WorldCom presntation
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Transcript of WorldCom presntation
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8/12/2019 WorldCom presntation
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The FraudGroup Members:
Jake - Cenk TolunayYan Wang
Hong Ma
Yuhong Zhang
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Background
Started as a small long
distance service provider calledLDDS in Mississippi in 1983
Grew with acquisitions in the 90s- Gone public in 1989
- 4th
largest in with $1.5 billion revenue in 1993 Changed its name to WorldCom in May 1995
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Background
Became number two telecom
company in 1998 after MCI
merger ($34.5 billion)
Aggressive accounting
practices surfaced in 01 Bankrupt in December
2001
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What Happened
Bernard J. Ebbers (CEO) principalbusiness strategy: growth through
acquisitions The currency is the WorldCom stock
The peak: Acquisition of MCI in 98
End of acquisitions with the forcedabandon of Sprint merger because ofantitrust objections
CEOs pressure on subordinates (Mr.Sullivan CFO) to feed Wall Streetsdouble digit expectations
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What Happened
Line costs are network
lease cost which is more
than half of expenditures The target: maintain the
line cost to revenue ratioconstant at 42% all cost
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What Happened
$3.8 billion of line coststransferred to capitalexpenditures between 2001and 2002
Another $3.8 billion was inimproperly reported earningsbefore taxes for 99, 00, 01
and first quarter 02. $ 80 billion write off on the
assets
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What Happened
Use two main methods to manipulate earnings
Reduction of line costJune 25, 2002, $3.852 billion
August 8,2002, $3.330 billion
Total $7.182 billion
Inflation of revenue
Identified improper $958 millionQuestionable $1.107 billion
Total $2.065 billion.
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Line Cost Reduction
1999 and 2000
Releases of Accruals to Reduce Line Costs
2001 and early 2002
Capitalization of operating line costs
103 140
396
493
683
832 862
771
606
744
942
798
0
200
400
600
800
1000
2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02
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Releases of Accruals to Reduce Line CostsProper accounting procedure for the accruals
Line Cost Reduction
Estimate cost
Recognize & Expense
Accrual the liability
Pay bill & reduce accrual
Adjustment of accrual
WorldComs violation
1. Release accrual without
analysis
2. Kept excess accruals
3. Release reserved accruals
to reduce cost
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Capitalization of Line Costs
Increase in line cost
$17,802$18,332$14,980
200120001999
Why:
Long-term, fixed rate contract
Line Cost Reduction
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Line Cost Reduction
Capitalization of line cost
Ongoing, operating expenses needrecognize immediately.
Capitalized it to exaggerate its pre-tax
incomeI/S
Line Cost
Depreciation
..
Pre-tax
income
B/S
Capitalexpenditure
A/D
Total asset
Shift to
Postpone offset to
revenue
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Line Cost Reduction
99 Adjusted 2000 Adjusted 2001 Adjusted 2002 1Q Adjusted
Revenu
e
35,908 35,908 39,090 39,090 35,179 35,179 8,120 8,120
Linecost 14,739 15,337 15,462 18,332 14,739 17,802 3,479 4,277
Gross
Profit
21,169 20,571 23,628 20,758 20,440 17,377 4,641 3,843
Operatin
g income
7,888 7,290 8,153 5,283 3,514 451 843 45
Net
Income
4,013 3,415 4,153 1,283 1,501 -1,562 172 -626
Asset 91,072 91,072 98,903 98,903 103,914 101,226 103,803 100,297
Gross
Margin
59% 57% 60% 53% 58% 49% 57% 47.30%
Profit
Margin
11% 9.50% 10.60% 3.30% 4.20% -4.40% 2.10% -7.70%
ROA 4.40% 3.70% 4.20% 1.30% 1.40% -1.50% 0.18% -0.60%Line
cost E/R
41% 42.70% 39.50% 47% 41.80% 50.60% 42.80% 52.60%
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Revenue Inflation
WorldCom revenue manage mechanism
MonRev
MCI billings WorldCom billings
Sales channels and
segments
Detailed Revenue
data
trends in the
business
segments,
customer
analyses
Corporate Unallocated
sale of a corporate asset
change of accounting policy
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Revenue Inflation
Specific Revenue items
Minimum Deficiency reserves 4th Q of 99 4th Q of 2001 : $312 million
Arise from customer agreements that
permit a telecommunications company tobill customers for usage amounts that fallbelow contractual minimum.
Those charges are rarely collected later.
