cost behavior analysis in lost profits damages...
TRANSCRIPT
Cost Behavior Analysis in Lost Profits
Damages: Calculation Methods, Best
Discovery Practices
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
The audio portion of the conference may be accessed via the telephone or by using your computer's
speakers. Please refer to the instructions emailed to registrants for additional information. If you
have any questions, please contact Customer Service at 1-800-926-7926 ext. 1.
WEDNESDAY, MARCH 6, 2019
Presenting a live 90-minute webinar with interactive Q&A
Joseph W. Lesovitz, CPA/ABV/CFF, CFA, CFE, Partner, Litigation and Advisory Services, Citrin Cooperman, Philadelphia
Jason S. McManis, Attorney, Ahmad Zavitsanos Anaipakos Alavi & Mensing, Houston
Tips for Optimal Quality
Sound Quality
If you are listening via your computer speakers, please note that the quality
of your sound will vary depending on the speed and quality of your internet
connection.
If the sound quality is not satisfactory, you may listen via the phone: dial
1-866-869-6667 and enter your PIN when prompted. Otherwise, please
send us a chat or e-mail [email protected] immediately so we can address
the problem.
If you dialed in and have any difficulties during the call, press *0 for assistance.
Viewing Quality
To maximize your screen, press the F11 key on your keyboard. To exit full screen,
press the F11 key again.
FOR LIVE EVENT ONLY
Continuing Education Credits
In order for us to process your continuing education credit, you must confirm your
participation in this webinar by completing and submitting the Attendance
Affirmation/Evaluation after the webinar.
A link to the Attendance Affirmation/Evaluation will be in the thank you email
that you will receive immediately following the program.
For additional information about continuing education, call us at 1-800-926-7926
ext. 2.
FOR LIVE EVENT ONLY
Program Materials
If you have not printed the conference materials for this program, please
complete the following steps:
• Click on the ^ symbol next to “Conference Materials” in the middle of the left-
hand column on your screen.
• Click on the tab labeled “Handouts” that appears, and there you will see a
PDF of the slides for today's program.
• Double click on the PDF and a separate page will open.
• Print the slides by clicking on the printer icon.
FOR LIVE EVENT ONLY
Cost Behavior Analysis in Lost Profit Profits Damages
Presented by:
JOSEPH LESOVITZ, CPA/ABV/CFF, CFA, CFEJASON S. McMANIS, ESQUIRE
Cost Behavior Analysis
• Overview of Cost Behavior
• Impact of Avoided Cost
• Methodology
• Best Practices for Attorneys
• Relevant Case Law/Legal Principles
6
Lost Profits Defined
• Lost profits are based upon the alleged harm suffered by the Plaintiff(s).
• Calculated as the amount necessary to place the Plaintiff in the position that
it would have been had the event not occurred.
• Only “Net Lost Profits” are allowable in economic damages – (Net Lost
Profits = Lost Revenues – Avoided/Incremental Costs)
7
What Are Lost Profits?
• Quantify the expected
earnings absent the
incident
• Quantify the actual
earnings given the
incident
• Damages are the
difference “but-for”
the incident
$
Time
Projected
Actual
Damages
8
“But for” the Event… Quantify:
A = Expected Sales
B = Actual Sales
Lost Sales = A – B
The “lost sales” are the incremental sales that would have been made “but for” the event.
Lost Sales
9
Lost Profits
Sales - Costs = Profits
Total Costs = Fixed Costs + Variable Costs + Semi-Variable Costs
Lost Sales - Incremental Costs = Lost Profits
10
Elements Requiring Analyses
Several elements that the financial expert must analyze in calculating
credible net lost profit damages include, but are not limited to:
– Cause of loss – there should be a link between the alleged wrongful act
and the damages sustained
– Factual basis for the claim
– Determination of evidence supporting the financial claims
– Estimation of lost revenues, including historical financial information to
support such amounts
– Incremental (avoided/saved) costs associated with the lost revenues,
including the cost drivers associated with the lost revenues, and support
in the record for each
– Net lost profits associated with lost revenues determined
– Deposition testimony
11
Other Items To Consider
Damages Period is Finite:
• Can vary depending on the underlying cause(s) of action
and the underlying facts of the case.
• Typically begins on date of the harmful act.
