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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

or

Commission File Number 001-10415

WorldCom, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (703) 886-5600

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

WorldCom Group Stock, $.01 Par Value

MCI Group Stock, $.01 Par Value

Rights to Purchase Series 4 Preferred Stock

Rights to Purchase Series 5 Preferred Stock

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

The aggregate market value of the voting and non-voting common equity of the registrant held by non-affiliates of the registrant as of June 30, 2002, based on the average bid and asked prices of its WorldCom Group Stock on the over-the-counter market on such date of $0.83 per share and the average bid and asked prices of its MCI Group Stock on the over-the-counter market on such date of $1.08 per share, was approximately $2.6 billion. As of December 31, 2003, there were outstanding 2,970,796,599 shares of WorldCom Group Stock and 118,733,605 shares of MCI Group Stock, net of treasury shares.

DOCUMENTS INCORPORATED BY REFERENCE:

None

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

The following statements (and other statements made by us) are or may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995:

(i) any statements contained or incorporated herein regarding possible or assumed future results of operations of our business, pricing trends, anticipated benefits from The Neighborhood, the markets for our services and products, anticipated capital expenditures, regulatory developments, or competition;

(ii) any statements preceded by, followed by, or that include the words “intends,” “estimates,” “believes,” “expects,” “anticipates,” “plans,” “projects,” “should,” “could” or similar expressions; and

(iii) other statements contained or incorporated by reference herein regarding matters that are not historical facts.

You are cautioned not to place undue reliance on these statements, which speak only as of the date this document is filed. These statements are based on management’s current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these expectations due to our bankruptcy proceedings and matters arising out of pending class action and other lawsuits and the ongoing internal and government investigations related to the previously announced restatements of our financial results. Other factors that may cause actual results to differ materially from management’s expectations include, but are not limited to:

The cautionary statements contained or referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We undertake no duty to update these forward-looking statements, even though our situation may change in the future.

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PART I

ITEM 1. BUSINESS

Overview

We are one of the world’s leading global communication companies, providing a broad range of communication services in over 200 countries on six continents. Each day, we serve thousands of businesses and government entities throughout the world and provide voice and Internet communication services for millions of consumer customers. We operate one of the most extensive communications networks in the world, comprising approximately 98,000 route miles of network connections linking metropolitan centers and various regions across North America, Europe, Asia, Latin America, the Middle East, Africa and Australia. We own one of the most extensive Internet protocol backbones, and we are one of the largest carriers of international voice traffic.

Since April 2003, we have conducted our business primarily using the brand name “MCI.” Our company, WorldCom, Inc., was incorporated under the laws of the State of Georgia in 1983 and operates its business through direct and indirect domestic and foreign subsidiaries. References in this annual report to WorldCom, MCI, we, our and us are to WorldCom, Inc. and its subsidiaries unless the context otherwise requires. Our website address is www.mci.com, and we make available free of charge through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file the material with, or furnish it to, the Securities and Exchange Commission (“SEC”). Our principal executive offices are located at 22001 Loudoun County Parkway, Ashburn, Virginia 20147 (telephone number 703-886-5600).

Bankruptcy and Related Investigations and Other Significant Recent Events

Bankruptcy. In July 2002, WorldCom, Inc. and substantially all of its U.S. subsidiaries filed voluntary petitions for relief in the U.S. Bankruptcy Court for the Southern District of New York under Chapter 11 of Title 11 of the U.S. bankruptcy code. We continue to operate our businesses and manage our properties as debtors-in-possession, and we have filed a plan of reorganization with the Bankruptcy Court. On October 31, 2003, the Bankruptcy Court confirmed our plan of reorganization and, subject to certain conditions, we currently expect to emerge from bankruptcy in 2004. Upon emergence, we will change our legal name to MCI, Inc. and will reincorporate as a Delaware corporation.

Restatement of Previously Issued Financial Statements. Since June 2002, we have undertaken a comprehensive review of our previously issued consolidated financial statements after it was determined that the statements were not prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). As a result of this review, we have restated our previously reported consolidated financial statements for the fiscal years ended December 31, 2001 and 2000. The consolidated financial statements in this Annual Report on Form 10-K, including the restated consolidated financial statements for 2001 and 2000, have been audited by KPMG LLP (“KPMG”), which replaced Arthur Andersen LLP (“Andersen”) as our external auditors in May 2002. These consolidated financial statements include restatements of earnings, write-downs of goodwill, other intangible assets and property, plant and equipment and other adjustments made in connection with our review. The adjustments resulted in a cumulative net reduction to shareholders’ equity of $70.8 billion as of December 31, 2001 and a reduction in previously reported net income attributable to common shareholders of $17.1 billion and $53.1 billion for the years ended December 31, 2001 and 2000, respectively. In addition, the $44.9 billion of goodwill reflected in our previously issued consolidated financial statements has been reduced to zero at December 31, 2001. The carrying values of property, plant and equipment and other intangible assets reflected in our previously issued consolidated financial statements as of December 31, 2001 and 2000, $44.4 billion and $42.8 billion, respectively, have been adjusted to their estimated aggregate value of approximately $23.8 billion as of December 31, 2001. For more information regarding the restatement, see “Item 7—

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Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 4 to our consolidated financial statements contained elsewhere in this Annual Report on Form 10-K.

SEC Proceedings. Our past financial reports have also been the subject of a civil action filed by the SEC on June 26, 2002. Since then, we have consented to the entry of a permanent injunction and related orders imposing on us certain ongoing obligations dealing with internal controls and corporate governance issues. We have agreed to adopt and implement recommendations made in the August 26, 2003 report “Restoring Trust” issued by Richard C. Breeden, who is a former Chairman of the SEC and who was appointed our Corporate Monitor by the U.S. District Court for the Southern District of New York in July 2002. Mr. Breeden has served as Corporate Monitor throughout our SEC and bankruptcy proceedings. Also, we have agreed upon a settlement with the SEC regarding a civil penalty that we will satisfy upon our emergence from bankruptcy by payment of $500 million and the transfer of newly issued MCI common stock having a value of $250 million.

Special Committee Investigation. On the date of filing petitions for relief under the bankruptcy code, a Special Committee of our Board of Directors was established to investigate our accounting practices and any other matters the Special Committee deemed appropriate to consider. The committee was comprised of three newly elected directors and the Corporate Monitor, and, with the assistance of special legal counsel and financial advisors, issued its Report of Investigation dated as of March 31, 2003.

Other Accounting-Related Investigations. Our past accounting practices are also under investigation by the U.S. Attorney’s Office for the Southern District of New York (the “U.S. Attorney’s Office”) and the Examiner appointed by the Bankruptcy Court, Richard Thornburgh, former Attorney General of the United States. The Examiner has issued three reports regarding, among other things, corporate governance matters and past accounting practices.

Call-Routing Investigations. The U.S. Attorney’s Office is also investigating our practices related to the routing of voice and data traffic that originates or terminates on the networks of local exchange companies. In addition, the Enforcement Bureau of the Federal Communication Commission (the “FCC”) is reviewing our call routing practices. We are cooperating fully with the U.S. Attorney’s Office and the FCC and are conducting our own internal review of our practices. Based on our preliminary findings, we believe that our current practices comply with all legal and regulatory requirements.

Oklahoma Proceedings. In August 2003, the Attorney General of Oklahoma filed a criminal action against us and six former WorldCom executives alleging violations of Oklahoma securities laws. We have entered a not guilty plea to the charges against us.

Lifting of Proposed GSA Debarment. On July 31, 2003, the U.S. General Services Administration (the “GSA”) issued a Notice of Proposed Debarment, which would exclude us from new federal programs, but not affect our existing contracts with federal government customers. After we addressed the GSA’s concerns about our internal controls and ethics program, the GSA lifted the proposed debarment on January 7, 2004, and we are again eligible to receive new federal government business and contract extensions.

Changes to Management and Board of Directors. Since January 2002, we have made extensive changes in the composition of our senior management and our Board of Directors. On April 29, 2002, Bernard Ebbers resigned as our President and Chief Executive Officer. In addition, we subsequently terminated or accepted the resignations of various financial and accounting personnel involved in the preparation of the financial statements referred to above, including our then chief financial officer and corporate controller.

On December 16, 2002, Michael D. Capellas joined MCI as our Chairman and Chief Executive Officer. We have also appointed a new President and Chief Operating Officer, a new Chief Financial Officer, a new General Counsel, a Chief Ethics Officer, a new Treasurer, a new Corporate Controller, a new head of Human Resources,

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and a new Chief of Staff. In addition, we have accepted the resignations of all members of our Board of Directors who served at the time we filed for bankruptcy. In the summer of 2002, we appointed three new directors. We have also appointed seven additional individuals to be new members of our Board of Directors, and their appointments will be effective on the date our plan of reorganization becomes effective.

For additional information on the above matters, see “Item 3—Legal Proceedings” and “Item 10—Directors and Executive Officers” below.

Company Background

Since our inception, we have grown significantly as a result of numerous acquisitions. On September 14, 1998, we acquired MCI Communications Corporation, one of the world’s largest providers of telecommunications services. On October 1, 1999, we acquired SkyTel Communications, Inc. (“SkyTel”), a leading provider of messaging services in the United States. On July 1, 2001, we acquired Intermedia Communications Inc. (“Intermedia”), a provider of voice and data services, and, as a result, a controlling interest in Digex, Incorporated (“Digex”), a provider of managed web and application hosting services. On November 17, 2003, we acquired the remaining equity interests in Digex.

Business Segments

We operate primarily through three business units, each of which focuses on the communication needs of customers in specific market segments:

We also own approximately a 19% economic interest and a 52% voting interest in Embratel Participações S.A. (“Embratel”), which is a Brazilian voice and data communications company. Because we own a controlling interest in Embratel, we consolidate Embratel in our consolidated financial statements. Embratel is operated by its own management and employees. On November 12, 2003, we announced our intention to sell our interest in Embratel.

The table below shows the revenues of our business segments for each of the three years in the period ended December 31, 2002. Other revenues include fees earned from telephone companies that terminate calls on our network and other revenues not allocated to our business segments. See Note 23 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further information on the results of our business segments.

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Strategy

Our strategic objective is to become the industry leader in Internet, data and voice communications. To achieve this objective, we aim to:

Industry and Market Overview

We estimate that approximately $1 trillion was spent worldwide in 2002 on telecommunication services, and about two-thirds of this amount was spent on fixed wireline services including voice, data and Internet communications. The United States accounts for approximately 40% of worldwide spending on fixed wireline services and is the largest individual market.

We have strategically positioned ourselves for the increasing global nature of communications with one of the world’s most extensive owned and operated networks. Our primary operations are in the largest market, which is the United States. This is augmented with network facilities, local offices and operations centers around the world to directly serve expanding customer needs for global communications. The benefits for our customers include the ease and simplicity of dealing with a single company for worldwide communications and the uniformity with which their needs are satisfied. We believe that this strategic position gives us a distinct competitive advantage in serving multinational companies and other entities engaged in worldwide communications.

The large size of the communications industry reflects the high level of growth achieved during the 1990’s. Through extraordinary levels of capital investments plus technological advancements, the capacity of

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communication networks increased at a rate even greater than the significant increase in customer spending on communications services during this period. More recently, slower growth in the communications industry, coupled with a general economic slowdown, has led to excess network capacity and changing customer requirements. Because of this changing environment, as well as operating limitations resulting from our bankruptcy proceedings, we have reduced our annual capital expenditures, and we are currently focusing on enhancements to the efficiency, functionality and reliability of our network operations, improvements in our customer service and the development of additional value-added services.

In the U.S. in 2002, we estimate that medium and large size businesses spent approximately $120 billion on fixed wireline voice, data and Internet services. Our Business Markets customers include such businesses and they are emphasizing the need for increased efficiency and productivity and are willing to outsource greater portions of their communication networks and the management of them. We believe that we should benefit from these developments since a key competitive strength is our sales, service and technical teams, who have extensive knowledge of network engineering and technology in addition to a thorough understanding of the communication needs of our customers. For many of our larger customers, our sales personnel and account representatives have long-standing customer relationships that have enabled the development of mutual understanding and shared experience in successfully solving communications problems.

We estimate that in 2002 U.S. consumer and small business spending on fixed wireline services was almost $90 billion and $50 billion, respectively. Our Mass Markets unit serves customers in both of these market segments. We believe that about one half of U.S. consumer spending in 2002 was on local telephony services, about one fourth on long distance services and the remainder on Internet access and other services. We estimate that half of U.S. small business spending on fixed wireline services in 2002 was on local and long distance services and half on Internet and data services.

The market for telecommunications services is subject to intense competition, regulatory changes, product substitution, decreasing differentiation among service providers and statutory limits on telemarketing activities. As a result, there have been significant shifts in the share of the overall market accounted for by the various segments and decreasing prices. In addition, several companies have experienced severe financial pressures and some, including our company, have declared bankruptcy and undertaken financial reorganization. Other competitors have exited the market and, in some cases, been forced to liquidate.

The Telecommunications Act of 1996 (the “Telecom Act”) has substantially changed the regulatory environment within the voice telephony market by enabling regional telephone companies to provide long distance calling services. As of the end of 2003, all of the regional phone companies have received FCC approval to offer long distance in each of the states in their respective regions. This regulatory change has provided important competitive advantages for regional companies operating as incumbent local exchange carriers due to their historic monopolistic control over local markets and their resulting ability to bundle local and long distance service as well as high speed Internet access services.

