*84 The amount of excessive profits of petitioner, a manufacturer of steel castings, derived from contracts subject to the Renegotiation Act, held, on record, to be $ 97,500.
*523 The parties herein have agreed that during the year 1942 petitioner realized profits from its operations, after the deduction of executives' salaries as provided by this Court in a prior hearing, amounting to $ 247,579.33, said profits being realized from the sale of manufactured articles to the United States*85 Government and being subject to renegotiation.
On January 14, 1944, the Secretary of the Navy determined that for the year ended December 31, 1942, petitioner had realized excessive profits in the amount of $ 80,000 and notified the petitioner accordingly.
On May 23, 1944, petitioner filed a petition with this Court requesting a redetermination of said excessive profits and alleged therein that the respondent erred in his determination of the amount of excessive profits received by petitioner. At the time of the trial all of the errors which the petitioner claimed the respondent had committed in his computation were eliminated by stipulation between the counsel except two, to wit:
(c) The Secretary of the Navy has erred in refusing to recognize Federal corporation taxes against the company for the year 1942;
(e) The Secretary of the Navy has erred in refusing to consider the factors set out in Subsection (a) (4) (A) of section 403 of the Renegotiation Act, such *524 as efficiency, costs, capital, risk, contribution to the war effort, character of business, and such other factors as the public interest and fair and equitable dealing may require.
The question of whether alleged*86 error "(c)" above is a permissible basis for complaint by the petitioner has not been discussed by the briefs herein. However, no testimony was introduced at the trial as to the amount of petitioner's corporation taxes, nor as to any other factor pertaining to this issue, which removes this claim of error from our consideration, even if it were a valid basis of complaint.
This leaves the issue for determination raised by the petition as to whether or not the determination of the Secretary of the Navy was proper under the directives of subsection (a) (4) (A) of section 403 of the Renegotiation Act. 1
*87 The answer of the respondent, however, filed on March 20, 1947, affirmatively claimed that the amount of excessive profits received by the petitioner in 1942 was $ 100,000, instead of the $ 80,000 originally determined by the Secretary of the Navy.
FINDINGS OF FACT.
The petitioner, Crucible Steel Casting Co., is a Pennsylvania corporation, organized in 1905, with its principal place of business in the Borough of Lansdowne, Delaware County, Pennsylvania.
Since its organization petitioner has been continuously engaged in the manufacture of steel castings of all types, including machinery parts for the manufacturers of various types of equipment. The manufacturing process requires the use of various alloys, such as nickel, chrome, molybdenum, carbon, manganese, and other chemical parts of steel. The items produced by petitioner are produced from blue prints and patterns supplied by petitioner's customers. Special *525 equipment is required, such as electric furnaces, heat treating furnaces, special mixture machines for the preparation and control of special sands, pressure work, and other equipment for testing the castings hydrostatically, and radio-graphic examination and magnaflux*88 for the purpose of determining internal flaws. The electric furnaces use a temperature as high as 3,200 degrees Fahrenheit.
During the year 1942 petitioner was not a prime contractor of the United States Government, or any of its agencies. Its orders were received from prime contractors throughout the Atlantic seaboard, and at all times during said year its products were subject to the highest priority regulations. At the end of 1942 petitioner had equipment to the value of $ 145,838.16 which was purchased on certificates of necessity.
Petitioner's orders and production record for the years 1936 through 1942 were as follows:
| Average | |||
| Year | Orders | Castings | number of |
| received | produced | pieces per | |
| order | |||
| 1936 | 7349 | 163,344 | 22 |
| 1937 | 6187 | 228,006 | 36 |
| 1938 | 4407 | 90,847 | 20 |
| 1939 | 6447 | 167,668 | 26 |
| 1940 | 8512 | 236,429 | 27 |
| 1941 | 9970 | 402,600 | 40 |
| 1942 | 7722 | 418,193 | 54 |
Petitioner's profit and loss statement for 1936, 1937, 1938, 1939, and 1942 is as follows:
| 1936 | 1937 | 1938 | 1939 | |
| Sales | $ 353,348.54 | $ 528,678.37 | $ 278,567.62 | $ 450,002.78 |
| Cost of sales | 294,014.00 | 414,043.08 | 256,104.60 | 348,554.68 |
| Gross profit | 59,334.54 | 114,635.29 | 22,463.02 | 101,448.10 |
| Selling and administrative | ||||
| expense | 49,911.65 | 67,903.79 | 50,841.86 | 61,171.87 |
| Operating profit | 9,422.89 | 46,731.50 | (28,378.84) | 40,276.23 |
| Other expenses | 6,707.37 | 5,870.43 | 1,276.97 | 6,407.77 |
| Less other income | 527.05 | 1,538.52 | 890.72 | 1,462.14 |
| Net other expense | 6,180.32 | 4,331.91 | 386.25 | 4,945.63 |
| Net profit before Federal | ||||
| taxes on income | 3,242.57 | 42,399.59 | (28,765.09) | 35,330.60 |
| 1942 | ||
| Subject to | ||
| Total | renegotiation | |
| Sales | $ 1,968,059.62 | $ 1,550,886.00 |
| Cost of sales | 1,441,589.97 | 1,136,016.18 |
| Gross profit | 526,469.65 | 414,869.82 |
| Selling and administrative | ||
| expense | 206,804.26 | 162,967.96 |
| Operating profit | 319,665.39 | 251,901.86 |
| Other expenses | 8,856.55 | |
| Less other income | 3,371.31 | |
| Net other expense | 5,485.24 | 4,322.53 |
| Net profit before Federal | ||
| taxes on income | 314,180.15 | 247,579.33 |
*526 Petitioner's balance sheets for 1936, 1937, 1938, 1939, 1941, and 1942 were as follows:
| 1936 | 1937 | 1938 | |
| ASSETS | |||
| Current: | |||
| Cash | $ 15,085.20 | $ 30,123.66 | $ 22,860.67 |
| Notes and accounts | |||
| receivable | 40,435.11 | 34,737.78 | 27,436.91 |
| Less reserve for bad debts | |||
| Net receivables | 40,435.11 | 34,737.78 | 27,436.91 |
| Inventories | 31,679.69 | 34,920.81 | 28,020.40 |
| Total current assets | 87,200.00 | 99,782.25 | 78,317.98 |
| Other assets: | |||
| Investments | 1,625.00 | 1,625.00 | 1,625.00 |
| Treasury stock | 13,300.00 | 13,300.00 | 13,300.00 |
| U. S. Govt. obligations | |||
| Cash in closed banks | |||
| Goodwill | 35,500.00 | ||
| Total other assets | 50,425.00 | 14,925.00 | 14,925.00 |
| Land, buildings and | |||
| equipment: | |||
| Buildings and equipment | 160,128.11 | 171,712.51 | 158,985.15 |
| Less reserves for | |||
| depreciation | 83,121.50 | 83,885.58 | 78,590.97 |
| Buildings and equipment, | |||
| net | 77,006.61 | 87,826.93 | 80,394.18 |
| Land | 20,310.41 | 20,310.41 | 20,310.41 |
| Total land, buildings and | |||
| equipment | 97,317.02 | 108,137.34 | 100,704.59 |
| Unexpired insurance | 2,507.58 | 2,485.43 | 2,328.06 |
| Total assets | 237,449.60 | 225,330.02 | 196,275.63 |
| LIABILITIES AND NET WORTH | |||
| Current liabilities: | |||
| Notes payable | 18,500.00 | 115,000.00 | |
| Trade creditors | 17,465.00 | 116,173.50 | 8,765.94 |
| Federal and state taxes | 2,095.01 | 9,395.76 | 1,278.54 |
| Total current liabilities | 28,060.01 | 25,569.26 | 25,044.48 |
| Net worth: | |||
| Capital stock | 350,000.00 | 205,850.00 | 205,850.00 |
| Surplus or (deficit) | (140,610.41) | (6,089.24) | (34,618.85) |
| Total net worth | 209,389.59 | 199,760.76 | 171,231.15 |
