In an attempt to estimate the future earnings and a valuation of the debtor's enterprise, and to assist him in assessing Jessop's offer, the Trustee engaged A. T. Kearney & Company, a firm of consulting engineers, to make a study of the enterprise in the light of the offer. The resulting report ("Kearney report"), dated November 7, 1956, was introduced in evidence and was the basis for the testimony of 2 principal witnesses for the Trustee on the subject of earnings and valuation. The testimony of these witnesses will be summarized hereinafter.

5

The Kearney report contains projections of additional capital ("new capital requirements") required by the reorganized debtor. A total of $6,415,000 will be required consisting of $2,925,000 to bring working capital up to the amounts deemed necessary in connection with the projected future operation of the business and $3,490,000 to purchase additional equipment. In projecting the new capital requirements, the Kearney report assumes two stages: an "initial stage", being the period following the acquisition of Green River by Jessop during which the changes in Green River's facilities and operations planned by Jessop are in process; and a "subsequent stage", being the period after the Jessop program for Green River has been fully put in effect. The duration of the initial stage is variously estimated at between 12 years and 4 years.

The Kearney report states that under Jessop management the output of Green River would be concentrated to the greatest extent feasible on high grade steel products; that the improved "product-mix" thus achieved would complement that of Jessop; and that the established Jessop sales organization would be immediately available for the marketing of Green River's products. The following table compares actual physical output and earnings of the debtor in the fiscal year ended July 31, 1956 with estimated physical output and earnings for the "initial stage" and "subsequent stage".

The plan provides that Jessop will lend Green River not less than $1,500,000 on 10-year notes. The balance of the required working capital funds are expected, in the Kearney report, to be provided from operations of Green River.

The projected reduction in total tonnage output shown in the above table is based on the following assumptions by Kearney: (1) sales of ingots would not occur in the future because under normal market conditions the possibilities for ingot sales would be small and (2) lowgrade carbon steel products would be eliminated and replaced with higher grade products to the fullest extent possible. The following table sets forth, by type of product, the tonnages actually sold by Green River in the fiscal year ended July 31, 1956, and the assumed projected tonnage output in the initial and subsequent stages, together with the dollar sales in each instance. The selling prices assumed for the future sales are approximately those prevailing recently for the type of product in question:

TABLE VII

Estimated-Subsequent stage

$9,000,000

9,589,800

3,600,000

2,400,000

942, 400

Jessop purchases..

2,672,700

$28, 204, 900

In estimating the future earnings to be derived from the projected production schedules and product-mix (Table VI), the Kearney report assumes that some $2,118,000 of income tax savings will be realized in respect of the debtor's tax loss carryover. It is further assumed that such savings, together with other cash generated in operations, will be available to the reorganized enterprise for use in connection with the needed additional working capital previously referred to. The earnings estimate for the subsequent stage, however, assumes that prior thereto the tax carryover will have been exhausted, and accordingly the subsequent stage earnings reflect full income taxes payable without any further benefits from loss carryover.

Subsequent stage net income is estimated at $1,939,000 a year after giving effect to interest charges of $443,000 and at $2,382,000 a year before giving effect to such deduction.

George Corson Ellis, a partner in A. T. Kearney & Company, testified on behalf of the Trustee. His testimony was based on the Kearney report. Ellis testified that in his opinion the debtor's enterprise could not be operated profitably in a normal market with its present facilities and personnel; that under the Jessop offer all the necessary factors would be supplied to enable the reorganized enterprise to realize the earnings estimates projected in the Kearney report; and that the time that would elapse before subsequent stage earnings were reached might be from 12 years to 4 years.

Corlis D. Anderson testified as an expert witness for the Trustee as to the valuation of the enterprise on a going concern basis after giving effect to the plan.' He adopted the conclusions of the Kearney report as to future earnings, and testified that in his opinion the subsequent stage earnings of $2,382,000 (before interest deductions) estimated in the report should be capitalized at 72 to 8 times. On this basis, Anderson arrived at a valuation of $17,865,000 to $19,056,000. Anderson's conclusions reflect utilization of (a) the tax loss carryover available to the enterprise, (b) the additional working capital which is to be provided by Jessop and by operations of Green River, and (c) the generation of additional cash which will be reinvested in the business.

