The witness is Mr. Defoe, who has been waiting to testify.
Mr. WELS. I would like to put in the record a letter from Mr. Gerard Swope to Senator Bridges.
(The letter referred to was received, marked “Exhibit No. 627,” and appears in the appendix of this volume.)
The ACTING CHAIRMAN. The letter is an expression of Mr. Swope’s opinion in this matter. Mr. Defoe, give your full name and your capacity with your company to the reporter.
Testimony of Harry J. Defoe, Defoe Shipbuilding Co., Bay City, Mich.
Mr. DEFOE. Harry J. Defoe, managing partner, Defoe Shipbuilding Co., Bay City, Mich.
Mr. KLINE. Your company is a partnership?
Mr. DEFOE. Yes.
Mr. KLINE. And the partnership consists of yourself and members of your family, does it not?
Mr. DEFOE. Yes.
Mr. KLINE. You are a builder of what I would call small ships, is that so?
Mr. DEFOE. Yes, our present contract is the 307-foot destroyer escorts.
Mr. KLINE. You have been in the process of renegotiation with the Navy Department for some months, haven’t you, Mr. Defoe?
Mr. DEFOE. Yes.
Mr. KLINE. You have not completed your renegotiation yet?
Mr. DEFOE. No.
Mr. KLINE. You have certain views, as I understand it, regarding renegotiation and regarding the manner in which it is being administered, which I think would be of interest to the committee. Would you kindly let us have them at this time?
Mr. DEFOE. I have a written statement here. If I may read it I think we would save time.
Mr. KLINE. I think so.
Mr. DEFOE. In presenting the following statement for the record we wish to make our position clear at the start by stating our belief that if the renegotiation law is let to stand it should be amended so that price adjustment should definitely be based on profits after taxes, that a floor for profits after taxes should be set below which renegotiation should not go, that definite consideration should be given for extra efficiency on the part of a contractor, and that there should be provision for post-war reconversion. The following is an attempt to show the application of the present law to our own case; the limited accomplishments possible in actual dollars and cents saved when the Treasury’s ultimate recovery is considered; and the time and efforts that its operation cannot help but draw from production by taking the time of management. I myself have spent more than 1 month on it counted by actual hours, and three other top members of our organization have spent at least an equal amount of time—a definite and positive hindrance to the war effort.
May I preface further discussion by a brief statement of the background of my company. The Defoe Boat & Motor Works, now the Defoe Shipbuilding Co., has been in business for 38 years without a shut-down, as peacetime builders of large steel yachts, tugs, lighthouse and Coast Guard vessels, having built in the past 20 years, 43 vessels for the United States Coast Guard alone.
Our first Navy contract since World War I was in 1939 for PC 451, a 173-foot submarine chaser. This was an experimental vessel built to Navy design and specifications at a cost of $1,250,000, and became the first of a large number subsequently constructed. The Navy complimented us highly on the experimental vessel but requested our assistance in rewriting the specification to reduce the cost. We did this and made the drawings from which the 173-foot PC fleet was built. At the request of the Navy we furnished all other builders with our drawings free of charge, they paying for copies only, and instructed other builders from the work going on in our yard. In a total of four contracts, we were asked to build 87 of these vessels—far more than any other builder, as our work and progress was always considered outstanding. With the second of these boats, we perfected what has become known as the upsidedown or roll-over type of construction and the application of mass production and assembly line methods to their completion. Resultingly, costs have consistently been at a level that enabled us to contract for their construction at a price more than $100,000 per boat lower than the Navy has been able to secure them elsewhere.