While the regional telephone companies have benefited from gaining access to the long distance market, the Telecom Act has also created expanded opportunities for us and other companies to compete in the markets for local service. The Telecom Act established a framework that enables non-incumbent companies to purchase certain network capabilities from incumbent local exchange carriers. As a result, we and other companies have become competitive local exchange carriers and are providing local voice service in numerous areas of the United States. By the end of 2002, the competitive local exchange carriers had less than a 15% share of the market for local telephony services but were seeking to grow their presence in the local markets. However, the ongoing ability of competitive local exchange carriers to compete in these markets will depend upon the continuation of fair regulatory rules and economical prices for the purchase of network capabilities from the incumbent local exchange carriers.

In the international markets, we estimate that business customers spent approximately $190 billion in 2002 on fixed wireline data, Internet and voice communication services. While many international markets are

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growing more rapidly than the U.S. market, the structure and competitive conditions of the telecommunications industry varies from country to country. In most countries, we compete with incumbent communications providers that have historically dominated the markets for local, long distance and international service within the country. Some of the incumbents continue to be wholly or partially government-owned and some have special regulatory status along with exclusive rights to provide certain services. In addition to the incumbents within each country, we compete with international carriers like AT&T and Cable & Wireless and, in some countries, with companies that are affiliated with an incumbent in another country, such as Equant, which is an affiliate of France Telecom, and BT Global Services, which is a division of British Telecom. Compared to other non-incumbent companies in the international markets, we differentiate ourselves by having owned or leased network facilities in most of the major markets worldwide.

Business Markets

Our Business Markets unit is one of the world’s leading providers of services to meet the technologically complex data and voice communication needs of large domestic and multinational businesses, medium size domestic businesses, as well as numerous federal, state, local and foreign government entities. Business Markets also provides wholesale network capacity and switching services to large Internet service providers, leading wireline and wireless telephone companies and cable television companies.

The revenues of our Business Markets unit represented 52.7% of our consolidated revenues in 2002, 54.2% in 2001 and 53.7% in 2000.

Services

Business Markets offers the following Internet, data, voice and managed services to businesses and governments:

Internet Services

Business Markets offers a comprehensive range of alternatives for customers to access the Internet. In addition, Business Markets provides sophisticated value-added services that make Internet communications more economical, efficient, reliable and secure as well as easier, faster and more effective in conveying data, information and entertainment. Although not currently comprising the largest portion of Business Markets’ revenues, Internet Services are an area of strategic focus that we are seeking to grow using both our position as owner of one the most extensive Internet protocol (“IP”) backbones as well as our considerable IP expertise.

Access services are built around our global Internet backbone providing connectivity in more than 2,700 cities in over 200 countries. Business Markets enables customers to access the Internet through dedicated broadband lines with speeds ranging from 768 kilobits per second to Gigabit Ethernet (equal to one billion bits per second) and up to OC-48 (2.5 billion bits per second). For customers using dial-up access, Business Markets uses approximately 3.2 million modems located throughout the world. Once connected, the customer’s traffic is routed over our networks to the desired location, whether on our network or elsewhere on the Internet.

Business Markets also provides Internet-based virtual private networks (“VPNs”) to customers desiring a high level of security when connecting their operating facilities, data centers, remote sites or mobile users over the public Internet. VPN services include encryption, bandwidth prioritization and centralized continuous monitoring and management. Customers for these services are attracted to the combination of using the low-cost public Internet network with the reliability and security we provide.

For high volume customers that desire a higher level of security and reliability for their VPN networks, Business Markets provides private Internet protocol (“PIP”) networks. We furnish PIP services using multi-protocol label switching (“MPLS”) to deliver voice, data and video traffic over our IP backbone network. Our use of MPLS also enables customers to continue utilizing their existing non-IP data and voice networks as they transition over time to operating on standard IP protocol.

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In addition, Business Markets provides web hosting services that enable customers to outsource portions of their Internet operations so that they can more rapidly and cost-effectively provide online information and business transaction capabilities to their own customers and to employees, suppliers, investors and other interested parties. These services are offered to customers directly by MCI and through our Digex subsidiary and are provided through 184 standard data centers and 20 premium data centers that operate 24 hours a day with enhanced service levels. The web hosting services of Business Markets include technical support and performance management for hardware, operating systems and applications. Other web hosting services include database management, server collocation, storage services, customized web site activity reporting, stress testing, firewall management, virus detection and elimination and other enhanced security services.

Internet services revenues of Business Markets were $3.6 billion (11.2% of our consolidated revenues) in 2002, $3.9 billion (10.4% of our consolidated revenues) in 2001 and $3.4 billion (8.4% of our consolidated revenues) in 2000.

Data Services

Business Markets uses our frame relay, asynchronous transfer mode and Internet protocol networks to provide high bandwidth data transmission services over both public and private networks.

Frame relay services allow cost-effective and secure high-speed interconnection of data centers, local area networks, remote facilities, branch offices, point of sale terminals and other sites that send or receive data. Frame relay is a high-speed communications technology that divides the information into frames or packets. Through our frame relay switches strategically located in 47 countries and our correspondent relationships, Business Markets offers frame relay services in over 70 countries. In addition, our network access relationships with other communication companies enable customers to access frame relay locations in most countries in the world.

Asynchronous transfer mode (“ATM”) services enable the integration of data, voice, video and multimedia communications over a single network. This consolidation of applications onto one network reduces network, equipment and operational costs. Through our ATM switches in 21 countries and interconnects with other data networks, Business Markets can extend ATM connectivity throughout most of the world.

For customers with high volume data transmission requirements or the need for heightened levels of security or availability, Business Markets provides private line services in which a customer contracts for the use of a specific circuit on a dedicated basis. The private line connects directly to our network, thereby reducing originating access costs compared to using “switched” access that is shared among many network users. Business Markets offers dedicated circuits as Metro Private Lines between two points in a single metropolitan area, Domestic Private Lines linking points within the United States and International Private Lines connecting points around the world.

For customers with less demanding data transmission requirements, Business Markets connects the customers to our network using switched access. For these services, Business Markets charges the customer based on the time that its network and switch facilities are utilized.

Data services revenues of Business Markets were $7.5 billion (23.4% of our consolidated revenues) in 2002, $9.1 billion (24.3% of our consolidated revenues) in 2001 and $9.0 billion (22.8% of our consolidated revenues) in 2000.

Voice Communication Services

Through our local, long distance and international voice communication services, the customers of Business Markets can call to anywhere in the United States and to virtually any telephone number around the

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world. High volume customers are connected to our global voice network through dedicated access lines, while lower volume customers are connected through switched access provided either by us or an incumbent local exchange carrier. Besides traditional telephone service, Business Markets also offers its customers calling cards, voice messaging, speed dialing and information service access.

In addition, Business Markets offers its customers the following value-added voice communication services:

Voice services revenues of Business Markets were $5.8 billion (18.1% of our consolidated revenues) in 2002, $7.4 billion (19.5% of our consolidated revenues) in 2001 and $8.8 billion (22.5% of our consolidated revenues) in 2000.

MCI Solutions

The MCI Solutions group within Business Markets provides comprehensive telecommunications industry expertise and broad understanding of network technology to solve customer problems and facilitate successful execution of their business operations. In addressing a customer’s specific needs, MCI Solutions integrates specialized knowledge inside of our company with highly regarded firms outside of our company that have leading positions in relevant technical areas. We aim to deliver value-added solutions, strengthen our relationship with customers and integrate our problem-solving capabilities into the customer’s internal business process.

For customers interested in creating, expanding or altering their networks, MCI Solutions provides network planning, design, implementation and optimization services. This may involve the configuration and installation of the customer’s equipment, the design of custom or dedicated network operating centers and security services, including firewalls, virus detection and elimination and the encryption of traffic over the customer’s network for added security.

For customers operating contact centers, MCI Solutions offers a variety of enhanced services for voice contacts as well as other contact mediums such as email and web site contacts. These services include routing for work load balancing among multiple contact centers and among individual agents, as well as routing to match contacts with the skills of agents. Other services include voice recognition and speech automation. During 2003, over one billion minutes per month of enhanced voice calls were handled through these services provided by MCI Solutions.

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For customers that outsource all or portions of their communications operations, MCI Solutions provides a variety of managed network services. These services extend from the operation and maintenance of individual network devices to the complete management of sophisticated global networks. Activities conducted on behalf of our clients include network monitoring and trouble-shooting, on-site repair services and the management of applications such as e-mail and other business programs that are used across a business enterprise or government agency. As of October 2003, we managed over 2,700 customer networks, including approximately 190,000 individual devices located in 120 countries.

We do not separately account for the revenues of our managed services and solutions business. The revenues for this business are included in the revenues noted above for our Internet, data and voice communication services.

Sales and Marketing

Our Business Markets unit serves its customers through approximately 6,500 sales and support employees. These representatives include highly trained and experienced network engineering, technology and operations experts, some of whom have long-standing relationships with specific customers and whose understanding of customer communication needs is a key aspect of the market strategy of Business Markets.

Business Markets’ sales and support representatives are organized into two groups, each of which covers different market segments.

Retail Account customers generated revenues of $11.9 billion in 2002 (37.0% of our consolidated revenues).

Mass Markets

Our Mass Markets business unit is a leading provider of voice telephone and Internet communication services to residential and small business customers in the United States. Subscription services include local, long distance, and international calling, operator assisted calling, inbound toll-free services, calling card services, collect calling and Internet access. Transaction services include products such as 10-10-220, 10-10-987, 1-800-COLLECT and pre-paid calling cards.

The revenues of our Mass Markets unit represented 22.3% of our consolidated revenues in 2002, 22.1% in 2001 and 23.5% in 2000.

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Subscription Services

Mass Markets offers the following subscription services to consumers and small businesses in the United States:

Mass Markets has “The Neighborhood built by MCI” as its primary brand and product portfolio, consisting of bundled local, long distance and Internet subscription services. Using its knowledge and experience in segmenting the consumer market, Mass Markets has designed variations of The Neighborhood that appeal to consumers with varying telecommunications usage patterns and lifestyle differences. Each of the variations bundles a unique combination of services and targets a different price and feature level.

Subscription services revenues of Mass Markets were $5.8 billion (18.1% of our consolidated revenues) in 2002, $6.8 billion (17.9% of our consolidated revenues) in 2001 and $7.4 billion (18.9% of our consolidated revenues) in 2000.

Transaction Services

Mass Markets also provides transaction services where customers use long distance services on a pay-per-use, non-subscription basis.

The transaction services of Mass Markets consist of the following five branded offerings:

Transaction services revenues of Mass Markets were $1.3 billion (4.1% of our consolidated revenues) in 2002, $1.6 billion (4.1% of our consolidated revenues) in 2001 and $1.8 billion (4.6% of our consolidated revenues) in 2000.

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Sales and Marketing

Mass Markets employs a variety of sales channels to market its subscription residential and small business services to current and prospective customers. These channels include telemarketing, customer service and direct response marketing.

The primary channel for subscription services is telemarketing, which enables contact with a large and diverse number of individuals as well as a favorable cost to gain additional customers. Mass Markets utilizes both its own employees and outsourced third party telemarketing firms. In addition to contacting prospective customers, telemarketing is used to sell additional services to existing customers. Due in large part to the implementation of do-not-call lists limiting the telephone numbers accessible by telemarketing, Mass Markets is placing increasing emphasis on other sales channels (see “Regulation—Do Not Call Registries”).

Another important subscription sales channel for Mass Markets is customer service. As with telemarketing, Mass Markets operates its own customer service centers as well as outsources some customer service operations to third party firms. To increase effectiveness in assisting customers and selling additional lines and services, customer service operates 24 hours a day and provides customer support in eleven languages.

Direct response marketing for subscription services includes direct mail, television advertising, on-line marketing and the use of marketing partners to offer customers unique awards and benefits. For selling subscription services to both residential and small business customers, Mass Markets also utilizes a direct sales force which includes our own employees as well as agents.

For transaction services such as 10-10-987 and 1-800-COLLECT, we use direct response marketing, including television advertising and direct mail.

International

Our International business unit provides a broad range of Internet, data and voice communications services through a combination of our own network facilities located in 52 countries and our correspondent relationships with other carriers in more than 150 countries throughout the world.

The largest operations of our International business unit cover Europe, the Middle East and Africa (“EMEA”). Within EMEA, we operate through wholly owned subsidiaries in Austria, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Israel, Italy, Ireland, the Netherlands, Norway, Poland, Portugal, Spain, South Africa, Sweden, Switzerland and the United Kingdom. In Belgium and Luxembourg, we operate through a joint venture company. Our facilities in EMEA include a pan-European fiber optic high speed network of almost 10,000 miles that links the United Kingdom, France, Germany, Italy, Switzerland, the Netherlands and Belgium. We also operate metro area fiber optic networks in several major European cities, including London, Paris, Frankfurt, Hamburg, Dusseldorf, Amsterdam, Rotterdam, Stockholm, Brussels, Dublin, Geneva, Zurich and Milan, as well as seven data centers within EMEA connected to our network.

In the Asia Pacific region, we offer services over owned and leased facilities in Australia, New Zealand, Singapore, Hong Kong, Japan, Taiwan and South Korea. In China, Thailand, Indonesia, Malaysia, the Philippines, and India, we offer data services through commercial arrangements with several local companies. We own or lease capacity on undersea cable systems linking China, Japan, Australia and New Zealand and other countries in the Asia Pacific region and linking these countries to our networks in the United States. We also operate metro fiber optic networks in Tokyo, Osaka, Sydney, Melbourne and Singapore as well as ten data centers in Asia connected to our network. Our IP network in Asia is interconnected by a pan-Asian IP backbone and is directly connected to our global IP network.

In Latin America, we operate through wholly owned subsidiaries in Argentina, Chile, Colombia, Panama, Peru, Puerto Rico and Venezuela. In Brazil, we operate Proceda, a wholly owned outsourcing company, and

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through Embratel, which we discuss below. In Mexico, we operate through Avantel S.A., in which we own approximately a 45% economic and voting interest. We also operate SkyTel paging operations through joint venture companies in Mexico and Guatemala.

