Art of Cash Accounting: Global Woe

Staff Reporter

Accounting has always been an obtuse art and in the case of Global Crossing Ltd., a seemingly simple determination in how to measure cash flows can be interpreted in any number of ways.

That's the problem. The company, now in Chapter 11 bankruptcy proceedings, claims that so-called cash revenues, used by many telecommunications companies, are a better way to determine cash flows than revenues allowable under generally accepted accounting principles.

Critics say that while cash revenues can be useful in measuring a company's performance, they can also be used to inflate the its results.

"Accounting as a profession is full of judgments, lots of gray areas and judgments," said Jeffrey Casterella, a former Ernst & Young auditor who is now a professor of accounting at Colorado State University. "You have the standards and then the judgment is often driven by the question of substance versus form."

Now, the Securities and Exchange Commission is examining Beverly Hills-run Global Crossing to determine whether the company simply stretched the rules for its own advantage or actually crossed a line, taking investors along for the ride. So is the company's own audit committee, which last week launched an internal investigation.

"These questionable accounting practices are common. But that does not mean they are acceptable," said Roderick S. Beck, a principal with telecommunications consulting firm Cwell in New York and a former in-house analyst with AT & T; Corp.

Don't be surprised if different conclusions are drawn.

In the race to build a high-capacity fiber-optic network, Global Crossing was hardly alone in publicizing measures of its financial performance that didn't conform to GAAP.

Numerous fiber-optics upstarts, including Level 3 Communications and 360Networks, emphasized non-GAAP metrics like cash revenues. The newly created measuring sticks were in response to guidelines put out by the SEC in 1999, which limited the amount of revenues that telecom companies could recognize on long-term leases of their lines.

SEC spells it out

As Global Crossing and others built their long-haul networks, they leased portions of them to customers in 20-year contracts granting "indefeasible rights of use," or IRUs.

Until 1999, telecommunications carriers routinely treated IRU payments as lump-sum revenues. But SEC Staff Accounting Bulletin 101, issued in November 1999, clarified that the revenue should be recognized as it is earned. So if a carrier leased out a circuit for 20 years, at a cost of $20 million, the seller could recognize only $1 million a year, even if all of the cash came in up front.

"SAB 101 really stirred a lot of problems in the industry," Beck said. "It meant that revenue recognition was changed in a way that sharply reduced their (reported) revenues."

In response, companies like Global Crossing began to calculate "cash revenues" as a supplemental revenue measurement. Cash revenues include the revenue that could be recognized under GAAP, plus "the change in the cash portion of deferred revenue," according to Global Crossing's quarterly statements. Essentially, it was a way to continue counting the cash received on IRU leases. GAAP-conforming figures, meanwhile, were de-emphasized.

"There's nothing wrong with the use of cash revenues," Beck said. "Cash revenues have been long recognized as proxies for cash flows."

However, in cases where Global Crossing and other carriers exchanged capacity on each other's networks, the rules got fuzzier. Global Crossing and others routinely treated these deals as revenue-producing IRUs, even though they could arguably be seen as non-revenue-producing asset swaps.

"In some cases, we may purchase capacity on a system in a region where we don't have any comparable infrastructure, and in many cases we may sell capacity or infrastructure in areas where another carrier doesn't have any assets," said Michelle Gagne, a spokeswoman for 360Networks, which is based in Vancouver. "In that case, it may not be considered a swap, but we record the capital expenditure and we disclose the purchase."

Irregularities alleged

Some of the most serious accounting-related allegations being raised by former Global Crossing executive Roy Olofson involve transactions that allegedly took place during the first half of 2001, a time when many Internet-related businesses saw volume drop off dramatically.

Global Crossing also experienced a slowdown, Olofson states in a press release issued by his attorneys. "Mr. Olofson believes that, as a result of this slowdown, and the need to meet or exceed financial expectations of financial analysts, Global Crossing engaged in a series of accounting irregularities," the released stated.

Global Crossing says that Olofson's allegations are without merit. It also claims that the issues raised were reviewed by its internal accounting and finance staff and by its outside auditor, Andersen. A Global Crossing spokeswoman declined to discuss the allegations in detail.