Even at that, early in 1942 it became apparent that our profits were higher than we wanted to keep. Some time before the Price Adjustment Board began to function, I had a talk with Congressman Vinson in his office and told him the conditions and that I meant to ask the Bureau for a reduction in contract price as soon as certain matters pertaining to amortization were definitely settled, and they were settled with the passage of the tax bill last fall. We, then, on our own initiative took the matter up with the Bureau of Ships and agreed to reduce the price on all PC vessels under contract to $485,000 per vessel except five which had been delivered in 1941, and on which the tax had been paid. This amounted to $2,337,000 on the PC’s in 1942, and more than $3,000,000 on those remaining to be built. In addition to this we conceded all claims for overtime and shift work, all escalator claims and all claims for wage rate increases by the Navy Wage Stabilization Committee amounting to an additional total of $1,735,000. That originated before Mr. Rockey’s committee started out. It was finished just previous to that time, but we weren’t kicked along by it, anyway. Besides the 25 PC vessels we also built in 1942 four 220-foot minesweepers at $6,282,071, which was the lowest the Navy obtained anywhere, and four rescue vessels at $1,960,389, which were let to all contractors at the same price. On the year’s work, which totaled in contract sales $22,773,405, we had a profit, after taxes, of $734,756, which included the salaries of five partners, or 3.2 percent, which, we think, we are entitled to keep, particularly because the largest share thereof resulted from PC construction at a price from $75,000 to $90,000 per ship below that of any other builder.
In November 1942, the Navy awarded our company a contract for 28 of its critically needed destroyer escort vessels at $3,198,000 each ($89,544,000), making a grand total of $108,000,000 in unfilled contracts on our books at this time—a recognition of merit, efficiency, and low-cost production probably without parallel for a yard as small as ours. Why should not the operation of a renegotiation law have a similar reward for efficiency? Three percent, after taxes, needs no defense as reasonable for outstanding inventiveness and efficiency in reducing costs on vital war implements regardless of comparison with peacetime volume or invested capital.
But the Price Adjustment Board steps in here and presents a picture like this. They say, “In 1942, you built 4 rescue vessels that cost you $1,403,637, and made a profit of $556,752, which was a profit of 39.6 percent on costs or 28.4 percent on sales. You built 4 minesweepers at a cost of $5,425,512, and made a profit of $856,559, which was a profit of 15.8 percent on cost or 13.6 percent on sales. You built 25 subchasers at a cost of $8,520,128, and made a profit of $3,673,817, which is 43.1 percent on your cost or 25.3 percent on sales. Or to sum it up, you built the above 33 ships at a total cost of $15,349,277 and made a total profit of $5,087,128, which was 33.1 percent of your cost, or 22.3 percent of sales. We must further readjust your contracts and recover for the Government $2,500,000 of your profits which will still leave you a profit of $2,587,128, or a profit of 16.8 percent on costs and 13.8 percent on adjusted sales.”
That is as far as Mr. Rockey and I have gotten so far. Now, we admit that the above figures are all correct, and the Price Adjustment Board is probably acting under the law and regulations in the position it takes, but let us in all fairness reduce these figures to a business basis, a basis of actual dollars left to do business with, and it amounts to just this: The actual profit on the year’s work after taxes is $734,756 (including salaries to five partners) or a total of 3.6 percent of adjusted sales for the year, including partners’ salaries. That is after taxes on that. That is definite. The tax reports are made out for filing, they are not filed; they are held up and reviewed by a C. P. A., and they are as correct as they can be before the Internal Revenue man gets at them, and he will cut them down. He won’t raise them, if anything. The actual dollars and cents, then, that the Government would gain if the Adjustment Board carries out the above program would not be $2,500,000 but $309,993, as the Treasury would recover the larger part through taxation anyway.
The Price Adjustment Board has pronounced our experience unreasonable. We submit that it is not and that the results of the application of the Board’s figures go beyond the intent of the law to prevent exorbitant profits, because I can’t see that it puts anybody in the millionaire profiteering class to come out after a $22 million year with $734,000, including the salaries of five partners. Summarizing, we believe the renegotiation law should be amended to operate on an after-tax basis; that a floor for profits after taxes should be set below which renegotiation should not go; that definite consideration should be given for extra efficiency; and that there should be provision for post-war reconversion. That only means with us to put our plant back in the shape in which it was before we tore it up for this special construction.
The ACTING CHAIRMAN. Let’s reduce this, Mr. Defoe, to probably one sentence. I may not have caught your statement correctly. But your contention is on renegotiation, similar to the other witnesses, that it should be left to taxes rather than renegotiated before taxes are paid, is that correct?