In Canada, we operate through a wholly owned subsidiary that provides voice, data and Internet services using owned and leased facilities.

The revenues of our International unit represented 10.8% of our consolidated revenues in 2002, 8.0% in 2001 and 7.1% in 2000. For percentage of revenue by region, refer to Note 23 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Services

We provide our international customers with Internet, data and voice communication services. These services are similar to the corresponding services provided by Business Markets to its customers (see “Business Markets—Services”). We also emphasize value-added services such as customized solutions for network design, configuration of customer premises equipment, proactive network monitoring, managed hosting as well as authentication, firewall and virus scanning services.

Sales and Marketing

Our International business unit generally seeks three different types of customers. The first are middle and large size businesses with the need for voice, data and Internet communications either internationally or within the countries in which they are located. The second are telecommunications carriers that purchase inter-regional and international transport services from us on a wholesale basis. The third are the branch operations of large multinational corporations that may be headquartered in the United States or overseas. Communication services to these multinational corporations are sometimes provided by our International business unit, but they are more typically Global Account customers of our Business Markets unit.

Embratel

We own approximately a 52% voting interest and a 19% economic interest in Embratel Participações S.A., which had total revenues of $3.6 billion in 2002, $4.6 billion in 2001 and $4.8 billion in 2000. On November 12, 2003, we announced that we intend to sell our economic and voting interests in Embratel and have engaged advisors to assist with the sale. As part of such a sales transaction, we plan to maintain a commercial relationship with Embratel and continue to utilize Embratel in serving our customers’ communication needs in Brazil. The sale of our ownership stake in Embratel is contingent upon our achieving satisfactory terms with a potential buyer and is subject to the approval of our board of directors, consents from any applicable regulatory agencies and third parties and, if the sale occurs prior to our emergence from bankruptcy, the approval of the Bankruptcy Court.

Embratel’s business consists primarily of providing domestic long-distance, Internet, data and international communications in Brazil to businesses and consumers. Service products include high-speed data transmission, Internet, frame relay, satellite and packet-switched data communication, toll-free service and switched and dedicated long-distance service. As a result of regulatory change in Brazil’s telecommunications industry, Embratel began providing local telephone services to its top corporate customers in Brazil’s major cities in the fourth quarter of 2002 and, in 2003, acquired Vesper S.A., a local telephone company.

Embratel owns the largest long-distance telecommunications network in Latin America, providing both national and international connections to thousands of businesses. The network connects all of the regional fixed-line and cellular operators throughout Brazil. Embratel is the main provider of high-speed data transmission and Internet services in Brazil, utilizing the largest network of broadband fiber optic transmission systems. The domestic long-distance and international transmission facilities extend to all 26 states of Brazil and the Federal District and include fiber optic, digital microwave, satellite and copper wireline networks.

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The following table shows Embratel’s operating revenue by service as a percentage of its total net operating revenue. Other services include local telephone services, as well as text, telex, sound and image transmission and mobile satellite and maritime communications.

Network

We operate one of the world’s largest and most sophisticated networks for Internet, data and voice communications. On a typical day, our network processes billions of messages, including 700 terabytes (equal to 700 trillion bytes) of data and over 370 million telephone calls consisting of approximately one billion minutes of voice communications. The network described within this section is utilized by each of our three primary business units, which are Business Markets, Mass Markets and International. Our fourth business unit is Embratel, which operates its own network that is described in the section titled “Embratel.”

Our long-haul network consists of approximately 98,000 route miles of fiber-optic cable that is capable of transporting traffic at speeds of 10 gigabits (10 billion bits) per second and connects with over 3,400 other networks around the world. Our IP network is one of the world’s largest and fastest, with connectivity to more than 2,700 cities in more than 200 countries across six continents. We also operate global frame relay and ATM data networks.

In addition to our Internet and data networks, we operate a voice communications network handling telephone calls within the United States and around the world. Our global voice network is comprised of over 300 switches, and calls are automatically completed through more than 100 possible routes. Reliability of the voice network is maximized using a process called Dynamically Controlled Routing (“DCR”) and by employing synchronous optical network (“SONET”) rings. DCR monitors each trunk in the network for any path degradation such as congestion or fiber cuts and, as necessary, dynamically reroutes calls to alternative non-degraded paths. SONET rings allow restoration of service within 50 milliseconds following a network failure.

As part of our overall network, we have an extensive metropolitan high-speed data network of over 13,000 route miles serving customers in all major United States and key international cities. We have local-to-global-to-local connectivity to over 91,500 buildings (with over 7,900 buildings directly connected to our network and approximately 83,600 indirectly connected) utilizing over 2,250 data switches. Deployed in business centers throughout the United States, Western Europe, the United Kingdom, Japan, Australia and Singapore, our local networks are constructed using closed-loop self-healing fiber rings.

In addition to land-based network facilities, we own or lease fiber optic capacity on most major intercontinental undersea cable systems in the Atlantic and Pacific Ocean regions. We also own and operate 36 gateway satellite earth antennas that enhance our ability to offer Internet, data and voice communications to and from locations throughout the world.

In view of the substantial capacity of our networks and the slowdown in telecommunications spending by customers in recent years, we have focused our network planning and engineering efforts on further reliability and efficiency rather than expanding network capacity. Through these efforts, we have achieved service levels that lead the telecommunications industry. In both 2002 and 2003, we had the lowest level of FCC reportable outages, with the next best performing major competitor reporting approximately twice as many total outages as our company.

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With regard to efficiency, we continue to deploy Dense Wavelength Division Multiplexing (“DWDM”) technology that allows an optical fiber to carry multiple wavelength signals. Originally, this technology allowed eight different wavelength signals to be transmitted. We have been a leader in further developing DWDM technology, enabling the deployment of systems capable of carrying 64, 80 and 160 separate wavelength signals per fiber. Consequently, we are able to handle additional network traffic at low incremental capital costs and with up to 160 channels within an optical fiber operating at 10 gigabits per second.

With one of the world’s largest and fastest IP networks, we have a strategically important position within the communications market. This is due to the extremely rapid growth of Internet usage resulting from the increasing availability of high speed broadband access, the decreasing cost of all types of Internet access, the expanding volume of informative and entertaining content, the continued improvement in email and instant messaging, and the ever increasing number of personal computers and other devices for accessing the Internet. Corporations and government entities have responded by developing additional applications to run over the Internet that allow communications and e-commerce transactions with customers, communications with employees and the transfer of data among offices and operating units.

As the Internet continues to evolve, the telecommunications market is shifting its focus from individual services based on distinct and separate circuit technologies to the convergence of voice and data services onto single networks. Also, for greater efficiency, simplicity and economy, corporations and governments are increasingly standardizing their applications and communication devices to operate on IP technology.

Our strategy of converging our Internet, data and voice traffic onto a common IP backbone is driven by these technological and market trends and on the strong competitive position of our IP network. The common IP backbone we envision will integrate our IP network and our existing frame relay, ATM and voice networks modified to operate under a unified standard IP protocol.

As part of this convergence strategy, we have incorporated advanced call processing Soft Switches into our network that can simultaneously handle both traditional dedicated-circuit voice traffic as well as voice-over-IP (“VoIP”) traffic. VoIP divides voice communications into digital packets and, instead of using a dedicated circuit, the individual packets seek the most efficient route over multiple transmission lines within IP networks before being reassembled at the destination point.

In addition to voice communications being handled as VoIP, an increasing portion of data, video and software applications traffic is being converted to digitized packets for routing across IP networks. In recognition of this, we have also installed Multi-Service Gateways that enable our customers to transmit voice, frame relay and ATM IP traffic across our high-speed IP network.

We believe that these developments represent the initial stages of the convergence of network communications and computing. In this environment, we expect the development of grid computing in which computing, storage and applications will be offered to customers as network utilities and made available on an as-needed basis. Similarly, technology known as web services is expected to greatly simplify the ability of separate software applications to communicate and work together across IP networks.

Through our strategy of integrating our network onto a common IP backbone and enhancing its capabilities, we are seeking to position ourselves as a provider of emerging services such as grid computing and web services. At the same time, our convergence strategy encompasses our existing frame relay, ATM, IP and voice communication services. Our objective is to have the ability to deliver all of these services to any customer regardless of where they are located or how they are connected to our network. This should produce cost savings for us and our customers, as well as improve our flexibility in delivering services and enable rapid introduction of new services on a global basis.

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Patents, Trademarks and Service Marks

We own or have licenses to various patents, trademarks, service marks, copyrights and other intellectual property used in our business. We do not believe that the expiration of any of our intellectual property rights, or the non-renewal of those rights, would materially affect our results of operations.

Competition

The telecommunications industry is highly competitive. Factors contributing to the industry’s increasingly competitive market include regulatory changes, product substitution, technological advances, excess network capacity and the entrance of new competitors. In this environment, competition is based on price and pricing plans, the types of individual services offered, the combination of services into bundled offerings, customer service, the quality and reliability of services provided and the development of new products and services.

Our competitors include the following:

Internationally, we compete primarily with incumbent telephone companies, some of which have special regulatory status and exclusive rights to provide certain services and have historically dominated their local markets. We also compete with other international service providers, some of which are affiliated with incumbent telephone companies in other countries.

Employees

As of December 31, 2002, we employed approximately 62,700 full and part-time employees, not including the approximately 12,000 employees of Embratel. As of December 31, 2003, we employed approximately 56,600 full and part-time employees, not including Embratel’s approximately 12,500 employees. The reduction in employees reflects our efforts to align personnel levels to the reduced spending levels in the telecommunications markets and our lower revenues.

Compared to other companies in the telecommunications industry, we have few employees who are represented by labor unions. As of December 31, 2002 and December 31, 2003 and excluding Embratel, we had 380 and 349 union employees, respectively, which is equal to less than 1% of our total employees. As of December 31, 2002, approximately 37% of Embratel’s employees were affiliated with state and/or municipal labor unions with which Embratel negotiates labor agreements.

As of December 31, 2003, our Business Markets unit employed approximately 15% of our total employees (not including those of Embratel), Mass Markets employed 32%, International employed 7% and approximately 46% were employed in our network operations, systems engineering and corporate functions. Approximately

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86% of our total employees (not including those of Embratel) are located in the United States and 14% are located outside of the United States. Over 99% of Embratel’s employees are located within Brazil.

Regulation

We are subject to varying degrees of federal, state, local, and international regulation. In the United States, our telecommunications subsidiaries are most heavily regulated by the states, especially for the provision of local exchange services. Generally, our telecommunications subsidiaries must be licensed separately by the public utility commission (“PUC”) in each state to offer local exchange and intrastate long distance services. No PUC, however, subjects us to rate of return regulation. Nor are we currently required to obtain authorization from the FCC for installation or operation of our network facilities used for domestic services, other than licenses for specific multi-channel multipoint distribution services (MMDS), wireless communications services, terrestrial microwave, and satellite earth station facilities that utilize radio frequency spectrum. FCC approval is required, however, for the installation and operation of our international facilities and services. We are subject to varying degrees of regulation in the foreign jurisdictions in which we conduct business, including authorization for the installation and operation of network facilities. No assurance can be given that changes in current or future regulations adopted by the FCC, state, or foreign regulators or legislative initiatives in the United States or abroad would not have a material adverse effect on us.

The FCC’s Local Competition Rules. In August 1996, the FCC established nationwide rules pursuant to the Telecom Act, designed to encourage new entrants to compete in local service markets through interconnection with the incumbent local exchange companies (“ILECs”), resale of ILECs’ retail services, and use of individual and combinations of unbundled network elements (“UNEs”) owned by the ILECs. “Network elements” are defined in the Telecom Act as any “facility or equipment used in the provision of a telecommunications service,” as well as “features, functions, and capabilities that are provided by means of such facility or equipment.” UNEs are network elements provided on an unbundled, or separately priced, basis. The FCC makes certain network elements available on an unbundled basis after considering whether the failure to provide those network elements would impair the ability of the telecommunications carrier seeking access to provide the services that it seeks to offer. One combination of UNEs, known as the unbundled network element platform (“UNE-P”), encompasses all the elements necessary to provide local telephone service. As a competitive local exchange carrier (“CLEC”), we rely upon UNEs, and in particular UNE-P, to provide local services, broadband services, and advanced services to consumer and business customers. Substantial reduction in ILEC unbundling requirements, including any near-term reduction in the availability of UNE-P, would limit our future range of options in provisioning local services to customers.

Numerous issues related to the FCC’s local competition rules have been reviewed by the courts and have been periodically reviewed by the FCC. In December 2001, the FCC initiated a “Triennial Review” of the unbundling requirements applicable to UNEs. The FCC also began an examination of whether certain high capacity and broadband services offered by ILECs were subject to sufficient competition such that they no longer needed to be regulated as “dominant.” In February 2002, the FCC established another proceeding to consider whether broadband Internet access, or “DSL service,” provided by ILECs should be treated as an information service and not subject to common carrier regulation or unbundling requirements on behalf of unaffiliated Internet service providers (“ISPs”).

