Question

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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	$30,395	$32,074	$45,834
Services and maintenance	61,662	56,920	58,013
Total revenues	92,057	88,994	103,847
Cost of Revenues
Product	$ 4,239	$ 5,431	$ 5,371
Services and maintenance	29,105	29,825	32,073
Amortization of purchased product rights	384	568	1,136
Total cost of revenues	33,728	35,824	38,580
Gross profit	58,329	53,170	65,267
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		1,224
Restructuring charges and adjustments		13,873	(1,169)
Total operating expenses	56,157	85,791	81,950
Income (loss) from operations	2,172	(32,621)	(16,683)
Other income (expense)
Interest income	1,281	1,680	3,346
Foreign exchange gain (loss)	429	(431)	(72)
Loss from equity investments	(1,201)	(693)	(692)
Realized loss on investments			(310)
Write-down of long-term strategic investments		(2,780)	(1,238)
Total other income (expense)	509	(2,224)	1,034
Income (loss) before income taxes and minority interest	2,681	(34,845)	(15,649)
Noncontrolling interest in subsidiary	4
Income (loss) before income taxes	2,685	(34,845)	(15,649)
Provision for income taxes	1,047	418	1,268
Net income (loss)	$ 1,638	$(35,263)	$(16,917)

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

	Year 3	Year 2	Year 1
Permanent earnings	2,556$	(16,956)$	(16,716)$

Answer 1

Consolidated Statements of Operations Year Ended December 31 ($ thousands) Year 3 Revenues Product Services and maintenance Total revenues Cost of Revenues Product Services and maintenance Amortization of purchased product rights S 384.00 Total cost of revenues Gross profit Operating expenses Sales and marketin Research and development General and administrative Total operating expenses Income (loss) from operations Provision for income taxes @ 34% Net income (loss Year 2 Year 1 $30,395.00 $ 32,074.00 $ 45,834.00 $61,662.00 56,920.00 58,013.00 $92,057.00$ 88,994.00 $103,847.00 S 4,239.00 S 5,431.00 5,371.00 29,825.00 32,073.00 S 568.00 S 1,136.00 35,824.00 38,580.00 ,170.00 $ 65,267.00 $29,105.00 $ $58,329.00 53 $26,322.00 34,985.00$ 44,128.00 .00$ 24,151.00 $ 14,840.00 S 83,119.00 $ (17,852.00) $ (5,958.00 S (6,070.00 6.00) $ (11,782.00) $17,266.00$ 22,566 $12,569.00 $ 13,143.00 $56,157.00 $ 70,694.00 2,172.00 $(17,524.00) $ 738.00 S 1,434.00 $(11,566