| Total liabilities and | |||
| net worth | 237,449.60 | 225,330.02 | 196,275.63 |
| 1939 | 1941 | 1942 | |
| ASSETS | |||
| Current: | |||
| Cash | $ 23,732.35 | $ 106,516.50 | $ 156,621.63 |
| Notes and accounts | |||
| receivable | 54,392.43 | 134,697.93 | 151,156.16 |
| Less reserve for bad debts | 1,420.25 | ||
| Net receivables | 54,392.43 | 134,697.93 | 149,735.91 |
| Inventories | 46,034.72 | 61,350.97 | 93,700.68 |
| Total current assets | 124,159.50 | 302,565.40 | 400,058.22 |
| Other assets: | |||
| Investments | 1,625.00 | 1,625.00 | 1,625.00 |
| Treasury stock | 13,300.00 | 13,300.00 | 13,300.00 |
| U. S. Govt. obligations | 10,000.00 | ||
| Cash in closed banks | 4,983.54 | 4,982.30 | |
| Goodwill | |||
| Total other assets | 14,925.00 | 19,908.54 | 29,907.30 |
| Land, buildings and | |||
| equipment: | |||
| Buildings and equipment | 137,299.21 | 212,441.97 | 323,511.25 |
| Less reserves for | |||
| depreciation | 55,214.38 | 62,777.63 | 101,558.59 |
| Buildings and equipment, | |||
| net | 82,084.83 | 149,664.34 | 221,952.66 |
| Land | 20,310.41 | 20,310.41 | 20,310.41 |
| Total land, buildings and | |||
| equipment | 102,395.24 | 169,974.75 | 242,263.07 |
| Unexpired insurance | 2,212.44 | 3,182.78 | 5,092.58 |
| Total assets | 243,692.18 | 495,631.47 | 677,321.17 |
| LIABILITIES AND NET WORTH | |||
| Current liabilities: | |||
| Notes payable | 115,000.00 | 115,000.00 | 115,000.00 |
| Trade creditors | 18,885.48 | 40,590.52 | 57,113.84 |
| Federal and state taxes | 10,162.88 | 133,164.01 | 262,954.73 |
| Total current liabilities | 44,048.36 | 188,754.53 | 335,068.57 |
| Net worth: | |||
| Capital stock | 205,850.00 | 235,850.00 | 235,850.00 |
| Surplus or (deficit) | (6,206.18) | 71,026.94 | 106,402.60 |
| Total net worth | 199,643.82 | 306,876.94 | 342,252.60 |
| Total liabilities and | |||
| net worth | 243,692.18 | 495,631.47 | 677,321.17 |
*91 *527 The salaries of the executive officers for 1939 and 1942, together with a list of stockholdings, are as follows:
| Salaries | |||
| Stockholdings | |||
| 1939 | 1942 | 1942 | |
| C. R. H. Cunningham | $ 9,966.67 | $ 39,600.00 | 1,110 |
| H. C. Cunningham | 7,016.53 | 29,500.00 | 570 |
| H. L. McClees | 4,253.33 | 19,800.00 | 297 |
| Harry Bloodsworth, Jr | 2,079.99 | 10,750.00 | 390 |
| John R. Adams | 5,472.67 | 18,160.00 | |
| C. R. H. Cunningham and Marie E. | |||
| Cunningham | 2,800 | ||
| Estate of Elizabeth M. Cunningham | 630 | ||
| Marie Cunningham | 200 | ||
| Irene D. Cunningham | 482 | ||
| Mildred Shimer Westover | 13 | ||
| Ellen Shimer | 13 | ||
| Provident Trust Co., executor, estate | |||
| of H. Bloodsworth, deceased | 518 | ||
| Fidelity-Philadelphia Trust Co., | |||
| trustee, estate of Elizabeth M. Shimer | 280 | ||
| Lillian F. Thorpe | 516 | ||
| H. Katherine Bullock | 635 | ||
| William F. Leopold, Jr., trustee under | |||
| option agreement for H. L. McClees | 400 | ||
| Elizabeth C. Parker | 160 | ||
| Total | 9,014 |
All of the above stock is controlled either by relations-in-law or blood relations of the executive officers.
The equipment used by petitioner in 1942 was the normal equipment used by producers of naval castings and was of the general type*92 used by petitioner prior to 1942. Petitioner did not operate under any patents and its manufacturing processes before, during, and after the war were essentially the same, requiring no reconversion measures for peacetime use.