On February 20, 2003, the FCC announced its decision in the UNE Triennial Review proceeding, and it released the text of the order on August 21, 2003. The new FCC rules took effect on October 2, 2003, though portions were temporarily stayed by a reviewing court. The FCC’s decision maintained many aspects of the prior unbundling rules, and gave state PUCs a major role in determining if and where use of UNE-P and certain other network elements would be permitted. Specifically, although the FCC made nationwide determinations that incumbent LECs must unbundle certain switching, transport, and high capacity loops, the FCC also directed state commissions to conduct granular inquiries pursuant to standards established by the FCC in order to determine in

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which geographic areas there is impairment. The state proceedings were to conclude within nine months of the effective date of the FCC Order, and during the pendency of the state proceedings, UNE-P was to remain available for residential and very small business customers (limited to three lines in zone 1 of the top 50 Metropolitan Statistical Areas). Transport and high capacity loops were also to remain available pending the state proceedings. The FCC order does not require ILECs to provide fiber loops on an unbundled basis to competitive broadband providers. Even before the FCC adopted its most recent order, we did not have meaningful access to ILEC fiber loops to serve broadband customers. The FCC’s decision also phases out the practice of joint use of loops known as “line-sharing,” which is used to provide DSL service over the same line used by the ILEC to provide voice service. Existing line sharing customers are grandfathered. Taken together, these latter aspects of the order will be significantly detrimental to the development of competition in broadband services because they relegate competitors to inferior and/or prohibitively costly facilities for delivering broadband services.

In September 2003, various ILECs filed petitions with the U.S. Court of Appeals for the District of Columbia Circuit seeking to have the court vacate the UNE-P rules. On September 9, the Company filed its own Petition for Review to review other portions of the FCC’s order and rules. Other CLECs and several state public utility commissions, likewise filed Petitions for Review of the FCC’s order. All Petitions for Review of the FCC’s Triennial order (of which there are over 30) were consolidated and transferred to the U.S. Court of Appeals for the D.C. Circuit (the “D.C. Circuit”).

On March 2, 2004, the D.C. Circuit issued a decision that vacated and remanded many of the portions of the FCC’s Triennial Review Order that the ILECs had challenged, including the unbundling of switching, which is a critical component of UNE-P. The Court’s decision also affirmed the portions of the FCC’s Order that had not required incumbents to lease unbundled elements for the provision of broadband services. The D.C. Circuit determined that its decision would take effect either May 1, 2004, or upon its denial of any petitions for rehearing if decided later than May 1. The decision, if left intact, may result in the incumbent local exchange carriers asserting that the Company has no legal authority to use UNE-P to serve local customers. Currently, the Company uses UNE-P to serve Mass Markets “Neighborhood” customers, many of whom also use our long distance service through bundled packages. Though the Company could seek to resell services provided by incumbent local exchange carriers or find other alternative means to provide service, the cost of such services would be substantially higher than our current cost of services. As a result, the D.C. Circuit’s decision, if not reversed, would have a material adverse effect on our Mass Markets segment’s ability to provide services on a competitive basis and sustain and grow its business. Three of the five FCC commissioners have publicly announced their intent to vote to seek certiorari from the Supreme Court and a stay, and the Company also intends to file a petition for certiorari in the United States Supreme Court and to seek a stay. We can provide no assurances that such petitions will be granted.

Pursuant to the FCC’s Triennial Review Order, the state PUCs had commenced “impairment” proceedings. In these proceedings, the states have been determining whether to uphold the FCC’s finding that MCI and other CLECs would be impaired in their ability to compete in local telecommunications markets without access to local switching (and certain other unbundled network elements) as an unbundled network element. After the D.C. Circuit Court’s decision, some state proceedings have been suspended. If the FCC’s order is reinstated, these determinations would continue to be made on a state-by-state basis and a finding that we are not impaired without access to the local switching UNE may cause us to change the method of providing local telephone service to our customers in certain areas of the country.

In addition, legislation was introduced in the 107^th Congress that would have had the effect of making it more difficult for competitors to resell incumbent local phone company high-speed data services or to lease the UNEs used to provide those services. Although such legislation passed the U.S. House of Representatives, the 107^th Congress ended without the Senate taking any action on the legislation. We cannot predict prospects for passage of similar legislation in the 108^th Congress.

RBOC Provision of Long Distance Services. The Telecom Act requires the largest ILECs, the Regional Bell Operating Companies (“RBOCs”), to petition the FCC for permission to offer long distance services for each

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state within their region. Under section 271 of the Telecom Act, for these applications to be granted, the FCC must find, among other things, that the RBOC has demonstrated it has satisfied a 14-point competitive checklist to open its local network to competition, and that granting the petition is in the public interest. With the approval of Qwest’s 271 application for Arizona on December 3, 2003, all of the RBOCs now have received 271 approval for all of the states in their respective regions.

“Do Not Call” Registries. The Telephone Consumer Protection Act of 1991 authorized the FCC to create a national database of residential telephone numbers to which, with limited exceptions, companies would be prohibited from placing telemarketing calls. In 1992, the FCC declined to establish such a database, instead requiring carriers to create their own “Do Not Call” lists. In September 2002, the FCC initiated a rulemaking proceeding to revisit its previous decision. In December 2002, the Federal Trade Commission (the “FTC”) issued rules establishing a national Do Not Call registry. On July 3, 2003, the FCC also issued rules establishing a national Do Not Call registry. As of September 2003, over 50 million telephone numbers had been registered with the Do Not Call registry. Numerous states have enacted similar legislation requiring their state agencies to create such registries on a state-wide level. Because telemarketing has been our primary consumer sales acquisition tool, to the extent that the FCC’s adoption of such a registry affects the number of households to which we can place telemarketing calls, our sales could be reduced.

License Transfer Request. We, as debtor-in-possession, filed a request with the FCC in mid-June 2003 for consent for authority to transfer and/or assign our FCC licenses and authorizations to the reorganized entity, MCI, Inc., upon emergence from bankruptcy. Two petitions in opposition to the request were filed by the August 8, 2003 deadline and we filed our response to those petitions on August 18, 2003. The FCC approved our applications for transfer and/or assignment on December 19, 2003. The Office of Communication of the United Church of Christ and individual Margaret F. Snyder have filed appeals of the FCC’s approval, and those appeals have been consolidated and are pending before the U.S. Court of Appeals for the D.C. Circuit.

Regulatory Approval of CLEC Consolidation. We filed applications with a number of state PUCs seeking approval of the corporate transactions described in the Plan of Reorganization. We have received the approval of our applications from all state PUCs with whom we have filed.

Payphone Compensation. A group of payphone service providers (“PSPs”) has petitioned the FCC to double the rates paid by us and other carriers as compensation for dial-around service calls placed from the PSPs’ payphones. If the petitions were granted, these proceedings could negatively impact our costs and the profitability of our dial-around products.

Inmate Telephone Services. A group of alternative inmate service providers has filed two petitions with the FCC requesting that the FCC examine the telephone services provided to prison inmates. We provide a significant amount of interexchange collect call operator services to inmates and, if the petitions are granted, these proceedings could negatively impact our revenues.

Access Charges. Certain ILECs have challenged the method we use to calculate the amount of switched access charges owed by us for Percentage of Interstate Use. If the ILECs’ challenges are upheld, these proceedings could negatively impact our costs.

Voice over IP. The FCC has opened a proceeding on the regulatory framework that will apply to various VoIP services and will address the extent to which switched access charges will apply to VoIP traffic. The outcome that the FCC reaches on these issues could have a material impact on MCI’s business.

Suspension by the State of New Jersey. Effective February 9, 2004, the State of New Jersey (the “State”) suspended us from entering new State contracts. As a result of this action by the State, our name was removed from the State’s automated bidders list and was listed in the State Disqualification Report. The suspension does not affect our current contracts with the State or subcontracts that we may have with other vendors who contract with the State. We are pursuing an administrative appeal of the State’s decision.

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International Regulation. We are subject, through our international operations, to regulations by foreign countries. These regulations are often as demanding as the requirements imposed on incumbent telephone companies, which frequently enjoy special regulatory status. We have played an active role in regulatory proceedings throughout Europe, at both the national and European Union levels, in an attempt to persuade regulators to impose measures that would reduce leased line costs and ensure timely delivery. Although many of the foreign countries where we operate are liberalizing their telecommunications markets, either as a result of domestic legislation or by virtue of international commitments, we are never certain as to the timing or continuation of these initiatives or as to whether we will benefit from such liberalization.

Overseas Fixed-to-Mobile Termination Rates. An increasing percentage of our U.S.-originated international voice calls terminate to mobile phones overseas. In addition, our overseas affiliates in a number of countries in Europe and in Asia originate voice calls, and a large proportion of these calls also terminate to mobile phones overseas. In both cases, we ultimately rely on a mobile operator, to whom we directly or indirectly pay mobile termination fees, to connect call to the mobile operator’s customer.

In general, the rates that we and other U.S. telecommunications carriers pay to our international correspondents for terminating U.S.-originated international voice calls to mobile phones overseas are much higher than corresponding international termination rates for wireline phones. Likewise, for overseas-originated calls, we pay significantly higher termination rates for calls made to overseas mobile phones than for calls made to overseas wireline phones.

We are actively encouraging the FCC and overseas governments to take appropriate action to reduce the rates required to be paid to terminate voice calls to mobile phones overseas. We cannot predict, however, whether the FCC and overseas regulators will eventually take action that will result in lower mobile termination rates.

Environmental Regulation. We are subject to various environmental, health and safety laws and regulations governing, among other things, the generation, storage, use and disposal of hazardous materials, the discharge of hazardous materials into the ground, air or water, and the health and safety of our employees. We have been required to pay fines in the past in connection with alleged violations of environmental laws, but these alleged violations have been resolved in all material respects. We have also been required, and may continue to be required, to remediate hazardous substance contamination at certain of our locations. Environmental laws are complex, change frequently and have tended to become stringent over time. We may incur additional capital or operating costs to comply with any such changes.

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RISK FACTORS

You should carefully consider the risks described below before investing in our securities. The risks described below are not the only ones facing us. Additional risks not currently known to us or that we currently believe are immaterial may also impair our results of operations and financial condition.

Risks relating to recent developments

Continuing negative publicity

As a result of the financial fraud committed by some of our former officers and employees and the resulting bankruptcy reorganization, we have been the subject of continuing scrutiny and negative publicity focused on these subjects. This negative publicity may have an effect on the terms under which some customers and suppliers are willing to continue to do business with us and could affect our financial performance or financial condition.

Continued scrutiny resulting from ongoing government investigations

Due in large part to the financial fraud committed by some of our former officers and employees and the resulting bankruptcy reorganization, we are the subject of various investigations by the SEC, the FCC, the U.S. Attorney’s Office and other governmental entities into our accounting and related controls, call routing practices and other matters. Our senior management team and Board of Directors have been required to devote significant time in the resolution process for these investigations and related matters. We continue to engage in dialog with these government agencies in order to reach reasonable conclusion to these investigations, but we cannot predict what the specific resolution for each of these investigations may be. In addition to penalties that have been announced to date, it is possible that we will be required to pay other material fines, consent to additional injunctions on future conduct, lose the ability to conduct business with government agencies under restrictive terms or lose our ability to conduct such business or suffer other penalties, each of which could have a material adverse effect on our business, financial condition and liquidity.

Identified weaknesses in our internal controls and corporate governance structures

On June 3, 2003, KPMG issued a letter identifying a substantial number of material weaknesses in our internal controls. In addition, reports finding numerous problems in our prior processes for corporate governance and internal controls have been released by the Special Committee of our board of directors, which conducted an independent investigation with the law firm of Wilmer, Cutler & Pickering as special counsel and PricewaterhouseCoopers LLP as their accounting advisors; Richard Thornburgh, the Examiner appointed by the Bankruptcy Court and a former Attorney General of the United States; and Richard C. Breeden, the Corporate Monitor appointed by the District Court and a former Chairman of the SEC. We are committed to addressing these deficiencies and have completed the action plans relating to all of the material weaknesses in internal controls set forth in the June 3, 2003 letter, subject to ongoing training and monitoring by management, and validation testing by internal audit. However, if we are unsuccessful in our focused effort to permanently and effectively remedy the weaknesses in our internal controls and to establish and maintain effective corporate governance practices, then this could adversely affect our ability to report our financial condition and results of operations accurately and in a timely manner and our ability to earn and retain the trust of our customers, suppliers and security holders. For more information, see “Item 9A—Controls and Procedures.”

Pending litigation

We are party to significant litigation, which is described in more detail in “Item 3—Legal Proceedings.” If any of these proceedings is decided against us, we could be subject to substantial damages or other penalties. These penalties and other effects of litigation could have a material adverse effect on our operating licenses, liquidity and financial condition.

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We have postponed the filing of our most recent quarterly reports, and material information concerning our current operating results and financial condition is therefore unavailable.

We have postponed the filing of our periodic reports for the quarters ended March 31, 2003, June 30, 2003 and September 30, 2003, and the information to be contained therein is unavailable at this time. Although we intend to make these filings in the near future, we cannot state with certainty when complete financial and operational information relating to our first three quarters for 2003 will become available. When it is, it may reflect changes or trends that are material to our business.

SEC review may require us to amend our public disclosures

We continue to discuss our periodic filings with the staff of the SEC’s Division of Corporation Finance. As part of this discussion, we may receive comments from SEC relating to this Annual Report on Form 10-K and our other periodic filings. As a result, we may be required to amend this Form 10-K or other reports filed with the SEC in order make adjustments or additional disclosures.

Our emergence from bankruptcy is not assured

Our Plan of Reorganization was confirmed by the Bankruptcy Court on October 31, 2003. On February 25, 2004, the Bankruptcy Court extended the period of time for our emergence from bankruptcy to April 30, 2004. While we expect to emerge from bankruptcy in the near future, there can be no assurance regarding emergence or the timing of emergence.

Risks Relating to our Business

Challenges in a highly competitive industry

There is substantial competition in the telecommunications industry, which has caused pricing pressure and reduced revenues. Rapid technological advances, product substitution and deregulation have all contributed to the increasingly competitive atmosphere. We expect competition and pricing pressure to intensify due to the efforts of competitors to address difficult market conditions through reduced pricing, bundled offerings or otherwise, as well as a result of the entrance of new competitors and the development of new technologies, products and services.