Since the debtor's loss carryover includes a substantial amount attributable to earlier accelerated amortization, for tax purposes, of the cost of plant, a Federal income tax rate of 54% was applied in the Kearney report for subsequent stage earnings, in order to give estimated effect to the reduced depreciable property base attributable to such earlier accelerated amortization.

'Anderson is a Professor of Finance at Northwestern University and was formerly engaged in the investment banking business and associated with a firm of business consultants.

Frank P. Rackley, president of Jessop, also testified in behalf of the Trustee. Rackley testified that the Green River facilities complemented those of Jessop, particularly as Green River's capacity for production of semi-finished steel relates to Jessop's finishing capacity. In this connection Rackley pointed out that Jessop's finishing capacity is about 3 times its melting capacity, and, consequently, that the basic melting capacity of Green River could supplement that of Jessop; further, that Jessop's presently established and growing sales organization could provide "distribution for Green River's product in a more attractive price and profit field". Rackley further testified that in his opinion the conclusions as to operations and earnings of the reorganized enterprise set forth in the Kearney report were "ultra-conservative", and that in the opinion of Jessop's management the debtor's enterprise is "worth $17 millions as a going concern under our plan."

Commission's Views on Valuation

As indicated, the Kearney report assumes an initial stage and subsequent stage of operations for Green River. It further assumes, as did Ellis, that the initial stage might be completed within 18 to 24 months following reorganization of the debtor, in which event the higher level of earnings projected for the subsequent stage would be attained shortly thereafter. Assumptions, however, were also made that the initial stage might last for about 4 years. In either case, the net operating profit in the subsequent stage (after deducting full provision for Federal income taxes but before deducting interest requirements) was estimated at an average of $2,382,000 a year.

We believe that the fact that the level of estimated future earnings is not expected to be realized for a few years is important for such purposes as determining the availability of adequate working capital requirements during the interim initial stage period, but that the valuation of the enterprise for reorganization purposes should be based essentially on its long-range earnings prospects and other long-term factors. We shall, therefore, consider the reorganization value of this enterprise to be a value based on capitalizing the reasonably foreseeable long-range earnings at a rate which gives due weight to the lag in time necessary to reach such earnings and to the risk factors inherent in the enterprise. This value must be adjusted, however, to reflect any other increments of value attaching to Green River, such as its

The Kearney report estimates that Jessop will use only 6,000 tons out of 100,000 tons to be produced annually by Green River. Rackley testified that in order to use more Jessop would have to acquire additional conditioning equipment.

valuable tax loss carryover, and any costs or expenditures required to achieve the long-range earnings.

In the Kearney report it is assumed that the long-range normal net sales revenue of Green River will approximate $28,205,000 a year, with the net operating profit (after deducting Federal income taxes but before deducting interest requirements) being approximately $2,382,000. This amount, it may be noted, is equal to a net operating profit rate of 8.45%.

In considering the reasonableness of the estimated $2,382,000 net operating profit which, as noted, results in a net operating rate of 8.45%, we note that such a rate is in excess of the results of operations for the calendar year 1955 (or fiscal year ended in 1956 where noted) for a group of 6 steel companies using the electric furnace production method of producing steel and which the Kearney report deems to be generally comparable to Green River."

The weighted average rate of net operating profit for these 6 companies was 7.28% while the arithmetic average of their respective profit rates was 7.07%.10

These 6 companies are: Carpenter Steel Co., Jessop Steel Co., Rotary Electric Steel Co., Superior Steel Corp., Universal-Cyclops Steel Corp., and Vanadium-Alloys Steel Co. The Kearney report refers to Vanadium Corp. of America rather than to Vanadium-Alloys Steel Co. Since Vanadium Corp. of America is principally an iron ore extracting company, we assume the Kearney report intended to refer to Vanadium-Alloys Steel Co.

10 The individual company data for the calendar year 1955 (or fiscal year 1956) from which these averages were derived are as follows: