Opinion ID: 3061983
Heading Depth: 2
Heading Rank: 1

Heading: Qwest’s Revenue Projections

Text: In July 2000, Qwest completed a merger with U.S. West, another (larger) telecommunications company. Mr. Nacchio told employees upon completion of the merger that “the five-year business plan is . . . grow, die, or sell.” Aplee.’s Supp. App., exh. 514A. In September 2000, he laid out new revenue, earnings, and growth targets for Qwest’s next year. He announced a public prediction, or “guidance,” of $21.3 to $21.7 billion in expected revenue in 2001. Qwest also -2- prepared a separate set of internal revenue targets, higher than the public guidance. Internal targets were typically set higher than public targets to encourage employees to exceed public targets. In addition, performance bonuses were paid to employees who met or exceeded internal targets. During most of the time relevant to this litigation, the 2001 year-end internal target was $21.8 billion, which was $500 million more than the bottom of the public guidance. At the time, some Qwest employees expressed concern that the guidance and targets were too high. That September, for example, Robin Szeliga, Qwest’s vice-president of financial planning, received a memo from two financial analysts who worked for her. The memo, called a “risk estimate,” forecast problems with Qwest’s revenue guidance. Ms. Szeliga shared the contents of the memo with Qwest’s Chief Financial Officer, Robert Woodruff, and later with Mr. Nacchio. The memo suggested that Qwest could make as little as $20.4 billion, a shortfall of $900 million from its public target. One particular problem was that Qwest had traditionally relied on revenues from long-term leases, known as indefeasible rights of use (IRUs), to use space on Qwest’s fiber optic network. Because Qwest collected money for the entire lease up front, IRU sales generated one-time revenue rather than a stream of recurring income. Therefore, to meet its 2001 public target, Qwest executives determined that Qwest had to make an “aggressive pivot” or “shift” from its reliance on the sale of IRUs to recurring revenue streams, such as standard -3- consumer phone service. App. 2177, 2600. In fact, even though Qwest had a poor track record in growing recurring revenue, the 2001 budget required Qwest to double its 2000 growth rate for recurring revenue. As early as December 2000, Qwest executives told Mr. Nacchio that this shift from IRUs to recurring revenue had to occur by April 2001 and he agreed. If Qwest failed to sign up enough new customers early in the year, it would not later benefit from sufficient compounding to close its third and fourth quarter budget gaps and would be forced to revise its public guidance downward. 1 Mr. Nacchio understood that a slow start in obtaining new recurring revenue would have a “snowball effect” which would doom Qwest’s year-end target for 2001. App. 2494. In January 2001, Mr. Nacchio acknowledged the importance of this when he told his sales staff that “something big” had to happen “by April” and that the first half of 2001 was “absolutely critical.” App. 2178; Aplee.’s Supp. App. exh. 551A, 559B. Although Qwest insiders clearly appreciated the risk inherent in the public guidance, it was not Qwest’s policy to disclose the portion of its income attributable to IRU sales, and thus the public was unaware of the degree of this risk. 1 Recurring revenue that begins early in the year increases annual earnings more than recurring revenue that begins later. For example, subscribers who begin service in January pay for 12 months of service while those who begin in December only pay for 1 month. -4- Qwest’s revenues met internal targets during the first two quarters of 2001, largely due to IRU sales. However, there was ominous news. In early April, Mr. Nacchio had conversations with Greg Casey, Qwest’s executive vice-president of wholesale markets, about the company’s sales of domestic IRUs. Mr. Casey told him: [T]he IRU market was drying up, that after the second quarter—in the second quarter, we felt like we were draining the pond in terms of the IRU deals that were out there, and that we couldn’t rely on IRUs—I couldn’t see—have any visibility to what IRUs would be doing after the second quarter. App. 2496. Similarly, Ms. Szeliga testified that on April 9: [T]he plans that we had at this point to cover estimated gaps were IRUs, and we had spoken with Mr. Nacchio . . . about the fact that the IRU market was worsening, in other words, there wasn’t as much demand for this product. So . . . the plan was very risky if we were just going to rely on IRUs. App. 2210–11. Mr. Nacchio also learned on April 9 that recurring revenue was off by 19%, indicating that the company was well short of increasing its recurring revenue in time to reduce its third and fourth quarter budget gaps. At the same time, however, Mr. Nacchio was told at a company meeting that even “with all of the debates . . . the internal current view of Qwest was that they would reach $21.5 billion by December 31st, 2001,” still meeting the public projections. App. 2323. -5- On April 24, Qwest announced its first quarter earnings in a press release, and Mr. Nacchio conducted a conference call to investors. In that call, Mr. Nacchio announced that the company was “still confirming” its previous guidance regarding long-term growth. App. 1598. He did not break down Qwest’s earnings into IRUs and recurring revenue. Later that day, Mr. Nacchio met with investors in Los Angeles, who pointed out that other telecommunications companies had lowered their guidance. One of them asked Mr. Nacchio how Qwest was going to meet its growth targets, saying “now was the time for [Qwest] to take [its] numbers to believability.” App. 1599. Mr. Nacchio responded that Qwest had better products and better management, and stressed its strong revenue growth in the category of “data and IP.” App. 1605. One-time transactions made up a portion of this revenue, but Mr. Nacchio did not mention this. Lee Wolfe, Qwest’s vice-president of investor relations, testified that investors asked, “[m]any times,” for “the makeup of data and IP,” but that Mr. Nacchio refused to tell them. App. 1600. In fact, as analysts and investors repeatedly requested a breakdown of Qwest’s revenue during the first quarter of 2001, insiders such as Mark Schumacher, the company’s controller, advocated disclosing the information. However, Mr. Nacchio, who retained the final say over Qwest’s public disclosures, declined to do so.