We have a variety of competitors, including:

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These factors could also have a material adverse effect on our business, financial condition or results of operations.

Overseas, we compete with the incumbent telephone companies, some of which still have special regulatory status and exclusive rights to provide services, and virtually all of which historically dominated their local, long distance and international services business. These companies have numerous advantages, including existing facilities, customer loyalty and substantial financial resources. We may be dependent upon obtaining facilities from these incumbent telephone companies. We also compete with other service providers, many of which are affiliated with incumbent telephone companies in other countries. Typically, we must devote extensive resources to obtain regulatory approvals necessary to operate overseas and then to obtain access and interconnection with the incumbent’s network on a non-discriminatory basis.

Our business will suffer if our technology and business methods become obsolete

The market for Internet, data and voice communication products and services is characterized by rapidly changing technology, evolving industry standards, emerging competition and frequent new product and service introductions. We may not be successful in identifying new product and service opportunities and developing and bringing new products and services to market in a timely manner. We are also at risk from fundamental changes in the way Internet, data and voice communication products and services are marketed, sold and delivered. This includes the risks that Do Not Call regulations impose upon our efforts to obtain new customers. Our pursuit of technological advances and new business methods may require substantial time and expense, and we may not succeed in adapting our business to the technologies, devices, protocols, regulations and marketing and sales methods that are anticipated and, in some cases, are currently being developed in the communications industry.

Covenants in our debt instruments

On our emergence from bankruptcy, the indentures relating to our senior unsecured indebtedness will impose restrictions on our operations and on financial transactions that we may wish to pursue. These restrictions will affect, and in many respects limit or prohibit, among other things, our and our subsidiaries’ ability to incur additional indebtedness; make investments; sell assets; declare or pay dividends or other distributions to shareholders; and repurchase equity interests. We also expect to enter into a credit facility following our emergence from bankruptcy. This credit facility is likely to include covenants similar to those discussed above, as well as other and more restrictive covenants, including financial ratios. The restrictions contained in the terms of each of these debt instruments, as well as the terms of other indebtedness we may incur from time to time, could limit our ability to plan for or react to market conditions or meet capital needs or otherwise restrict our activities or business plans. These restrictions could also adversely affect our ability to finance our operations or other capital needs, or to engage in other business activities that would be in our interest.

Reliance on the cooperation of established local telephone companies

As a participant in the competitive local telecommunications services industry, we rely on the networks of established telephone companies or those of competitive local exchange carriers for some aspects of transmission. Federal law requires most of the established telephone companies to lease or “unbundle” elements of their networks and permit us to purchase the call origination and call termination services we need, thereby decreasing our operating expenses. However, established local telephone companies continue to challenge these requirements in court and on March 2, 2004, the D.C. Circuit issued a decision that vacated and remanded much of the portions of the FCC’s Triennial Review Order that the established telephone companies had challenged, including the unbundling of switching, which is a critical component of UNE-P.

If the decision is left intact, we may experience difficulties in ordering, interconnecting and leasing premises from established telephone companies and suffer substantial harm to our Mass Markets business. If we are unable to obtain the cooperation of an established telephone company in a region, our ability to continue to offer local services in that region on a timely and cost-effective basis would be adversely affected. For additional information, see “Regulation.”

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Government regulation of our businesses

We are subject to varying degrees of federal, state, local and international regulation. In the United States, our subsidiaries are most heavily regulated by the states, especially for the provision of local exchange services. We are also subject to varying degrees of regulation in foreign jurisdictions in which we conduct business, including authorization for the installation and operation of network facilities. Changes in current or future regulations adopted by the FCC, state or foreign regulators or legislative initiatives in the United States or abroad could have a material adverse effect on us by restricting our ability to price our products and services and/or otherwise placing us at a competitive disadvantage. For additional information, see “Regulation.”

In addition to the regulation of our business by the FCC, the FTC has recently introduced “Do Not Call” registries that permit consumers to request that they not be contacted by telemarketers. Such registries are the subject of litigation but could have a material adverse effect on telemarketing, which is one of our principal sales and marketing initiatives.

Telecommunications industry trends

In 2001, the business environment for the telecommunications industry deteriorated significantly and rapidly. This environment has remained weak through 2003 and into 2004, primarily due to:

We expect these trends to continue, including reduced business from financially troubled customers and downward pressure on prices due to reduced demand and overcapacity. These trends could continue to have a material adverse impact on our business, financial condition and results of operations.

Exposure resulting from international operations

Because we derive substantial revenue from international operations, our business is subject to risks inherent to international operations, including:

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Our international operations are conducted through a variety of different methods, including wholly owned subsidiaries, joint ventures and operating agreements with local telecommunications companies. Each of these methods presents risks. For example, certain countries have foreign ownership limitations with respect to companies that provide telecommunications services within their borders. These restrictions obligate us to partner with one or more local companies if we want to participate in the market. As a result, our ability to control or direct the operations of the local entity is limited, either contractually or statutorily, by our obligations to our local partners.

In the event of any dispute arising from our international operations, we may be subject to the exclusive jurisdiction of foreign courts and may not be successful in subjecting foreign persons or entities to the jurisdiction of the courts of the United States. We may also be hindered or prevented from enforcing our rights with respect to foreign governments because of the doctrine of sovereign immunity. In addition, there can be no assurance that the laws, regulations or administrative practices of foreign countries relating to our ability to do business in that country will not change.

In most of our international operations, we are competing with incumbent telecommunications operators from whom we require services and support. For example, we require interconnection with the incumbent operator’s network in order to provide ubiquitous service for our customers. Without interconnection, our customers would not be able to contact customers of the incumbent operator. There can be no assurance, however, that interconnection (or other services) will be provided by the incumbent operator in a timely manner or that the terms and conditions of any proposed interconnection, particularly the cost, will not have an adverse effect on our local operation.

Although most of the foreign countries where we operate are liberalizing their telecommunications market, whether as a result of domestic legislation or by virtue of international commitments, there are no guarantees as to the continuation, timing or effectiveness of such liberalization. For example, certain countries have bound themselves to undertake liberalizing measures in their telecommunications market pursuant to treaty commitments under the World Trade Organization. There can be no assurance, however, that such liberalizing measures will be implemented in a timely manner or at all. In addition, if there is a failure to implement those liberalizing measures, there may not be adequate or effective recourse against the foreign government for such failure.

While we have a growing dependence on Internet-related services, the rate of development and adoption of the Internet has been slower outside the United States. Laws in the U.S. and foreign countries regarding the Internet and related data privacy issues are largely unsettled, but are becoming an increasing focus for lawmakers. Changes in these laws could require us to expend significant resources to comply or could limit our business. In addition, the application of multiple sets of laws and regulations may subject us to regulation, taxation, enforcement or other liability in unexpected ways, which could make it more expensive to conduct our business or limit our ability to conduct business. Regulation of the Internet may also harm our customers’ businesses, which could lead to reduced demand for our services.

The rates that we charge our customers for international services may decrease in the future due to the entry of new carriers with substantial resources and aggressiveness on the part of new or existing carriers. In addition, the consummation of mergers, joint ventures and alliances among large international carriers that facilitate targeted pricing and cost reductions, and the availability of international circuit capacity on new undersea fiber optic cables and new high capacity satellite systems, may have a negative impact on our pricing ability.

Customers of our international operations may be invoiced in United States dollars or in foreign currencies. Customers invoiced in United States dollars whose revenues are derived in other currencies may be subject to unpredictable and indeterminate increases in the event those currencies devalue relative to the United States dollar. Furthermore, those customers may become subject to exchange control regulations restricting the conversion of their revenue currencies into United States dollars. In that event, the affected customers may not be

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able to pay us in United States dollars. In addition, where we invoice for our services in currencies other than United States dollars, our results of operations may suffer due to currency translations in the event that those currencies devalue relative to the United States dollar and we do not elect to enter into currency hedging arrangements in respect of those payment obligations.

ITEM 2. PROPERTIES

Our owned properties consist primarily of equipment and buildings used to provide Internet, data and voice communication services in North America, Latin America, Europe, the Middle East, Africa, Australia and Asia. We also lease certain switching equipment and several general office facilities. In addition, we have been granted easements, rights-of-way and rights-of-occupancy, mainly by railroads and other private land owners, for our fiber-optic network.

Properties used by us as of December 31, 2003 that are significant to our operations are as follows:

We also lease smaller office facilities for sales, maintenance and administrative operations in the markets in which we operate. We had approximately 400 and 300 of these leases in effect at December 31, 2002 and 2003, respectively, including approximately 110 properties in international markets as of December 31, 2003. These leases generally have terms ranging from one to five years, not including extensions related to the exercise of renewal options.

In addition, we also leased approximately 5,100 and 4,750 other facilities at December 31, 2002 and 2003, respectively, including 1,050 properties in international markets as of December 31, 2003. The majority of these leases are for telecommunications equipment sites and with terms generally ranging from month-to-month to 25 years. These property leases tend to have renewal options ranging from one to five years.

During 2003, we have disposed of some significant facilities which were in excess of 100,000 square feet. These larger disposals include the sale of four owned properties totaling approximately 800,000 square feet and the elimination of eight leased facilities totaling approximately 2,000,000 square feet. None of these facilities are included in the table above.

Embratel conducts the majority of its management functions from Rio de Janeiro and they own and lease office space in other cities including Sao Paulo, Porto Alegre, Belo Horizonte, Curitiba, Brasilia, Salvador and Belem.

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See Notes 7 and 19 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for the carrying value of our property, plant and equipment and the future minimum payments under our operating and capital leases.

ITEM 3. LEGAL PROCEEDINGS

Bankruptcy Filings

On July 21, 2002, (the “Petition Date”), we and substantially all of our direct and indirect domestic subsidiaries (the “Initial Filers”) filed voluntary petitions for relief in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) under chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). On November 8, 2002, we filed additional chapter 11 petitions for 43 of our subsidiaries (collectively with the Initial Filers, the “Debtors”), most of which were effectively inactive and none of which had significant debt. The Debtors continue to operate their businesses and manage their properties as debtors-in-possession pursuant to sections 1107(a) and 1108 of the Bankruptcy Code. By orders dated July 22, 2002 and November 12, 2002, the Debtors’ chapter 11 cases were declared to be jointly administered. Accordingly, pursuant to section 362 of the Bankruptcy Code, most of the litigation against us has been stayed.

By orders dated, May 28, 2003, July 11, 2003, August 2, 2003, and September 12, 2003, the Bankruptcy Court approved the Debtors’ proposed disclosure statement for their proposed joint plan of reorganization and the proposed modifications thereto (collectively, the “Disclosure Statement”). Pursuant to the Disclosure Statement, the Debtors solicited votes on their proposed plan of reorganization.

By order dated October 31, 2003, after due notice and a hearing, the Bankruptcy Court confirmed the Debtor’s Modified Second Amended Joint Plan of Reorganization dated October 21, 2003 (the “Plan”), which provides for, among other things, certain settlements, the substantive consolidation of the Intermedia debtors (collectively, the Intermedia parent company and subsidiaries), and the separate substantive consolidation of the WorldCom debtors (collectively, all debtors other than the Intermedia debtors). The confirmation order determined that the Plan complied with all of the requirements of the Bankruptcy Code.

On February 24, 2004, on a motion made by the Debtors, the Bankruptcy Court extended the period of time for us to emerge from bankruptcy to April 30, 2004.

Review of Previously Issued Financial Statements

On June 25, 2002, we announced that as a result of an internal audit of our capital expenditure accounting, it was determined that certain transfers from line cost expenses (now referred to as access cost expenses) to capital accounts in the amount of $3.9 billion during 2001 and the first quarter of 2002 were not made in accordance with GAAP. We promptly notified KPMG, and subsequently engaged KPMG to audit our consolidated financial statements for the years ended December 31, 2001 and 2000. We also notified Andersen, which audited our consolidated financial statements for 2001 and reviewed such interim condensed consolidated financial statements for first quarter 2002, promptly upon discovering these improperly reported amounts. On June 24, 2002, Andersen advised us that in light of the inappropriate transfers of line costs, Andersen’s audit report on our consolidated financial statements for 2001 and Andersen’s review of our interim condensed consolidated financial statements for the first quarter of 2002 could not be relied upon.

On August 8, 2002, we announced that our ongoing internal review of our consolidated financial statements discovered an additional $3.9 billion in improperly reported pre-tax earnings for 1999, 2000, 2001, and the first quarter of 2002. On November 5, 2002, we announced that we expected a further restatement of earnings in addition to amounts previously announced and that the overall amount of the restatements could total in excess of $9 billion.

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On March 13, 2003, we announced that we had completed a preliminary review of our goodwill and other intangible assets and property, plant and equipment (“PP&E”) accounts. This review resulted in the write-off of all existing goodwill and a substantial write-down of the carrying value of PP&E and other intangible assets, which was subsequently adjusted during our restatement process.

A Special Committee of our Board of Directors conducted an independent investigation of these matters with the law firm of Wilmer, Cutler & Pickering as special counsel and PricewaterhouseCoopers LLP as their financial advisors.

The Special Committee’s report was released publicly on June 9, 2003.

Our Corporate Monitor, Richard C. Breeden, former Chairman of the SEC has closely overseen the overall process under which we have reviewed our prior accounting practices, the carrying value of our assets and the quality of our internal controls. Mr. Breeden has made reports on such issues to both the SEC and the District Court from July 2002 through the present time.