During 1942 C. R. H. Cunningham was president, H. C. Cunningham was vice president and treasurer, H. L. McClees was secretary, Harry Bloodsworth, Jr., was sales manager, and John R. Adams was works manager.
During 1942 petitioner maintained no sales representative or sales organization. It utilized its maximum manufacturing facilities and increased its manpower from 395 to 425, and it operated its plant on 3 shifts or 24 hours per day. It maintained production schedules and cooperated with other manufacturers by lending pattern equipment or pattern duplicates. The quality of its product was satisfactory and the percentage of rejections was three-fourths of 1 per cent. The company did not borrow any Government funds in 1942.
During 1942 petitioner conformed with and set its prices in conformity with OPA price schedules which were established in the steel industry in July 1941. Petitioner submitted to the OPA for its approval a requested price on all products*93 which did not appear in the OPA schedules.
*528 Petitioner did some experimental and development work in 1942, as it had done in prior years, the cost of which was included in manufacturing costs.
During the year 1942 petitioner's profits from sales subject to the Renegotiation Act were excessive within the meaning of the Renegotiation Act in the amount of $ 97,500.
For the first nine months of 1942 the steel castings industry throughout the United States divided the sales dollar received as follows:
| Cost of sales: | ||
| Materials used | $ 0.199 | |
| Production labor | .260 | |
| Other manufacturing expense | .200 | $ 0.659 |
| Selling and administrative expense | .440 | |
| Operating profit | .297 |
Seventy-two companies engaged in the steel casting business and producing 67 per cent of total steel castings, related their profits and earnings to cost, sales, and net worth as follows:
| Ratio of profits to cost, 1936 to 1939 | 6.1% | |
| Ratio of profits to cost, 1940 | 13.3% | |
| Ratio of profits to sales, 1936 to 1939 | 5.8% | |
| Ratio of profits to sales, 1940 | 11.8% | |
| Ratio of earnings to net worth, | 1940 | 14.2% |
| 1941 | 40.2% | |
| 1942 | 71.0% |
OPINION.
Petitioner contends that it received no*94 "excessive profits" in 1942 as those profits are defined by section 403 (a) (4) (A) of the Renegotiation Act. This section requires that certain factors in the taxpayer's conduct of his business shall be taken into consideration in the determination of the question of the reasonable or excessive nature of the profits involved.
The first factor is a consideration of efficiency in production. In order to establish its efficiency, petitioner referred to the long hours and heavy responsibilities of its officers. The added responsibility was, of course, the natural consequence of the increased war production load and the training of new personnel. To compensate for these added responsibilities, however, all of the officers received very substantial pay increases in 1942 over the prewar schedule, the compensation in 1942 being roughly four times that received in 1939. The overtime work by the officers would also seem to be adequately compensated for, but the existence of this work might be just as persuasive of inefficiency as the reverse, since it might be argued that, instead of a fourfold increase in salary, an increase in staff and a division of responsibility might have resulted*95 in greater efficiency.
*529 It was also contended that in peacetime production 2 per cent rejections are expected, whereas petitioner in its production for the Government had but three-fourths of 1 per cent rejections. However, this difference could be accounted for by the greater duplication of Government castings over those used by industry generally; by the presence of a Government inspector on the job; and by the great increase in the duplication of castings with each order. We heard no testimony as to whether or not petitioner's rejection percentage differed in any way from the record of rejections of other producers of similar products. Furthermore, there was no testimony that any efficiency developed by petitioner resulted in either better products, more rapid delivery, or lower prices to the Government than occurred with competing producers.
