Mark,
It seems that maybe the oil was drained out of it. Otherwise, the parts inside the transmission cover wouldn't be rusty. I am curious to see what the gears look like after you split the case. I hope they are in good usable condition. I am sure you will do fine on the restoration. You have experience and it's a labor of love. I have my sandcast restoration just about complete. Everything is done, except for assembly. My bike will be both blue/green and red. I have a freshly painted blue/green set done and will be getting the red set painted very soon so that I can change the color of the bike each season. That way, I don't have to buy two sandcasts. Remember, any heartache you go through, do to the rust, etc. issues will be long forgotten when you have your early VIN restored. You are a very lucky guy to have such a low VIN. I feel fortunate to own a sandcast too. 4646.
Joe K.