• End date is generally when plaintiff returned to the position
it would have originally occupied had the alleged actions
not occurred.
• Trial date in most cases does not provide the end point to
the loss.
• Future damages periods need to be discounted.
12
Conceptual Issues in Economic Damages
Courts have stated the general rule permitting alternate theories of recover:
“[I]f a business is completely destroyed, (then) the proper total measure of damages is the market value of the business on the date of the loss. If the business is not completely destroyed, then it may recover lost profits. A business may not recover both lost profits and the market value of the business.”¹
1. Montage Group, Ltd. V. Athle-Tech Computer Systems, Inc., 889 So.2d 180, 191 (Fla. App.2004)
(internal citations omitted). From “The Comprehensive Guide to Lost Profit Damages,” 2009, Chapter 8
13
Conceptual Issues in Economic Damages (cont.)
• Scenario 1: Temporary Impairment
• Scenario 2: Immediate Destruction of Business
• Scenario 3: Slow death of a Business
• Other Scenarios: Startup/Emerging Businesses
14
Comparative Summary of Lost Profits vs. Lost Business
Attribute Lost Profits Business Valuation
Income stream Incremental income stream net
of avoided costs
Typically net after tax income
Income stream Before income tax Typically after tax income
Income stream Typically limited life Into perpetuity
Valuation methods Present value of post trial lost
incremental income added to
pretrial lost incremental income
including appropriate pre-
judgment interest added to the
date of trial
Discounted net income or net cash flow
model, supported by other valuation
methodologies as needed
Discount rate Based on either risk assessment,
risk-free rate, or plaintiff’s use of
funds depending on
circumstances (see Chapter
10A)
Based on risk assessment
Prejudgment and post judgment
interest
Considered Considered
Use of hindsight
(the “Book of Wisdom”)
Typically considered Seek guidance
The following table summarizes the differences between lost profits and lost business damages:¹
¹”The Comprehensive Guide to Lost Profits Damages”, 2009, pg. 86, Business Valuation Resources. 18
Estimating Revenues
Quantities:
▪ Market share/behavior (demand)
▪ Geographic issues
▪ Industry and economic trends
▪ Technology
▪ Capacity
19
Estimating Revenues
Price:▪ Market share
▪ Cost of production
▪ Competition
▪ Regulations
Support:▪ Justify your conclusions
o Number of comparables (transactions, companies, etc.)
o Written documentation
o Contracts or sales orders
20
Estimating Revenues
Growth Rates:
▪ Before and after method (Historical)
▪ Yardstick method (Industry & Guidelines)
▪ Sales projections method
▪ Market model
▪ Combined methods
21
Relevant Cases
Before and After Method:
See, e.g., Coastal Fuels of Puerto Rico, Inc. v. Caribbean Petroleum
Corp. 79 F.3d 182 (1st Cir. 1996)
• The court looks at the plaintiff’s business before the violation
occurred, during the violation period, and after the violations
ended, and estimates the amount by which the violation reduced
the plaintiff’s profits.
See also Springs Window Fashions Div., Inc. v. The Blind Maker, Inc.,
184 S.W. 3d 840 (Tex. App. 2005)
• Court considers award of lost profits as consequential damages
stemming from a fraud claim, and permitted recovery based on a
before and after analysis of overall business profits.
22
Relevant Cases (cont.)
Yardstick Method:• Compare the Coastal Fuels case which the court confirmed the comparability of guideline
companies used in the yardstick analysis, to Montage v. Athle-Tech, in which the court
found the plaintiff company and the single guideline comparable substantially different in
size, operation, etc. Notably, the Athle-Tech, expert assumed that the plaintiff’s business
was comparable to the selected guideline “because he was instructed to do so by plaintiff’s
counsel. He made no independent study of the two companies to determine whether their
businesses were actually comparable.” 889 So.2d at 195.
• In re Blood Reagents Antitrust Litig., No. 09-2081, 2015 WL 6123211, at *21-22 (E.D. Pa.
Oct. 19, 2015)
“What is required with respect to comparability of a proposed yardstick product at the
Daubert stage is unsettled. Several courts, however, have ruled that under Daubert, exact
correlation is not necessary . . . the products need only be fair congeners. A proposed
yardstick must be rejected as inadmissible where the expert testimony is so deficient that
the comparison is manifestly unreliable and cannot logically advance a material aspect of
the proposing party's case. This generally occurs when an expert has failed to perform any
substantive analysis of those factors most relevant to comparability.”