The second factor of production set out by the Renegotiation Act is reasonableness of costs and profits, having regard to volume of production and prewar earnings. During 1942 petitioner charged OPA ceiling prices. In 1943 OPA made a complete survey of the steel casting business and as a result thereof declared that the 1942 *96 prices were too high by 10 per cent and accordingly reduced the ceiling prices by that amount. Such reduction, if it had been applied to petitioner's sales in 1942, would have reduced its income from sales to the Government during that year by $ 155,088.60. Such a reduction would probably be unwarranted in 1942, because of the added expense incurred by the taxpayer in expanding its equipment and personnel during that year. However, petitioner has not shown what percentage of its sales dollar was consumed by the cost of expansion in 1942. Most certainly a large portion if not all of that cost would be absorbed by the economy of larger production and the increased duplication of units per order. During normal years petitioner's profit per casting was 8.03 cents. In 1943, with a fivefold increase in volume, petitioner's net profit per casting was 75.12 cents. The effect of increased volume on cost and profit is reflected by the remarks of the Court in Aircraft Screw Products Co., 8 T. C. 1037, wherein the Court said:
* * * Even if it could have been reasonably anticipated that labor or other costs would increase, we think it could have also been anticipated*97 that such increased costs would be offset by the gain from reduced unit cost of manufacturing incident to the increased production so that its percentage of profit on net sales would be maintained and, at least since its prices were not reduced, that it would realize a substantially larger amount in net profits from its operations than in the prior year.
Petitioner's brief contains the following:
The amount of gross sales subject to renegotiation represents about 79% of the total sales for the calendar year. The remaining 21% being work for others than agencies of the Federal Government. The net profit too results in about 79%. In other words, about 79% of the net profits of the Corporation resulted from work done as subcontractor for customers having Governmental work.
*530 The above statement, of course, would follow the practice of charging both the Government and the private consumer ceiling OPA prices, yet the volume of Government production was almost four times that of private industry, and with the former no sales effort was needed, the payments were prompt and assured, priorities were expedited, and there was much more duplication. It would seem that the percentage*98 of profits in Government work should be considerably less than with private customers.
The next factor for consideration is the use of public and private capital by the producer and the producer's net worth. During 1942 petitioner borrowed no funds from the Government, but did borrow $ 15,000 from private sources. Whether or not that $ 15,000 was borrowed to finance petitioner's private or its public business is not shown.
Furthermore, petitioner purchased $ 145,800 of new equipment which was completely depreciated during the war and before the end of 1945. Just how much depreciation was taken in 1942 is not shown, but we do know that the whole amount was amortized in four years and that at the end of the war the petitioner possessed all of this equipment completely charged off to the cost of production of Navy castings and that after four years' use the evidence indicates it had many years of valuable service.
Petitioner's net worth at the beginning of 1942 was $ 306,876. Its profits on its private and its public business were $ 314,180, of which $ 247,579 was on renegotiable business. An expert witness, testifying for the Government after making a survey of the composite report*99 of 72 companies producing 67 per cent of our tonnage of steel castings, showed the ratio of profits to net worth for the industry generally. This testimony was not contradicted by petitioner, except to the extent that petitioner asserted that some of the companies reporting were very large companies engaged in heavy steel casting work, such as parts for railroad rolling stock and armor plates. However, petitioner produced no evidence to indicate that its ratio of profit should be larger than the ratio of profit of other steel casting companies. The ratio of profits to the net worth of petitioner and the net worth of the industry generally is as follows:
| Year | Petitioner | 72 companies |
| 1936 | 0.065 | 0.057 |
| 1937 | .202 | .103 |
| 1940 | .31 | .142 |
| 1941 | .865 | .402 |
| 1942 | 1.028 | .71 |
*531 From the above it appears that the ratio of petitioner's profits in 1942 to its net worth for that year is considerably out of line with the industry generally.
The next production factor to consider in ascertaining excessive profits is the extent of risk assumed by the producer. The net profit per casting during the 3 years of the so-called normal prewar period, eliminating 1938, which was*100 a loss year, is as follows: 1936, $ .0198; 1937, $ .1860; and 1939, $ .2107. Thus, petitioner's average peacetime profit per casting was $ .1388. In 1942 it was $ .7512 per casting, or petitioner enjoyed a safety factor in 1942 5.4 times as great as it had in its 3 profit prewar years. In addition, petitioner in 1942 had the United States Government for a debtor.
Our next two considerations pertain to petitioner's contribution to the war effort, its inventive and development work, and the complexity of its production. It is stipulated that petitioner's products were satisfactory both in quality and quantity. It did a good job in our industrial army just as many million individuals did in a military way. It had no patents. It used substantially the same manufacturing process employed by others in steel casting work. Its work was comparatively unimaginative, was uncomplicated, and was of the same general type performed by it both before and after the war.
