WorldCom Tilts Toward Abyss

Updated from June 25

As the storm swirled around WorldCom (WCOM), Wall Street was forced to grapple with the implications for the financial markets of a potential $30 billion debt foreclosure.

Stock investors, meanwhile, saw their already devalued WorldCom investment all but evaporate and worried more bad accounting news was in the offing.

The onetime telecom standard-bearer stunned an already shell-shocked marketplace Tuesday night with word that its financial statements for the last five quarters contained some $3.8 billion of fraudulent capital expenses. The discovery during a routine internal audit cost longtime Chief Financial Officer Scott Sullivan his job as well as that of David Myers, its senior vice president and controller.

Specifically, WorldCom copped to inflating its earnings before interest, taxes, depreciation and amortization, a measure of cash flow, by $3.8 billion over five quarters by improperly identifying routine operating costs as longterm capital costs. Absent the misallocation, WorldCom said it would have lost money in 2001 rather than earn the $1.4 billion it reported, as well as in the first quarter of 2002, when it purportedly had earned $130 million for the first quarter of 2002.

The amount of the mislabeled costs was $3.055 billion for 2001 and $797 million for the first quarter of 2002, the company said. Without those transfers, reported EBITDA would be reduced to $6.339 billion for 2001 and $1.368 billion for the first quarter of 2002.

In a statement regarding WorldCom, the Securities and Exchange Commission said the disclosures "confirm that accounting improprieties of unprecedented magnitude have been committed in the public markets."

The SEC said the public "can be assured that we are actively investigating these and other events relating to the veracity of WorldCom's financial statements and disclosures." As part of the investigation, the agency is ordering the company to file, under oath, a detailed report on the incident.

Teetering Colossus

Of immediate concern is the impact those restatements will have on WorldCom's debt structure, which consists of $30 billion in unsecured bonds and loans. Recently appointed CEO John Sidgmore said Tuesday night that with no debt maturing during the next two quarters, the restatement of its operating results for 2001 and 2002 is not expected to have an impact on its cash position and will not affect its service to customers.

WorldCom announced immediate cash-conservation steps, including plans to lay off 17,000 employees and cut capital spending to $2.1 billion annually.

It wasn't known how the company's banks would react to the news and whether the restatement would cause a default. WorldCom has been negotiating for a $5 billion line of credit and in May drew down a $2.65 billion credit line. Since the fraud stretches back five quarters, speculation emerged that a WorldCom bond offering from May 2001 could become a problem for its underwriters, who are supposed to thoroughly vet a company's bookkeeping through the due diligence process.

WorldCom's stock traded down 89%, to 9 cents each, on the Instinet premarket early Wednesday.

Who Knew What

Another pending question is that of executive culpability. The company said the first evidence of the fraud was detected soon after the ouster of its longtime chief executive, Bernard J. Ebbers, in April. WorldCom then turned the matter over to the company's audit committee and its newly hired auditors, KPMG LLP, who deemed the issue was serious enough to alert the SEC. The agency already had launched its own investigation into WorldCom in February.

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Ebbers, who wasn't available to comment, is said to have worked from an office adjacent to ousted CFO Sullivan. WorldCom's longtime auditor, Arthur Andersen, issued a statement Tuesday night that laid the blame with Sullivan. "It is of great concern that important information about line costs was withheld from Andersen auditors by the chief financial officer of WorldCom," the statement said.

"Our senior management team is shocked by these discoveries," said Sidgmore, who was appointed on April 29. "We are committed to operating WorldCom in accordance with the highest ethical standards."

The company asked KPMG to conduct a comprehensive audit of the financial statements for 2001 and 2002 and said it will issue unaudited financial statements for 2001 and for the first quarter of 2002 as soon as practicable. When an audit is completed, the company will provide new audited financial statements for all required periods, it said.

"I want to assure our customers and employees that the company remains viable and committed to a longterm future," Sidgmore said. "Our services are in no way affected by this matter, and our dedication to meeting customer needs remains unwavering.

Even before the report aired, the company's stock was a shadow of what it once was. WorldCom has been dogged for months by worries about its debt load, and in the spring, longtime CEO Bernie Ebbers stepped down from his post.

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