23
Relevant Cases (cont.)
Sales Projection Method:
See, e.g., U.S. Salt, Inc. v. Broken Arrow, Inc., 2008 WL 2277602 (Minn.
2008)
• Expert’s wholesale acceptance of management projections
without any verification of the estimates or any independent
market analysis were too speculative;
Telxon Corp. v. Smart Media of Delaware, Inc., 2005 WL 2292800 (Ohio
App. 2005)
• Expert’s opinion and report based entirely on a business plan that
plaintiff developed some three years after the breach and almost
15 months after filing the lawsuit were unreliable and speculative.
24
Relevant Cases (cont.)
Market Model:
See, e.g., Conwood Co. v. U.S. Tobacco Co., 290 F.3d 768 (6th Cir.
2002); and Crystal Semiconductor Corp. v. Tritech Microelectronics
International Inc., 246 F.3d 1336 (Fed. Cir. 2001)
• Plaintiff sought lost profits for alleged patent infringement based
on its market share.
25
Estimating Cost – Methods and Drivers
Understanding Cost Drivers:▪ Know your subject company and how they track costs
▪ May have to rely on statistical (e.g. regression analyses or attribute
sampling) and/or non statistical (e.g. detailed account analyses, direct
assignments, accounting estimates, cost accounting allocations, ratio
analyses, etc.) methods to estimate costs
▪ Expert must know the market and economic conditions within the
industry that the subject company participates
▪ Must understand the fixed, variable, and semi variable cost related to
the harmful act
26
Case Study
Income Statement for XYZ Corp.
Sales $100
COGS 15
Gross Profit 85
Less:
Selling 20
General 25
Admin. 15
Net Income $25
Assume that if sales increase by 100 percent from $100 to $200, that General expenses double, Selling expenses increase to $30 and that Admin. expenses do not change.
28
Income statement for XYZ Corp.
Additional Sales Total SalesSales $100 $100 $200COGS 15 15 30Gross Profit 85 85 170Less:
Selling 20General 25Admin. 15
Net Income $25
Assume that if sales increase by 100 percent from $100 to $200, Selling expenses increase to $30, General expenses double, and Admin. expenses do not change.
29
Income statement for XYZ Corp.
Additional Sales Total Sales
Sales $100 $100 $200
COGS 15 15 30
Gross Profit 85 85 170
Less:
Selling 20 10 30
General 25
Admin. 15
Net Income $25
Assume that if sales increase by 100 percent from $100 to $200, Selling expenses increase to $30, General expenses double, and Admin. expenses do not change.
30
Income statement for XYZ Corp.
Additional Sales Total Sales
Sales $100 $100 $200
COGS 15 15 30
Gross Profit 85 85 170
Less:
Selling 20 10 30
General 25 25 50
Admin. 15
Net Income $25
Assume that if sales increase by 100 percent from $100 to $200, Selling expenses increase to $30, General expenses double, and Admin. expenses do not change.
31
Income statement for XYZ Corp.
Additional Sales Total Sales
Sales $100 $100 $200
COGS 15 15 30
Gross Profit 85 85 170
Less:
Selling 20 10 30
General 25 25 50
Admin. 15 - 15
Net Income $25 $50 $75
Assume that if sales increase by 100 percent from $100 to $200, Selling expenses increase to $30, General expenses double, and Admin. expenses do not change.
32
• Incremental Profit is defined as the revenue recognized on additional sales less the costs necessary to make those additional sales.
• In this case, the following costs are incremental:➢ COGS➢ Selling➢ General
• Incremental profit is:Incremental Profit = Additional Sales – COGS – Selling – General
= $100 – $15 – $10 – $25= $50
• In this case, incremental profit as a percentage is:
Incremental Profit % = Incremental Profit / Sales= $50 / $100= 50%
Incremental Profit
33
Income Statement (Common Sized)
Actual Profits Lost Profits Expected Profits
Sales 100 100% 100 100% 200 100%
COGS 15 15% 15 15% 30 15%
Gross Profit 85 85% 85 85% 170 85%
Less:
Selling 20 20% 10 10% 30 15%
General 25 25% 25 25% 50 25%
Admin. 15 15% 0 0% 15 8%
Net Income 25 25% 50 50% 75 38%
34
COST BEHAVIOR ANALYSIS IN LOST PROFITS DAMAGES
Jason McManis
Ahmad, Zavitsanos, Anaipakos, Alavi & Mensing P.C.
