Level 3's Crowe: "We're Clean"

In the wake of yet more revelations of creative carrier accounting, Level 3 Communications Inc. (Nasdaq: LVLT) is preemptively defending itself.

"I want to address a number of questions we have received concerning IRU sales and their impact on our company's reported financial results," writes CEO James Q. Crowe in a statement issued this morning (see Jim Crowe Speaks).

Crowe states that Level 3 has not engaged in any of the reciprocal transactions called "hollow swaps" presently under investigation relative to other carriers -- even though Level 3 engaged in seven transactions last year in which "we sold... capacity or services to a company from which we purchased similar kinds of items at approximately the same time."

Crowe is apparently reacting to ongoing reports of the accounting methods used by Global Crossing Ltd. (NYSE: GX). A former employee has questioned the way that carrier accounted for IRUs (indefeasible rights of use) -- capacity on fiber, conduits, or wavelengths leased to other providers.

Roy Olofson, a former vice president of finance at Global Crossing, has alleged that Global Crossing used IRUs for similar amounts of capacity from other providers to inflate its financial position. Global Crossing, which fired Olofson, denies his allegations and has painted him as a disgruntled employee (see GlobalX Issues Defense).

Global Crossing in the past has been questioned about how it accounted for deferred revenue transactions, but there are any number of issues the SEC may choose to look at (see Global Crossing Under Fire and Global Crossing: More Questions). Qwest Communications International Inc. (NYSE: Q) was subpoenaed for information about its exchanges of capacity with Global Crossing (see Qwest Called on Global Crossing ). Because the use of IRUs is quite widespread, the accounting issues are likely to be examined throughout the entire industry.

All this seems to have urged Crowe to take action. And he's not alone. KPNQwest NV (Nasdaq/Amsterdam: KQIP) also issued a statement today defending its accounting (see KPNQwest Reiterates).

Are these carriers shooting themselves in the foot? Apparently, Level 3 hasn't been immune to analyst questions about its accounting. On the company Website, Level 3 separately states cash revenue ($2.1 billion in 2001) and revenue corresponding to GAAP ($1.3 billion in 2001).

"Their cash accounting is suspect," says Timothy Horan, analyst at CIBC World Markets. While declining to be specific, he says it's "possible" that Level 3's revenues were augmented by the transactions Crowe defends in his release.

How would one go about doing that? Well, for example, a company could trade an IRU for equal bandwidth on another network, and treat the incoming cash as revenue while charging the outlay as a capital expenditure over a longer period of time. Such treatment would improve a company's revenue picture.

According to Crowe, each of the seven reciprocal transactions the carrier recorded in 2001 "had a valid business purpose and... the accounting treatment was proper. In any event, the total amount of revenue Level 3 recorded in connection with these transactions was immaterial, representing only 2% of our GAAP revenue for 2001."

Other sources say there's nothing funky at Level 3. "I've gone through the company's 10Ks and other reports, and they're much cleaner and simpler than those of other carriers," says analyst Michael Davey of Investec Ernst & Co.

Others say 10Ks won't reveal the information needed to discern whether Level 3 cooked its books. Some say details (if there are any) would be recorded amongst off-balance-sheet transactions, for which information is typically available only at the company's discretion. Hypothetically, information on transactions like these also might point to other activities a company engaged in, such as hiding debt in partnerships à la Enron.

By press time, Level 3 had not responded to inquiries about whether it had any off-balance-sheet transactions.

Early this afternoon, Level 3 shares were trading at $2.30, up $0.08 (3.60%).

— Mary Jander, Senior Editor, Light Reading
http://www.lightreading.com