Other factors which might be considered embrace loss at conversion into and out of war work, loss of private customers during war work, and conditions of the market caused by war work injurious to peacetime production.
Petitioner, *101 on engaging in war production, used its former plant. It merely purchased additional equipment, which it quickly depreciated. It retained its former private business, and in fact it greatly increased that business in 1942 over its normal peacetime volume. On its reconversion to peacetime activities, it was not required to expend any money. It merely continued to produce the same general type of product which it had produced during the war. There was no problem of retooling. In fact, it was in a far better position because of equipment purchased during the war than it was at the beginning of hostilities. Unlike many industries, the war work of petitioner did not supply the Government with great quantities of surplus property which could be dumped on the market to interfere with petitioner's normal market demands. In fact, its experience in producing for the Navy during the war placed it in a position to obtain postwar work for the Navy which it did not formerly enjoy.
Because of the above considerations, it is our conclusion that the profits realized by petitioner in 1942 were excessive within the meaning of the definitions set forth in section 403 (a) (4) (A) of the Renegotiation*102 *532 Act. In deciding the extent of that excessive profit, we have given consideration to the testimony of an expert employed by the Government in connection with all the other evidence. The petitioner introduced no evidence to contradict the testimony of this expert witness and only argued against its conclusiveness by the statement that the witness had not visited petitioner's plant and had used some profit figures pertaining to types of steel casting business somewhat unlike that of petitioner. However, petitioner did not submit any figures of its own showing the situation as to the type of steel casting production in which it was specifically engaged. Our conclusion is that a reasonable net profit for petitioner, when considered in the light of profits in similar industries generally in 1942, would be $ 97,500.
Petitioner's income tax return for 1942 is not in evidence, nor have we been presented with any analysis of the relation of petitioner's taxes to its income. However, petitioner, in its brief, argues earnestly on this point and the arguments raised would have considerable appeal to any court if substantiated by evidence and if the period involved were not a war*103 period. The emergency Court of Appeals was presented with a similar situation and a similar argument in the brief in Interwoven Stocking Co. v. Bowles, 141 Fed. (2d) 696, wherein the court says of such a contention:
The contention is wholly without merit. If it were accepted the complainant would be accorded the right to escape its share of war-time taxation by passing the burden of its taxes on to its customers in the form of increased prices for its hosiery. Certainly neither the Constitution nor the act accords to the complainant any such unique tax exemption.
We have also examined the reported decisions of renegotiation cases before this Court and have found none in which this Court computed the allowable profits after taxes. All of the computations were made before taxes, independent of the tax results.
We therefore conclude that petitioner's profit for 1942 was excessive in the amount of $ 97,500.
An order will issue in accordance with the above.
Arundell, J., dissenting: I see no reason in the facts found to justify increasing the excessive profits of the petitioner from the amount of $ 80,000 determined by the respondent*104 to $ 97,500, and I therefore dissent.
Footnotes
1. Sec. 403. (a) For the purposes of this section --
* * * *
(4) (A) The term "excessive profits" means the portion of the profits derived from contracts with the Departments and subcontracts which is determined in accordance with this section to be excessive. In determining excessive profits there shall be taken into consideration the following factors:
(i) efficiency of contractor, with particular regard to attainment of quantity and quality production, reduction of costs and economy in the use of materials, facilities, and manpower;
(ii) reasonableness of costs and profits, with particular regard to volume of production, normal pre-war earnings, and comparison of war and peacetime products;
(iii) amount and source of public and private capital employed and net worth;
(iv) extent of risk assumed, including the risk incident to reasonable pricing policies;
(v) nature and extent of contribution to the war effort, including inventive and developmental contribution and cooperation with the Government and other contractors in supplying technical assistance;
(vi) character of business, including complexity of manufacturing technique, character and extent of subcontracting, and rate of turn-over;
(vii) such other factors the consideration of which the public interest and fair and equitable dealing may require, which factors shall be published in the regulations of the Board from time to time as adopted.↩