Qwest Backtracks Fast
Last week, it was WorldCom Inc.'s (Nasdaq: WCOME) filing for bankruptcy (see WorldCom Files for Bankruptcy). Then Qwest Communications International Inc. (NYSE: Q) started off this week with a bang, announcing yesterday that it expects to restate its earnings from 1999 to 2001 due to accounting errors related to optical capacity and equipment sales, as well as to telephone service and the company’s QwestDex directory service (see Qwest May Restate Earnings).
Of course, Qwest’s announcement -- which snuck over the wires late Sunday night -- should come as no surprise. The company is already under Securities and Exchange Commission (SEC) investigation for its accounting practices, and its former auditor is none other than the notorious Arthur Andersen LLP (see Qwest: Ciao Nacchio? and Qwest Gets New Auditor). Following the allegations of fraud at WorldCom last month, Light Reading's own Christopher P. Bulkey, a research analyst with the Optical Oracle, opined that Qwest would likely be the next American company to reveal accounting irregularities (see Carrier Scandals: Who's Next?). Other analysts have shared this sentiment. The question now, however, is whether Qwest's admissions come too late to save the company from bankruptcy.
“I don’t think that it’s completely unexpected,” says Network Conceptions LLC analyst Phil Jacobson. He says that there will probably be more restatements and goodwill writedowns before the SEC's August 14 deadline for CEOs and CFOs to assert that, to the best of their knowledge, previous annual and quarterly reports contain no untrue statements.
"[This is just the] tip of the iceberg," writes Craig Johanson, an independent analyst based in Portland, Ore., in an email to Light Reading.
But while observers agree that revelations of accounting irregularities at Qwest were expected, the market didn’t seem to have seen this coming. In early trading today, the company’s stock lost nearly 23 percent of its value, dropping 34 cents to a 52-week-low of $1.16 a share. Over the past year, the company’s stock has fallen 89 percent.
On a conference call this morning, Qwest CEO Richard Notebaert emphasized that the company is only disclosing that it is investigating the accounting irregularities, and that it is not yet restating its earnings. A restatement is expected, but Notebaert said it’s hard to predict, as the company’s new auditor KPMG is still analyzing the books. “I think everybody’s interested in getting this done as expeditiously as possible,” he said on the conference call, but he continued to say that the analysis would probably take months, rather than days.
“There are obviously not just a couple of transactions,” Jacobson says. “I’ve got a feeling that there’s a lot to clean up.” He points out that KPMG is being extremely tough on former Andersen clients. “When you take over a nuclear waste site,” he says, “you have to be extremely careful to clean it up really well if you don’t want to be blamed for the mess that’s left over.”
At Qwest, there does seem to be a lot of mess to clean up. The company said it improperly accounted for approximately $1.16 billion in recognized revenues from sales of optical capacity on its network, which account for about 18 percent of its total optical capacity sales. The company would not rule out having to restate earnings for all optical capacity sales during the period. In addition, Qwest said that its financial statements would include adjustments relating to its sale of equipment to other companies.
“We’re not disclosing who the customers were,” said Oren Shaffer, Qwest’s CFO, on the conference call.
In addition, the Denver-based telecom said that it may have to make “significant” adjustments to the timing of the recognition of revenues from its QwestDex directory service. Qwest has said that it's received several bids for the service, which is worth approximately $9 billion; according to reports, the company is expected to decide the winning bid sometime this week (see Qwest Gets Bids on Directory). On today’s conference call, Notebaert said that the disclosure of possible accounting irregularities in regards to QwestDex should have a minimal impact on the negotiations.
The company also said that during 2000 and 2001 it received service from third-party telecom providers, which it paid without properly recording the costs for the services. The company has preliminarily estimated that its costs for 2000 were overstated by $15 million, and that its 2001 costs were understated by $113 million.
Shaffer rejected the notion that the misleading accounting could be compared to WorldCom’s allegedly fraudulent misstating of nearly $4 billion, revealed in June (see Qwest: 'We're Different'). “This is purely and simply an accounting error,” he said. “These things happen.”
Guzman and Company analyst Patrick Comack says he doesn’t think that Qwest will run into the same kind of problems that WorldCom has -- at least, not yet. “[The revelations] are not anywhere near the magnitude of WorldCom,” he says. “Nor do they indicate any kind of fraud.” If fraud charges do surface, however, he says the company will be in real trouble.
Qwest is clearly not out of the woods yet. The company had expected revenues of as much as $18.4 billion for the year (see Qwest Posts Loss, Preps Asset Sales). Observers say the company’s credit agreements might be in danger if it doesn’t hit that target. Those agreements require that the company maintains a certain ratio of debt to EBITDA (earnings before interest, taxes, depreciation and amortization).
“I think they’re going to have to renegotiate [their credit agreements],” Comack says. However, once the QwestDex deal goes through, he says, the company should have the cash needed to renegotiate. In his opinion, it will probably convert to a secured credit line.
Qwest says it will issue new guidance when it reports its second quarter earnings on August 8.
— Eugénie Larson, Reporter, Light Reading
Editor's Note: Light Reading is not affiliated with Oracle Corporation.