WorldCom, the nation's second-largest long-distance carrier, said last night that it had overstated its cash flow by more than $3.8 billion during the past five quarters in what appears to be one of the largest cases of false corporate bookkeeping yet.
The discovery of the problem in an internal audit throws the survival of WorldCom and MCI, the long-distance company it acquired in 1999, into doubt. The company, which already was the subject of a federal investigation into its accounting practices, has been struggling to refinance $30 billion in debt. Its credit was relegated to junk-bond status last month, and even before last night's announcement, the stock price was down more than 94 percent so far this year.
Some analysts see a bankruptcy filing as a strong possibility, which would follow the pattern of Enron, Global Crossing and other companies laid low by accounting scandals since last fall. In an effort to avoid that fate, WorldCom said last night that it would cut 17,000 employees, or one-fifth of its work force. Analysts had been expecting a job cut of that magnitude for several weeks.
Instead of the profit of $1.4 billion the company reported in 2001 and $130 million in this year's first quarter, WorldCom says it lost money during those periods, although it did not say how much.
In disclosing the bookkeeping problem, WorldCom said it had fired its chief financial officer, Scott D. Sullivan, the executive widely credited with helping orchestrate the financial strategy during the mid-to-late 1990s that enabled WorldCom to rise from a second-tier telecommunications company to a world giant through a series of acquisitions that included the $30 billion purchase of MCI in 1998.
Sullivan had been the executive closest to Bernard J. Ebbers, the company's longtime chief executive, who abruptly resigned in April, owing WorldCom more than $366 million for loans and loan guarantees the company had made to him.
WorldCom's board said it had fired Sullivan after discovering a strategy in which operating costs like basic network maintenance were booked as capital investments, an accounting gimmick that enabled WorldCom to hide expenses and inflate its cash flow and profits.
Until last month, WorldCom's auditor had been Arthur Andersen, the accounting firm that also audited the books of Enron and Global Crossing. WorldCom replaced Arthur Andersen with KPMG last month and said last night that it had asked KPMG to undertake a comprehensive audit of the company's financial statements for 2001 and 2002.
"Our senior management team is shocked by these discoveries," said John W. Sidgmore, who became WorldCom's chief executive after Ebbers left in April. "I want to assure our customers and employees that the company remains viable and committed to a long-term future."
But it remains to be seen how WorldCom's customers will react to the disclosure of the huge accounting irregularities. In addition to providing millions of consumers with long-distance service through its MCI unit, WorldCom sells sophisticated data communications services to many of the world's largest companies.
WorldCom, which had a peak value of $115.3 billion in June 1999 when its shares reached a high of $62, is now worth less than $1 billion. Its stock, which had already been down more than 94 percent for the year before last night's disclosure, plunged as low as 26 cents in after-hours trading last night.
In addition to firing Sullivan, WorldCom's board said it had accepted the resignation of David Myers as senior vice president and financial controller. The company said it had notified the Securities and Exchange Commission, which already had been investigating the company's accounting.
WorldCom also said it was hiring William R. McLucas, former chief of the SEC's enforcement division, to conduct an independent investigation.
The company said last night that it had informed its main bank lenders of the bookkeeping problems. It is in tense negotiations with its banks, a group led by Citigroup, Bank of America and J.P. Morgan Chase, about restructuring lines of credit worth about $5 billion.
Last night's disclosure is expected to add to the problems of telecommunications companies to arrange financing as the industry's long slump continues.
"This is horrible for the industry," said Susan Kalla, senior telecommunications analyst at Friedman, Billings & Ramsey. "If we can't hang our hat on historical numbers, why should we believe in the present figures?"
The size of WorldCom's restatement surprised even hardened short-sellers - investors who profit when stocks fall and generally view corporate America with skepticism.
"I'm kind of shaken by that," said James Chanos, a short-seller who played a major role in unearthing Enron's overstated profits and hidden debt. "I'm about as cynical as they come. It's pretty amazing."
Particularly disturbing, Chanos said, is that WorldCom had manipulated its cash flow statements, not just its reported earnings. Investors used to believe that cash flow was a more reliable indicator of a company's financial health because the number could not be manipulated as easily as earnings, but that assumption appears to be wrong. WorldCom joins a list that includes Dynegy Inc., Adelphia Communications Corp. and Tyco International Ltd. as companies that have apparently used financial gimmicks to inflate their cash flow.
"The one touchstone that investors had was that you couldn't fudge cash flow numbers, but apparently you can," Chanos said. WorldCom's news rattled investors in other companies. In after-hours trading, technology and telecom stocks and broad market indexes plunged after word of the accounting problem, first reported by the financial news cable network CNBC.
Stocks had already fallen in regular trading yesterday. The Nasdaq 100 index, composed mainly of big technology stocks, fell almost 3 percent in after-hours trading, and the Standard & Poor's 500 index of major companies dropped more than 1.5 percent.