Mr. DEFOE. Correct, because if it had been, we would have been done before we started.
The ACTING CHAIRMAN. I didn’t catch that.
Mr. DEFOE. I say, had that been done, we would have been through with the job before we started. Taxes would have brought it down to within 3 and 4 percent actual profit.
The ACTING CHAIRMAN. You consider that the profit you made of some 700—what was your first figure on your 22 million?
Mr. DEFOE. Seven hundred thirty-four thousand dollars.
The ACTING CHAIRMAN. After taxes?
Mr. DEFOE. After taxes.
The ACTING CHAIRMAN. You consider that a reasonable profit?
Mr. DEFOE. That is 3.6 percent of the adjusted sales after we cut them all down.
The ACTING CHAIRMAN. You base that on sales?
Mr. DEFOE. Yes.
The ACTING CHAIRMAN. What was your investment on December 31, 1942?
Mr. DEFOE. I would like to have you get that picture. It is next to nothing.
The ACTING CHAIRMAN. It is next to nothing?
Mr. DEFOE. It is very limited compared with the investment of a shipyard such as we are. There is probably left on the books now $600,000.
The ACTING CHAIRMAN. That was your original investment?
Mr. DEFOE. Yes.
The ACTING CHAIRMAN. Because of war work, your profit after taxes in 1 year was over and above your original investment—it was $100,000 over, is that correct?
Mr. DEFOE. Yes, sir.
The ACTING CHAIRMAN. You are a partnership?
Mr. DEFOE. A partnership, yes.
The ACTING CHAIRMAN. A family partnership. How many people was the partnership composed of at the beginning of the war?
Mr. DEFOE. We were all five in at the beginning of the war. At the beginning there were my brother and myself, and as my sons became of age we took them in.
The ACTING CHAIRMAN. How many of those sons have been taken in?
Mr. DEFOE. Two, and his one. But they are definitely in. Those boys quit school in their junior year and they came back and have taken a real load because they grew up in the business, were educated for it.
The ACTING CHAIRMAN. So there are five partners now?
Mr. DEFOE. Five.
Mr. KLINE. Two sons and a nephew?
Mr. DEFOE. Yes.
The ACTING CHAIRMAN. What was the main reason for taking them into the partnership, do you recall?
Mr. DEFOE. As I tell you, they grew up for the business; they went to school for it, and the idea was always that as soon as the younger boys became of age they could come in, and they have come in and have taken the load they grew up to. I couldn’t do without them.
The ACTING CHAIRMAN. How do they participate in the $700,000? That includes salaries, of course.
Mr. DEFOE. The total salary in that for the five members is $107,000 before taxes.
The ACTING CHAIRMAN. How old is the nephew?
Mr. DEFOE. Twenty-seven.
The ACTING CHAIRMAN. And the other two are 18, 19?
Mr. DEFOE. No; when the younger boy was 21 they came in, and that was a year and a half ago, 2 years ago. They are 23 and 24 now.
The ACTING CHAIRMAN. Their 1942 salaries were approximately $10,000 apiece, is that correct?
Mr. DEFOE. ’42? I think that is right; yes.
The ACTING CHAIRMAN. What was their share in the partnership over and above their salaries?
Mr. DEFOE. It is split up in sixths. The two of them own one-sixth each.
The ACTING CHAIRMAN. What, in round figures, would the 23-year-old boy get out of this partnership, including his salary?
Mr. DEFOE. He would get—wait now, I’d better get that straight. As a matter of fact, he wouldn’t get any of it. In the last 5 or 6 years we haven’t pulled 100 to 125 thousand dollars out of the business, the whole lot of us. It has all stayed in there, and that is why we have developed what we have.
The ACTING CHAIRMAN. But he could take it out, that is, the profits and earnings.
Mr. DEFOE. He could, legally speaking, but he couldn’t for all of that.
The ACTING CHAIRMAN. He could, legally speaking.
Mr. DEFOE. It is there.
The ACTING CHAIRMAN. The Government put it there.