Our accounting practices also are under investigation by the U.S. Attorney’s Office. In addition, the Bankruptcy Court appointed Richard Thornburgh, former Attorney General of the United States, as an Examiner to investigate historic accounting matters and corporate governance practices in order to identify potential causes of action against third parties. On November 4, 2002, the Examiner released his first Interim Report regarding the Examiner’s preliminary observations. On June 9, 2003, the Examiner released his second Interim Report regarding, among other things, corporate governance matters and past accounting practices. The Examiner released his third and final report on January 26, 2004, containing a discussion of the potential claims that we may have against third parties.

We have terminated or accepted the resignations of various company officers and other financial and accounting personnel, including our former chief financial officer and corporate controller.

In addition, in June 2003, KPMG identified a substantial number of material weaknesses in our internal controls. For more information, see “Item 9A—Controls and Procedures.”

As a result of the process of reviewing and restating our financial statements, since June 2002 we had been unable to file periodic reports with the Securities and Exchange Commission. The financial statements for 2000, 2001 and 2002 presented in this Annual Report on Form 10-K have been audited by KPMG and reflect each of the restatements and adjustments discussed above, as well as other adjustments made in connection with the review of our previously issued financial statements.

Regulation

We are subject to varying degrees of federal, state, local and international regulation. For more information, see “Item 1. Business—Regulation.”

Litigation

We and various current or former directors, officers, and advisors have been named as defendants in a number of lawsuits alleging violations of federal and state securities laws and related claims. The filing of the Chapter 11 cases automatically stayed proceedings in private lawsuits relating to pre-petition claims as to the Debtors. The Plan specifies how pre-petition litigation claims against the Debtors will be treated following our emergence from bankruptcy. Claims arising after the filing date generally will not be discharged following emergence.

SEC Lawsuit and Related Proceedings. On June 26, 2002, the SEC filed a suit against the Company and certain members of former management for violations of sections 10(b) and 13(a) of the Exchange Act and SEC Rules 10b-5, 12b-20, 13a-1, and 13a-13, alleging that from at least the first quarter of 2001 through the first quarter of 2002, we defrauded investors by disguising our true operating performance via improper accounting methods that materially overstated our income. On November 5, 2002, the SEC filed an amended complaint that broadened the scope of the claims, including a claim under section 17(a) of the Securities Act. On May 19, 2003,

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the SEC filed a second amended complaint that added a claim for disgorgement of unlawful gains obtained as a result of the alleged misstatements.

On November 26, 2002, we consented to the entry of a permanent injunction (“Permanent Injunction”) that partially resolved the claims brought in this suit. The Permanent Injunction imposes certain ongoing obligations on us and permits the SEC to seek a civil penalty. On June 11, 2003, we consented to the entry of two orders dealing with internal controls and corporate governance issues that modified certain of the ongoing obligations imposed in the Permanent Injunction. One of the orders required us to adopt and implement recommendations to be made in a report by the Corporate Monitor appointed by the U.S. District Court, Richard C. Breeden, former Chairman of the SEC. The Corporate Monitor’s report was released publicly on August 26, 2003. On December 17, 2003, the Court issued an order further modifying its November 26, 2002 order. The December 17, 2003 order directed us to submit a report relating to the status of certain of our internal controls efforts to the District Court, Corporate Monitor and the SEC; and directed us to cause Deloitte & Touche LLP (“Deloitte”) which has acted as our consultant with respect to internal controls, to submit a similar report. We and Deloitte submitted our reports on December 24, 2003.

On May 19, 2003, we announced a proposed settlement with the SEC regarding a civil penalty. Pursuant to the initial proposed settlement, we would satisfy the SEC’s civil penalty claim by payment of $500 million upon the effective date of our emergence from Chapter 11 protection. On July 2 and 3, 2003, we filed documents in the U.S. District Court modifying the proposed settlement. Pursuant to the revised proposed settlement, we will satisfy the SEC’s civil penalty claim by payment of $500 million upon the effective date of our emergence from Chapter 11 protection and by transfer of common stock in the reorganized company having a value of $250 million. On July 7, 2003, the U.S. District Court issued an order approving the proposed settlement. On September 3, 2003, one of our creditors filed a notice of appeal of this order to the U.S. Court of Appeals for the Second Circuit. On August 6, 2003, the U.S. Bankruptcy Court for the Southern District of New York issued an order approving the proposed settlement. On August 18, 2003, certain creditors filed a notice of appeal of the order to the U.S. District Court. Pursuant to agreements entered into in connection with the Plan, those creditors have agreed to withdraw their appeals upon the effective date of the Plan. The District Court’s order provides that the funds paid and common stock transferred by us in satisfaction of the SEC’s penalty claim will be distributed pursuant to the Fair Funds provisions of the Sarbanes-Oxley Act of 2002.

Securities Litigation. Beginning on April 30, 2002, various groups of plaintiffs filed in excess of 100 complaints, purportedly on behalf of certain of our shareholders and bondholders or groups or classes thereof, in federal and state courts in approximately 24 states and the District of Columbia. The complaints generally allege that the Company, certain former officers and directors and other third party defendants misstated our earnings in our public filings and failed to account properly for goodwill and other intangible assets in connection with numerous acquisitions. In November 2000, class action complaints were filed in Mississippi, New York and the District of Columbia alleging, among other things, that our financial disclosures and statements regarding the integration of MCI, the success of UUNET, and our expansion were misleading. Additionally, in August 1997, three complaints were filed in the U.S. District Court for the District of Columbia as class actions of purchasers of MCI shares alleging that MCI and some of its officers and directors had failed to disclose material information about MCI, including that MCI was renegotiating the terms of the MCI-British Telecom merger agreement. The April 2002 litigation continues as to the individual defendants and, to the extent the Company has been named as a defendant, is stayed as to the Company; the November 2000 litigation has been dismissed as to the individual defendants and is stayed as to the Company; and the August 1997 litigation has been stayed as to all parties. We believe that this litigation will not have a material impact on us due to the subordination of these claims pursuant to section 510(b) of the Bankruptcy Code and the discharge and injunction provisions in the Second Amended Plan of Reorganization.

Insurance Coverage Litigation. On January 28, 2003 and February 3, 2003, two of our excess directors and officers (“D&O”) and excess blended liability insurance carriers filed declaratory judgment actions in the

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United States District Court for the Southern District of New York against certain of our former directors and/or officers. These actions seek to rescind insurance coverage under the excess D&O and excess blended policies (collectively, the “Policies”) each carrier issued to us in December 2001. The stated grounds to rescind the Policies were that we made certain material misrepresentations in our applications which we completed in connection with the issuance of the Policies. On January 29, 2003, we commenced an adversary proceeding (the “Adversary Proceeding”), in the form of declaratory judgment action, against all of our excess directors and officers and excess blended insurance carriers in the United States Bankruptcy Court for the Southern District of New York seeking an affirmative declaration of coverage under the Policies. On February 13, 2003, we filed a motion in the Adversary Proceeding seeking to enforce the automatic stay with respect to the declaratory judgment actions filed by the carriers. Our motion was granted by the Bankruptcy Court on August 1, 2003.

On September 8, 2003, we filed a motion for partial summary judgment in the Adversary Proceeding. The excess carriers have moved to dismiss our Adversary Proceeding complaint on numerous grounds. All motions were argued on October 21, 2003 and were taken under advisement by the Bankruptcy Court.

ERISA Litigation. On March 18, 2002, one current and one former employee filed suit in federal court in California against us and two of our former executive officers on behalf of a putative class of participants in the WorldCom 401(k) plan and its predecessor plans, claiming that defendants breached their fiduciary duties under the Employee Retirement Income Security Act (“ERISA”) with respect to the administration of the plans by, among other things, misrepresenting our financial results and by allowing plan participants to continue to invest in our stock as one of their plan options. Following our June 25, 2002 restatement announcement, participants in 401(k) plans for us and various affiliates filed approximately 15 additional putative class action suits against us and certain of our executive officers in federal courts in New York, Mississippi, Florida, Oklahoma, and the District of Columbia.

On July 10, 2002, certain of our directors submitted to the Judicial Panel on Multidistrict Litigation (the “Panel”) motions to centralize these actions. On October 8, 2002, the Panel issued an order centralizing 39 cases arising under the federal securities and ERISA laws before Judge Denise L. Cote in the United States District Court for the Southern District of New York. On September 18, 2002, Judge Cote entered an order consolidating the ERISA cases pending in the Southern District of New York, and thereafter designated lead plaintiffs for the consolidated cases. The Panel subsequently entered final orders transferring initial and additional cases to Judge Cote for consolidated or coordinated pretrial proceedings.

On December 20, 2002, the lead plaintiffs filed a consolidated complaint alleging that defendants breached their fiduciary duties under ERISA and seeking damages and other relief. The complaint, which was amended January 24, 2003, sought to certify a class of persons who participated in the WorldCom 401(k) plan and certain predecessor plans during the period from at least September 14, 1998 to the present. On January 24, 2003, defendants filed motions to dismiss the amended complaint pursuant to Fed.R.Civ.P. 8(a), 9(b), and 12(b)(6), asserting that the complaint failed to allege that the individual defendants were ERISA fiduciaries of the 401(k) Salary Savings Plan and, therefore, cannot be liable for fiduciary breach claims. On June 17, 2003, Judge Cote issued a decision granting the motion to dismiss filed by the former directors and certain employees and denying the motions, in whole or in part, filed by other defendants.

On July 25, 2003, Judge Cote issued an order establishing a schedule for class certification proceedings, initial discovery and the filing of an amended complaint. Lead plaintiffs subsequently filed second and third amended complaints pursuant to Judge Cote’s July 25 order. The third amended complaint charges the defendants with breaching their fiduciary duties under ERISA. Certain individual defendants filed a joint motion to dismiss the third amended complaint on October 13, 2003. Briefing on the motion to dismiss was completed on November 14, 2003. On January 15, 2004, the U.S. Department of Labor filed an amicus brief in opposition to the individual defendants’ motion to dismiss. The individual defendants filed a response to the Secretary’s Amicus brief on January 30, 2004.

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On September 12, 2003, lead plaintiffs also filed a motion for class certification on their claims. The defendants filed a joint motion opposing class certification on October 31, 2003. The briefing on plaintiff’s motion for class certification has been completed, and the court has taken this matter under advisement.

This litigation continues as to the individual defendants but is stayed as to us. We believe that this litigation will not have a material impact on us due to the subordination of these claims pursuant to section 510(b) of the Bankruptcy Code and the discharge and injunction provisions in the Modified Second Amended Joint Plan of Reorganization.

Call Routing Investigation. On July 23, 2003, we received a subpoena from the United States Attorney’s Office for the Southern District of New York asking for information and documents concerning our projects relating to the routing of interstate or intrastate voice or data transmission that originate or terminate on the network of local exchange companies. The U.S. Attorney’s Office is investigating our practices relating to call routing that allegedly have the purpose of avoiding or reducing our payment of access charges to local exchange companies. We are cooperating fully with the U.S. Attorney’s Office, and have conducted an internal review of practices identified by the subpoena. Based on an internal review, we believe that our current practices in originating and terminating calls comply with all legal and regulatory requirements.

Settlement with AT&T of Virginia Litigation. On September 2, 2003, AT&T filed suit against us and telecommunications provider Onvoy, Inc. in the U.S. District Court for the Eastern District of Virginia (‘Virginia Litigation”) alleging that we violated the Racketeering Influenced and Corrupt Organizations Act (“RICO”) and committed mail and wire fraud. On September 24, 2003, we filed a motion with the Bankruptcy Court seeking imposition of contempt sanctions against AT&T on the basis that the AT&T suit violated the automatic stay arising under the Bankruptcy Code.

On February 23, 2004, we filed a motion requesting approval from the Bankruptcy Court of a settlement agreement that we entered into with AT&T, the material terms of which were disclosed therein. The Bankruptcy Court approved the Settlement Agreement on March 2, 2004. The out-of-court resolution settles all claims that the two companies have had against each other, both before and after we filed our voluntary chapter 11 Petition in July 2002, including, the Virginia Litigation.

Investigation of the FCC Into Allegations of Improper Routing of Network Traffic. The Enforcement Bureau of the FCC has also initiated a review of our call routing practices, and has requested information from us regarding any conduct that might involve withholding, substituting, or modifying automatic number identification (ANI) or calling party number (CPN) information associated with interstate interexchange traffic. We are fully cooperating with the FCC in this matter and are providing the information requested. Based upon an internal review, we believe that our current practices comply with FCC regulations.

Oklahoma Litigation. On August 27, 2003, the Attorney General of Oklahoma filed a criminal action in Oklahoma County District Court against us and six of our former executives alleging 15 criminal violations of the state’s securities laws. On September 11, 2003, we entered a not guilty plea to these charges. Our preliminary hearing is set to commence on March 29, 2004. In November 2003, the Attorney General dismissed the charges against one of our former executives, Mr. Bernard Ebbers. The Attorney General has expressed his intention to refile the charges later this year.

State Tax. In conjunction with our bankruptcy claims resolution proceeding, certain states have filed or may file claims concerning our state income tax filings and our approach to related-party charges. We are working with the appropriate state taxing officials on these issues in an attempt to resolve the claims.

Other Investigations. In addition, following our June 25, 2002 announcement, various investigations have been initiated by the U.S. Attorney’s Office, several state agencies, and the U.S. Congress. These investigations are ongoing. We are cooperating fully in those inquiries.

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In the normal course of our business, we are subject to proceedings, lawsuits and other claims, including proceedings under government laws and regulations related to environmental and other matters. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, we are unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters at December 31, 2002. While these matters could affect operating results of any one quarter when resolved in future periods, it is management’s opinion that after final disposition, any monetary liability or financial impact to us would not be material to our annual consolidated financial position or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On June 14, 2002, we held our 2002 Annual Meeting of Shareholders for purposes of:

The tabulation of the voting was as follows:

Each of the directors listed above either resigned from the board or was disqualified from further service as a director on or prior to December 31, 2002. In addition, Bernard J. Ebbers, our former President and Chief Executive Officer, resigned as a director on April 29, 2002, and did not stand for election at the Annual Meeting of Shareholders.

