Question 17.6: Non-Recurring Items Enron Corp. EXHIBIT 6 Excerpts from Enro......
Non-Recurring Items
Enron Corp.
1 . How does the trend in Enron’s operating income compare with the trend in its income after other income and deductions (i.e., Income before interest, minority interests, and income taxes)?
2 . What items appear to be non-recurring as opposed to being a result of routine operations? How significant are these items?
3 . The Enron testimony of short seller James Chanos before US Congress referred to “a number of one-time gains that boosted Enron’s earnings” as one of the items that “strengthened our conviction that the market was mispricing Enron’s stock” ( Chanos 2002 ). What does Chanos’s statement indicate about how Enron’s earnings information was being used in valuation?
| EXHIBIT 6 Excerpts from Enron and Subsidiaries Consolidated Income Statement, Year- Ended 31 December | |||
| (In millions, except per share amounts) | 2000 | 1999 | 1998 |
| Total revenues | $100,789 | $40,112 | $31,260 |
| Total costs and expenses | 98,836 | 39,310 | 29,882 |
| Operating income | $1,953 | $802 | $1,378 |
| Other income and deductions | |||
| Equity in earnings of unconsolidated equity affiliates | $87 | $309 | $97 |
| Gains on sales of non-merchant assets | 146 | 541 | 56 |
| Gain on the issuance of stock by TNPC, Inc. | 121 | 0 | 0 |
| Interest income | 212 | 162 | 88 |
| Other income, net | -37 | 181 | −37 |
| Income before interest, minority interests, and income taxes | $2,482 | $1,995 | $1,582 |
to 1: Enron’s operating income varied dramatically from year to year, declining from 1998 to 1999 and then more than doubling in 2000. In contrast, Enron’s income before interest, minority interests, and income taxes shows a smooth, upward trend with significant increases each year. The increases were 24% and 26% for 2000 and 1999 relative to 1999 and 1998, respectively.
to 2: Items that appear to be non-recurring are gains on sales of non-merchant assets and the gain on the issuance of stock by TNPC. Although gains from sales of non-merchant assets do recur in each year, this type of activity is not a part of Enron’s energy distribution operations. In addition, two other non-operating items—the amount of equity in earnings from unconsolidated subsidiaries and the amount of other income—are highly variable. Two aspects of these items are significant. First, the smooth, upward trend in Enron’s income is the direct result of these items. Second, these items collectively represent a significant percentage of the company’s income before interest, minority interests, and income taxes, particularly in 1999 when these items represent 52% of the total: ($309 + $541+ $181)/ $1,995 = $1,031/$1,995.
to 3: Chanos’s statement suggests that at least some market participants were mistakenly using Enron’s reported income as an input to earnings-based valuation, without adjusting for non-recurring items.