PENNSYLVANIA COMPANY (COMPANY ONLY) PENNSYLVANIA COMPANY AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (dollar amounts in thousands) (1) Principles of Consolidation: The consolidated financial statements include the accounts of the company and its majority-owned subsidiaries, except the Wabash Railroad Company, the divestment of which is arranged as ordered by the Interstate Commerce Commission. The following significant subsidiaries were acquired during the years 1965 to 1969, and their operations have been included in the statement of consolidated earnings and retained earnings since the respective dates of acquisition: 51% interest acquired in July 1965; increased to 58% in 1966 Arvida Corporation Great Southwest Corporation... Macco Corporation ...... 60% interest in common stock acquired July to 100% interest acquired in October 1965 (merged In December 1969 Great Southwest Corporation, acquired all the outstanding stock of Richardson Homes Corp. by purchase and in January 1970 acquired I. C. Deal Companies Inc. through an exchange of stock treated as a pooling of interests. Earnings of Richardson Homes are consolidated from date of acquisition; the accounts of I. C. Deal have not been included in the consolidation as of December 31, 1969 since they are not material. Great Southwest sold in 1968 Great Southwest Warehouses, Inc., a subsidiary, and Six Flags Over Georgia, a division of a subsidiary, and in 1969 sold Six Flags Over Texas, another division. Operations of the subsidiary and divisions were included in earnings until date of disposition. In connection with the sale of the divisions, Great Southwest entered into an agreement with the new owners to manage the operations of the divisions on a fee basis related, in part, to the net earnings generated from operations. PENNSYLVANIA COMPANY (COMPANY ONLY) PENNSYLVANIA COMPANY AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS-(Continued) (dollar amounts in thousands) Certain investments held by Pennsylvania Company were acquired from Penn Central Transportation Company, generally in exchange for funds obtained by Pennsylvania through financing. The valuation placed on securities exchanged has been determined sometimes on the basis of market value or underlying equity on the date of exchange and sometimes on the basis of the transportation company's cost. During the last three years securities with an aggregate cost to the transportation company of $36,171 were sold to Pennsylvania for $36,180. The aggregate estimated market (or underlying equity) value of such securities on the respective dates of exchange was $30,613. In addition, the transportation company has from time to time purchased securities from Pennsylvania, but the aggregate amount of such purchases in the last three years was not significant. Wabash Railroad Company The Wabash properties have been leased to Norfolk and Western Railway Company since October 1964 under a rental arrangement that provides for a fixed rental, additional rental equated to dividends declared on Norfolk and Western stock, and payment of all expenses related to operation of the properties. An agreement also provides for exchange of all the Wabash common stock for 671,692 shares of Norfolk and Western common stock by October 1970. The Norfolk and Western common shares to be acquired through this exchange are subject to the voting restriction and extended divestiture requirements as explained under Norfolk and Western Railway Company below. Unaudited net earnings and dividends received from Wabash were: The net assets attributable to 50%-owned companies, on the basis of unaudited financial statements, were less than the Company's investment therein by $3,428 ($3,283 consolidated) at December 31, 1969. Dividends received from such companies were $225 in 1965; $248 in 1966; $169 in 1967; $281 in 1968; and $225 in 1969. Affiliated Companies The net assets attributable to 'the investment in stock of affiliated companies, on the basis of unaudited financial statements, exceeded the Company's investment therein by $38,169 ($39,912 consolidated) at December 31, 1969. Dividends received from such companies were $2,556 in 1965 and $2,497 in each of the years 1966 through 1969. Norfolk and Western Railway Company On October 16, 1964 The Norfolk and Western-Nickel Plate-Wabash Unification Plan became effective pursuant to an order of the Interstate Commerce Commission. As ordered by the Commission, voting rights of the Norfolk and Western holdings are placed with trustees under voting agreements until completion of divestiture, which is required by October 15, 1974, as to 791,905 shares, and by October 15, 1979 as to the remaining shares in accordance with an extension of the original divestiture period approved by the Commission in 1969. Under an April 1966 agreement with Norfolk and Western 800,000 shares of its common stock are to be exchanged in stipulated installments to June 1974 for $104,000, principal amount of Norfolk and Western 45%% debentures, convertible into Norfolk and Western common stock by any holder other than Penn Central or its affiliates. The total consideration of $104,000 received or receivable under the exchange agreement was recorded as an investment in 1966. The resulting profit is being recognized as income ratably over the term of the agreement. At December 31, 1969 there is $27,845 of profit allocable to the remaining periods under the agreement. Profit recognized during the five years ended December 31, 1969 was none in 1965; $7,025 in 1966; $6,921 in 1967; $6,538 in 1968 and $6,305 in 1969. A total of 400,000 shares has been exchanged to December 31, 1969 and of the $52,000 principal amount in debentures received therefor, $41,600 have been sold. For purposes of reporting to the Interstate Commerce Commission, the gain is being recognized as disposition of securities received in exchange occurs. The cumulative effect at December 31, 1969 is a reduction of $7,631 in earnings reported to the Commission. At December 31, 1969 the market value of Norfolk and Western common stock holdings, including shares receivable in exchange for Wabash common stock, was $144,196 a substantial portion of which is subject to pledge or other restriction. Dividends and interest received from Norfolk and Western in the aggregate were $15,555 in 1965; $15,188 in 1966; $13,771 in 1967; $12,783 in 1968; and $10,836 in 1969. PENNSYLVANIA COMPANY (COMPANY ONLY) Transportation properties of the railroad companies are stated at valuations determined by the Interstate Commerce Commission in 1915 to 1919, with subsequent additions at cost or less. Pipeline and other properties are stated at cost. Transportation properties generally are depreciated in accordance with regulations issued and at rates approved by the Interstate Commerce Commission. As required, replacement accounting is used for certain