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Revenue Inflation
Minimum Deficiency reserves
When collectibility cannot be established
with reasonable assurance, GAAP doesnot permit recognition of revenue
From the second quarter of 2000, release
Collectibility is establishedB/S:
A/R
Recognize
I/S:
revenue
Offset
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Revenue Inflation
Specific Revenue items
Customer Credits
2nd Q of 2001 1st Q of 2002 : $215million
Be treated as discounts, rebates or
adjustments. It should be reported as a reduction of
revenue on the income statement.
Contra-revenue account Bad debt expense
Customer Credit Miscellaneous expense
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Revenue Inflation
Specific Revenue items
Early Termination Charges 2nd Q of 2001 3rd Q of 2001 : $30
million
Based on rarely enforced contractualprovisions with customers
Main part of this amount from anaccount will never collect.
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Revenue Inflation
Adjustment of financial data for revenue only
99 Adjusted 2000 Adjusted 2001 Adjusted 2002 1Q Adjusted
Revenu
e*
35,908 35,703 39,090 38,762 35,179 34,821 8,120 8,053
Line
cost
14,739 14,739 15,462 15,462 14,739 14,739 3,479 3,479
Gross
Profit
21,169 20,964 23,628 23,300 20,440 20,082 4,641 4,574
Net
Income
4,013 3,808 4,153 3,825 1,501 1,313 172 150
Asset 91,072 91,072 98,903 98,903 103,914 103,914 103,803 103,803
GrossMargin
59% 58.70% 60% 60% 58% 57.60% 57% 56%
Profit
Margin
11% 10.60% 10.60% 9.80% 4.20% 3.70% 2.10% 1.80%
ROA 4.40% 4.20% 4.20% 3.90% 1.40% 1.26% 0.18% 0.13%E/R 41% 41.20% 39.50% 39.80% 41.80% 42.30% 42.80% 43.20%*Questionable revenue inflation is not included.
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What Happened
Adjustment of financial data for line cost and revenue
99 Adjusted 2000 Adjusted 2001 Adjusted 2002 1Q Adjusted
Revenu
e*
35,908 35,703 39,090 38,762 35,179 34,821 8,120 8,053
Line
cost
14,739 15,337 15,462 18,332 14,739 17,802 3,479 4,277
Gross
Profit
21,169 20,366 23,628 20,430 20,440 17,019 4,641 3,776
Net
Income
4,013 3,210 4,153 955 1,501 -1750 172 -648
Asset 91,072 91,072 98,903 98,903 103,914 101,226 103,803 100,297
Gross
Margin
59% 57% 60% 52.70% 58% 48.80% 57% 46.90%
Profit
Margin
11% 8.90% 10.60% 2.50% 4.20% -5% 2.10% -8%
ROA 4.40% 3.50% 4.20% 1% 1.40% -1.70% 0.18% -0.62%
E/R 41% 42.90% 39.50% 47% 41.80% 51% 42.80% 53.10%*Questionable revenue inflation is not included.
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Management Incentives
Conceal the poor performance
Maintain high stock value Boost compensations
CEOs generous giveaways
One of the highest pay for a CEO in the US
Bonus plan that promoted the short term growth
M t I ti
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Management Incentive
Mr. Sullivans Estate
$15 million mansionin Florida
18-seat movie
theater Two-story boathouse
Domed exerciseroom
Art gallery
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Warning Signs
From 1999 to 2000
Revenue increasedfrom $37,120M to$39,090M
Cost of goods solddecreased from$15,951M to$15,462M
Operation efficiency
constant
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
1999 2000
Revenue COGS
i Si
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Warning Signs
From 1999 to 2000
Net income increased from $4,013M to$4,153M
Accounts receivable increased from
$5,746M to $6,815M Free cash flow decreased from $2,289M
to $(3,818)M
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Warning Signs
From 1998 to 2001
The increase of expense
exceed the growth of
revenue
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
1999 2000 2001
Revenue change(%)
Expense change(%)
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Consequences
Stock
Mid 1999 - $64.50 a share
Prior fraud announcement
- $2 a share
After announcement
- below $1 a share
Today - $.06 a share
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Consequences
C
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Consequences
BankruptcyJuly 21st, 2002 WorldCom filed
for Chapter 11 bankruptcy protection
Layoff
New CFO
Fraud ChargeFederal prosecutors charged former CFO andcontroller with securities fraud, conspiracy and
filing false statements with the SEC
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Question
Is it really worth manipulating the
financial numbers for the long term?