Qwest, WorldCom Under Scrutiny

WorldCom disclosed Tuesday night that it overstated its cash flow by almost $4 billion over the last 16 months, and the accounting of as much as $1.4 billion in Qwest Communications fiber sales is being questioned.

by Brian Morrissey and Jim Wagner of internetnews.com [June 27, 2002]

WorldCom disclosed Tuesday night that it overstated its cash flow by almost $4 billion over the last 16 months, putting the telecom giant's future in grave doubt and adding it to the list of former corporate titans felled by shady bookkeeping.

The already troubled telecom said an internal audit had discovered the company overstated its cash flow by $3.8 billion over the past five quarters, wiping out a $1.4 billion profit in 2001 and $130 million in the first quarter of 2002.

The disclosure might be the coup de grace for the nation's second-largest long-distance carrier, which has faced a host of problems, from a Securities and Exchange Commission (SEC) investigation to a crushing $30 billion in debt to the sudden resignation of its CEO.

In an attempt to salvage the company, WorldCom announced it would cut 17,000 of its 85,000 employees. WorldCom also fired its chief financial officer, Scott Sullivan.

"Certainly, in the near term it looks like things are going to be very dicey," said Giga Information Group telecom analyst Lisa Pierce. "This is certainly going to make customers who are thinking of signing with WorldCom rethink how much they should be committing to them."

Pierce said she had already fielded calls from concerned customers of WorldCom's Falls Church, Va.-based UUNet unit, which provides corporate Internet services.

"The questions come down to the stability" of the company, she said. "Some customers may find they are obligated to continue with the carrier they are with until they have fulfilled their obligations."

But with WorldCom's future in the balance, UUNet customers run the risk of major disruptions. Pierce said she is advising businesses using UUNet to diversify their risk profile by shifting some contracts to another provider, such as Sprint or Genuity. But in the hard-hit telecom sector, stability is a tough commodity to come by.

"We don't know where another shoe is going to drop with another facilities provider," Pierce added.

WorldCom said its internal audit had revealed that Sullivan had improperly accounted for network maintenance as a capital investment, allowing WorldCom to sweep expenses off its balance sheets.

The company's auditor during the period was Arthur Andersen.

The news comes just two months after WorldCom was rocked by the resignation of Bernie Ebbers, its longtime CEO. Ebbers left under a cloud created by $366 million in loans and loan guarantees the company made to him in the days when WorldCom's stock was flying high.

After helping found WorldCom in 1985, Ebbers built the Clinton, Miss., company from a mid-tier telecom to the second largest through a five-year acquisitions binge highlighted by the $30 billion merger with Sprint in 1998.

WorldCom's demise is the latest blow to the severely depressed telecom sector, which has been battered by high debt loads, over-expansion, and weak demand.

Yesterday morning, shortly after the opening bell, Nasdaq halted trading of WorldCom's shares, which had plunged to sell at 83 cents.

In addition to Global Crossing's retreat into Chapter 11 protection in January, the sector has seen former up-and-comer Qwest Communications teeter under federal probes and high debt. The SEC is probing the company's accounting, while its chief executive, Joseph Nacchio, resigned last week.

As much as $1.4 billion in Qwest Communications fiber sales are under the Securities & Exchange Commission (SEC) microscope as part of an accounting probe begun in February.

According to a report in The Wall Street Journal, Qwest's outside lawyer, Jonathan Schiller, called the accounting practices "reasonable" and hoped the SEC saw it that way, too.

Federal officials first targeted the incumbent local exchange carrier (ILEC) back in February, when the agency was looking into questionable accounting practices conducted by Qwest peer Global Crossing.

WorldCom was also implicated in the same probe, which prompted that company's descent into a possible bankruptcy. Reports Wednesday indicate the carrier bloated it's pre-earnings before interest, taxes, depreciation and amortization (EBITDA) by almost $4 billion. It's also reported the carrier will lay off 17,000 of its workers at week's end.

Qwest's auditors, Arthur Andersen, were included in the probe.

One of the main issues of the SEC probe is the telecom carriers' reporting of indefeasible right of use (IRU) deals. Also called "swapping," Qwest would purchase a certain amount of Global Crossing bandwidth over a 20-year span while Global Crossing would purchase a similar amount of bandwidth from Qwest. In the accounting books, the swaps were considered revenue and beefed up the profit margin.

Qwest officials were unavailable for comment at press time.

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