properties, principally track structure and grading accounts. Under this method, amounts capitalized are not depreciated but replacements in kind are expensed; betterments and additions are capitalized; and retirements are charged to expense. Leased railroad equipment is depreciated over the initial lease life (approximately 20 years). Depreciation of other properties is provided on the straight-line method over the estimated useful lives of such assets. Depreciation expense on a consolidated basis was: 1965 (unaudited) $12,874 13,031 13,442 14,212 15,234 At December 31, 1969, long-term debt, including debt due within one year, was as follows: Certain issues require annual installments of principal, in varying amounts, to the final maturity dates indicated. Payments of principal for the next five years are: Company Consolidated 133 PENNSYLVANIA COMPANY (COMPANY ONLY) PENNSYLVANIA COMPANY AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS-(Continued) (dollar amounts in thousands) Investments with a cost of $234,567 for the Company, including investments in consolidated subsidiaries, and $423,478 on a consolidated basis, as well as substantially all properties have been pledged as security for loans or are otherwise restricted. The Company is required, under the terms of the indenture relating to a $50,000 issue of 9% Sinking Fund Debentures due 1994, to maintain net tangible assets, as defined, of at least 300% of the debentures and all other funded debt which is not subordinated to such debentures. Net tangible assets at December 31, 1969 exceeded the amount which the Company was required to maintain. The 4%% cumulative preferred stock and certain additional debt instruments similarly limit the amount of funded debt which may be incurred by the Company, but in an amount which at December 31, 1969 was less restrictive than that described above. (5) Federal Income Taxes: The taxable income of the Company and of its subsidiaries owned 80% or more is included in the consolidated Federal income tax returns filed by Penn Central Company. No taxes are payable on this basis for the years 1965 to 1969, nor are the Company or its subsidiaries, other than Great Southwest Corporation, required to pay to Penn Central any amount in lieu of such taxes. Federal income taxes reported in the statement of consolidated earnings and retained earnings are applicable to subsidiary companies which file separate tax returns and consist of the following: Current taxes shown above include $2,573 for 1968 and $5,190 for 1969 payable to Penn Central Transportation Company by Great Southwest Corporation under a tax-allocation agreement entered into in 1968, the terms of which provide for a charge in lieu of Federal income taxes equal to 95% of taxes which would be payable if Great Southwest had filed separate returns. No deferred income taxes are reflected for companies included in the consolidated tax return or for companies subject to Interstate Commerce Commission regulations which prohibit the reflection of such taxes in reports thereto. Deferred income taxes arise from timing differences due principally to reporting for tax purposes of depreciation on accelerated methods and property sales on the installment basis. On a consolidated basis the deferred income taxes, if reflected as required by generally accepted accounting principles (after giving recognition to tax effect of capital gains, dividend income and maximum utilization of investment tax credits), would have approximated $55,000 at December 31, 1969 and would have had the effect of decreasing reported consolidated earnings as follows: Deferred taxes applicable to Pennsylvania Company (company only) are not considered to be material. The Internal Revenue Service has proposed tax deficiencies of approximately $50,000, exclusive of interest, against Penn Central Company and its subsidiaries relating to the years 1954 to 1961. Pennsylvania Company and its subsidiaries are severally liable for any such deficiency. However, Penn Central and its subsidiaries have filed protests against the proposed deficiencies; counsel is of the opinion that these protests will be settled substantially in the companies' favor. Accordingly, no accrual has been made in the accounts for such taxes, or interest thereon. PENNSYLVANIA COMPANY (COMPANY ONLY) (6) Preferred Stock: NOTES TO FINANCIAL STATEMENTS—(Continued) Beginning in 1974, the company will be required to make annual redemptions of the 45%% cumulative preferred stock equal to 5% of the maximum shares outstanding at any time prior to redemption, at par plus unpaid dividends and a premium of $5.00 a share in 1974, which decreases in equal annual amounts to $2.50 a share in 1979. In addition the stock is redeemable at the option of the company at any time, at par plus unpaid dividends and a premium of $10.00 a share in 1970, which decreases in equal annual amounts to $5.00 a share in 1979. At the option of the holder, each share of stock is convertible into approximately 73 shares of Norfolk and Western common stock. During the three years ended December 31, 1969, 112 shares of preferred stock have been redeemed for 80 shares of Norfolk and Western common stock. (7) Pension: Pension plans for various subsidiaries provide retirement benefits for substantially all full-time employees. It is generally the policy of these companies to fund pension costs accrued. Pension expense in each of the five years ended December 31, 1969 was as follows: Rents from lease of road and equipment to Penn Central Transportation Company, included in the statement of consolidated earnings and retained earnings as railroad revenues, were as follows: Certain consolidated subsidiaries have obligations under long-term leases which expire at various dates to 2031. The annual rentals on these leases, including rail transportation equipment leases, will be approximately $3,400 annually for the years 1970 through 1974. (10) Contingent Liabilities: The consolidated group has contingent liabilities aggregating $73,683 as of December 31, 1969 in respect of the principal of obligations issued by nonconsolidated companies. Of these contingent obligations, $57,290 have been entered into jointly, or jointly and severally, with other companies. In addition, there are other contingent liabilities but management believes these contingencies will not have a material adverse effect upon the company or consolidated financial position. (11) Subsequent Event: On March 31, 1970 the 595,255 shares of Wabash Railroad Company common stock held as an investment were exchanged for 671,692 shares of Norfolk and Western Railway Company common stock in accordance with the terms of an agreement entered into in October 1964 (see note 2). The Norfolk and Western shares were recorded as an investment at their fair market value on date of exchange, resulting in a gain of $46,940 ($50,989 consolidated). |