges by 1976 is within the range of the preliminary studies referred to in the Trustees' Report of February 15 and filed with this Court with their Report of February 24, if the Trustees promptly obtain the relief they believe necessary and if the percentage of overall traffic increase from 1 970 to 1 976 is within the general order of magnitude predicted by TBS. Achievement of the goal of discharge of all post-bankruptcy obligations during the reorganization period appears to the Trustees to be a function of cash flow improvement resulting from how soon the requested critical relief is obtained, the length of the period of reorganization, and how soon the level of the Debtor's freight traffic substantially improves. The Trustees cannot guarantee that it will be possible fully to discharge post-bankruptcy obligations during the reorganization period, any more than they can guarantee that $275 million in income available for fixed charges will be achieved at the end of the period. However, no information or analysis so far available to the Trustees convinces them that this cannot be done. The Trustees recognize that the goal of discharging real estate taxes and administration claims during the reorganization period is an ambitious one. If the Debtor reaches a level of income available for fixed charges enough above $275 million to carry some unpaid real estate taxes and administration claims and still to achieve the purposes explained below, the Trustees would probably seek to consummate the reorganization without waiting for complete discharge of such obligations. On the tentative assumption that the reorganized system will need as much equipment as the Debtor's management predicts for a system not substantially reduced in size, operating at levels of traffic predicted for 1976 by TBS in Attachment 4, the Debtor would require, on January 1, 1976, a freight equipment fleet comprising some 4,000 -12- 698 locomotives and 1 53,000 freight train cars. Assuming that one-third of the Debtor's freight cars are off line at any one time and that the Debtor continues normal usage of foreign cars and private cars, a total of 200,000 freight cars would be available to handle 1976 traffic. Approximately half of the Debtor's equipment owned by the reorganized Debtor would be subject to approximately S436 million in principal amount of equipment trust and conditional sale obligations as of December 31, 1975. For the year 1 976, interest on equipment obligations is projected at $35 million. The Debtor's remaining freight equipment would be held under long-term leases for which annual rentals are projected at $ 1 32 million for the year 1 976. Based on the formula presently approved by the ICC, $44 million of such lease rentals would be considered as equivalent to interest for the purpose of calculating fixed charge coverage. The New System Mortgage Bonds proposed in the Plan reflect the confidence of the Trustees and the management in the future of Penn Central as a unified transportation system. The economic interests of the bondholders — as well as the stockholders — of the reorganized Debtor will be hinged to the success of the whole system rather than to the relative prospects of individual segments. The amount of New System Mortgage Bonds initially issuable upon reorganization has been limited to approximately $800 million in order to provide a satisfactory credit rating for the debt obligations of the reorganized Debtor. Unless the reorganized Debtor can establish its credit in the eyes of the investing community, the New System Mortgage Bonds issued upon reorganization will trade at a discount from their full face value, and the new company would have difficulty arranging new long-term financing for its capital expenditures. The interest rate of 7 1/2% assumed in the Plan for the initial issue of New System Mortgage Bonds will be reviewed in the light of changes in money market conditions and will be determined at a level designed to equate as closely as possible the face amount of such bonds to their market value at the time of issuance. Based on the Plan outlined herein, fixed charges of the reorganized Debtor would be approximately $99 million in 1976, viz.: Principal Amount Annual 1—1—76 Interest Trustees' Certificates $ 50 million $ 3.5 million Equipment Obligations 436 35.1 (a) New System Mortgage Bonds 800 60.0 Subtotal $1286 $ 98.6 Interest component on leased rentals 44.0 Total fixed charges $142.6 (a) This figure takes account of anticipated retirement and issuance of new obligations during 1976. On the assumption that $275 million is available for fixed charges, such an amount would be about 2 — 3/4 times the interest charges of $98.6 million set forth above. However, it is necessary also to take account of the interest element in equipment lease rentals, which are treated in ICC accounting as an operating cost, before arriving at income 13- 699 available for fixed charges. Applying the ICC formula approved for calculating fixed charge coverage, income available for fixed charges would be increased by $44 million (representing the interest element in equipment lease rentals) to $319 million, and fixed charges would be increased to $142.6 million. Using the foregoing calculations, the reorganized Debtor would have a fixed-charge coverage ratio of 2.23 (319-=- 143) in 1976. Kuhn, Loeb & Co., financial advisers to the Trustees, consider that such a fixed-charge coverage ratio is acceptable for the purpose of a reorganization plan for the Debtor. The recommendation by Kuhn, Loeb & Co. of a single class of New Common Stock for equity interests in the reorganized Debtor is made from the viewpoint of future financing flexibility. If the reorganized Debtor starts out with the simplest possible equity capital structure, it should be easier in the future to raise additional equity financing for the reorganized Debtor's railroad operations. The value attributable to the common stock of the reorganized Debtor will be primarily dependent on earnings available for such common stock. On the basis of $275 million income available for fixed charges and $98.6 million fixed charges, net income before Federal income taxes would be approximately $176 million. The Trustees have been advised that the Federal income tax loss carryforward under Section 172 of the Internal Revenue Code should be fully available to the reorganized Debtor, and in consequence significant Federal income taxes are not anticipated for several years following reorganization. Equity values in the reorganized Debtor would also take some account of undeveloped nonoperating real property interests retained by the Debtor or subsidiaries thereof. On these assumptions, Kuhn, Loeb & Co. considers it reasonable to project the creation of New Common Capital Stock on the basis of eight times earnings, or a total New Common stock issue of $1.4 billion. Thus the total value of new securities issued by the reorganized Debtor — additional to Trustees' Certificates and equipment obligations — would be $2.2 billion on the foregoing assumptions. The extent to which pre-bankruptcy interests in the Debtor's estate would be compensated by such a reorganization cannot yet be predicted with precision. As the Trustees' report on proof of claims (Attachment 5) indicates, much work must be done and many claims must be analyzed and adjudicated before a precise prediction can be made. What can be accomplished by reorganization of the type presently proposed by the Trustees as their present goal and what are the consequences if this goal cannot be reached? On the basis of presently available information, the Trustees note that the Plan of Reorganization proposed would provide compensation for pre-bankruptcy interests substantially in excess of what the Trustees believe they could have any certainty of obtaining in the event of dismissal of the proceedings and liquidation of the Debtor. From the standpoint of the public interest, if reorganization could be achieved on the proposed basis, the reorganized Debtor would be left in a strong financial position for sustained future railroad operations in bad times as well as in good. Without now taking a position on the precise level of income necessary to support a constitutional reorganization, the Trustees emphasize that if achievement falls too far below the goals expressed in the Plan they presently propose, the Debtor could not constitutionally be reorganized on an income basis without substantial governmental financial aid. In brief, the Trustees propose this Plan of Reorganization because (1) there appears to be a reasonable probability that it can be achieved if there is prompt progress in the direction of granting the relief outlined by the Trustees in their Report of February 1 5, (2) reorganization at such a level should largely avoid difficult and delay-producing constitutional issues, and (3) such a reorganization would leave the reorganized Debtor with the greatest financial and operating flexibility for the best future railroad service. If -14- 74-924 O - 73 - 46 700 it later appears that the foregoing goals cannot be met, the Trustees will propose amendments to the Plan or will withdraw it. VI. Payment of Taxes The Trustees are aware of the need to resume some payment of local real estate taxes as soon as their cash position permits. The latest forecast indicates the likelihood of a partial resumption of tax payments by October 1, 1972. A petition requesting modification of Order No. 70 to permit this to be done will be filed. Further, the Trustees are currently exploring the possibility of combining the funds which they will have available from operations with proceeds from sale of assets to discharge or reduce existing tax claims. Respectfully submitted, /s/ George P. Baker George P. Baker /s/ Richard C. Bond Richard C. Bond /s/ Jervis Langdon, Jr. Jervis Langdon, Jr /s/ Willard Wirtz WlLLARD WlRTZ /s/ Robert W. Blanchette Robert W. Blanchette Counsel For Trustees /s/ Covington & Burling Covington & Burling Special Counsel For Trustees Dated: April 1, 1972 15- 701 Exhibit 61 Philadelphia, January 30, 1967. B. J. R. : As per discussion at the December 20th budget meeting, I have the following comments in connection with your advice dated December 30th, in regard to price variance, volume variance and market position : PRICE VARIANCE I fail to see where any practical value results from using the trend in revenue per ton and revenue per ton mile as a yardstick to measure revenue losses. For many years it has been necessary for competitive reasons to make many drastic rate adjustments in order to recover or retain traffic from other modes. Your conclusions ignore increase in length of haul and the revenue losses that would have taken place if the level of freight rates had been frozen. In recent years, pricing officers, led by the Pennsylvania, have attempted wherever possible to adjust rates for competitive reasons on the incentive principle — i.e., a reduced rate for a heavier load and higher revenue per car ; also volume rates and unit train rates. This program has been supported by the Operating and Financial Departments through the furnishing of higher-capacity cars with the result that average revenue per car and per car mile have increased substantially. As an example, while the decline in revenue per ton mile, between 1962 and 1965, produced a decrease of $39,852,000 in our revenues, the increase overall in revenue per car mile between these same years produced an increase of $35,- 090,000, and the increase of $11.15 in revenue per car produced an increase of $42,000,000. VOLUME VARIANCE No comment is necessary in connection with these figures, as your example is based on your price variance assumptions. MARKET POSITION Detailed comparisons of PRR originated, received and total traffic with that of our five major railroad competitors in the East are available quarterly. These are examined care- fully by responsible officers of the Traffic Department to determine where we have slipped and to formulate a program for recovery of position. This, however, is only part of the story, as our pricing people are constantly examining not only the railroad market but the entire transportation field in relation to specific commodities in an effort to recover traffic from other modes. There is no question, and it has been well known for some time, that the PRR position in recent years overall has slipped in a number of major commodities. For your ready reference, there is attached an analysis of the more important of these areas. A generalized statistic confirming this is of no practical value. The figures used by you, for instance, ignore the impact to the PRR of the spectacular growth of the export coal market by the N&W and C&O, the impact of the sale of the Sandusky Branch, port strikes, major industrial developments, etc. (The two most serious problems confronting the Traffic Department and its marketing division today are accurate cost formulae to help in formulating pricing policies and to guide determinations for the acquisition of new equipment. I think, you will agree with me that we are a long way today from achieving those two goals, as we are still largely de- pendent on system averages applied to specific commodities and movements.) I understand that our computer people are now progressing in an effort to take more advantage of com- puter techniques, and I would urge that your department apply its valuable talents in ex- pediting a breakthrough in those areas at the earliest practical date and to expeditious cost analyses when requested to do so. H. W. L. Exhibit 62 Philadelphia, November 14, 1969. Mr. Saunders : You requested we send you, as of possible interest to Mr. Gorman, the proposed Price/Cost Management Information System descriptive material as designed by George Wallace and the Market Research group. Attached hereto is a summary state- ment, a brief digest of the entire system, the full report, and a report on a computer run demonstrating the machine feasibilities of the system. . It is estimated there is a potential earnings improvement of at least $96,000,000 in the event this system is installed. (There is no question about the shortcomings of our existing cost data. This is a severe handicap in making sound pricing and equipment investment decisions in the highly competitive transportation market. The M.I.S. has valuable added advantages in that the data produced through this system will provide operating personnel with accurate cost reactions to decisions in the field.) I think the suggestion that we run a pilot study on the Delmarva Peninsula is highly desirable and would give all interested departments an opportunity to put a true valuation on this program. We are prepared to make an illustrated presentation on this system on short notice in the event that either you or Mr. Gorman might be interested in seeing this. H. W. Large. 74-924 O - 73 - 47 702 Exhibit 63 The Pennsylvania Railroad Co., Labor Relations and Personnel Department, Philadelphia, Pa., August 30, 1965. Mr. F.L. Kattau, Assistant to President-Administration, New York Central Railroad, 230 Park Avenue, New York, N.Y. Dear Fred : I have just gotten through the conglomeration of material that confronted me on return from vacation. It was most thoughtful of you to prepare a memorandum summarizing the status of various merger planning projects. This has been invaluable as a guide and served to cut hours, if not days, in the time for me to get back in tune with what is going on. Incidentally, Frank's write-up of your meeting on August 9 was well done. From that and various comments concerning it, I get the impression that it was an excellent meeting. I am searching desperately for some concrete evidence of progress — completed proj- ects, approved networks, etc. — but finding little. Nevertheless, everyone seems to be work- ing very hard and I am sure there is as much progress being made as can be expected at this particular time. I will try to have a summary ready for you on return. Sincerely, Basil Cole. Exhibit 64 april 6, 1970 interim report — president's task force The task force has spent the last five weeks evaluating the activities and functions of a region. We have looked into many areas to determine the strengths and weaknesses of the region. There are certain visible signs that many areas need improvement. A few of them are : 1. High payroll costs. Annual earnings statements for T. & E. employes on the Cleve- land and Toledo Divisions in 1969 showed : 396 employes paid over $15,000 233 employes paid over 16,000 70 employes paid over 18,000 8 employes paid over 20,000 2. High constructive allowance payments. 3. Quality of service — latest Ford Motor Co. and Allied Chemical Corp. service analyses and examples. 4. Lack of uniform procedures : A. Payroll and time claim processing. B. FCMR-MCR car reporting system. C. Management reports — Transportation and Finan.ce. 5. Lack of denned duties and responsibilities in some supervisory positions and lack of uniformity in these positions between regions and divisions. It is our opinion that these problems exist for several reasons. 1. Turnover in management at all levels. 61% of Trainmasters in their present assignments less than one year. 81% of Transportation Superintendents in their present assignment less than one year. 44% of Division Superintendents in their present assignment less than one year. 80% of Division Superintendents in their present assignment less than 15 months. All but one General Manager in his present assignment less than 15 months. 2. Lack of adherence to the operating plan. A. Grouping manuals and freight train schedules not up-to-date and not followed. Lack of discipline and follow-up. 3. General Managers have individually set policy in areas where system uniformity should prevail. A few examples are : A. Information systems. 1. Financial & budget. 2. Transportation reports. B. Timeslip processing and handling of time claims. C. Regional organization. D. Handling of people. 1. Promotion. 2. Replacement. 3. Traininf. It is felt that the tremendous turnover in supervision has had an adverse effect on operations and control. Different philosophies and concepts on how to operate a railroad existed in the two former companies. These simply don't disappear by changing the name of the company. Developing the one best way to operate the Penn Central requires that every supervisor must change to some extent. The difficulties in forming a solid cohesive team on each region and division are obvious and have been understated. With the turnover rate that has existed, the field level supervision has been constantly trying to adjust to changes in environment. They must learn new physical territory, new superiors, new operating rules and regulations, and new concepts and philosophies. All of this takes time. 703 It is recommended that the transferring of supervision be sharply reduced for a one to two year period in order to consolidate and stabilize. During this same period, it is further recommended that when transfers are absolutely necessary, a man should be transferred to a position where he has to make the fewest adjustments to change in environment. With the large numbei of changes in the past 15 months, there should be a sufficient number of people in each level of management now that are adjusting to a complete change and will be fa- miliar with both sides of the merged company. Nearly every other problem we saw could be related to supervisory personnel that were not yet qualified to handle the duties and re- sponsibilities delegated to them. A concerted effort must be initiated across the entire system to adhere to the grouping manuals and scheduled freight train briefs. There have been changes in the grouping manuals, and some yards have not kept up with them. It is recommended that these man- uals be revised as quickly as possible and that they continue to be re-issued at six month or yearly intervals so long as such revisions appear necessary. Each region on a daily basis should scrutinize train consists and take corrective action with the supervision involved to reduce cars moving in the wrong block, on the wrong train, or being handled in yards that could be overheaded. It is recommended that the reports prepared by the Marketing Department on the quality of freight service between key points and for particular shippers be given wider distribution and more attention. The regions should analyze their service deficiencies, es- tablish a program to improve the service and most important, follow through to see that the program is carried out. The task force, while recognizing the lack of uniformity in many areas, has not yet covered enough of the railroad to say what should be the standard. Certain changes in the regional organization on the Western Region have been proposed and the division organi- zations on the Western Region will be investigated next to determine what each person is doing and what are the results of his efforts. The lack of defined responsibility in partic- ular areas is spelled out in a separate report. It is our goal to define the duties and respon- sibilities more clearly in these hazy areas before leaving the Western Region. Separate recommendations will also be submitted to cover other areas where uniformity and stand- ardization are required. The task force has looked at various items of expense. Yard crew overtime is one ex- ample. In the Cleveland Terminal excessive overtime appears to be built into particular assignments. This item will be detailed in a separate report and recommendations to reduce it will be handled directly with the Superintendent of the Cleveland Division. The task force will recommend specific training for field level supervision. The train- ing that is most necessary is in the basic fundamentals and is on the job training. It is not the three day seminars or classes but rather a daily stress on the basics. Some of the items that should be covered are : 1. How to reduce overtime. 