PENN CENTRAL COMPANY AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS-(Continued) (4) Federal Income Taxes: (dollar amounts in thousands) Federal income tax returns are filed on a consolidated basis for all companies owned 80% or more and no taxes were payable on such basis for the five years ended December 31, 1969. Federal income taxes reported in the statement of consolidated earnings are comprised of: Current income taxes are applicable to earnings of subsidiary and lessor companies for which separate returns are filed; deferred income taxes are applicable to non-regulated subsidiaries not includable in the consolidated income tax return. No deferred income taxes are reflected in the accompanying financial statements 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: (1) depreciation on accelerated methods, (2) property sales on the installment basis, and (3) merger, casualty costs and losses, and loss on investment in long-haul passenger service facilities on the cash 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 had the effect of decreasing (increasing) consolidated earnings as follows: The cumulative amount of deferred income taxes at December 31, 1969 is not considered to be material. No deferred taxes are applicable to the transportation company. In filings with the Securities and Exchange Commission deferred taxes as shown above will be reflected. Investment tax credits of approximately $90,000 are available for carry-forward to future years. The consolidated Federal income tax returns filed by the Pennsylvania Railroad affiliated group for the years prior to 1954 have been examined by the Internal Revenue Service and all tax liabilities have been settled. For the years 1954 through 1961 the Internal Revenue Service has proposed additional taxes of approximately $50,000, exclusive of interest, based primarily upon the assertion that certain deductions should be spread to later years to a degree inconsistent with treatment of similar items accepted by the Service in prior years. The Company and its subsidiaries have filed initial protests against the proposed deficiencies; counsel is of the opinion that these protests will be settled substantially in the Company's favor. Accordingly, no accrual has been made in the accounts for additional taxes, or interest thereon, with respect to the years 1954 to 1961. The consolidated returns for years 1962 to 1964 are under examination by field agents of the Internal Revenue Service; no deficiency for these years has been proposed. The consolidated Federal income tax returns filed by the New York Central affiliated group for the years prior to 1956 have been examined by the Internal Revenue Service and all tax liabilities have been settled. The tax returns for subsequent years, all of which indicated no tax liability, are subject to examination by the Internal Revenue Service; however, the statute of limitations bars any deficiency assessment for the years prior to 1966, other than 1962. PENN CENTRAL COMPANY AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS-(Continued) (dollar amounts in thousands) (5) Tax-Allocation Agreements: The Penn Central Transportation Company statement of earnings reflects amounts receivable under tax-allocation agreements entered into between the transportation company and certain of its subsidiaries included in the consolidated income tax return. Under these agreements the subsidiaries pay to the transportation company the amount by which their tax liability is reduced or eliminated because of utilization in the consolidated return of operating losses or capital losses of other members of the group, but in no event more than 95% of the tax which would have been due if the subsidiaries had filed separate returns. (6) Merger Reserves and Liabilities: The merger of The New York Central Railroad Company into The Pennsylvania Railroad Company in 1968 resulted in duplication or obsolescence of certain railroad facilities and supplies and in the requirement to rehire certain otherwise surplus furloughed employes, for which appropriate valuation reserves and liabilities, aggregating $275,422, were established. Charges against these accounts were $22,466 in 1969 and $39,684 in 1968. (7) Long-Term Debt: 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: Transportation $228,130 $106,058 155,948 68,922 172,349 112,621 269,889 212,234 160,240 99,759 Substantially all investments and properties included in the consolidated balance sheet and substantially all the properties of the transportation company, together with certain of its investments, principally Pennsylvania Company (a subsidiary which holds the stock of Norfolk and Western Railway Company and of the principal real estate and other non-railroad subsidiaries), have been pledged as security for loans or are otherwise restricted under indentures and loan agreements. (8) Common Stock and Additional Paid-in Capital: The changes in common stock and additional paid-in capital for the transportation company and for the holding company for the three years ended December 31, 1969 were as follows: PENN CENTRAL COMPANY AND CONSOLIDATED SUBSIDIARIES Transactions in stock option plans during the three years ended December 31, 1969 were as follows: Options outstanding at December 31, 1969 are exercisable at prices ranging from $12.50 to $77.25 per share and generally are exercisable over a four-year period, commencing one year after date of grant. No material dilution in earnings per share would have occurred if all options outstanding at December 31, 1969 had been exercised. PENN CENTRAL COMPANY AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS-(Continued) (dollar amounts in thousands) (9) Lease Obligations: Penn Central Transportation Company and certain other subsidiaries have obligations under long-term rail transportation equipment leases. Remaining rentals payable under these leases at December 31, 1969 are $511,669 consolidated and $627,225 for the transportation company. Annual rentals under existing leases will range during the next five years from a high of $46,638 to a low of $45,549 on a consolidated basis and from a high of $62,554 to a low of $58,326 for the transportation company. The rentals under these lease arrangements in 1969 were $43,014 consolidated and $59,175 for the transportation company. Rental obligations for miscellaneous real estate and sundry equipment are considered not to be material. (10) Contingent Liabilities: On a consolidated basis contingent liabilities