Mr. DEFOE. But the business wouldn’t last very long if he did or if any of us did it that way.
The ACTING CHAIRMAN. What would it be if he pulled what he could have pulled out last year the 23-year-old boy? It would be over $100,000, wouldn’t it?
Mr. DEFOE. He would pull out in rough figures $125,000. But I don’t see, Mr. Chairman, where that applies.
The ACTING CHAIRMAN. The matter of investment as it is comparable to what the Government puts into these yards, Government sales, and what is taken out is very important to the committee. That is part of the problem of renegotiation.
Mr. DEFOE. I know. That is just the point I would like—
The ACTING CHAIRMAN (interposing). This is all war work.
Mr. DEFOE. What I would like to have the committee clear for me is where do we stand on that.
The ACTING CHAIRMAN. We don’t know. We are merely trying to get the information.
Mr. DEFOE. I see. But here is the picture as we see it. We went into this with everything we have up there, an organization and the yard. We have put in about $500,000 since the war started, which the Government has covered.
The ACTING CHAIRMAN. Let’s you and I be clear right now. You say you have put in $500,000. Where did that $500,000 come from? From your own Government profits, isn’t that correct?
Mr. DEFOE. No, we had about that amount in working capital when we started in.
Mr. KLINE. Private investment?
Mr. DEFOE. Please don’t try to corner me in this. I am trying to make it clear. I want to make this clear, and I want you to make me clear on it. We put that much in there and the Government, knowing that it was purely for the operation of the war—this upside-down business, the material, and the set-up that we make to operate on isn’t worth a penny after the boat is done; and that took a greater share of it. Then the shifting of the tracks around the yard and all, to carry out this down-the-line production scheme, isn’t worth a penny after it is done. We put that in on our own. We haven’t asked the Government for a penny and we have developed our own organization, haven’t asked for an advance payment. I could name another yard, and you could, that has a contract for 28 of these same vessels, to whom the Government has given, is it $12,000,000 to develop a plant. They have been nearly a year doing it and the first boat is nowhere near out. We are delivering our first boat next week. Our first destroyer escort vessel is going into service next week. We got the contract last November and got the steel in the yard last December.
Mr. KLINE. Isn’t that conversion into war production which you are describing an allowable cost? Won’t that be treated as a cost and not as a part of your profit at all?
Mr. DEFOE. We hope so.
The ACTING CHAIRMAN. In other words, you didn’t have to ask—
Mr. DEFOE (interposing). That certificate of necessity is supposed to take care of that and let us charge it off.
Mr. KLINE. Isn’t that so, Mr. Rockey? That would be considered a cost and not charged to profit at all?
Mr. ROCKEY. That is right.
The ACTING CHAIRMAN. Mr. Defoe, I gather from your financial estimate that you didn’t have to ask the Government for money. Your profits were such that you could put them back.
Mr. DEFOE. Maybe we could have. We have to have our working capital there, anyway.
The ACTING CHAIRMAN. In other words, you started out with $600,000 in your yard, and on Government contracts your profits, after taxes, were greater than your original investment.
Mr. DEFOE. I know it, but I am trying to get you to see that the original investment—I don’t see where it has any place in the picture. I want to show you what we have up there and what we have accomplished and see if that doesn’t amount to something.
The ACTING CHAIRMAN. This must be taken into consideration. After all, this is all taxpayers’ money that is going to you, and you are doing a job of building PC boats, some of which have been satisfactory and some haven’t.
Mr. BATES. What do you mean by that?
Mr. DEFOE. They have all been satisfactory, Mr. Magnuson. I would like to discuss that a little later. We wouldn’t have been placed where we are by the Bureau, in this position in that work, if our work wasn’t tops.
The ACTING CHAIRMAN. But I am talking about the original investment. All we are looking at is this, Mr. Defoe, one basic principle: That because of war business, we are going to attempt to stop excessive profits or see that a man, because of the war, doesn’t make a great deal of money out of it. Now, in your case in 1 year you have made more money than your original investment.
Mr. DEFOE. See here though, Mr. Magnuson, we are facing that right now. I haven’t asked the Government for a contract.