2. How to conduct investigations and trials. 3. How to reduce personal injuries and subsequent claims. 4. Labor regulations, local agreements and arbitraries which the supervisor must know. 5. Operating rules and safety rules. We have talked to a great number of people on the Western Region. Nobody has really tried to hide anything from us. One of the most prevalent complaints we have heard is the inability to attract and hold good front-line supervisors. In this particular area, money is the key issue. The average Trainmaster earns between $10,000 and .$13,000 per year on the Toledo and Cleveland Divisions while nearly 400 T. & E. employes under their jurisdiction earned over $15,000. It is felt that more use should be made of the merit increase plan for this level of management with emphasis on increasing the salaries of those that perform well rather than moving them to a new assignment at an increase in pay. The physical condition of the yards in the Cleveland Terminal is of great concern to the local supervision. In Collinwood Yard alone, there were 78 reported derailments in Feb- ruary at cost of $37,712. There are strong indications this is not a complete record. Rockport, Kinsman St. and Motor Yard also are in poor physical condition. It is recommended that some programmed work be started, particularly in Collinwood, during 1970 even if other maintenance work has to be postponed. It is our feeling that the greatest opportunity for improvement is in Transportation and it is in this area that we intend to concentrate. There is a real need for defining the duties and responsibilities of the supervision in the Transportation Department. As an example, the following positions existed prior to merger on one railroad or the other but not on both : D „,-,„ New York Pennsylvania rOSINOn Hontral RailrnaH Central Railroad Penn Centra! Supervisor dab control, division No Yes Yes Surervisor data control region ""_" ' No Yes" Yes Supervisor yard procedures (principal yards) YYYYY.YYYYYYYYYYYYY. Yes No " Someareai Division supervisor operators rules (division operator) No "Yes""" "Yes SUH^---;,--,-; i — .:::::::::::::::::::: Yes:::;;;:;:: no".:::::::: some areas. Mipervi«or train operations, division (supervisor train movement) No Yes Do Regional supervisor operations rules _ _ No Yes" Yes Terminal superintendent, division YYYYYYYYYYYYYYYYYYYYYYYYYYYYYYYYYYYY. Yes;;;;".;".;;; No.":; Sonie areas. General vard mas'er (excepted position). Yes No Do Terminal trainmaster Yes" No Do Superintendent station... "" No" " Yes Yes IZl'^'t ,' st H tio r s r-- -.--.- :""":::::::::::::::::::::::::::: no::::::::::: Yes::::::;::: some areas. Supervisor industrial car control. y es _ No Do. 704 It has been our observation that there is no uniformity from division to division and region to region in the duties and responsibilities assigned to these positions. The people in these positions are doing what they think the job calls for or what their superior thinks the job calls for. This is based primarily on past experience rather than any clearly denned list of duties and responsibilities that is uniform throughout the Penn Central. This Deed for definition of duties and responsibilities is not limited to the Transporta- tion Department but it is more critical in this area because of the inter-relationship between divisions, regions and system in every transportation function. It is recommended that the duties and responsibilities of each supervisory position in the Transportation Department be clearly denned and implemented on a uniform basis on each division and region of the company. By doing this, the hazy areas of responsibility will be minimized and every supervisor in the Transportation Department will know and understand what his duties and responsiblities are and what those of his associates are no matter where he might be assigned. This is a necessary first step toward establishing trans portation guidelines that will be uniform throughout the company. Exhibit 65 Penn Central Co., November 13, 1969. Mr. Saunders : Enclosed is a memorandum which I prepared for discussion with you today. It occurs to me that it may save some of your time if I place it in your hands in advance of my seeing you. [Enclosure.] David E. S mucker. PENN CENTRAL MERGER WILL COST $125.0 MILLION IN FIRST TWO YEARS Since February 1, 1968, Penn Central has expended or authorized expenditures of cash for merger-related projects or programs in excess of $95,000,000. This is over and above the cost of completing the Alfred E. Perlman Yard and diesel locomotive repair shop which had been advanced by the New York Central and was under construction. Including such costs indicates that the total sum involved (allowing for anticipated over-runs of actual costs above estimated costs) is not less than $125,000,000 either spent or authorized. In general, these costs fall into four categories : (A) $28.2 million for severance allowances to 3,338 employees through September 30, 1969 ($4.3 million charged to expenses and $23.9 million charged to the reserve). (B) $6.6 million paid to train and engine service employees as guarantees for time not worked or miles not run relative to a base period. These figures comprehend payments made through August 31, 1969. Payments lag the liability by several months, however, but are charged to expenses when paid. (C) $7.5 million in expense and moving allowances and real estate costs covering relocation of employees transferred to follow their work. (D) $53.2 million to cover the cost of 25 merger-related physical expansions or reloca- tions of fixed facilities authorized since merger and ranging downward from the $23.6 million estimated cost of the new classification yard at Columbus, Ohio. The proposed charges to capital accounts for these projects aggregates $50.8 million. Reduction in operat- ing and other costs when all are fully in service is forecast at an aggregate annual rate of $30.9 million, 38% of the $81.0 million on which the merger was justified. RESULTS ARE GROSSLY DISAPPOINTING Post audit of actual versus forecast savings thirteen months after Alfred E. Perlman Yard went into regular service indicated that at Dewitt and Geddes St. in Syracuse and at Selkirk the net of identifiable savings over added costs at these three yard locations fell short of the forecast by $2,327,000, representing a short-fall in savings of 51.7%. Assump- tions that forecast savings had actually been achievedat other points (such as the unrelated savinsrs at Weehawken because that operation was consolidated at Greenville) lead to a statistically sound but misleading conclusion that the shortfall was only 43.9%. PROSPECTIVE MERGER SAVINGS FROM SPENDING $125.0 MILLION LOOK LIKE $51.0 MILLION Regardless of whether 43.9% or 51.7%, it seems prudent now (subject to further precise check) to expect annual cost reduction from investment of $53.2 million to fall some- where between $15.0 and $17.3 million rather than $30.9 million. If the employment cost of the 3,338 "present employees" who have been paid severance allowances averaged $10,000 annually, this action alone has reduced costs by $33.4 million. Adding this to $17.3 million derived above produces total prospective annual savings of $50. i million compared to $81.0 million savings on which the merger was based, not to mention the somewhat higher figures which have been expected simply because of advancing unit costs. THE MASTER OPERATING PLAN HAS NOT BEEN FOLLOWED Being discontented with the plan for merged operation prepared under the direction of Messrs. Kenefick and Morris, and placed in the merger record by Witness Patchell, Mr. Perlman directed additional studies leading to preparation of a Master Operating Plan. When completed after many months of effort on the part of the best informed people on both roads, all copies were stamped "Preliminary" and withheld from distribution by spe- cific direction of the man who had ordered it prepared. 705 By its very nature, it is an up-to-date and improved version of another operating plan which had supported the merger proposal by asserting a potential for saving $81- million annually at cost levels then in effect. As such, the Master Operating Plan is either a plan to save $81-million, inf.ated by increased costs of labor and material, or it is nothing. If the latter then there is cause to question what plan we have been following, as well as the much more important question "What plan will we follow in the future"? Mr. Flannery has now authorized that copies of the Master Operating Plan be sent to the General Managers for their review and comment. (See his letter of October 14.) It is generally understood that little if any cash will be available during 1970 for Road Capital items. For whatever value it may have produced, the annual capital budget meeting has already been held. What effective use we can now make of the General Managers' comments in respect to the Master Operating Plan as it affects their territory is difficult to visualize. We cannot now get back any of the money that has been spent but we can make sure that anything we spend from now on relates definitely to an identifiable objective which is in itself an understandable part of a whole plan to make one railroad out of two railroads, with operating costs in the area of $100-million lower than the cost of operating both. PLAN FOR THE FUTURE A. Expand the post audit function to determine the degree of savings currently being made from projects and programs which have been advanced. Drive to get more ! B. Identify the missing links between physical units which are limiting the savings. Where the benefit/cost relationship is most attractive and funds can be made available, push forward to improve the return from earlier investment. C. Consolidate regions and divisions in the direction indicated by experience to date. It has been clear from the start that nine regions are far too many to be competently staffed and effectively managed. As a beginning, it seems perfectly feasible now to reduce this to six, realigned to most effectively deal with the problems which post-merger opera- tion have pinpointed. It would be difficult to conceive of a less likely plan than the one which I understand to be under serious consideration — to eliminate the Lake Region by attaching the Cleveland Division to the Northeast Region and the Toledo Division to the Western Region. D. Revive the system of budgeting and forecasting by responsibility centers, then comparing actually incurred costs with those which had been planned. There can be no more effective system than for each level of manager to control his own subordinates through the same number series with which he is called to account. In view of the experience during the recent past, it will probably be wise to budget revenue-related units and dollars of expenses at relative levels which may produce system deficit figures rather than to insist that budgets reflect unattainable relationships, being forced, thereby, to deal with variances of meaningless and unmanageable size. E. Recognize that revenue freight volume by Penn Central TrailVan service has been in a consistent decline while rail-highway services of our competitors have been increasing. The decline in patronage parallels investment of added millions of dollars in expansion of terminal facilities, additional vans and trailers, and more and more short high-speed train miles. We must begin a stern and non-paternal analysis of actual corporate profit rather than of paper profitability which comes only from the Treasury of the parent and, even when so subsidized, continues to decline in volume. F. Reinstitute the maximum extent of local control, insisting on local assumption of responsibility to act as swiftly changing condition require. Except and be prepared for people undergoing training and experience to make mistakes. Deal more sternly with those who do nothing than with those who occasionally use poor judgment. Consistent with this general policy, we should drastically curtail the local acitivities of system officers who have been wandering about aimlessly managing each day what they can see without regard to the effects elsewhere. G. Reinforce and strengthen the activities of the planning organization and bring into chis unit many related but independently functioning activities. We have wasted incalcul- able money and time because electronic data processing has been considered beyond the reach of those who have data to process. Begin to plan toward a system of regular periodical review of methods, procedures, costs, benefits and relationships of every activity carried out by Penn Central Transporta- tion. Nothing should escape review — nothing should be taken for granted — nothing should be considered permanent or unchangeable. David E. Smucker. Exhibit 66 Peat, Marwick, Mitchell & Co., Certified Public Accountants, Philadelphia, Pa., December 22. 1969. Mr. C. S. Hill, Vice President-Controller, Penn Central Co., Six Penn Center, Philadelphia. Pa. Dear Mr. Hill : We were requested to perform an outside investigation of the freight billing system used by Penn Central Company. Using both Penn Central and Peat, Marwick, Mitchell & Co. personnel, three review teams were organized to conduct such a study. The accompanying report relates our findings, conclusions and recommendations resulting from this review. 706 FINDINGS We did not find a major occurrence resulting in the failure to collect freight revenue. However, we did And serious weaknesses which prevent billings being rendered to patrons on a prompt basis. Actually, we consider these delays to be excessive. The current system is almost totally dependent upon quality performance by agreement personnel. Manage- ment control over the quality and promptness of rendering bills to patrons is too late in the system and otherwise inadequate. The only current method of detecting whether agen- cies are promptly preparing revenue waybills for patron billing is by physical inspection and research. The errors and inaccuracies in the system as noted during the study occur in two critical areas. The first is revision. Inaccurate rating generates an excessive volume of disputed bills. The result is a lengthening of the collection cycle with additional effort expended toward resolving the disputes. The second area is in accounts receivable-cash application. We detected a recent alarming build-up of unresolved and overage items which were not being resolved at certain locations — notably Indianapolis and Detroit. Credit and collection performance deteriorates as these two situations worsen. CONCLUSIONS AND RECOMMENDATIONS The major concern we have is that the current control systems are too late and do not attempt to relate car movement to freight billing. The post audit computer system has not functioned since the merger. On the other hand, we sampled and examined physical car movements and related records to determine if billing was rendered. While our sample was small, because of timing requirements, we found the car movement consist records to have a reliability of approximately 95% which improved to better than 98% when trains in Eastern New York were excluded. Based upon our findings, we recommend a mechanical control system be designed, "developed and installed so as to reconcile billing and car movement records. Such a system will also provide management reports for follow-up purposes. We also recommend that procedures be established to better control the transmittal of paperwork. Secondly, we found sufficient evidence of confusion and inadequately prepared personnel which indicate that the training programs of the six Supervisor of Revenue Accounting (SRA) offices are inadequate. We recommend that a specific training program be developed for the revision area which would embrace all aspects of tariff interrogation. Also, we recommend that abbreviated procedures manual be prepared for the accounts receivable area on a position-by-position basis. These manuals should contain specific illustrations of the various transactions. As our study progressed, we became more convinced that the recent organizational change which placed the agent under the jurisdiction of the trainmaster threatens a basic financial control technique. That is the check and balance feature of the former Agent/ Trainmaster relationship wherein one party is primarily responsible for providing service and the other for properly recording the transaction for financial control purposes. We recommend that this organizational change be re-evaluated. The area of miscellaneous charges, particularly intra-plant switching and placement for patron convenience is totally dependent upon personnel providing documentation that the services have been rendered. Based principally on interviews (crew riding was not included in the study) we were appraised of a number of circumstances wherein the Penn Central was not compensated for revenue moves. To prove or disprove such an occurrence requires a separate and distinct type of audit. To insure collection, we can see the possibility of developing a system of documentation tied into a work performance system. That is, work performed is measured and the performance appraised. Since the moves made are recorded under this concept, the data is then available as billing support. Finally, we observed two agency locations with probably the worst working conditions we have ever seen— Kalamazoo and Niagara Falls. It is inconceivable that personnel svorking under these conditions can perform quality work commensurate with the rest of the system. We recommend, notwithstanding capital improvement budget limitations, that steps be taken immediately to relocate these two agencies. We appreciate the opportunity afforded us of participating in this study. We would particularly like to commend the excellent assistance rendered us by the three industrial engineers assigned by the Penn Central to the study teams. The accompanying report is a summary of the individual team reports prepared by region which are in turn a summary of the detailed working papers. This documentation and specific examples of findings will be made available to you or your staff as you require. Yours truly, Peat, Marwick, Mitchell & Co. [Attachment.] i — introduction During the period of time elapsed since the former Pennsylvania and New York Central Railroads were merged, major difficulties have been encountered in establishing workable procedures which would permit the uninterrupted continuation of the merged Penn Central operations. Paperwork processing, particularly in the areas of billing and revenue account- ing has presented serious problems. Comments and questions have been raised from time to time as to whether major failures in the revenue control system could have occurred during the transition period. Such questions have been raised by patrons as well as by Penn Central management. 