713-655-1101
36
Lost Profits: Must Be Profits!
• Springs Window Fashions Div., Inc. v. Blind Maker,
Inc., 184 S.W.3d 840 (Tex. App.—Austin 2006):
“[L]ost profits, by definition, must be
profits . . . . Lost profits are damages for
the loss of net income to a business, and,
broadly speaking, reflects income from lost
business activity less expenses that would
have been attributable to that activity.”
37
Avoided Costs Are Required to Receive Award of Lost Profits
• Bessemer & Lake Erie R.R. Co. v. Seaway Marine
Transport, 596 F.3d 357 (6th Cir. 2010):
“Because Bessemer never provided a critical
piece of the lost-profits puzzle—evidence of
avoided costs—the district court did not
abuse its discretion in concluding that
Bessemer came up short in meeting its Rule
26 obligations.”
38
Avoided Costs Are Required to Receive Award of Lost Profits
• Englewood Terrace Ltd. P’ship v. U.S., 113 Fed. Cl.
718 (2013):
“In reviewing the record as a whole, this
court, cannot determine which, if any, were
costs not avoided by the breach. . . .
Plaintiff . . . has failed to provide necessary
evidence to prove its damages as a result of
that breach. Therefore, the original
damages award . . . of $3,272,217.00 is
reduced to zero.”
Get Your Expert Involved . . . EARLY!:Defendant’s Perspective
40
• Consult with your expert.
• Before discovery.
• During discovery.
• Identify missing discovery.
• Help prepare motion to compel.
• Don’t delay getting discovery to your expert.
• All inputs necessary to break down lost profits model.
• Including internal information that can be used to undercut the cost estimates of plaintiff.
Get Your Expert Involved . . . EARLY!: Plaintiff ’s Perspective
41
• Consult with your expert.
• Before discovery.
• During discovery.
• Identify missing information to build model.
• Put your expert in touch with relevant witnesses.
• All inputs necessary to build complete lost profits model.
Use Discovery to Build/Attack Lost Profits
42
• Requests for Production
• Interrogatories
• Rule 30(b)(6) “Corporate Rep” Depositions
• Motions to Compel
Use Discovery to Build/Attack Lost Profits
43
• Requests for Production
• Interrogatories
• Rule 30(b)(6) “Corporate Rep” Depositions
• Motions to Compel
• Defense Side – THINK GRANULAR• Financial statements
• Balance Sheets / cash flow statements / general ledgers
― Underlying Data: sales reports, sales journals, databases, invoices, invoice registers
• Hurdle rates, historic profit margins
• Leases, utility bills, etc.
• Financial forecasts, budgets
• Price lists, discounts
• Salaries, commission based payments
• Capacity/utilization of capacity/ability to expand (and cost)
• Production costs (materials, machinery, etc.)
Requests for Production: Defense Perspective
44
Requests for Production: Plaintiff ’s Perspective
45
• Plaintiff’s Side – THINK COMPREHENSIVE…
• COLLECT AND PROVIDE EVERYTHING YOU CAN! → Even if
they don’t ask, you’ll need to produce it with expert
report.
• …AND GRANULAR
• Seek same types of discovery back from defendant.
• Collect your own information as broken down as possible.
Use Discovery to Build/Attack Lost Profits
46
• Requests for Production
• Interrogatories
• Rule 30(b)(6) “Corporate Rep” Depositions
• Motions to Compel
Interrogatories: Defense Perspective
47
• Build on/double up on the Requests for Production
• Start seeking specifically the avoided costs:
― EXAMPLE: Identify and describe all costs not incurred,
reimbursed, or otherwise avoided as a result of the
widget sales you contend you lost as a result of
Defendant’s conduct.
― EXAMPLE: Identify and describe all costs associated with
the sale of widgets.
― EXAMPLE: Identify and describe all operating expenses
for the widget division.
Interrogatories: Plaintiff ’s Perspective
48
• Provide complete responses and identifying your avoided costs.
― Supplement your responses as you discover more information.