Dennis R. Beresford, Nicholas deB. Katzenbach and C.B. Rogers, Jr. were each appointed as directors during July and August 2002 to fill vacancies and Michael D. Capellas was appointed Chairman of the Board of Directors in December 2002. See “Item 10—Directors and Executive Officers of the Registrant” for information about the current composition of our Board of Directors. No other matters were submitted to a vote of security holders during the fiscal year ended December 31, 2002.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

Prior to June 7, 2001, WorldCom, Inc. common stock was quoted on the Nasdaq National Market (“NASDAQ”) under the symbol “WCOM.” On June 7, 2001, our shareholders approved a recapitalization involving the creation of two separately traded tracking stocks: WorldCom group common stock, which was intended to track the separate performance of our data, Internet, international and commercial voice businesses; and MCI group common stock, which was intended to reflect the performance of our consumer, small business, wholesale long distance voice and data, wireless messaging and dial-up Internet access businesses. From our recapitalization on June 7, 2001 through July 29, 2002, the shares of WorldCom group common stock and MCI group common stock were quoted on NASDAQ under the symbols “WCOM” and “MCIT”, respectively.

On July 29, 2002, we issued a press release announcing that a NASDAQ Listing Qualifications Panel had issued a written decision that, based on our July 21, 2002 bankruptcy filing and the pending restatement of our financial statements, the shares of the WorldCom group common stock and MCI group common stock would be delisted from NASDAQ effective as of the opening of trading on July 30, 2002. As of July 30, 2002, the shares of WorldCom group common stock and MCI group common stock commenced trading in the over-the counter market under the symbols “WCOEQ” and “MCWEQ.”

The following table sets forth the high and low bid quotations per share of WorldCom group common stock and MCI group common stock as reported on the over-the-counter market from July 30, 2002 through December 31, 2002, the high and low bid information of WorldCom, Inc. common stock, WorldCom group common stock and MCI group common stock as reported on the NASDAQ for prior periods, and the dividends declared per MCI group common share for the periods indicated, including the dividend declared on March 7, 2002 that was never paid. The stock price information is based on published financial sources. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions.

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Under the Plan of Reorganization confirmed by the Bankruptcy Court on October 31, 2003, upon our emergence from bankruptcy proceedings the shares of WorldCom group common stock and MCI group common stock held by existing shareholders will be cancelled and rendered null and void and, therefore, will have no value. As part of our settlement with the SEC, holders of WorldCom group common stock and MCI group common stock will be eligible to share in the amount we pay to the SEC.

Holders

As of December 31, 2003, there were 2,970,796,599 shares of WorldCom group common stock issued and outstanding, net of treasury shares, held by approximately 53,000 shareholders of record, and 118,733,605 shares of MCI group common stock issued and outstanding, net of treasury shares, held by approximately 36,000 shareholders of record.

Dividends

On July 11, 2002, we announced that, in light of the circumstances following our June 25, 2002 announcement to restate our financial statements for the year ended December 31, 2001 and the first quarter of 2002, our Board of Directors determined that we would not pay the dividend of $0.60 per share of MCI group common stock that was scheduled to be paid on July 15, 2002. Cash dividends paid on MCI group common stock were $142 million in 2002, with $71 million paid on each of January 15, 2002 and April 15, 2002, respectively. No additional cash payments were paid subsequent to April 15, 2002 on our common stock. From the period from June 7, 2001 through December 31, 2001, we paid cash dividends on MCI group common stock of $71 million on October 15, 2001.

Prior to the creation of two separately traded stocks, we did not pay cash dividends on our common stock, and we have never paid cash dividends on the WorldCom group common stock. The policy of our Board of Directors was to retain earnings attributed to the WorldCom group to provide funds for the operation and expansion of our businesses. We will not pay any cash dividends to WorldCom group or MCI group common shareholders. Under the Plan of Reorganization, no cash or other dividends will be paid to holders of the WorldCom group common stock or MCI group common stock and such stock will be canceled. We have not yet determined our dividend policy with respect to the shares of new MCI common stock to be issued upon consummation of our Plan of Reorganization.

Securities Authorized For Issuance Under Equity Compensation Plans

Effective with our emergence from bankruptcy, all equity options and compensation plans will be cancelled and rendered null and void. The Plan includes the creation of a management restricted stock plan and an employee stock purchase plan. These equity plans were not effective as of December 31, 2002 or as of the date of this filing.

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ITEM 6. SELECTED FINANCIAL DATA

We derived the selected historical consolidated financial data presented below as of and for each of the three years in the period ended December 31, 2002 from our audited consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K except for (i) Other Data: “Number of Employees”, (ii) the summarized balance sheet data as of December 31, 2000 and 1999 and (iii) the unaudited pro forma balance sheet as of December 31, 2002 as further described below. You should refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Annual Report on Form 10-K and the notes to our consolidated financial statements for additional information regarding the financial data presented below, including matters that might cause this data not to be indicative of our future financial condition or results of operations. In addition, readers should note the following information regarding the selected historical consolidated financial data presented below.

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We will adopt fresh-start reporting under the provisions of SOP 90-7 as of the fresh-start reporting date. Under SOP 90-7, our reorganization value will be allocated to our assets and liabilities (excluding debt). Our assets will be stated at fair value in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141 “Business Combinations,” and liabilities will be recorded at the present value of amounts estimated to be paid. In addition, our accumulated deficit will be eliminated, and our new debt and equity will be recorded in accordance with distributions pursuant to the Plan. We anticipate that the adoption of fresh-start reporting will have a material effect on our consolidated financial statements. As a result, our consolidated financial statements published for periods following the application of fresh-start reporting will not be comparable with those previously published. As such, the historical results presented below may not be indicative of future results.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information in this Management’s Discussion and Analysis and elsewhere in this document contains certain forward-looking statements, which reflect our current view with respect to future events and financial performance. Wherever used, the words “believes,” “estimates,” “expects,” “plans,” “anticipates” and similar expressions identify forward-looking statements. Any such forward-looking statements are subject to risks and uncertainties that could cause our actual results of operations to differ materially from historical results or current expectations. See “Cautionary Statement Regarding Forward-Looking Statements” on page 1 and “Item 1—Business—Risk Factors.”

Business Overview

We are one of the world’s leading global communication companies, providing a broad range of communication services in over 200 countries on six continents. Each day, we serve thousands of businesses and government entities throughout the world and provide voice and Internet communication services for millions of consumer customers. We operate one of the most extensive communications networks in the world, comprising approximately 98,000 route miles of network connections linking metropolitan centers and various regions across North America, Europe, Asia, Latin America, the Middle East, Africa and Australia. We own one of the most extensive IP backbones, and we are one of the largest carriers of international voice traffic.

Since April 2003, we have conducted our business primarily using the brand name “MCI.” We operate primarily through three business units, each of which focuses on the communication needs of customers in specific market segments:

We also own approximately a 19% economic interest and a 52% voting interest in Embratel, which is a Brazilian voice and data communications company that is operated by its own management and employees. Because we own a controlling interest in Embratel, we consolidate Embratel in our consolidated financial statements and it is a separate business segment in our segment results (see Note 23 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K). On November 12, 2003, we announced our intention to sell our interest in Embratel.

Since our inception, we have grown significantly as a result of numerous acquisitions. On September 14, 1998, we acquired MCI Communications Corporation, one of the world’s largest providers of telecommunications services. On October 1, 1999, we acquired SkyTel, a leading provider of messaging services in the United States. On July 1, 2001, we acquired Intermedia, a provider of voice and data services, and, as a result, a controlling interest in Digex, a provider of managed web and application hosting services. On November 17, 2003, we announced that we acquired the remaining shares of Digex’s common stock and, as a result, Digex became a wholly-owned subsidiary.

Voluntary Reorganization under Chapter 11

On July 21, 2002, WorldCom, Inc. and substantially all of its direct and indirect domestic subsidiaries filed voluntary petitions for relief in Bankruptcy Court under Chapter 11. On November 8, 2002, we filed bankruptcy petitions for an additional 43 of our domestic subsidiaries, most of which were effectively inactive and none of which had significant debt. The Debtors continue to operate their businesses and manage their properties as debtors-in-possession. The Bankruptcy Court consolidated the Debtors’ Chapter 11 cases for procedural purposes and these are now being jointly administered. As a consequence of the bankruptcy filing, most litigation against the Debtors has been stayed.

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Our Plan was confirmed by the Bankruptcy Court on October 31, 2003. A summary of the significant provisions of the Plan is set forth below:

The following summarizes the Plan’s classification and treatment of claims and equity interests, and is qualified in its entirety by reference to the full text of the Plan filed as Exhibit 2.1 to the Current Report on Form 8-K filed on November 18, 2003.

Restatements and Reclassifications of Previously Issued Consolidated Financial Statements

In June 2002, we announced that, as a result of an internal audit of our capital expenditure accounting, it was determined that certain transfers from line cost expenses (also referred to as access cost expenses) to capital accounts during 2001 and the first quarter of 2002 were not made in accordance with GAAP. We promptly notified Andersen, which had been our external auditor until May 2002, had audited our consolidated financial

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statements for 2001 and 2000, and had reviewed our interim condensed financial statements for the first quarter of 2002. On June 24, 2002, Andersen advised us that in light of the inappropriate capitalization of access costs, Andersen’s audit report on the consolidated financial statements for 2001 and its review of our interim condensed consolidated financial statements for the first quarter of 2002 could not be relied upon. We also promptly notified KPMG, which had been retained in May 2002 as our external auditor, and engaged them to audit the consolidated financial statements for the years ended December 31, 2001 and 2000.

Our previous financial management employees, including the previous chief financial officer and corporate controller, as well as many of other financial and accounting personnel, were terminated in connection with the discovery and announcement of accounting irregularities discussed above. Virtually all of our present senior management, including our chief executive officer, our chief financial officer and our corporate controller, were not employed by us during the period from January 1, 2000 through the date of our bankruptcy filing and most of the senior accounting personnel that prepared our restated consolidated financial statements were not employed by us in their current capacity during such period. During the restatement process, we identified a substantial number of material weaknesses in our internal controls, including poor accounting records. Due to the lack of systematic and reliable internal controls and the lack of access to our prior management and senior personnel, the restatement process required an extensive effort by hundreds of financial and accounting professionals, including external consultants, to locate, verify and/or reconstruct supporting records for financial statement accounts.

We have restated our previously reported consolidated financial statements for the fiscal years ended December 31, 2001 and 2000. The restatement adjustments (including impairment charges) resulted in a cumulative net reduction to shareholders’ equity of $70.8 billion and $53.6 billion as of December 31, 2001 and 2000, respectively and a reduction in previously reported net income of $17.1 billion and $53.1 billion for the years ended December 31, 2001 and 2000, respectively. We have also restated the January 1, 2000 opening retained earnings balance to reflect corrected items that relate to prior periods. Except as otherwise specified, all information presented in the consolidated financial statements and the related notes include all such restatements.

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Summary of restatement items

The following table sets forth the effects of the restatement adjustments on (i) revenue and (ii) pre-tax income/(loss) (income from continuing operations before income taxes, and the cumulative effect of change in accounting principle) in the consolidated statements of operations for the years ended December 31, 2001 and 2000. Due to the substantial number of restatement adjustments, each of the restatement categories listed in the table reflects a number of related adjustments that have been aggregated for disclosure purposes. The principal adjustments in each category are described in the paragraphs following the table below.

Additionally, the impact of the restatement adjustments on the consolidated balance sheets and the consolidated statements of shareholders’ equity for the years ended December 31, 2001 and 2000 are shown following the discussion of the categories listed below (in millions):

We implemented Staff Accounting Bulletin 101, “Revenue Recognition in Financial Statements” (“SAB 101”) effective January 1, 2000. Upon adoption of SAB 101, we reported an $85 million deferral of revenue as a cumulative effect of a change in accounting principle in our consolidated statements of operations. Adjustments to that amount of $12 million were made as a part of the restatement process to arrive at a net cumulative effect of a change in accounting principle for the year ended December 31, 2000 of $97 million.

We implemented SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“SFAS No. 133”), effective January 1, 2001. Upon adoption of SFAS No. 133, we did not record a cumulative effect of a change in accounting principle in our consolidated statements of operations. As part of the restatement process, we recorded $1 million of income as a cumulative effect of a change in accounting principle in our consolidated statements of operations in 2001.

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Provision for income taxes was adjusted as a result of corrections to previously recorded tax amounts and the restatement adjustments made. The result was a decrease to income tax expense of $425 million and $4.9 billion for the years ended December 31, 2001 and 2000, respectively.

Restatement adjustments to pre-tax income combined with taxes, discontinued operations, minority interest and the cumulative effects of changes in accounting principle, totaled $17.1 billion and $53.1 billion for the years ended December 31, 2001 and 2000, respectively.

Impairment

As part of the restatement process, we identified conditions at various dates which indicated that the carrying values of goodwill and long-lived assets were impaired. For the periods under review, we found no evidence that SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Assets To Be Disposed Of” impairment analyses had been previously performed even though trigger events were apparent. As a result, we performed those impairment analyses for the periods being restated and recorded impairment adjustments as applicable. See Note 5 to our consolidated financial statements for a complete discussion and analysis of our asset impairments.