707 Perm Central management decided that it was desirable to retain an impartial third party to make a procedural audit of the freight billing system. Peat, Marwick, Mitchell & Co. was selected to make such a review. In conducting this evaluation we organized three teams to perform a procedural audit of the Supervisor, Revenue Accounting (SRA) loca- tions, as well as selected agencies and yards and terminals. At the same time we observed paperwork handling techniques and tested car movement records. PUEPOSE AND SCOPE OF THE REVIEW The review was performed to determine if a significant breakdown was occurring in rendering freight revenue bills to patrons for services rendered. Specifially, the teams were charged with determining if a large number of revenue movements were unrecorded or the paperwork overlooked, misplaced, etc. and therefore not being billed to patrons and collected. The next point was that if this condition existed, was it caused by a basic weakness of the overall revenue procedure or did it happen because practices were not in compliance with standard procedures. In conducting the review, the teams analyzed the effectiveness of both procedures and practices in the major functional areas of SRA, Agencies and Yards and Terminals. These areas have the principal control over initiation and control of the freight revenue procedure. Another objective was to establish whether control elements of the revenue procedures were adequate and timely. Also to be determined was if these controls were being applied across all aspects of the revenue responsibility. Consideration was to be given towards the effectiveness of procedures, practices and controls, so as to assure the reconciliation of actual services rendered to freight revenue billed and collected. Finally, as the study progressed, it became obvious that we should devote attention to the area of miscellaneous charges particularly in intraplant switch moves. Rather than attempt to develop an audit program, we reviewed procedures, observed paperwork flow and implied or real controls. ORGANIZATION OF THE STUDY Our approach toward establishing adequate review coverage was to organize three teams jointly staffed with personnel from Peat, Marwick, Mitchell & Co. and Selected Penn Central employees. Each team consisted of two Peat, Marwick, Mitchell & Co. personnel and one industrial engineer from Penn Central. The teams visited and performed observa- tions and analyses in all regions with the exception of the New Haven region. It should be noted that coverage in the Lake Region was very limited. The following is a listing of the number of facilities visited by the teams and where some degree of review was performed : 8 Regions 6 SRA's 51 Agencies 81 Yards or Terminals The Penn Central engineers assigned to the teams as well as other Philadelphia person- nel made most of the advance arrangements for the visits to insure that the teams dealt with responsible parties and to minimize delays. This advance planning greatly accelerated our progress. Before the teams left System Headquarters, a series of briefing sessions were conducted by representatives of Penn Central accounting and operations. After the teams had visited the first three SRA's and four regions, a debriefing session was conducted in Philadelphia. The review approach was then revised to develop more specific statistics and analyses from the remaining SRA's and regions. After the second series of visits and reviews, another debriefing session was conducted. The teams then committed to writing their significant findings and conclusions for each region and SRA visited. This letter summarizes the team reports. Finally, three oral presentations were made to Penn Central management — two after the first series of visits and one after the second set of visits. II — FINDINGS In the brief time we spent in the field we did not find major occurrences of revenue loss to Penn Central. However, the purpose of our study was not to uncover specific occur- rences of lost revenue but rather to examine from a systems viewpoint the systems and con- trols in effect. We have uncovered some major deficiencies. These findings will be stated in the following major functional areas. SRA In all SRA's visited and reviewed, the accounting procedures which are formally desig- nated as AD 206 and AD 260A were being followed. This was confirmed by the practices observed and review of the records maintained. (a) Paperwork Control We found that effective batch controls over the input source documents were not part of the system throughout the functional areas of SRA. Logs are not maintained for input, with volumes of waybills or specific waybill data by related agency. The criticism of ran- dom processing without proper control of waybills is applicable to all departments of the SRA as well as data processing at the SRA locations, which is not subject to the authority of the SRA's. This lack of paperwork control makes resolution of errors, tracing and waybill identification difficult. As a result, serious delays develop. In addition, there is a lack of 708 positive control preventing the loss of waybills while being processed throughout the SRA. Finally, the quality of performance is not closely controlled to minimize human errors. The system is not designed to eliminate the many possibilities for misinterpretation. If an error is generated in the system, it will normally flow through the entire cycle of EDP recording and patron billing. This condition is not brought to the attention of the SRA until it is made known by the customer or by the agency in the event the transaction is for a cash customer. In summary, the SRA lacks a positive control system that insures revenue waybills and patron billing are submitted for all revenue moves reported. (6) Personnel/ 'Training — Revision A critical personnel situation exists at most of the SRA's visited. This is especially applicable to the rate revision area which is the one that demands the greatest skill, yet the incentives do not exist to attract or maintain individuals with the needed skills. The lack of experience currently existing is exemplified by the condition in Detroit. Of the 18 personnel in revision, 6 have 14 or more years of service; 9 have less than 1% years ; and the remainder falling between the two extremes. The revision section of the Eastern Region SRA (Philadelphia) will lose an estimated 51% of the total years of railroad service between October, 1969 and June, 1970 due to retirements. The breakdown of personnel by service is 6 with 12 years or more service, 6 with 1 to 12 years service and 6 with service measured in weeks and months. We did not observe any formal training during our visits to the SRA's. We have been advised that one individual tours the SRA's for this purpose. Obviously, a much more meaningful program is necessary to replace and train personnel to cover loss of experience. Job training techniques that were observed must be termed informal. The practices we observed could best be defined as "on the job" training, supplemented only by brief clerical instruction. SRA management appears to have little time to practice follow-up reviews on training progress or more important the subsequent capabilities of the personnel holding positions. Lead clerks and supervisors fill the voids in order to process the work. (c) Accounts Receivable Another significant area that indicates a need for control is the unsettled accounts receivables. Specific examples of uncontrollable items were revealed throughout this area. One practice discovered at an SRA was the use of a fictitious patron account titled the "Paul P. Account". This is a suspense account for disputed transactions. Such unsettled items are held there until resolved by the lead clerk in the correction section in Indianap- olis. To control and eventually eliminate the use of this account, a continuous account analysis is required. In reviewing this account at one agency, we found that items were not promptly resolved. In addition, we were not able to determine that standard procedures permit this practice since the open item loses its identity in the EDP system when it becomes a "Paul P." item. (d) Correspondence The volumes of disputed correspondence that were evaluated during our visits to SRA's indicated a significant problem related to the effective control of revenue. This correspond- ence was primarily related to patron complaints regarding rating errors and duplicate billing. In addition, examples of triplicate billing resulted in stronger than normal com- mentary from reputable patrons. (e) Inexact Cash Remittances Another problem area detected was the recording and accounting for cash remittances by the Bank Remittance Customers. The bank receives and processes these payments by type of transaction. Group I is composed of checks for payment in full accompanied by remittance cards. Group II includes checks and statements from which the bank prepares a remittance card. Group III consists of checks supported by limited detail but not sufficient to be included in Group I or II. Group IV includes checks received with no supporting detail to identify payments. Groups I and II should present no problem for reconciliation. The volume of Groups III and IV remittances currently are ranging from 45% of total remittance as reviewed at the Indianapolis SRA to 68% at the Detroit SRA. These volumes are based on dollars and not on open items. We have been advised that Groups III and IV represent about 25% of the transaction count of accounts receivables (unsettled) at this current time. The open items not resolved are transferred to the overage and advances (O&A) account. (/) Cash Application Inherent in the system is a time limit that necessitates the accounts receivable clerk making journal entries to post the actual amount of money received from the bank deposits. If the payment is not identified by the cutoff time, the unidentified portion becomes unap- plied credits. The clerk will receive from data processing a cumulative total of all payments received which must balance to the statement submitted by the bank. An attempt will be made to further identify items that were recorded as unapplied credits. If the unapplied credits are not identified the day they are recorded, these transactions may remain in this account for several months, as evidenced at the Indianapolis SRA where unapplied items were generated back in May, 1969. Based on volumes currently outstanding it appears that considerable unapplied credits could remain unresolved indefinitely, with the contra effect somewhere in accounts receivable (unsettled). Since these unapplied credits do not erase tho receivable from the tape, the patron will receive a delinquency notice ten days later for a bill that has already been paid. This condition influences the major problem of excessive 709 correspondence on a daily basis. Credit and collection practices become of academic interest when the unapplied credit and O&A account balances increase. The high volume of rating errors which came to our attention have greatly contributed to the conditions described above. (<7) Forced Waybills While attempting to resolve open items at one agency we uncovered several occurrences of forced revenue waybills. These were detected at the Charleston, W.Va. agency, with processing through the Indianapolis SRA. Four waybills amounting to approximately $2,000, which were readily identifiable as prepaid, were processed as collect waybills. The patron is fully cognizant that these bills are in error and, therefore, will not remit. Currently, these bills remain in the unsettled account status. To aggravate the case cited, the cars involved were interline movements involving percenting and settlement with a foreign road. This set- tlement was made, therefore the loss of revenue resulting from this act was magnified. A question that remains with us is what volume of similar incidences exist, undetected, throughout the system. (h) Current Revenue Waybill Follow-up We were made aware of serious deficiencies in the AD 1634 and AD 1635 control pro- gram. The volumes of AD 3604's, the inquiry request submitted at month's end by the agent to the SRA for resolution of waybills unreported by the SRA exceeds the SRA's ability to respond. During our review, little was being accomplished by the SRA's in answering these AD 3604's. The situation is rapidly deteriorating. As an example, the East St. Louis agency is experiencing the following accelerating volume of 3604's : July, 1969—126 items August, 1969—146 items September, 1969—579 items A similar progression but with higher numbers exists at Buffalo. AGENCIES The following findings were observed in the reviews of selected agencies. As stated earlier, in our report, it is our opinion that these findings could have unfavorable effects upon revenue control and efficient cash flow. (a) Agency Control Forms In our reviews of agencies, adherence to the AD 1634 and AD 1635 control program was unfavorable. The attitude of a great percentage of the agents toward this program may be defined as non-acceptable with certain agency personnel making little effort toward complete adherence. In a specific agency (Cincinnati), a memorandum was issued by the agent ordering his people not to adhere to any segment of the 1634's and 1635's because of lack of personnel. Copies of this memo were sent to the SRA instructing the Supervisor of Revenue Accounting to discontinue submitting reported waybill statements to his agency. In many agencies delays in preparing 1634's and 1635's destroy the value of this inter- mediate control program. The reasons most often given for this breakdown were the budget cut or organizational change wherein the agent reports to the trainmaster. Another condition that existed at the agencies was the lack of a transmittal control between agency and SRA. We found poor morale existing throughout most of the agencies. This personnel atmos- phere was primarily the result of the recent budget cuts. The across the board force reduc- tion, as observed, was being often applied to personnel performing functions directly related to revenue document processing or, as mentioned earlier in this report, revenue control functions at agency level. (&) Memo Waybills Delays in revenue processing and possible loss of revenue could result from excessive use of memo waybills. The continuation of the practice of using memo waybills to move cars and trains has put a severe strain toward timely processing of revenue waybills. As agency forces are cut, this practice will increase with the result of pyramiding the work to resolve the memos. The threat of loss of revenue becomes more critical when volume repeti- tive movements are involved as was the case pointed out at our progress meetings in connec- tion with Midwest Steel. Large volume memo billing also presents a difficult control problem at East St. Louis. Deficiencies in waybill numbering were observed at a few agencies (Toledo, Buffalo and Detroit). An example of this was observed at Todelo and Buffalo where waybill numbers were not always used. Detroit was using its own waybill numbering procedure which presented a problem with regard to standardization and uniformity. (c) July 1 Study Our follow-up of a few unresolved car placements that appeared as a result of the "July 1, 1969 study" proved successful. The purpose of the "July 1" study was to identify all car placements of that date as shown in the car movement records (waybill records) and match the data to related waybill data processed by the SRA. The objective of this study was to determine if revenue waybills were being processed by matching mechani- cally and resolving exception items manually. With the information available to the review teams, the agents at Dayton, Ohio and West Carrollton, Ohio, were in position to resolve two cars appearing as "no bills". Not only did the agent process the two outstanding cars but a third car which was outstanding as a no bill on the AD 1634 for that date, with the 710 same destination, consignee, origin, routing and freight, was way-billed based on the infor- mation provided by the Manager, Revenue Accounting. This experience demonstrates the possibilities of improved control that could result from the proper use of mechanical car movement data. YABDS AND TERMINALS The following findings were observed in the reviews of selected yards and terminals. As stated earlier in our report, it is our opinion that these findings demonstrate an un- favorable impact upon revenue control and efficient cash flow. (a) Illegal Form Observations at yards and terminals detected the use of an illegal form at one location. This was the use of the T-1572 form at Detroit. This is a single copy record originally designed to document miscellaneous charges. Use of this form presents a potentially serious revenue problem. That is, if this single copy record is lost then there is no defined follow- up system to force revenue recovery. We found cars that moved from Niagara Falls to Kalamazoo on this document. These cars were forwarded through Detroit. In addition, during our visits, we observed miscellaneous and sundry forms, papers, etc., used as legal documentation to move cars. These non-standard forms are substitutes for waybill forms. (b) Prevailing Attitude Throughout our visits and contacts, one consistent finding prevailed and this was the attitude that "moving cars has priority". The operating and transportation personnel we talked to typically showed little concern for revenue control and processing of source docu- ments related to freight revenue. (c) Miscellaneous Charges The status of reporting, processing and control of miscellaneous services could be classified as questionable. The system, regarding miscellaneous charge revenues collected from patrons, is only as good as the reporting performance by operating personnel. At the Homestead, Pa. agency there were occurrences where the original source document, AD 1582, the conductor's switch list, was not transmitted to the agency. In these particular instances, revenue was lost by Penn Central. The current system does not have a control technique to verify actual miscellaneous services performed to billings rendered. (d) Physical Check of Trams Considerable time and effort was spent to check the accuracy of physical car movement records versus the related data posted to official source documents, such as train consist, AD 1580, AD 1582, AD 1634 and AD 1635. The results of these observations follow : 1. 1,838 cars were virtually checked and verified against the consist. Of the total there were 69 "no bills", 6 bad car numbers and 17 overbills. 2. 322 cars were checked and verified between the AD 1580 and 1582 and the AD 1634 and 1635 with 12 errors resulting. The review for item 1 above indicates a 5% error factor for both types of source docu- mentation. This random physical checking was performed in yards across a representa- tive section of the system. However, if the errors found in the New York Region (59 no bills and 16 overbills out of 844 cars) are eliminated, the error percentage drops to a very respectable 1.7%. In addition, because of our commentary at an oral presentation following our first series of visits, the Eastern Region provided an industrial engineer to test percent return. Or can modernize. This passenger situation is only one of the symptoms. The whole situation is deteriorating. . . . We don't have the financial resources to do the job we ought to do. The passenger situation is only one seg- ment of it. . . ." (emphasis mine). This colloquy took place between Senator Hartke and me at that hearing : Senator Hartke. "I have been out on these roadbeds myself and I am not an expert in engineering, but it doesn't take an expert to know they are in bad shape." Mr. Saunders. "They are not in the condition that they ought to be. The railroads of this country are being starved to death, we haven't got the money to put into the property we ought to." On November 12, 1969, I testified before the Subcommittee on Transportation and Aeronautics of the House Committee on Interstate and Foreign Commerce to this effect: "You have before you, in my judgment, a two-pronged problem. The first is the urgency for immediate relief, even if it is short-term and stopgap. Our problem cannot wait another year or even another few months. This house is on fire, and we cannot sit around and talk about the best way to put it out while it burns completely down. . . . Time is of the essence. "I respectfully submit that there is not sufficient understanding of the plight of the railroad industry. Passenger service is only the most obvious symptom of the perilous con- dition of our industry." (emphasis mine). 