• Seek additional discovery into and explanation of Defendant’s profit margins, revenues, variable and invariable costs, etc.
― What did it cost defendant to make the sales you’re contending were lost?
― But also look into identifying your own costs (client’s policies, commission scales, manufacturing costs, etc., all may be specific to your client).
Use Discovery to Build/Attack Lost Profits
49
• Requests for Production
• Interrogatories
• Rule 30(b)(6) “Corporate Rep” Depositions
• Motions to Compel
Corporate Representative Depositions: Defense Perspective
50
• Seek a witness to explain key financial documents
and interrogatory responses.
― Use specific topics.
• If haven’t gotten documents you need to establish
avoided costs, seek witnesses to identify 1) what
documents exist; 2) who has them; 3) how long it
would take to prepare/produce.
― Also seek a witness to testify as to the specific avoided
costs from any lost sales.
Corporate Representative Depositions: Plaintiff ’s Perspective
51
• Prepare your corporate rep to be able to
thoroughly answer on issues of avoided costs.
― If you’ve done your job in document production and
interrogatory responses, this should be easy!
• Testimony on defendant’s cost and profit trends
over time.
• If modeling off of Defendant’s profits, make sure to
get a corporate rep to explain their financials and
testify as to their variable and fixed costs.
Use Discovery to Build/Attack Lost Profits
52
• Requests for Production
• Interrogatories
• Rule 30(b)(6) “Corporate Rep” Depositions
• Motion(s) to Compel
54
Bessemer & Lake Erie R.R. Co. v. Seaway Marine Transport
• Seaway used discovery requests to defeat a claim
for lost profits:
• Sent RFP seeking “copy of all documents that relate to,
support, or are in any way connected with the
allegation” of lost profits.
• Sent interrogatory on same issue.
• Noticed corporate representative deposition on
“estimate and breakdown as to actual costs that would
have been incurred.”
• Noticed second corporate representative deposition
seeking testimony regarding “savings realized as a result
of the cancelation of shipments.”
55
Bessemer & Lake Erie R.R. Co. v. Seaway Marine Transport (cont.)
• Seaway used early expert involvement to defeat a
claim for lost profits:
• Expert testified as to all the information Bessemer did
not provide that would be needed.
• Offered conclusion that Bessemer provided insufficient
data for a calculation of avoided costs, which prevented
any expert from determining the actual amount of lost
profits.
56
Englewood Terrace Ltd. P’ship v. United States
• Plaintiff’s failure to establish evidence of avoided
costs negates lost profits award.
• On remand, court requested data on operational costs or
expenses plaintiff did not have to pay but would have
paid had the contract not been breached.
• Plaintiff produced general ledgers, created after the
fact, with no explanation.
• Plaintiff offered nothing that could demonstrate avoided
costs and expenses with reasonable certainty.
57
Champion Foodservice, LLC v. Vista Food Exchange, Inc.
• Plaintiff’s failure to provide discovery in face of
court order to do so resulted in exclusion of lost
profits model:
• Defendant sought multiple times to have lost profits
excluded, Court instead compelled discovery.
• Plaintiff provided only a general identification of avoided
costs, without any of the backup information.
• Plaintiff resisted discovery at every turn, and did not use
its available information to support the avoided cost
assumptions.
• Plaintiff omitted certain avoided costs from its
calculations entirely.
59
Discovery of Avoided Costs Is a Critical Component of Lost Profits Litigation
• Your experts are a resource—don’t waste them!
• Your client witnesses are a resource—don’t waste them!
• If you are defending a lost profits claim, use the discovery process to break down avoided costs as much as possible—or hem the plaintiff in to be unable to do so.
― Make sure the costs are in range of what makes sense to your client.
• If you are advancing a lost profits claim, make sure you can provide all available supporting documentation and evidence (even by deposition) to support your calculation of avoided costs.
― If you are advancing a lost profits claim without that information, try to get it from the defendant.
QUESTIONS?
Jason S. McManisAHMAD, ZAVITSANOS, ANAIPAKOS, ALAVI & MENSING P.C.1221 McKinney, Suite 2500Houston, Texas 77010
Telephone: 713-655-1101Email: [email protected]
Joseph W. LesovitzCitrin Cooperman1800 JFK BoulevardPhiladelphia, PA 19103
Telephone: 267-479-0060Email: [email protected]