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Erie Railroad Company

The Delaware, Lackawanna and Western Railroad Company

REPORT ON ECONOMICS OF MERGER

Introduction

The Erie Railroad Company and The Delaware, Lackawanna and Western Railroad Company operate 3,135 miles of road, 79% of which is concentrated in the states of New Jersey, Pennsylvania and New York as indicated in the table below:

Our physical studies of the economics of an Erie-Lackawanna merger have been confined to the portions of this three-state territory where physical changes might result from merger as follows:

• Delaware, Lackawanna and Western - All line except
• Roseville Ave. - Denville, NJ
• Gladstone Branch
• Portland and Martin's Creek to Pine Argyl and Bath
• Syracuse and Utica Branches
• Binghamton-Gibson NY
• Phillipsburg Branch
• Netcong-Branchville
• Washington line
• Erie - All lines east of Hornell and Buffalo NY except
• Suspension Bridge and Lockport Branches
• Alexander-Rochester
• Lakeville and Conesus Branches
• Blossburg and Newberry Jct Branches
• Watkins Glen Branch
• Middletown-Pine Bush NY
• Pine Island-Mntgomery NY
• Newburgh Branch
• Nysck Branch
• New Jersey and New York RR
• Binghamton-Gibson NY

Facilities and operations either coordinated or expected to be coordinated prior to merger have been omitted from consideration.

Basic organization of merger study and summary results.

The economic studies underlying this report were outlines and directed by a so-called "Steering Committee" consisting of the following:

In the final stages of the studies Mr. W.G. White, Vice President-Operations of the Lackawanna, replaced Mr. Jonas.

The headquarters for the study were in the offices of Wyer, Dick & Co., Upper Montclair (formerly East Orange), New Jersey. The Steering Committee representatives also performed their normal duties during the study and Steering Committee meetings were held as often as necessary.

The Steering Committee first decided on a list of subjects to be investigated. The original list included 22 definitive studies and five underlying studies. A description of each study with the estimated changes in net income (at revenue and expense levels of 1956), and estimated net cash realizable from or required to effectuate the merger is introduced as Appendix G. A summary statement at current revenue and expenses levels, is shown in the table on the following page.

G - Gain - or net cash realized

L - Loss - or net cash required

Each study or subject to be investigated was discussed with the members of the Steering Committee, and the methods to be followed in the subsequent detailed investigation were outlined in so-called "Procedure Sheets". These sheets were first circulated in tentative form among the department heads who would be responsible for furnishing the information requested and then discussed with them at a general meeting. After consideration of all of the suggestions received from the various department heads, the "Procedure Sheets" were issued in final form.

The four major studies of the effect of merger upon physical facilities and their maintenance and operation were as follows:

• Study I - Common Points
• Study II - Duplicate Lines
• Study VIII - General Repair Facilities - Equipment
• Study XV - Effect of Merger on Expense of Operating Lines Retained

In Studies I, II, and VIII a field inspection was made by the Steering Committee or its representatives, as described in greater detail under the various studies, and the findings of the field parties, as approved or modified by the Steering Committee, served as the basis for estimates by the engineering and accounting departments of the savings which could be realized from merging facilities and operations at the point covered. The inspections were made during part of 1957. During this period the most recent full calendar year for which data was available was 1956, and in general 1956 has been the base year for the study. Operating data available to the inspection parties reflected operations in November, 2956. There have been many chances in operations since that time, and these changes were examined, new data obtained and new inspections made when it was thought that they would produce conditions which would materially change the conclusions reached in this report. Whenever new data was obtained, however, it was evaluated at 1956 cost and revenue levels so that it would be comparable with the results of the other studies.

The development of the other studies, including Study XV, followed essentially the same patterns, although field inspections were considered unnecessary. During the progress of the studies the Steering Committee was at all times available for consultation, and many were reviewed by members of the Steering Committee and any questions were taken up with the officers who prepared the basic data, sometimes resulting in changes.

Generally speaking, every report as now presented was concurred in by the full-time members of the Steering Committee. This unanimous concurrence usually also extended to lower levels. Many of the supporting reports underlying the different studies were signed jointly by the responsible department heads of both companies. In Studies I, II and XXI where the final report involved consolidation of figures from several different departments, such consolidation was performed by one of the accounting departments which coordinated the partial reports of the various departments and produced the final document, which thus again represented the combined judgment of the participating departments. In Study I, Common Points, and Study II, Duplicate Lines, where the final estimates were based on field checks, the field-reports represent in practically every instance the unanimous opinion of the local officers of both roads and the representative of Wyer, Dick & Co. who conducted the check. As indicated hereinafter, the field checks of four of the largest common points and some of the more important duplicate lines were conducted by the Steering Committee itself, whose reports in these instances were again unanimous.