724 My statement to this Committee was printed and a copy of that printed statement was sent to every member of Congress and the editorial page editors of leading newspapers. On February 24, 1970, Mr. Paul A. Gorman, then our President, and Mr. Jonathan O'Herron, then our Vice President, Finance, and I met with members of ICC and certain members of their staff. We went over in detail our 19(J8 and 19G9 financial results, for both the consolidated and transportation companies, the source and application of funds for 1909, our projections for 1970 and our financial plans for 1970. During February and prior to March 13, 1970, I had at least three meetings with Secretary Volpe in which our problems were discussed. On March 13, 1970, Mr. Gorman, Mr. O'Herron and I had a full discussion of our problems with Secretary Volpe and his top aides and made substantially the same presentation that we had made on February 24 to the members of the ICC. Secretary Volpe and his aides agreed that we should get in touch with them again as soon as we had a better picture of PC's financial results for the first quarter of 1970. There was no discussion with Secretary Volpe at that time about a Government-guaranteed loan a PC's financial department believed then that it would be able to meet the Company's needs through private financing. As soon as figures regarding PC's first-quarter earnings for 1970 were available, 1 sought a further meeting with Secretary Volpe and his top aides, and a meeting was held on April 30, 1970. Secretary Volpe stated that he would discuss our financial problems with other governmental officials and especially with Secretary Kennedy of the Treasury De partment. Secretary Volpe arranged appointments for me to see Secretary Kennedy at which time I explained the problems with which PC was faced. For some time, our financial people had been working on a $100 million debenture issue by Pennco which they planned to market in the latter part of May. In this connec- tion, see the remarks of Mr. Bevan at the Annual Meeting of Stockholders on May 12, 1970, and his statement in the Wall Street Journal on May 15, 1970 to the effect that the financing would be consummated. On May 28, 1970, however, our financial officers and the underwriting group concluded that the sale of this issue should be postponed and on that date, PC made a public announcement to that effect. The Company was also exploring other methods of financing. One of the alternatives considered was a government-guaranteed loan, and a number of discussions and conferences were held with governmental officials in that regard. As a result of these meetings, a plan was developed for a government-guaranteed loan of $200 million under the Defense Pro- duction Act of 1950. We were given every reason to believe that such a loan could be arranged and it was only at the last moment, namely on June 19, 1970, that Penn Central was advised that this would not be done. Inasmuch as I retired on June 8, 1970, I am not in a position to discuss anything that occurred after that time. The facts which I stated in the pages immediately preceding were set forth in my testimony before the Subcommittees of the Senate Commerce Committee and the House Committee on Interstate and Foreign Commerce in July 1970. ******* BOARD OF DIRECTORS' COMMITTEE ON INFORMATION DISCLOSURE AND CONFLICT OF INTEREST I would like to comment briefly on the Committee on Information Disclosure and Conflict of Interest which was created by PC's Board of Directors, on my recommendation, at its meeting on September 24, 1968, It was an able and active Committee. Its functions were defined by the Committee in its report to the Board on December 19, 1969 as follows : "Upon instructions from the Committee, counsel made a survey of the overall opera- tions of the Company with particular emphasis upon areas involving (i) possible con- flicts of interest; (ii) procedures for the dissemination of news to the general public; (iii) transactions in securities of the Company by directors, officers, and others, and (iv) the organizational structure of the Company. In the course of the survey counsel reviewed, among other materials, the following : annual reports and proxy statements for the past several years; periodic reports required to be filed by the Company with Securities and Exchange Commission ("SEC") ; periodic reports required to be filed by officers and direc- tors with the SEC relating to their transactions in the Company's securities ; reports required to be filed by PC and its directors and officers with the Interstate Commerce Com- mission ("ICC") : copies of the questionnaire which the Pennsylvania Railroad Company sent in 1961 to its officers and directors relating to the subject of possible conflicts of interest and the answers thereto." This Committee employed outside counsel — the firm of Skadden, Arps, Slate, Meagher, and Flom of New York — and made a number of studies on such matters as E.TA. Penphil and "insider trading". It also prepared a Manual on Conflict of Interest and a Questionnaire on that subject — both of which were sent to directors and officers of PC and its principal subsidiaries. The Committee made frequent reports to PC's Board on its activities. Such matters as alleged conflicts of interest and monitoring of any trading on the part of diree tors and officers should he handled on the Board level rather than by me as Chief Executive Officer. Certainly, the problem of handling anv such alleged transactions by me would have been inappropriate (such as inquiring into the personal affairs of officers and directors). It was for this reason that I asked the Board to create the Committee on Information Disclosure and Conflict of Interest. In the areas mentioned the Committee acted independ- ently of management and had jurisdiction over these matters. 725 THE WABASH TRANSACTION On page 121 of the Bureau's brief, reference is made to acceleration of the exchange of Wabash stock for N & W stock. It is stated that : "Before N & W would advance the exchange date from October 15, 1970 to March 31, it exacted certain concessions from PC, including an agreement to sell certain land in Michigan at $20,000 per acre even though it had been assigned a market value of $30,000 per acre by an independent appraiser retained by PC (V.S. 9— pp. 12-14)". This statement places an unfair light upon the transaction. In the first place, the Commission provided that the exchange of stock should take place "on or before October 15, 1970" and not on October 15, 1970. We had a legal right to execute the exchange prior to October 15, 1970— subject to ICC approval and it was approved by the Commission on March 26, 1970 (Finance Docket No. 21510). Secondly, the transaction was advantageous to PC. The 675,000 shares of N & W stock to be received in exchange for 598,186 shares of Wabash were much more marketable than Wabash stock. Actually, there was no market for Wabash stock. Moreover, N & W stock would enable us to switch collateral and give Pennsylvania Company greater flexibility in its financing. Another consideration from PC's standpoint of accelerating the exchange date was that the parties were able to settle a longstanding controversy between PC, N & W, and the City of Erie, Pennsylvania with reference to trackage in the streets of that city. A further consideration was the sale of 28.62 acres of land in Melvindale, Michigan to the N & W. PC had had extended negotiations with N & W with reference to the sale of this property. PC's "trading" figure was initially $30,000 per acre — PC actually expected to get about $15,000 per acre. The land was acquired for $63,473 and was sold to the N & W for $572,400 cash. And, of course, cash was an important consideration. The sale was much more attractive because the N & W had had a lease on the property for ten years which expired on July 31, 1970. The rental on the property was only $8,080 per year— which, I doubt, would even pay the taxes. But, the important fact is that the N & W had an option to renew this lease for an- other five (5) years from July 31, 1970 at this absurdly low rental. This is completely ig- nored by the Bureau's brief. The brief also ignores the fact (all of which is disclosed in V. S. 9, pp. 12-14, of ICC papers) that the appraised market value to which the Bureau's brief refers was on the basis "of this land, as if vacant." The property was not "vacant" for the N & W had been leasing the property for the purpose of loading automobiles in its cars for a period of 10 years and had a right, as stated above, to renew this lease for a period of 5 years from July 31, 1970 at the low rental just mentioned. Moreover, the Bureau's brief ignores the fact (which the ICC records also disclose) that N & W has an option from Marathon Oil Company to purchase an adjoining 10 acre parcel until 1975, at $10,000 an acre, or half of what N & W paid per acre to PC. It was also provided that a new operating agreement would be entered into between PC and N & W whereby PC would be able to continue to use the premises for the purpose of loading automobiles in its cars. PC's use of the property amounted to about 20% and N & W's about 80%. When all the facts are considered, PC's exchange of PC's Wabash stock for N & W stock was very attractive. ALLEGED DELAY OF THE RETIREMENT OF NON-DEPRECIABLE PROPERTY At page 122 of the Bureau's brief it is stated that "PC's decision in September, 1969, to delay the retirement of non-depreciable property was motivated by the fact that such retirement would involve the recording of service losses". This charge is unfounded, and the next sentence of the Bureau's brief shows the real reason for what PC proposed to do. In September 1969, PC was in the process of preparing a "master abandonment program" whereby it hoped to get ICC approval for abandonment of some 5,800 to 6,500 miles of track. It was hoped that, by presenting a comprehensive or package program to the ICC, we could get much quicker relief than if PC proceeded on a piecemeal basis. It is a well- known fact that any proposed abandonment of consequence is subject to protracted hear- ings before the ICC and frequently Court proceedings to review the Commission's decision. This program was no secret — it was discussed with the Commission and the Commission has since made suggestions for expediting its trackage abandonment procedures. The Trustees of PC actually propose to go much further with this program. Their proposal is to abandon some 9,000 miles of PC's trackage or almost one-half of its total mileage. They are now actively pursuing this approach. ******* Again, on page 122 of the Bureau's brief, criticism is made of PC's write-down of long- haul passenger equipment and facilities west of Harrisburg, Pennsylvania and Albany, Now York, effective January 1, 1969. The brief shows that this matter was fully discussed with the Commission and that PC followed the advice of its independent auditors (PMM) in reporting this transaction to stockholders and at the same time footnoted the Com- mission's view in its Annual Report to Stockholders. It is significant that practically all other railroads having similar problems are following substantially the same approach in connection with their Amtrak transactions. 726 LABOR PROTECTION COSTS The Bureau's brief discusses "Labor Protection Costs" (pages 80-98). It says that the agreement made on May 20, 1964, by Pennsylvania Railroad and NYC with 23 labor unions, representing some 77,000 employees has come to be known as the "Saunders Agree- ment". This characterization is unjustified. An agreement cannot be made by one party. All of the negotiations were at arm's length and every meeting with reference to the negotiations were handled jointly by Mr. Perlman and me, along with our respective vice presidents in charge of labor matters. Before the agreement was signed it was approved by the Boards of Directors of NYC and Pennsylvania Railroad, some three and one-half years before the merger. The Bureau's chief focuses primarily on the merged company's obligation to "recalled" employees and indicates that the Pennsylvania and NYC should have offered evidence at the 1964 hearing regarding the costs of "recall" employees. I did not prepare the figures with reference to the costs of the 1964 Labor Protection Agreement. They were prepared by the Labor Departments of the NYC and the Pennsyl- vania Railroad. I am advised by the Labor Department of PC that the reason no costs for "recalled" employees were included was the fact that no "present employees" were in a furloughed status on either Railroad at that time (September 16, 1964) and that no "recall" costs could be reported. No one contemplated at that time that it would be some three and one-half years before the merger would be consummated. By December 1967, when we realized that this "recall" provision could prove quite expensive, we brought it to the Commission's attention and asked for special relief. All the facts were made known to the Commission. It had full opportunity to review the changed conditions and all the facts were presented to the Bureau of Accounts, and upon appeal, to Division 2 of the ICC. Division 2 approved the establish- ment of a Merger Reserve of approximately $275,000,000, including $117,000,000 primarily for "recalled" employees under the Labor Merger Agreement. The Bureau's brief states that "since the agreement was 'unique', it is not surprising that counsel for other parties (including the Bureau of Enforcement) who questioned Mr. Saunders failed to inquire about applicants 'recall' obligation." (p. 91 of Bureau's brief). Not only was counsel for the Bureau present, but scores of other lawyers were present, including lawyers from the Department of Justice, many of whom were experienced in ICC proceedings. They knew, or should have known, that the N. & W.-NKP-WAP Merger Labor Agree- ment of April 16, 1962 was the same, so far as "recalled" employee obligations, as the PC agreement. Likewise, the N. & W.-Virginia Merger Labor Agreement of June 18, 1959 was inter- preted to treat "recalled" employees substantially the same as such employees were treated under the PC agreement. Both of the above agreements were reviewed by the ICC and approved by it, and, of course, the 1964 PC Labor Agreement was presented at the September 16, 1964 hearing for all of the numerous counsel to scrutinize and for purposes of cross-examination. Subsequent to this hearing, but prior to the ICC's approval of the establishment of PC's Merger Reserve for "recalled" employees and obsolescent property, the Commission ap- proved similar labor protection agreements in the Seaboard Coast Line and the Burlington Northern merger cases. Taking this record of protection for "recalled" employees, starting with the N. & W.- Virginian Merger Labor Protection Agreement on June 18, 1959, it seems strange for the Bureau to claim that the PC agreement was "unique" in this respect. Moreover, there were numerous appeals to the Federal courts to review the record before the Commission, particularly several appeals to the U.S. Court of Appeals for the 2nd Circuit and the Supreme Court of the United States. These appeals were vigorously contested and there was adequate opportunity to review every aspect of the merger. It was not until January 15, 1968, that the U.S. Supreme Court finally decided the case. In its decision the Supreme Court said : "Examination of the record and the findings in the present case satisfies us that the Commission has properly and lawfully discharged its duties with respect to the merits of the merger. In these elaborate and lengthy proceedings the Commission has considered evidence tendered by others and compiled by its own staff. Upon the aggressive suit of parties representing conflicting interests it has analyzed every pertinent aspect of the merger. . . . "It has weighed conflicting viewpoints on all of the fundamental issues and many that are tangential. As the Commission concluded, the evidence before it, with negligible excep- tions, attested to the probability of significant benefit from the merger, not only to the railroads and their investors, but also to shippers and the general public." (389 U.S. 486, 493). DIVIDENDS Neither PC. the Pennsylvania Railroad, nor to my knowledge. NYC had any fixed policy with respect to the payment of dividends. At each meeting where dividends were declared, the Finance Committee reviewed (a) financial results as of that time, (b) business outlook and (c) the cash situation and other relevant matters. The Finance Committee would make dividend recommendations to the Board. The Board, itself, declared the dividends and, in every case, the action of the Finance Com- mittee and of the Board was unanimous. 727 The last dividend declared by PC was at its June 1969 meeting. At the time the dividend was declared, the figures available showed that, on a consolidated basis, the dividend would be earned for the third quarter and for the year 1969. POSITIVE STEPS TAKEN TO IMPLEMENT THE MERGER It is significant that practically all of the ICC staff investigating PC only discuss nega- tive aspects of PC and its predecessors. No mention is made of the fact that some $1.5 bil- lion was spent on the railroad from 1963 through 1967 ; that the railroad spent some $70 million in developing the Metroliner service, which is proving to be a great success; that after the merger PC spent about $121 million in developing new yards and facilities, to wit : 10 classification yards were built or expanded and 35 key terminals and 24 freight stations were consolidated ; that road operations had been combined at 29 points ; that the ratio of cars awaiting repair was reduced from 9.2 to 5.9 percent; that the bulk of the capital expenditures to implement the merger were made prior to June 1970 ; that PC spent in 1968 and 1969 over $30 million on the Waynesburg branch which opened up a billion or more tons of coal traffic ; that it built a new coal pier at Ashtabula, Ohio at a cost of over $13 mil- lion ; that it built a new passenger station in New York at a cost of more than $30 million ; that between February 1, 1968 (date of merger) and June 8, 1970, the employment of PC was reduced by 8,400 employees which meant a saving of more than $90 million each year ; and that testimony before the ICC showed that it would take about eight years from the date of merger to attain the full merger savings and make it fully effective. Nor do the ICC investigators mention any of the factors discussed above as to the basic causes of the PC bankruptcy which amounted to many hundreds of millions of dollars. ******* At my meeting with Mr. Deller and Mr. Russo we also discussed Appendix "A" 1 of the Verified Statement of Peter N. Stravu in which he listed under the heading "Shares Recently Sold" of PC — 1,517 shares sold by me. This statement was made sometime in 1970 or 1971 and is untrue. I have not sold any PC stock since March 1967. At that time, I sold approximately 4,000 shares, primarily to pay off bank loans. In December 1967, I bought over 40,000 shares of PC stock. I still have about 42,000 shares. In 1968 and 1969, I gave approximately 1,500 shares to charitable organizations and that is apparently what Mr. Stravu is referring to. These gifts were reported to the SEC. On the PC stock which I still hold, I have lost several million dollars of potential profits as well as the fact that I still owe substantially over one million dollars which I borrowed to buy this stock. ADDITIONAL INFORMATION AVAILABLE TO ICC, OTHER GOVERNMENTAL AGENCIES, AND THE PUBLIC REGARDING THE FINANCIAL CONDITION OF PC AND ITS PREDECESSOR COMPANIES I have made reference above to statements which I made between 1965 and 1970, par- ticularly before the Senate and House Committees in the fall of 1969, with respect to the critical financial condition of the railroad operations of PC and its predecessors. At this point, I would like to call attention to other documents and opportunities which the ICC, other government agencies and the public had to familiarize themselves with these prob- lems. During the period 1965 to June 1970, there were literally hundreds of contacts between PC and is predecessors with the ICC and its various departments. I attach as Exhibit "A" a list of some of the reported and unreported proceedings before the ICC during the 1965- 1970 period. It does not include all such proceedings, but is indicative of the matters that were presented to the Commission. All of these were public proceedings in which the ICC and its staff had a full opportun- ity to inquire into the financial condition, including working capital, of PC. I refer par- ticularly to the many PC merger proceedings before the Commission in this period, as well as those between 1967 and 1969 relating to the New Haven inclusion. In all of the proceed- ings, the financial condition and working capital of PC were the subject of review and pub- lic scrutiny. I have already discussed the widespread and protracted opposition to the PC merger. In many other proceedings before the ICC, there was adequate opportunity for the Commission to review PC's and its predecessors' financial condition. In the proceedings, for example, involving "Increased Freight Rates" in 1967, 1968 and 1969 (Esc Parte 256, 259 and 262), there appeared some 400 to 5O0 or more protestants in each proceeding and lawyers ad infinitum. These cases involved the financial condition of the railroads and in particular the PC and its predecessors. In this connection, I refer to my Verified Statement in Ex Parte No. 259 where I said : "The large reductions in working capital experienced by PC in the last eight years should also be brought to the Commission's attention. These are set forth in Appendix 9. The largest year-to-year decline was that shown for 1967 as compared with 1966. The 1967 figure showed a net working capital deficit of $119,720,864 (including debt due within one year among current liabilities). Our working capital position must be substantially im- proved. We cannot continue with this huge deficit, nor with the trend that is shown on Ap- pendix 9." I also attach as Exhibit "B" from the Verified Statment (Appendix 9) showing the working capital of PC and its predecessors from 1960 through 1967. An examination of this statement (which was a public document) shows that these railroads were in a dangerously bad condition. The petitions of PC and its predecessors to issue commercial paper, to issue equipment trust certificates, to obtain bank loans, including standby and revolving credit loans for 728 several years prior to 1970, all required careful scrutiny l>y the ICC of every aspect of the PC's and its predecessors' financial position. These transactions ran into many hundreds of millions of dollars. It is worth noting the problems that the Trustees of PC are having with their ac- counting and this is not said critically. For the year 1!)70 the Trustees had a variance of approximately $10!) million in their estimate of earnings in a period of about 30 days. The