Olofson claims that in May 2001, he alerted Global Crossing's executive vice president of finance, Joseph P. Perrone, that he believed Global Crossing had entered into last-minute swap transactions to reach targets for cash revenue and "adjusted EBITDA," another non-GAAP measurement used by Global Crossing.

In the first quarter of 2001, Global Crossing reported cash revenue of $1.6 billion and adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) of $441 million. (It also disclosed that $567 million of its cash revenue came from IRUs. Of that total, it disclosed that a large portion came from carrier customers from whom Global Crossing also purchased capacity.)

Olofson questions the inclusion in cash revenue of at least $273 million in reciprocal transactions that took place in the first quarter of 2001. On one deal, Olofson alleges that Global Crossing purchased $200 million in capacity from a customer that was about to file for bankruptcy protection, and in return for $150 million of capacity and $50 million in cash. Global Crossing, he alleges, never received any cash in the transaction, although it recorded $150 million in cash revenue.

A source has identified 360Networks, which filed for bankruptcy protection in June 2001, as the company on the other side of this alleged transaction.

360Networks' response

Gagne of 360Networks declined to comment on any specific transactions, but said, "we never count any kind of capacity or infrastructure swap as revenue." She added that 360Networks' auditor, PricewaterhouseCoopers, is comfortable with the company's revenue-recognition practices.

Another allegedly questionable Global Crossing exchange involved Qwest Communications International Inc., the Denver-based carrier. According to Olofson, Global Crossing recorded cash revenues of approximately $100 million from capacity sales to Qwest, and "roundtripped" the cash by purchasing a similar amount of undefined capacity from Qwest.

Olofson claims in his press release that Qwest treated the transaction differently than Global Crossing did, despite both firms having the same outside auditor, Andersen.

A Qwest spokesman said he did not know whether the two companies did, in fact, treat the transaction differently.

At first blush, Beck said, the allegations raised by Olofson appear to be credible. "If (Olofson's) description of the transactions is correct, then it appears that Global Crossing engaged in questionable accounting treatment. Clearly, asset swaps that involve no net cash flows should not be recognized as cash transactions."

Casterella said he's inclined to reserve judgment on Global Crossing and its auditor until the investigation process takes it course. "It seems very likely that the auditors would have looked very hard at these transactions," he said.

But in the wake of the Enron scandal, there are plenty of doubters. Besides Olofson, there have been numerous lawsuits filed on behalf of shareholders who believe they were misled.

Firm Anticipated Problems

The list of unsecured trade creditors that got dinged by Global Crossing Ltd.'s bankruptcy last month includes a number of telecom heavyweights, including Alcatel, Lucent Technologies and SBC Communications.

Buried in that list is a small local company, Calabasas-based Tekelec, which is owed $3.7 million. As it turns out, the company anticipated the possibility that it wouldn't get paid.

While Tekelec shipped equipment to Global Crossing last year, it didn't recognize any revenue on the shipments, said spokesman Erik Randerson. "There's very minimal exposure," limited to the cost of producing the equipment, Randerson said.

He added that Tekelec hopes to recover the full price of the equipment in bankruptcy court.

Tekelec couldn't completely escape the Global Crossing fallout. On Jan. 29, as Tekelec announced results for the fourth quarter ended Dec. 31, it said it would have to reduce its previously existing order backlog by $30.6 million to reflect the "increased financial pressures affecting certain wireline carriers." (Most of the reduction was attributable to Global Crossing, the company said.)

Tekelec also lowered earnings guidance for the first quarter ending March 31, and the forecast was followed by at least one analyst downgrade. Its stock price fell 7 percent on the news, after falling 5 percent the previous day, on news of the trade debt to Global Crossing.

Altogether, Tekelec's stock has fallen 27 percent since word of the Global Crossing bankruptcy broke, to a recent price of $13.48.

Despite the challenging environment, Chief Executive Michael Margolis said that Tekelec continues to gain market share. The company recently announced a multimillion-dollar contract with France Telecom. "Unlike many of the companies out there in this industry, we are not planning on a down year," Margolis said.

Anthony Palazzo

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