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

“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
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.

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