Trustees proposed earnings for 1!)71 is even more striking (and, mind you, PC stock is still being traded on the principal stock exchanges). According to a petition filed by the Trustees with the Federal Reorganization Court on March 27, 1972, they asked the Court to overrule the ICC Bureau of Accounts and Division 2 and permit them to show a loss of $284,520,000 instead of $560,152,00 Ounder ICC accounting practices. Ironically, the Trustees wait (1) to claim a credit of $137,213,000 for the unused balance remaining in the Merger Reserve Account for labor protection costs and (2) to claim a credit for $136,419,000 for obsolescence in connection witli Amtrak. These figures indicate some of the problems involved in running a railroad like PC. As a matter of fact, the Commission stated in its Report of March 17, 1971 to the Honorable Warren G. Magnuson, Chairman of Senate Committee on Commerce and to the Honorable Harley O. Staggers, Chairman of House Committee on Interstate and Foreign Commerce that : "The present condition of the railroad industry, including the distress of the Penn Central Company, is not attributable to the Nation's transportation merger policy of the administration of the merger laws. When the ICC was appraising the Penn Central merger proposal, it noted that in none of the preceding five years did the New York Central have sufficient net railway operating income to meet fixed charges. Except for one year (19(54) the same was true for the Pennsylvania Railroad. Neither railroad had made a profit in the transportation business for many years, and this was especially significant since the national economy was approaching record levels for sustained expansion. Their working capital was dangerously low." Beyond everything that is mentioned above as to the Commission's and to the public's knowledge of PC's financial condition is the fact that PC officers and its predecessors, as well as PMM, had many discussions with the Cimmission (verbally and written), in non- advisory proceedings, regarding accounting treatment of various transactions. The ICC Bureau of Accounts has maintained an Office and staff in Philadelphia from at least 1965, a primary function of which has been to police and review the accounting and financial practices of PC and its predecessor, the Pennsylvania Railroad. The financial results, accounting practices and merger proceedings of PC and its predecessors were subjected probably to the most widespread newspaper, radio, television and magazine coverage ever given to any company for a period of many years prior to June 1970. At a hearing before the Special Subcommittee on Investigation of the House Com- mittee on Interstate and Foreign Commerce (September 24, 1970) at which, among others, were Mr. Dale W. Hardin, then Vice Chairman of ICC, Mr. Richard B. Smith, a Com- missioner of SEC, Mr. Fritz R. Kahn, General Counsel of ICC, Mr. Philip A. Loomis, Jr., General Counsel of SEC, Mr. Irving H. Pollack, Director, Division of Trading & Markets, SEC, and Mr. Matthew Paolo, Director of Bureau of Accounts, ICC. Mr. Pollack testified as follows : Mr. Lishman. (Chief Counsel of House Subcommittee). "Did the SEC consider a suspension of trading [in PC stock] ?" Mr. Pollack (Director of SEC Division of Trading and Marketing). "No." Mr. Lishman. "Why not?" Mr. Pollack. "Because I think at that point the information concerning the filing of the petition in bankruptcy was publicly known. There had been during the early part of 1969 and continuing to the filing of the petition a release of information idicating a deterioration in the financial condition of Penn Central." ******* This statement cannot be considered as an answer to all the points raised by the ICC or other governmental investigations. It is simply an attempt to comment on some areas which were covered by the ICC investigation. If you desire any additional information, I will be glad to furnish it. I hope that you will submit this statement to the Commission and that the Commission will submit it to anyone else to whom its reports are sent. Respectfully, Stuart T. Saunders, [exhibit "a"] selected pctc-icc cases 1. Ingot Molds from Pa. to Ky., 323 ICC 758 (1965), 326 ICC 77 (1965). 2. Investigation of Adequacy of Freight Car Otcnership. 322 ICC 48 (1964). 3. Official-Southern Divisions. 325 ICC '1 (1965). 4. Merger NYC into PRR, 327 ICC 475 (1966) : 328 ICC 304 (1966) ; 330 ICC 328 (1967) ; 331 ICC 643 (1967) ; 331 ICC 754 (1968) ; 334 ICC 25 (1968) : 334 ICC 528 (1969). 5. Issuance of Notes by Pennsylvania Tunnel d- Terminal R.R. guaranteed by PRR. 328 ICC 253 (1965). 6. Discontinuance of trains between NY, NY, and St. Louis, Mo., 328 ICC 921 (1965) ; 330 ICC 458 (1966). 7. Increased Freight Rates 1967 (Ex Parte 256). 329 ICC 854 (1967) : 332 ICC 280 (1968). 8. PRR Lease (Newark-Journal Square) to PA TH, 330 ICC 503 (1966). 729 9. PRR Discontinuance of Trains between Chicago, III., and Valparaiso, Ind., 331 ICC 464 (1968). 10. Canned Goods between Pacific Coast and the East, 332 ICC 55 (1967) . 11. Increased Rates, 1968, Ex Parte 259, 332 ICC 714 (1969) . 12. Discontinuance of Trains Detroit to Chicago, 333 ICC 768 (1968). 13. Discontinuance of Trains New York to St. Louis, 333 ICC 736 (1968). 14. Discontinuance of Trains Chicago to New York, 333 ICC 638 (1968). 15. Discontinuance of Trains Chicago to Cincinnati, 333 ICC 674 (1968). 16. Discontinuance of Trains Albany to Boston, 334 ICC 618 (1969). 17. Discontinuance of Trains Harrisburg to Buffalo, 334 ICC 312 (1969). 18. Discontinuance of Trains St. Louis to New York, 334 ICC 638 (196!)). 19. Investigation of Adequacy of Freight Car Ownership, Ex Parte 241, 335 ICC 264 (1969). 20. Multiple Car Rates, Canned Foodstuffs, 334 ICC 612 (1969). 21. Penn Central Fare Revision, 335 ICC 720 (Jan. 1970). 22. Vegetables and Melons Transcontinental Eastbound, 335 ICC 798 (Feb. 1970). 23. Penn Central Transportation Co. Notes, 336 ICC 1 (1969). 24. Penn Central Notes (F.D. 25931), 336 ICC 280 (1969). 25. Penn Central and I.C. Train Discontinuance, 336 ICC 56 (1969). 26. Penn Central Train Discontinuance, 336 ICC 182 (1969). 27. Penn Central Train Discontinuance, 336 ICC 416 (B'eb. 1970). 28. Penn Central Train Discontinuance, 336 ICC 518 (March, 1970). 29. Penn Central Train Discontinuance, 336 ICC 759 (May, 1970). 30. Increased Rates 1969, Ex Parte 262, ICC . 31. Increased Rates 1970, Ex Parte 265 (Filed March 3, 1970). Unreported I.C.C. Cases 1. PRR Notes, F.D. No. 24634, July 17, 1967. 2. Penn Central Notes, F.D. 25179, August 15. 1967. 3. Penn Central Notes, F.D. 25397, December 11, 1968. 4. Penn Central Notes, F.D. 25570, March 20, 1969. 5. Penn Central Notes, F.D. 25622, May 16, 1969. 6. PRR Equipment Trust, Series A, F.D. 24014, March 8, 1966. 7. PRR Equipment Trust, Series B, F.D. 24014, May 21, 1966. 8. Not completed. 9. Penn Central Debentures, F.D. 25114, 1968. 10. Lease of N. Y. Connecting, F.D. 25811 and F.D. 25833, 1969. 11. Not completed. 12. Guaranty of Bonds, Waynesburg Southern, F.D. 25089, 1965. 13. Lease of Little Miami, F.D. 25362, 1969. 14. PC Holding Co. Control of Penn Central, F.D. 25660, August 7, 1969. 15. Sale of Long Island R.R., F.D. 23956, 1966. ADDITIONAL UNREPORTED ABANDONMENT AND TRAIN DISCONTINUANCE CASES, 1965 TO 1970 Applicants Finance docket No. Application for— P. R. R. Co P. R. R. Co P. R. R. Co P. R. R. Co P. R. R. Co. and Penndel Co P. R. R. Co. and P. B. & W P. R. R. Co.... P. R. R. Co P. R. R. Co. and Penndel Co.. P. R. R. Co. and P. B. & W P. R. R. Co. and Penndel Co P. R. R. Co.... P. R. R. Co P. R. R. Co. and P. B. & W P. R. R. Co. and P. F. W. R. R. Co., and Cleveland and Pittsburgh. P. C. T. Co P. C. T. Co. and Lake Erie and Pittsburgh Penn Central Co. and Penndel Co Penn Central Co. and P. B. & W P. C. T. Co. (trains 574-575) P. C. T. Co. (trains 24-33) P. C. T. Co. (trains 50-53) P. C. T. Co. and Connecting Railway P. C. T. Co. (trains 574-575). P. C. T. Co. (trains 574-575) P. C. T. Co. (trains 354) P. C. T. Co P. C. T. Co P. C. T. Co P. C. T. Co ............. P. C. T. Co. and Connecting Railway... P. C. T. Co. and Little Miami Railway P. C.T. Co. (trains 65-66) P. C. T. Co P. C.T. Co ....I.....M... ........... P. C. T. Co. and Michigan Central _ P. C.T. Co. (trains 15-18).. P. C.T. Co. and Penndel Co P. C. T. Co. (trains 136-7, 142-7) P. C. T. Co. (trains 572, 578, et al.) P. C. T. Co 23554 Abandonment. 23614 Do. 23735 Do. 23736 Do. 23763 Do. 23922 Do. 24278 Do. 24279 Do. 24282 Do. 24401 Do. 24602 Do. 24612 Do. 24793 Do. 24831 Do. 24963 Do. 25088 Do. 25094 Do. 25160 Do. 25335 Abandonment. 25373 Discontinuance. 25558 Do. 25755 Do. 25817 Abandonment. 25859 Discontinuance. 25895 Do. 25898 Do. 25899 Abandonment. 25913 Do. 25925 Do. 25936 Do. 25971 Do. 25973 Do. 26011 Discontinuance. 26018 Abandonment. 26023 Do. 26036 Do. 26065 Discontinuance. 26147 Abandonment. 26165 Discontinuance. 26182 Do. 26194 Abandonment. 730 [EXHIBIT "B"| PENN CENTRAL WORKING CAPITAL FOR THE YEARS 1960 THROUGH 1967 Materials and Year Working capital i supplies Working capital 2 1 year debt Working capital » I960.... $78,798,139 $80,886,817 ($2,088,678) $64,170,989 ($66,259,667) 1961 - - 53,181,021 74,962,052 (21,781,031) 64,428,731 (86,209,762) 1962 45,026,553 70,900,942 (25,874,389) 73,763,441 (99,637,830) 1963 _. 28,039,393 69,892,872 (41,853,479) 60,866,779 (102,720,258) 1964- 41,071,657 67,242,047 (26,170,390) 58,705,267 (84,875,657) 1965 72,287,619 79,927,598 (7,639,979) 72,877,958 (80,517,937) 1966 77,704,771 90,662,241 (12,957,470) 76,764,553 (89,772,023) 1967 34,895,458 85,681,305 (50,785,847) 68,935,017 (119,720,864) 1 Current assets less current liabilities. 2 Working capital less materials and supplies. 3 Working capital less materials and supplies and 1-year debt. Note: The figures above are the sum of the separately reported positions of The Pennsylvania Railroad Co., and New York Central. Figures in parenthesis denotes deficit. Exhibit 70 Philadelphia, May 21, 1963. A meeting of the Finance Committee of the Board of Directors of The Pennsylvania Railroad Company was held this day at 7 :15 P.M. There were present Messrs. Symes, Chairman, Gowen, Clarke, Hollister, Ingersoll, Day and Bevan. There were also present by invitation Messrs. R. G. Rincliffe, Howard Butcher, III, A. J. Greenough, President, and John B. Prizer, Vice President and General Counsel. The Chairman reminded the Committee that the Examiner in the case before the Inter- State Commerce Commission involving the merger of the Norfolk and Western Railway Company and New York, Chicago and St. Louis Railroad Company recommended that as a condition to the merger, The Pennsylvania Railroad Company be required to divest itself of its ownership of stock in the Norfolk and Western. This Company and Pennsylvania Company together own 2,397,284 shares of Norfolk and Western common stock having a total current market value of $288,872,723. Of these shares, 1,711,343 are pledged as collateral for loans but the remaining 680,000 shares are available for sale. He stated that there are two questions to be decided in the near future — whether to begin selling Norfolk and Western stock, and if so, how to invest the proceeds. He thereupon asked Mr. Bevan to discuss the problems involved in deciding these questions. Mr. Bevan reported that for some years Pennsylvania Company has played an important part in the financial program of The Pennsylvania Railroad Company. Fortunately it has been possible to adhere substantially to the program approved by the Board in 1953. Recently the consolidated mortgage bonds in the principal amount of $35,000,000, were refinanced and $49,000,000 of Chicago Union Station bonds have just been refinanced at an interest cost to us of 4.64%. However, the next seven years will be the most difficult from a financial standpoint of any period in the history of the Company. Earnings during the past five years amounted to only $695,000 and there is no assurance of a sudden upturn in net profits. For the years 1952 to 1962, inclusive, there was a cash loss of about $110,000,000 notwithstanding the receipt of approximately $10,000,000 a year from the sale of real estate. During 1963, based on current budget estimates, there will be a net cash loss of $20,000,000. At the end of 1962 there was an adjusted working capital deficit of $60,000,000 and at present this deficit is $68,000,000. Provisions will have to be made for maturities during the next seven years of $565,000,000, including $61,000,000 of 4%% General Mortgage Bonds of 1965, $20,000,000 of Pittsburgh, Cincinnati, Chicago and St. Louis 5% Bonds of 1970, and $46,000,000 of General Mortgage 5% Bonds of 1968. In addition, the merger with the New York Central Railroad Company will require capital expenditures during the first five years of $75,000,000, less $45,000,000 to be provided through salvage. The New York Central at the end of 1962 had an adjusted working capital deficit of $40,000,000. Both com- panies had a net income deficit last year and if there should be a deficit for them again this year, there will be a further cash loss. He stressed the importance under these conditions of maintaining liquidity and credit. Liquidity is presently provided by Norfolk and Western common stock and this fact is recognized by the financial institutions. Credit is available in Pennsvlvanfa Company and it is essential to continue this situation for purposes of further borrowing. A third important ingredient in the financial picture is the necessity of replacing the income which is currently being received on the Norfolk and Western stock. He plointed out that largely through the use of this income Pennsylvania Company has been able to bolster the financial needs of The Pennsylvania Railroad Company. Its net income has increased from $11,000,000, in 1946 to $24,000,000, as of last year. In the meantime, Pennsylvania Company has made cash available to this Company and has acquired interests in other railroads such as the Detroit, Toledo and Ironton and Toledo, Peoria and Western Railroad Companies. Total earnings for the ten-year period beginning in 1953 have amounted to $209 000 000. of which $198,000,000, has been made available to this Comnanv either in the form of dividends or by purchase of securities. These earnings must be maintained. 731 If proceeds from the sale of Norfolk and Western stock were to be used to retire debt at, for example, 6%, this would be the same as investing money on a 2.88% basis taking income taxes into consideration. At the same time, the dividend income which is now subject only to a 7.8% tax would not be forthcoming. On the other hand, Norfolk and Western common stock at $120 per share provides a 4.58% return before taxes and 4.22% return after taxes. If all unpledged iNorioiu and Western common stock were to be sold and the proceeds invested in 4%% bonds, the income would be only $6,000,000, after taxes com- pared with a present return of $12,156,000. During the years 1954 to 1962, inclusive, consolidated net profit amounted to $214,- 000,000, but $13,U0O,000, was taxable before the dividend allowances. There is presently an $85,000,000, carry-forward tax loss which will be reduced by $7,000,000, for the year 1962 because of gains on certain sales. If cash received from Norfolk and Western stock should be used to retire debt or should be reinvested in the property, the result would be to concentrate rather than diversify. The Vice President, Finance, recommended as a general program that the Company gradually sell its Norfolk and Western stock until the ownership is reduced to about 15% and that the proceeds be invested in common stocks equal in quality to Norfolk and Western. Preferably, 80% of the stock of a given company should be acquired in order to permit the filing of consolidated income tax returns and take advantage of our tax losses. In looking for a company in which to invest, his Department has seriously considered a pipeline company in the general area served by the railroad, and the Buckeye Pipeline Company appears to offer the best possibilities. He thereupon reviewed pertinent information con- cerning that company, which had been sent to the members of the Committee before the meeting. During the discussion period which followed, it was suggested by one member that the Company dispose of his holdings in Norfolk and Western to the extent possible and devote the proceeds to the purchase of its own bonds in preparation for the maturities of 1965 and 1968. This course of action, he said, would not only solve many of the financial problems but remove the obstacle to the Norfolk and Western merger case which owner- ship of Norfolk and Western stock by this Company presents. He also expressed the opin- ion that the market value of the Norfolk and Western common stock is now very high and may not continue at that level indefinitely. Other problems discussed were the means of compensating for the capital gain resulting from the sale of Norfolk and Western stock, the desirability of obtaining cash through the sale of such stock rather than creating additional debt, the future of Norfolk and Western Railway Company and the general requirements for cash facing this Company within the next seven years. It was the sense of the meeting that the financial officers should study the situation further and come back with recommendations at the next meeting probably to be held in about a month. On motion, adjourned. Bayard H. Roberts. Exhibit 71 August 31, 1966. S. T. S. : In considering the capital budget for 1967, I think it is desirable that we consider a number of salient factors in arriving at a conclusion as to the level of expendi- tures which are necessary and expedient and also prudent in light of all the circumstances. During the ten-year period 1956-1965, inclusive, New York Central including the P&LE spent $452 million on equipment and the Pennsylvania Railroad spent $875 million, or almost twice as much. During the, years 1964 through 1966, it is estimated that we will spend $480 million. To meet these commitments we have had to increase our debt sharply and reduce our cash resources to minimal margins. In the two years 1965-66, exclusive of intercompany transfers of debt, our interest charges on an annual basis will have increased by $13 million and our annual depreciation by $4.5 million or a total of $17.5 million, equal to $1.26 per In 1967 it is estimated that our maturities will be somewhere in the neighborhood, depending on the level of our capital program, of about $56 million. This compares with estimated equipment depreciation of $37 million. Our road depreciation is estimated at about $19 million so that it will take our entire depreciation now to meet our 1967 maturi- ties. The usual rule of thumb formula used by analysts of the railroad industry is that when equipment depreciation equals equipment maturities, you are fairly well in balance but anything above this is a danger signal and I might add that analysts are already com- menting on this deficiency in our case. . . As contrasted to our situation, the New York Central depreciation for 1966 is esti- mated at about $42 million and their maturities at $20 million. The attached exhibit clearly indicates that we are not realizing anything but a nominal return on the huge capital investment we have put into the Pennsylvania Rail- road in the last three years. For 1967, as you know, the Operating Department has submitted a proposed budget of $57 million for'road and $175 million for equipment or a total of $232 million. It is my understanding that you have tentatively asked them to reduce the equipment budget to $140 million. 