The ACTING CHAIRMAN. No. The Government has called on you because you know how to build boats.
Mr. DEFOE. I haven’t, no. I have stepped into the Bureau and they have said, “Here is your share. Take them home and build them.” I don’t know when I got the contract for destroyer escorts. I told them about a year ago I was in a position to build the destroyer escorts to good advantage if they wanted me to. I was called down there after that. I am not sure that I was on that either, but anyhow, right out of a clear sky I am to build 28 of those vessels. I haven’t gone after that for business reasons. We have gone at it out there to do our share and we are facing that $110,000,000 of unfinished contracts with $700,000 in cash in our pockets to do it with.
The ACTING CHAIRMAN. Let me ask you this question and maybe we can clear it up. Do you think on 100-some million dollars of Government business, war business, that the taxpayers are paying for, that you should make a profit in a ratio to the volume of that business?
Mr. DEFOE. I certainly do feel that I should make a profit regardless of invested profit, and on that point I want to know where I sit.
The ACTING CHAIRMAN. Say that profit amounted to 5 percent, that you should make a profit of $5,000,000?
Mr. DEFOE. No, I’m not asking for any $5,000,000. I said three.
The ACTING CHAIRMAN. $3,000,000 on an original investment of $600,000. That is the point we are trying to get at. If you feel that way, you are entitled to feel that way.
Mr. DEFOE. I do feel that way and I wish I could make my position clear.
The ACTING CHAIRMAN. In 1941 your salary was $25,000, and you raised it to $75,000, in ’42 because of the war business. You do nothing but Navy business?
Mr. DEFOE. You realize, don’t you, Mr. Magnuson, that doesn’t mean a thing in the partnership. When the Treasury comes to that, that is only a division of that. When the Treasury comes to figure that they don’t consider a salary.
The ACTING CHAIRMAN. I understand what it means to take in three more salaried partners when you are making money. As a lawyer, I understand that.
Mr. DEFOE. You check that down, check what it means.
Mr. MAAS. It does on earned income. You get a credit for earned income, and it certainly makes a difference.
Mr. DEFOE. That is no major matter in a case like that; it doesn’t. You figure it out and see. It doesn’t. All of those partners in that amount there now are practically at the top. The difference is almost nothing whether I put it all in one pile, whether my brother and I split it up for the three.
The ACTING CHAIRMAN. You are only sitting here because of the $110,000,000 being paid by this Government to you to build ships, and you have answered the question that you feel (and we want those opinions) that you should be entitled to make a profit of whatever that percentage is; let’s say 3 percent for the rough figure on that gross amount of sales, and raise your salary from $25,000 to $75,000 because of the war business.
Mr. DEFOE. You can eliminate the salary if you want to; it doesn’t mean a thing.
The ACTING CHAIRMAN. Not if you got the $3,000,000 it wouldn’t in a partnership, it wouldn’t.
Mr. DEFOE. In a partnership it doesn’t, am I right?
Mr. MAAS. Really right, yes. It doesn’t make a substantial difference.
The ACTING CHAIRMAN. To allow the other three boys just coming into the business (and I don’t question their competency at all) to have in one case—the 23-year-old boy could take out over $100,000 legally.
Mr. DEFOE. He won’t take out a cent. He has that interest in the business.
The ACTING CHAIRMAN. That may be, but legally the Government has put in the $110,000,000 for him.
Mr. MAAS. You must have considered, however, that it would affect the renegotiations on the basis of that cost if you could show an item of cost of $75,000 salary and these other salaries. You must have felt that the renegotiators would treat that as cost rather than as net income, otherwise, why did you raise it? If it meant nothing, why did you raise your salary from 25 to 75?
Mr. DEFOE. I tell you the load I took on in proportion to the other brother who is not active, his son is not active, made that comparison fair. That was the main reason.
Mr. MAAS. Does he have a different percentage of ownership than his $10,000 indicates?
Mr. DEFOE. Yes, they two own one-third and my two boys and myself own the other two-thirds.
Mr. MAAS. Because he is not active in the firm you pay him a $10,000 salary? You mean he is not very active?