In spite of the degree of unanimity behind the final results of this study, the report officially represents nothing more than our opinion as to the advantages realizable from merger, as offset by certain accompanying disadvantages which are also set forth. In order to estimate the economies which would result from the proposed merger it was necessary to determine a practicable plan of operation for the proposed merged company, including a proposed organization of the executive and other departments which were analyzed. Having in mind the limitations on capital money available, we believe the plan as proposed in this study to be such a plan. However, this is a report to the top managements of the companies involved and has not officially been approved or adopted by either of them. The new Board of Directors would ultimately be responsible for the organization and operation of the merged company, and this report can only serve for the present as an estimate of the savings, and for the future as a preliminary blueprint for the detailed plans which would eventually have to be prepared to effect merger. The report,. cannot, and nothing in it should be construed as indicating that it does, bind the management of the new company in any particular.

3. General principles and methods of estimating savings.

Several other basic principles or general methods of estimating savings were adopted to govern the development of all studies:

A. No economies have been included which could be realized apart from merger.

B. The improvement of existing conditions which could be done by present management without merger has been excluded from the studies.

C. It was impracticable to analyze all of the carload freight traffic handled in 1956, and estimates of the effect of merger upon freight revenues were based primarily on October, 1956, as described in Appendix A.

Property retired - the income tax which would be saved because of the retirement of non- depreciable property, or depreciable property retired prematurely, adjusted for cost of dismantling less salvage realized, has been included.

Extraordinary expenditures next four years the increase the income taxes because of avoiding that portion of the total expenditure which would otherwise be chargeable to operating expenses has been included.

Property acquired and property relocated the income tax which would be saved because of that portion of the total cost chargeable to operating expenses, has been included.

Interest at 5% on net cash which would be realized from merger in any study was included as a saving in the final summaries, and interest at the same rate on cash which would be required in order to effect merger was included as a loss.

5. Estimated realization of savings and net cash requirements by years, first five years after merger.

The estimated change in net income and cash realized or required would not, of course, be achieved in full at the outset. Considerable construction work would be necessary before the savings dependent on physical changes would be achieved. The savings resulting from the abandonment of lines must await the granting of the requisite permission by the legal authorities. It is believed that the full potential changes would not be realized for five years, although most of them should be realized by the end of the fourth year, and the amounts estimated for each year during this transition period are shown in Appendix D for net savings, and in Appendix E for the net cash requirements. The assumptions used in making the allocation are shown either in the text or in notes attached to each Appendix.

6. Adjustment of savings and net cash requirements to current revenue, expense and volume levels.

The studies were originally based on 1956 data and savings and net cash requirements were determined at 1956 revenue and expense levels. Before adjusting to current revenue and expense levels effect was given to changes in the volume of business since 1956. Revenues have been brought up to the rate level of May 1, 1959. Wage levels were adjusted to reflect the increases effective May 1, 1957, November 1, 1957, May 1, 1958 and November 1, 1958. The material price adjustment was based on the 1958 Index of Average Unit Prices of Railway Material and Supplies issued by the Bureau of Railway Economics of the Association of American Railroads. Payroll taxes were adjusted to reflect the increases which became effective June 1, 1959. The per cents used to adjust both for changes in volume, and revenue and expense levels are shown in Appendix F.

7. Allowance for contingencies.

While these changes in net income represent the unanimous judgment of those members of the Steering Committee directly involved, as already outlined, nevertheless an allowance of 15% "for contingencies' has been included in the study for several reasons. The savings in Study II, Duplicate Lines, are based on certain abandonments of line, authority for which must ultimately come from the Interstate Commerce Commission. authority may not be received to abandon all of the lines included in the study. There is always the possibility that other changes included in the estimates may ultimately prove to be impracticable, that additional expenses not now foreseen would be incurred, or that necessary agreements with labor could not be reached in all instances. The estimates with respect to changes in traffic, while carefully made, must by their very nature be less reliable than estimates involving physical property.

8. Treatment of non-recurring charges to operating expenses.

All such estimated charges in connection with retirements, new construction, and payments under the Washington Agreement, or the Inter- state Commerce Act included in Study XVI, Labor Contracts, have been included in the net cash requirements, and 5% on these amounts has been deducted in arriving at the annual estimated savings.

9. Benefits to other railroads.

In addition to the economies estimated herein to accrue to the merged lines, certain fairly substantial benefits will accrue to other lines. For example, for the purpose of estimating the losses in Study XVIII it was assumed that the Chesapeake and Ohio would discontinue operation- over the Erie between Suspension Bridge and East Buffalo and all of the C&O Buffalo traffic would use the Black Rock gateway resulting in elimination of trackage charges between Suspension Bridge and International Jct. Other roads would also gain from consolidated (and in some instances, more economical) interchanges, and would benefit from consolidated accounting, especially as to interline settlements. No attempt has been made to estimate these savings to other lines.

10. Studies I-XXII summarized.

A description of the methods used, in developing each of the 22 definitive studies underlying this report, together with a summary of the estimated savings or additional costs, and estimated cash realized from or required for merger, is included in Appendix G. Certain line and trackage abandonments are recommended in these studies and Map No. 2 included in the envelope shows the lines of the proposed merged company. This map reflects the proposed trackage and line abandonments included in this report as well as those expected to be made under separate operation and under coordination.

Respectfully submitted, Wyer, Dick & Co.