732 First, the requested road budget of $57 million is, I believe, the highest in the history of the Pennsylvania Railroad. In 1965 it was $49,800,000 and in 1966 it was set at $53.7 million with the request that further reductions be made in it. The extent of these reduc- tions are as yet unknown from our standpoint. The requested increase in the total budget of 1967 is despite the fact that the 1966 budget contains $2.5 million for merger items not in the 1967 budget and the Pennsylvania Station, New York, expenditures will be $4.5 million less than in 1966. The equipment budget even at $140 million has only been exceeded twice in the past when it was $147 mil- lion in 1960 and $194 million in 1965. It will represent an increase of about $5 million over 1966. Looking at this budget from a cash standpoint, if we accept the premise that we can- not go back to New York Central for a change in the debt limitation, about the maximum we can finance as indicated in a previous memorandum is $85 million. On this basis of $140 million there is a cash requirement for equipment of about $55 million. If you add to this the request of $57 million for road this represents a total of $112 million. To this is added the regular dividend in 1967 of $2.40 per share or approximately $34 million, a grand total of $146 million. As now estimated, our cash on hand at the end of the year will barely support the outstanding loans we have with banks and, therefore, no further draw down of our cash resources will be practical in 1967. At the present time it appears that the Pennsylvania Railroad, including dividends to be received from the Pennsylvania Company, will only realize about $40 million net income in 1966. With a real possibility of a slow down in business next year as a result of our tight money situation coupled with increased costs in the form of wage increases, it does not seem reasonable at least to budget on a basis of any higher net than will be realized this year. Therefore, if you subtract a total of $40 million and I might add all this will not he true cash flow, there still is a minus cash flow of approximately $106 million with no indicated way of meeting it. Turning to another area, at the present time we are confronted with the tightest money situation in my business career and most of the knowledgeable financial people that I know consider it far more serious than the general public seems to realize. The top New York banks are now approaching the unheard ratio of 85% of loans to deposits and they have yet to encounter their full peak. Most of the big insurance companies are now making commitments for the latter part of 1967 and 1968. Unless something gives some place, there are going to be many high grade companies, not to speak of the weak ones, who just will not be able to get funds next year. It should also be kept in mind that there are a number of high credit companies that carried large balances without borrowings for many years. These are now coming into the banks and they must be taken care of regardless of anything else and it is quite likely that other top companies which have been consistent borrowers, such as the Pennsylvania Railroad, may be told that we have more than our shaire and that no more is available to us. General Electric Company, as an example, is coming into Philadelphia banks for probably the first time in history for any sizeable amount and I could cite a number of other companies on the same basis. Therefore, no one at this point can give any guarantee of just how much money can be raised next year .regardless of the debt limitation factor. If something does give, and if the administration continues its policy of monetary restraint, the only place it can give is an easing of business and, therefore, the loan de- mand. If this occurs, of course, our business will not be as good as this year. It is also a fact that almost certainly there will be a GE strike this Fall and I think it is quite likely at the present time that we in the railroad industry may likewise be faced with a strike next year. After the plane strike and settlement, the feature of retroactivity, which has a direct bearing on our cash resources, looms quite large. All in all it seems to us that a very cautious and conservative policy should be followed until the economic outlook is clarified and that our capital expenditures should be held to a bare minimum. I am quite sure that as time progresses it will be found that we will have lots of company in this direction because most of the factors with which we are confronted are faced by most of the railroad industry as well as other companies. On top of these, of course, we are handicapped by a debt limitation problem and the fact that our cash re- sources are down to minimum levels and our debt has substantially increased in the last three years. D. C. B. Exhibit 72 October 5, 1967. personal and confidential D. C. Bevan : I recommend that the salarv of Charles S. Hill. Manager, General Ac- counting, be increased effective November 1. 1967 from $25,500 to $27,500 annually. Hill has done an outstanding job in the General Accounting capacity and his back- ground, personality and interest are ideal for this important position. Prior to joining the Pennsylvania Railroad in 1955 he was a Regional Comptroller in the Post Office Department and is a Certified Public Accountant in the State of Virginia. He has been instrumental in the progress that has been made in the Accounting Department within the last several years. He is extremely creative, is an excellent manager and is very cost conscious. His imaginative accounting is adding millions of dollars annually to our reported net income. Although he has consistently assumed additional work within his organization, he has 733 reduced the number of employes from 268 to 167 since being appointed to this position in 1963, a reduction of 101 or 38%. He has constantly underrun his budget which has been reduced each year since he has been responsible for this function. Mr. Hill is an unusually qualified accountant and is highly regarded in the rrilroad industry, by the public accounting fraternity and by his associates within the Company. He is very familiar with I.C.C. accounting and at the same time is a real authority on generally accepted accounting principles. I cannot overstate the contribution that he has made to the Company within the last several years. The range on Hill's job is $22,620 to $29,580 a year. Mr. Hill's last increase was granted in April 1966. May I please have your approval of this recommendation subject, of course, to subse- quent approval of Mr. Saunders. W. S. Cook. Exhibit 73 June 2, 1969. D. C. Bevan : This refers to Mr. Gerstnecker's letter of May 29 to you, copy of which you handed me. I gather that the new settlement with Messrs. Wynne, Baker, Ray and Caldwell is the best that can be made under the circumstances and subject to the comments which I am making here it has my approval. In talking with Mr. Gerstnecker this morning, I suggested that we attempt to work out some provision for an adjustment downward in the capital settlement if in any given year the earnings of Great. Southwest do not reach $25 million in that year. He said he would see what could be done about this. I understand Mr. Gerstnecker believes, and I gather you also agree, that the new settle- ment and agreement will provide sufficient incentives for these officers to maximize Great Southwest's earnings. I also understand that there is a provision for termination of the services of any of these particular officers in case we are not satisfied with the results which they produce. S. T. Saunders. Exhibit 74 [Interstate Commerce Commission, Docket No. 35291, Verified Statement 11, Exhibit NPE 8, Memo in working papers of Peat, Marwick, Mitchell & Co.] Penn Central Company — 1969 Accounting Problems 1. merger reserves The merger of the Pennsylvania and New York Central railroads occurred on Febru- ary 1, 1968. As the transaction was considered to be a pooling of interests, the roads issued combined financial statements for the year 1967. Included as an extraordinary charge in the earnings statement for that year was a provision in the amount of $275,422,000 for "costs and losses incurred upon merger." While these statements were not audited by PMM & Co., consultations were held with Mr. Hanson, Messrs. Webster and Quinn, and the Department of Professional Practice on certain accounting matters including the establish- ment of the merger reserve. Mr. Hanson, in fact, visited the ICC on behalf of Penn Central and supported the company's position in setting up the reserve. The original purpose of the reserve was to provide for duplication or obsolescence of certain railroad properties, equipment, materials and supplies and for the requirement to rehire certain otherwise surplus furloughed employees resulting from the merger of the New York Central Railroad Company into The Pennsylvania Railroad Company. Approxi- mate amounts provided and the principles applied in compiling the respective segments of the reserve were as follows : 1. Facilities ($149,000,000) — Facilities which the company's engineers determined to be excess or unneeded have been included in the reserve at net book value less estimated salvage value, plus costs of demolition, etc. In applying this principle PC was guided by the concept of costs or market, whichever lower. Any property to be abandoned was left on the books at cost if it was determined that the property could be sold for cost or above cost ; otherwise it was written down to the anticipated selling price. It should be noted that under this method if a substantial gain was anticipated on the sale of real estate no longer needed for railroad operations, this anticipated gain was not offset against the estimated losses. 2. Equipment ($3,000,000)— Losses (net book value of equipment less estimated salv- age value) were determined primarily on the basis of whether equipment would be needed at a specific location. These losses apparently were considered by the chiefs of operations and maintenance on an overall basis, but not with a view toward recognizing losses only if equipment is to be scrapped. 3. Materials and Supplies ($6,000,000)— Losses (net book value less estimated salvage value) included both items to be scrapped and, to some extent, the value of excess stocks. 4. Labor ($117,000.000) — An estimate was prepared by location of all job require- ments. This was compared to the total number of persons to be employed subsequent to merger. After consideration of those who would not return to work when recalled and 734 those who would be used to fill job requirements (as defined), a provision was made for (a) the cost of relocating recalled employees, (b) settlement with employees who would not accept transfer to a qualified job, and (c) wages to be paid to employees not filling qualified jobs. The following summarizes the activity in the reserve account since inception : [In thousands! Original provision at 9 months ended Balance Dec. 31,1967 Year 1968 Sept. 30, 1969 Sept. 30, 1969 Facilities $149,347 10,959 2,037 136,351 Equipment 3,133 3,156 412 (435) Materials and supplies 6,014 3,145 611 2,258 Recalled labor: Severence payments 7,618 4,478 Other charges: Altoona works (principal location utilizing recalled labor) 3,238 3,535 All other locations 11,604 4,591 Total 116,928 22,460 12,604 81,864 Grandtotal 275,422 39,720 15,664 220,038 The problems encountered in determining the appropriateness of charges against the reserve are discussed below : Facilities In our initial discussions with PC we were told that duplicate facilities would be abandoned within approximately two years from date of merger. This timetable has proved to be too ambitious. The current level of activity would suggest that it may be many years before this portion of the reserve is used up, and this raises the question as to its necessity. We are, however, generally satisfied with the validity of charges to date. Equipment This portion of the reserve now has a negative balance. We are still discussing this situation with management to determine if future equipment charges will be forthcoming. Management believes that the negative balance should be offset against the remaining credit balance in the facilities protion of the reserve. If the charges are now substantially complete, we believe this would be acceptable. Materials and Supplies It was our understanding that obsolete and duplicate items would be scrapped within the first year of merger. It would seem that such materials would easily be identified and physically eliminated. We have expressed this concern to management. It is our intention to insist that management now identify all remaining items to be scrapped and establish a definite date for completion of the program. Recalled Labor This is the biggest problem area from an audit standpoint. The reserve was calculated on the assumption that 4,447 employees would return ; whereas only 2,877 actually returned. During 1968 and the first nine months of 1969, a total of 1,478 recalled employees were severed and apparently 206 were absorbed into the labor pool, leaving 1,193 on the "recalled" list. Under the original concept of recalled labor, specific persons would be identified as being recalled without a specific job assignment. They would then either be idle or placed on "make-work" projects, such as cleaning up facilities which otherwise would not have been cleaned, etc. — in all cases the work was to be demonstrably "non-productive." As time went by, the concept of "recalled labor" was extended to include "substitutes" within the same union. "Substitute" status is reached when a recalled employee is added to the active labor pool and an otherwise active employee with seniority elects to assume (or is transferred to) a non-active role. PMM&Cn. agreed to the substitution arrangement, since it consisted in maintaining a one-for-one balance of active and non-active employees. Recalled employees, in fact, do not stand around idle. All are given work assignments and are integrated into regular working teams, particularly at Altoona. which has the greatest number of recalled employees. The determination that a recalled employee is not productively employed is left to the discretion of operating management personnel. Dif- ferent colored time cards are used to distinguish "chargeable" versus "non-chargeable" labor costs. Essentially, as far as we can determine the labor costs of all recalled employees not working on capital projects gets charged against the reserve. In our audit work thus far. we have made visits to the shops and from visual observa- tion we could not distinguish regular workers from recalled personnel — all seemed to be doing the same work. Management rebuts that the size of work crews has increased, but not their productivity and. therefore, they are still burdened with the costs of unneeded person- nel. We have requested engineering studies or statistical proof that this is the case, but 735 have not received an answer to date. The question remains whether, in principle, we can accept such data as a basis for charges against the reserve. We agreed at the outset that this portion of the reserve should not be used beyond about a five-year period. It should be noted, that on this basis over half the labor reserve will not be used. Exhibit 75 Philadelphia, May 18th, 1969. A meeting of the Finance Committee of the Board of Directors of Penn Central Com- pany was held this day at 12 :00 Noon. There were present Messrs. Bevan, Chairman, Granger, Hanley, Lunding, Perlman, Routh and Saunders. The Chairman of the Board reviewed briefly estimated earnings on a consolidated basis for the second quarter of the year. He reported also on the steps being taken to improve the earnings of the railroad. Whereupon the Committee, on motion, approved a recommendation to the Board that it declare a regular quarterly dividend of sixty cents a share. On motion, adjourned. Exhibit 76 board memorandum, tuesday, may 13, 1969 Proposed Dividend At this time we will take up the matter of the Second Quarter dividend. Our earnings projections for the Second Quarter are inconclusive as of this time. We estimate, however, that our consolidated earnings will be around $20 million. 1 This com- pares with $18.7 million (an improvement of nearly 10% ), for the Second Quarter of 1968, after taking into account the $4.9 million loss incurred by the New Haven in the same period. 2 Our preliminary figures show that while it is still an uphill fight, we are making real progress in bringing the railroad back into the black. For the first three months of this year the railroad produced a $12.8 million deficit, but we expect to be well above the break-even point by the end of June. One adverse development arises out of the recent decision in the Southern Divisions Case. As it stands, the order of the Federal Court in New Orleans will require the repayment of about $11.4 million. Some undetermined portion of this will be a charge against income this quarter, but we will not know how much until the I.C.C. acts on our petition to price the offsetting items and balances are settled. The strike that began at seven General Motors plants on April 28 is costing us about 225 cars per day, which is at the rate of about 5,000 cars per month. If it continues, the monthly revenue loss will be over $1 million. On the other hand, steel production continues very strong and is running at a level only 2% below a year ago during the pre-strike inventory build-up. Since the settlement of the wildcat strikes, coal output has been high and our coal carloadings have been showing better trends than production generally. For the first five weeks of the Second Quarter our coal carloadings are 3.5% ahead of last year. Despite the effect of the General Motors strike, business is holding up very well and we are rapidly regaining the share of the market lost during the last six months because of our service difficulties. Based on traffic levels for the 2-year period prior to merger, Penn Central has traditionally handled about 357c of Eastern District ton-miles. During the last quarter of 1968 we dropped to about 30 percent, then rose to 33 percent last quarter. In April we experienced a further improvement — to 34.4 percent. This is equivalent to a gain of 297 million net ton miles, a 4% improvement over the monthly average of the first quarter. Based on this trend, we recently established our revenue goal at $402.7 million, which is $10.5 million above our original forecast, and $18 million above Second Quarter last year. Based on recent reports from the field, our Sales people say that our prospects are excellent for attaining this goal. We are also paving a grpat deal of attention to cost control. Last week Mr. Perlman and I met with all of our General Managers, together with the Regional Accounting and Sales Officers, to revise the Second Quarter expense budgets in line with our income require- ments. We had hoped to catch up on a great deal of maintenance work this spring, but it now appears that we will have to cut back on some of these plans. The expense goal is $356 million, which is $20 million below the original forecast and $13.5 million above the Second Quarter of last year. Status reports from the Regions are due today. A recent check of the diversified subsidiaries indicated a $2.5 million increase over the original forecast for Buckeye, Great Southwest and Macco. In addition, Great Southwest 1 For basis of this estimate, see attached Sutnmarv dated May 5, 1969. ' Second Quarter 1968 Penn Central (excl. New Haven). Railroad $1- 413 Subs 22. 208 Consolidated $23, 621 74-924 O - 73 - 49 736 is working on a large transaction which, if completed in the Second Quarter, could increase our net by $10 to $12 million. We will give you more details on this at an appropriate time. While, as I have said, it is much too early to know exactly where we will come out, I think that prospects are very good to equal or better the results in the Second Quarter of last year. Recommendation. — In light of the results to date and the prospects for the remaining weeks of this Quarter, the Finance Committee recommends the payment of the regular quarterly dividend of 60tf per share, payable June 20th to stockholders of record at the close of business on May 26th. Will someone make a motion approving this recommendation ? All in favor, please say "yea" Opposed, "no" So ordered. SECOND QUARTER 1969-RAILR0AD EXCLUDING PROPERTY SALES AND NEW HAVEN [Dollars In thousands! 2d quarter 1969 forecast, May 5, 1969 Goal 2d quarter 1969 budget 2d quarter 1968 ' Operating revenues: Freight Passenger Mail Express All other Total Revenues. Expenses: Operations departments: Administration Stations Transportation... Maintenance equipment. Maintenance way. Subtotal Equipment rents Corporation adjustment (Cr.)_ Total Oper. Depts Executive offices Treasury and investment.. Accounting, budget, taxes. Management planning Public relations Research Services Traffic Legal System development Labor relations Secretary Ind. dev. and real estate.. Material and purchasing.. Total system offices Total operation and system offices. Taxes Total expenses Income (loss) from operations. Other expenses Net income (loss). New Haven operations... Capitalized maintenance. Gain on property sales... Subsidiaries: D.T.& l._ I.H.B. R.R P.R.S.L P. &L.E. R.R Other operating R.R. Lessor railroads Equipment lease Companies. Truck Co Pennsylvania Co Arvida Buckeye Great South West.. Macco.. Others Adj. and elim Total subsidiaries. $333, 275 27, 500 12, 275 1,550 17,775 392, 375 15, 301 20, 889 153,421 86, 463 59, 895 904 1,068 4,703 152 977 351 294 5,057 1,663 6,042 905 299 832 3,027 26, 274 400, 689 8,408 409. 097 (16,722). 15,366 . (32,088). (1.542). 8.561 . 4,162 . 909 . (182). (1,127). 2,384 . (128). 2,810 . 674 . 2,362 . 8,960 . 786 . 2,242 282 4,000 1,856 . (13,258). 12. 570 $402, 750 6,408 2,500 524 6,000 $343, 325 $324, 655 26, 500 25,746 11,525 15, 143 2,250 3,075 19, 150 17, 358 402, 750 16, 027 21,269 142, 978 80, 146 54, 736 26, 226 374, 709 8.353 383,062 19, 688 11,873 7,815 5. SSO 909 (497) (1,127) 2,462 (296) 2,823 674 2,374 9.037 786 2,242 463 4,000 (333) (11,568) 11.949 385, 977 NA NA NA NA NA 335, 969 ... 315,156 39, 327 6,000 306, 553 44,446 ... 41,166 6,000 .. 4,991 374,415 356, 116 348, 483 342, 728 856 839 1.068 1,321 4,703 5,447 152 85 977 618 351 326 294 243 5,057 6,141 1.663 1,986 6,042 6,066 905 955 299 374 832 876 3,027 3,629 28,906 371,634 7,934 379, 568 6,409 7,413 (1,004) (4, 950) 7,675" 779 255 (1.179) 2,425 115 2,673 654 2,234 9,285 643 3,160 1,744 4,265 412 (10,515) 16,950 Footnote at end of table, p. 737. 