aggregate $226,146 as of December 31, 1969 in respect of the principal of obligations issued by non-consolidated companies, principally terminal companies, in which the transportation company and other subsidiaries have an interest. Of these contingent obligations, $191,302 have been entered into jointly, or jointly and severally, with other companies. Penn Central Transportation Company has contingent liabilities as of December 31, 1969 aggregating $437,084 as guarantor of the principal of obligations of affiliated companies. Of these contingent obligations $177,682 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 consolidated or transportation company financial position. (11) Pensions: Penn Central Transportation Company and certain other consolidated subsidiaries have pension plans which provide retirement benefits for substantially all management employes and certain personnel covered by labor union agreements. It is the policy of the companies to fund pension costs accrued and substantially all of the plans are fully-funded at December 31, 1969. Pension expense was as follows: Effective January 1, 1969 the Company wrote down its investment in facilities directly related to long-haul passenger service west of Harrisburg, Pa. and Albany, N. Y. (including related mail-handling facilities and equipment) to estimated salvage value because prior operating losses make any possibility of recovery of such investment through future operations clearly remote. Proceedings are being initiated before the Interstate Commerce Commission for permission to abandon substantially all such service. As a result of the write-down, depreciation expense for the year 1969 was reduced approximately $4,500. (13) Retroactive Adjustments: In 1969, retained earnings were restated from amounts previously reported to reflect a retroactive charge of $9,191 consolidated and $8,818 for the transportation company for the court-ordered resettlement, including interest, of certain 1965-1968 revenues between Northern and Southern railroads. In 1968, retained earnings were restated to reflect a net retroactive increase of $7,253 on a consolidated basis, and a net charge of $39,142 for the company. The net increase on a consolidated basis results from (1) a credit of $46,395 arising out of conformance of accounting policies with respect to deferred income taxes at time of the merger of The New York Central Railroad into The Pennsylvania Railroad Company, and (2) a net charge of $39,142 to correct retroactively certain account balances (principally accruals for injuries to persons, loss and damage freight claims and other items PENN CENTRAL COMPANY AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS-(Continued) (dollar amounts in thousands) relating to prior years) as a result of the first audit of the merged company and to effect uniform accounting policies and practices. Retained earnings of the transportation company were not affected by the credit relating to deferred income taxes. As a result of these adjustments, earnings have been appropriately decreased (increased) as follows: In addition, the earnings statements for 1965 to 1968 have been restated, where appropriate, to conform with classifications adopted in 1969. In accordance with a January 29, 1970 Interstate Commerce Commission order, the method of calculating rental charges for railroad freight cars was altered retroactively to August 1, 1969, the effect of which reduced 1969 consolidated railroad expenses by $7,100 and reduced the transportation company's rent expense by $6,500. (14) Reports to the Interstate Commerce Commission: Financial reports filed with the Interstate Commerce Commission by Penn Central Transportation Company differ from the accompanying financial statements of the transportation company (which are in accordance with generally accepted accounting principles) in the following respects: (1) Shares issued in December 1968 in connection with the acquisition of New Haven properties have been reflected in the accompanying financial statements at $41.125 per share, the average fair market value of the stock during the period of negotiation of the acquisition agreement; whereas the Commission has ruled that such shares be valued at $87.50 per share, the value determined by the Commission. The difference in purchase price has been reflected partly as a deferred credit of $23,077 and partly as additional paid-in capital of $21,284 in reports to the Commission; whereas a liability of approximately $40,000 for rehabilitation and other costs assumed in connection with the acquisition of New Haven properties has been reflected in the accompanying financial statements, but not in reports to the Commission. In 1969, the net loss for the transportation company, as reported to shareholders, was $21,986 less than the loss reported to the Commission because of charge-offs against the liability for rehabilitation and other costs. (2) The extraordinary charge for loss on investment in long-haul passenger service facilities (see note 12) has not been reflected in reports to the Commission. Accordingly, 1969 depreciation expense in such reports was $4,500 higher. (3) The 1965-1968 revenue resettlement and interest costs, amounting to $8,818 and the net charge made in 1968 amounting to $39,142, which are treated as adjustments of prior years' earnings in the accompanying financial statements are reflected in reports filed with the Commission as extraordinary reductions of 1969 and 1968 net income. (4) During 1969 the Commission ordered the transportation company to reclassify a $21,000 gain on security sales originally included in 1968 earnings from ordinary operations to an extraordinary item in reports to the Commission. In addition, the gain on sale of certain securities by a subsidiary of the company under an exchange agreement entered into in a prior year is being amortized to income over the term of the agreement for financial reporting purposes, but gains are being recognized in reports to the Commission 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. (15) Subsequent Events: In February 1970 Penn Central Company purchased all the outstanding stock of Southwestern Oil & Refining Company and Royal Petroleum Corporation through an issue of 400,000 shares of $3 cumulative preference stock convertible into two shares of common stock, or after five years, into one share of Norfolk and Western Railway Company common stock. 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 $50,989. |