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Cablevision Systems Corp. cleaned house at its AMC programming unit last week, firing top executive Kate McEnroe along with 13 other employees amidst an accounting scandal that left many industry observers scratching their heads.

In a statement issued last Wednesday after the stock markets closed, Cablevision said an internal and external audit of its Rainbow Media Group programming arm discovered that about $6.2 million in AMC's marketing expenses for 2003 were improperly accrued in 2002.

Cablevision said improper accruals for 2000 and 2001 were expected to be about the same size.

The Bethpage, N.Y.-based MSO said its investigation included reviews of financial and accounting records, and that more than 150 external vendors were contacted.

No revenue impact

It also said "certain employees" at Rainbow's national services division had "fabricated invoices," and that their actions had the effect of inappropriately accelerating expenses that should properly have been accrued in the following year.

Cablevision said the auditors found no indication of improper revenue recognition.

A five-month review of finances from 1999 through 2002 identified $6.2 million of expenses for 2003 that were accelerated and improperly accrued in 2002.

All but $1.7 million of that amount was identified and reversed before the company's 2002 results were released, Cablevision said.

Cablevision doesn't expect to restate previously issued financial statements, it said, adding that auditors KPMG LLC agreed with that assessment.

The company hired a well-known independent auditor, William McLucas, the former director of the Securities and Exchange Commission's enforcement division, to investigate further, with the help of hired forensic accountants.

In a statement, CEO James Dolan said Cablevision "cannot tolerate any improprieties related to financial matters. As soon as our internal accountants identified this problem, the company launched an extensive review and has taken measures to help ensure that a problem of this type does not occur again."

Many fired

In response, Cablevision fired 14 people at AMC, or roughly 10% of the unit's work force, including several of its most-senior executives.

According to several sources, the AMC Networks employees let go apart from McEnroe included Noreen O'Loughlin, AMC's executive vice president and general manager, and Martin von Ruden, executive vice president and general manager of WE: Women's Entertainment.

Rorie Papscoe, AMC Networks vice president of finance and operations, also was among those fired, according to sources.

Others fired, several sources said, were: Isabel Miller, AMC's senior vice president of marketing; Ben Lines, AMC Networks assistant director of marketing; Lee Heffernan, WE's senior vice president of marketing; Bonnie Boyle, AMC Networks's director of affiliate marketing; and Melani Griffith, senior vice president of affiliate sales and marketing, AMC and WE.

McEnroe, O'Loughlin, von Ruden, Miller, Papscoe, Lines, Heffernan, Boyle and Griffith could not be reached for comment.

Cablevision last week continued to decline to comment on whom was let go, apart from McEnroe. Reportedly, none of the 14 let go had contracts and none were paid severance.

Several of them apparently were informed by phone that they had been terminated last Wednesday.

Audit caught it

According to sources in the financial community, Cablevision uncovered the accounting irregularities as part of a wider audit of the company finances initiated shortly after Adelphia Communications Corp. encountered its own accounting difficulties.

While no one is comparing Cablevision's current situation to Adelphia's — a widespread fraud that led to the federal indictments of several corporate officers — it was serious enough to prompt a closer look.

"The audit went a lot further," said one source in the financial community. "It included Rainbow and it extended into other areas of the company — the other programming entities and, to some extent, the cable operations. But this [the AMC irregularities] is all that they found."

While other sources in the industry expressed surprise that McEnroe, a highly respected cable executive, would be involved in such a scandal, the source said that the former AMC president was a willing participant.

"The way it's been explained to me is that she [McEnroe] knew all about it and it was done at her direction," the source added.

To hit targets

The source also stressed that the problems at AMC did not benefit Cablevision or Rainbow itself. But it did provide a benefit for some employees at the AMC division in that it made it easier to hit internal financial targets.

"They did it for a reason," the source in the financial community said. "A big part of it was, there was pressure to make their numbers."

One MSO source who asked not to be named said the number of firings at the unit could indicate that more bad news is to come.

"If it is what they [Cablevision] reported, I can't imagine this kind of bloodbath over something like that," said one MSO executive who asked not to be named. "It would have to be something bigger."

One network executive also expressed surprise at the method of the deception.

"Usually revenues are the thing that gets manipulated, not expenses. That's what people are finding very odd," one network chief said.

For comparisons

Paul R. Brown, immediate past chair of the accounting department at New York University's Stern School of Business, said that pushing back expense accruals makes the prior year look worse from a financial standpoint, but makes the current year's financials look better.

"The real advantage," Brown said, "is that you set yourself up for having an easier set of quarters going forward. The overarching problem here is that expenses are not supposed to be smoothed, they're supposed to be reported in the quarter of the year that they relate to. As soon as you start pushing numbers from one quarter to the next, you're violating reporting [standards]."

Brown also expected the SEC would conduct its own investigation of the matter and likely expand that probe to all of Cablevision.

"The issue you have to concern yourself with is whether there is the possibility that there are actions that go beyond just this unit that have been condoned or implicitly accepted as part of the culture of the whole corporation," Brown said. "There are clearly other situations where disclosures start in one unit, and you find out later that it was systemic."

Brown commended Cablevision for getting out in front of the matter and disclosing it publicly, but added that won't preclude at least an informal SEC investigation.

Moody's Investors Service analyst Russell Solomon agreed, adding that Moody's hasn't changed its ratings on Cablevision, but is waiting for more information to come out of the company.

Eye on covenants

"It is sort of indicative of some of the things that trouble us about the company," Solomon said. "Like many media companies out there, corporate governance is not the best.

"We have become accustomed to having to build some cushion in our ratings, for reasons such as this and generally because of the aggressive way the company is run. Even though this is a surprise, it was able to be withstood in the current ratings."

Solomon said that one remaining question is whether Cablevision has violated any covenants on a $350 million credit facility it obtained in March for Rainbow and AMC. The two-part package deal involved a $280 million loan to Rainbow and a $70 million loan to AMC.

Solomon said Cablevision executives told him the company was not in violation of the loan agreement. But he said that was still unclear to him.

He said Cablevision apparently never told the banks that there might be accounting problems at AMC at the time they received the loan, even though it was in the midst of an investigation of the unit.

Small figures

Cable analysts for the most part shrugged off the accounting snafu mainly because of its small size — $1.7 million accounts for less than 1% of AMC's estimated $200 million in cash flow.

Fulcrum Global Partners cable analyst Richard Greenfield said the size of the accounting irregularities were not a concern and would have no impact on his estimates for the MSO.

Stifel Nicolaus & Co. cable analyst Ted Henderson said that he believed the AMC problem was immaterial, but also wondered aloud about the magnitude of the AMC firings.

"My sense is that internal audit discovered something, that should give you comfort that internal audit is on it," Henderson said. "But the mass firings don't seem to jibe with the immateriality."

Although sources familiar with Cablevision said that Rainbow Media Holdings president and CEO Josh Sapan would will take over McEnroe's duties in the interim, Henderson said the question remains who will fill in the remaining 13 positions.

That question, he said, may accelerate an outright sale of AMC.

"Now that they've fired all of these people, is this a precursor of a sale?" Henderson asked, adding that although Cablevision was expected to join former Vivendi Universal S.A. vice chairman Edgar Bronfman Jr.'s bid for the latter's U.S. entertainment assets — contributing AMC, the Independent Film Channel and WE: Women's Entertainment — that may not seem as likely now.

"In my opinion, Vivendi is a longer process than a straight sale [of AMC] to MGM or Liberty or Viacom or NBC," Henderson said. "A straight sale could happen quicker."

Henderson added that by selling AMC to an existing network, the buyer could easily fill those operational spots with its own people.