737 SECOND QUARTER 1969-RAILROAD EXCLUDING PROPERTY SALES AND Ni |Dollars in thousands!— Continued • AVEN-Continued 2d quarter 1969 forecast, May 5, 1969 Goal 2d quarter 1969 budget 2d quarter 1968 > Quarter earnings: Parent Subsidiaries ($23, 765) 15,428 Total. (8,337) Other transactions: Bonds _ N. & W. stock Dallas Park (gross proceeds). $6,909 17, 928 24, 837 14, 000 $9, 505 15,539 25, 044 ($3, 537) 22, 208 18,671 ' Restated to exclude New York Central Transport Co. Supplement "A" PENN CENTRAL CO.— EXPENSES, TOTAL OPERATING DEPARTMENT, 2d QUARTER 1969 [In Thousands] May 5, 1969 Forecast April 29, 1969 Budget forecast Variance from, April 29, 1969 Budget Forecast 374,415 348, 594 376,116 (25,821) 1,701 15,301 16, 026 15, 724 725 423 20, 889 21, 269 21,172 380 283 Operations— System $41,954 $40,505 $42,187 ($1,449) $233 Heavy maintenance shops 16,114 13,848 16,226 (2,266) 112 Eastern region 47,973 46,461 48,133 (1,512) 160 Central region 50,417 46,156 50,815 (4,261) 398 Western region 23,521 21,997 23,803 (1,524) 282 New York region 33,334 32,647 32,894 (687) (440) Northeastern region 30,286 26,740 30,418 (3,546) 132 Lake region 24,958 23,729 25,440 (1,229) 482 Northern region 19,671 18,181 19,857 (1,490) 186 Southern region. 46,866 44,236 47,583 (2,630) 717 Georgia & Eastern Railway 875 767 874 (108) (1) Equipment rents. 44,446 39,327 43,886 (5,119) (560) Corporate aajustments(CR) 6,000 6,000 6,000 Total operations Administration Stations Transportation: Freight operations 106,941 97,400 107,400 (9,541) 459 Passenger operations... 15,420 14,965 15,455 (455) 35 Block stations 4,802 4,832 4,774 30 (28) Allother... 26,258 25,782 26,744 (476) 486 Total transportation 153,421 142,979 154,373 (10,442) 952 Maintenance of Equipment: Carshops 24,889 23,505 24,710 (1,384) (179) Enginehouses 18,857 17,447 18,659 (1,410) (198) Heavy Maintenance shops 16,114 13,848 16,226 (2,266) 112 Allother 26,603 25,346 26,713 (1,257) 110 Total Maintenance of equipment 86,463 80,146 86,308 (6,317) (155) Maintenance of works: Track 29,961 23,849 30,318 (6,112) 357 Communications and Signals 7,330 7,362 7,324 32 (6) Structures 5,586 5,645 5,613 59 27 Allother 17,018 17,991 17,398 973 380 Total , maintenance of works Equipment rentals Corporate adjustments (CR). Total, operations. 374,415 348,594 376,116 (25,821) 1,701 59, 395 54, 847 60, 653 (5, 048) 758 44, 446 39, 327 6,000 43, 886 6,000 (5,119) (560) 6,000 (# ) denotes unfavorable. Exhibit 77 board memorandum wednesday, june 25, 19c9 Proposed Third Quarter Dividend Last year our Third Quarter dividend action was taken at the June meeting, following the pattern set on the former Pennsylvania Railroad because of the practice of cancelling stated meetings during July and August. Later in the meeting we will consider the schedule to be followed this summer but, whether or not we meet during those months, I understand 738 that the Exchange rules would require us to make a public announcement if we postpone consideration of the dividend at this time. As we discussed at the meeting of the Executive and Finance Committees on June 13, preliminary estimates for the Third Quarter of 1969 are about the same as last year when we earned $15.2 million on a consolidated basis. 1 Since then the steel industry has announced that steel orders at midwestern and Eastern mills have broken a 2-month seasonal down- turn and officials are now predicting that the third quarter could reach the 'S.i million ton record level set in 1965. This compares with only 20.8 million tons in the third quarter of last year. Heavy steel activity produces a beneficial effect on other commodities, such as coal and ore. On the other hand, the coal miners' holiday period, which usually spans part of June and July, will fall entirely in the Third Quarter of this year, inventories of motor vehicles in dealers' hands is rather high, indicating a prolonged changeover period beginning in July, and there is no end in sight to the Canadian ore strike. In short, the general econ- omy continues to show strength, but therei are indications that the high cost of money and anti-inflationary measures are having a depressing effect. We are not unaware of the pos- sibility that some of these forces could combine to reduce July and August business below the projected levels and are now making preparations to store locomotives, furlough non- protected employees, and take other economy measures at the first sign of an adverse revenue impact. Despite these unsettled conditions, the Finance Committee, after consideration of all the factors, recommends the payment of the regular quarterly dividend of 60 cents per share, payable on September 12, 1969, to stockholders of record on August 11. Will someone make a motion approving that recommendation? All in favor, please say "aye", opposed say "no". So ordered. Second quarter 1969 We are still two weeks from the close of the second quarter and some of the factors mentioned in connection with the dividend are affecting current results. However, we are now estimating consolidated net income to be approximately $25 million, or $1.03 per share." This represents an improvement of $1.4 million, or 5.8% over earnings of $23.6 million in the second quarter of last year. 2 This is also a substantial improvement over our showing in the first quarter with earnings of only $4.6 million compared with $13.4 million, or a drop of 65.6% from the year before. For the first half consolidated earnings will be $29.6 million, which is 20% helow the $37 m"lion earned in the first half of 1968. As indicated by our discussion at the Executive and Finance Committees meeting, we have very good prospects of equalling the $90 million consolidated net income produced in the earlier year. As far as the second quarter results for the Railroad (i.e., Parent Company) is con- cerned, we are now forecasting a $5.5 million lass, as compared with a net of $2 million in the second quarter of last year. This is about $5 million below the results we were anticipating only 2 weeks ago. This is the result of: (1) Coal revenues for the month of June being about $1.4 million below earlier estimates because of the John L. Lewis memorial holiday and sporadic wildcat walkouts resulting from internal union politics ; 1 All 1968 earnings data in the text exclude the New Haven, which reported a $6.4 million loss in Third Quarter of last year. Last year's results included $11.7 million Washington Terminal dividend, but this is expected to be matched in the Third Quarter of 1969 by a $12 million profit in the Rancho California trans- action. '» Earnings (thousands): 1969 1968 Variance Percent 1st quarter (actual) : Parent _._ Other Consolicated 2d quarter (estimate) : Parent— Other ($12, 764) 17,365 $1,026 12, 362 ($13, 790) 5,003 40.5 4,601 13,388 (8, 787) (65.6) » (5, 500) 2,065 21,556 (7,565) •30,500 8,944 41.5 ■25,000 23,621 1,379 5.8 (18, 264) 47, 865 3,091 33, 918 (21, 355) 13, 947 41.1 Consolidated - 6 months: Parent _ Other Consolidated 29,601 37,009 (7,408) 20.0 » The forecast for the second quarter contemplates a $8,600,000 improvement from the mid-June forecast (in line with the goals assigned at the June 23 budget meeting) and a $11,000,000 special dividend from the subsidiaries to parent company. 2 The 1968 figure does not reflect a $4.9 million loss reported by the New Haven in the second quarter of last year. 739 (2) The Canadian strike on the Great Lakes, which will cost us about $200,000 in June; anil (3) Work stoppage in General Motors plants, which produced an abnormally low motor vehicle output 15.4 percent below 1968, resulting in revenue losses of about $1 million earlier this month. The balance of the decline (nearly $4 million) was apparently pro- duced by a billing lag and lost production in plants we serve during the long Memorial Day weekend at the end of May. Although these results are disappointing, they are mainly from developments beyond our control and there is ample evidence that we have overcome our service problems and are rapidly regaining lost traffic. Operating revenues for the second quarter are non- expected to be $388.5 million 3 or a gain of $13.9 million (3.7%) over the first quarter and $2.5 million (0.7%) ahead of second quarter last year. Freight revenues show an improve- ment of $3.4 million over the 1968 (1.0%) and, due to the Metroliner and some minor commuter fare increase, passenger revenues are $2 million or 7.9% ahead of second quarter last year. Unfortunately, these gains were greatly reduced by mail and express losses of $4.7 million or 25.8% under second quarter 1968. Another indication of service improvement is that our share of Eastern District ton miles increased 0.5%, to 33.9%, which is the equivalent of 235 million net ton miles, or $4.5 million in revenues, based on the current yield of 1.94 per ton mile. Operating Costs. — Operating costs in the second quarter are projected at $400.5 million, which is an $11.6 million increase (or 3%) over first quarter costs of $389 million. 4 Since July of last year wage rates and retirement taxes have gone up 7.6% per employee 6 al- though, by stringent controls over employment, our total labor costs for the last 6 months of 1969 have risen only 2.3%. 8 Our average employment for the second quarter (months of April, May and June) was 99,732, which is down 4,164 or 4% compared with the same three months of last year. Labor costs, which were $6 million above second quarter of last year, would have been $11 million higher had it not been for this force reduction. 3 Operating revenues (thousands): Freight Passenger.. Mail Express Allother... Total Variance from — 1969 2d quarter 1969 1968 1st quarter Percent 2d quarter Percent ■ $328, 063 27,786 12, 836 679 19, 138 +$11,131 +1,871 -954 -381 -2, 502 3.5 6.0 6.9 35.9 15.0 +$3, 408 +2,040 -2,307 -2,396 +1,780 1.0 7.9 15.2 77.9 10.3 388, 502 -13,869 3.7 +2, 525 » Freight revenues reflect an increase of $5,000,000 over the mid-June forecast, in line with the discussion at budget meeting on June 23. Operating costs (thousands) : Variance from- 1969 1968 2d quarter 1st quarter Percent 2d quarter Percent System offices $27,136 +$1,378 5.3 -$1,770 Operations _ "320,676 +8,083 2.6 +19,114 Equipment rents _ 44,657 +1,542 3.6 +3,491 Taxes 8,057 +547 7.2 +123 Total 400,526 +11,550 3.0 +20,958 6.1 6.3 8.5 1.6 • $3,600,000 below the mid-June estimates, in line with goal assigned on June 2. • Wage rates increased 3.5 percent on July 1, 1968, and 2 percent on Jan. 1, 1969. Railroad retirement tax rate increased from 8.9 percent to 9.55 percent on Jan. 1, 1969. These taxes also increased by reason of higher taxable wages due to the wae rate grants. • Employment: Employees Labor costs Per employee +$12, 000 +2.3 1st half— 1969 98,212 $524,000 1st half— 1968 103,210 $512,000 Variance _ —4,998 Percent... —4.8 2d quarter— 1969 99,732 $264,000 2d quarter— 1968 103,896 $258,000 Variance —4,164 +$6,000 Percent _ -4.0 +2.3 $5, 335 $4,960 +$375 +7.6 $2,647 $2,483 +$164 +6.6 740 A second round of wage rate increases this year goes into effect on July 1, hiking wages another 3%. This is estimated to cost an additional $13. ft million during the last half based on our present employment level. While we hope to secure selective rate in- creases amounting to about $10 million on an annual basis, there is no general freight rate increase in immediate prospect and these increased costs can only be offset by even more austere measures in the future. Another real concern at this time has to do with the recent rise in the prime interest rate to 8V2%- Not only has this contributed to the increased cost of borrowing funds, which is already 34% higher this year, 7 but the tight-money situation makes it difficult to finance the capital improvements which are essential for implementing the merger and obtaining operating economies. Our operating results in the second quarter were again greatly influenced by non- recurring merger "start-up" costs. Current figures ae not yet available but, based on our experience during the first three months of this year, 8 I estimate that these expenditures amounted to more $125 million, with cumulative savings of about $2 milion, producing an adverse effect of about $5 million in the income account. PENN CENTRAL CO. (INCLUDING NEW HAVEN) MERGER STARTUP COST AND SAVINGS 1ST QUARTER 1969 Amounts reflected in— Income Reserve Capital Total Costs: Personnel $2,887,072 $4,946,000 $261,319 $8,094,391 Properties: A. E. Perlman yard _ Columbus 'yard _ _ Stanley yard _. Big Four yard Seneca yard _ 1 . . Rensselaer passenger station Fairlane control siding ._ Karner N.Y. passenger station Sharonville yard.. Cinci-Columbus signals Other(each under 200,000) 1,126,000 2, 062, 000 2, 062, 000 1,028,660 1,028,660 640, 362 640, 362 948, 901 948,901 532, 000 532, 000 544,000 544, 000 282, 595 282, 595 306, 000 306, 000 250,915 250, 915 217, 190 217,190 360, 910 1,486,910 Total, properties 1,126,000 7,173,533 8,299,533 Service 17,266,000 17,266,000 Totalcosts 20,153,072 6,072.000 7,434,852 33,659,924 Savings: Elim-Consol fixed facilities.. 6,913,960 6,913,960 Maintenance of equipment 3,023,320 3,023.320 Maintenance of roadway 1 392,255 392,255 Train operations.. 2,507,690 2,507,690 Labor not included above 4,554,919 4,554,919 Property taxes, insurance 3, 000 3, 000 Total savings 17,395,144 17,395,144 Net savings (costs). (2,757,928) (16,264,780) Ratio, costs to savings 1.16:1 1.94:1 ' Interest on funded debt: 1969 (6 months).. - $42,500,000 1968 (6 months).-.- 31,800,000 Variance (increase)... 10, 700, 000 Percent - 33- 6 8 Merger "start-up" costs and savings: Amounts reflected in- Reserve and Income capital Total 1st quarter 1969: Costs and losses $20,153,072 $13,506,852 $33,659,924 Saving 17,395,144 17,395,144 Net savings (costs) Ratio costs to savings Feb. 1, 1968 to Mar. 31, 1969: Costs and losses Savings Net savings (costs) Ratio costs to savings 2.38:1 - 4.80:1 • Including advances of $14,000,000 to New Haven in 1968, applied to purchase price. (2 757 928) (16, 264, 780) 1 16:1 1. 94: 1 $95, 009, 165 $82, 376, 246 $191,385,411 39 887 496 39, 887, 496 (55,121,669).. (151,497,915) 741 The most significant factor in producing net income on a consolidated basis in the second quarter was the gain realized by Great Southwest in the sale of Six Flags over Texas, the Dallas Amusement Park, in a transaction similar to the sale of the Atlanta Park last year. This deal — which is to produce a net gain of about $25 million — will be explained in detail by Dave Bevan. Macco and Great Southwest are also up about $1.8 million in ordinary income, but Buckeye is about $600 thousand below Second Quarter last year. Aside from this, the undistributed earnings of the subsidiaries, especially Manor Real Estate and the leased lines, are about $5.4 million below second quarter last year. This is primarily due to a drop in real estate sales — the direct result of the high interest situation (see table below). SIGNIFICANT ITEMS, 2ND QUARTER Increase (+) or 1969 1968 decrease (-) Subsidiaries— Undistributed earnings $16,359 $21,556 -$5, 197 Sale or properties: Lessor railroads (various) _ _ 1,489 Manor Real Estate (sale in 1968 to Republic Steel) 2,205 Strick profits (sale of company in 1968).. —492 Other operating railroads _ —526 Indianapolis Union.. _ —256 Federal income tax credit 1968: Monongahela railway.. —179 Waynesburg Southern startup costs _ _ —435 Buckeye pipeline —658 Federal income tax credit, 1968 —476 Other taxes increased —166 Total -642 ( -5,370 Dallas Park 1+25,000 1+19, 630 Grand Central Terminal — Tower Building. — The New York City Administration con- tinues to oppose our Grand Central Terminal Tower project with the result that the Landmark Commission has again raised technical objections to our plans. While the architect has prepared new plans, we are weighing the advantages of a course of action urged by the City in keeping with its legal position. New York feels that we cannot be denied the right to proceed unless we are offered equivalent rights elsewhere. Accordingly, it is suggested that if we will drop our plans we will be permitted to transfer our Grand Central rights to other parcels of property. Our Real Estate people have made some preliminary calculations based on a transfer of the air rights to the 466 Lexington Avenue site and the Biltmore or Roosevelt Hotel sites, and it appears possible that such a plan could net us anywhere from $700,000 to $2.0 mil- lion more than the Grand Central Tower plan. However, a number of changes will be re- quired in the applicable law and there is some doubt that the City will be able to accom- plish them. We will, of course, make careful studies of all of the alternatives before making any decision which would forfeit our Grand Central rights. Service. — There has been a decided improvement in the overall service performance during the last two months. Shippers who were routing against Penn Central during 1968 and early in 1969, are returning their long-haul traffic to us and continue to write us con- cerning the significant measure of our recovery. As of June 10, the improvements in our service had resulted in gains of lost traffic totaling about $9 million on an annual basis. Our shipper contract program is still being actively progressed. The Task Force con- sisting of sales and operating personnel has made 80 calls with system representation and 611 calls with regional, divisional and district representation. You wil recall that the pur- pose of this group is to identify the service problems of the shipper and initiate appropri- ate corrective measures. In order to be prepared for the traffic peaks anticipated in October, we have initiated a locomotive acquisition program which will make available 150 2,000-horse power units before the end of October. By June 17, eleven of those units had been shipped to us. Inclusion to Date. — The terms of the program for the purchase and lease of the West End commutation service have been agreed upon in principle with New York (MTA) and Connecticut (CTA). Now that legislative authorization enabling CTA to consummate the transaction has been obtained, implementation of the program awaits only the restructuring of passenger fares in the West End area. Our objective is an effective date prior to September 1. In the interim period, studies concerning the type of new equipment to be purchased, modernization of power between Grand Central Terminal and Woodlawn, and the location of a new shop facility supporting the Hudson, Harlem and New Haven commutation services will be progressed. 742 You probably noted in the press that on June 9, a 3-hour, 39-minute run was instituted for the Turboservice between Boston and New York. This cuts 16 minutes from the previous running time and has been determined to be the optimum schedule under present track con- ditions. A program to advertise the new schedule is being progressed with funds authorized by the Department of Transportation. We have informed the Secretary of Transportation that no further reductions in TurboTrain running time can be made without substantial programs of track upgrading and grade crossing elimination and that funding of such programs must be the responsibility of the Federal government. As I have indicated in the past, it is imperative that we continue to receive the state subsidies and tax relief which the New Haven received. Contracts in support of our long- haul passenger services have now been signed with Connecticut and Rhode Island assuring aid from the two states in the amount of $1,335,000 during 1969. While a legislative contro- versy has temporarily blocked authorization of the aid promised by Massachusetts, it is hoped that a special bill being readied for early submission will remedy this situation. Negotiations have begun with both Connecticut and Rhode Island on permanent support programs. The Legislatures of Connecticut and Massachusetts made no changes in the basic tax relief programs this year. However, the relief is contingent upon Penn Central meeting set standards of passenger service and upon the West End program. In Rhode Island, a com- promise was reached in the closing moments of the Legislature which continues the impor- tant principle of railroad tax relief with full exemption from the gross earnings tax and a 25% exemption on property taxes. PASSENGER — LOSSES AND METROLINER Losses. — We are continuing our efforts to reduce our passenger service losses which in the first quarter were $26 million as compared with $28.8 million for last year. As of June 13, our passenger train service withdrawal program included proceedings involving 12 trains which, if discontinued, would reduce our passenger train mileage by 1,634,725 miles and would effect savings of approximately $3,990,291. It is anticipated that the studies now being progressed relating to our overall passenger service restructuring program will be completed in August. You will recall that our pre- liminary studies indicate that discontinuance of all long-haul service west of Harrisburg and Buffalo would eliminate 8.8 million train miles annually, producing net savings of $21 million a year. This does not include the Boston- Washington corridor or the Empire Service in New York State— both of which are being reviewed for potential savings. Metroliner Operations. — Our experience with the Metroliner operation continues to be quite favorable. For the period January 16 through June 15, we had a total of 208,377 passengers and a seat mile utilization factor of 76.7 percent. The estimated revenue was $2.3 million. Our on-time performance for the period was 88.3 percent. Long Island Divisions Case. — The petition of the Long Island Rail Road for an in- vestigation of its divisions of joint rates has been denied by the Interstate Commerce Commission. This remits the Long Island to the filing of a complaint if it desires to pursue this matter. The procedural difference between an investigation by the Commission and a complaint case is rather slight when the investigation results from a petition filed by one who seeks affirmative relief and thus has the burden of proof. Status of Holding Company Proposal Before the ICC. — The State of New Jersey and the New Jersey Board of Public Utility Commissioners filed a petition for leave to intervene in our holding company proceeding for the purpose of determining what effect it might have on transportation within New Jersey. There are no other interveners. If the State of New Jersey can be persuaded to withdraw promptly, the matter can be expeditiously processed to a decision ; and if Division 3 is willing to approve the application, a decision in June is possible. Ohio Full Crew Case — The Supreme Court of Ohio which, on April 16, 1969, dismissed the railroads' appeal of a lower court decision upholding the constitutionality of the full crew law of that state, has now denied the railroads' motion for rehearing. Remedies for overturning the state law in the Ohio courts have now been exhausted ; and it is the con- sensus of the railroad Legal Committee that it would be useless to attempt certiorari to the Supreme Court of the United States, which earlier this year refused to hear an appeal of the New York full crew case, and which on two occasions reversed decisions in Arkansas cases favorable to the railroads. Furthermore, no new issue under the Federal Constitution is involved in the Ohio case. New York Public Utility Commission Investigation of Penn Central Service. — On June 5. 