Improper reduction of access costs

The primary adjustments pertaining to the improper reduction of access costs related to inappropriate amounts capitalized as additions to property, plant and equipment during the period from the first quarter of 2001 through the first quarter of 2002. Both our accounting policy and GAAP require that access cost expenses be expensed as incurred. Improper capitalization of access costs represented a decrease in access cost expenses of $2.8 billion for the year ended December 31, 2001. Those amounts were removed from property, plant and equipment during the restatement process and recorded as access cost expense.

In addition, access cost expenses were decreased through the inappropriate reduction of accrual balances on the balance sheet. These adjustments reduced the accrual balances to levels below those indicated by our estimation policies and historical experience. Additionally, other balance sheet accruals, unrelated to access cost expenses, were reduced to offset access cost expenses. Improper reduction of accrual balances resulting in the reduction of access costs represented a decrease in access cost expenses of $144 million and $1.8 billion for the years ended December 31, 2001 and 2000, respectively.

We also discovered that certain costs recorded in other line items in the consolidated statement of operations should have been reflected as access costs. These errors were corrected and the amounts were reclassified during the restatement process.

Purchase accounting

Between 1993 and 2001, we acquired numerous telecommunication service providers offering complementary or similar services to those we provided. As part of the restatement process, all significant acquisition transactions, including the MCI Communications and Intermedia (see Note 9 to our consolidated financial statements) acquisitions, were reviewed and the fair value allocations and purchase price calculations were re-performed. As a result of this process, errors were found in the application of purchase accounting in connection with many of the acquisitions accounted for as purchases. Adjustments with a significant impact to the 2001 and 2000 operating results are described in the following paragraphs. See Note 5 to our consolidated financial statements for a discussion of impairment procedures that were performed subsequent to the completion of the purchase accounting restatements that impacted the carrying value of goodwill, intangible assets and tangible assets.

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Goodwill and intangible assets

Goodwill. Restatement adjustments to the amount allocated to goodwill were required as a result of the various purchase accounting allocation adjustments. In addition, we determined that we had incorrectly calculated the amount of consideration paid in certain acquisitions due to inappropriate measurement dates for valuing the equity instruments issued and errors in valuing stock options and other equity related securities.

In many cases, a 40-year life was previously assigned to the goodwill that resulted from the above described acquisitions. We adjusted the estimated life that was originally assigned to goodwill in each transaction, based on the applicable accounting guidance, to more accurately reflect the useful life of the goodwill for each acquisition. Lives were adjusted from approximately 40 years down to an average of approximately 15 years.

The adjustments in goodwill amounts and changes in goodwill life impacted the amount of amortization expense for the restated periods.

Intangible assets. Original calculations for the fair value of intangible assets had been improperly performed and required the valuation of the intangible assets to be re-performed. As a result, we recorded adjustments to the fair value assigned to intangible assets acquired in the various purchase transactions, such as customer lists, developed technology, trade names and assembled workforces based on the new valuations. We also adjusted the useful lives that were originally assigned to these assets to reflect the expected period of benefit that was determined as a part of the new fair value calculations. These changes resulted in adjustments to amortization expense associated with these assets.

Additionally, amounts allocated to in-process research and development (“IPR&D”) acquired as part of the purchases of MCI Communications, ANS/Compuserve and MFS Communications were reversed due to improper inclusion of research and development projects that failed to qualify under GAAP and incomplete information from which to measure the applicable amounts. The result was the reversal of expenses recorded to write off such IPR&D in the acquisition periods. The reduction in the allocations of the IPR&D assets resulted in an increase in goodwill. Although the effect of the expense reversal did not impact pre-tax income for the periods being presented since the related acquisitions occurred prior to 2000, the increase to goodwill resulted in increased amortization expense for the years ended December 31, 2001 and 2000.

Tangible assets

Restatement adjustments were recorded to properly reflect the fair value assigned to property, plant and equipment which resulted from the re-performance of valuation work during the restatement process. New fair valuation calculations were performed and fair value adjustments were made to tangible assets as a part of the purchase accounting review and were primarily focused on the MCI Communications Corporation acquisition as the value of tangible assets for the other transactions was deemed to be reasonable based on work previously performed by us. As a result of the fair value adjustments made, tangible asset amounts for the assets acquired as a part of the purchase of MCI Communications were increased and this resulted in an increase to depreciation expense partially offset by decreased amortization associated with the decrease in goodwill.

Liabilities

We determined that we had inappropriately applied the accounting guidance for the establishment of liabilities in connection with purchase transactions (unfavorable contract liabilities (such as leases, service and supply contracts), synergy accruals, exit and restructuring costs liabilities and pre-acquisition contingencies). The misapplication of the purchase accounting guidance resulted in the improper establishment of liabilities. Adjustments were required to reverse the improperly established liabilities and the impact of those items on goodwill and operating expenses during the post-acquisition periods.

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The primary impact on pre-tax income from purchase accounting adjustments resulted from an increase to depreciation and amortization expense of $1.5 billion and $3.0 billion for the years ended December 31, 2001 and 2000, respectively. The remaining impact was largely due to the reversal of improperly established and utilized liabilities.

Long-lived asset adjustments

We identified a variety of previous errors with respect to the accounting and asset balances for long-lived assets. The resulting primary adjustments include:

Impairment related adjustments

As part of the impairment review, we performed the analyses mentioned above. As a result of those analyses, assets that had been previously depreciated or amortized during the normal course of business were determined to be impaired and this resulted in decreases in asset values to reflect their new carrying values. Consequently, depreciation and amortization was reduced in order to eliminate the portion of the expense that was no longer appropriate due to the impairment adjustment.

Reductions in depreciation and amortization expense resulting from the impairment adjustments increased pre-tax income $4.5 billion for the year ended December 31, 2001 and had no impact on the year ended December 31, 2000.

Changes in useful lives

In conjunction with the restatement process, errors were identified relating to assets that were previously depreciated over inappropriate or inconsistent lives. As a result, we reviewed our procedures and documentation for depreciable assets and made adjustments where improper lives had been used.

In particular, we reviewed the procedures and documentation related to the establishment of the useful lives of assets acquired in connection with the acquisition of MCI Communications Corporation in September 1998, through a reassessment of the facts and circumstances which existed at the date of the acquisition and were used to determine the lives of the assets. The primary results of this analysis were that the depreciable life that had been previously used for ocean cable (40 years) should instead have been limited to the specific contract life, which averaged approximately 11 years, and that the depreciable life for fiber cable was reduced from 40 to 25 years, which more appropriately reflected its expected useful life. In addition, there were other depreciable life changes, principally the reduction of fiber optic electronics from 15 to eight years.

Adjustments due to changes in useful lives decreased pre-tax income by $1.0 billion and $672 million for the years ended December 31, 2001 and 2000, respectively.

Other long-lived asset adjustments

The previously issued 2001 and 2000 consolidated financial statements included certain capitalized assets, primarily property, plant and equipment that had been inappropriately capitalized, or were no longer in service and were not written off when they were taken out of service. Additionally, adjustments were made to amounts recorded for certain long-lived assets resulting from the improper recording of the acquisition or disposition of the asset.

Adjustments due to other long-lived asset adjustments reduced pre-tax income by $688 million and $1.0 billion for the years ended December 31, 2001 and 2000, respectively.

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International

International adjustments consist primarily of the following:

Audit adjustments for international subsidiaries

Prior to the restatement process, separate legal entity audits for some international subsidiaries were not performed. As part of the restatement process, the audits, primarily due to statutory filing obligations, were completed and audit adjustments applicable under U.S. GAAP were made to the December 31, 2001 and 2000 consolidated financial statements. Adjustments made as a part of the international subsidiary audits described above included adjustments for intercompany interest and transfer pricing, capitalized labor, bad debt expense and accounts receivable and other intercompany reconciliation items.

Functional currency designation

In our previously filed financial statements, all significant international subsidiaries used their local currency as their functional currency. As a result of the evaluation of factors as prescribed by SFAS No. 52 “Foreign Currency Translation,” it was determined that all significant international subsidiaries other than Embratel should have utilized the U.S. dollar as their functional currency. Pursuant to our analysis and as a part of the restatement process, each significant international subsidiary, other than Embratel, changed its functional currency designation to the U.S. dollar.

Revenue related adjustments

Revenue related adjustments consist primarily of the following:

Deferral of customer activation, installation and provisioning revenue and cost.

In 2000, we adopted the provisions of SAB 101 and began amortizing customer activation, installation and provisioning revenue over the average customer contract life. It was determined as a part of the restatement process that, although a policy for the deferral of revenue had been established consistent with SAB 101, we did not properly apply our policy and sufficient records to support the revenue deferred were not available. As a result, we restated our deferred revenue balances consistent with the provisions of SAB 101 based on the available support.

Prior to January 1, 2000, our policy was to capitalize and defer customer activation, installation and provisioning costs over a five-year period. In 2000, in conjunction with the adoption of the provisions of SAB 101, we began amortizing these costs consistent with the customer contract life. It was determined as a part of the restatement process that, although our policy had been to defer such costs, we did not properly apply this policy as the requisite criteria for deferral were not met and sufficient records to support the amounts deferred were not maintained. As a result, we eliminated the deferred cost balances and restated our consolidated statements of operations to recognize such costs in the period incurred.

Accounts receivable adjustments

We determined that allowances for doubtful accounts reserves had not been established in accordance with GAAP, allowance methodologies were not applied consistently and revenue adjustments were needed to correct the balances in accounts receivable.

As a result, we reduced revenue and increased our previously reported allowance for doubtful accounts as of and for the years ended December 31, 2001 and 2000. The adjustments to the allowance for doubtful accounts increased selling, general and administrative expenses in the consolidated statements of operations.

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Revenue recognition adjustments

Also as part of the restatement process, we identified errors in the recognition and presentation of revenue and the recording of the associated costs of services and products. For example, we determined that we acted as an agent rather than a principal for certain products and hence the criteria for revenue recognition were not met. As a result, restatement entries were made to reverse the recording of revenue and cost of service expenses as though a sale had occurred and to reflect only the net of such amounts as income from acting as an agent on these transactions.

Adjustments to accrued liabilities

Prior to the restatement process, we improperly established accruals for various purposes, including legal reserves, telecommunications reserves, employee benefits and other tax liabilities. As part of the restatement process, all liabilities, including accruals, were reviewed for validity and adequacy given the supporting documentation. Adjustments were made to increase or decrease these liabilities based on the adequacy of the supporting documentation for the liability being reviewed. Those adjustments resulted in corresponding adjustments to the appropriate expense category in the consolidated statement of operations in the appropriate period.

Embratel and Avantel

Embratel and Avantel restatement adjustments presented in the consolidated statement of operations primarily resulted from the consolidation of Embratel and the deconsolidation of Avantel, as described below. In addition, the adjustments also include the corrections of errors made during the deconsolidation of Embratel in the originally reported financial statements, when many Embratel-related items remained on the balance sheet in error.

Embratel consolidation

In 1998, we acquired approximately a 52% voting interest and a 19% economic interest in Embratel as a part of the acquisition of MCI. In accordance with GAAP, a greater than 50% interest in the voting rights of an investee generally gives an investor control over the investee and its results should be consolidated with those of the investor. From the date of the MCI acquisition until the second quarter of 2001, we consolidated the results of Embratel. During the second quarter of 2001, we restructured our investment in Embratel and incorrectly determined that, as a result of this restructuring, control could no longer be exercised over Embratel. As part of the restatement process, we determined that we continued to retain control of Embratel through our power to hire and terminate management and through our control over Embratel’s Board of Directors. Therefore, Embratel’s results have been consolidated for all periods presented.

Avantel deconsolidation

In 1998, we acquired a 44.5% voting interest in Avantel as a part of the acquisition of MCI. The remaining equity interest was owned by a third party, which had a controlling interest in Avantel. As a result of this ownership structure, we accounted for our investment in Avantel under the equity method. In 2000, we entered into a memorandum of understanding (“MOU”) related to our investment in Avantel. The purpose of the MOU was to change the corporate structure and to alter the voting control of Avantel. The MOU also stated that a new joint venture agreement would be executed as soon as possible to reflect these changes. In March 2000, we inappropriately changed our accounting to consolidate the financial results of Avantel, even though a new joint venture agreement was never executed and the changes to the corporate structure and voting controls were not made. Therefore, we have deconsolidated Avantel and have reflected Avantel’s results as a part of the restatement process.

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Unclassified income/(expense)

During the restatement process, we determined that certain accrued liability accounts were incorrectly transferred to various line items in the consolidated statements of operations without any justification or supporting documentation. We have been able to determine the periods, amounts, and line items that were improperly reflected in our previously filed consolidated statements of operations and have reversed those amounts in our consolidated financial statements. However, due to of a lack of adequate documentation, we have been unable to determine the appropriate statement of operations line item where an offsetting entry should have been applied. We have determined that such correcting entries should be aggregated and reflected as “Unclassified income/(expense)” in the applicable period.

In addition to the activities in the accrual accounts, our investigation identified other assets and liabilities that were recorded on our historical balance sheet, but for which there is inadequate support to establish the existence of such assets or liabilities. With respect to these amounts, we concluded that they do not represent assets or liabilities and have instead charged them to our consolidated statements of operations. Because there is no documentary support related to these amounts, we are unable to determine the appropriate statement of operations line item to which such amounts applied. As a result, these amounts have been included in “Unclassified income/(expense)” in the applicable period.

Other

Other adjustments consist primarily of reclassifications between accounts, adjustments made for derivatives, intercompany imbalances and improperly capitalized interest, labor and overhead associated with capital projects.

Balance Sheet Impact

In addition to the effects on our 2001 and 2000 consolidated statements of operations discussed above, the restatement impacted our consolidated balance sheets as of December 31, 2001 and 2000 and the opening retained earnings as of January 1, 2000. The following tables set forth the effects of the restatement adjustments on our 2001 and 2000 consolidated balance sheets (in millions):