Another Shoe Drops

The news keeps getting bad for the telecom sector, as Qwest Communications announced late Sunday it would restate its earnings from 1999 to 2001, slicing off nearly $1.1 billion of transactions.

After beginning a review earlier this year, Qwest, a Denver-based telecom operating in 14 western states, determined that it had incorrectly accounted for sales of optical capacity assets (usually known as Indefeasible Rights of Use, or IRUs), in addition to some equipment transactions. The company said it, along with auditor KPMG, would continue to probe the transactions, but it expects to restate its financial results at the end of the investigation.

"We are committed to completing this analysis," CEO Richard Notebaert said in a conference call Monday morning. "We will provide transparency in our financial" reporting.

The accounting scandals that have engulfed the telecom industry were expected to touch Qwest, which has been the subject of numerous federal and state investigations into its financial-reporting practices. In March, the Securities and Exchange Commission (SEC) began informally investigating the company's2000 and 2001 earning reports. The SEC has also probed Qwest's dealings with bankrupt telecommunications firm Global Grossing. Earlier this year, the SEC issued staff recommendation that action should be taken against the company for not releasing some information when it acquired U.S. West in Jan. 2001 for $44 billion.

The crux of Qwest's questionable accounting practices is its treatment of 220 IRU transactions from 1999 to 2001, when woebegone auditor Arthur Andersen checked its books. An IRU is the right to use an amount of communications capacity over a defined amount of time. During the telecom boom, IRUs became very popular, as new carriers looked to expand their networks quickly. Instead of booking the revenue over the leng of the contract, many telecoms booked the revenues upfront. With its initial analysis, Qwest said it incorrectly recognized about $1.16 billion of revenues from IRUs.

How to treat IRUs has become a thorn in the side of telecom companies, since they can easily be used to inflate earnings by selling them back and forth. In February, the SEC began to probe Global Crossing's use of IRUs, subpoenaing documents from Qwest in the process.

The company's myriad of woes forced out CEO Joseph Naccio last month. Naccio's replacement, Notebaert, said the restatements would not force Qwest into bankruptcy, but he declined to discuss Qwest's negotiations with its creditors. In addition to the accounting errors and the many investigations into other aspects of its business conduct, Qwest has a mountain of long-term debt, $25 billion at the end of last year.

In addition to announcing the anticipated restatement, Qwest withdrew its 2002 financial guidance and announced it would report its second-quarter earnings on Aug. 8.