1969, the New York Public Service Commission ordered the Penn Central to make imme- diate arrangements for the acquisition of at least eighty new multiple unit passenger cars for the replacement within two years of specified existing MU cars and certain heavy- weight cars presently used in the electrified territory. The order also directed Penn Central to replace twenty-four existing P&T locomotives used in suburban service with more modern power units within the next two years. It further directed Penn Central to increase its program for track surfacing in subur- ban territory from its present program of 69 miles per year to 100 miles for the next two years. The order also directed the continuation of certain programs of track work, the mainte- nance of right of way so as to provide adequate and safe operation, and the installation of public address systems at suburban stations within the next two years. The proceeding in which the order was made began in the Summer of 1968 and was 743 related to tax relief under which Penn Central realized annual tax savings of from $14 to $17 million. General Attorney Smith, in New York, states that the order contains two "substan- tially objectionable conditions". The first of these is the requirement to increase track sur- facing to 100 miles per year in the suburban territory. According to the Chief Engineer, the addition of new equipment will afford the capacity to meet this requirement. Mr. Smith also states that he has been advised that twenty-four P&T class engines will in fact be replaced this year with more modern power units. With respect to the acquisition of eighty new multiple unit cars, there is some question as to whether adequate notice was given that this subject would be considered in this phase of the investigation and there is some question as to the evidentiary basis for such an order. Mr. Smith has expressed the opinion that the New York Public Service Commission is endeavoring by this order to force the Metropolitan Transportation Authority to acquire equipment and lease it to the railroads engaged in communter service. A petition for rehearing and reconsideration will be filed with the New York Commis- sion to protect our right of appeal. Exhibit 78 (Interstate Commerce Commission, Docket No. 35291 Verified Statement 4, Exhibit DD7] PENN CENTRAL-COMPUTATION OF INTEREST COST RELATIVE TO MONEY BORROWED TO REPLACE MONEY EXPENDED THROUGH DIVIDEND PAYMENTS, JAN. 1, 1963, THROUGH JUNE 30, 1970 Dividends Cumulative Interest Interes paid value rate Year cos 1963. 1964 1965 _ 1966 1967 1968... 1969.. Total Penn Central Transportation Company — Summary of cash impact from diversification Cash expended by transportation group : ( /n millions) Stock purchases $157 Dividends paid downstream 16 Loans and advances 33 Total cash expended $209 Cash received by transportation group : Dividends 41 Proceeds received from sale of assets 15 Total cash received 56 Net cash expenditures from the transportation group $153 Estimated interests costs 56 Total cash expended from diversification 209 PENN CENTRAL TRANSPORTATION CO.-ANALYSIS OF CASH IMPACT BY COMPANIES FROM DIVERSIFICATION [In millions] Cash from Cash to Net cash from transportation transportation transportation Companies group group group Buckeye Arvida Great Southwest Macco Madison Square Garden Executive Jet... Strick. Total... $10,026,872 $10,026,872 39, 001, 468 84, 388, 378 138, 035, 044 193, 086, 950 248, 487, 308 291,883,525 4.63 4.67 5.71 6.25 7.76 9.0 10.0 1964 1965 1966 1967 1968 1969 1970 $464, 244 28, 974, 596 1,821,369 45, 386, 910 4,818,576 53, 646, 666 8,627,190 55,051,906 14, 983, 551 55, 400, 358 22, 363, 857 43,396,217 14, 594, 176 291.883.525 .. 67. 672. 963 $50 $37 $13 22 22 26 4 22 61 61 5 5 21 21 24 15 9 409 56 153 744 PENN CENTRAL TRANSPORTATION CO.-Continued COMPUTATION OF CASH IMPACT TO TRANSPORTATION COMPANIES RESULTING FROM DIVERSIFICATION IN NONRAILROAD ACTIVITIES, JAN. 1, 1963, THROUGH JUNE 30, 1970 (In thousands] Buckeye Arvida Great Southwest Macco Madison Suqare Garden Executive Jet Strick Total CASH PASSED DOWNSTREAM TO SUBSIDIARY COMPANIES Acquisition of stock: 1963 $28,170 .. $28 170 1964 2,197 .. $14, 834 6,111 4,712 i 3, 000 357 $20 253 72 $15,000 17,050 64 028 1965 14 18,335 3,712 $39,315 136 (6,000) i (7,400) (5, 500) 1966 1967 23, 633 9,000 1968.. 7,757 1969.. 2,000 . 7,500 Total 30, 381 22, 047 29,014 58, 351 2,000 345 15, 000 157,138 Dividends paid downstream in connection with 1,530 .. acquisition of stock: 1964 1,530 1965 3,268 .. 3 268 1966 3,265 .. 3,265 1967 3,265 .. 3 265 1968 3,264 .. 3,264 1969 3.264 .. 3,264 1970.. 1,632 .. 1,632 Total 2 19,488 .. 19, 488 Loans and advances: 1963 1964.. 575 7,588 5,425 2,441 390 1,324 2,000 .. 575 1965 7,588 1966 2,997 6,440 8,422 1967 244 3 2, 458 9,225 1968 2,848 1969 2,324 1970 2,000 Total 2,802 20, 743 9,437 32,982 Total downstream cash 49, 869 22, 047 29, 041 58, 351 4,802 21,088 24, 437 209, 608 Dividends: 1963 128 3,438 5,965 5,800 6,300 6,300 6,300 3,100 .. 128 1964 3,438 1965 5,965 1966 5,800 1967 210 630 3,416 6,510 1968 6,930 1969 9,716 1970 3,100 Total 37,331 4,256 41,587 Sale of assets 15,000 15,000 37,331 .. 4,256 . 15,000 56, 587 Net cash from transporta- tion group. 12, 538 22, 047 24, 758 58,351 4,802 21,088 9,437 153,021 i Originally advanced as cash in 1967, 1968, and 1969. Converted to capital stock in December 1969. 2 Dividend payments on Pennsylvania Co. preferred stock issued in connection with acquisition of Buckeye Pipeline Co. > Advances made to predecessor company— Pennsylvania Terminal Real Estate Co. 745 PENN CENTRAL TRANSPORTATION CO.— COMPUTATION OF INTEREST COST RELATIVE TO MONEY BORROWED TO REPLACE MONEY EXPENDED IN CONNECTION WITH DIVERSIFICATION PROGRAM, JAN. 1, 1963 THROUGH JUNE 30, 1970 | In thousands] Net cash Cash paid Cash outlay by Total cash Interest Year out received year outlay rate Interest ' (1) (2) (3) (4) (5) (6) (7) 1963 $28,169 $129 $28, 040 $28, 040 4.52 $634 1964 19,155 3,438 15,717 43, 757 4.63 1,662 1965 74,884 5,965 68,919 112,676 4.67 3,653 1966 - 35,319 5,800 29, 519 142, 195 5.71 7,277 1967 -. -- 21,490 6,510 14, 980 157,175 6.25 9,355 1968 - 13,870 6,931 6,939 164, 114 7.76 12, 466 1969. 13,088 2 24, 716 (11,627) 152,487 8.66 13, 709 1970 (6 months) 3,632 3,100 532 153,019 10.00 7,638 Total 209,607 56,589 153,019 .. 56, 394 ' Interest computed by average balance outstanding for year. 2 Includes $15,000,000 received for sale of Strick Holding Co., 1968. Penn Central Transportation Company equipment financing — Interest rates ' Percent . 5.22 1966 . 5.04 1967 4.91 . 4.52 1968 1969 . 4.63 Last . 4.67 1960 1961 1962 1963 1964 1965 1 Source of Interest rates from sheet 1. The above affective Interest rates were presented to the Commission by Mr. Jervis Langdon on behalf of Penn Central Transportation Company in his verified statement in support of freight rate increases in Docket 267. Percent 5.71 6.25 7.76 8.66 Last quarter of 1969 10. OO Exhibit 79 SEPTA. — Charlie Ingersoll thinks that the proposal to reform the SEPTA Board that Mr. Bertrand called you about is both beneficial and politically feasible. He and Dick Tomlinson are putting together what they describe as a "position paper" on the center city connection and other items to be negotiated with SEPTA. They are also working on a letter for you and Mr. Bertrand, setting forth suggested ground rules and procedural guidelines to govern future relations between SEPTA and the two railroads. P&LE merger. — No plan for including the P&LE in the Penn Central has been formu- lated. At one time there was talk of obtaining appropriate approvals at the meeting of the P&LE Board on December 11, but this schedule was abandoned when it was realized that (1) merger into Penndel (which was the original proposal) would carry with it several disadvantageous legal consequences; (2) that no study to determine whether physical consolidation is operationally or economically feasible had ever been conducted; and (3) that the cost of protecting P&LE employes whether or not there was physical inclusion would undoubtedly outweigh any advantage from squeezing out minority shareholders. Consideration is now being given to what Ted Warner calls a "reverse" merger, which would involve creating a new Delaware corporation and merging it into P&LE. He says that this has the same effect in eliminating minority interests as the standard merger but would not have the same adverse labor consequences, despite any conditions that might be prescribed by the I.C.C., since there would be no effect on employes arising out of this transaction. Whether or not to thereafter consolidate P&LE operations and properties could be determined on the basis of a study concerning the economic advantages and dis- advantages of taking this next step. 746 Consultants. — Attached is a list of the firms and individuals who received payment as consultants during the month of October. I am obtaining an explanation for those we do not already know about. With reference to Joe Borkin, you will be interested to know that he is being paid $2,750 per month on a regular basis. Last year he received a total of $56,075 from the Central ! In view of your instruction to discontinue the use of consultants wherever possible, I have arranged for a continuing check and report on payments being made in this account. Cash situation. — Our cash balance is down to $28.7 million, due mainly to a $42 million bond issue that matured earlier this week. The program to generate cash seems to be going well, although it is impossible to put a dollar value on the results to date : Capital Expenditures. — The M-W people assure me that deferred road improvements add to $23 million, and probably more, but I have been unable to get a fix on the exact amount because the man with the figures (Pete Piper) is out on the road. I will keep after him. Inventory. — Mai Richards' dispute with the accountants has been resolved in his favor, but the projected year-end balance is still $85 million. It would be lower except for the deferred construction. What is more significant, current cash outlay has been cut to the bone, primarily by deferred fuel and tie purchases, with a favorable effect on cash outlay from $3 to $4 million. For the year to date, total purchases are running $5 to $6 million below last year. Scrap Sales. — Bids are due on Monday on offers to sell in place scrap in the New York Harbor area and Sunnyside Yard. It is difficult to estimate the cash effect because the buyers' cost in removing the structures is an offsetting element. These are extraordinary transactions in excess of the normal scrap sales of approximately $2 million per month. Real Estate Sales. — While I do not have a figure as to the cash expected from real estate sales this quarter, my guess is that the amount actually generated will be substan- tially greater because the forecast of closings this quarter is now $7.0 million, which is more than double the initial estimate. In addition, about a half-million dollars cash will be received in connection with the coal lands sale. Accounts Receivable. — A special study to identify the most fruitful areas for concen- trating the effort to collect outstanding bills has produced the following information about delinquent (over 10 days) accounts: Number of firms whose delinquent accounts total $2 million 2 $7 million 35 $3 million 5 $8 million 50 $4 million 8 $9 million 88 $5 million 15 $10 million 161 $6 million 23 Some of the large offenders are holding back as an offset against unpaid freight claims. When these firms are all identified, various officers in the organization will be requested to contact them specially. The Accounts Receivable balance is now $75 million, which is $15 million higher than it was assumed to be in October. This does not represent a loss of position as much as it does identifying more accurately the scope of the problem. This effort to collect outstand- ing bills will have a continuing beneficial effect in improving the policing of the account to keep shippers on a more current basis. 1969 income projection. — As anticipated, the revenue and expense figures reported yes- terday did not conform to the standards prescribed and are now in the process of revision. The Staff Meeting originally set for December 9 has been postponed until Friday. Decem- ber 13, but we exnect to have sufficient detail bv Monday afternoon for the Budget group to consider preliminarily the 1969 income projection. I am preparing an analysis of the figures for your use. Basil Cole. Exhibit 80 Peat, Marwick, Mitchell & Co., Certified Public Accountant, Philadelphia. Pa., June 3, 1969. Mr. Stuart T. Saunders. Chairman of the Board, Penn Central Co., Philadelphia, Pa., Dear Mr. Saunders : Our examination of the financial statements of Penn Central Com- pany and subsidiaries for the year ended December 31, 1968 was completed on March 7. 1969. As is our customary practice following an examination, we now present for your con- sideration comments and recommendations with respect to internal controls and accounting procedures. The comments contained herein represent a summary of the more important matters which came to our attention during the course of our regular examination and are not the result of a special study of the accounting system. Separate letters with specific comments on individual accounting matters related to their respective functions have been addressed to Mr. Hill. Comptroller, Mr. Shaffer, Treasurer, and Mr. McTernan, Assistant Vice Presi- 747 dent-Budgets and Controls. In addition, Mr. Hill has received a complete copy of all of our comments and recommendations. System (corporate) accounting It is our opinion that significant time savings and improved reporting would result from mechanization of presently hand-posted ledgers and implementation of standard forms for recording recurring journal entries, reporting of operating results by subsidiary com- panies and preparation of bank reconciliations. A considerable time-lag occurs in the closing of balance-sheet accounts at the end of each calendar month. For example, accounts for the month of September 1968 were not closed until late in November. The principal causes of this time-lag appear to be delays in the receipt of information from the Treasurer's Office and Systems Development (Data Processing) Department. Also, as 1968 was the first year of merged operations, this con- tributed to some extent to the delays experienced. Balance-sheet data is only effective as an operating tool if received on a timely basis. Considering the computer capacity available and the opportunities for the use of increased mechanization, it should be possible to sub- stantially reduce the current time-lag in monthly reporting. Presently, reconciliations of account details to the general ledger are not consistently made at the end of each month. Monthly reconciliations of supporting ledgers with the general ledger are essential in the operations of an efficient accounting system. Bank account reconciliations are not prepared promptly by the Treasurer's Office at the close of an accounting month. Delays of as long as three to five months occurred in the preparation of such reconciliations. This is also true with respect to the recon- ciliation of the detail of "estimated checks and drafts outstanding" to the general ledger, a reconciliation of which, in fact, has not been made since 1965 for certain portions of the account. Obviously, failure to reconcile promptly bank accounts and outstanding checks and drafts causes a serious breakdown in the maintenance of an effective system of internal control. In addition, the present bank reconciliations are prepared on typed sheets, the form of which varies from month to month and does not lend itself to quick and intelligent review. We recommend that the procedures followed with respect to reconciliation of bank accounts and outstanding drafts be carefully reviewed. We understand that such a review has been initiated recently. There is no detailed listing of "audited bills payable" to support the balance carried in the general ledger. We recommend that a listing be prepared and balanced with the general ledger at least on a quarterly basis. Physical inventories are taken annually over a period of months beginning in April and extending through August. The compilation of the physical inventories was not completed until late in December. Every attempt should be made to reduce this time-lag. There was a serious reversal in the timeliness of accounts receivable collections during the year. Admittedly, this was caused, in part, by the conversion to a uniform accounts receivable system for the merged roads. Replies received to our requests for confirmation of account balances often included copies of letters written by patrons requesting that old and disputed items be clarified to permit payment of account balances. The patrons indi- cated that they had not received responses to these letters from company personnel. Prompt follow-up of such inquiries would not only improve control over accounts receivable records but would also result in an improved cash flow. Considerable difficulty was experienced in verifying charges to the "merger reserve" account for non-productive employees. Clarification of the definition of a non-productive em- ployee, properly disseminated to regional operating personnel, should eliminate this problem. The effectiveness of the Internal Audit Department would be enhanced, if it were to make greater use of computer processing and operational or procedural auditing techniques. Regional accounting Amounts included in "Auditer Items Awaiting Billing" should be relieved from the account on a timely basis so as to reduce costly analysis to determine the composition of the account balance. Documentation of charges against the merger reserve, including information as to the reason for such charges, should be improved. We noted numerous instances where authorizations for the purchase or construction of capital items were exceeded without additional approval. We also noted instances where authorizations for capital projects were used for purposes other than those stipulated in the original authorization. A procedure should be instituted to ensure that situations of this nature are not allowed to recur. Subsidiary records are not balanced on a regular basis to the controlling accounts in the region general ledgers. Regular reconciliation procedures of this nature are essential to good internal control and would facilitate preparation of financial statements by the regions. ******* Should you have any questions concerning these matters, we would be pleased to discuss them with you at your convenience. We would like to express our appreciation to the officers and employees of the company for the cooperation received during the course of our examination. Very truly yours, Henry A. 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