Mr. DEFOE. He handles the legal end. His office is in New York but he handles the legal end as an attorney.
Mr. MAAS. In other words, that was the method you arrived at for a distribution of the profits?
Mr. DEFOE. Just a shifting among ourselves.
Mr. MAAS. You had no such thought in mind that that would be allowed as an item of cost when you renegotiated.
Mr. DEFOE. Absolutely not. I don’t see where it would.
The ACTING CHAIRMAN. Mr. Maas, and members of the committee, I think we will have several more questions to ask in this case, and the other members not being here—
Mr. MAAS (interposing). The witness will have to preside the way the committee is dwindling away.
The ACTING CHAIRMAN. We will adjourn the hearings until 10 o’clock tomorrow and Mr. Defoe will come back.
Mr. BATES. Let me ask one question, Mr. Chairman. When we were speaking of your investment of $600,000 you say it is an original investment as of what date? Is that what you carry on the books today?
Mr. DEFOE. Yes.
Mr. BATES. What about the $500,000 that you put back as a capital expenditure in bringing your yard up to date to meet this destroyer escort program? Isn’t that an investment?
Mr. DEFOE. I don’t get that.
Mr. BATES. $600,000 is your original investment roughly, is that right?
Mr. DEFOE. Yes.
Mr. BATES. What do you mean by your original investment? That is something you put into the plant 25 years ago or last year or when, or is that what is carried on the books today?
Mr. DEFOE. Yes, I am a production man and I know my plant from start to finish, and the one branch of the business I can’t stand an argument on is accounting. Don’t get into details or you will corner me in a minute unless I can have my accountant here.
Mr. BATES. The chairman infers that the $700,000 profit you made is $100,000 in excess of your capital investment. I am trying to get at the question as to how you can take on a 28 destroyer escort ship program under contract with the Navy with a plant that only cost $600,000. There must be more than that in the plant.
Mr. DEFOE. The only thing that I would like you to see is what we are doing.
Mr. BATES. The plant must represent more than $600,000 there somewhere. You just can’t build a plant for $600,000 that will build 28 destroyer escort vessels within a certain period of time. How many ways have you got?
Mr. DEFOE. Mister, you can, and we have done it.
Mr. BATES. How many ways have you got?
Mr. DEFOE. I don’t have ways; we build bottom up, roll them over on their sides and slide them into the river sideways.
Mr. BATES. Are those the DE’s?
Mr. DEFOE. DE’S.
Mr. BATES. How many forms, molds?
Mr. DEFOE. Two forms, and that makes four boats under way at once. They are all in a little space of about three acres.
Mr. BATES. Let me ask you this question. I know something about the DE program because I read the testimony of an investigation of the whole program. From the time you start to work fabricating that material until the time that you place that boat into the water ready for fitting out, how much time does it take?
Mr. DEFOE. The first three boats have gone off that. Just as soon as we are under way that is going to take, the way the program is pegged now, 18 days from the first piece to the time she rolls. We have to put in the water or we have to deliver, under this contract, a boat a month between now and the fall, and three boats in 2 months starting January.
Mr. BATES. Let me ask you another question. From the time you start fabricating the material and the time that you are actually fitting that boat up—that is, not after you roll it over, but when it is ready to fit out—how much time will have elapsed, according to your statement?
Mr. DEFOE. The job is a 6-month job from start to finish. They spend so much time bottom up, so much right side up, so much in the water, and moved three spaces on the water, and then done.
Mr. BATES. That is a longer period of time than when they are building it on the ways?
Mr. DEFOE. Oh, no.
The ACTING CHAIRMAN. We will go into this further tomorrow. Mr. Defoe, I would like to have you here tomorrow because the fundamental purpose of renegotiation and what we are trying to get at is, what a man begins with when the war begins, and what he ends up with when the war is over because of war work.
Mr. DEFOE. All right, because I am just as anxious myself to see that question straightened out as you are.
(Whereupon at 1:40 p.m. the committee adjourned to 10 a.m. Thursday morning, June 17, 1943.)