Question

Permanent Versus Transitory Earnings

Entrust, Inc., is a global provider of security software; it operates in one business segment involving the design, production, and sale of software products for securing digital identities and information. The consolidated statements of operations for a three-year period (all values in thousands) follows. On January 1, Year 1, the Entrust common shares traded at $10.40 per share; by year end Year 3, the shares traded at $3.80 per share. The company’s cash flow from operations was $(27,411), $(20,908), and $9,606, for Year 1, Year 2, and Year 3, respectively.
Calculate the sustainable earnings of Entrust, Inc., for each of the three years. Compare the company’s reported net income (loss) with its sustainable earnings. Does Entrust’s share price at year-end Year 3 reflect the firm’s apparent turn-around? Why or why not?

ENTRUST, INC.
Consolidated Statements of Operations
Year Ended December 31 ($ thousands)	Year 3	Year 2	Year 1
Revenues
Product	$31,495	$33,174	$46,934
Services and maintenance	61,662	56,920	58,013
Total revenues	93,157	90,094	104,947
Cost of Revenues
Product	$ 4,329	$ 5,521	$ 5,461
Services and maintenance	29,105	29,825	32,073
Amortization of purchased product rights	384	568	1,136
Total cost of revenues	33,818	35,914	38,670
Gross profit	59,339	54,180	66,277
Operating expenses
Sales and marketing	26,322	34,985	44,128
Research and development	17,266	22,566	24,151
General and administrative	12,569	13,143	14,840
Impairment of purchased product rights		1,314	(1,169)
Restructuring charges and adjustments		13,973	(1,259)
Total operating expenses	56,157	85,981	80,691
Income (loss) from operations	3,182	(31,801)	(14,414)
Other income (expense)
Interest income	1,281	1,680	3,346
Foreign exchange gain (loss)	429	(431)	(72)
Loss from equity investments	(1,291)	(783)	(782)
Realized loss on investments		(2,780)	(400)
Write-down of long-term strategic investments		(2,780)	(1,238)
Total other income (expense)	419	(5,094)	854
Income (loss) before income taxes and minority interest	3,601	(36,895)	(13,560)
Noncontrolling interest in subsidiary	4
Income (loss) before income taxes	3,605	(36,895)	(13,560)
Provision for income taxes	1,406	443	1,098
Net income (loss)	$ 2,199	$(37,338)	$(14,658)

Calculate the sustainable earnings of Entrust, Inc., for each of the three years. Remember to use negative signs with answers, when appropriate.

Answer 1

1) sustainable earnings refers to the earnings which the firm is expected to earn in the future on a continuos basis i.e., income from operations excluding all incomes or losses on a non recurring nature and taxes....The investors mainly focus on the sustainable earnings rather than the net income or loss reported in financials.

The sustainable earnings therefore can be calculated by adding back the non recurring items to Income from operations.

The share price of the company dropped from 10.4 per share to 3.8 per share by end of year 3.....The share price DOES NOT reflect the substantial turnaround of the company. The company's income is in negatives in the initial 2 yrs....And it turnaround to positive in the 3rd yr. If the share price reflects the turnaround, it should increase. Hence the investors are not much focussing on the turnaround of the company. Instead if we observe the loss from equity instruments is increased from 782 in yr 1 to 1291 in yr 3......hence the equity investors are more focussing on the gain or loss on equity instruments...

Hope it helps,

Thank u.